Cambridge VCE Accounting Units 3 & 4 [3 ed.] 9781107640702, 1107640709

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UNIT

3

RECORDING AND REPORTING FOR A TRADING BUSINESS

In Unit 3 of the VCE Accounting course, we will cover the following chapters: 3

CHAPTER 1

THE ROLE OF ACCOUNTING

CHAPTER 2

THE ACCOUNTING EQUATION

CHAPTER 3

THE GENERAL LEDGER

CHAPTER 4

THE GOODS AND SERVICES TAX (GST)

CHAPTER 5

SPECIAL JOURNALS 1: CREDIT JOURNALS

CHAPTER 6

SPECIAL JOURNALS 2: CASH JOURNALS

CHAPTER 7

THE GENERAL JOURNAL

CHAPTER 8

ACCOUNTING FOR STOCK

CHAPTER 9

DETERMINING PROFIT OR LOSS

CHAPTER 10

BALANCE DAY ADJUSTMENTS: EXPENSES

217

CHAPTER 11

DEPRECIATION OF NON-CURRENT ASSETS

239

CHAPTER 12

THE CASH FLOW STATEMENT

21

35 59 85 107

143 163 195

263

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Cambridge University Press

© Anthony SImmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

Where are we headed? After completing this chapter, you should be able to: s EXPLAIN the role of accounting s IDENTIFY the users of accounting information and THEFINANCIALINFORMATIONTHEY MAYREQUIRE s DISTINGUISH between financial data and financial information s IDENTIFY and EXPLAIN the stages in the accounting process

s DEFINE and APPLY the accounting principles and QUALITATIVECHARACTERISTICS s EXPLAIN the relationships between the accounting PRINCIPLESANDQUALITATIVE characteristics s IDENTIFY and DEFINE the elements of financial statements.

CHAPTER 1

THE ROLE OF ACCOUNTING KEY TERMS After completing this chapter, you should be familiar with the following terms: s elements of s accounting principles s financial data financial statements n ENTITY s financial information s transaction

– Going Concern

– assets

s source documents

– Reporting Period

– liabilities

s recording

– Historical Cost

n OWNERSEQUITY

s reporting

– Conservatism

– revenue

s advice

n #ONSISTENCY

– expense

s agreed value

n -ONETARY5NIT

s MATERIALITY

s QUALITATIVECHARACTERISTICS – Relevance n 2ELIABILITY n #OMPARABILITY n 5NDERSTANDABILITY

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4

CAMBRIDGE VCE ACCOUNTING

1.1

UNITS 3&4

THE PURPOSE OF ACCOUNTING

5NFORTUNATELY FOR BUSINESS OWNERS HAVING A GREAT BUSINESS IDEA IS NOT ENOUGH TO GUARANTEESUCCESS9OUDONTHAVETOLOOKVERYFARTOlNDSTORIESOFBUSINESSOWNERS WHOSTARTEDOUTWITHWHATTHEYTHOUGHTWASAFANTASTICPRODUCTORSERVICE BUTENDED UPGOINGBUST!SIDEFROMTHEQUALITYOFWHATBUSINESSOWNERSARESELLING THEREAREA VARIETYOFOTHERFACTORSTHATWILLINmUENCETHEIRCHANCEOFSUCCESS INCLUDING s CONSUMERTASTESANDDEMAND s THELEVELOFCOMPETITION s THEQUALITYOFTHEIRSTAFFEMPLOYEES s THEECONOMICCLIMATE s THEMANAGEMENTSKILLSOFTHEOWNERS 4HISLASTPOINTISPARTICULARLYIMPORTANTBECAUSEINMOSTSMALLBUSINESSESOWNERSHAVEA HANDS ONMANAGERIALROLE ANDTHEIRMANAGEMENTSKILLSCANHAVEADIRECTANDSIGNIlCANT EFFECTONWHATHAPPENSTOTHATBUSINESS7HETHERTHEYAREDETERMININGSELLINGPRICES DECIDING ON ADVERTISING CAMPAIGNS EMPLOYING STAFF OR UNDERTAKING MORE MUNDANE TASKS SUCHASPAYINGBILLS THEOWNERMUSTMAKEIMPORTANTDECISIONSONADAILYBASIS #ERTAINLY SMALLBUSINESSOWNERSMUSTHAVEDETAILEDKNOWLEDGEOFWHATEVERITISTHEY ARETRYINGTOSELL BUTTHEYMUSTALSOHAVEDETAILEDINFORMATIONONAWHOLERANGEOFOTHER ISSUESTHATMAYAFFECTTHEIRCHANCESOFSUCCESS4HISISWHEREACCOUNTINGCOMESINTOTHE PICTUREITISESSENTIALLYANINFORMATIONSERVICE Accounting is the collection and recording of financial data, and the reporting, analysis and interpretation of financial information. purpose of accounting to provide financial information to assist decision-making

The purpose of accountingISTOPROVIDEBUSINESSOWNERSWITHlNANCIALINFORMATION THATWILLASSISTTHEMINMAKINGDECISIONSABOUTTHEACTIVITIESOFTHEIRlRM4HISDOESNOT mean that accounting will ensure owners make the right decisions, but it should help them to make more informedDECISIONS WHICHWILLHOPEFULLYIMPROVETHEPERFORMANCE OFTHElRMANDITSCHANCESOFSUCCESS

The purpose of accounting is to provide business owners with financial information that will assist them in making decisions about the activities of their firm

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CHAPTER 1

5

THE ROLE OF ACCOUNTING

2%6)%715%34)/.3

1 ,ISTlVEFACTORSTHATCANINmUENCETHELIKELIHOODTHATASMALLBUSINESSWILLBE successful. 2 ,IST three important decisions that a business owner would need to make on ADAILYBASIS 3 $ElNE ‘accounting’. 4 %XPLAIN the purpose of accounting.

1.2

USERS OF ACCOUNTING INFORMATION

4HIS COURSE CONCENTRATES SPECIlCALLY ON ACCOUNTING FOR SOLE TRADERS THAT IS TRADING BUSINESSESTHATAREOWNEDBYONLYONEPERSON WHOISUSUALLYRESPONSIBLEFORRUNNING THE lRM &OR THIS REASON WE WILL CONCENTRATE ON THE INFORMATION THAT THE owner will WANTTOSEE(OWEVER ITISIMPORTANTTONOTETHATANUMBEROFDIFFERENTPARTIESMAYBE INTERESTEDINTHElRMSlNANCIALINFORMATION4HESEPARTIESAREKNOWNASTHE@USERSOF THEACCOUNTINGINFORMATION ANDMAYINCLUDE s debtors and other customers WHOMAYWISHTOKNOWABOUTTHElRMSCONTINUING ABILITYTOPROVIDETHEMWITHSTOCK s creditors and other suppliers WHOMAYWISHTOKNOWABOUTTHElRMSABILITYTO REPAYWHATITOWESTHEM s banks and other financial institutions WHOWILLWANTTOKNOWABOUTTHElRMS CURRENTLEVELSOFDEBTBEFOREPROVIDINGITWITHANYADDITIONALlNANCE s employees WHOMAYWISHTOKNOWABOUTTHElRMSLONG TERMVIABILITYnANDTHEIR LONG TERMEMPLOYMENTPROSPECTSnORITSABILITYTOAFFORDIMPROVEMENTSINWAGES and conditions s prospective owners WHOMAYWISHTOKNOWABOUTTHElRMSlNANCIALSTRUCTURE and earnings performance s the Australian Tax Office (ATO) WHICHWILLREQUIRElNANCIALINFORMATIONFORTAXATION purposes. #ONSIDERING THE VARIETY OF USERS OF ACCOUNTING INFORMATION AND THE DIFFERENT INFORMATIONEACHMAYREQUIRE WHATINFORMATIONSHOULDTHEACCOUNTINGSYSTEMPROVIDE 4HISSEEMINGLYDIFlCULTQUESTIONHASASURPRISINGLYSIMPLYANSWERTHEACCOUNTINGSYSTEM SHOULDPROVIDEWHATEVERINFORMATIONTHEUSERDECIDESISNECESSARY4HISMEANSTHATITIS the usernNOTTHEACCOUNTANTORTHEACCOUNTINGSYSTEMnWHODECIDESWHATISNECESSARY

Financial data versus financial information Given that accounting is concerned with providing information, it is worth noting the DIFFERENCEBETWEENlNANCIALdataANDlNANCIALinformation. Financial data refers to the RAWFACTSANDlGURESONWHICHlNANCIALINFORMATIONWILLBEBASED&ORMOSTBUSINESSES THIS DATA IS CONTAINED IN THEIR RECEIPTS CHEQUE BUTTS INVOICES AND OTHER BUSINESS DOCUMENTS&ORINSTANCE AlLEFULLOFBUSINESSDOCUMENTSMAYPROVIDETHEDETAILSDATA RELATINGTOTHElRMSACTIVITIESOVERTHELASTWEEKORMONTH However, in their original form these documents would be of limited use as the data HASNOTBEENPROCESSEDINANYWAY/NLYWHENTHISINFORMATIONISSORTED CLASSIlEDAND summarised into a more useable and understandable form does it become financial informationTHATCANBEUSEDASTHEBASISFORBUSINESSDECISIONS4HISSORTING CLASSIFYING ANDSUMMARISINGISPERFORMEDBYTHEACCOUNTINGSYSTEM

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financial data raw facts and figures upon which financial information is based

lNANCIALINFORMATION financial data that has been sorted, classified and summarised into a more useable and understandable form

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

2%6)%715%34)/.3

1 ,ISTSIXLIKELYUSERSOFACCOUNTINGINFORMATION 2 %XPLAINWHYBANKSANDOTHERlNANCIALINSTITUTIONSWILLBEINTERESTEDINTHE lNANCIALINFORMATIONOFASMALLBUSINESS 3 %XPLAINTHEDIFFERENCEBETWEEN@lNANCIALDATAAND@lNANCIALINFORMATION

1.3

THE ACCOUNTING PROCESS

If we work backwards, then what the owner is looking for is the information the ACCOUNTINGSYSTEMCANPROVIDE$ATAMUSTBECOLLECTED PROCESSEDINTOAUSEABLEFORM and then communicated so that the business owner has meaningful information on which to base a decision. The accountant should then provide some guidance as to appropriate courses of action. These four ‘phases’ or ‘stages’ are the basis of what is known as the accounting process. Figure 1.1 The accounting process

Sources documents

Records

Reports

Provides advice

Stage 1: collecting source documents TRANSACTION an exchange of goods or services with another party SOURCEDOCUMENTS paper or electronic documents that provide both the evidence that a transaction has occurred and the details of the transaction itself

Collecting source documents is sometimes known as the ‘input stage’, where the business collects the source documents relating to its transactions. A transaction is SIMPLYANEXCHANGEOFGOODSORSERVICESWITHANOTHERPARTY Source documents are the paper or electronic documents that provide both the evidence that a transaction has occurred and the details of the transaction itself. Source documents provide the data on which the accounting information will be based. Common source documents include: s receipts WHICHPROVIDEEVIDENCEOFCASHRECEIVEDBYTHEBUSINESS s cheque butts WHICHPROVIDEEVIDENCEOFCASHPAIDBYTHEBUSINESS s invoices, which provide evidence of credit sales and purchases s memos WHICHPROVIDEEVIDENCEOFTRANSACTIONSWITHINTHElRMITSELF These source documents are covered in more detail in Chapter 4. ! BUSINESS WILL ENTER INTO MANY TRANSACTIONS EVERY DAY AND EVERY ONE OF THESE transactions must be detailed on a source document. As far as the accounting process is concerned, if it isn’t written down, it didn’t happen.

Stage 2: recording recording sorting, classifying and summarising the data contained in the source documents so that it is more useable

/NCETHESOURCEDOCUMENTSHAVEBEENCOLLECTED THEDATATHEYCONTAINMUSTBEWRITTEN down or noted in a more useable form, or ‘recorded’. Recording involves sorting, CLASSIFYINGANDSUMMARISINGTHEDATACONTAINEDINTHESOURCEDOCUMENTSSOTHATITIS more useable. This is sometimes known as the ‘processing’ stage, where data becomes information. Common accounting records include: s journals WHICHRECORDDAILYTRANSACTIONSOFACOMMONTYPESUCHASALLCASHPAIDOR ALLSTOCKPURCHASEDONCREDIT s ledgers WHICHRECORDTHEEFFECTOFEACHTRANSACTIONONTHEITEMSINTHElRMS accounting reports s stock cards, which record all the movements of stock in and out of the business.

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CHAPTER 1

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THE ROLE OF ACCOUNTING

4HESEACCOUNTINGRECORDS ANDHOWTHEYAREUSED WILLBEDISCUSSEDINDETAILTHROUGHOUT this text.

Stage 3: reporting The ‘output’ stage of the accounting process involves taking the information generated BYTHEACCOUNTINGRECORDSINSTAGE ANDREPORTINGTHATlNANCIALINFORMATIONTOTHE owner of the business in an understandable form. Reporting involves the preparation OF lNANCIAL STATEMENTS THAT COMMUNICATE lNANCIAL INFORMATION TO THE OWNER SO THAT decisions can be made. There are three general-purpose reports that all businesses should prepare: s a Cash Flow Statement WHICHREPORTSONTHElRMSCASHINmOWSANDOUTmOWS AND the change in its cash balance over a period s an Income Statement WHICHREPORTSONTHElRMSABILITYTOEARNAPROlTFROMITS trading activities over a period s a Balance Sheet WHICHREPORTSONTHElRMSASSETSANDLIABILITIESATAPARTICULAR point in time.

reporting the preparation of financial statements that communicate financial information to the owner

Stage 4: advice Armed with the information presented in the reports, the owner should be in a much better position to make informed decisions. However, the best course of action is sometimes unclear. Therefore, the accountant should be able to offer advice BYMAKING SOMESUGGESTIONSABOUTANAPPROPRIATECOURSEOFACTIONOR ATTHEVERYLEAST PRESENTING OWNERSWITHARANGEOFOPTIONSFROMWHICHTHEYCANTHENCHOOSE 4HEPROVISIONOFADVICEISTHEACCOUNTANTSKEYFUNCTION BUTTHISADVICERESTSONTHE INFORMATIONGENERATEDBYTHElRSTTHREESTAGESOFTHEACCOUNTINGPROCESS %SSENTIALLY THEACCOUNTINGPROCESSINVOLVESCOLLECTINGDATAFROMSOURCEDOCUMENTS SORTINGIT CLASSIFYINGITANDWRITINGITDOWNCOMMUNICATINGTHElNANCIALINFORMATIONTO the owner; and providing advice about that information. We will refer to this accounting PROCESSTHROUGHOUTTHETEXT SOTHATYOUHAVEACLEARIDEAOFHOWEACHTOPIClTSINTO the overall process.

advice the provision to the owners of a range of options appropriate to their aims/objectives, together with recommendations as to the suitability of those aims/objectives

2%6)%715%34)/.3

1 ,ISTthe four stages in the accounting process. 2 %XPLAINthe role of source documents in the accounting process. 3 3TATETHETYPEOFTRANSACTIONEVIDENCEDBYTHEFOLLOWINGSOURCEDOCUMENTS CUMENTS s receipt s CHEQUEBUTT s invoice s memo. 4 %XPLAINthe difference between the ‘recording’ and ‘reporting’ stages of the accounting process. 5 3TATEthe purpose of the following accounting reports: s Cash Flow Statement s Income Statement s Balance Sheet.

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8

CAMBRIDGE VCE ACCOUNTING

1.4

accounting principles the generally accepted rules that govern the way accounting information is generated

UNITS 3&4

ACCOUNTING PRINCIPLES

"YANDLARGE ACCOUNTANTSAPPROACHTHEIRCRAFTFROMACOMMONPERSPECTIVE&ORINSTANCE MOSTWOULDAGREETHATAMOTORVEHICLEOWNEDBYTHElRMSHOULDBEREGARDEDASANASSET However, from time to time certain issues arise where proper accounting procedure is unclear, and a number of alternative approaches are possible. For instance, if a business PURCHASEDABUILDINGINFOR ANDSPENTONRENOVATIONSIN ATWHATVALUESHOULDITBERECORDEDANDREPORTEDTODAY7HATIFTHEBUILDINGWOULD BEWORTHIFSOLDTODAY7HATIFITSPLUMBINGSYSTEMREQUIRESREPLACEMENT )NSHORT HOWMUCHISTHEBUILDINGWORTH 4HESEAREBUTAFEWOFTHEQUESTIONSTHATANACCOUNTANTMUSTANSWER ANDINMANY CASES EACHOFTHESEQUESTIONSCOULDHAVEMORETHANONEANSWER 4O PROVIDE FOR SOME DEGREE OF CERTAINTY THE ACCOUNTING PROFESSION HAS AGREED to a number of accounting principles THAT GOVERN THE WAY ACCOUNTING INFORMATION IS generated. In this course, we will investigate the following accounting principles: s ENTITY s 'OING#ONCERN s 2EPORTING0ERIOD s (ISTORICAL#OST s #ONSERVATISM s #ONSISTENCY s -ONETARY5NIT

Entity Entity the business is assumed to be separate from the owner and other businesses, and its records should be kept on this basis

The Entity principle states that from an accounting perspective, the business is assumed to be separate from the owner and other businesses, and its records should be kept on THISBASIS4HISMAYSEEMASLIGHTLYBIZARREIDEA ESPECIALLYWHENWECONSIDERTHATTHE OWNEROFASOLEPROPRIETORSHIPISFREQUENTLYTHEPERSONBEHINDTHECOUNTER ORTHEONE ACTUALLYPERFORMINGTHESERVICE(OWEVER IFWEARETOASSESSTHEPERFORMANCEOFTHE business itself WEMUSTINCLUDEONLYINFORMATIONRELEVANTTOTHATBUSINESS4HEOWNER MAYHAVEABEACHHOUSEORAFOUR WHEELDRIVE BUTIFTHISITEMISNOTBEINGUSEDBYTHE business, it must not be included as a business asset. Transactions between the business and the owner )NPRACTICALTERMS THE%NTITYPRINCIPLEMEANSTHATTHEBUSINESSMUSTHAVEASEPARATE BANKACCOUNT ANDTHATITSHOULDONLYBEUSEDFORBUSINESSPURPOSES)FTHEOWNERUSES the business’s funds for personal purposes, this must be recorded in the business’s records as drawings. )NTHESAMEWAY IFTHEOWNERCONTRIBUTESPERSONALASSETSTOTHEBUSINESS THENTHIS SHOULD BE RECORDED AS A CAPITAL CONTRIBUTION FROM ONE ENTITY THAT IS THE OWNER TO ANOTHERENTITYTHATIS THEBUSINESS  )NTHECASEOFACONTRIBUTIONOFNON CASHASSETS SUCHASAVEHICLE THE%NTITYPRINCIPLE WILLHAVEAFURTHEREFFECTINTERMSOFTHEWAYTHEASSETISVALUED#ONSIDERANASSET SUCH ASAVEHICLE PURCHASEDBYTHEOWNERBUTTHENCONTRIBUTEDTOTHEBUSINESS4HISASSET CANNOTBEVALUEDATTHEORIGINALPRICEPAIDBYTHEowner, as it is the cost to the business, ASASEPARATEENTITY THATISIMPORTANT However, although the business and the owner are assumed to be separate ACCOUNTING ENTITIES THERE WOULD BE NO SOURCE DOCUMENT TO VERIFY THE @SALE BY THE OWNER TO THE BUSINESS AS THEY ARE IN FACT ONE AND THE SAME )N THIS CASE THE ASSET

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CHAPTER 1

9

THE ROLE OF ACCOUNTING

If a business owner contributes a personal asset, such as a vehicle, to the business, this should be recorded as a capital contribution from one Entity (the owner) to another Entity (the business)

would be recorded in the books of the business at an agreed value DETERMINEDATTHE TIMETHEASSETISCONTRIBUTEDTOTHEBUSINESS 4HISAGREEDVALUEWOULDTHENBECOMETHE effective Historical Cost as far as the business is concerned.

Going Concern The Going Concern principle assumes that the life of the business is continuous, and its records are kept on that basis. This principle is important because it allows us to record transactions that have an effect on the future. For instance, where a sale is made on CREDITTERMS THECASHWILLNOTHAVEBEENRECEIVEDFROMTHECUSTOMER"YASSUMINGTHAT THEBUSINESSWILLCONTINUETRADINGINDElNITELY THE'OING#ONCERNPRINCIPLEALLOWSUSTO RECORDDEBTORSAMOUNTSOWEDTOTHEBUSINESSBYCREDITCUSTOMERS ASANASSETBECAUSE ATSOMESTAGEINTHEFUTURETHEBUSINESSISLIKELYTORECEIVECASH4HESAMEAPPLIESTO amounts the business owes to its creditors for its credit purchases, or to amounts the BUSINESSHASPAIDINADVANCEFORBENElTSITISYETTORECEIVE 4HEEFFECTOFTHE'OING#ONCERNPRINCIPLEISALSOSIGNIlCANTINDISTINGUISHINGBETWEEN EXPENSESWHOSEBENElTISCONSUMEDENTIRELY ANDASSETSWHOSEBENElTEXTENDSINTO THEFUTURE /NLYBYASSUMINGTHATTHELIFEOFTHEBUSINESSISONGOINGCANWERECOGNISE THEBENElTTHATwill beDERIVEDSOMETIMEINTHEFUTUREFROMTHEASSETSUNDERTHElRMS CONTROL3EE@4HEELEMENTSOFlNANCIALSTATEMENTSFORADISCUSSIONOFTHEDIFFERENCE BETWEENASSETSANDEXPENSES

agreed value the accepted value of a non-cash asset at the time of its contribution by the owner Going Concern the life of the business is assumed to be continuous, and its records are kept on that basis

Reporting Period The Reporting Period principle states that the life of the business must be divided into PERIODS OF TIME TO ALLOW REPORTS TO BE PREPARED 4HIS PRINCIPLE IS INEXTRICABLY LINKED to the idea that the business is a Going Concern. Because the life of the business is ASSUMEDTOBECONTINUOUS ITISNECESSARYTODIVIDETHATLIFEINTOARBITRARYPERIODSSO THATPROlTCANBEDETERMINED7ECANNOTWAITUNTILTHEENDOFTHElRMSLIFETOCALCULATE PROlTBECAUSEWEAREASSUMINGTHATTHEENDWILLNEVERCOME SOWECALCULATEPROlTFOR THEMONTH ORYEAR!2EPORTING0ERIODCANBEASSHORTASTHEOWNERREQUIRES BUTIN MOSTCASES TOMEETTAXATIONREQUIREMENTS ISNOLONGERTHANAYEAR

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Reporting period the life of the business must be divided into periods of time to allow reports to be prepared; these accounting reports should reflect the Reporting Period in which a transaction occurs

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accrual accounting calculating profit by comparing revenues earned against expenses incurred in a particular reporting period Historical Cost the recording of a transaction at its original cost or value, as this value is verifiable by reference to the source document

UNITS 3&4

/NEPOSSIBLECONSEQUENCEOFDIVIDINGTHELIFEOFTHEBUSINESSISTHATATTHEENDOFA 2EPORTING0ERIODTHEBUSINESSMAYSTILLBEWAITINGFORSOMECASHFROMDEBTORS ORMAY NOTYETHAVEPAIDFORSOMEEXPENSES4HESEAMOUNTSARESTILLINCLUDEDINTHECALCULATION OF PROlT AS THE REVENUE WAS earned WHEN THE GOODS WERE SOLD AND THE EXPENSE incurredWHENTHEITEMWASCONSUMED INTHECURRENTREPORTINGPERIOD4HISMETHODOF CALCULATINGPROlTASREVENUESearned less expenses incurred in each Reporting Period is known as accrual accounting.

Historical Cost The Historical Cost principle states that a transaction should be recorded at its original COSTORVALUE ASTHISVALUEISVERIlABLEBYREFERENCETOTHESOURCEDOCUMENT4HISPRINCIPLE APPLIESPARTICULARLYTOASSETS WHICHMUSTBERECORDEDATTHEIRORIGINALPURCHASEPRICE !NYOTHERVALUATION SUCHASRESALEVALUEORREPLACEMENTVALUE ISSUBJECTTOACERTAIN amount of guesswork, and therefore Historical Cost is preferred. For instance, if land ISBOUGHTFOR ANDISLATERESTIMATEDTOBEWORTH ITSHOULDREMAIN INTHEACCOUNTINGRECORDSASASTHEOTHERPRICEISONLYANESTIMATE ANDNOT VERIlABLE4HEREARECERTAINSITUATIONSINWHICHITISACCEPTABLETOUSEAVALUATIONOTHER than Historical Cost, but these situations will be covered in later chapters.

Conservatism Conservatism losses should be recorded when probable but gains should only be recorded when certain, so that liabilities and expenses are not understated and assets and revenues are not overstated

The Conservatism principle states that losses should be recorded when probable but GAINS SHOULD BE RECORDED ONLY WHEN CERTAIN SO THAT LIABILITIES AND EXPENSES ARE NOT understated and assets and revenues are not overstated. This principle advocates a worst-case scenario approach to accounting. Where different valuations are possible, or it is impossible to avoid the use of an estimate, accountants should use whichever data gives the most cautious or ‘conservative’ assessment. This does not mean the records SHOULDDELIBERATELYREPRESENTASITUATIONASWORSETHANITACTUALLYIS BUTITDOESMEAN THEY SHOULD NOT REPRESENT THE SITUATION AS BETTER THAN IT MIGHT TURN OUT TO BE &ROM AN ACCOUNTING POINT OF VIEW IT IS BETTER TO BE CAUTIOUS AND CONSERVATIVE THAN OVERLY OPTIMISTICANDTHENGETARUDESHOCKWHENREALITYDOESNOTMATCHEXPECTATIONS 

Consistency Consistency accounting methods should be applied in a consistent manner to ensure that reports are comparable between periods

The Consistency principles states that accounting methods should be applied in a consistent manner from one period to the next, so that reports can be compared BETWEENPERIODS7ITHOUTCONSISTENTACCOUNTINGMETHODS ITISDIFlCULTTOTELLWHETHER changes in accounting reports are the result of changes in business performance, or SIMPLY CHANGES IN ACCOUNTING PROCEDURES 4HIS MAKES IT DIFlCULT TO COMPARE REPORTS from one period to the next. The amounts in the reports do not need to be the same, BUTTHEWAYTHEYARECALCULATEDDOES

Monetary Unit Monetary Unit all items must be recorded and reported in a common unit of measurement; that is, Australian dollars

The Monetary Unit principle states that all items must be recorded and reported in a common unit of measurement; that is, Australian dollars. This is one of the more obvious principles. It would make little sense to record the purchase of a motor vehicle as ‘1 Holden Commodore’ without attaching a valuation in dollars. To do so would make it impossible to aggregate total assets or make comparisons between periods ORBUSINESSES3IMILARLY RECORDINGLOANSIN!USTRALIANDOLLARSANDSTOCKIN*APANESEYEN would make the information impossible to use.

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CHAPTER 1

THE ROLE OF ACCOUNTING



The Monetary Unit principle states that all items must be recorded and reported in a common unit of measurement; that is, Australian dollars

2%6)%715%34)/.3

1 $ElNE the following accounting principles: s ENTITY s Going Concern s Reporting Period s Historical Cost s Conservatism s #ONSISTENCY s -ONETARY5NIT 2 %XPLAINONEPRACTICALCONSEQUENCEOFADOPTINGTHEENTITYPRINCIPLE 3 3TATETHELENGTHOFA2EPORTING0ERIOD"EWARETHISISATRICKQUESTION
4 %XPLAINWHYTHEIMPLEMENTATIONOFTHE'OING#ONCERNPRINCIPLEREQUIRESTHE adoption of the Reporting Period principle. 5 3TATEHOWPROlTISCALCULATEDUNDERACCRUALACCOUNTING

1.5

QUALITATIVE CHARACTERISTICS

In addition to the accounting principles, which guide the recording process, the profession IS GUIDED BY WHAT IS KNOWN AS The International Framework for the Preparation and Presentation of Financial Reports. The Framework, as it has become known, sets out the BROADCONCEPTSTHATUNDERPINTHEPREPARATIONOFlNANCIALREPORTS4HESECONCEPTSARE known as qualitative characteristics4HE&RAMEWORKALSODElNESTHEITEMSTHATWILLBE reported in each report. The Framework also provides the basis for the development of Accounting Standards, WHICH ARE RULES GOVERNING SPECIlC ACCOUNTING PROCEDURES THAT ALL ACCOUNTANTS ARE COMPELLED TO FOLLOW 4HESE STANDARDS UNDERPIN MANY OF THE TECHNIQUES USED IN THIS TEXT BUTSTUDENTSARENOTREQUIREDTOKNOWTHERELEVANT!CCOUNTING3TANDARD If we follow and implement the accounting principles when we are recording, then OUR ACCOUNTING REPORTS SHOULD POSSESS THE QUALITATIVE CHARACTERISTICS OUTLINED IN THE &RAMEWORK4HEQUALITATIVECHARACTERISTICSAREBASICALLYTHEQUALITIESWEWOULDLIKEOUR ACCOUNTING INFORMATION TO POSSESS 4HE FOUR QUALITATIVE CHARACTERISTICS OF ACCOUNTING reports are: s 2ELEVANCE s 2ELIABILITY s #OMPARABILITY s 5NDERSTANDABILITY © Anthony SImmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and this material must not be transferred to another party.

qualitative characteristics the qualities of the information in accounting reports

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STUDY TIP

Accounting principles APPLYMAINLYTORECORDS WHEREASQUALITATIVE CHARACTERISTICSAPPLYTO reports. Relevance accounting reports should include all information that is useful for decision-making materiality size or significance

UNITS 3&4

Relevance Relevance states that reports should include all information that is useful for decisionmaking, and exclude information that is not. This information should be up-to-date, ANDAPPROPRIATETOTHEDECISIONATHAND4HEQUALITYOF2ELEVANCEGUIDESUSINWHAT TO INCLUDE IN OUR REPORTS AND WILL BE PRESENT IF WE FOLLOW THE %NTITY AND 2EPORTING Period principles. For example, when preparing a Balance Sheet for a business, it is not relevant to include the personal assets of the owner, as these are not being used BYTHEBUSINESSTOEARNREVENUE ANDTHUSARENOTUSEFULFORMAKINGDECISIONSABOUT FUTUREBUSINESSACTIVITIES3IMILARLY THE)NCOME3TATEMENTSHOULDINCLUDEONLYREVENUES ANDEXPENSESFROMTHECURRENT2EPORTING0ERIODnLASTYEARSWAGES ORNEXTYEARSSALES lGURESWILLNOTHELPUSTOASSESSTHISYEARSPROlT4HEKEYISWHETHERTHEINFORMATIONIS useful for decision-making. !LTHOUGH2ELEVANCEISDETERMINEDLARGELYBYWHETHERTHEnature of the item makes it useful for decision-making, the size or materiality of the item can also be important. )TEMSTHATARETOOSMALLORINSIGNIlCANTTOAFFECTDECISION MAKINGMAYBECONSIDEREDTO BEIMMATERIAL MEANINGTHEYCANBEREPORTEDINTHEVALUEOFALARGERITEM ORINSOME cases omitted from the reports. For instance, Relevance allows us to omit from the "ALANCE3HEETSPENTONSTATIONERYASITISSUCHASMALLAMOUNT ANDINSTEADREPORT THISASANEXPENSE)TSINCLUSIONOREXCLUSION FORTHATMATTER INTHE"ALANCE3HEETWILL NOTAFFECTDECISION MAKINGINANYMATERIALWAY

Reliability Reliability accounting reports should contain information that is accurate, and free from bias or error

Reliability states that reports should contain information that is free from bias and ERROR ANDTHUSCANBERELIEDUPONFORITSACCURACY4HEQUALITYOFReliability means that in relation to the amounts we show in reports, we should avoid the use of estimates. 2ELIABILITY WILL BE ASSISTED VIA THE (ISTORICAL #OST PRINCIPLE BECAUSE THE BEST WAY TO ENSURE THAT INFORMATION IS FREE FROM BIAS AND ERROR IS TO MAKE SURE IT IS VERIlABLE BY REFERENCETOASOURCEDOCUMENT2ELIABLEINFORMATIONHASPROOFTOSUPPORTITSACCURACY For example, it should be possible to check the level of credit sales reported in the Income Statement against the invoices that documented the sales. This ensures there is NOROOMFORSUBJECTIVITYORGUESSES

Comparability Comparability accounting reports should be able to be compared over time

Understandability accounting reports should be presented in a manner that makes it easy for them to be understood by the user

Comparability states that reports should be comparable over time, and between different companies, through the use of consistent accounting procedures. One of the most basic uses of accounting reports is to compare performances of businesses and BETWEENPERIODS(OWEVER THISWILLONLYBEPOSSIBLEIFCONSISTENTACCOUNTINGMETHODS have been used. Where accounting procedures are changed, this should be stated CLEARLYDISCLOSED INTHEREPORTS SOTHATTHEUSERSCANMAKEMOREINFORMEDASSESSMENTS of what the reports are telling them.

Understandability Understandability states that reports should be presented in a manner that is simple to understand. It is important to remember that the most basic function of accounting reports is to COMMUNICATEINFORMATIONTOTHEUSERTHATIS SOLETRADERSANDOROWNERS-OSTSMALL business owners are not accountants, so it is not sensible to present reports in a form that owners cannot understand. The characteristic of 5NDERSTANDABILITYMEANSITISEASY FORTHEUSERTOCOMPREHENDTHEMEANINGOFREPORTS&ORTHISREASON ITMAYBEMORE EFFECTIVETOPRESENTINFORMATIONINGRAPHS TABLESORCHARTS ORSIMPLYINLANGUAGETHATIS FREEFROMACCOUNTINGJARGON

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THE ROLE OF ACCOUNTING



)NSUMMARY THEACCOUNTINGPROCESSISGUIDEDBY s ACCOUNTINGPRINCIPLES WHICHGOVERNTHEWAYACCOUNTINGINFORMATIONISRECORDED s QUALITATIVECHARACTERISTICS WHICHINFORMTHEWAYACCOUNTINGREPORTSAREPREPARED 2%6)%715%34)/.3

1 $ElNETHEFOLLOWINGQUALITATIVECHARACTERISTICS s 2ELEVANCE s 2ELIABILITY s #OMPARABILITY s 5NDERSTANDABILITY 2 %XPLAINHOWTHE%NTITYAND2EPORTING0ERIODPRINCIPLESENSURE2ELEVANCEIN the accounting reports. 3 2EFERRING TO ONE QUALITATIVE CHARACTERISTIC EXPLAIN WHY ACCOUNTANTS MUST follow the Historical Cost principle. 4 %XPLAIN HOW THE RECORDING SYSTEM CAN ENSURE Comparability of accounting reports. 5 3UGGESTTWOWAYSOFIMPROVINGTHE5NDERSTANDABILITY of accounting reports.

1.6

THE ELEMENTS OF FINANCIAL STATEMENTS

7EHAVEDISCUSSEDATLENGTHTHEQUALITIESTHATACCOUNTINGREPORTSSHOULDPOSSESS BUT WHATITEMSSHOULDTHEYINCLUDE4HE&RAMEWORKDElNESTHEELEMENTSOFTHEACCOUNTING reports as: s ASSETS s LIABILITIES s OWNERSEQUITY s REVENUES s EXPENSES

Assets AssetsARERESOURCESCONTROLLEDBYANENTITY ASARESULTOFPASTEVENTS FROMWHICHFUTURE ECONOMICBENElTSAREEXPECTEDTOmOWTOTHEENTITY&ORANITEMTOBERECOGNISEDAS ANASSET ITMUSTMEETEACHPARTOFTHEDElNITION!NITEMTHATFAILSTOMEETANYOFTHESE REQUIREMENTSCANNOTBECONSIDEREDTOBEANASSET ,ETSBREAKTHISDElNITIONDOWNINTOITSMAINCOMPONENTS Resources controlled by the entity

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

2ESOURCES ARE SIMPLY ITEMS THAT ARE CAPABLE OF GENERATING AN ECONOMIC GAIN FOR A BUSINESS SUCHASBANKTHECASHHELDTHERE NOTTHEBUILDING DEBTORS STOCK VEHICLES and premises. (OWEVER ONLYTHOSEITEMSTHATAREUNDERTHElRMScontrolCANBEDElNEDASASSETS 4HISMEANSTHATTHElRMMUSTBEINAPOSITIONTODETERMINEHOWANDWHENTHEITEMIS used. For instance, it is up to the business to determine how and when the cash in the BANKACCOUNTWILLBESPENT WHENTHEDEBTORSAREEXPECTEDTOPAYANDHOWTHEVEHICLES will be used. "YCONTRAST THEOWNERSHOMECANNOTBECLASSIlEDASAbusiness asset because it is not under business control$ONTFORGETTHE%NTITYPRINCIPLEHERETHEOWNERSHOMEIS UNDERTHECONTROLOFTHEOWNER WHOISCONSIDEREDTOBEASEPARATEACCOUNTINGENTITY from the business.

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.OTETHATALTHOUGHABUSINESSWILLOWNMANYOFITSASSETS OWNERSHIPITSELFISNOTA NECESSARY CONDITION FOR AN ITEM TO BE CLASSIlED AS A BUSINESS ASSET Control is much broader than ownership SOTHElRMSASSETSWILLOBVIOUSLYINCLUDE BUTNOTBERESTRICTED to, what it owns. Future economic benefits In addition to falling under business control, assets must be capable of generating a futureECONOMICBENElT4HATIS THEYMUSTREPRESENTSOMESORTOFBENElTTHATISYETTO BERECEIVED4HISREmECTSTHE'OING#ONCERNPRINCIPLE&OREXAMPLE CASHINTHEBANK can be spent and stock can be sold at some point in the future; the amount owed to THEBUSINESSBYITSDEBTORSWILLBERECEIVEDASCASHSOMETIMEINTHENEXTMONTHORSO ANDITEMSSUCHASPREMISESANDVEHICLESWILLUSUALLYBEUSEDFORBUSINESSACTIVITIESFORA NUMBEROFYEARSINTOTHEFUTURE On the other hand, cash paid for this month’s wages is not an asset, as there is no FUTUREBENElT)NORDERTOGAINAFURTHERBENElTFROMEMPLOYEES AFURTHERPAYMENTMUST BEMADE)TEMSSUCHASTHISCANNOTBECLASSIlEDASASSETSBECAUSETHEIRBENElTDOES NOTEXTENDBEYONDWHATHASALREADYBEENRECEIVED

Liabilities liability a present obligation of the entity as a result of past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits

LiabilitiesAREPRESENTOBLIGATIONSOFTHEENTITYASARESULTOFPASTEVENTS THESETTLEMENT OF WHICH IS EXPECTED TO RESULT IN AN OUTmOW FROM THE ENTITY OF RESOURCES EMBODYING ECONOMICBENElTS4HISMAYSEEMLIKEALOTOFJARGON BUTBROKENINTOITSCOMPONENTS it is easier to understand. Present obligations )FTHEBUSINESSHASALEGALRESPONSIBILITYORobligation TOSETTLEADEBT THENTHISDEBTIS LIKELYTOBEALIABILITY)NTHECASEOFABANKOVERDRAFTORMORTGAGE THECONTRACTWITHTHE LENDERMEANSTHEBUSINESSISOBLIGEDTOREPAYTHEAMOUNTOWING #ONTRASTTHESEITEMSWITHTHEAMOUNTTHATTHEBUSINESSEXPECTSTOPAYNEXTYEARFOR ADVERTISING4HISCANNOTBEREPORTEDASALIABILITY ASATPRESENTTHEREISNOOBLIGATION TO PAY 4HE OBLIGATION WILL ONLY OCCUR ONCE THE lRM HAS SIGNED THE CONTRACT OR THE advertising itself has been provided. Expected to result in an outflow of economic benefits 4HEFACTTHATALIABILITYISexpectedTORESULTINANOUTmOWORSACRIlCEOFECONOMICBENElTS MEANSTHATTHEOUTmOWSACRIlCEHASNOTYETOCCURRED)NTHISWAY ALIABILITYCOULDBE SEENASREQUIRINGAfuture economic sacrifice. )NMOSTCASES THEECONOMICBENElTTOBESACRIlCEDWILLBECASH ANDTHEEXPECTED OUTmOWWILLOCCURWHENTHEBUSINESSPAYSITSDEBTS(OWEVER THISISNOTALWAYSTHECASE THERE MAY BE AN ALTERNATIVE ECONOMIC BENElT THAT MUST BE SACRIlCED &OR EXAMPLE A lRM MAY HAVE RECEIVED CASH IN ADVANCE FOR A JOB YET TO BE COMPLETED IT IS NOT A PAYMENTTHATISREQUIREDTOEXTINGUISHTHISLIABILITY BUTTHECOMPLETIONOFTHEWORK

Owner’s equity owner’s equity the residual interest in the assets of the entity after the deduction of its liabilities

Owner’s equityISTHERESIDUALINTERESTINTHEASSETSOFTHEENTITYAFTERTHEDEDUCTIONOF ITSLIABILITIES)NEFFECT OWNERSEQUITYISWHATISLEFTOVERFORTHEOWNERONCEAlRMHAS METALLITSLIABILITIES'IVENTHATTHEOWNERANDTHElRMARECONSIDEREDTOBESEPARATE entities, it can also be described as the amount the business ‘owes the owner’.

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CHAPTER 1

THE ROLE OF ACCOUNTING



Revenue Revenues ARE INmOWS OF ECONOMIC BENElTS OR SAVINGS IN OUTmOWS IN THE FORM OF INCREASES IN ASSETS OR DECREASES IN LIABILITIES THAT INCREASE OWNERS EQUITY EXCEPT FOR CAPITAL CONTRIBUTIONS BY THE OWNER #APITAL CONTRIBUTIONS ARE EXCLUDED BECAUSE THEY occur not due to the activities of the business, but rather the actions of the owner. Revenue then represents the increasesINOWNERSEQUITYTHATOCCURTHROUGHBUSINESS activities, and in most cases will represent what the business has gained from the goods it has sold or the work it has done. But there are other forms of revenue, and although REVENUE MAY TAKE THE FORM OF CASH THIS IS NOT A REQUIREMENT CREDIT SALES WOULD BE REVENUEINTHEFORMOFANINCREASEINANASSETOTHERTHANCASHNAMELY DEBTORS WHEREAS DISCOUNTREVENUEWOULDTAKETHEFORMOFADECREASEINALIABILITYCREDITORS 4HEKEYIS THATAREVENUEMUSTINCREASEOWNERSEQUITY BUTNOTASACONSEQUENCEOFTHEOWNER making a contribution.

revenue an inflow of economic benefits (or saving in outflows) in the form of an increase in assets (or decrease in liabilities) that increases owner’s equity, except for capital contributions by the owner

Expenses ExpensesAREOUTmOWSORCONSUMPTIONSOFECONOMICBENElTSINTHEFORMOFDECREASES INASSETSORINCREASESINLIABILITIES THATREDUCEOWNERSEQUITY EXCEPTFORDRAWINGSBY THEOWNER$RAWINGSISEXCLUDEDBECAUSEITDOESNTCONTRIBUTETOTHElRMSABILITYTO CARRYOUTITSTRADINGACTIVITIES ANDSODOESNOTAFFECTITSABILITYTOEARNREVENUEORPROlT Expenses then represent the decreasesINOWNERSEQUITYTHATOCCURTHROUGHBUSINESS ACTIVITIESOR PUTSIMPLY WHATABUSINESSHASCONSUMEDORUSEDUP TOEARNITSREVENUE %VENTHOUGHMANYEXPENSESAREPAIDINCASH THISISNOTAREQUIREMENTSTOCKLOSSDUE TOTHEFTWOULDBEANEXPENSEINTHEFORMOFADECREASEINASSETSSTOCK WHEREASWAGES COULDTAKETHEFORMOFANINCREASEINLIABILITIESIFITWEREYETTOBEPAID4HEKEYHEREIS THATANEXPENSEMUSTDECREASEOWNERSEQUITY BUTNOTASACONSEQUENCEOFTHEOWNER making a withdrawal from the business. 2 % 6 ) % 7 1 5 % 3 4 ) / . 3   

1 $ElNE the following items: s asset s LIABILITY s OWNERSEQUITY s revenue s expense. 2 3TATEONEREASONWHYWAGESISNOT considered to be an asset. 3 3TATEONEREASONWHYTHEADVERTISINGFORNEXTYEARISNOT considered to be a LIABILITY 4 %XPLAINWHYACAPITALCONTRIBUTIONISNOT considered to be revenue. 5 %XPLAINWHYDRAWINGSISNOT considered to be an expense.

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expense an outflow or consumption of economic benefits (or reduction in inflows) in the form of a decrease in assets (or increase in liabilities) that reduces owner’s equity, except for drawings by the owner

STUDY TIP

#OMPARETHEDElNITIONS of revenues and expenses. Opposites APPLYHERE

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CAMBRIDGE VCE ACCOUNTING



UNITS 3&4

WHERE HAVE WE BEEN? s s

s

s

s s

EXERCISES

4HE PURPOSE OF ACCOUNTING IS TO PROVIDE lNANCIAL INFORMATION TO ASSIST DECISION making. 4HEACCOUNTINGPROCESSINVOLVESCOLLECTINGSOURCEDOCUMENTS RECORDINGlNANCIAL DATAANDTHENREPORTINGlNANCIALINFORMATION ANDSUBSEQUENTLYADVISINGTHEOWNER on an appropriate course of action. !CCOUNTINGPRINCIPLES THEGENERALLYACCEPTEDRULESGOVERNINGTHEWAYACCOUNTING information is generated, are: n ENTITY – Going Concern – Reporting Period – Historical Cost – Conservatism n #ONSISTENCY n -ONETARY5NIT 1UALITATIVECHARACTERISTICS THEQUALITIESWEWOULDLIKEOURlNANCIALREPORTSTOPOSSESS are: – Relevance – Reliability – Comparability n 5NDERSTANDABILITY 4HE THREE GENERAL PURPOSE lNANCIAL REPORTS ARE THE #ASH &LOW 3TATEMENT THE Income Statement and the Balance Sheet. 4HEELEMENTSOFTHElNANCIALREPORTSAREASSETS LIABILITIES OWNERSEQUITY REVENUE and expenses.

EXERCISE 1.1 ACCOUNTING PRINCIPLES

W B

page 4

In each of the following situations, STATEand EXPLAINthe accounting principle that has been breached. a 2HONDARECORDEDTHEPAYMENTOFHERDAUGHTERSORTHODONTISTSFEESASABUSINESS expense. b The proprietor of Richmond Spare Parts decided to combine the recording of repair EXPENSESWITHVEHICLEEXPENSESAFTERRECORDINGTHEMSEPARATELYFORSEVERALYEARS a $UETOUNCERTAINTIESWITHTHEEXCHANGERATE $IG&REELYDECIDEDTORECORDFOREIGN EARNINGSINYUANTHE#HINESECURRENCY  a $URING*ANUARY *EAN3IMONSRECEIVEDCASHFORGOODSSOLDIN$ECEMBER *EANDECIDEDTORECORDTHECASHASREVENUEFOR e -ILLS3ONHAVEJUSTREVALUEDTHEIRNON CURRENTASSETSUPWARDSBYTOREmECTTHE RATEOFINmATION f Paul Rullett is the proprietor of PR Traders. He has decided to list all the liabilities of THElRMASCURRENTTOGIVEHIMABETTERPICTUREOFWHATHEOWES DESPITEAMORTGAGE THATISDUEINYEARS g +AREN2OBERTSONLYPREPARESlNANCIALREPORTSEVERYTWOYEARS

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CHAPTER 1

EXERCISE 1.2 ACCOUNTING PRINCIPLES AND QUALITATIVE CHARACTERISTICS

THE ROLE OF ACCOUNTING

W B

page 6

$URING$ECEMBER "ON7ILHELMPAIDFORAFAMILYHOLIDAYUSINGABUSINESSCHEQUE 4HISTRANSACTIONWASTREATEDASABUSINESSEXPENSE WITH"ONARGUING @)TSMYBUSINESS ITSMYMONEY Required a

Referring to one accounting principle, EXPLAIN WHY THIS TRANSACTION SHOULD HAVE been recorded as drawings. b %XPLAINHOW7ILHELMSDECISIONWILLUNDERMINETHE2ELEVANCEOFTHElNANCIALREPORTS

EXERCISE 1.3 ACCOUNTING PRINCIPLES AND QUALITATIVE CHARACTERISTICS

W B

page 7

)N/CTOBER -ARK,ARKIN THEOWNEROF,ARKIN,IGHTING DECIDEDTHATTHElRMSSTOCK should be valued at its selling price rather than its cost price because, according to -ARK @4HATSWHATITISACTUALLYWORTH Required a

Referring to one accounting principle, EXPLAINWHYTHESTOCKMUSTBEVALUEDATITS cost price. b %XPLAINHOWVALUINGSTOCKATITSSELLINGPRICEWILLUNDERMINETHE2ELIABILITYOFTHE reports.

EXERCISE 1.4 ACCOUNTING PRINCIPLES AND QUALITATIVE CHARACTERISTICS

W B

page 8

Erica Carr’s business has been sued for false advertising, and her solicitor has indicated THATSHEISLIKELYTOLOSETHEFORTHCOMINGCOURTCASEANDBELIABLETOPAYDAMAGES%RICA has decided to not disclose the damages in the Income Statement. Required a

Referring to one accounting principle, EXPLAIN WHY %RICA SHOULD DISCLOSE THE damages in the Income Statement. b 3TATETHEQUALITATIVECHARACTERISTICTHATSUPPORTSYOURANSWERTOPART@A*USTIFYYOUR answer.

EXERCISE 1.5 ACCOUNTING PRINCIPLES AND QUALITATIVE CHARACTERISTICS

W B

page 9

)NANATTEMPTTOSATISFYTHE#ONSISTENCYPRINCIPLE #OOLICK2EFRIGERATORSALWAYSREPORTS THESAMElGUREFORDEPRECIATIONOFEQUIPMENT Required a $ElNE@CONSISTENCYASANACCOUNTINGPRINCIPLE b 2EFERRING TO ONE QUALITATIVE CHARACTERISTIC EXPLAIN WHY THE ACCOUNTING RECORDS SHOULDBEMAINTAINEDBYFOLLOWINGTHE#ONSISTENCYPRINCIPLE © Anthony SImmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and this material must not be transferred to another party.

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

EXERCISE 1.6 ACCOUNTING PRINCIPLES, QUALITATIVE CHARACTERISTICS AND ELEMENTS OF THE REPORTS

W B

page 10

)N/CTOBER 2AD-AGAZINESSUCCESSFULLYCOMPLETEDAMARKETINGCAMPAIGNWHERE READERS PAY IN ADVANCE FOR MAGAZINES TO BE DELIVERED IN  4HE OWNER WANTS TO RECORDALLTHECASHRECEIVEDASREVENUEFOR Required a

Referring to one accounting principle, EXPLAINWHYTHECASHRECEIVEDSHOULDNOT be RECORDEDASREVENUEFOR b 3TATETHEQUALITATIVECHARACTERISTICTHATWILLBEUNDERMINEDIFTHECASHRECEIVEDIS REPORTEDASREVENUEFOR*USTIFYYOURANSWER c 2EFERRING TO THE DElNITIONS OF THE ELEMENTS OF THE REPORTS EXPLAIN WHY THE CASH received is NOTYETREVENUE

EXERCISE 1.7 ACCOUNTING PRINCIPLES AND QUALITATIVE CHARACTERISTICS

W B

page 11

4HE ACCOUNTING DEPARTMENT OF 0LASTIC #UPS %MPORIUM RECENTLY ISSUED A REPORT TO A MEETING OF THE WORKERS OF THE lRM COMPLETE WITH VARIOUS lNANCIAL STATEMENTS AND lNANCIALRATIOS.ONEOFTHEWORKERSATTHEMEETINGHADANYKNOWLEDGEOFACCOUNTING Required a 2EFERRINGTOONEQUALITATIVECHARACTERISTIC EXPLAINWHYTHEACCOUNTINGREPORTSWILL NOTFULlLTHEIRINTENDEDFUNCTION b 3TATE ONE TECHNIQUE THE ACCOUNTING DEPARTMENT COULD EMPLOY TO IMPROVE THE APPROPRIATENESSOFITSlNANCIALREPORTS

EXERCISE 1.8 ACCOUNTING PRINCIPLES AND QUALITATIVE CHARACTERISTICS

W B

page 12

4HEOWNEROF&ROSTY&RIDGESBELIEVESITSMARKETVALUEISSHOWNINTHE"ALANCE3HEETAS the difference between total assets and total liabilities. Required a

Referring to one accounting principle, EXPLAIN WHY THE MARKET VALUE OF &ROSTY Fridges will NOT be shown as the difference between total assets and total liabilities.

EXERCISE 1.9 ACCOUNTING PRINCIPLES, QUALITATIVE CHARACTERISTICS AND ELEMENTS OF THE REPORTS

W B

page 13

/N!PRIL -AXCONTRIBUTEDSECOND HANDSHELVINGTOHISBUSINESSWITHANAGREED VALUEOF-AXORIGINALLYPAIDFORTHESHELVING/N*UNE THE RESALEVALUEOFTHESHELVINGWAS

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CHAPTER 1

THE ROLE OF ACCOUNTING

Required a 2EFERRINGTOTHEDElNITIONSOFTHEELEMENTSOFTHEREPORTS EXPLAIN how the shelving SHOULDBECLASSIlEDINTHE"ALANCE3HEETOF-AXSBUSINESS b Referring to one accounting principle, EXPLAIN how the shelving should have been VALUEDINTHE"ALANCE3HEETOF-AXS-ARTASAT!PRIL c 2EFERRINGTOONEQUALITATIVECHARACTERISTIC EXPLAINWHYTHESHELVINGSHOULDNOT be VALUEDATITSRESALEVALUEINTHE"ALANCE3HEETASAT*UNE

EXERCISE 1.10 ELEMENTS OF THE REPORTS

W B

page 14

For each of the following items, STATE whether it should be reported in the Income 3TATEMENTORTHE"ALANCE3HEET USINGTHEDElNITIONSOFTHEELEMENTSOFTHEREPORTSTO EXPLAINHOWITSHOULDBECLASSIlED a debtors b loan – principal c interest on loan d stock loss e cash sales f wages incurred g wages owing h discount revenue.

EXERCISE 1.11 ELEMENTS OF THE REPORTS

W B

page 15

(ARD 5TES SPECIALISES IN THE SALE OF UTILITY VEHICLES /N  !UGUST  THE lRM PURCHASEDANEWVEHICLEWORTHONCREDITFROM(OLDEN Required a %XPLAIN the difference between an asset and an expense. b %XPLAIN one circumstance in which the cost of the vehicle would be reported as a current asset. c %XPLAIN one circumstance in which the cost of the vehicle would be reported as a non-current asset. d %XPLAIN one circumstance in which the cost of the vehicle would be reported as an expense.

EXERCISE 1.12 GOODWILL

W B

page 16

/VERTHELASTCOUPLEOFYEARS %LAINEHASBUILTUPALOYALCLIENTELEFORHERFASHIONBOUTIQUE &INE&ASHIONS4HESECUSTOMERSBUYFROM%LAINEONAREGULARBASISBECAUSETHEYTRUST HERJUDGEMENTANDEXPERTISE Required a

$ISCUSSwhether Elaine should recognise this ‘goodwill’ as an asset.

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Where are we headed? After completing this chapter, you should be able to: s defineANDidentifyASSETS LIABILITIESANDOWNERSEQUITY s explainTHERELATIONSHIP BETWEENTHEELEMENTSOFTHE ACCOUNTINGEQUATION s calculateOWNERSEQUITY USINGTHEACCOUNTING EQUATION s explainTHERELATIONSHIP BETWEENTHEACCOUNTING EQUATIONANDTHE"ALANCE 3HEET

s defineANDidentifyCURRENT ANDNON CURRENTITEMS s prepareAFULLYCLASSIFIED "ALANCE3HEET s applyTHERULESOFDOUBLE ENTRYACCOUNTING s analyseHOWTRANSACTIONS AFFECTTHEACCOUNTING EQUATIONANDTHE"ALANCE 3HEET

CHAPTER 2

THE ACCOUNTING EQUATION KEY TERMS After completing this chapter, you should be familiar with the following terms: s EQUITIES s "ALANCE3HEET s CLASSIFICATION s CURRENTASSET s NON CURRENTASSET s CURRENTLIABILITY s NON CURRENTLIABILITY s DOUBLE ENTRYACCOUNTING

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CAMBRIDGE VCE ACCOUNTING

2.1

UNITS 3&4

ASSETS, LIABILITIES AND OWNER’S EQUITY

4HEMOSTOBVIOUSPLACETOSTARTANASSESSMENTOFANYBUSINESSISWITHITSCURRENTSITUATION OR IFYOULIKE ITSCURRENTlNANCIALPOSITION!TITSMOSTBASIC THISASSESSMENTWILLCONSIDER THEECONOMICRESOURCESITCONTROLSnITSASSETSnANDTHEOBLIGATIONSITHASnITSLIABILITIES "YPREPARINGA"ALANCE3HEET WHICHDETAILSTHESEASSETSANDLIABILITIES ANOWNERCAN ASSESSTHEOWNERSEQUITYnTHENETWORTHOFTHEOWNERSINVESTMENTINTHEBUSINESS ,ETSSTARTBYREFRESHINGOURUNDERSTANDINGOFASSETS LIABILITIESANDOWNERSEQUITY

Assets !SWASEXPLAINEDIN#HAPTER ASSETSAREDElNEDASRESOURCESCONTROLLEDBYANENTITY ASARESULTOFPASTEVENTS FROMWHICHFUTUREECONOMICBENElTSWILLmOWTOTHEENTITY !COMMONLISTOFASSETSFORATRADINGBUSINESSMIGHTINCLUDETHEFOLLOWINGITEMS s banknCASHKEPTINTHEBUSINESSSBANKACCOUNT s debtorsnTHEAMOUNTOWEDTOTHEBUSINESSBYCUSTOMERSWHOWERESOLDGOODS ONCREDIT s stocknGOODSPURCHASEDANDHELDFORRESALETOCUSTOMERS s fixtures and fittingsnITEMSUSEDINTHEBUSINESSPREMISES SUCHASSHELVINGOR WINDOWCOVERINGS s vehiclesnCARS TRUCKSANDVANSUSEDFORBUSINESSPURPOSES s premisesnTHEBUILDINGS FROMWHICHTHEBUSINESSACTIVITYISCONDUCTED

Liabilities ,IABILITIESAREPRESENTOBLIGATIONSOFTHEENTITYASARESULTOFPASTEVENTS THESETTLEMENT OFWHICHISEXPECTEDTORESULTINANOUTmOWOFRESOURCESEMBODYINGECONOMICBENElTS !COMMONLISTOFLIABILITIESMIGHTINCLUDE s bank overdraftnANAMOUNTOWEDTOTHEBANKWHENABUSINESSSPENDSMORE THANISCURRENTLYINITSBANKACCOUNT s creditorsnTHEAMOUNTOWEDBYTHEBUSINESSFORGOODSITHASBOUGHTONCREDIT s loan nANAMOUNTTHATISBORROWEDFROMABANKOROTHERlNANCIALINSTITUTIONAND MUSTBEREPAIDATSOMETIMEINTHEFUTURE s MORTGAGEnASPECIlCTYPEOFLOANTHATISSECUREDAGAINSTPROPERTY 9OU MIGHT BEGIN BY THINKING OF ASSETS AS @WHAT THE lRM OWNS AND LIABILITIES AS @WHAT THE lRM OWES BUT SUCH SIMPLISTIC DElNITIONS WILL NOT SUFlCE IN MORE COMPLEX ACCOUNTINGSITUATIONS INCLUDINGTHEEXAM
4HEMORESOPHISTICATEDDElNITIONSASLISTED ABOVEANDDESCRIBEDINDETAILIN#HAPTER MUSTBEAPPLIEDTODETERMINEACCURATELY ANDCONCLUSIVELYWHETHERANITEMISANASSETORALIABILITY

Owner’s equity /WNERSEQUITYISTHERESIDUALINTERESTINTHEASSETSOFTHEENTITYAFTERTHEDEDUCTIONOFITS LIABILITIES,IABILITIESAREOBLIGATIONSTOEXTERNALENTITIESTHATIS PARTIESOUTSIDETHElRM SUCHASBANKS CREDITORSANDOTHERLENDERS4HISMEANSTHATLIABILITIESAREDEBTSOWEDTO ENTITIESOTHERTHANTHEOWNER4HEAMOUNTOWEDTOTHEOWNERnTHEOWNERSCLAIMONTHE ASSETSOFTHElRMnMUSTBEREPORTEDSEPARATELYASOWNERSEQUITY (OWCANABUSINESSOWEITSOWNER$ONTFORGETTHE%NTITYPRINCIPLEASACCOUNTANTS WE ASSUME THAT THE BUSINESS AND THE OWNER ARE SEPARATE ENTITIES SEPARATE BEINGS 4HEASSETSOFTHEfirmARENOTASSETSOFTHEowner ANDNORARETHELIABILITIESTHEYARE ASSUMEDTOBELONGTOTHEBUSINESSALONE"ECAUSETHEVALUEOFTHElRMSASSETSMUST EXCEEDITSLIABILITIES THEREWILLBEANAMOUNT@LEFTOVER)TISTHISLEFTOVERORRESIDUAL

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CHAPTER 2

23

T H E A C C O U N T I N G E Q U AT I O N

AMOUNTTHATTHElRMOWESNOTTOANYEXTERNALPARTY BUTTOTHEOWNER SOOWNERSEQUITY ISTHERESIDUALINTERESTINTHEASSETSOFTHEENTITYAFTERTHEDEDUCTIONOFITSLIABILITIES

The accounting equation 7HAT LIABILITIES AND OWNERS EQUITY HAVE IN COMMON IS THAT THEY ARE BOTH equities ORCLAIMSONTHEASSETSOFTHEBUSINESS4HATIS LIABILITIESAREWHATTHEBUSINESSOWES TOexternal parties WHILEOWNERSEQUITYISWHATTHEBUSINESSOWESTOTHEowner"OTH TYPESOFCLAIMMUSTBEFUNDEDFROMTHEBUSINESSSASSETS 4HISRELATIONSHIPnBETWEENASSETS LIABILITIESANDOWNERSEQUITYnISDESCRIBEDBYTHE accounting equation

equities claims on the assets of the business, consisting of both liabilities and owner’s equity

accounting equation the rule that states that assets must always equal liabilities plus owner’s equity

The relationship between assets, liabilities and owner’s equity is described by the accounting equation

Accounting equation Assets

=

Liabilities

+

Owner’s equity

4HEACCOUNTINGEQUATIONISASIMPORTANTTOACCOUNTINGAS%INSTEINSTHEORIESARETO PHYSICSANDITISSUBJECTTOONEIMMUTABLELAWITMUSTALWAYSBALANCE4HATIS ASSETS MUSTALWAYSEQUALLIABILITIESPLUSOWNERSEQUITY)TISNOTPOSSIBLEFORTHEEQUATIONTOBE OUTOFBALANCE &ORINSTANCE IFAlRMHASASSETSOFANDLIABILITIESWORTH ITSOWNERS EQUITY MUST BE THE RESIDUAL THAT IS WHAT IS LEFT OVER   )T IS NOT POSSIBLE FOR OWNERSEQUITYTOEQUALANAMOUNTgreaterTHANTHIS BECAUSETHEREWOULDBEINSUFlCIENT ASSETSTOFUNDTHECLAIM /NTHEOTHERHAND ITISNOTPOSSIBLEFOROWNERSEQUITYTOEQUALANAMOUNTlessTHAN THIS)FLIABILITIESCLAIMED ANDTHEOWNERCLAIMEDONLY THATWOULDLEAVE ANAMOUNTOFTHATHASNOTBEENCLAIMEDBYLIABILITIES NORBYTHEOWNERAND NO ONEISSUGGESTINGITSHOULDJUSTBEGIVENAWAY
)TISNOTPOSSIBLEFORANAMOUNTTO REMAINUNCLAIMED PROVINGTHATTHEACCOUNTINGEQUATIONMUSTALWAYSBALANCE

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UNITS 3&4

REVIEW QUESTIONS 2.1

1 DefineTHETERM@ASSET 2 ListTHREEASSETSTHATWOULDBEFOUNDINTHE"ALANCE3HEETOFATYPICALTRADING lRM 3 DefineTHETERM@LIABILITY 4 List THREE LIABILITIES THAT WOULD BE FOUND IN THE "ALANCE 3HEET OF A TYPICAL TRADINGlRM 5 DefineTHETERM@OWNERSEQUITY 6 2EFERRING TO ONE ACCOUNTING PRINCIPLE explain HOW A BUSINESS CAN @OWE ITS OWNER 7 StateTHEACCOUNTINGEQUATION

2.2 Balance Sheet an accounting report that details the business’s assets, liabilities and owner’s equity at a particular point in time

THE BALANCE SHEET

4HE RELATIONSHIP BETWEEN ASSETS LIABILITIES AND OWNERS EQUITY n AS DESCRIBED BY THE ACCOUNTING EQUATION n IS AT THE HEART OF THE Balance Sheet 4HE "ALANCE 3HEET IS AN ACCOUNTINGREPORTTHATDETAILSTHElRMSASSETS LIABILITIESANDOWNERSEQUITYATAPARTICULAR POINTINTIME ANDISAREmECTIONOFTHElRMSACCOUNTINGEQUATION4HISRELATIONSHIPIS SHOWNIN&IGURE

Figure 2.1 The accounting equation and the Balance Sheet Assets

=

Assets

Liabilities + Owner’s equity Liabilities plus Owner’s equity TOTAL EQUITIES

TOTAL ASSETS

!"ALANCE3HEETFORATRADINGlRMMAYLOOKLIKETHEONESHOWNIN&IGURE

Figure 2.2 Balance Sheet MORGAN’S MERCHANDISE Balance Sheet as at 30 June 2015 Assets

$

$

Liabilities

$

Creditors

$

Bank

5 000

Stock

34 000

Loan – MHB Bank

Debtors

12 000

Owner’s Equity

Vehicles

45 000

Capital – Morgan

54 000

Total Assets

96 000

Total Equities

96 000

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

6 000 36 000

42 000

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T H E A C C O U N T I N G E Q U AT I O N

4HEASSETSARELISTEDONTHELEFT HANDSIDE WITHTHEEQUITIESLIABILITIESANDOWNERS EQUITY LISTEDONTHERIGHT JUSTLIKETHEACCOUNTINGEQUATION .OTE HOW THE TITLE OF THE REPORT STATES who IT HAS BEEN PREPARED FOR -ORGANS -ERCHANDISE whatKINDOFREPORTITISA"ALANCE3HEET ANDwhenITWASPREPARED *UNE   "ECAUSE BUSINESSES ENGAGE IN A NUMBER OF TRANSACTIONS EVERY DAY AND EVERYTRANSACTIONCHANGESTHE"ALANCE3HEET THE"ALANCE3HEETISONLYEVERACCURATE ONTHEDAYITISPREPARED4HUS THETITLESAYS@ASATAPARTICULARDATE .OTE ALSO HOW THE TERM @/WNERS %QUITY IS USED AS A HEADING 4HE ACTUAL ITEM REPRESENTINGTHEOWNERSCLAIMISKNOWNAS@#APITAL WITHTHENAMEOFTHEOWNERLISTED NEXTTOIT!NYPROlTSEARNEDBYTHEBUSINESSnANDTHUS@OWEDTOTHEOWNERnWOULD ALSOBELISTEDUNDERTHEHEADINGOF@OWNERSEQUITY REVIEW QUESTIONS 2.2

1 ExplainWHATISSHOWNINA"ALANCE3HEET 2 Explain THERELATIONSHIPBETWEENTHEACCOUNTINGEQUATIONANDTHE "ALANCE3HEET 3 State THETHREEPIECESOFINFORMATIONTHATMUSTBEPRESENTINTHETITLEOF EVERYACCOUNTINGREPORT 4 Explain WHYTHE"ALANCE3HEETISTITLED@ASATAPARTICULARDATE

2.3

CLASSIFICATION IN THE BALANCE SHEET

'IVENTHATACCOUNTINGEXISTSTOPROVIDElNANCIALINFORMATIONTOASSISTDECISION MAKING ACCOUNTANTSAREALWAYSSEEKINGWAYSTOIMPROVETHEUSEFULNESSOFTHEINFORMATIONTHEY PROVIDE/NESIMPLEBUTVERYEFFECTIVEWAYOFIMPROVINGTHEUSEFULNESSOFTHE"ALANCE 3HEETISBYCLASSIFYINGTHEINFORMATIONITCONTAINS ClassificationINVOLVESGROUPINGTOGETHERITEMSTHATHAVESOMECOMMONCHARACTERISTIC )NRELATIONTOTHE"ALANCE3HEET THEASSETSANDLIABILITIESHAVEALREADYBEENGROUPED TOGETHER BUTWITHINTHESEGROUPINGSTHEITEMSCANBECLASSIlEDACCORDINGTOWHETHER THEYARECURRENTORNON CURRENT

classification grouping together items that have some common characteristic

Current versus non-current assets !LLASSETSAREDElNEDAS@FUTUREECONOMICBENElTS BUTITISTHEDElNITIONOF@FUTURETHAT DETERMINESWHETHERTHEYAREcurrent assetsORnon-current assets0UTSIMPLY ASSETS ARECLASSIlEDASCURRENTORNON CURRENTACCORDINGTOHOWLONGTHEYAREEXPECTEDTOLAST )FITISEXPECTEDTHATTHEASSETWILLBESOLD USEDUPORTURNEDINTOCASHWITHINAYEAR THATIS IFITISEXPECTEDTOPROVIDEANECONOMICBENElTONLYin the next 12 months THEN ITSHOULDBECLASSIlEDASACURRENTASSET#OMMONCURRENTASSETSINCLUDETHECASHINTHE BUSINESSSBANKACCOUNT THESTOCKITISHOLDINGFORRESALE ANDTHEAMOUNTSOWEDTOIT BYITSDEBTORS !NY ASSETS THAT ARE EXPECTED TO PROVIDE AN ECONOMIC BENElT for more than 12 months SUCH AS BUSINESS PREMISES VEHICLES OR SHOP lTTINGS SHOULD BE CLASSIlED AS NON CURRENTASSETS

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

current asset a resource controlled by the entity as a result of past events, from which a future economic benefit is expected to flow to the entity in the next 12 months non-current asset a resource controlled by the entity as a result of past events, from which a future economic benefit is expected to flow to the entity for more than the next 12 months

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

If it is expected that an asset will be sold, used up or turned into cash within a year (such as stock held for resale in a warehouse) it should be classified as a current asset

An asset that is expected to provide an economic benefit for more than the next 12 months (such as a business’s premises or truck) should be classified as a non-current asset

current liability a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow of resources embodying economic benefits in the next 12 months non-current liability a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow of resources embodying economic benefits in more than 12 months

Current versus non-current liabilities 4HE SAME @ MONTH TEST APPLIES TO LIABILITIES Current liabilities ARE OBLIGATIONS THAT AREEXPECTEDTOBEMETin the next 12 months SUCHASAMOUNTSOWINGTOCREDITORSAND LOANSDUEINTHENEXTYEAR!BANKOVERDRAFTWOULDALSOBECLASSIlEDASACURRENTLIABILITY NOTSOMUCHBECAUSEITwillBEMETINTHENEXTMONTHSASBECAUSEIT can BE4HAT IS ALTHOUGHITISUNLIKELYTOOCCUR ITISPOSSIBLETHATANOVERDRAFTCOULDBECALLEDINFOR REPAYMENT ONVERYSHORTNOTICE MAKINGITACURRENTLIABILITY "YCONTRAST non-current liabilitiesARETHOSEOBLIGATIONSTHATMUSTBEMETSOMETIME in more than 12 months,ONGER TERMLOANS SUCHASMORTGAGES ARETHEMOSTCOMMON NON CURRENTLIABILITIES

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T H E A C C O U N T I N G E Q U AT I O N

Loans 7HEN CLASSIFYING LOANS IT IS IMPORTANT TO RECOGNISE THAT SOME OF THE AMOUNT OWING MAYBECURRENTANDSOMENON CURRENT&OREXAMPLE WITHALOANSUCHASAMORTGAGE THELENDERUSUALLYABANK WOULDEXPECTTHEBORROWERTHEBUSINESS TOMAKEGRADUAL REPAYMENTSOFFTHEPRINCIPALRATHERTHANREPAYONEMASSIVEAMOUNTATTHEENDOFTHE LOAN)NTHISCASE THEAMOUNTTHATISDUEFORREPAYMENTINTHENEXTMONTHSWOULD BECLASSIlEDASACURRENTLIABILITY WITHTHEREMAINDERWHICHDOESNOTHAVETOBEREPAID UNTILAFTERMONTHS CLASSIlEDASANON CURRENTLIABILITY!SARESULT THEAMOUNTOWING ONALONG TERMLOANMAYNEEDTOBESPLITBETWEENCURRENTANDNON CURRENTLIABILITIES )FWETAKETHE"ALANCE3HEETSHOWNEARLIERINTHISCHAPTERANDCLASSIFYITSCONTENTS THERESULTWOULDAPPEARASISSHOWNIN&IGURE Figure 2.3 Classified Balance Sheet MORGAN’S MERCHANDISE Balance Sheet as at 30 June 2015 Current Assets

$

Bank

5 000

Stock

34 000

Debtors

12 000

$

Current Liabilities Creditors Loan – MHB Bank

$

$

6 000 12 000

18 000

51 000 Non-Current Liabilities Loan – MHB Bank

Non-Current Assets Vehicles

24 000

45 000 Owner’s Equity

Total Assets

96 000

Capital – Morgan

54 000

Total Equities

96 000

)NTHISEXAMPLE THE,OANn-(""ANKFORHASBEENSPLITBETWEENCURRENT AND NON CURRENT LIABILITIES  MUST BE REPAID IN THE NEXT  MONTHS WITH THE REMAININGDUEFORREPAYMENTSOMETIMEAFTERTHAT .OTEALSOTHEUSEOFCOLUMNSWHERENECESSARY THELEFT HANDCOLUMNONEACHSIDE OFTHESTATEMENTHASBEENUSEDFORLISTINGINDIVIDUALAMOUNTS LEAVINGONLYTHETOTALOF EACHCLASSIlCATIONINTHERIGHT HANDCOLUMN4HISISASIMPLEMECHANISMFORIMPROVING THELAYOUTOFTHEREPORT ANDMAKINGITMOREUSER FRIENDLY

STUDY TIP

#HECKTHEDATEWHENA LOANHASTOBEREPAID THISISTHEKEYTO WHETHERITISCURRENTOR NON CURRENT

Uses of the classified Balance Sheet 7ITHCURRENTANDNON CURRENTITEMSIDENTIlED THE"ALANCE3HEETNOWHASMORERelevance FORDECISION MAKING&OREXAMPLE ITCANBEUSEDTOIDENTIFYTHEAMOUNTOFDEBTSTHAT MUSTBEMETINTHEFORTHCOMINGYEARTHATIS CURRENTLIABILITIES)FTHEOWNERWANTSTO GOFURTHER THECURRENTLIABILITIESCANBECOMPAREDAGAINSTTHECURRENTASSETSTOASSESS THE lRMS ABILITY TO MEET THOSE SHORT TERM DEBTS 4HIS IS IN EFFECT AN ASSESSMENT OF THElRMSLIQUIDITYBYCALCULATINGITS7ORKING#APITAL2ATIO BUTWEWILLLEAVETHISUNTIL #HAPTER

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UNITS 3&4

REVIEW QUESTIONS 2.3

1 2 3 4 5 6

DistinguishBETWEENACURRENTASSETANDANON CURRENTASSET ListTHREECURRENTASSETSANDTHREENON CURRENTASSETS DistinguishBETWEENACURRENTLIABILITYANDANON CURRENTLIABILITY ListTHREECURRENTLIABILITIES ExplainHOWAMORTGAGESHOULDBECLASSIlEDINTHE"ALANCE3HEET ExplainONEBENElTOFCLASSIFYINGTHE"ALANCE3HEET

2.4

double-entry accounting a system that records two effects on the accounting equation as a result of each transaction

DOUBLE-ENTRY ACCOUNTING

!LTHOUGH THE "ALANCE 3HEET STATES A lRMS lNANCIAL POSITION AT A PARTICULAR POINT IN TIME THISPOSITIONISNOTSTATICITWILLCHANGEAFTEREVERYTRANSACTION3PECIlCALLY WHEN ABUSINESSEXCHANGESGOODSANDORSERVICESWITHANOTHER%NTITY ATLEASTTWOITEMSWILL CHANGEINITSACCOUNTINGEQUATIONAND THEREFORE ITS"ALANCE3HEET4HISISTRUEOFEVERY TRANSACTION THAT A lRM COULD HAVE 4HIS MEANS THE ACCOUNTING EQUATION AND "ALANCE 3HEETWILLNEEDTOBEREWRITTENAFTEREVERYTRANSACTION!TTHESAMETIME THEACCOUNTING EQUATIONMUSTALWAYSBALANCE SOEVENAFTEREACHTRANSACTIONHASBEENRECORDED THE ACCOUNTINGEQUATIONANDTHE"ALANCE3HEETMUSTSTILLBALANCE4HESETWORULESFORMTHE BASISOFWHATISKNOWNASdouble-entry accounting Rules of double-entry accounting 1 Every transaction will affect at least two items in the accounting equation: a double entry. 2 After recording these changes, the accounting equation must still balance.

EXAMPLE

Imelda’s Shoe Shop has presented the following transactions:

 )MELDACONTRIBUTEDTOESTABLISHABUSINESSBANKACCOUNT !SARESULTOFTHISTRANSACTION THEBUSINESSNOWHASINITS"ANKACCOUNT ANINCREASEINITSASSETSOF)NADDITION BECAUSETHATCASHCAMEFROMTHE OWNERWHOISASSUMEDTOBEASEPARATEACCOUNTING%NTITY THE/WNERS%QUITYHAS INCREASEDBY4HEACCOUNTINGEQUATIONFOR)MELDAS3HOE3HOPAFTERTHIS TRANSACTIONISSHOWNIN&IGURE Figure 2.4 Accounting equation 1 Assets Bank

$

$ 20 000

Liabilities

$

$

nil Owner’s Equity

Total Assets

20 000

Capital – Imelda

20 000

Total Equities

20 000

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T H E A C C O U N T I N G E Q U AT I O N

.OTE HOW THE TRANSACTION HAS CHANGED TWO ITEMS n "ANK ASSET AND #APITAL OWNERS EQUITY n BOTH OF WHICH HAVE INCREASED BY   !S A RESULT THE ACCOUNTINGEQUATIONSTILLBALANCES  0URCHASEDSTOCKONCREDITFROM-ILANO,EATHER0RODUCTSFOR 4HISTIMEITISNOT"ANKTHATINCREASES BUTADIFFERENTASSET3TOCK/NTHEOTHERSIDE OFTHEACCOUNTINGEQUATION ALIABILITYISCREATED CALLED#REDITORS REPRESENTINGTHE AMOUNT OWED TO -ILANO ,EATHER 0RODUCTS 4HE ACCOUNTING EQUATION FOR )MELDAS 3HOE3HOPAFTERTRANSACTIONISSHOWNIN&IGURE Figure 2.5 Accounting equation 2 Assets

$

$

Liabilities

Bank

20 000

Creditors

Stock

45 000

Owner’s Equity

Total Assets

65 000

$

$ 45 000

Capital – Imelda

20 000

Total Equities

65 000

7HILETHEREISNOCHANGETO"ANK THENEWASSETn3TOCKnINCREASESTHEASSETS TO/NTHEOTHERSIDEOFTHEACCOUNTINGEQUATION #REDITORSINCREASESTHE EQUITIESTOTHESAMEAMOUNTAND ONCEAGAIN THEACCOUNTINGEQUATIONBALANCES  0AIDTOPURCHASENEWSHOPlTTINGS 4HISTRANSACTIONCREATESATHIRDASSET3HOP&ITTINGS BUTINTHEPROCESSDECREASES "ANK BY THE SAME AMOUNT 4HUS THE AMOUNTS OF THE INDIVIDUAL ASSETS CHANGE WITHOUTCHANGINGTHETOTALASSETSlGURE4HEREISNOCHANGEONTHEEQUITIESSIDEOF THEEQUATION PROVINGTHATALTHOUGHTWOITEMSMUSTCHANGE THEYCANBOTHBEON THESAMESIDEOFTHEACCOUNTINGEQUATION PROVIDEDTHATTHERESULTSTILLBALANCES4HE ACCOUNTINGEQUATIONFOR)MELDAS3HOE3HOPAFTERTRANSACTIONISSHOWNIN&IGURE  Figure 2.6 Accounting equation 3 Assets

$

$

Liabilities Creditors

$

$

Bank

8 000

45 000

Stock

45 000

Owner’s Equity

Shop Fittings

12 000

Capital – Imelda

20 000

Total Assets

65 000

Total Equities

65 000

%ACHANDEVERYTRANSACTIONWILLHAVEATLEASTTWOEFFECTSONTHEACCOUNTING EQUATIONAND AFTERTHESEEFFECTSHAVEBEENRECORDED THEEQUATIONMUSTBALANCE )FITDOESNOTBALANCE THENTHERECORDINGISINCORRECT REVIEW QUESTIONS 2.4

1 Explain WHYTHEACCOUNTINGEQUATIONMUSTBEREDRAWNAFTEREVERYTRANSACTION 2 State THETWORULESOFDOUBLE ENTRYACCOUNTING

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

WHERE HAVE WE BEEN? s s

s s s

s

s

s

EXERCISES

!SSETSARERESOURCESCONTROLLEDBYTHE%NTITYASARESULTOFPASTEVENTS FROMWHICH AFUTUREECONOMICBENElTISEXPECTEDTOmOWTOTHE%NTITY ,IABILITIES ARE PRESENT OBLIGATIONS OF THE %NTITY ARISING FROM PAST EVENTS THE SETTLEMENT OF WHICH IS EXPECTED TO RESULT IN AN OUTmOW OF RESOURCES EMBODYING ECONOMICBENElTS /WNERSEQUITYISTHERESIDUALINTERESTINTHEASSETSOFTHE%NTITYAFTERTHEDEDUCTION OFITSLIABILITIES 4HEACCOUNTINGEQUATIONIS@!SSETS,IABILITIES/WNERS%QUITY ANDITMUSTALWAYS BALANCE 4HE "ALANCE 3HEET IS AN ACCOUNTING REPORT THAT DETAILS THE BUSINESSS ASSETS LIABILITIESANDOWNERSEQUITYATAPARTICULARPOINTINTIME ANDISAREmECTIONOFTHE lRMSACCOUNTINGEQUATION !SSETSARECLASSIlEDASCURRENTIFTHEYAREEXPECTEDTOPROVIDEANECONOMICBENElT INTHENEXTMONTHS!SSETSTHATPROVIDEANECONOMICBENElTFORMORETHAN MONTHSARECLASSIlEDASNON CURRENT ,IABILITIESARECLASSIlEDASCURRENTIFITISEXPECTEDTHEYWILLBESETTLEDINTHENEXT MONTHS,IABILITIESTHATWILLBESETTLEDINLONGERTHANMONTHSARECLASSIlEDAS NON CURRENT $OUBLE ENTRYACCOUNTINGMEANSEACHANDEVERYTRANSACTIONWILLHAVEATLEASTTWO EFFECTSONTHEACCOUNTINGEQUATION ANDAFTERTHESEEFFECTSHAVEBEENRECORDEDTHE ACCOUNTINGEQUATIONMUSTBALANCE

EXERCISE 2.1 CLASSIFYING ITEMS

W B

page 18

ClassifyEACHOFTHEFOLLOWINGITEMSASASSETSORLIABILITIES ANDASCURRENTOR NON CURRENT s CREDITORS s BANKOVERDRAFT s CASHONHAND s CAPITAL s DEBTORS s EQUIPMENT s MORTGAGEOWINGONPREMISESFORBOTHTHISYEARANDREMAINDER s PREMISES s STOCK s VEHICLES s WAGESOWINGTOEMPLOYEES s RENTPAIDINADVANCE s '34PAYABLE

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T H E A C C O U N T I N G E Q U AT I O N

EXERCISE 2.2 BALANCE SHEET

W B

page 19

-ARK&LORENCEISTHEOWNEROF0ONTE*EWELLERS ANDHASPROVIDEDTHEFOLLOWINGLISTOFTHE lRMSASSETSANDLIABILITIESASAT-AY 3TOCK #REDITORS ,OANn.!"REPAYABLE 3HOP&ITTINGS "ANK $EBTORS /FlCE%QUIPMENT

      

Required

*

a b c d

ExplainWHATISMEANTBYTHETERM@EQUITIES Calculate#APITALASAT-AY PrepareACLASSIlED"ALANCE3HEETFOR0ONTE*EWELLERSASAT-AY 2EFERRINGTOYOURANSWERTOPART@C explainYOURTREATMENTOF#REDITORS

EXERCISE 2.3 BALANCE SHEET

W B

page 20

'REG-ILLEROWNS'REGS'ARDENING3UPPLIESANDHASPROVIDEDTHEFOLLOWINGINFORMATION ASAT*ANUARY Item

$

Item

$

Term Deposit (matures 2020)

8 000

Bank

700

Debtors

2 490

Creditors

Wages Owing Stock

600 50 000

1 400

Motor Vehicle

22 000

Loan from ANZ due 2025 (repayable $2 000 p.a.)

36 000

Required

*

a Calculate#APITALASAT*ANUARY b PrepareACLASSIlED"ALANCE3HEETFOR'REGS'ARDENING3UPPLIESASAT*ANUARY  c 2EFERRINGTOYOURANSWERTOPART@B explainYOURTREATMENTOF3TOCK d 4HE MOTOR VEHICLE IS THREE YEARS OLD AND THE OWNER HAS ESTIMATED ITS VALUE AT  RATHERTHANASLISTEDINTHE"ALANCE3HEETDiscuss HOWTHEMOTOR VEHICLESHOULDBEVALUED CITINGATLEASTTWOQUALITATIVECHARACTERISTICSINYOURANSWER

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UNITS 3&4

EXERCISE 2.4 BALANCE SHEET

W B

page 21

,AURA$ESTIOOWNS-ALLACOOTA7INESANDHASPROVIDEDTHEFOLLOWINGINFORMATIONASAT *UNE Item

$

Item

Bank Overdraft

2 500

Shelving

43 000

Mortgage

60 000

Debtors

10 500

Stock

12 000

Creditors

5 000

Premises

100 000

$

GST Payable

1 700

Note: 4HEMORTGAGEISREPAYABLEINQUARTERLYINSTALMENTSOF Required

*

a PrepareACLASSIlED"ALANCE3HEETFOR-ALLACOOTA7INESASAT*UNE b ExplainWHYA"ALANCE3HEETISTITLED@ASAT c ExplainYOURTREATMENTOF s $EBTORS s "ANK/VERDRAFT d StateTWOEXTERNALUSERSWHOMIGHTBEINTERESTEDINTHIS"ALANCE3HEET

EXERCISE 2.5 TRANSACTIONS AND THE ACCOUNTING EQUATION

W B

page 23

State THEEFFECTEACHOFTHEFOLLOWINGTRANSACTIONSHASONTHEACCOUNTINGEQUATION s ALOANFORWASRECEIVEDFROM!.:"ANK s OFlCEFURNITUREWORTHWASPURCHASEDONCREDITFROM(0%NTERPRISES s ACREDITORWASPAID s THEOWNERCONTRIBUTEDTOTHEBUSINESSAVEHICLEWORTH s WASPAIDOFFTHELOANPRINCIPAL s STOCKWORTHWASPURCHASEDWITHCASH s WASRECEIVEDFROMADEBTOR

EXERCISE 2.6 TRANSACTIONS AND THE BALANCE SHEET

W B

page 24

!SAT-ARCH THEASSETSANDLIABILITIESOF0ETES0AINT%MPORIUMWEREASFOLLOWS Assets

$

Equities

$

Bank

2 300

Creditors

9 000

Debtors

8 000

Wages Owing

2 000

Fixtures and Fittings

18 000

Delivery Van

25 000

Stock

24 000

Capital – Pete

?

Total Assets

77 300

Total Equities

77 300

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CHAPTER 2

T H E A C C O U N T I N G E Q U AT I O N

)NTHElRSTWEEKOF!PRIL THEFOLLOWINGTRANSACTIONSOCCURRED Apr.

1

Paid $3 000 to a creditor.

2

Borrowed $28 000 cash from the NAB, which was used to purchase another van. The loan is to be repaid in monthly instalments of $1 000, commencing in May 2015.

3

Received $2 400 from a debtor.

4

Pete withdrew $1 500 worth of paint for his own purposes.

5

Paid the wages owing.

6

Pete contributed to the business his personal computer. Pete had paid $4 600 but its agreed value on this date was $4 000.

Required

*

a Calculate#APITALASAT-ARCH b ExplainWHYTHECOMPUTERCONTRIBUTEDON!PRILMUSTBEVALUEDAT c Prepare A TABLE TO SHOW THE EFFECT OF EACH TRANSACTION ON THE "ALANCE 3HEET OF 0ETES0AINT%MPORIUM d PrepareACLASSIlED"ALANCE3HEETFOR0ETES0AINT%MPORIUMASAT!PRIL

EXERCISE 2.7 TRANSACTIONS AND THE BALANCE SHEET

W B

page 26

!SAT3EPTEMBER THEASSETSANDLIABILITIESOF3AM"OOKER,IQUORWEREASFOLLOWS Assets

$

Debtors

3 000

Equities

$

Bank Overdraft

2 500 7 000

Fixtures and Fittings

15 000

Creditors

Stock

25 000

Loan – ANZ (repayable $6 000 p.a)

Fridges

40 000

Capital – Sam

?

Total Assets

83 000

Total Equities

83 000

36 000

)NTHElRSTWEEKOF/CTOBER THEFOLLOWINGTRANSACTIONSOCCURRED Oct.

1

Paid $2 000 to a creditor.

2

Sam contributed $5 000 of his own money to the business.

3

Paid $3 000 off the loan principal.

4

Purchased stock on credit for $10 000.

5

Sam took $2 500 of the fixtures and fittings home for personal use.

6

Paid $1 200 rent in advance for the next 6 months.

Required

*

a PrepareATABLETOSHOWTHEEFFECTOFEACHTRANSACTIONONTHE"ALANCE3HEETOF3AM "OOKER,IQUOR b PrepareACLASSIlED"ALANCE3HEETFOR3AM"OOKER,IQUORASAT/CTOBER c 2EFERRINGTOYOURANSWERTOPART@B explainYOURTREATMENTOF2ENTPAIDINADVANCE

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33

Where are we headed? After completing this chapter, you should be able to: s explainTHEROLEOFTHE 'ENERAL,EDGER s applyTHERULESOFDOUBLE ENTRYACCOUNTINGTOTHE 'ENERAL,EDGER s recordTRANSACTIONSINTHE 'ENERAL,EDGER s explainTHEROLEOFACROSS REFERENCE s explainTHERELATIONSHIP BETWEENOWNERSEQUITYAND REVENUESANDEXPENSES

s recordOPENINGBALANCESIN THE'ENERAL,EDGER s recordCASHANDCREDITSALES OFSTOCKINTHE'ENERAL ,EDGER s stateTHEEFFECTOFCASHAND CREDITSALESONTHEACCOUNTING EQUATION s footLEDGERACCOUNTS s prepareA4RIAL"ALANCE s balanceLEDGERACCOUNTS

CHAPTER 3

THE GENERAL LEDGER KEY TERMS After completing this chapter, you should be familiar with the following terms: s LEDGERACCOUNT s 'ENERAL,EDGER s CROSS REFERENCE s 4RIAL"ALANCE s FOOTING s BALANCING

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CAMBRIDGE VCE ACCOUNTING

36

3.1

ledger accounts accounting records showing all the transactions that affect a particular item

General Ledger the collective name for the main group of ledger accounts

UNITS 3&4

LEDGER ACCOUNTS

#HAPTERINTRODUCEDTHECONCEPTOFDOUBLE ENTRYACCOUNTINGnTHEPRINCIPLETHATFOR EVERYBUSINESSTRANSACTION THEREWILLBEATLEASTTWOEFFECTSONTHEACCOUNTINGEQUATION 4HISWASILLUSTRATEDBYANYNUMBEROFTRANSACTIONS EACHOFWHICHREQUIREDAREDRAWING OFTHEACCOUNTINGEQUATIONTOREmECTHOWITSCOMPONENTSHADCHANGED )T MAY HAVE OCCURRED TO YOU THAT REWRITING THE ACCOUNTING EQUATION AFTER EVERY TRANSACTIONWOULDNOTBEPRACTICALFORAREAL FUNCTIONINGSMALLBUSINESS)NADDITION THE ACCOUNTANTORBOOKKEEPERWOULDPROBABLYlNDITVERYREPETITIVEANDBORING 4HIS IS PARTICULARLY THE CASE WHEN WE CONSIDER THAT ALTHOUGH EVERY TRANSACTION WILL CHANGE TWO ITEMS IN THE ACCOUNTING EQUATION THERE MAY WELL BE A LARGE NUMBER OF ITEMSTHATDOnotCHANGE&ORINSTANCE ACREDITPURCHASEOFSTOCKWILLINCREASE3TOCK ASSET AND #REDITORS LIABILITY BUT WILL HAVE NO EFFECT WHATSOEVER ON "ANK $EBTORS ,OANSOREVEN#APITAL4HEREMAYBEMANYITEMSTHATDONOTNEEDTOBECHANGED BUT THEYWILLSTILLNEEDTOBEREWRITTENINANUPDATEDVERSIONOFTHEACCOUNTINGEQUATION 4HECHALLENGETHENISTODEVELOPANACCOUNTINGSYSTEMTHATISCAPABLEOFRECORDING CHANGESINTHEACCOUNTINGEQUATION WITHOUTREQUIRINGTHATTHEACCOUNTINGEQUATIONBE REWRITTENEVERYTIME4HERESPONSETOTHISCHALLENGEISTORECORDTRANSACTIONSINledger accounts

What are ledger accounts? !TITSMOSTBASIC ALEDGERACCOUNTISSIMPLYANACCOUNTINGRECORDLIKEAPAGEINABOOK WHERETRANSACTIONSAREWRITTENDOWN WITHASEPARATELEDGERACCOUNTORPAGE FOREACH ITEMINTHElRMSRECORDS4HATIS THEREWILLBEALEDGERACCOUNTFOR"ANK ANDASEPARATE LEDGERACCOUNTFOREACHOF3TOCK $EBTORS #REDITORS ,OANS #APITAL ETC)FTHEBUSINESS HASITEMSINITSREPORTS ITWILLNEEDLEDGERACCOUNTS#OLLECTIVELY THISGROUPOF LEDGERACCOUNTSISKNOWNASTHEGeneral Ledger %ACHINDIVIDUALACCOUNTWILLRECORDALLINCREASESORDECREASESINTHATPARTICULARITEM &ORINSTANCE THE"ANKLEDGERACCOUNTWILLRECORDALLMOVEMENTSOFCASHINANDOUTOF THElRMSBANKACCOUNTTHE3TOCKLEDGERACCOUNTWILLRECORDALLMOVEMENTSOFSTOCK INANDOUTOFTHEBUSINESSTHE#REDITORS,EDGERACCOUNTWILLRECORDALLINCREASESAND DECREASESINWHATTHElRMOWESTOITSSUPPLIERS %ACHTRANSACTIONCHANGESATLEASTTWOITEMSINTHEACCOUNTINGEQUATION SOATLEAST TWOLEDGERACCOUNTSWILLNEEDTOBECHANGED"YRECORDINGEACHTRANSACTIONONLYINTHE LEDGERACCOUNTSOFTHETWOITEMSTHATAREAFFECTED THECHANGESTOTHEACCOUNTINGEQUATION CANBERECORDEDWITHOUTHAVINGTOREWRITEEVERYITEMINTHATACCOUNTINGEQUATION

The T-form account !4 FORMACCOUNTISCREATEDBYDIVIDINGTHEPAGEINTOTWOCOLUMNS4HELEFT HANDCOLUMN ISLABELLEDTHEDEBITCOLUMNORDEBITSIDE ANDTHERIGHT HANDCOLUMNISLABELLEDTHE CREDITCOLUMNORCREDITSIDE &IGURESHOWSTHEFORMATOFA4 FORMACCOUNT Figure 3.1 T-form account Name of item/account $EBITCOLUMNSIDE (Dr)

#REDITCOLUMNSIDE (Cr)

4HEWORD@DEBITINTHISCONTEXTSIMPLYMEANSTHELEFTSIDEOFALEDGERACCOUNT AND @CREDITMEANSTHERIGHTSIDEOFALEDGERACCOUNTNEITHERONESHOULDBETHOUGHTOFAS GOODORBAD/NEOFTHESECOLUMNSWILLBEUSEDTORECORDINCREASESINTHEVALUEOFTHE ITEMTHEOTHERWILLBEUSEDTORECORDDECREASES ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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CHAPTER 3

THE GENERAL LEDGER

REVIEW QUESTIONS 3.1

1 Explain the role of a ledger account. 2 In reference to ledger accounts, define the following terms: s 'ENERAL,EDGER s DEBITSIDE s CREDITSIDE

3.2

DOUBLE-ENTRY RECORDING IN LEDGER ACCOUNTS

4HEREARESETRULESFORRECORDINGTRANSACTIONSINLEDGERACCOUNTS RULESTHATAPPLYTHE CONCEPTSOFDOUBLE ENTRYRECORDINGANDPRESERVETHEACCOUNTINGEQUATION *UST AS EVERY TRANSACTION WILL AFFECT AT LEAST TWO ITEMS IN THE ACCOUNTING EQUATION EVERY TRANSACTION WILL AFFECT AT LEAST TWO LEDGER ACCOUNTS )N ORDER TO ENSURE THAT THE ACCOUNTING EQUATION REMAINS IN BALANCE THE TRANSACTION MUST BE RECORDED IN ONE OF THOSELEDGERACCOUNTSONTHEDEBITSIDE ANDINTHEOTHERONTHECREDITSIDE4HERULES FORRECORDINGINLEDGERACCOUNTSARESHOWNBELOW Double-entry rules 1 Every transaction must be recorded in at least two ledger accounts. 2 Every transaction must be recorded on the debit side of one ledger account and the credit side of another. 'IVEN THAT EVERY TRANSACTION MUST BE RECORDED ON THE DEBIT SIDE OF ONE LEDGER ACCOUNT AND THE CREDIT SIDE OF ANOTHER THE MOST OBVIOUS QUESTION IS WHEN ARE TRANSACTIONSRECORDEDONTHEDEBITSIDE ANDWHENARETHEYRECORDEDONTHECREDITSIDE 5NFORTUNATELY THEREISNOONEANSWERASITDEPENDSONWHATTYPEOFITEMISINQUESTION &ORTUNATELY JUSTASA4 FORMACCOUNTLOOKSLIKEA"ALANCE3HEET THERULESFORRECORDING INALEDGERACCOUNTFOLLOWASIMILARPATTERN

Assets !SSETITEMSAPPEARONTHEleftSIDEOFTHE"ALANCE3HEET SOTORECORDANINCREASEIN ANASSETRECORDTHETRANSACTIONONTHEdebitSIDEOFTHATLEDGERACCOUNT"YTHELAWOF OPPOSITES DECREASESMUSTBERECORDEDONTHECREDITSIDE Bank (Asset) )NCREASESARERECORDEDONTHE debit side

$ECREASESARERECORDEDONTHE credit side

Liabilities and owner’s equity ,IABILITIESANDOWNERSEQUITYITEMSAPPEARONTHErightSIDEOFTHE"ALANCE3HEET SO TORECORDANINCREASEINALIABILITYOROWNERSEQUITYRECORDTHETRANSACTIONONTHEcredit SIDEOFTHATLEDGERACCOUNT"YTHELAWOFOPPOSITES DECREASESMUSTBERECORDEDON THEDEBITSIDE Creditors (Liability) $ECREASESARERECORDEDONTHE debit side

)NCREASESARERECORDEDONTHE credit side

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38

UNITS 3&4

Capital (Owner’s Equity) $ECREASESARERECORDEDONTHE debit side

)NCREASESARERECORDEDONTHE credit side

REVIEW QUESTIONS 3.2

1 State the two rules of recording in ledger accounts. 2 Identify on which side of a ledger account a transaction would be recorded in order to: s INCREASEANASSETACCOUNT s DECREASEANASSETACCOUNT s INCREASEALIABILITYOROWNERSEQUITYACCOUNT s DECREASEALIABILITYOROWNERSEQUITYACCOUNT

3.3

RECORDING LEDGER ENTRIES

,ETSEXAMINEASIMPLETRANSACTIONTOSEEHOWITWOULDBERECORDEDINLEDGERACCOUNTS

EXAMPLE

Jan. 1

Bill Brighton deposited $40 000 of his own funds in a business bank account to commence business operations as Bright Books.

7HATLEDGERENTRIESAREREQUIREDTORECORDTHISTRANSACTION&IRST THEDEPOSITBYTHE OWNER MEANS THAT THE lRMS "ANK IS INCREASING "ECAUSE "ANK IS AN ASSET WHICH WILL APPEARONTHEleftSIDEOFTHE"ALANCE3HEET THEINCREASEMUSTBERECORDED ONTHELEFTSIDEnthe debit sidenOFTHISLEDGERACCOUNT4HISWOULDBEDESCRIBEDAS debitingTHE"ANKACCOUNT Bank (A) Date

Cross-reference

Jan. 1

Amount $

Date

Cross-reference

Amount $

40 000

!TTHESAMETIME THEFACTTHATTHECASHHASCOMEFROMTHEOWNERMEANSTHAT#APITAL ISINCREASING!SANOWNERSEQUITYITEM #APITALWOULDAPPEARONTHErightSIDEOFTHE "ALANCE3HEET SOTHEINCREASEMUSTBERECORDEDONTHERIGHTSIDEnthe credit sidenOF THE#APITALLEDGERACCOUNT4HISWOULDBEDESCRIBEDAScreditingTHE#APITALACCOUNT Capital (OE) Date

Cross-reference

Amount $

Date

Cross-reference

Jan. 1

Amount $ 40 000

/NETRANSACTIONHASPRODUCEDANEFFECTONTWODIFFERENTACCOUNTS WITHONEENTRY ONTHEDEBITSIDEINTHE"ANKACCOUNT ANDONEENTRYONTHECREDITSIDEINTHE#APITAL ACCOUNT 

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CHAPTER 3

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39

The cross-reference .OTE HOW EACH ENTRY IN THIS EXAMPLE SHOWS BOTH THE DATE OF THE TRANSACTION AND ITS AMOUNT)THASPROBABLYNOTESCAPEDYOURATTENTIONTHATTHEREISAGAPINGHOLEINEACH OF THE LEDGER ACCOUNTS SHOWN n A HOLE THAT SEEMS TO REQUIRE AN ADDITIONAL PIECE OF INFORMATION)FITHADINITIALLYESCAPEDYOURATTENTION ITSHOULDBEOBVIOUSNOWTHATIT HASBEENPOINTEDOUT
4HISSPACEBETWEENTHEDATEANDTHEAMOUNTOFEACHTRANSACTIONISUSEDTORECORD WHAT IS KNOWN AS THE cross-reference "ECAUSE EACH TRANSACTION AFFECTS TWO LEDGER ACCOUNTS AT THE SAME TIME THESE ACCOUNTS ARE LINKED 4HE CROSS REFERENCE SPECIlES THELINKBETWEENTHESETWOACCOUNTSBYIDENTIFYINGTHEotherACCOUNTAFFECTED)NTHE "ANKACCOUNT FOREXAMPLE THECROSS REFERENCEWOULDBE@#APITAL WHILEINTHE#APITAL ACCOUNTTHECROSS REFERENCEWOULDBE@"ANK 4HETWOACCOUNTSnWITHTHEIRCROSS REFERENCESNOWENTEREDnWOULDSHOW

cross-reference the name of the other account affected by a transaction, so that both accounts affected by a particular transaction can be identified

Bank (A) Date Jan. 1

Cross-reference Capital

Amount $ Date

Cross-reference

Amount $

Cross-reference

Amount $

40 000 Capital (OE)

Date

Cross-reference

Amount $ Date Jan. 1

Bank

40 000

)T IS THE amount NOT THE CROSS REFERENCE THAT DETERMINES WHETHER AN ACCOUNT HAS BEENDEBITEDORCREDITED)NTHISEXAMPLE THEAPPEARSONTHELEFTSIDEOFTHE "ANKACCOUNT SOITISTHISACCOUNTTHATHASBEENDEBITED4HECROSS REFERENCE@#APITAL APPEARSONLYTOSHOWTHENAMEOFTHEotherACCOUNTAFFECTEDBYTHATPARTICULARTRANSACTION

More examples #ONTINUINGWITHTHELEDGERACCOUNTSUSEDABOVE THEFOLLOWINGTRANSACTIONSWOULDBE RECORDEDINTHELEDGERACCOUNTSASFOLLOWS Jan. 2

Purchased $12 000 worth of stock on credit

4HIS TRANSACTION WILL INCREASE 3TOCK ASSET AND SIMULTANEOUSLY INCREASE #REDITORS LIABILITY "ECAUSE3TOCKISANASSETLEFT HANDSIDEOFTHE"ALANCE3HEET INCREASESMUST BERECORDEDONTHEdebitSIDEOFTHEACCOUNT#REDITORS ONTHEOTHERHAND ISALIABILITY RIGHT HANDSIDEOFTHE"ALANCE3HEET SOINCREASESINTHISACCOUNTMUSTBERECORDED ONTHEcreditSIDE !LTHOUGH IT IS LIKELY THAT THERE WILL BE MORE THAN ONE 3TOCK ITEM ALL TRANSACTIONS AFFECTING 3TOCK WILL BE RECORDED IN THE SAME 'ENERAL ,EDGER ACCOUNT CALLED @3TOCK #ONTROL 4HE SAME WILL APPLY FOR CREDITORS WHICH WILL BE RECORDED IN THE @#REDITORS #ONTROLACCOUNT ANDFORDEBTORSUSINGTHE@$EBTORS#ONTROLACCOUNT Jan. 3

Borrowed $20 000 from Sunbank

4HISTRANSACTIONINCREASES"ANKASSET VIAAdebitTOTHATACCOUNT ANDALSOINCREASES ,OANn3UNBANKLIABILITY VIAACORRESPONDINGcreditTOTHATACCOUNT Jan. 4

Paid $15 000 cash for a van to use for business deliveries

!LTHOUGH"ANKISANASSETANDWOULDNORMALLYAPPEARONTHELEFTSIDEOFTHE"ALANCE 3HEET THIS TRANSACTION ACTUALLY INVOLVES A decrease TO THAT ITEM 4HIS DECREASE MUST THEREFOREBERECORDEDONTHEcreditSIDEOFTHE"ANKACCOUNT4HEINCREASETOASSETSIN THEFORMOFTHE6ANWOULDBERECORDEDONTHEdebitSIDEASUSUAL ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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UNITS 3&4

4HELEDGERACCOUNTSINTHE'ENERAL,EDGERWOULDTHENAPPEARASSHOWNIN&IGURE Figure 3.2 General Ledger accounts General Ledger Bank (A) Date

Cross-reference

Jan. 1 3

Amount $

Capital

40 000

Loan – Sunbank

20 000

Date Jan. 4

Cross-reference Van

Amount $ 15 000

Capital (OE) Date

Cross-reference

Amount $

Date Jan. 1

Cross-reference Bank

Amount $ 40 000

Stock Control (A) Date Jan. 2

Cross-reference

Amount $

Creditors Control

12 000

Date

Cross-reference

Amount $

Cross-reference

Amount $

Creditors Control (L) Date

Cross-reference

Amount $

Date Jan. 2

Stock Control

12 000

Loan – Sunbank (L) Date

Cross-reference

Amount $

Date Jan. 3

Cross-reference Bank

Amount $ 20 000

Van (A) Date

Cross-reference

Jan. 4

Bank

Amount $

Date

Cross-reference

Amount $

15 000

%VERYTRANSACTIONHASBEENRECORDEDASAdebitENTRYINONEACCOUNT ANDAcredit ENTRYINANOTHERACCOUNT ENSURINGTHATTHELEDGERRULESAREUPHELD!SSTATEDBEFORE THESERULESAREASFOLLOWS s s

!TLEASTTWOLEDGERACCOUNTSAREAFFECTED 4HEREISADEBITENTRYANDACREDITENTRYFOREVERYTRANSACTION

3.4

RECORDING RULES FOR REVENUES AND EXPENSES

4HELEDGERRULESFORRECORDINGREVENUESANDEXPENSESCANBEDETERMINEDBYREFERRING TOTHEIRRELATIONSHIPTOOWNERSEQUITY

Revenue 2EVENUEREPRESENTSANincreaseINOWNERSEQUITYITIS INFACT PARTOFTHEDElNITION SOTHERULESFORRECORDINGREVENUEARETHESAMEASTHOSEFORRECORDINGANINCREASEIN OWNERSEQUITY2EMEMBER INCREASESINOWNERSEQUITYARERECORDEDONTHECREDITSIDE SO TO RECORD AN increase IN REVENUE RECORD THE TRANSACTION ON THE credit side OF THE LEDGERACCOUNT"YTHELAWOFOPPOSITES DECREASESMUSTBERECORDEDONTHEDEBITSIDE

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CHAPTER 3

THE GENERAL LEDGER

41

Cash Sales (Revenue) $ECREASESARERECORDEDONTHE debit side

)NCREASESARERECORDEDONTHE credit side STUDY TIP

Expenses %XPENSESREPRESENTAdecreaseINOWNERSEQUITYAGAIN ASDICTATEDBYTHEDElNITION SOTHERULESFORRECORDINGEXPENSESARETHESAMEASTHOSEFORRECORDINGADECREASEIN OWNERSEQUITY$ECREASESINOWNERSEQUITYARERECORDEDONTHEDEBITSIDE SOTORECORD ANINCREASEINEXPENSES RECORDTHETRANSACTIONONTHEdebitSIDEOFTHELEDGERACCOUNT /NCEAGAIN THELAWOFOPPOSITESMEANSDECREASESMUSTBERECORDEDONTHECREDITSIDE

2EVENUESANDEXPENSES ARERECORDEDON OPPOSITESIDESOFTHE LEDGERREVENUESONTHE CREDITSIDEEXPENSESON THEDEBITSIDE

Wages (Expense) )NCREASESARERECORDEDONTHE debit side

$ECREASESARERECORDEDONTHE credit side

EXAMPLE

Continuing with the earlier example, the following transactions occurred: Jan. 5 6

Received $600 commission from a publisher Paid wages $1 200

4HESEREVENUEANDEXPENSETRANSACTIONSWOULDBERECORDEDINTHE'ENERAL,EDGER ASISSHOWNIN&IGURE Figure 3.3 General Ledger: recording revenues and expenses General Ledger Bank(A) Date Jan. 1

Cross-reference

Amount $

Date

Capital

40 000

Jan. 4

3

Loan – Sunbank

20 000

6

5

Commission Revenue

Cross-reference Van

Amount $ 15 000

Wages

1 200

600 Commission Revenue (R)

Date

Cross-reference

Amount $

Date Jan. 5

Cross-reference

Amount $

Bank

600

Wages (E) Date Jan. 6

Cross-reference Bank

Amount $

Date

Cross-reference

Amount $

1 200

&IGUREONTHENEXTPAGE SUMMARISESHOWTORECORDANINCREASEORDECREASEIN EACHTYPEOFLEDGERACCOUNT

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UNITS 3&4

Figure 3.4 Summary of ledger entries Type of account

Increase

Decrease

Asset

Debit side

Credit side

Liability

Credit side

Debit side

/WNERS%QUITY

Credit side

Debit side

Revenue

Credit side

Debit side

Expense

Debit side

Credit side

Recording procedure

Analysing Chart a tool used to identify the steps for recording transactions in the General Ledger

5NTILTHESERECORDINGRULESBECOMESECONDNATUREWHICHTHEYWILLAND INFACT MUST IT MAYBEWORTHWHILETOFOLLOWTHEFOURSIMPLESTEPSOUTLINEDBELOW  )DENTIFYTHEITEMSACCOUNTSAFFECTED2EMEMBERTHEREWILLBEATLEASTTWO  )DENTIFYWHATTYPEOFACCOUNTSTHEYAREn!,/%2%  )DENTIFYWHETHERTHEYAREINCREASINGORDECREASING  5SETHETABLETOIDENTIFYWHETHERTHEACCOUNTSHOULDBEDEBITEDORCREDITED 4HISPROCEDURECANBEFOLLOWEDBYCOMPLETINGWHATISKNOWNASANAnalysing Chart 4HE!NALYSING#HARTFORTHESIXTRANSACTIONSDESCRIBEDEARLIERISSHOWNIN&IGURE Figure 3.5 Analysing Chart Date Jan. 1

Accounts affected Bank Capital

Jan. 2

Stock Control Creditors Control

Jan. 3

Bank Loan – Sunbank

Jan. 4

Van Bank

Jan. 5

Bank Commission Revenue

Jan. 6

Wages Bank

Type of account

Increase/ Decrease

Debit $

Asset

Increase

40 000

/WNERS%QUITY

Increase

Asset

Increase

Liability

Increase

Asset

Increase

Liability

Increase

Asset

Increase

Asset

Decrease

Asset

Increase

Revenue

Increase

Expense

Increase

Asset

Decrease

Credit $

40 000 12 000 12 000 20 000 20 000 15 000 15 000 600 600 1 200 1 200

"YCONVENTION THEDEBITENTRYISSHOWNlRST ANDTHESECONDENTRYISINDENTEDSLIGHTLY TOEMPHASISETHATITISTHECREDITENTRY 4HE!NALYSING#HARTISNOTANACCOUNTINGRECORDITISSIMPLYATOOLYOUMAYUSEUNTIL YOULEARNTHELEDGERENTRIES LIKETRAININGWHEELSWHENYOULEARNTORIDEABIKE7HEN YOUFEELTHATYOUKNOWTHELEDGERRULESnANDCANBALANCEONYOUROWNTWOWHEELSnYOU CANSTOPUSINGTHE!NALYSING#HARTANDRECORDTHETRANSACTIONSSTRAIGHTINTOTHELEDGER ACCOUNTS

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43

REVIEW QUESTIONS 3.4

1 2EFERRINGTOTHEIRRELATIONSHIPTOOWNERSEQUITY, explain why: s REVENUEACCOUNTSINCREASEONTHECREDITSIDE s EXPENSEACCOUNTSINCREASEONTHEDEBITSIDE 2 Draw a table to summarise the rules for recording in ledger accounts. 3 Explain the role of an Analysing Chart.

3.5

SOME CHALLENGING ENTRIES

Opening balances 7HENLEDGERACCOUNTSARESTARTEDFORABUSINESSTHATHASALREADYBEENTRADINGFORSOME TIME THEREWILLBEPRE EXISTINGBALANCESFORITEMSINITSREPORTS4HESEBALANCESMUST BEENTEREDINTHELEDGERACCOUNTSBEFOREANYNEWTRANSACTIONSCANBERECORDED4HE NORMALRULESFORRECORDINGINLEDGERACCOUNTSSTILLAPPLY SUCHASINCREASEASSETSONTHE DEBITSIDE ANDINCREASELIABILITIESANDOWNERSEQUITYONTHECREDITSIDE(OWEVER THE BALANCESINEACHACCOUNTWILLBETHEPRODUCTOFANUMBEROFDIFFERENTTRANSACTIONS AND THUSWILLNOTBETRACEABLETOONESINGLEACCOUNT4HISMEANSTHATTHECROSS REFERENCECAN BESTATEDASSIMPLY@"ALANCE

EXAMPLE

The assets and equities of Mickelham Frames as at 1 July 2015 were as follows: Bank $ 1 000 Creditors Control $ 2 000 Stock Control 4 000 Capital – Malloy 20 000 Shelving 17 000

%VENWHENENTERINGOPENINGBALANCES APROPERDOUBLEENTRYMUSTSTILLBERECORDED WITHTOTALDEBITSEQUALLINGTOTALCREDITS&IGURESHOWSTHE!NALYSING#HARTTOENTER THESEOPENINGBALANCES Figure 3.6 Analysing Chart: opening balances Date July 1

Accounts affected

Type of account

Increase/ Decrease

Debit $

Credit $

Bank

Asset

Increase

1 000

Stock Control

Asset

Increase

4 000

Shelving

Asset

Increase

17 000

Creditors Control

Liability

Increase

2 000

Capital

/WNERS%QUITY

Increase

20 000

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UNITS 3&4

&IGURE  SHOWS HOW THESE OPENING BALANCES WOULD BE ENTERED IN THE LEDGER ACCOUNTS Figure 3.7 General Ledger: opening balances General Ledger Bank (A) Date July 1

Cross-reference Balance

Amount $

Date

Cross-reference

Amount $

Cross-reference

Amount $

Cross-reference

Amount $

Cross-reference

Amount $

1 000 Stock Control (A)

Date July 1

Cross-reference Balance

Amount $

Date

4 000 Shelving (A)

Date July 1

Cross-reference Balance

Amount $

Date

17 000 Creditors Control (L)

Date

Cross-reference

Amount $

Date July 1

Balance

2 000

Capital – Malloy (OE) STUDY TIP

Date

Cross-reference

Amount $

Date July 1

)FTHECAPITALFIGUREIS NOTGIVEN ITCANALWAYS BECALCULATEDUSINGTHE ACCOUNTINGEQUATION /%!n,

Cross-reference Balance

Amount $ 20 000

Cash sales (of stock) -OSTOFTHEENTRIESTHATHAVEBEENDEALTWITHTODATEHAVEHADONLYTWOEFFECTSONTHE LEDGERACCOUNTSONEDEBITENTRYANDONECREDITENTRY4HESALEOFSTOCKnWHETHERFOR CASHORONCREDITnISMORECOMPLICATEDBECAUSEITREQUIREStwoDOUBLEENTRIES 4HESIMPLEMECHANICSOFACASHSALEINVOLVETHEBUSINESSRECEIVINGTHECASH ANDTHE CUSTOMERRECEIVINGTHEGOODS"UTTHECASHANDTHEGOODSWILLBEVALUEDDIFFERENTLYTHE CASHWILLBEFORTHESELLINGPRICE WHILETHESTOCKWILLBEVALUEDATCOSTPRICE)NFACT ITIS THEDIFFERENCEBETWEENTHESETWOAMOUNTSTHATCREATESA'ROSS0ROlTFROMTHESALE&OR EXAMPLE GOODSPURCHASEDFORMAYBESOLDFOREARNING'ROSS0ROlT  "ECAUSETHEREAREtwo pricesTORECORD THEREAREtwo double entriesTORECORD

Figure 3.8 Cash sale of stock Cash Customer

Supplier Goods (stock)

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!CASHSALEWILLINCREASE"ANK WHICHMUSTBERECORDEDASADEBITTOTHISACCOUNT 4HECREDITENTRYCOMESFROMRECOGNISINGTHESOURCEOFTHATINCREASETHATIS THE3ALES REVENUEEARNED4HISTRANSACTIONWILLBERECORDEDATTHESELLINGPRICE )NADDITION ASALEOFSTOCKWILLDECREASE3TOCK#ONTROLBYCREDITINGTHISACCOUNT  )NEFFECT THISSTOCKHASBEENCONSUMED SOANEXPENSEMUSTBERECOGNISEDTORECORD THE VALUE OF THE STOCK CONSUMED OR SOLD 4HIS EXPENSE IS CALLED #OST OF 3ALES 4HIS TRANSACTIONWILLBERECORDEDATCOSTPRICE

July 7

EXAMPLE

Sold stock for $590 cash (cost price $320).

&IGURESHOWSHOWTHISSALEWOULDBEENTEREDINTHELEDGERACCOUNTS Figure 3.9 Analysing Chart: cash sale Date

Accounts affected

July 7

Bank

Type of account

Increase/ Decrease

A

Increase

Sales

R

Increase

Cost of Sales

E

Increase

A

Decrease

Stock Control

Debit $

Credit $

590 590 320 320

7HENSTOCKISSOLD THEasset3TOCK#ONTROL BECOMESANexpense#OSTOF3ALES  )NOTHERWORDS THESTOCKISNOLONGERAfutureECONOMICBENElT BECAUSEITSVALUEHAS BEENconsumed 4HECASHSALEWOULDBEPOSTEDTOTHE'ENERAL,EDGERASSHOWNIN&IGURE Figure 3.10 General Ledger: cash sale General Ledger Bank (A) Date

Cross-reference

July 1

Balance



Sales

Amount $

Date

Cross-reference

Amount $

Cross-reference

Amount $

1 000 590 Sales (R)

Date

Cross-reference

Amount $

Date July 7

Bank

590

Stock Control (A) Date July 1

Cross-reference Balance

Amount $

Date

4 000

July 7

Cross-reference

Amount $

Cost of Sales

320

Cost of Sales (E) Date July 7

Cross-reference Stock Control

Amount $

Date

Cross-reference

Amount $

320

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UNITS 3&4

Effect on the accounting equation !CASHSALETHUSHASTHEFOLLOWINGEFFECTONTHEACCOUNTINGEQUATION Increase/Decrease/No effect

Amount $

Assets

Increase (increase Bank $590, decrease Stock Control $320)

Liabilities

No effect

Owner’s Equity

Increase (Sales $590 less Cost of Sales $320 = Profit)

270

270

Credit sales ! CREDIT SALE IS ONE WHERE THE CUSTOMER TAKES THE GOODS BUT PROMISES TO PAY AT A LATERDATE!SWITHACASHSALE ACREDITSALEISREVENUEBECAUSEITCREATESANINmOWOF FUTUREECONOMICBENElTSINTHEFORMOFANINCREASEINASSETSTHATLEADSTOANINCREASE INOWNERSEQUITY4HEFACTTHATCASHHASNOTBEENRECEIVEDDOESNOTMEANTHATACREDIT SALEISNOTREVENUE4HEONLYDIFFERENCEISTHATFORACASHSALE THEINCREASEINASSETSISIN THEFORMOFcash ("ANK WHEREASFORACREDITSALE THEASSETISINTHEFORMOFANAMOUNT OWEDBYdebtors ($EBTORS#ONTROL 

EXAMPLE

July 12 Sold goods on credit for $720 (cost price $480)

&IGURESHOWSHOWTHISSALEWOULDBEENTEREDINTHELEDGERACCOUNTS Figure 3.11 Date July 12

Analysing Chart: recording a credit sale Accounts affected

Type of account

Debtors Control Sales Cost of Sales Stock Control

Increase/ Decrease

Debit $

A

Increase

720

R

Increase

E

Increase

A

Decrease

Credit $

720 480 480

#REDITSALESSHOULDBERECOGNISEDASREVENUEINTHE2EPORTING0ERIODWHENTHESALE ISMADE BECAUSEITISATTHISPOINTTHATTHEINmOWOFFUTUREECONOMICBENElTSnINTHE FORMOFTHEINCREASEDAMOUNTOWEDBYTHEDEBTORSnOCCURS ANDASACONSEQUENCETHE REVENUEISEARNED&AILINGTOINCLUDECREDITSALESASREVENUEWOULDBEOMITTINGFROMTHE )NCOME3TATEMENTANIMPORTANTANDRelevantPIECEOFINFORMATION Effect on the accounting equation !CREDITSALETHUSHASTHEFOLLOWINGEFFECTONTHEACCOUNTINGEQUATION Increase/Decrease/No effect

Amount $

Assets

)NCREASEINCREASE$EBTORS#ONTROL DECREASE3TOCK #ONTROL

Liabilities

.OEFFECT

Owner’s Equity

)NCREASE3ALESLESS#OSTOF3ALES0ROFIT

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CHAPTER 3

THE GENERAL LEDGER

47

Receipts from debtors 4HE MOST COMMON ERROR IN RECORDING CASH RECEIVED FROM A DEBTOR IS TO TREAT IT AS ADDITIONALREVENUE RATHERTHANASSIMPLYTHESWAPPINGOFONEASSET$EBTORS#ONTROL FOR ANOTHER "ANK  4HE FACT THAT ASSETS DO NOT INCREASE OVERALL MEANS THAT A RECEIPT FROMADEBTORcannotBERECORDEDASREVENUEITDOESNOTlTTHEDElNITION)NADDITION RECORDINGARECEIPTFROMADEBTORASREVENUEWOULDBEDOUBLE COUNTINGTHEREVENUE WASALREADYRECORDEDnASACREDITSALEnWHENITWASEARNEDTHATIS ATTHEPOINTOFSALE WHENTHEGOODSWEREPROVIDEDTOTHECUSTOMER &IGURESHOWSHOWTHISRECEIPTFROMADEBTORWOULDBEENTEREDINTHELEDGER ACCOUNTS

EXAMPLE

July 24 $500 was received from a debtor

Figure 3.12 Analysing Chart: receipt from a debtor Date July 24

Accounts affected

Type of account

Bank Debtors Control

Increase/ Decrease

A

Increase

A

Decrease

Debit $

Credit $

500 500

4HE CREDIT SALE and THE RECEIPT FROM THE DEBTOR WOULD BE POSTED TO THE 'ENERAL ,EDGERASSHOWNIN&IGURE Figure 3.13 General Ledger: credit sale and receipt from a debtor General Ledger Bank (A) Date

Cross-reference

July 1

Balance

7 24

Amount $

Date

Cross-reference

Amount $

Cross-reference

Amount $

1 000

Sales

590

Debtors Control

500 Debtors Control (A)

Date

Cross-reference

July 1

Balance

12

Sales

Amount $

Date

3 000

July 24

Bank

500

720 Sales (R)

Date

Cross-reference

Amount $

Date July 7 12

Cross-reference

Amount $

Bank

590

Debtors Control

720

Cross-reference

Amount $

Stock Control (A) Date July 1

Cross-reference

Amount $

Balance

4 000

Date July 7

Cost of Sales

320

12

Cost of Sales

480

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CAMBRIDGE VCE ACCOUNTING

48

UNITS 3&4

Figure 3.13 (cont.) General Ledger: credit sale and receipt from a debtor Cost of Sales (E) Date

Cross-reference

Amount $

July 7

Stock Control

320

12

Stock Control

480

Date

Cross-reference

Amount $

Drawings $RAWINGSREPRESENTSTHEVALUEOFTHEASSETSTHEOWNERHASWITHDRAWNFROMTHEBUSINESS !LTHOUGH IT IS CLASSIlED AS AN OWNERS EQUITY ACCOUNT BECAUSE IT RECORDS decreases IN OWNERS EQUITY IT IS IN FACT A negative OWNERS EQUITY ACCOUNT 4HIS ACCOUNT MUST THEREFOREBEdebitedWHENDRAWINGSOCCUR4HEACCOUNTTOBECREDITEDDEPENDSONTHE ASSETTHEOWNERHASWITHDRAWNIFCASHHASBEENWITHDRAWN "ANKWOULDBECREDITEDTO RECORDTHEDECREASEIFSTOCKHASBEENWITHDRAWN THEN3TOCK#ONTROLISCREDITED

EXAMPLE

July 28 Owner withdrew $650 in cash July 31 Owner took home stock worth $1200

&IGURESHOWSHOWTHESEDRAWINGSWOULDBEENTEREDINTHELEDGERACCOUNTS Figure 3.14 Analysing Chart: drawings Date July 28

Accounts affected

Type of account

Drawings

– OE

Increase

A

Decrease

– OE

Increase

A

Decrease

Bank 31

Drawings

Increase/ Decrease

Stock Control

Debit $

Credit $

650 650 1 200 1 200

4HESEENTRIESWOULDBEPOSTEDTOTHE'ENERAL,EDGERASSHOWNIN&IGURE Figure 3.15 General Ledger: drawings General Ledger Bank (A) Date

Cross-reference

July 1

Balance

7 24

Amount $

Date

1 000

July 28

Sales

590

Debtors Control

500

Cross-reference Drawings

Amount $ 650

Stock Control (A) Date

Cross-reference

July 1

Balance

Amount $ 4 000

Date

Cross-reference

Amount $

July 7

Cost of Sales

320

12

Cost of Sales

480

31

Drawings

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1 200

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CHAPTER 3

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49

Drawings (– OE) Date July 28 31

Cross-reference Bank

Amount $

Date

Cross-reference

Amount $

650

Stock Control

1 200

4OTALDRAWINGSnINTHISCASECASHANDWORTHOFSTOCK nISTHEN REPORTEDINTHE"ALANCE3HEETUNDERTHEHEADING@/WNERSEQUITY BUTASAdeduction FROM#APITAL ASISSHOWNIN&IGURE Figure 3.16 Balance Sheet: owner’s equity Balance Sheet (extract) as at 30 June 2015 Owner’s Equity

$

$

Capital Plus Net Profit

30 000 5 400 35 400 1 850

33 550

Less Drawings

REVIEW QUESTIONS 3.5

1 Show the debit and credit entries necessary to record: s ACASHSALESTOCK s ACREDITSALEOFSTOCK s ARECEIPTFROMADEBTOR s CASHDRAWINGS 2 Explain why a receipt from a debtor does not increase profit.

3.6

THE TRIAL BALANCE

/NCEALLTRANSACTIONSHAVEBEENRECORDEDINTHE'ENERAL,EDGER ITMUSTBECHECKEDTO SEETHATTHEACCOUNTINGEQUATIONSTILLBALANCESTHATIS THATTHETOTALDEBITSEQUALTHETOTAL CREDITS4HISCHECKISCARRIEDOUTBYPRESENTINGATrial Balance WHICHISALISTOFALLTHE LEDGERACCOUNTSANDTHEIRBALANCESTHEBALANCEBEINGTHENETAMOUNTLEFTINANACCOUNT

Footing an account Footing IS THE PROCESS OF CALCULATING THE BALANCE OF AN ACCOUNT AND INVOLVES THE FOLLOWINGSTEPS  !DDINGUPALLTHEAMOUNTSONTHEdebitSIDE ANDPENCILLINGTHETOTALBELOWTHE LASTDEBITAMOUNT  !DDINGUPALLTHEAMOUNTSONTHEcreditSIDE ANDPENCILLINGTHETOTALBELOWTHE LASTCREDITAMOUNT  $EDUCTINGTHESMALLERTOTALFROMTHELARGERTOTAL  0ENCILLINGTHISlGUREnTHEBALANCEnONTHEside of the larger total ANDDRAWING ACIRCLEAROUNDIT 4HISBALANCESHOULDNOTBEWRITTENINTHESAMECOLUMNASTHEOTHERAMOUNTS BECAUSE THISRISKSINADVERTENTLYANDINCORRECTLY COUNTINGITASANENTRY4HEBALANCESHOULDBE WRITTEN IN THE CROSS REFERENCE SECTION TO MAKE IT CLEAR THAT IT IS NOT AN entry BUT THE balanceOFTHEACCOUNT&IGURESHOWSHOWTHE"ANKACCOUNTWOULDBEFOOTED

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Trial Balance a list of all the accounts in the General Ledger, and their balances, to determine if total debits EQUALTOTALCREDITS footing an informal process used to determine the balance of a ledger account

Cambridge University Press

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

Figure 3.17 Footing an account Bank (A) Date March 1

Cross-reference Balance

Amount $

Date

12 500

March 3

Cross-reference

Amount $

Wages

4 000

15

Cash Sales

6 000

12

Rent

9 000

22

Debtors Control

3 400

25

Drawings

6 250

2 650 21 900

19 250

4HEBALANCEOFTHE"ANKACCOUNTISONTHEDEBITSIDE  /NCEALLTHEACCOUNTSHAVEBEENFOOTED THEBALANCESARELISTEDINTWOCOLUMNSONE FOR$EBITBALANCES ANDONEFOR#REDITBALANCES4HECOLUMNSARETHENTOTALLEDANDnIF THELEDGERRECORDINGISCORRECTnTHETOTALSSHOULDBETHESAME&IGURESHOWSTHE 4RIAL"ALANCEFOR#LACKS3HOE3HOPASAT-ARCH Figure 3.18 Trial Balance CLACK’S SHOE SHOP (PROP. G. CLACK) Trial Balance as at 31 March 2015 Account

Debit

Bank

2 650

Stock Control Debtors Control Shop Fittings

Credit

24 700 8 900 33 100

Creditors Control

6 500

Loan – KH Bank

40 000

Capital – Clack

19 450

Sales

13 000

Cost of Sales

5 600

Rent

1 500

Wages

2 100 400

Advertising Totals

78 950

78 950

Errors revealed )FTHE4RIAL"ALANCEDOESnotBALANCE THELEDGERENTRIESHAVENOTBEENRECORDEDCORRECTLY PERHAPSBECAUSE s 4WOENTRIESHAVEBEENRECORDEDONTHEsame sideOFTHE'ENERAL,EDGER FOREXAMPLE TWODEBITSORTWOCREDITS INSTEADOFONEDEBITANDONECREDIT  s /NLYone entryHASBEENRECORDEDFOREXAMPLE ONEDEBITENTRYWITHOUTA CORRESPONDINGCREDITENTRY ORVICEVERSA  s Different amountsHAVEBEENRECORDEDONEACHSIDEFOREXAMPLE ONTHE DEBITSIDE BUTONTHECREDITSIDE  )NTHISCASETHEENTRYTHATHASCAUSEDTHEDIFFERENCEBETWEENTHETWOTOTALSMUSTBE FOUND ANDCORRECTED

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CHAPTER 3

THE GENERAL LEDGER

Errors not revealed

51

STUDY TIP

)NSPITEOFITSBENElTS THEUSEFULNESSOFA4RIAL"ALANCEASADIAGNOSTICTOOLINDETECTING ERRORSISLIMITEDITWILLONLYDETECTERRORSIFTOTALDEBITSDONOTEQUALTOTALCREDITS/NE ORMOREOFTHEFOLLOWINGERRORSMAYBEPRESENTINTHELEDGERACCOUNTSEVENWHENTHE 4RIAL"ALANCEBALANCES s !TRANSACTIONHASBEENomittedALTOGETHER s 4HEDEBITANDCREDITENTRIESHAVEBEENreversed. &OREXAMPLE INSTEADOF RECORDINGAPAYMENTTOACREDITORBYDEBITING#REDITORS#ONTROLANDCREDITING "ANK THEENTRYISERRONEOUSLYRECORDEDASADEBITTO"ANKANDACREDITTO#REDITORS #ONTROL s 4HETRANSACTIONHASBEENRECORDEDINTHEwrong ledger accounts.&OREXAMPLE INSTEADOFRECORDINGTHEPAYMENTOFWAGESASADEBITTOTHE7AGESACCOUNT THE TRANSACTIONISINCORRECTLYDEBITEDTO2ENT s !Nincorrect amountISRECORDEDONBOTHSIDESOFTHELEDGER .ONEOFTHESEINCORRECT ENTRIESWOULDBEDETECTEDORREVEALEDBYA4RIAL"ALANCE BECAUSEEACHOFTHEMSTILLHASAMATCHINGDEBITANDCREDITENTRY4HATIS EVENTHOUGH THEENTRYWOULDBEWRONG THEREWOULDSTILLBEANAMOUNTRECORDEDONTHEDEBITSIDE ANDANEQUALAMOUNTRECORDEDONTHECREDITSIDE4HE4RIAL"ALANCEISAUSEFULTOOL BUT ITWILLNOTDETECTALLTHEERRORSTHATMAYEXISTINTHELEDGER

)FTHE4RIAL"ALANCEDOES NOTBALANCE LOOKFORA TRANSACTIONINVOLVING THEAMOUNTIDENTIFIED ASTHEDIFFERENCE ORHALF ORTWICETHEDIFFERENCE ANDCHECKTHISENTRY FIRST

REVIEW QUESTIONS 3.6

1 2 3 4

State the purpose of a Trial Balance. Referring to ledger accounts, stateWHATISMEANTBYTHETERM@FOOTING List the steps involved in footing a ledger account. State three errors that will be detected by the preparation of a Trial Balance. 5 State four errors that will not be detected by the preparation of a Trial Balance.

3.7

BALANCING

&OOTINGISANINFORMALPROCESSTHATCANBEDONETOANYACCOUNTATANYTIMETODETERMINE ITSBALANCE"UTATTHEENDOFTHEREPORTINGPERIOD ASSET LIABILITYANDOWNERSEQUITY ACCOUNTSMUSTBEFORMALLYRULEDOFF ANDTHEIRBALANCECARRIEDFORWARDTOTHENEXTPERIOD SOTHATTHEIRBALANCESCANBEREPORTEDINTHE"ALANCE3HEET

Balancing procedure "OTHFOOTINGANDbalancingINVOLVECALCULATINGTHEBALANCEOFANACCOUNT BUTTHEREARE THREEMAINDIFFERENCES s "ALANCINGISDONEONLYATTHEENDOFTHEREPORTINGPERIOD s /NLYASSET LIABILITYANDOWNERSEQUITYACCOUNTSAREBALANCED2EVENUEANDEXPENSE ACCOUNTSAREclosed4HISWILLBECOVEREDINDETAILIN#HAPTER s "ALANCINGISAMOREFORMALPROCESS INVOLVINGAPROPERDOUBLEENTRYTHATIS ADEBIT ANDMATCHINGCREDITENTRY

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

balancing ruling off an asset, liability OROWNERSEQUITYACCOUNT to determine its balance at the end of the reporting period and transferring that balance to the next reporting period

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CAMBRIDGE VCE ACCOUNTING

52

UNITS 3&4

Steps for balancing "ALANCINGANACCOUNTINVOLVESTHEFOLLOWINGSTEPS  4OTALTHEAMOUNTSONEACHSIDE ANDWRITETHELARGEROFTHESETWOTOTALSONboth sides.)NTHEEXAMPLEBELOW THETRANSACTIONSONTHEDEBITSIDEADDUPTO ANDTHETRANSACTIONSONTHECREDITSIDEADDUPTOONLY SOISWRITTEN ON both sides4HISlGURESHOULDBE@RULEDOFFWITHADOUBLELINETOINDICATETHATIN THATREPORTINGPERIODTHEREARENOMORETRANSACTIONSTHATAFFECTTHEACCOUNT4HISIS NOTTHEbalanceOFTHEACCOUNTITISTHEtotal!TTHISPOINT THEAMOUNTSONONLYONE SIDEnINTHISCASETHEDEBITSIDEnWILLADDUPTOTHISTOTALOF  #ALCULATETHEBALANCEBYDEDUCTINGTHETOTALOFTHESMALLERSIDEFROMTHETOTALOFTHE ACCOUNT)NTHEEXAMPLE THISIS TOTAL nSMALLERSIDE BALANCE   %NTERTHISBALANCEASAPROPERLEDGERENTRYWITHAMATCHINGDEBITANDCREDITabove THETOTALONTHEsmallerSIDEandbelowTHETOTALONTHElargerSIDE4HISENTRY@CARRIES FORWARDTHEBALANCEFROMTHEENDOFONEREPORTINGPERIODTOTHESTARTOFTHENEXT 4HISISWHYINTHEEXAMPLETHEDATEISGIVENAS-ARCHaboveTHETOTALBUTAS!PRIL below &IGURESHOWSTHE@"ANKACCOUNTAFTERITHASBEENBALANCED Figure 3.19 ‘Balancing’ an account Bank (A) Date March 1 STUDY TIP

#OMPARETHIS@BALANCED ACCOUNTWITHTHE @FOOTEDACCOUNTIN &IGURE4HE BALANCEOFTHEACCOUNT ISTHESAME BUTTHIS ACCOUNTHASBEENMORE FORMALLYCOMPLETED

Cross-reference Balance

Amount $

Date

12 500

March 3

Cross-reference

Amount $

Wages

4 000

15

Cash Sales

6 000

12

Rent

9 000

22

Debtors Control

3 400

25

Drawings

6 250

31

Balance

2 650

21 900 April 1

Balance

21 900

2 650

)NTHISEXAMPLETHEBALANCEOFMUSTBERECORDEDon the credit side above the totalSOTHATTHECREDITSIDEEQUALS)TMUSTTHENBETRANSFERREDTOTHEdebit side, but below the total ASTHEOPENINGBALANCEFORTHENEXTPERIOD!PRIL  REVIEW QUESTION 3.7

1 List three differences between footing and balancing a ledger account. 2 List the steps involved in balancing a ledger account. 3 ExplainWHYTHEENTRIESREQUIREDTOBALANCEALEDGERACCOUNTARESHOWNWITH different dates.

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CHAPTER 3

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53

WHERE HAVE WE BEEN? s s s s s s s s s s s

s

!LEDGERACCOUNTISANACCOUNTINGRECORDSHOWINGALLTHETRANSACTIONSTHATAFFECTAPARTICULARITEM 4HE'ENERAL,EDGERISTHECOLLECTIVENAMEFORTHEMAINGROUPOFLEDGERACCOUNTS 4HELEFT HANDSIDEOFALEDGERACCOUNTISTHEDEBITSIDETHERIGHT HANDSIDEISTHECREDITSIDE %VERYTRANSACTIONMUSTBERECORDEDINATLEASTTWOLEDGERACCOUNTS %VERYTRANSACTIONMUSTHAVEADEBITENTRYANDACREDITENTRY 4ORECORDANINCREASEINASSETSOREXPENSES RECORDTHETRANSACTIONONTHEdebitSIDE 4ORECORDANINCREASEINLIABILITIES OWNERSEQUITYORREVENUES RECORDTHETRANSACTIONONTHEcredit SIDE 4HECROSS REFERENCESPECIlESTHELINKBETWEENTWOACCOUNTSBYIDENTIFYINGTHEOTHERACCOUNTAFFECTED &OOTINGISANINFORMALPROCESSTOCALCULATETHEBALANCEOFANACCOUNT %RRORSA4RIAL"ALANCEwillREVEALTWOENTRIESRECORDEDONTHESAMESIDEONLYONEENTRYRECORDEDOR ADIFFERENTAMOUNTRECORDEDONEACHSIDE %RRORS A 4RIAL "ALANCE will not REVEAL A TRANSACTION OMITTED ALTOGETHER DEBIT AND CREDIT ENTRIES REVERSEDATRANSACTIONRECORDEDINTHEWRONGLEDGERACCOUNTSORANINCORRECTAMOUNTRECORDEDON BOTHSIDESOFTHELEDGER "ALANCINGINVOLVESRULINGOFFANASSET LIABILITYOROWNERSEQUITYACCOUNTTODETERMINEITSBALANCEAT THEENDOFTHECURRENTREPORTINGPERIODANDTRANSFERRINGTHATBALANCETOTHENEXTREPORTINGPERIOD

EXERCISE 3.1 RECORDING IN THE GENERAL LEDGER

W B

page 28

EXERCISES

*ANE'REENISANEXGROUNDS KEEPERWHOHASJUSTGONEINTOBUSINESSFORHERSELFSELLING LAWNSEED OPERATINGUNDERTHENAME2EAPAND3OW(ERTRANSACTIONSFORTHElRSTWEEK OF-AYARESHOWNBELOW -AY



     

#ONTRIBUTEDCASHTOCOMMENCEBUSINESS 2ENTEDASMALLOFlCE PAYINGRENTFOR-AY 0URCHASEDSTOCKWORTHONCREDITFROM,USH,AWNSEED 0AIDFOROFlCEFURNITURE 0AIDFORADVERTISINGINTHELOCALPAPER *ANECONTRIBUTEDTOTHEBUSINESSHERPERSONALCOMPUTERAGREEDVALUE

Required a PrepareAN!NALYSING#HARTTOSHOWTHEDOUBLEENTRYREQUIREDTORECORDEACHENTRY INTHE'ENERAL,EDGEROF2EAPAND3OW b RecordTHETRANSACTIONSFORTHElRSTSIXDAYSOF-AYINTHE'ENERAL,EDGEROF 2EAPAND3OW c 2EFERRINGTOONEACCOUNTINGPRINCIPLE explainWHYTHETRANSACTIONON-AY MUSTBERECORDEDINTHEACCOUNTSOFTHEBUSINESS

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

EXERCISE 3.2 RECORDING IN THE GENERAL LEDGER

W B

page 30

0HIL -EECUP JUST COMMENCED BUSINESS AS 1UICK 0ERK A COMPANY THAT SELLS COFFEE MACHINES4HEFOLLOWINGTRANSACTIONSOCCURREDDURINGTHElRSTWEEKOF.OVEMBER .OV





      

0HILCONTRIBUTEDCASHTOCOMMENCEBUSINESS 0URCHASEDPREMISESFORUSINGAMORTGAGEFROMTHE"ANKOF2,- 0URCHASEDSTOCKWORTHONCREDITFROM.EW#AFFE3UPPLIES 0AIDWAGESTOOFlCEMANAGER 0HILWITHDREWCASHFORPERSONALUSE 0AIDFORADVERTISINGTHATWILLNOTBEGINUNTIL$ECEMBER 0AID.EW#AFFE3UPPLIES

Required a PrepareAN!NALYSING#HARTTOSHOWTHEDOUBLEENTRYREQUIREDTORECORDEACHENTRY INTHE'ENERAL,EDGEROF1UICK0ERK b RecordTHETRANSACTIONSFORTHElRSTWEEKOF.OVEMBERINTHE'ENERAL,EDGER OF1UICK0ERK c 2EFERRINGTOTHEDElNITIONS explainWHYTHEADVERTISINGSHOULDBERECOGNISEDAS ACURRENTASSETASAT.OVEMBER

EXERCISE 3.3 CASH SALES IN THE GENERAL LEDGER

W B

page 32

-ELITA !NOGRA JUST OPENED -ELITA -OWS A SHOP SPECIALISING IN THE SALE OF MOWERS 4HElRMSTRANSACTIONSFORTHElRSTWEEKOF*ANUARYSHOWEDTHEFOLLOWING *AN







     

#ONTRIBUTEDCAPITALTOCOMMENCEBUSINESSnCASHANDONEVEHICLE AGREEDVALUE 0AIDRENTOFFOR*ANUARY 0URCHASEDSTOCKONCREDITFORFROM(AVANNA-OWERS 3OLDONEMOWERFORCASHCOSTPRICE 0AIDWAGESOFASSISTANT 3OLDTWOMOWERSFORCASHEACHCOSTPRICE 0AIDTO(AVANNA-OWERS

Required a ExplainWHYTHEVEHICLECONTRIBUTEDON*ANUARYMUSTBEVALUEDATITSAGREED VALUE b PrepareAN!NALYSING#HARTTOSHOWTHEDOUBLEENTRYREQUIREDTORECORDEACHENTRY INTHE'ENERAL,EDGEROF-ELITA-OWS c RecordTHETRANSACTIONSFORTHElRSTWEEKOF*ANUARYINTHE'ENERAL,EDGEROF -ELITA-OWS d StateTHEEFFECTONTHEACCOUNTINGEQUATIONOFTHETRANSACTIONON*ANUARY e Calculate'ROSS0ROlTFOR-ELITA-OWSFORTHElRSTWEEKOF*ANUARY

EXERCISE 3.4 CASH AND CREDIT SALES IN THE GENERAL LEDGER

W B

page 35

+IM3WOODJUSTOPENEDHEROWNSPAREPARTSSHOPCALLED-ONARO-OTORS4RANSACTIONS FOR!UGUSTSHOWEDTHEFOLLOWING

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CHAPTER 3

!UG







 

      

THE GENERAL LEDGER

#APITALCONTRIBUTIONOFSTOCKAGREEDVALUE ANDCASH 0URCHASEDPREMISESWORTHPAYINGACASHDEPOSITWITH THEBALANCEFUNDEDBYAMORTGAGEFROM16"ANK #ASHSALEOFPARTSFORCOSTPRICE 0AIDCASHTO7ILSON&ITTINGSFORSHELVING 0URCHASEDSTOCKONCREDITFROM(OL&ORD0ARTSFOR 3OLDPARTSONCREDITTO,EMON2ENTALSFORCOSTPRICE 0AIDWAGESOFAPPRENTICE +IM3WOODTOOKHOMESTOCKWORTH 2ECEIVEDCASHFROM,EMON2ENTALS

Required

*

a Prepare AN !NALYSING #HART TO SHOW THE DOUBLE ENTRY REQUIRED TO RECORD EACH TRANSACTIONINTHE'ENERAL,EDGEROF-ONARO-OTORS b RecordTHETRANSACTIONSFOR!UGUSTINTHE'ENERAL,EDGEROF-ONARO-OTORS c FootTHEACCOUNTSANDprepareA4RIAL"ALANCEASAT!UGUST d StateONEERRORTHATWOULDCAUSETHE4RIAL"ALANCETOnotBALANCE e 2EFERRINGTOTHEDElNITIONS explainWHYTHERECEIPTOFCASHFROM,EMON2ENTALSON !UGUSTSHOULDnotBEREPORTEDASREVENUE f StateTHEEFFECTONTHEACCOUNTINGEQUATIONOF-ONARO-OTORSIFTHETRANSACTIONON !UGUSTHADnotBEENRECORDED

EXERCISE 3.5 OPENING BALANCES IN THE GENERAL LEDGER

W B

page 39

&INOULA/2ILEYOWNSASMALLSHOPCALLED(OT$OGGIESTHATSELLSDOG GROOMINGPRODUCTS &INOULA HAS BEEN OPERATING FOR THREE YEARS BUT ON  *UNE  DECIDED TO ADOPT A DOUBLE ENTRY RECORDING SYSTEM (ER OPENING ACCOUNT BALANCES ON  *UNE  WERE "ANK   3TOCK #ONTROL   $EBTORS #ONTROL   3HELVING   AND #APITALn/2ILEY 4RANSACTIONSFOR*UNESHOWEDTHEFOLLOWING *UNE 























2ECEIVEDCASHFROMADEBTOR,YNX FORSTOCKSOLDIN-AY &INOULACONTRIBUTEDHERLAPTOPTOTHEBUSINESSAGREEDVALUE 3TOCKWASSOLDONCREDITTO!LLENDALE+ENNELSFORCOSTPRICE 0AIDWAGES 0URCHASEDSTOCKWORTHONCREDITFROM,AMINAR0RODUCTS #ASHSALESOFCOSTPRICE 2ECEIVEDFROM!LLENDALE+ENNELS 0URCHASEDEXTRASHELVINGFORCASH #ASHSALESOFCOSTPRICE 0AIDFORREPAIRSTOSOMEOFTHEOLDSHELVING 3TOCKWASSOLDONCREDITTO*OANIES$OG7ASHFORCOSTPRICE 0AIDWAGES

Required

*

a RecordTHEOPENINGBALANCESINTHE'ENERAL,EDGEROF(OT$OGGIES b RecordTHETRANSACTIONSFOR*UNEINTHE'ENERAL,EDGEROF(OT$OGGIES c 2EFERRINGTOONEACCOUNTINGPRINCIPLE explainWHYTHECASHRECEIVEDFROM,YNXON *UNESHOULDnotBEREPORTEDASREVENUEFOR*UNE d StateTHEPURPOSEOFA4RIAL"ALANCE e FootTHEACCOUNTSANDprepareA4RIAL"ALANCEFOR(OT$OGGIESASAT*UNE

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55

CAMBRIDGE VCE ACCOUNTING

56

UNITS 3&4

EXERCISE 3.6 OPENING BALANCES IN THE GENERAL LEDGER

W B

page 43

0AUL-C-ARTINISTHEOWNEROPERATOROF"RIGHT#AMPING ABUSINESSTHATSELLSCAMPING GEAR/N/CTOBER 0AULDECIDEDTOADOPTADOUBLE ENTRYRECORDINGSYSTEM4HE lRMSBALANCESONTHATDATEWEREASFOLLOWS3TOCK#ONTROL $EBTORS#ONTROL  3HOP&ITTINGS 0REMISES ,OANn(IGHLAND"ANK #REDITORS#ONTROLAND"ANK/VERDRAFT 4HETRANSACTIONSFOR/CTOBERWEREASFOLLOWS /CT







 

       

3OLDSTOCKONCREDITTO3LEEPY(OLLOW#ARAVAN0ARKFORCOSTPRICE 0URCHASEDNEWSHOPFITTINGSFORnPAIDINCASHWITHTHEREMAINDER FINANCEDBYASHORT TERMLOANFROM0UNKAH#REDIT#O 2ECEIVEDCASHFROMADEBTOR-ILAWA!DVENTURES #ASHSALESOFCOSTPRICE 0AULPAIDFORTHEFIRMSADVERTISINGUSINGAPERSONALCHEQUE 0URCHASEDSTOCKONCREDITFROM(ARDY#AMP'EARFOR 0AIDWAGESOF 2ECEIVEDCASHFROM3LEEPY(OLLOW 3OLDSTOCKONCREDITTO(IGH0EAK!DVENTURESFORCOSTPRICE 0AIDTOACREDITORn*ILLAROOS#HOICE

Required

*

a RecordTHEOPENINGBALANCESINTHE'ENERAL,EDGEROF"RIGHT#AMPING b RecordTHETRANSACTIONSFOR/CTOBERINTHE'ENERAL,EDGEROF"RIGHT#AMPING c ExplainTHEIMPORTANCEOFACROSS REFERENCEWHENRECORDINGTRANSACTIONSINLEDGER ACCOUNTS d FootTHEACCOUNTSANDprepareA4RIAL"ALANCEFOR"RIGHT#AMPINGASAT/CTOBER  e StateTWOERRORSINTHE'ENERAL,EDGERTHATWILLnotBEDETECTEDBYA4RIAL"ALANCE

EXERCISE 3.7 IDENTIFYING TRANSACTIONS

W B

page 47

-IRA 6AN 3ANDEN IS A PHOTOGRAPHER WHO OWNS AND OPERATES A SHOP IN -ELBOURNE CALLED0ERFECT0HOTOGRAPHS4HElRMS'ENERAL,EDGERFOR$ECEMBERSHOWEDTHE FOLLOWING Bank (A) Date

Cross-reference

Dec. 1

Balance

Amount $

Date

Cross-reference

Amount $

1 000

$EC

/FFICE%QUIPMENT



$EC

2EPAIRS





3ALES





$EBTORS#ONTROL

 Stock Control (A)

Date Dec. 1 

Cross-reference Balance #REDITORS#ONTROL

Amount $

Date

Cross-reference

5 000

$EC

#OSTOF3ALES







#OSTOF3ALES



ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Amount $

Cambridge University Press

CHAPTER 3

THE GENERAL LEDGER

Debtors Control (A) Date

Cross-reference

Dec. 1

Balance



3ALES

Amount $

Date

Cross-reference

1 700

$EC

"ANK

Amount $ 

 Office Equipment (A)

Date

Cross-reference

Dec. 1

Balance



"ANK

Amount $

Date

Cross-reference

4 000

$EC

$RAWINGS

Amount $ 

 Creditors Control (L)

Date

Cross-reference

Amount $

Date

Cross-reference

Dec. 1

Balance



Amount $ 1 100

3TOCK#ONTROL



Capital (OE) Date

Cross-reference

Amount $

Date Dec. 1

Cross-reference

Amount $

Balance

10 600

Sales (R) Date

Cross-reference

Amount $

Date

Cross-reference

$EC

"ANK



$EBTORS#ONTROL



Cross-reference

Amount $

Cross-reference

Amount $

Cross-reference

Amount $



Amount $

Drawings (– OE) Date $EC

Cross-reference

Amount $

/FFICE%QUIPMENT



Date

Cost of Sales (E) Date

Cross-reference

Amount $

$EC

3TOCK#ONTROL





3TOCK#ONTROL



Date

Repairs (E) Date

Cross-reference

$EC

"ANK

Amount $

Date



Required

*

a 5SINGTHE'ENERAL,EDGER describeEACHTRANSACTIONINDATEORDER  b CalculateTHERATEOFMARK UPTHATISAPPLIEDTOSTOCK c PrepareA4RIAL"ALANCEFOR0ERFECT0HOTOGRAPHSASAT$ECEMBER

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CAMBRIDGE VCE ACCOUNTING

58

UNITS 3&4

/N  $ECEMBER  -IRA PAID  FOR OFlCE EXPENSES 4HE TRANSACTION WAS POSTEDINTOTHE'ENERAL,EDGERASFOLLOWS Ledger account /FFICE%QUIPMENT

Debit $

Credit $

200

Bank

200

d StateWHETHERTHE4RIAL"ALANCEWOULDIDENTIFYTHISERRORJustifyYOURANSWER e StateTHEEFFECTONTHEACCOUNTINGEQUATIONOF0ERFECT0HOTOGRAPHSIFTHISERROR WASnotCORRECTED f ShowTHEDEBITANDCREDITENTRIESNECESSARYTOCORRECTTHISERROR

EXERCISE 3.8 TRANSACTIONS TO REPORTS

W B

page 49

4URNING 0OINTS IS A lRM THAT SELLS EXERCISE MACHINERY )TS OWNER 4RACEY .ICOLE HAS DECIDEDTOADOPTADOUBLE ENTRYRECORDINGSYSTEM!T*ULY THElRMSASSETSAND LIABILITIESWEREASFOLLOWS "ANK 3TOCK#ONTROL $EBTORS#ONTROL /FFICE%QUIPMENT 0REMISES #REDITORS#ONTROL -ORTGAGEn*(&INANCE

      

4HElRMSTRANSACTIONSFOR*ULYSHOWEDTHEFOLLOWING *ULY









             

#ASHSALETO2$ONNEGANCOSTPRICE 0AIDFORELECTRICITY #REDITSALESTO,OWDOWN'YMCOSTPRICE 0URCHASEDSTOCKONCREDITFROM(AVILLAND-ACHINES 0AIDWAGES #REDITSALESTO3T-ARTINS(OSPITALCOSTPRICE 2ECEIVEDCASHFROM7ALKERS7ORLDFORGOODSSOLDIN*UNE 0AIDCASHTO(AVILLAND-ACHINES -ADEMONTHLYPAYMENTONMORTGAGEINCLUDINGINTEREST 4RACEYTOOKHOMEANEXERCISEMACHINEFORHERSON 0AIDWAGES #ASHSALETO*.OTTSCOSTPRICE 2ECEIVEDCASHFROM,OWDOWN'YM 0AIDINADVANCEFORSIXMONTHSADVERTISING WHICHWILLBEGIN IN!UGUST

             

Required

*

a b c d e f

* *

g h i

Calculate4RACEYSCAPITALASAT*ULY RecordTHEOPENINGBALANCESINTHE'ENERAL,EDGEROF4URNING0OINTS RecordTHETRANSACTIONSFOR*ULYINTHE'ENERAL,EDGEROF4URNING0OINTS BalanceTHEACCOUNTSWHEREAPPROPRIATE ANDprepareA4RIAL"ALANCEASAT*ULY StateTHEEFFECTONTHEACCOUNTINGEQUATIONOF4URNING0OINTSIFTHETRANSACTIONON *ULYWASnotRECORDED 2EFERRINGTOONEACCOUNTINGPRINCIPLE explainWHYTHETRANSACTIONON*ULYIS notCONSIDEREDTOBEREVENUEFOR*ULY PrepareAN)NCOME3TATEMENTFOR4URNING0OINTSFOR*ULY PrepareACLASSIlED"ALANCE3HEETFOR4URNING0OINTSASAT*ULY 2EFERRING TO ONE QUALITATIVE CHARACTERISTIC explain WHY THE ADVERTISING MUST BE REPORTEDINTHE"ALANCE3HEETASAT*ULY

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Where are we headed? After completing this chapter, you should be able to: s explainTHEEFFECTOFTHE 'OODSAND3ERVICES4AX'34 ONTHEACCOUNTINGSYSTEMOFA SMALLBUSINESS s explainTHEROLEOFTHE'34 #LEARINGACCOUNT s explainTHECIRCUMSTANCESIN WHICHA'34REFUNDAND'34 SETTLEMENTWILLOCCUR s explainTHEROLEOFSOURCE DOCUMENTSINTHEACCOUNTING PROCESS INCLUDINGTHEIR RELATIONSHIPTOTHEACCOUNTING PRINCIPLESANDQUALITATIVE CHARACTERISTICS s identifyANDrecord TRANSACTIONSVERIlEDBYA

s identifyANDexplainTHEROLE OFASTATEMENTOFACCOUNTAND ANORDERFORM s identifyTHEEFFECTOF'34ON THERECORDINGOFCASHAND CREDITSALESANDPURCHASES ANDONTHEACCOUNTING EQUATION s report'34#LEARINGINTHE "ALANCE3HEET

n CASHRECEIPT n CHEQUEBUTT n SALESINVOICE n PURCHASEINVOICE n MEMO

CHAPTER 4

THE GOODS AND SERVICES TAX (GST) KEY TERMS After completing this chapter, you should be familiar with the following terms: s 'OODSAND 3ERVICES4AX'34

s SALESINVOICE

s SOURCEDOCUMENTS

s MEMO

s CASHRECEIPT

s STATEMENTOFACCOUNT

s CHEQUEBUTT

s ORDERFORM

© Anthony SImmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and this material must not be transferred to another party.

s PURCHASEINVOICE

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4.1 Goods and Services Tax (GST) a 10% tax levied by the federal government on most purchases of goods (excluding fresh food) and services

UNITS 3&4

THE GOODS AND SERVICES TAX (GST)

4HEINTRODUCTIONOFTHEGoods and Services Tax (GST)IN*ULYMEANTTHATINADDITION TOBEINGTRADINGOPERATIONS ANUMBEROFSMALLBUSINESSESBECAMETAXCOLLECTORSFORTHE !USTRALIAN4AX/FlCE!4/ 5NDERTHE'34nWHICHAPPLIESTOMOSTGOODSEXCEPTFRESH FOOD ANDSERVICESnTHEFEDERALGOVERNMENTCHARGESCONSUMERSATAXOFOFTHE PRICEOFWHATEVERTHEYHAVEPURCHASED4HISMEANSTHEBUSINESSTHATSELLSTHEGOOD SERVICEMUSTCHARGEANDCOLLECTFROMTHECUSTOMERTHESELLINGPRICEplusANAMOUNTFOR '344HE'34AMOUNTISTHENTRANSFERREDTOTHE!4/BYTHEBUSINESSATALATERDATE 7HENABUSINESSCHARGESITSCUSTOMERS'34 ITDOESSOONBEHALFOFTHEGOVERNMENT !SARESULT ANYGST on salesCREATESALIABILITYnANAMOUNTOF'34OWEDTOTHE!4/ )FTHEBUSINESSHASBEENCHARGEDANY'34BYITSSUPPLIERS ITISALLOWEDTODEDUCTTHIS GST on purchases FROMITS'34LIABILITY4HE'34ONITSPURCHASESWILLBEFORWARDEDTO THE!4/BYTHElRMSSUPPLIERS SOITISTREATEDASIFTHEBUSINESSHADACTUALLYPAIDTHE '34STRAIGHTTOTHEGOVERNMENT !TTHEENDOFTHEPERIOD THEBUSINESSMUSTCALCULATEHOWMUCH'34OVERALLITOWES TO THE !4/ OR WHETHER IT IS OWED A REFUND BY THE !4/ 4HIS MEANS THE ACCOUNTING SYSTEMMUSTBECAPABLEOFIDENTIFYING RECORDINGANDREPORTINGFORTHEEFFECTSOF'34

Recording GST !LL TRANSACTIONS INVOLVING '34 ARE RECORDED IN A NEW LEDGER ACCOUNT CALLED @'34 #LEARING WHICHCANEITHERBEACURRENTLIABILITYORACURRENTASSET GST liability "ECAUSE SELLING PRICES ARE USUALLY HIGHER THAN COST PRICES IN MOST CASES the GST on sales will be greater than the GST on purchases SO THE BUSINESS WILL HAVE A current liabilityINRELATIONTO'344HISMEANSTHAT OVERALL THEBUSINESSWILLOWE'34TOTHE !4/ WHICHITWILLPAYWHENITMAKESA'34SETTLEMENT GST asset )F THE BUSINESS MAKES A BULK ORDER OF STOCK WHICH IT HAS NOT SOLD OR PURCHASES AN EXPENSIVENON CURRENTASSET THENITSGST on purchases could be greater than its GST on sales SOTHEBUSINESSWILLHAVEAcurrent assetINRELATIONTO'344HISMEANSTHE BUSINESSWILLBEOWED'34BYTHE!4/ WHICHITWILLRECEIVEINTHEFORMOFA'34REFUND

REVIEW QUESTIONS 4.1 1 Define THETERM@'OODSAND3ERVICES4AX'34  2 Explain WHY'34ONSALESCREATESA'34LIABILITY 3 Explain WHY'34ONPURCHASESLEADSTOAREDUCTIONINANY'34LIABILITY 4 State THEROLEOFTHE'34#LEARINGACCOUNT 5 Explain WHYMOSTSMALLBUSINESSWILLENDUPWITHA'34LIABILITYATTHEEND OFTHEPERIOD 6 State TWOWAYSASMALLBUSINESSCOULDENDUPBEINGOWEDA'34REFUNDBY THE!4/

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CHAPTER 4

4.2

T H E G O O D S A N D S E R V I C E S TA X ( G S T )

61

SOURCE DOCUMENTS

4HEEXERCISESIN#HAPTERINVOLVINGRECORDINGTRANSACTIONSINTHELEDGER WEREGENERALLY PRESENTEDASALIST WITHTHEDATEANDDETAILSOFTHETRANSACTIONSPELTOUTCLEARLY4HIS IS NOT A LUXURY AFFORDED TO BOOKKEEPERS IN REAL BUSINESSES )N A FUNCTIONING BUSINESS THEINFORMATIONWOULDBECONTAINEDONTHEsource documents ANDPARTOFTHEJOBOF THEBOOKKEEPERWOULDBETOSORTTHEDOCUMENTS ANDDECIPHERTHEINFORMATIONTHEY CONTAIN 3OURCEDOCUMENTSCOMEINAVARIETYOFSHAPESANDSIZES BUTHAVEINCOMMONONE ESSENTIALQUALITYTHEYPROVIDETHEEVIDENCE ORPROOF THATATRANSACTIONHASOCCURRED )NFACT SOURCEDOCUMENTSARETHElRSTSTAGEINTHEACCOUNTINGPROCESSSEE&IGURE ANDPROVIDETHEFACTSANDDETAILSONWHICHALLSUBSEQUENTACCOUNTINGINFORMATIONWILL BEBASED

source documents printed or electronic documents that provide evidence that a transaction has occurred, and the details of the transaction itself

Figure 4.1 The accounting process

Source documents

Records

Reports

Advice

"ECAUSESOURCEDOCUMENTSPROVIDETHEEVIDENCEOFTHEDETAILSOFEVERYTRANSACTION THEYAREINTEGRALINENSURINGTHATACCOUNTINGREPORTSCONTAININFORMATIONTHATISreliable ORFREEFROMERRORS BIASANDSUBJECTIVITY

Source documents and the GST "ECAUSEOFTHE'34 SOURCEDOCUMENTSMUSTINCLUDETHEFOLLOWINGINFORMATION s THEWORDS@TAXINVOICESTATEDCLEARLY s THENAMEOFTHESELLER s THE!USTRALIAN"USINESS.UMBER!". OFTHESELLER s THEDATEOFTHETRANSACTION s ADESCRIPTIONOFTHEGOODSERVICEPROVIDED s THEPRICEOFTHETRANSACTION INCLUDINGTHE'34 s THEAMOUNTOFTHE'34 3ALES OF MORE THAN  MUST ALSO SHOW THE NAME AND ADDRESS OR !". OF THE BUYER7ITHOUTTHESEDETAILS THESOURCEDOCUMENTSCANNOTBEUSEDTOSUBSTANTIATE'34 TRANSACTIONS ANDTHEBUSINESSMAYENDUPPAYINGTOTHE!4/MORE'34THANISREQUIRED Calculating GST !LTHOUGHATAXINVOICEMUSTSPECIFYTHEAMOUNTOFTHE'34 ITISSTILLUSEFULTOUNDERSTAND THERELATIONSHIPBETWEEN s THESELLINGPRICEOFTHEGOODSERVICEexcluding GST s THE'34ITSELF s THE total price OFTHETRANSACTIONincluding GST  )NITSSIMPLESTFORM '34ISCALCULATEDASOFTHESELLINGPRICE ANDADDEDTOTHE SELLINGPRICETODETERMINETHE total price ASSHOWNIN&IGURE STUDY TIP

Figure 4.2 Calculating GST and total price (including GST )

Example

Selling price

+

GST (selling price x 10%)

=

Total price (including GST)

$350

+

$35

=

$385

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5SETHISMETHODWHEN AQUESTIONSAYS@PLUS '34

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CAMBRIDGE VCE ACCOUNTING

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UNITS 3&4

!T OTHER TIMES IT MAY BE NECESSARY TO WORK backwards FROM THE total price TO DETERMINEEITHERTHE'34OFTHEtotal price ORTHESELLINGPRICEOFTHEtotal price &IGURESHOWSTHISRELATIONSHIP STUDY TIP

5SETHISMETHOD WHENAQUESTIONSAYS @INCLUDING'34

Figure 4.3 Calculating GST or selling price from total price

Example

Total price (including GST)

=

Selling price (10/11 of total price)

+

GST (1/11 of total price)

$385

=

$350

+

$35

REVIEW QUESTIONS 4.2

1 2EFERRING TO ONE QUALITATIVE CHARACTERISTIC explain THE ROLE OF SOURCE DOCUMENTSINTHEACCOUNTINGPROCESS 2 List THEINFORMATIONTHATMUSTBESHOWNONASOURCEDOCUMENTTHATINCLUDES '34 3 ShowHOWTHE'34WILLAFFECTTHECALCULATIONOF s TOTALPRICEWHENGIVENSELLINGPRICE s SELLINGPRICE'34WHENGIVENTOTALPRICE

4.3

cash receipt a source document used to verify cash received

CASH INFLOWS AND CASH RECEIPTS

7HENCASHISRECEIVED THEBUSINESSWILLISSUEAcash receiptTOTHECUSTOMER ANDKEEP A COPY OF THE RECEIPT FOR ITS OWN RECORDS 4HE CASH RECEIPT CAN BE HAND WRITTEN OR GENERATEDELECTRONICALLYORBYACASHREGISTER3OMESMALLERBUSINESSESWILLNOTISSUEAN INDIVIDUALISEDRECEIPTTOEVERYCUSTOMER PREFERRINGINSTEADTOISSUEONLYACASHREGISTER RECEIPT ANDRELYONTHESUMMARYGENERATEDBYTHEREGISTERTOVERIFYTHECASHRECEIVED IN A SINGLE DAYS TRADING 2EGARDLESS OF THE TYPE OF RECEIPT ISSUED IT SHOULD CONTAIN ALL THE INFORMATION NECESSARY TO ACCOUNT FOR THE '34 PLUS A RECEIPT NUMBER FOR EASY IDENTIlCATIONANDVERIlCATION

Cash sales and the GST !TTHETIMEACASHSALEISMADE THEBUSINESSWILLRECEIVETHECASHFORTHEGOODS PLUS THE'34ONTHESALE ANDTHISMUSTBEDOCUMENTEDONACASHRECEIPT4HE'34DOESNOT AFFECTTHESALESREVENUEEARNED ORTHECOSTOFTHESTOCKSOLDINSTEAD ITISANADDITIONAL AMOUNTCOLLECTEDONBEHALFOF ANDTHEREFOREOWEDTO THE!4/

EXAMPLE

On 7 April 2015, Snaps Photographic Equipment sold a Menolta camera to J. Mortlock for $400 plus $40 GST (Rec. 17). The camera had a cost price of $250.

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CHAPTER 4

T H E G O O D S A N D S E R V I C E S TA X ( G S T )

4HECASHRECEIPTTHATPROVIDESEVIDENCEOFTHISCASHSALEISSHOWNIN&IGURE Figure 4.4 Cash receipt (hand-written): cash sale

Snaps Photographic Equipment

TAX INVOICE

22 Grace St, Essendon VIC 3041

ABN: 11 049 411 049

Date:

7/4/2015

Received from:

J. Mortlock

The sum of:

Four hundred dollars plus forty dollars GST

Being for:

Cash sale – Menolta camera

Amount:

$440.00

Receipt:

17

J. Buckley

Signed:

3UCHARECEIPTCOULDEASILYBEGENERATEDELECTRONICALLY ASISSHOWNIN&IGURE Figure 4.5 Cash receipt (electronically generated): cash sale

Snaps Photographic Equipment

TAX INVOICE

22 Grace St, Essendon VIC 3041

ABN: 11 049 411 049

Date:

7/4/2015

Receipt:

17

Received from: J. Mortlock For:

Cash sale of 1 Menolta camera

Amount:

$440.00 (incl. $40.00 GST)

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63

64

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

%XACTLYTHESAMEINFORMATIONISPROVIDEDONBOTHVERSIONS s THEWORDS@TAXINVOICE s THEDATEOFTHETRANSACTION s THERECEIPTNUMBER s THENAMEAND!".OFTHESELLER3NAPS0HOTOGRAPHIC%QUIPMENT  s ADESCRIPTIONOFWHATHASBEENSOLDONE-ENOLTACAMERA s THESELLINGPRICEINCLUSIVEOFTHE'34$440 4HISISTHEAMOUNTOFCASHRECEIVED s THEAMOUNTOFTHE'34 4HISMEANSTHESELLINGPRICEOFTHECAMERAIS .OTE THAT THE COST PRICE OF THE SALE  IS NOT SHOWN BECAUSE WE DO NOT WANT TO DISCLOSEOURMARK UPTOTHEBUYER
Identifying sales revenue "OTHOFTHEPRECEDINGDOCUMENTSIDENTIFYTHETOTALCASHOF$440 THAT 3NAPS0HOTOGRAPHIC %QUIPMENTHASRECEIVEDFROMTHECUSTOMER"ECAUSETHETOTALCASHRECEIVEDINCLUDES '34ONTHESALEWHICHISCOLLECTEDONBEHALFOF ANDTHEREFOREOWEDTO THE!4/ NOTALLOFTHIS$440CANBERECORDEDASSALESREVENUEONLYCANBECOUNTEDASSALES REVENUEEARNEDBY3NAPS0HOTOGRAPHIC%QUIPMENT 4HIS SALES REVENUE lGURE IS IDENTIlED DIFFERENTLY IN THE PRECEDING DOCUMENTS 7HEREAS&IGURESEPARATELYIDENTIlESTHESALESREVENUEOF IN&IGURETHIS AMOUNTMUSTBECALCULATEDBYDEDUCTINGTHE'34 FROMTHETOTALAMOUNTRECEIVED $440 

Recording a cash sale with GST (ADWERECORDEDTHECASHSALEOFTHECAMERAwithout'34 THEDEBITSANDCREDITSINTHE LEDGERACCOUNTSWOULDHAVEBEEN $2 #2 $2 #2

"ANK #ASH3ALES #OSTOF3ALES 3TOCK#ONTROL









.OWTHAT'34ISINVOLVED THEPROCESSTORECORDACASHSALEINTHELEDGERMUSTBE AMENDED BUTONLYALITTLE4HECOSTPRICEOFTHESALEISNOTAFFECTEDATALL ANDNEITHERIS THEAMOUNTOFSALESREVENUEEARNED(OWEVER THEAMOUNTDEBITEDTOBankWILLINCREASE BECAUSETHEBUSINESSWILLRECEIVENOTONLYTHEFORTHESALE BUTALSO'34!SA RESULT THEDEBITSANDCREDITSTORECORDACASHSALEWITH'34WOULDBE DR #2 #2 $2 #2

Bank #ASH3ALES '34#LEARING #OSTOF3ALES 3TOCK#ONTROL

$440

 





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CHAPTER 4

T H E G O O D S A N D S E R V I C E S TA X ( G S T )

4HISENTRYWOULDBERECORDEDINTHE'ENERAL,EDGERASSHOWNIN&IGURE Figure 4.6 General Ledger: recording a cash sale with GST General Ledger Bank (A) Date April 1 7

Cross-reference

Amount $

Balance

Date

Cross-reference

Amount $

Date

Cross-reference

Amount $

April 7

Bank

1 000

Sales/GST Clearing

440 Sales (R)

Date

Cross-reference

Amount $

400

GST Clearing (A or L) Date

Cross-reference

Amount $

Date

Cross-reference

April 7

Bank

Amount $ 40

Stock Control (A) Date April 1

Cross-reference Balance

Amount $

Date

Cross-reference

15 000

April 7

Cost of Sales

Amount $ 250

Cost of Sales (E) Date

Cross-reference

April 7

Stock Control

Amount $

Date

Cross-reference

Amount $

250

4HE CROSS REFERENCE IN THE "ANK ACCOUNT REFERS TO BOTH 3ALES AND '34 #LEARING BECAUSETHECASHRECEIVEDCONSISTSOFPARTSALESANDPART'344HEENTRYONTHECREDIT SIDE OF THE '34 #LEARING ACCOUNT SHOWS THE LIABILITY OWED TO THE !4/ FOR THE TAX COLLECTEDBYTHEBUSINESS WHICHTHEBUSINESSMUSTFORWARDTOTHE!4/ATSOMETIMEIN THEFUTURE Effect on the accounting equation !CASHSALEWITH'34HASTHEFOLLOWINGEFFECTONTHEACCOUNTINGEQUATION Increase/Decrease/No effect Assets

Increase (increase Bank $440, decrease Stock Control $250)

Liabilities

Increase (GST Clearing)

Owner’s Equity

Increase (Sales $400 less Cost of Sales $250 = Profit)

Amount $ 190 40 150

Other cash inflows #ASHRECEIPTSSHOULDBEISSUEDEVERYTIMECASHISRECEIVED WHETHERITISFORACASHSALE A RECEIPTFROMADEBTOR ACAPITALCONTRIBUTIONORSOMEOTHERSOURCE4HEONLYEXCEPTIONS AREWHENCASHISDEPOSITEDDIRECTLYINTOTHEBUSINESSSBANKACCOUNT INWHICHCASETHE SOURCEDOCUMENTMIGHTSIMPLYBETHEBANKSTATEMENT

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UNITS 3&4

&IGURESHOWSTHECASHRECEIPTTOPROVIDEEVIDENCEOFARECEIPTFROMADEBTOR

Snaps Photographic Equipment

22 Grace St, Essendon VIC 3041

TAX INVOICE ABN: 11 049 411 049

Date:

30th April 2015

Received from:

Moondance Club

For:

Settlement of account

Amount:

$2 000.00

Receipt:

99

Figure 4.7 Cash receipt: receipt from a debtor

STUDY TIP

)NTHE6#%!CCOUNTING 3TUDY$ESIGN TRANSACTIONSTHATARE SUBJECTTO'34WILL BEIDENTIlED BUTTHE AMOUNTMAYNOTBE

)NTHISCASE THEREASONFORTHERECEIPTREFERSTO@SETTLEMENTOFACCOUNT INDICATING THATTHECASHHASBEENRECEIVEDFROMADEBTOR-OONDANCE#LUB TOSETTLETHEAMOUNT OUTSTANDING)TISALSOIMPORTANTTOIDENTIFYTHENAMEOFTHEDEBTORFROMWHOMTHECASH ISRECEIVED4HISALLOWSTHETRANSACTIONTOBERECORDEDINTHE$EBTORS,EDGER4HISWILL BEEXPLAINEDIN#HAPTER 4HEREISNO'34TOACCOUNTFORWHENCASHISRECEIVEDFROMADEBTOR BECAUSETHE '34ISRECOGNISEDANDREPORTEDONLYATTHETIMESALESAREMADE)NFACT ARECEIPTFROM ADEBTORISJUSTONEOFTHECASHINmOWSTHATISNOTSUBJECTTO'34 WITHOTHERSINCLUDING s INTERESTREVENUE s CAPITALCONTRIBUTIONS s LOANS

REVIEW QUESTIONS 4.3

1 2 3 4 5

StateTHESOURCEDOCUMENTUSEDTOVERIFYCASHRECEIVED ShowTHEDEBITANDCREDITENTRIESNECESSARYTORECORDACASHSALEWITH'34 ExplainWHYTHE'34RECEIVEDONACASHSALEINCREASESTHE'34LIABILITY ListTHREEDIFFERENTTRANSACTIONSFORWHICHACASHRECEIPTMAYBEISSUED ExplainWHYTHEREISNO'34TOACCOUNTFORWHENCASHISRECEIVEDFROM ADEBTOR

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4.4

T H E G O O D S A N D S E R V I C E S TA X ( G S T )

67

CASH OUTFLOWS AND CHEQUE BUTTS

$ESPITETHERISINGPROMINENCEOFONLINEBANKING THEREARESTILLANUMBEROFSITUATIONSIN WHICHITISNECESSARY ANDPERHAPSEVENDESIRABLE FORABUSINESSTOPAYBYCHEQUE4HE MAINBENElTSOFPAYINGBYCHEQUEINCLUDE s securitynPAYINGBYCHEQUEAVOIDSTHERISKSOFCARRYINGLARGESUMSOFCASH ANDTHE DANGEROFTHEFTTHISENTAILS s traceabilitynCHEQUESMUSTBEDEPOSITEDINTOABANKACCOUNT MEANINGITISPOSSIBLE TOTRACETHEEVENTUALRECIPIENTOFTHEFUNDS s verifiability n ALL PAYMENTS MADE BY CHEQUE ARE RECORDED ON THE CHEQUE BUTT PROVIDINGASOURCEDOCUMENTTOVERIFYTHETRANSACTION !STHECHEQUEITSELFISGIVENASPAYMENT ITISTHE cheque butt THATWILLBERETAINED BYTHEBUSINESSASEVIDENCEOFTHECASHITHASPAID%VENIFACHEQUEISCANCELLED THE CHEQUEBUTTSHOULDSTILLBECOMPLETEDTOVERIFYTHATTHECHEQUEHASNOTBEENSTOLEN

cheque butt a source document used to verify cash payments

Cash payments and the GST !T THE TIME A CASH PAYMENT IS MADE THE BUSINESS WILL PAY CASH FOR WHATEVER IT IS PURCHASING plusTHE'34ONTHEPURCHASE ANDTHISMUSTBEDOCUMENTEDONTHECHEQUE BUTT4HE'34PAIDDOESNOTCHANGETHEVALUEOFWHATISPURCHASEDnITWILLDECREASE THE'34LIABILITY

EXAMPLE

On 14 April 2015, Snaps Photographic Equipment paid $1 320 for 12 months’ insurance: $1 200 plus $120 GST (Ch. 245).

4HECHEQUEBUTTTHATPROVIDESEVIDENCEOFTHISPAYMENTISSHOWNIN&IGURE Figure 4.8 Cheque butt Pig-e-Bank Australia

ABN 49 100 001 222

14th April 2015 Date .............................................................. AGI Insurance To.................................................................. Yearly insurance For ................................................................ $1 200 (+$120 GST) ..................................................................... Bal c/fwd $ ................................................... Deposits $ ....................................................

$1 320.00 Amount ....................................................... Balance $...................................................... CHQ No. 245

4HISCHEQUEBUTTPROVIDESALLTHEINFORMATIONWENEEDTORECORDTHETRANSACTION BUT TOSATISFYTHE!4/ WEWOULDALSONEEDTOKEEPTHETAXINVOICEISSUEDBYTHESUPPLIER

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

Recording a cash payment with GST (ADWERECORDEDTHECASHPAYMENTFORINSURANCEwithout'34 THEDEBITSANDCREDITSIN THELEDGERACCOUNTSWOULDHAVEBEEN $2 #2

0REPAID)NSURANCE

"ANK





.OTE THAT THE DEBIT ENTRY IS TO AN ASSET ACCOUNT CALLED 0REPAID )NSURANCE 4HE INSURANCEISYETTOBEINCURRED SOITISAfutureECONOMICBENElT 7ITH'34INVOLVED THEAMOUNTOFCASHPAIDWILLINCREASE4HEBUSINESSMUSTPAY FORTHEINSURANCE PLUS'344HISMEANSBankWILLDECREASEBY$1 320IN TOTAL!SARESULT THEDEBITSANDCREDITSTORECORDACASHPAYMENTWITH'34WOULDBE $2 $2 CR

0REPAID)NSURANCE '34#LEARING Bank

  1320

4HISENTRYWOULDBERECORDEDINTHE'ENERAL,EDGERASISSHOWNIN&IGURE Figure 4.9 General Ledger: cash payment with GST General Ledger Bank (A) Date April 1 7

Cross-reference

Amount $

Balance

1 000

Sales/GST Clearing

Date

Cross-reference

April 14

Prepaid Insurance/

440

Amount $ 1 320

GST Clearing

Prepaid Insurance (A) Date April 14

Cross-reference

Amount $

Bank

Date

Cross-reference

Amount $

Amount $

1 200 GST Clearing (A or L)

Date April 14

Cross-reference

Amount $

Date

Cross-reference

120

April 7

Bank

Bank

40

/NCEAGAIN THECROSS REFERENCEINTHE"ANKACCOUNTREFERSTOBOTH0REPAID)NSURANCE AND'34#LEARINGASBOTHAMOUNTSHAVEBEENPAID!LTHOUGHTHE'34ISPAIDTOTHE SUPPLIERWHICHINTHISCASEIS!'))NSURANCE THATSUPPLIERISTHENOBLIGEDTOFORWARDTHE '34TOTHE!4/4HISMEANSTHEBUSINESSHASEFFECTIVELYPAIDSOMEOFITS'34LIABILITYTO THE!4/BUTVIATHEINSURANCECOMPANY#ONSEQUENTLY THE'34PAIDISDEBITEDTOTHE '34#LEARINGACCOUNTTOREDUCETHE'34OWEDTOTHE!4/ Effect on the accounting equation 4HIS CASH PAYMENT FOR 0REPAID )NSURANCE WITH '34 HAS THE FOLLOWING EFFECT ON THE ACCOUNTINGEQUATION Increase/Decrease/No effect

Amount $

Assets

Decrease (decrease Bank $1320, increase Prepaid Insurance $1200)

120

Liabilities

Decrease (GST Clearing)

120

Owner’s Equity

No effect

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69

Other cash outflows #HEQUES SHOULD BE USED TO MAKE PAYMENTS FOR MOST CASH OUTmOWS SUCH AS WAGES INSURANCE RENT ADVERTISING PAYMENTSTOCREDITORS ANDDRAWINGS&IGURESHOWSTHE CHEQUEBUTTTOPROVIDEEVIDENCEOFAPAYMENTTOACREDITOR Figure 4.10 Cheque butt: payment to a creditor Pig-e-Bank Australia

ABN 49 100 001 222

30th April 2015 Date .............................................................. Pentacks Cameras To.................................................................. Settlement of For ................................................................ account ..................................................................... Bal c/fwd $ ................................................... Deposits $ ....................................................

$600.00 Amount ....................................................... Balance $...................................................... CHQ No. 253

/NACHEQUEBUTT SETTLEMENTOFACCOUNTINDICATESTHATTHECASHHASBEENPAIDTO ACREDITORINTHISEXAMPLE 0ENTACKS#AMERAS TOSETTLETHEAMOUNTOUTSTANDING4HE NAMEOFTHECREDITORTOWHOMTHECASHWASPAIDWILLBEIMPORTANTWHENTHETRANSACTION ISRECORDEDINTHE#REDITORS,EDGERSEE#HAPTER  )NTHESAMEWAYTHATTHEREISNO'34ONARECEIPTFROMADEBTOR THEREISNO'34ONA PAYMENTTOACREDITOR BECAUSETHE'34ISRECOGNISEDANDREPORTEDONLYATTHETIMETHE PURCHASEISMADE4HELISTOFPAYMENTSTHATARENOTSUBJECTTO'34INCLUDES s PAYMENTSTOCREDITORS s COUNCILRATES s INTERESTEXPENSE s CASHDRAWINGS s WAGES s LOANREPAYMENTS /FCOURSE ITWILLNOTBEPRACTICALTOMAKEALLPAYMENTSBYCHEQUE&ORINSTANCE MOST MILKBARSWOULDBEUNWILLINGTOACCEPTACHEQUEFORFORALITREBOTTLEOFMILK)N CASESLIKETHIS PETTYCASHCANBEUSED BUTEVENTHEESTABLISHMENTOFTHEPETTYCASH FUNDSHOULDBEDONEBYCHEQUE4HEOTHEREXCEPTIONWOULDBEWHERECASHISDEDUCTED DIRECTLYFROMTHEBUSINESSSBANKACCOUNTFORITEMSSUCHASWAGESORLOANREPAYMENTS ANDTRANSFERREDELECTRONICALLY

STUDY TIP

!SWITHCASHRECEIPTS TRANSACTIONSTHATARE SUBJECTTO'34WILL BEIDENTIlED BUTTHE AMOUNTMAYNOTBE

STUDY TIP

0ETTYCASHISNOT ACTUALLYPARTOFTHIS COURSEnYOUDONT HAVETOKNOWHOWTO RECORDIT


REVIEW QUESTIONS 4.4

1 ExplainTHREEREASONSWHYCASHPAYMENTSSHOULDBEMADEBYCHEQUE 2 StateTHESOURCEDOCUMENTUSEDTOVERIFYCASHPAID 3 ShowTHEDEBITANDCREDITENTRIESNECESSARYTORECORDACASHPAYMENTWITH '34 4 ExplainWHY'34PAIDDECREASESTHE'34LIABILITY 5 ListlVEDIFFERENTTRANSACTIONSFORWHICHACHEQUEBUTTMAYBEISSUED 6 ExplainWHYTHEREISNO'34TOACCOUNTFORWHENCASHISPAIDTOACREDITOR

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4.5

sales invoice a source document used to verify a credit sale of stock

UNITS 3&4

CREDIT SALES

#REDIT TRANSACTIONS EFFECTIVELY SEPARATE A SALE OR PURCHASE INTO TWO TRANSACTIONS THE EXCHANGEOFGOODSOCCURSlRST WITHTHEEXCHANGEOFCASHONLYOCCURRINGATSOMELATER DATE7HENSTOCKISSOLDONCREDITANDTHEGOODSAREEXCHANGED THESOURCEDOCUMENT WILL BE A sales invoice 2EMEMBER THE '34 IS RECOGNISED AND REPORTED AT THE TIME OF THE SALE SO THE SALES INVOICE MUST SHOW ALL THE INFORMATION NECESSARY FOR IT TO BE CLASSIlEDASATAXINVOICEPARTICULARLYTHEAMOUNTOFTHE'34 BUTTHE'34WILLNOTAFFECT THEREVENUE EXPENSEORPROlTMADEONTHESALE

Credit sales and the GST 7HENSTOCKISSOLDONCREDIT THECUSTOMERDEBTOR WILLOWEBOTHTHEAMOUNTOFTHESALE FORTHESTOCK plusTHE'34ONTHESALE

EXAMPLE

On 21 April 2015, Snaps Photographic Equipment sold 5 Menolta cameras to A. Windley for $400 (plus $40 GST) each (Inv. 34). Each camera had a cost price of $250.

4HESALESINVOICETHATPROVIDESEVIDENCEOFTHISCREDITSALEISSHOWNIN&IGURE Figure 4.11 Sales invoice

Snaps Photographic Equipment

TAX INVOICE

22 Grace St, Essendon VIC 3041

ABN: 11 049 411 049 Customer:

A. WINDLEY Lakeside Dve Sth Melb. VIC 3205 ABN: 24 653 817 620

STUDY TIP

/NANINVOICE THE NAMEOFTHEseller ALWAYSAPPEARSAT THETOP

Item Menolta camera

21 April 2015 Invoice: 34 Terms: 5/7, n/30

Quantity

Unit Price

Total

5

400

2 000

GST (10%)

200 TOTAL

$2 200

/NCEAGAIN THECOSTPRICEOFTHESALETHATIS  ISNOTSHOWN BUTTHESALES INVOICESHOWSTHATTHEDEBTOROWES$2 200FORlVECAMERAS PLUS'34 4HE CREDIT TERMS OF THE SALE INDICATE HOW LONG THE DEBTOR HAS TO PAY AND IF A SETTLEMENTDISCOUNTAPPLIES WILLSPECIFYTHETERMSOFTHATDISCOUNT)N&IGURE THE TERMSOFTHESALE N INDICATETHATTHEDEBTOR!7INDLEY HASDAYSTOSETTLE THEDEBT BUTIFITISREPAIDWITHINSEVENDAYS ADISCOUNTWILLBEAPPLIEDTOTHETOTAL AMOUNTOWING © Anthony SImmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and this material must not be transferred to another party.

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CHAPTER 4

T H E G O O D S A N D S E R V I C E S TA X ( G S T )

Recording a credit sale with GST 2ECORDINGACREDITSALEISVERYSIMILARTORECORDINGACASHSALE THEONLYDIFFERENCEBEING THATACREDITSALETAKESTHEFORMOFANINCREASEIN$EBTORS#ONTROLRATHERTHAN"ANK 4HE '34DOESNOTAFFECTTHECOSTPRICEOFTHESALEORTHESALESREVENUEEARNED SOTHELEDGER ENTRIESTORECORDACREDITSALEWITH'34WOULDBE DR #2 #2 $2 #2

Debtors Control #REDIT3ALES '34#LEARING #OSTOF3ALES 3TOCK#ONTROL

$2 200

 





4HISENTRYWOULDBERECORDEDINTHE'ENERAL,EDGERASISSHOWNIN&IGURE Figure 4.12 General Ledger: credit sale with GST General Ledger Debtors Control (A) Date April 1 21

Cross-reference

Amount $

Balance

6 000

Sales/GST Clearing

2 200

Date

Cross-reference

Amount $

Cross-reference

Amount $

Sales (R) Date

Cross-reference

Amount $

Date April 7 21

Bank

400

Debtors Control

2 000

Cross-reference

Amount $

GST Clearing (A or L) Date April 14

Cross-reference Bank

Amount $ 120

Date April 7 21

Bank

40

Debtors Control

200

Cross-reference

Amount $

Stock Control (A) Date April 1

Cross-reference Balance

Amount $

Date

15 000

April 7

Cost of Sales

250

21

Cost of Sales

1 250

Cost of Sales (E) Date

Cross-reference

Amount $

April 7

Stock Control

250

21

Stock Control

1 250

Date

Cross-reference

Amount $

4HE$2 200OWEDBYTHEDEBTORSINCLUDESTHEFORTHESALE PLUS'34 SO THE CROSS REFERENCE IN THE $EBTORS #ONTROL ACCOUNT REFERS TO BOTH 3ALES AND '34 #LEARING (OWEVER THE '34 IS CHARGED TO THE DEBTOR ON BEHALF OF THE !4/ SO IT IS CREDITEDTO'34#LEARINGTOINCREASETHELIABILITYOWEDTOTHE!4/

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Cambridge University Press

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72

UNITS 3&4

Effect on the accounting equation !CREDITSALEWITH'34HASTHEFOLLOWINGEFFECTONTHEACCOUNTINGEQUATION Increase/Decrease/No effect

Amount $

Assets

Increase (increase Debtors Control $2 200, decrease Stock Control $1250)

950

Liabilities

Increase (GST Clearing)

200

Owner’s Equity

Increase (Sales $2 000 less Cost of Sales $1 250 = Profit)

750

REVIEW QUESTIONS 4.5

1 2 3 4 5

4.6 purchase invoice a source document used to verify a credit purchase of stock or other items

EXAMPLE

StateTHESOURCEDOCUMENTUSEDTOVERIFYACREDITSALE ExplainWHATISMEANTBYTHETERMS N ShowTHEDEBITANDCREDITENTRIESNECESSARYTORECORDACREDITSALEWITH'34 ExplainWHYTHE'34CHARGEDONACREDITSALEINCREASES$EBTORS#ONTROL ExplainWHYTHE'34CHARGEDONACREDITSALEINCREASESTHE'34LIABILITY

CREDIT PURCHASES

7HENGOODSAREPURCHASEDONCREDIT THESUPPLIERWILLISSUEApurchase invoice WHICH MUSTSATISFYTHEREQUIREMENTSOFTHE!4/TOQUALIFYASA'34DOCUMENT!PURCHASE INVOICEWILLLOOKALMOSTIDENTICALTOASALESINVOICE DETAILINGTHESAMEINFORMATION BUT FROMADIFFERENTPERSPECTIVETHISTIMEITWILLSPECIFYNOTTHENAMEOFTHEDEBTORANDTHE GOODSSOLD BUTRATHERTHENAMEOFTHECREDITORANDTHEGOODSPURCHASED 4HEPURCHASEINVOICETHATWOULDPROVIDEEVIDENCEOFTHISCREDITPURCHASEISSHOWN IN&IGURE

On 28 April 2015, Snaps Photographic Equipment purchased 10 cameras from Pentacks for $270 (plus $27 GST) each (Inv. A16).

Figure 4.13 Purchase invoice 28 April 2015

PENTACKS

41 Kookaburra St, Frankston VIC 3199

ABN: 22 098 822 098 TAX INVOICE A16

STUDY TIP

5SETHENAMEOFTHE SELLERATTHETOPOFTHE INVOICETODETERMINE WHETHERTHEINVOICE VERIlESACREDITSALEOR CREDITPURCHASE

Charge to:

ORIGINAL

TERMS: 30 days

Snaps Photographic Equipment Grace St, Essendon VIC 3041 ABN: 11 049 411 049 Item

Qty

Unit cost

Pentacks 550 Series camera

10

270

GST (10%)

$ 2 700 270

$

© Anthony SImmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and this material must not be transferred to another party.

2 970

Cambridge University Press

CHAPTER 4

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73

)NTHERECORDSOF0ENTACKS THISDOCUMENTWOULDBEIDENTIlEDASASALESINVOICEAND RECORDEDASACREDITSALE(OWEVER INTHERECORDSOF3NAPS0HOTOGRAPHIC%QUIPMENT IDENTIlEDWHEREITSAYS@#HARGETO THISISAPURCHASEINVOICE VERIFYINGACREDITPURCHASE OFSTOCK

Recording a credit purchase with GST !SARESULTOFACREDITPURCHASE WEWILLOWETHESUPPLIERFORBOTHTHESTOCKplusTHE '34 BUTTHEITEMSARESEPARATETHE'34DOESNOTAFFECTTHECOSTPRICEOFTHESTOCK PURCHASED4HELEDGERENTRIESTORECORDACREDITPURCHASEWITH'34WOULDTHUSBE $2 $2 CR

3TOCK#ONTROL '34#LEARING Creditors Control

  2 970

4HISENTRYWOULDBERECORDEDINTHE'ENERAL,EDGERASISSHOWNIN&IGURE Figure 4.14 General Ledger: credit purchase with GST General Ledger Stock Control (A) Date April 1 28

Cross-reference Balance

Amount $

Date

15 000

April 7

Cost of Sales

250

2 700

21

Cost of Sales

1 250

Creditors Control

Cross-reference

Amount $

GST Clearing (A or L) Date April 14 28

Cross-reference

Amount $

Date

Cross-reference Bank

Bank

120

April 7

Creditors Control

270

21

Amount $ 40

Debtors Control

200

Cross-reference

Amount $

Creditors Control (L) Date

Cross-reference

Amount $

Date April 1 28

Balance

7 000

Stock Control/

2 970

GST Clearing

4HE $2 970OWEDTOCREDITORSINCLUDESTHEFORTHESTOCK PLUS'34 SO THECROSS REFERENCEINTHE#REDITORS#ONTROLACCOUNTREFERSTOBOTH3TOCK#ONTROLAND '34 #LEARING BOTH ACCOUNTS ARE LINKED TO #REDITORS #ONTROL BECAUSE THE BUSINESS OWESTHECREDITORSBOTHAMOUNTS4HE'34ONTHEPURCHASE WILLREDUCETHE'34 LIABILITYTOTHE!4/ ANDSOITISDEBITEDTOTHE'34#LEARINGACCOUNT

STUDY TIP

Effect on the accounting equation !CREDITPURCHASEOFSTOCKWILLTHUSHAVETHEFOLLOWINGEFFECTONTHEACCOUNTINGEQUATION Increase/Decrease/No effect

Amount $

Assets

Increase (Stock Control $2 700)

2 700

Liabilities

Increase (increase Creditors Control $2 970, decrease GST Clearing $270)

2 700

Owner’s Equity

No effect

© Anthony SImmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and this material must not be transferred to another party.

!LTHOUGHINVOICES WOULDBEISSUEDFOR CREDITPURCHASESOFALL ITEMSnSTOCKANDNON CURRENTASSETSALIKEn 5NITONLYCOVERSCREDIT PURCHASESOFSTOCK

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

74

STUDY TIP

$ONTPANICIFTHE '34ISNOTYETCLEAR #HAPTERSANDWILL EXPLORE'34INDETAIL USINGARANGEOF EXAMPLES4HISCHAPTER ISONLYDESIGNEDTOBE ANOVERVIEW

UNITS 3&4

GST Clearing: summary 4HE'34#LEARINGACCOUNTSHOWS s '34RECEIVED ONCASHSALES s '34CHARGEDTODEBTORS ONCREDITSALES s '34PAID ONCASHPURCHASES s '34CHARGEDBYCREDITORS ONCREDITPURCHASES )F '34 ON SALES IS GREATER THAN '34 ON PURCHASES THEN '34 #LEARING WILL HAVE A CREDITBALANCE ANDBEREPORTEDASACURRENTLIABILITY4HEBUSINESSWILLBEREQUIREDTO MAKEAPAYMENTTOTHE!4/CALLEDA'34SETTLEMENT/NTHEOTHERHAND IF'34ON PURCHASESISGREATERTHAN'34ONSALES THE'34#LEARINGACCOUNTWILLBEACURRENTASSET WITHADEBITBALANCE ANDTHEBUSINESSWILLBEDUEA'34REFUNDFROMTHE!4/ REVIEW QUESTIONS 4.6

1 StateTHESOURCEDOCUMENTUSEDTOVERIFYACREDITPURCHASE 2 ShowTHEDEBITANDCREDITENTRIESNECESSARYTORECORDACREDITPURCHASEOF STOCKWITH'34 3 ExplainTHEEFFECTON3TOCK#ONTROLOFTHE'34ONACREDITPURCHASE 4 ExplainWHYTHE'34ONACREDITPURCHASEDECREASESTHE'34LIABILITY 5 ExplainWHATMUSTOCCURIFTHE'34#LEARINGACCOUNTHASACREDITBALANCE ATTHEENDOFTHEPERIOD 6 ExplainWHATMUSTOCCURIFTHE'34#LEARINGACCOUNTHASADEBITBALANCE ATTHEENDOFTHEPERIOD

4.7

OTHER BUSINESS DOCUMENTS

Memos 3OME TRANSACTIONS WILL NOT BE EVIDENCED BY ANY OF THE PRECEDING DOCUMENTS AS THEY INVOLVE NEITHER A SALE NOR PURCHASE NOR THE RECEIPT OR PAYMENT OF CASH 4HESE TRANSACTIONSMAYINCLUDE s OPENING CLOSING CORRECTINGANDADJUSTINGENTRIES s STOCKLOSSES GAINS WRITE DOWNSANDTRANSFERS s NON CASHTRANSACTIONSWITHTHEOWNER s OTHERNON CASH INFREQUENTTRANSACTIONS

memo a source document used to verify an internal transaction

%ACHOFTHESETRANSACTIONSISCOVEREDINDETAILLATERINTHISTEXT 4HESE TRANSACTIONS MUST STILL BE VERIlED BY A DOCUMENT BUT FOR THE PRECEDING TRANSACTIONSITWILLBEADOCUMENTISSUEDFROMWITHINTHElRM CALLEDAMEMORANDUM ORmemo-EMOSCANBEISSUEDFORANYNUMBEROFTRANSACTIONS ANDSOTHEIRFORMAT ISMUCHMOREmEXIBLETHANTHEOTHERDOCUMENTSDISCUSSEDSOFAR0UTSIMPLY THEYWILL DESCRIBEAPARTICULARENTRY ANDREQUESTTHATITISRECORDED&IGURESHOWSACOMMON LAYOUTFORAMEMO

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Cambridge University Press

CHAPTER 4

T H E G O O D S A N D S E R V I C E S TA X ( G S T )

Figure 4.15 Memo

75

m

e

graphic

Snaps Photo

19 mo

Equipment

ril 2015 Date: 30 Ap Room From: Stock

Department g n ti n u o c c To: A s e of Pentack k ta k c o st l a Physic s 0 series) show cameras (55 and. 20 units on h

M. Hillsington ger Stock Mana

4HEDOCUMENTISDATEDANDNUMBEREDANDINFORMSTHEACCOUNTINGDEPARTMENTTHAT ASTOCKTAKEHASCOUNTEDCAMERAS4HISlGURECANTHENBECOMPAREDWITHTHESTOCK CARDSTOCHECKTHEIRACCURACY ANDDETECTANYSTOCKLOSSORGAIN WHICHCOULDTHENBE RECORDEDINTHELEDGERACCOUNTS

Statements of account 4HElRST ANDMOSTIMPORTANT POINTTONOTEABOUTAstatement of accountISTHATITIS NOTEVIDENCEOFASINGLETRANSACTIONWITHACREDITORORDEBTOR BUTRATHERAsummaryOFA NUMBEROFTRANSACTIONSINVOLVINGTHATDEBTORORCREDITOROVERACERTAINPERIOD"ECAUSE ITISALISTOFTRANSACTIONSTHATHAVEALREADYOCCURREDnANDSHOULDHAVEALREADYBEEN RECORDEDnTHESTATEMENTOFACCOUNTISNOTASOURCEDOCUMENTTHATMUSTBERECORDED &IGURESHOWSTHESTATEMENTOFACCOUNTFROMACREDITORn0ENTACKSnFOR!PRIL

© Anthony SImmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and this material must not be transferred to another party.

statement of account a summary of the transactions a firm has had with a particular debtor/ creditor over a certain period of time (usually a month)

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

76

UNITS 3&4

Figure 4.16 Statement of account

PENTACKS

41 Kookaburra St, Frankston VIC 3199

ABN: 22 098 822 098

STATEMENT OF ACCOUNT

Account of:

Date April 1 April

Snaps Photographic Equipment Grace St, Essendon VIC 3041

For period: April 2015

Details

Payments

Sales

Balance

Balance 200

8

Inv. A09

400

600

Ap

28

Inv. A16

2 970

3 570

Apr

30

Payment received: thank you (Ch. 245)

Balance owing: 30 April 2015

600

2 970

$ 2 970

4HISSTATEMENTOFACCOUNTSUMMARISESTHEVARIOUSCREDITPURCHASESMADEby3NAPS 0HOTOGRAPHIC %QUIPMENT from 0ENTACKS DURING !PRIL  AS WELL AS THE PAYMENTS IT MADE %ACH TRANSACTION SHOULD BE CHECKED AGAINST THE SOURCE DOCUMENT THAT WAS ISSUEDATTHETIMETOCHECKITSACCURACYnANDITMAYBEAREMINDERTOPAYTHECREDITOR THEBALANCEOWINGnBUTNOFURTHERRECORDINGISREQUIREDWHENTHISSTATEMENTISRECEIVED

Order forms order form a document requesting the supply of stock or other goods

*UST LIKE STATEMENTS OF ACCOUNT order forms ARE A TYPE OF SOURCE DOCUMENT THAT DO NOTNEEDTOBERECORDED/RDERFORMSARECOMPLETEDWHENABUSINESSREQUESTSSTOCK OROTHERSUPPLIESASSETSFROMASUPPLIER BUTTHETRANSACTIONDOESNOTOCCURUNTILTHE

© Anthony SImmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CHAPTER 4

T H E G O O D S A N D S E R V I C E S TA X ( G S T )

Figure 4.17 Order form

Snaps Photographic EQUIPMENT

22 Grace St, Essendon VIC 3041

ORDER FORM ABN: 11 049 411 049

Supplier:

Menolta Cameras 55 High St, Armadale VIC 3143

3 May 2015

Please supply the following items:

Item Menolta camera – Model #310

Qty 20

Please inform re. delivery date

GOODSAREEXCHANGED)TISONLYWHENTHEGOODSARERECEIVEDOR INTHECASEOFASALE DELIVERED THATTHEINVOICEWILLBESENT ANDITISTHEinvoice NOTTHEORDERFORM THAT MUSTBERECORDED!NORDERFORMISSIMPLYAREQUESTFORITEMSnTHEITEMSMAYNOTBE AVAILABLE ORMAYNOTBEDELIVEREDFORSOMETIMETOCOMEnSOITCANNOTBERECORDEDAS ATRANSACTION .OTEHOWTHEORDERFORMIN&IGUREDOESNOTSPECIFYANAMOUNTTHEBUSINESS ORDERINGTHESTOCK3NAPS0HOTOGRAPHIC%QUIPMENT ISNOTABLETOSETTHESELLINGPRICE SOITCANNOTSPECIFYANAMOUNTONTHEORDERFORM)TISALSOUNABLETOSPECIFYTHE'34 OR THAT IT IS A TAX INVOICE 4HE AMOUNT WILL BE SPECIlED ON THE PURCHASE INVOICE THAT ACCOMPANIESTHEGOODSWHENTHEYAREDELIVERED ANDITISthenTHATTHETRANSACTIONCAN BERECORDED 4HIS IS NOT AN EXHAUSTIVE LIST OF BUSINESS DOCUMENTS BUT IT ILLUSTRATES THE MAIN DOCUMENTS THAT WILL BE USED IN THE 6#% !CCOUNTING COURSE TO VERIFY TRANSACTIONS ANDENSURETHATREPORTSAREReliableTHATIS FREEFROMBIASANDERROR/THERBUSINESS DOCUMENTSINCLUDINGBANKSTATEMENTS PAYADVICETOEMPLOYEES GROUPCERTIlCATES TAX REMITTANCES DELIVERYDOCKETSANDSTATEMENTSOFSUPERANNUATIONCONTRIBUTIONS WILLBE IMPORTANTINTHENORMALCOURSEOFBUSINESSACTIVITIES ANDEACHANDEVERYONEOFTHESE DOCUMENTSMUSTBECOLLECTED CHECKED RECORDEDWHERENECESSARY ANDlLED

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Cambridge University Press

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

WHERE HAVE WE BEEN? s 4HE'OODSAND3ERVICES4AX'34 ISATAXLEVIEDBYTHEFEDERALGOVERNMENT ONMOSTGOODSANDSERVICESEXCLUDINGFRESHFOOD s '34 ON SALES IS OWED TO THE GOVERNMENT BUT '34 ON PURCHASES REDUCES THAT LIABILITY s !LL'34TRANSACTIONSARESUMMARISEDINTHE'34#LEARINGACCOUNT WHICHCANBEA CURRENTASSETORCURRENTLIABILITY s )F '34 ON SALES IS GREATER THAN '34 ON PURCHASES THE BUSINESS WILL HAVE A '34 LIABILITY ANDBEREQUIREDTOMAKEA'34SETTLEMENT s )F'34ONPURCHASESISGREATERTHAN'34ONSALES THEBUSINESSWILLHAVEA'34ASSET ANDISDUEA'34REFUND s !SSELLINGPRICESAREGENERALLYHIGHERTHANCOSTPRICES MOSTlRMSWILLENDUPWITHA '34LIABILITY s 3OURCEDOCUMENTSPROVIDEBOTHTHEEVIDENCETHATATRANSACTIONHASOCCURRED AND THEDETAILSOFTHETRANSACTIONITSELF4HEYENSURETHEREPORTSAREReliableORFREEFROM ERRORANDBIAS s -OSTCASHPAYMENTSSHOULDBEMADEBYCHEQUEBECAUSETHEYARESECURE TRACEABLE ANDVERIlABLE s 7HENCASHISRECEIVED THESOURCEDOCUMENTWILLBEACASHRECEIPT s 7HENCASHISPAID THESOURCEDOCUMENTWILLBEACHEQUEBUTT s 7HENSTOCKISSOLDONCREDIT THESOURCEDOCUMENTWILLBEASALESINVOICE s 7HEN STOCK IS PURCHASED ON CREDIT THE SOURCE DOCUMENT WILL BE A PURCHASE INVOICE s '34ISRECOGNISEDANDREPORTEDONLYATTHETIMETHEPURCHASEORSALEISMADE s 4HE CREDIT TERMS OF THE SALE INDICATE HOW LONG THE DEBTOR HAS TO PAY AND IF A SETTLEMENTDISCOUNTAPPLIES WILLALSOSPECIFYTHETERMSOFTHATDISCOUNT s !MEMOISASOURCEDOCUMENTUSEDTOVERIFYANINTERNALTRANSACTION s ! STATEMENT OF ACCOUNT IS A SUMMARY OF THE TRANSACTIONS A lRM HAS HAD WITH A PARTICULARDEBTORCREDITOROVERACERTAINPERIODOFTIMEUSUALLYAMONTH  s !N ORDER FORM IS SIMPLY A REQUEST FOR STOCK OR OTHER SUPPLIESASSETS FROM A SUPPLIER

© Anthony SImmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CHAPTER 4

T H E G O O D S A N D S E R V I C E S TA X ( G S T )

EXERCISE 4.1 CASH TRANSACTION

W B

page 56

79

EXERCISES

4HEFOLLOWINGDOCUMENTWASFOUNDINTHEOFlCEOF(ATS/FFTO(ATS
4HEOWNER (ARRY APPLIESMARK UPTOALLSTOCK

555 Mickleham Road Tullamarine VIC 3043

Hats Off to Hats!

ABN: 45 983 453 101

Total:

2 November 2015 60 (tax invoice) Cash sales Two hundred and twenty dollars 2 top hats @ $100 each $ 200.00 $ 20.00 $ 220.00

Signed:

Paula Ekland

Date: Receipt no.: Received from: The sum of: Being for: Amount: Plus GST:

Required a IdentifyTHESOURCEDOCUMENTABOVE b DescribeTHETRANSACTIONVERIlEDBYTHISDOCUMENT c Show THE DEBITS AND CREDITS NECESSARY TO RECORD THIS DOCUMENT IN THE 'ENERAL ,EDGEROF(ATS/FFTO(ATS
d ExplainWHYTHISTRANSACTIONCREATESA'34LIABILITYFOR(ATS/FFTO(ATS
e 2EFERRING TO ONE QUALITATIVE CHARACTERISTIC explain THE ROLE OF SOURCE DOCUMENTS INTHEACCOUNTINGPROCESS

EXERCISE 4.2 CASH TRANSACTION

W B

page 57

)#2EDD THEOWNEROF"OOK-E$ANNO FOUNDTHEFOLLOWINGDOCUMENTWHENCLEANING HISDESK

Book Me Danno

Rec. #83

Antique and rare books Puckle St, Moonee Ponds VIC 3039

Received from: V. Deo

ABN: 50 505 505 505

Date: 15.8.15

The sum of: Two hundred and seventy dollars Being for: Settlement of account Signed: Alex Micari

Amount:

$270.00

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UNITS 3&4

Required a 2EFERRINGTOTHEPRECEDINGDOCUMENT identifyTHEENTITYTHATHASRECEIVEDTHECASH b ExplainWHYTHEREISNO'34IDENTIlEDINTHISDOCUMENT c ShowTHEDEBITANDCREDITENTRIESNECESSARYTORECORDTHISTRANSACTIONINTHE'ENERAL ,EDGEROF"OOK-E$ANNO d Explain THE EFFECT THAT THIS TRANSACTION HAS ON THE PROlT OF "OOK -E $ANNO FOR !UGUST

EXERCISE 4.3 CASH TRANSACTION

W B

page 58

4HEFOLLOWINGSOURCEDOCUMENTWASDISCOVEREDBYTHEMANAGEROF3ALLYS3HOE3HOP

ABN 63 217 846 199

National Australia Bank

1 March 2015 Date .............................................................. Courier Newspaper To.................................................................. Advertising paid in advance For ................................................................ $1 400 plus GST of $140 ..................................................................... Bal c/fwd $ ................................................... Deposits $ ....................................................

$1 540.00 Amount ........................................................ Balance $...................................................... CHQ No. 200

Required a StateWHETHERSOURCEDOCUMENTSTAKEPLACEATTHEINPUT PROCESSINGOROUTPUTSTAGE OFTHEACCOUNTINGPROCESS b IdentifyTHESOURCEDOCUMENTABOVE ANDdescribeTHETRANSACTION c State TWO REASONS WHY PAYMENTS SHOULD NOT BE MADE USING CASH FROM THE CASH REGISTER d ShowTHEDEBITANDCREDITENTRIESNECESSARYTORECORDTHISTRANSACTIONINTHE'ENERAL ,EDGEROF3ALLYS3HOE3HOP e StateTWOREASONSWHYTHISDOCUMENTWOULDnotSATISFYTHEREQUIREMENTSOFATAX INVOICE

EXERCISE 4.4 CREDIT TRANSACTION

W B

page 59

4HEACCOUNTANTFOR-ENTONE-USIC3HOPCAMEACROSSTHISSOURCEDOCUMENTINADRAWER

© Anthony SImmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and this material must not be transferred to another party.

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T H E G O O D S A N D S E R V I C E S TA X ( G S T )

MUSICAL MAYHEM

TAX INVOICE

72 City View Rd Balwyn VIC 3930

Invoice: 480 (Original) Net 30 days 8 February 2015

ABN: 61 363 217 404

Customer:

Mentone Music Shop (ABN: 12 945 362 733) 91 Balcombe Rd, Mentone VIC 3194

Attn:

B. Gill

Item 205

Description

Qty

Unit Cost

$

15

500

7 500

Saxophones Plus GST 10%

750

Total

$

8 250

Required a IdentifyTHESOURCEDOCUMENTABOVE ANDdescribeTHETRANSACTION b Show THE DEBITS AND CREDITS NECESSARY TO RECORD THIS TRANSACTION IN THE 'ENERAL ,EDGEROF-ENTONE-USIC3HOP c ExplainTHEEFFECTOFTHISTRANSACTIONONTHE'34LIABILITYOF-ENTONE-USIC3HOP d State THE VALUE AT WHICH THIS STOCK WOULD BE REPORTED IN THE "ALANCE 3HEET OF -ENTONE-USIC3HOPJustifyYOURANSWER

EXERCISE 4.5 CREDIT TRANSACTION

page 60

W B

!LEX THEOWNEROF$ECO$ÏCOR FOUNDTHEFOLLOWINGDOCUMENTUNDERTHECASHREGISTER )THASNOTBEENRECORDED

Deco Décor

Invoice:

Block Arcade Melbourne VIC 3000

Duplicate Tax invoice

ABN: 98 564 872 575

6/7, n/30

90

Charge to: Lloyds Country Inn, Ballarat VIC 3350 Date

Details

Qty

May 4

Single bed sheet sets

12

Unit Price $ 60

GST (10%)

Total $ 720 72

Total

$792

© Anthony SImmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

81

82

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

Required a IdentifyTHEPRECEDINGSOURCEDOCUMENT ANDdescribeTHETRANSACTION b ExplainWHATISMEANTBYTHETERMS@ N c 'IVENTHATALLSALESAREMARKEDUPBY showTHEDEBITSANDCREDITSNECESSARY TORECORDTHISTRANSACTIONINTHE'ENERAL,EDGEROF$ECO$ÏCOR d ExplainWHYTHISTRANSACTIONINCREASESTHE'34LIABILITYOF$ECO$ÏCOR

EXERCISE 4.6 STATEMENT OF ACCOUNT

W B

page 61

4HE OWNER OF #ELTIC 3ENSATIONS HAS RECEIVED THE FOLLOWING SOURCE DOCUMENT IN THE MAIL

Look of the Irish

5 July 2015

ABN: 34 221 768 999 110 Main Rd Greensborough VIC 3085

STATEMENT OF ACCOUNT Statement for:

Celtic Sensations 45 Burke Rd, Camberwell VIC 3350 Particulars

June 1

ACC: 8613

Debit

ABN: 16 422 031 164

Credit

Balance b/fwd

12

Inv. MH 365

24

Thank you – payment

29

Inv. MH 372

Days outstanding Amount outstanding

Balance 3 200

1 200

4 400 2 400

1 500 Current

2 000 3 500

30 – 60

2 700

60+ 800

Please pay any outstanding amounts immediately to ensure continuance of supply

Required a StateTHEROLEOFASTATEMENTOFACCOUNT b Explain HOW ,OOK OF THE )RISH WOULD BE REPORTED IN THE "ALANCE 3HEET OF #ELTIC 3ENSATIONS c ExplainHOW#ELTIC3ENSATIONSWOULDBEREPORTEDINTHE"ALANCE3HEETOF,OOKOF THE)RISH d Explain HOW THIS DOCUMENT SHOULD BE USED BY #ELTIC 3ENSATIONS TO IMPROVE THE ReliabilityOFITSREPORTS

© Anthony SImmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CHAPTER 4

T H E G O O D S A N D S E R V I C E S TA X ( G S T )

EXERCISE 4.7 MEMORANDUM

W B

page 62

4HEACCOUNTANTOF&ERRIS&RAMESRECEIVEDTHEFOLLOWINGSOURCEDOCUMENTINTHEINTERNAL MAILFROMTHEMANAGER

Ferris Frames Shannon Street Sunbury VIC 3429

To:

memo

5

The Accountant

Re: $300 worth of stock has been taken for personal use. Signed:

K. Ferris

Required a IdentifyTHESOURCEDOCUMENTABOVE ANDdescribeTHETRANSACTION b ExplainTHEROLEOFMEMOSINANACCOUNTINGSYSTEM c 2EFERRINGTOONEACCOUNTINGPRINCIPLE explainWHYTHISTRANSACTIONMUSTBERECORDED INTHE'ENERAL,EDGEROF&ERRIS&RAMES d Show THE DEBITS AND CREDITS NECESSARY TO RECORD THIS TRANSACTION IN THE 'ENERAL ,EDGEROF&ERRIS&RAMES e StateTHEEFFECTONTHEACCOUNTINGEQUATIONOF&ERRIS&RAMESIFTHISDOCUMENTWAS notRECORDED f StateTWOOTHERTYPESOFTRANSACTIONTHATWOULDBEVERIlEDBYAMEMO

© Anthony SImmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

83

84

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

EXERCISE 4.8 ORDER FORM

W B

page 64

4HE-ANAGEROF"EVS0HOTO3HOPSENTTHEFOLLOWINGDOCUMENTTOHERSUPPLIER+OMAK

Bev’s Photo Shop

Purchase Order: 91

Highpoint Centre Maribyrnong VIC 3168

29 April 2015

The Photographer’s Friend Supplier

KOMAK Industrial Lane, Dandenong VIC 3162

Please supply the following: Qty

Photographic supplies

25

Film – Kodak 400

10

Paper – A45 (high gloss) Please deliver within 7 days

Required a ExplainWHYORDERFORMSAREnotPARTOFTHEACCOUNTINGPROCESS b ExplainWHYTHEREARENOPRICESLISTEDONTHISDOCUMENT c 2EFERRING TO THE DElNITIONS explain WHY THIS DOCUMENT DOES not LEAD TO THE RECOGNITIONOFANASSETINTHERECORDSOF"EVS0HOTO3HOP d NameTHEDOCUMENTTHATWILLVERIFYTHEPURCHASEOFTHEPHOTOGRAPHICSUPPLIESWHEN THEYAREDELIVERED

© Anthony SImmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

Where are we headed? After completing this chapter, you should be able to: s explainTHEROLEOFSPECIAL JOURNALSANDTHEBENElTS THEYBRINGTOTHEACCOUNTING PROCESS s listTHEFOURSPECIALJOURNALS ANDidentifyTHETRANSACTIONS THEYAREUSEDTORECORD s recordCREDITPURCHASES OFSTOCKWITH'34 INTHE 0URCHASES*OURNAL s postTHE0URCHASES*OURNAL TOTHE'ENERAL,EDGERAND #REDITORS,EDGER s prepareA#REDITORS3CHEDULE s recordCREDITSALESOFSTOCK WITH'34 INTHE3ALES *OURNAL

s postTHE3ALES*OURNALTOTHE 'ENERAL,EDGERAND$EBTORS ,EDGER s prepareA$EBTORS3CHEDULE s explainTHERELATIONSHIP BETWEENCONTROLACCOUNTS ANDTHESUBSIDIARYLEDGER s explainTHEBENElTSOFUSING ASYSTEMOFCONTROLACCOUNTS ANDSUBSIDIARYLEDGERS s identifyTHEEFFECTOF'34 ONTHERECORDINGOFCREDIT PURCHASESANDSALES s report'34#LEARINGINTHE "ALANCE3HEET

CHAPTER 5

SPECIAL JOURNALS 1: CREDIT JOURNALS KEY TERMS After completing this chapter, you should be familiar with the following terms: s SPECIALJOURNAL s 0URCHASES*OURNAL s CONTROLACCOUNT s SUBSIDIARYLEDGER s 3ALES*OURNAL s '34SETTLEMENT s '34REFUND ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

86

5.1

UNITS 3&4

SPECIAL JOURNALS

,EDGER ACCOUNTS ARE IDEAL FOR RECORDING THE EFFECT OF TRANSACTIONS ON INDIVIDUAL ITEMS IN BUSINESS REPORTS BUT HAVING COMPLETED THE EXERCISES IN #HAPTER  YOU WILL KNOW THATRECORDINGINLEDGERSINVOLVESAFAIRDEALOFREPETITION4RANSACTIONSTHATOCCUREVERY DAYSUCHASCASHSALES CASHPAYMENTSORPURCHASESOFSTOCKONCREDIT WILLNEEDTOBE RECORDEDINTHELEDGERACCOUNTSEACHDAY USINGEXACTLYTHESAMEDEBITANDCREDITENTRIES

EXAMPLE

Linen and McCartney is a shop that sells sheets, towels and bed linen. Its transactions for October were as follows: Oct.

1 6 17 22 25 29

Purchased stock on credit from Marks and Co. – $230 plus $23 GST (Inv. B93) Stock purchased from Walton Traders for $220 including $20 GST (Inv. 13) Purchased $190 worth of stock (plus $19 GST) from Jackson Suppliers (Inv. 142) Bought stock from Highlife Ltd for $320 plus $32 GST (Inv. A17) Purchased stock on credit from Marks and Co. for $410 plus GST (Inv. B99) Stock purchased from Walton Traders for $187 (includes GST) (Inv. 21)

%ACHOFTHETRANSACTIONSABOVEISAcredit purchase of stock ANDWILLREQUIREEXACTLY THESAMEDEBITANDCREDITENTRIESEVERYTIMEITISRECORDEDINTHELEDGER4HATIS $2 $2 CR

3TOCK#ONTROL '34#LEARING Creditors Control

!FTERRECORDINGTHESETRANSACTIONSINTHE'ENERAL,EDGER THEACCOUNTSWOULDSHOW General Ledger Stock Control (A) Date

Cross-reference

Amount $

Oct. 1

Creditors Control

230

6

Creditors Control

200

17

Creditors Control

190

22

Creditors Control

320

25

Creditors Control

410

29

Creditors Control

170

Date

Cross-reference

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Amount $

Cambridge University Press

CHAPTER 5

SPECIAL JOURNALS 1: CREDIT JOURNALS

87

GST Clearing (A or L) Date

Cross-reference

Amount $

Oct. 1

Creditors Control

23

6

Creditors Control

20

17

Creditors Control

19

22

Creditors Control

32

25

Creditors Control

41

29

Creditors Control

17

Date

Cross-reference

Amount $

Creditors Control (L) Date

Cross-reference

Amount $

Date

Cross-reference

Amount $

Oct. 1

Stock Control/GST Clearing

253

6

Stock Control/GST Clearing

220

17

Stock Control/GST Clearing

209

22

Stock Control/GST Clearing

352

25

Stock Control/GST Clearing

451

29

Stock Control/GST Clearing

187

!LTHOUGHTHESELEDGERACCOUNTSSHOWONLYSIXTRANSACTIONS THEREPETITIONISOBVIOUS )MAGINEWHATTHESEACCOUNTSWOULDLOOKLIKEWITHORCREDITPURCHASESPERMONTH
'IVEN THAT THERE WILL BE A NUMBER OF TRANSACTIONS THAT HAVE THE SAME EFFECT ON THE 'ENERAL,EDGER ITHARDLYMAKESSENSETOREPEATTHESAMELEDGERENTRIESOVERANDOVER AGAIN&ORTHISREASON special journalsAREUSEDTOSUMMARISESIMILARTRANSACTIONSBEFORE POSTINGTHETOTALSTOTHE'ENERAL,EDGERACCOUNTSATTHEENDOFTHEMONTH

Types of special journals 7HEREAS LEDGER ACCOUNTS RECORD ALL TRANSACTIONS THAT AFFECT A PARTICULAR item SUCH AS "ANK OR#REDITORS#ONTROLOR3ALES SPECIALJOURNALSRECORDALLtransactionsOFAPARTICULAR TYPE4HEFOURMOSTCOMMONSPECIALJOURNALSnANDTHETRANSACTIONSTHATTHEYRECORDn ARESHOWNIN&IGURE Figure 5.1 Types of special journals Journal

Transaction

Purchases Journal (PJ)

Credit purchases of stock (from creditors)

Sales Journal (SJ)

Credit sales of stock (to debtors)

Cash Receipts Journal (CRJ)

Cash received (from all sources)

Cash Payments Journal (CPJ)

Cash paid (for all uses)

4HEMAINPURPOSEOFTHESESPECIALJOURNALSISTOSUMMARISESIMILARTRANSACTIONSSO THATTOTALSCANBEPOSTEDTOTHE'ENERAL,EDGER INTHEPROCESSREDUCINGTHENUMBEROF LEDGERENTRIESREQUIREDANDIMPROVINGTHEEFlCIENCYOFTHERECORDINGSYSTEM 7HILETHESEARETHEMOSTCOMMONSPECIALJOURNALS ITSHOULDBENOTEDTHATITISUPTO EACHlRMTODETERMINEWHICHSPECIALJOURNALSTOUSE DEPENDENTONITSOWNCIRCUMSTANCES ANDNEEDS&ORINSTANCE IFCREDITPURCHASESOFSTOCKOCCURONLYINFREQUENTLY THEREISNO NEEDFORA0URCHASES*OURNAL/NTHEOTHERHAND EVERYlRMWILLHAVECASHTRANSACTIONS SOTHESEJOURNALSAREALMOSTINDISPENSABLE ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

special journal an accounting record that summarises similar transactions

STUDY TIP

4HEREISNONEEDTO SPECIFYcreditINTHE TITLEOFTHE0URCHASES *OURNALOR3ALES*OURNAL ASTHISISTHEONLYTYPE OFTRANSACTIONTHEY CANRECORDALLCASH PURCHASESORSALESWILL BERECORDEDINEITHER THE#ASH0AYMENTS *OURNALOR#ASH 2ECEIPTS*OURNAL

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

88

UNITS 3&4

!NYTRANSACTIONSTHATAREUNABLETOBERECORDEDINASPECIALJOURNALMUSTBERECORDED IN THE 'ENERAL *OURNAL WHICH IS USED TO RECORD ALL INFREQUENT NON CASH TRANSACTIONS 4HISWILLBECOVEREDIN#HAPTER Every transaction must be recorded in a journal before it is posted to the ledger accounts. !SARESULT THEJOURNALSnSPECIALAND GENERALnPLAYANADDITIONALROLEOFPROVIDING ALINKBETWEENTHELEDGERENTRIESANDTHESOURCEDOCUMENTSTHATPROVIDETHEEVIDENCE ANDDETAILSOFTHETRANSACTIONSTHEMSELVES

REVIEW QUESTIONS 5.1

1 2 3 4

5.2

ListTHEFOURSPECIALJOURNALS ANDstateTHETYPESOFTRANSACTIONSTHEYRECORD ExplainTHEFUNCTIONOFASPECIALJOURNAL ExplainTHEFUNCTIONOFTHE'ENERAL*OURNAL ExplainWHYNOTALLBUSINESSESWILLUSETHESAMESPECIALJOURNALS

THE PURCHASES JOURNAL

!SWASSTATEDINTHEPREVIOUSEXAMPLEOF,INENAND-C#ARTNEY ALLTRANSACTIONSINVOLVING THEPURCHASEOFGOODSONCREDITHAVEEXACTLYTHESAMEDEBITANDCREDITENTRIES $2 $2 #2 Purchases Journal an accounting record that summarises all transactions involving the purchase of stock on credit during a month

3TOCK#ONTROL '34#LEARING

#REDITORS#ONTROL

4HESE TRANSACTIONS CAN BE SUMMARISED IN A Purchases Journal TO ALLOW THE total CREDITPURCHASESOFSTOCKTOBEPOSTEDTOTHE'ENERAL,EDGERACCOUNTSATTHEENDOF THEMONTH

Recording in the Purchases Journal 4HE CREDIT PURCHASES FOR ,INEN AND -C#ARTNEY FOR /CTOBER ARE SUMMARISED IN THE 0URCHASES*OURNALIN&IGURE Figure 5.2 Purchases Journal

Date1

Creditor2

Invoice number3

Stock Control4

GST5

Creditors Control6

Oct. 1

Marks and Co.

B93

230

23

253

6

Walton Traders

13

200

20

220

17

Jackson Suppliers

142

190

19

209

22

Highlife Ltd

A17

320

32

352

25

Marks and Co.

B99

410

41

451

29

Walton Traders

21

170

17

187

1 520

152

1 672

Totals

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CHAPTER 5

SPECIAL JOURNALS 1: CREDIT JOURNALS

89

Notes for recording in the Purchases Journal 1

Date !LTHOUGH THE TOTALS WILL BE POSTED TO THE 'ENERAL ,EDGER ONLY AT THE END OF THE MONTHTHATIS ON/CTOBER THETRANSACTIONSARERECORDEDINTHEJOURNAL ONTHEDATETHEYOCCUR4HISDATEWILLBEVERYIMPORTANTFORTHEINDIVIDUALCREDITORS RECORDS

2 Creditor !LL THESE TRANSACTIONS WILL BE RECORDED IN ONE #REDITORS #ONTROL ACCOUNT IN THE 'ENERAL,EDGER BUTBECAUSETHEBUSINESSHASMORETHANONECREDITOR THEJOURNAL MUSTSHOWTHENAMEOFEACHINDIVIDUALCREDITOR!SEPARATERECORDWILLBEMAINTAINED ELSEWHEREFOREACHINDIVIDUALCREDITOR 3 Invoice number )NORDERTOENSUREReliability THESOURCEDOCUMENT WHICHFORTHISJOURNALISAPURCHASE INVOICE MUSTBERECORDED)FAQUERYARISESASTOTHEDETAILSOFTHETRANSACTION IT CANBETRACEDBACKEASILYTOTHESOURCEDOCUMENTFORCLARIlCATIONANDVERIlCATION 4HEPURCHASEINVOICESLISTEDINTHE0URCHASES*OURNALOF,INENAND-C#ARTNEYWILL NOTRUNINORDER BECAUSETHEYAREISSUEDNOTBY,INENAND-C#ARTNEY BUTBYTHEIR SUPPLIERS SUCHAS-ARKSAND#OAND7ALTON4RADERS"ETWEENPURCHASESBY,INEN AND-C#ARTNEY THESESUPPLIERSWILLISSUEINVOICESTOALLTHEIROTHERCUSTOMERS 4 Stock Control 3TOCK#ONTROLISTHEVALUECOSTPRICE OFTHESTOCKTHATHASBEENPURCHASED EXCLUDING THE'34 5 GST 4HISISTHE'34CHARGEDBYSUPPLIERSONCREDITPURCHASES CALCULATEDASOFTHE PURCHASEPRICE ASRECORDEDINTHE3TOCK#ONTROLCOLUMN4HE'34CHARGEDBYTHE SUPPLIERSDOESNOTAFFECTTHEVALUATIONOFSTOCKITSIMPLYREDUCESTHE'34LIABILITY OWEDTOTHE!4/ ANDINCREASESTHEDEBTOWEDTOCREDITORS

STUDY TIP

4RANSACTIONSMAYASK YOUTOCALCULATETHE AMOUNTOF'34 BUTWILL ALWAYSIDENTIFYTHAT'34 APPLIES

6 Creditors Control 4HISISTHETOTALAMOUNTOWEDTOCREDITORS CALCULATEDBYADDINGTOGETHERTHEVALUE OFTHESTOCKPURCHASEDANDTHE'347EOWETHECREDITORFORTHESTOCKPURCHASED ANDTHE'34ONTHATSTOCK

Posting the Purchases Journal to the General Ledger !TTHEENDOFTHEMONTH THETOTALOFTHE0URCHASES*OURNALCANBEPOSTEDTOTHE'ENERAL ,EDGERACCOUNTSASISSHOWNIN&IGURE Figure 5.3 General Ledger: posting the Purchases Journal General Ledger Stock Control (A) Date Oct. 1 31

Cross-reference Balance Creditors Control

Amount $

Date

Cross-reference

Amount $

Cross-reference

Amount $

10 000 1 520 GST Clearing (A or L)

Date Oct. 31

Cross-reference Creditors Control

Amount $

Date

152

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

90

UNITS 3&4

Figure 5.3 (cont.) General Ledger: posting the Purchases Journal Creditors Control (L) Date

Cross-reference

Amount $

Date Oct. 31

Cross-reference Stock Control/

Amount $ 1 672

GST Clearing

2ECORDING TRANSACTIONS IN THE 0URCHASES *OURNAL BEFORE POSTING TO THE 'ENERAL ,EDGERHASALLOWEDUSTORECORDallCREDITPURCHASESWITHJUSTONEENTRY NOTSIX INEACH ACCOUNT 2EMEMBERTHATTHECROSS REFERENCEINTHE#REDITORS#ONTROLACCOUNTREFERSTOBOTH 3TOCK #ONTROL and '34 #LEARING BECAUSE BOTH ACCOUNTS ARE LINKED TO THE AMOUNT RECORDEDINCreditors Control )NTHE'34#LEARINGACCOUNT THE'34CHARGEDBYTHESUPPLIERISRECORDEDONTHE DEBITSIDE ASITREDUCESANY'34LIABILITYTHEBUSINESSMAYHAVEACCRUED)TISTREATEDAS IFSOME'34HASALREADYBEENPAIDTOTHE!4/)FTHE'34#LEARINGACCOUNTALREADYHAD ADEBITBALANCE THIS'34CHARGEDBYSUPPLIERSWOULDINCREASETHEVALUEOFTHEASSET The Purchases Journal is posted to the General Ledger using the column totals at the end of the month.

REVIEW QUESTIONS 5.2

1 ExplainTHEROLEOFTHE0URCHASES*OURNAL 2 StateWHICHTYPEOFSOURCEDOCUMENTISUSEDTOVERIFYALLTRANSACTIONSRECORDED INTHE0URCHASES*OURNAL 3 ExplainTHEEFFECTONTHEVALUATIONOFSTOCKOF'34CHARGEDBYSUPPLIERS ON CREDITPURCHASES 4 2EFERRINGTOTHE0URCHASES*OURNAL stateONEREASONWHYTHEAMOUNTRECORDED INTHE#REDITORS#ONTROLCOLUMNISGREATERTHANTHEVALUEOFSTOCKPURCHASED 5 ShowTHEDEBITANDCREDITENTRIESNECESSARYTOPOSTTHE0URCHASES*OURNALTO THE'ENERAL,EDGER 6 ExplainTHEEFFECTONTHE'34#LEARINGACCOUNTOF'34CHARGEDBYSUPPLIERS ONCREDITPURCHASES

5.3

control account an account in the General Ledger summarising the transactions recorded in the subsidiary ledger accounts subsidiary ledger an additional set of ledger accounts kept outside the General Ledger, recording individual transactions for each individual debtor or creditor

THE CREDITORS (SUBSIDIARY) LEDGER

!LTHOUGHWEHAVERECORDEDTHETOTALPURCHASEDFROMCREDITORS THEREISATPRESENTNO RECORDOFTHEAMOUNTSOWEDTOINDIVIDUALCREDITORS4HE0URCHASES*OURNALWASPOSTED TOAcontrol accountINTHE'ENERAL,EDGERCALLED#REDITORS#ONTROL WHICHSUMMARISED THEPURCHASESFROMallCREDITORS 4HE'ENERAL,EDGERACCOUNTISCALLEDCreditors Control MAKINGITCLEARTHATITISA summaryACCOUNT ANDFURTHERDETAILSARERECORDEDELSEWHERE)NTHECASEOFCREDITORS THE DETAILED RECORDS ARE KEPT IN A subsidiary ledger CALLED THE #REDITORS ,EDGER ! SUBSIDIARY LEDGER IS AN ADDITIONAL SET OF LEDGER ACCOUNTS KEPT OUTSIDE THE 'ENERAL ,EDGER7HEREASTHE'ENERAL,EDGERCONTAINSTHE#REDITORS#ONTROLACCOUNT SHOWINGA SUMMARYOFALLTRANSACTIONSAFFECTINGCREDITORSASAWHOLE THE#REDITORS,EDGERCONTAINS A SEPARATE ACCOUNT FOR EACH INDIVIDUAL CREDITOR SHOWING EACH INDIVIDUAL TRANSACTION AFFECTINGTHATCREDITORSBALANCE

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CHAPTER 5

SPECIAL JOURNALS 1: CREDIT JOURNALS

Posting the Purchases Journal to the Creditors Ledger

91

STUDY TIP

!LTHOUGH IT IS STILL A LEDGER THE DOUBLE ENTRY RECORDING RULES ARE MODIlED SOMEWHAT WHENPOSTINGTOTHE#REDITORS,EDGER)TISINTHE'ENERAL,EDGERTHATTHEDOUBLE ENTRY RECORDING RULE n REQUIRING A MATCHING DEBIT AND CREDIT ENTRY n MUST BE MAINTAINED )NTHE#REDITORS,EDGER ALLTHATMUSTBESHOWNARETHEdetailsTHATIS THEINDIVIDUAL TRANSACTIONSTHATTOGETHERMAKEUPTHEONECREDITENTRYINTHE#REDITORS#ONTROLACCOUNT 4HE 0URCHASES *OURNAL IN &IGURE  WOULD BE POSTED TO THE #REDITORS ,EDGER AS SHOWNIN&IGURE

,OOKINGATTHE INDIVIDUALACCOUNTSIN THE#REDITORS,EDGER ISLIKE@ZOOMINGINON THE#REDITORS#ONTROL ACCOUNTnSORTOFLIKE ZOOMINGINON'OOGLE %ARTH

Figure 5.4 Creditors Ledger: posting the Purchases Journal Creditors Ledger Marks and Co. (L) Date

Cross-reference

Amount $

Date

Cross-reference

Amount $

Oct. 1

Stock Control/GST Clearing

253

25

Stock Control/GST Clearing

451

704 Walton Traders (L) Date

Cross-reference

Amount $

Date

Cross-reference

Amount $

Oct. 6

Stock Control/GST Clearing

220

29

Stock Control/GST Clearing

187

407 Jackson Suppliers (L) Date

Cross-reference

Amount $

Date Oct. 17

Cross-reference Stock Control/GST Clearing

Amount $ 209

STUDY TIP

209 Highlife Ltd (L) Date

Cross-reference

Amount $

Date Oct. 22

Cross-reference Stock Control/GST Clearing

Amount $ 352

352

4HEENTRIESINA CONTROLACCOUNTMUST BEREPLICATEDINTHE SUBSIDIARYLEDGER BUTASINDIVIDUAL TRANSACTIONS

4HEDOUBLEENTRYISMAINTAINEDINTHE'ENERAL,EDGER BUTINTHE#REDITORS,EDGER EACHINDIVIDUALCREDITORSACCOUNTISCREDITEDFORTHEINDIVIDUALTRANSACTIONSTHATMADE UPTHATTOTAL ONTHEDATETHATTHEYOCCURRED The Purchases Journal is posted to the Creditors Ledger using the individual transactions on the date they occur.

The Creditors Schedule )N ORDER TO CHECK THAT THE SAME INFORMATION HAS BEEN RECORDED ALBEIT IN A DIFFERENT FORM INTHE'ENERAL,EDGERAND#REDITORS,EDGER ACreditors ScheduleOR#REDITORS 2ECONCILIATION IS PREPARED 4HIS OCCURS AT THE END OF THE MONTH BEFORE THE "ALANCE 3HEETISPREPARED4HE#REDITORS3CHEDULELISTSTHENAMEANDBALANCEOFEACHINDIVIDUAL ACCOUNTINTHE#REDITORS,EDGER&IGURESHOWSTHE#REDITORS3CHEDULEFOR,INENAND -C#ARTNEYASAT/CTOBER ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Creditors Schedule a list of the name and balance of each individual account in the Creditors Ledger, added together to enable checking against the balance of the Creditors Control account

Cambridge University Press

92

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

Figure 5.5 Creditors Schedule LINEN AND McCARTNEY Creditors Schedule as at 31 October 2015 Creditor

Balance $

Marks and Co.

704

Walton Traders

407

Jackson Suppliers

209

Highlife Ltd

352

Balance as per Creditors Control account

1 672

4HETOTALOFTHE#REDITORS3CHEDULEISCALCULATEDBYADDINGTOGETHERTHEBALANCES OFTHEINDIVIDUALCREDITORACCOUNTSINTHE#REDITORS,EDGER ANDTHISSHOULDEQUALTHE BALANCEOFTHE#REDITORS#ONTROLACCOUNTINTHE'ENERAL,EDGER4HE#REDITORS3CHEDULE FULlLSACONTROLFUNCTIONBYACTINGASACHECKINGMECHANISM/NLYTHEBALANCEOFTHE #REDITORS#ONTROLACCOUNTOF$1 672WILLBEREPORTEDINTHE"ALANCE3HEET Note:)NTHISEXAMPLE THESUMOFTHEBALANCESOFTHEINDIVIDUALCREDITORSACCOUNTS MATCHESNOTONLYTHEBALANCEOFTHE#REDITORS#ONTROLACCOUNT BUTALSOTHETOTALOFTHE 0URCHASES*OURNALBECAUSENOCASHPAYMENTSTOCREDITORSHAVEBEENRECORDED)TISNOT NECESSARY NORLIKELY THATTHE#REDITORS3CHEDULEWILLEQUALTHETOTALOFTHE0URCHASES *OURNALITMUSTONLYMATCHTHEBALANCEOFTHE#REDITORS#ONTROLACCOUNT REVIEW QUESTIONS 5.3

1 Explain THE RELATIONSHIP BETWEEN THE #REDITORS #ONTROL ACCOUNT AND THE #REDITORS,EDGER 2 State TWO DIFFERENCES IN THE WAY THE 0URCHASES *OURNAL IS POSTED TO THE #REDITORS,EDGERASCOMPAREDTOTHE'ENERAL,EDGER  3 StateTHEFUNCTIONOFA#REDITORS3CHEDULE 4 ExplainHOWTHE#REDITORS3CHEDULEAIDSINTHECONTROLOFCREDITORS

5.4

THE SALES JOURNAL AND THE DEBTORS (SUBSIDIARY) LEDGER

*USTASALLCREDITPURCHASESHAVEEXACTLYTHESAMEDEBITANDCREDITENTRIES SOTOODOALL CREDITSALES DR #2 #2

Debtors Control

3ALES2EVENUE

'34#LEARING

AND $2 #2

#OSTOF3ALES

3TOCK#ONTROL

4HESETRANSACTIONSCANBESUMMARISEDINA Sales JournalTOALLOWTHETOTALCREDITSALESOF Sales Journal an accounting record STOCKTOBEPOSTEDTOTHE'ENERAL,EDGERACCOUNTSATTHEENDOFTHEMONTH summarising all transactions involving the sale of stock on credit during a month

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

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SPECIAL JOURNALS 1: CREDIT JOURNALS

93

Recording in the Sales Journal 4HECREDITSALESFOR/CTOBERFOR,INENAND-C#ARTNEYARESUMMARISEDINTHE3ALES *OURNALIN&IGURE Figure 5.6 Sales Journal

Date1

Debtor2

Invoice

Cost of

number3

Sales4

Sales5

GST6

Debtors Control7

R. Starr

45

290

450

45

495

G. Martin

46

160

300

30

330

14

R. Starr

47

200

380

38

418

20

B. Epstein

48

220

400

40

440

27

G. Martin

49

150

270

27

297

1 020

1 800

180

1 980

Oct. 2 6

Totals

Notes for recording in the Sales Journal 1

Date !S WITH THE 0URCHASES *OURNAL TRANSACTIONS ARE RECORDED IN THE 3ALES *OURNAL ON THEDATETHEYOCCUR ASTHISISTHEDATEONWHICHTHEYWILLBEPOSTEDTOTHE$EBTORS ,EDGER

2 Debtor 7HEREASCREDITPURCHASESWILLINCREASE#REDITORS#ONTROL CREDITSALESWILLINCREASE $EBTORS#ONTROL)NADDITION THE3ALES*OURNALMUSTSHOWTHENAMEOFEACHINDIVIDUAL DEBTORSOTHATTHEINDIVIDUALTRANSACTIONSCANBEPOSTEDTOTHEAPPROPRIATEACCOUNTS INTHE$EBTORS,EDGER 3 Invoice number !LTHOUGHTHEINVOICESWILLNOTRUNINSEQUENCEINTHE0URCHASES*OURNAL THEYWILLIN THE3ALES*OURNAL BECAUSETHEYAREALLISSUEDBYTHEBUSINESSKEEPINGTHEJOURNAL 4 Cost of Sales 4HE AMOUNT LISTED UNDER #OST OF 3ALES WILL BE THE COST PRICE OF THE STOCK SOLD EXCLUDINGANY'344HISISTHEAMOUNTTHATWILLBEPOSTEDTORECORDTHEEXPENSE INCURREDWHENSTOCKISSOLD

$2 #2

#OSTOF3ALES%

3TOCK#ONTROL!





5 Sales 4HISISTHESELLINGPRICEOFTHESALE excludingANY'34THATIS THEAMOUNTOFSALES REVENUEEARNEDFROMTHESALE 6 GST 4HISISTHE'34CHARGEDTODEBTORS ONCREDITSALES CALCULATEDASOFTHEPRICE OFTHESALEASRECORDEDINTHE3ALESCOLUMN 4HE'34CHARGEDDOESNOTAFFECTTHE AMOUNT OF REVENUE EARNED IT INCREASES THE '34 LIABILITY OWED TO THE !4/ AND INCREASESTHEAMOUNTOWEDBYDEBTORS 7 Debtors Control 4HISISTHETOTALAMOUNTOWEDBYDEBTORS CALCULATEDBYADDINGTOGETHERTHESELLING PRICEOFTHESTOCKSOLDandTHE'34CHARGED4HATIS EACHDEBTOROWESUSFORTHE SALEANDTHE'34ONTHATSALE ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

STUDY TIP

!SWITHCREDIT PURCHASES CREDITSALES WILLALWAYSIDENTIFYTHAT '34APPLIES

Cambridge University Press

94

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

Posting the Sales Journal to the General Ledger and Debtors Ledger 4HETOTALSOFTHE3ALES*OURNALAREPOSTEDTOTHE'ENERAL,EDGERACCOUNTSATTHEENDOF THEMONTHINTHISCASE /CTOBER ASISSHOWNIN&IGURE Figure 5.7 General Ledger: posting the Sales Journal General Ledger Debtors Control (A) Date Oct. 31

Cross-reference Sales/GST Clearing

Amount $

Date

Cross-reference

Amount $

Cross-reference

Amount $

1 980 Sales (R)

Date

Cross-reference

Amount $

Date Oct. 31

Debtors Control

1 800

GST Clearing (A or L) Date Oct. 31

Cross-reference Creditors Control

Amount $

Date

152

Oct. 31

Cross-reference Debtors Control

Amount $ 180

Stock Control (A) Date Oct. 1 31

Cross-reference Balance Creditors Control

Amount $

Date

10 000

Oct. 31

Cross-reference Cost of Sales

Amount $ 1 020

1 520 Cost of Sales (E)

Date Oct. 31

Cross-reference Stock Control

Amount $

Date

Cross-reference

Amount $

1 020

2ECORDINGTRANSACTIONSINTHE3ALES*OURNALHASREDUCEDTHENUMBEROFDEBITAND CREDITENTRIESFROMTWOENTRIESATCOSTPRICEANDTHREEENTRIESATSELLINGPRICE TIMES lVETRANSACTIONS TOJUSTlVEINTOTAL The Sales Journal is posted to the General Ledger using the column totals at the end of the month.

Posting the Sales Journal to the Debtors Ledger )N CONTRAST TO THE 'ENERAL ,EDGER IN WHICH ONLY THE TOTALS ARE POSTED AT THE END OF THEMONTH THE$EBTORS,EDGERMUSTSHOWEACHINDIVIDUALCREDITSALE INTHEACCOUNT OF EACH INDIVIDUAL DEBTOR ON THE DATE THE TRANSACTION ACTUALLY OCCURRED !S WITH THE #REDITORS,EDGER THE$EBTORS,EDGERRECORDSANADDITIONALDEBITTOMIRRORTHEDEBITTO $EBTORS#ONTROLINTHE'ENERAL,EDGER4HISISSHOWNIN&IGURE

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CHAPTER 5

SPECIAL JOURNALS 1: CREDIT JOURNALS

95

Figure 5.8 Debtors Ledger: posting the Sales Journal Debtors Ledger R. Starr (A) Date

Cross-reference

Amount $

Oct. 2

Sales/GST Clearing

495

14

Sales/GST Clearing

418

Date

Cross-reference

Amount $

Cross-reference

Amount $

913 G. Martin (A) Date

Cross-reference

Amount $

Oct. 6

Sales/GST Clearing

330

27

Sales/GST Clearing

297

Date

627 STUDY TIP

B. Epstein (A) Date Oct. 20

Cross-reference

Amount $

Date

Cross-reference

Amount $

440

Sales/GST Clearing

The Sales Journal is posted to the Debtors Ledger using the individual transactions on the date they occur.

7HATEVERENTRIES APPEARINACONTROL ACCOUNTMUSTBE REPLICATEDINTHE SUBSIDIARYLEDGER BUTASINDIVIDUAL TRANSACTIONS

The Debtors Schedule !$EBTORS3CHEDULECANBEPREPAREDTOCHECKTHEACCURACYOFTHEPOSTING FOLLOWING THESAMEPROCESSTHATWASUSEDTOPRODUCEA#REDITORS3CHEDULE&IGURESHOWSTHE $EBTORS3CHEDULEFOR,INENAND-C#ARTNEYASAT/CTOBER

Figure 5.9 Debtors Schedule LINEN AND McCARTNEY Debtors Schedule as at 31 October 2015 Debtor

Balance $

R. Starr

913

G. Martin

627

B. Epstein

440

Balance as per Debtors Control account

1 980

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

96

UNITS 3&4

REVIEW QUESTIONS 5.4

1 ExplainTHEROLEOFTHE3ALES*OURNAL 2 State WHICH TYPE OF SOURCE DOCUMENT IS USED TO VERIFY ALL TRANSACTIONS RECORDEDINTHE3ALES*OURNAL 3 ExplainTHEEFFECTONREVENUEEARNEDOF'34CHARGEDTODEBTORSONCREDIT SALES 4 2EFERRINGTOTHE3ALES*OURNAL stateONEREASONWHYTHEAMOUNTRECORDEDIN THE$EBTORS#ONTROLCOLUMNISGREATERTHANSALESREVENUEEARNED 5 ShowTHEDEBITANDCREDITENTRIESNECESSARYTOPOSTTHE3ALES*OURNALTOTHE 'ENERAL,EDGER 6 ExplainTHEEFFECTONTHE'34#LEARINGACCOUNTOF'34CHARGEDTODEBTORS ONCREDITSALES 7 Explain THE RELATIONSHIP BETWEEN THE $EBTORS #ONTROL ACCOUNT AND THE $EBTORS,EDGER 8 StateTWODIFFERENCESINTHEWAYTHE3ALES*OURNALISPOSTEDTOTHE$EBTORS ,EDGERASCOMPAREDTOTHE'ENERAL,EDGER  9 StateTHEFUNCTIONOFA$EBTORS3CHEDULE 10 ExplainHOWTHE$EBTORS3CHEDULEAIDSINTHECONTROLOFDEBTORS

5.5

REPORTING GST CLEARING

!TTHEENDOFTHEREPORTINGPERIOD THE'34#LEARINGACCOUNTMUSTBEBALANCED AND REPORTEDASEITHERACURRENTASSETORACURRENTLIABILITY DEPENDINGONWHETHERITHASA DEBITBALANCEORACREDITBALANCE!FTERBALANCINGATTHEENDOF/CTOBER THE'34 #LEARINGACCOUNTFOR,INENAND-C#ARTNEYWOULDSHOW GST Clearing (A or L) Date Oct. 31

Cross-reference Creditors Control Balance

Amount $ 152

Date Oct. 31

Cross-reference Debtors Control

180 Nov. 1

GST refund a cash receipt from the ATO to refund the excess that occurs when GST on sales is less than GST on purchases

180

28 180

GST settlement a cash payment made to the ATO to settle the liability that occurs when GST on sales is greater than GST on purchases

Amount $

Balance

28

4HECREDITBALANCEOFINDICATESTHATTHISACCOUNTISAcurrent liability'34CHARGED TODEBTORSONSALES ISGREATERTHAN'34CHARGEDBYCREDITORSONPURCHASES SO THE BUSINESS OWES  TO THE !4/ '34 #LEARING WOULD THUS BE REPORTED IN THE "ALANCE3HEETWITHOTHERCURRENTLIABILITIES SUCHAS"ANKOVERDRAFTAND#REDITORS#ONTROL ASAPRESENTOBLIGATIONTHEBUSINESSMUSTMEETATSOMETIMEWITHINTHENEXTMONTHS WHENITMAKESAPAYMENTTOTHE!4/INTHEFORMOFAGST settlement )F THE '34 ON SALES HAD BEEN less THAN THE '34 ON PURCHASES THE '34 #LEARING ACCOUNT WOULD HAVE HAD A debit BALANCE 4HIS WOULD MEAN '34 #LEARING WOULD BE A current asset A RESOURCE CONTROLLED BY THE BUSINESS FROM WHICH A FUTURE ECONOMIC BENElT IS EXPECTED IN THE NEXT  MONTHS '34 #LEARING WOULD BE REPORTED IN THE "ALANCE 3HEET WITH OTHER CURRENT ASSETS SUCH AS "ANK 3TOCK #ONTROL AND $EBTORS #ONTROL ANDTHEBUSINESSWOULDBEDUEAGST refundFROMTHE!4/

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CHAPTER 5

SPECIAL JOURNALS 1: CREDIT JOURNALS

REVIEW QUESTIONS 5.5

1 ExplainHOWTHE'34#LEARINGACCOUNTMAYENDUPWITHACREDITBALANCE 2 Explain HOW THE '34 #LEARING ACCOUNT SHOULD BE REPORTED IN THE "ALANCE 3HEETIFITHASACREDITBALANCE 3 DefineTHETERM@'34SETTLEMENT 4 ExplainHOWTHE'34#LEARINGACCOUNTMAYENDUPWITHADEBITBALANCE 5 Explain HOW THE '34 #LEARING ACCOUNT SHOULD BE REPORTED IN THE "ALANCE 3HEETIFITHASADEBITBALANCE 6 DefineTHETERM@'34REFUND

5.6

BENEFITS OF USING CONTROL ACCOUNTS AND SUBSIDIARY LEDGERS

!LTHOUGHITMAYSEEMLIKEMOREWORKTHANSIMPLYUSINGASINGLEACCOUNTINTHE'ENERAL ,EDGER USINGASYSTEMOFCONTROLACCOUNTSANDSUBSIDIARYLEDGERSISVITALINENSURING THATALLRELEVANTINFORMATIONISAVAILABLE4HETHREEMAINBENElTSOFUSINGASYSTEMOF CONTROLACCOUNTSANDSUBSIDIARYLEDGERSARE Double-checking that allows detection of recording errors. 4HE PREPARATION OF A $EBTORS OR #REDITORS 3CHEDULE ALLOWS THE BALANCE OF THE CONTROL ACCOUNT TO BE CHECKED AGAINST THE SUM OF THE BALANCES OF THE SUBSIDIARY LEDGER ACCOUNTS 4HIS ALLOWSFORRECORDINGERRORSTOBEDETECTEDANDCORRECTED IMPROVINGTHEReliability OFTHEBALANCEREPORTEDINTHE"ALANCE3HEET s Ease of reporting. 4HESINGLEBALANCEFORALLDEBTORSORCREDITORSPROVIDEDBYTHE CONTROLACCOUNTINTHE'ENERAL,EDGER ANDTHE3CHEDULE MEANSTHATTHE"ALANCE 3HEET NEED ONLY REPORT THE BALANCE OF THE CONTROL ACCOUNT RATHER THAN LIST EVERY INDIVIDUALDEBTORORCREDITOR ANDTHEIRINDIVIDUALBALANCES/MITTINGTHESEDETAILS GIVES GREATER Relevance AS THESE DETAILS WOULD NOT BE USEFUL FOR THE TYPES OF DECISION MAKINGTHATRELYONTHE"ALANCE3HEETFORINFORMATION s Allocation of responsibility. 3EPARATING THE SUBSIDIARY LEDGER ACCOUNTS FROM THE 'ENERAL,EDGERMEANSTHEMANAGEMENTOFTHESUBSIDIARYLEDGERCANBEALLOCATED TOAPARTICULAREMPLOYEE4HISEMPLOYEECANTHENBERESPONSIBLEFORMANAGINGALL DEALINGSWITHDEBTORSSUCHASTHEASSESSMENTOFCREDITWORTHINESSTHEISSUINGOF SALESINVOICESTHECOLLECTIONOFRECEIPTSFROMDEBTORSANDTHEMANAGEMENTOFBAD DEBTS ORCREDITORSSUCHASTHECOLLECTIONOFPURCHASEINVOICESANDTIMELYPAYMENT OF CREDITORS  'REATER ACCOUNTABILITY WOULD HOPEFULLY IMPROVE EFFECTIVENESS AND WOULDALSOLEAVETHESENIORBOOKKEEPERFREETOMANAGETHE'ENERAL,EDGER 4HUS USINGASYSTEMTHATINCORPORATESBOTHSUBSIDIARYLEDGERSANDCONTROLACCOUNTS HAS BENElTS FOR RECORDING DOUBLE CHECKING REPORTING EASE OF REPORTING AND MANAGEMENTALLOCATIONOFRESPONSIBILITY  4HE ALTERNATIVE WOULD BE TO INCLUDE ALL INDIVIDUAL ACCOUNTS IN THE 'ENERAL ,EDGER BUT THIS WOULD REMOVE THE DOUBLE CHECKING MECHANISM REQUIRE MANY lGURES TO BE REPORTEDINTHE"ALANCE3HEETANDDISALLOWTHEALLOCATIONOFRESPONSIBILITY s

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

97

98

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

WHERE HAVE WE BEEN? s 3PECIALJOURNALSSUMMARISESIMILARTRANSACTIONSSOTHATTOTALSCANBEPOSTEDTOTHE 'ENERAL,EDGER WHICHREDUCESTHENUMBEROFLEDGERENTRIESREQUIREDANDIMPROVES THEEFlCIENCYOFTHERECORDINGSYSTEM s 4HE'ENERAL*OURNALISUSEDTORECORDALLINFREQUENT NON CASHTRANSACTIONS s !CONTROLACCOUNTISANACCOUNTINTHE'ENERAL,EDGERSUMMARISINGTHETRANSACTIONS RECORDEDINTHESUBSIDIARYLEDGER*OURNALTOTALSAREPOSTEDATTHEENDOFTHEMONTH s !SUBSIDIARYLEDGERISANADDITIONALSETOFLEDGERACCOUNTSKEPTOUTSIDETHE'ENERAL ,EDGER CONTAININGINDIVIDUALTRANSACTIONSPOSTEDONTHEDAYTHEYOCCUR s !3CHEDULELISTSTHENAMEANDBALANCEOFEACHINDIVIDUALACCOUNTINTHESUBSIDIARY LEDGER ANDSHOULDEQUALTHEBALANCEOFTHECONTROLACCOUNT s 4HE'34ONCREDITPURCHASESDOESNOTAFFECTTHEVALUATIONOFSTOCKITREDUCESTHE '34LIABILITYOWEDTOTHE!4/ANDINCREASESTHEDEBTOWEDTOCREDITORS s 4HETOTALAMOUNTOWEDTOCREDITORSINCLUDESTHEVALUEOFTHESTOCKPURCHASEDAND THE'34 s 4HE'34ONCREDITSALESDOESNOTAFFECTTHEAMOUNTOFREVENUEEARNEDITINCREASES THE'34LIABILITYOWEDTOTHE!4/ANDINCREASESTHEAMOUNTOWEDBYDEBTORS s 4HETOTALAMOUNTOWEDBYDEBTORSINCLUDESTHESELLINGPRICEOFTHESTOCKSOLDAND THE'34 s !TTHEENDOFTHEREPORTINGPERIOD THE'34#LEARINGACCOUNTMUSTBEBALANCED ANDREPORTEDASEITHERACURRENTASSETORACURRENTLIABILITY DEPENDINGONWHETHER ITHASADEBITORACREDITBALANCE s 4HEMAINBENElTSFROMUSINGASYSTEMOFCONTROLACCOUNTSANDSUBSIDIARYLEDGERS AREDETECTIONOFRECORDINGERRORS EASEOFREPORTINGANDALLOCATIONOFRESPONSIBILITY

Transaction

Document

Journal

General Ledger: sTOTALS sENDOFTHEMONTH

Subsidiary ledger: sINDIVIDUALTRANSACTIONS sTRANSACTIONDATE

Credit purchases of stock

Purchase invoice

Purchases Journal

DR Stock Control DR GST Clearing CR Creditors Control

CR Each individual creditor

Credit sales of stock

Sales invoice

Sales Journal

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

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

DR Each individual debtor

Cambridge University Press

CHAPTER 5

SPECIAL JOURNALS 1: CREDIT JOURNALS

EXERCISE 5.1 PURCHASES JOURNAL

page 66

W B

99

EXERCISES

4HEFOLLOWINGDOCUMENTWASHANDEDTOTHEMANAGEROF0ORCELAIN-AGIC ASHOPTHAT SELLSTEASETSANDPORCELAINSTATUES

Fine Tea China

322–335 Swindle St, Melbourne VIC 3000 ABN: 24 664 237 190

Invoice: S.90

Tax invoice Terms: 5/7, n/30

Charge to:

Porcelain Magic 245 Bulla Rd, Keilor VIC 3043 ABN: 82 100 346 275

Date

Details

Qty

Unit Price $

4 May 2015

Fine China Tea Sets

10

120

Total $ 1200

GST (10%)

120 Total

$1 320

Required a IdentifyTHESOURCEDOCUMENTABOVE ANDdescribeTHETRANSACTIONITVERIlES b RecordTHISTRANSACTIONINTHEAPPROPRIATESPECIALJOURNALOF0ORCELAIN-AGIC c ShowTHEDEBITANDCREDITENTRIESNECESSARYTORECORDTHISTRANSACTIONINTHE'ENERAL ,EDGEROF0ORCELAIN-AGIC d ExplainWHYTHE'34ONCREDITPURCHASESDOESNOTAFFECTTHEVALUATIONOFSTOCK

EXERCISE 5.2 PURCHASES JOURNAL

W B

page 67

0HILS0IANOSHASPROVIDEDTHEFOLLOWINGLISTOFTRANSACTIONSFOR!UGUST Aug.

3 8 15 24 29

Purchased 5 grand pianos from Yamaha on credit. Each grand piano cost $4 000 plus GST of $400 (Inv. Yh3764) Bought 6 upright pianos from Bernstein at a total cost of $6 600 including $600 GST (Inv. B4801) Purchased 2 standard pianos from Yamaha on credit for $2 000 (plus GST) each (Inv. Yh3784) Received delivery of 4 grand pianos from Rachman, at a total cost of $17 160 including GST (Inv. R132) Purchased 3 upright pianos from Bernstein at a cost of $1 320 (including GST) each (Inv. B4816)

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

100

UNITS 3&4

Required

*

a ExplainTHEROLEOFTHE0URCHASES*OURNAL b RecordTHETRANSACTIONSFOR!UGUSTINTHE0URCHASES*OURNALOF0HILS0IANOS c PostTHE0URCHASES*OURNALTOTHERELEVANTACCOUNTSINTHE'ENERAL,EDGEROF0HILS 0IANOS d PostTHE0URCHASES*OURNALTOTHERELEVANTACCOUNTSINTHE#REDITORS,EDGEROF0HILS 0IANOS e ExplainONEDIFFERENCEINTHEWAYTHE0URCHASES*OURNALISPOSTEDTOTHE'ENERAL ,EDGERCOMPAREDTOTHEWAYITISPOSTEDTOTHE#REDITORS,EDGER f ExplainHOWUSINGASYSTEMOFCONTROLACCOUNTSANDSUBSIDIARYLEDGERSCANIMPROVE THE2ELIABILITYOFTHEREPORTS

EXERCISE 5.3 PURCHASES JOURNAL

W B

page 69

'LOW7ARMISALIGHTINGSTOREOWNEDBY$ONALD$IMM!SAT!PRIL s

s

THE'ENERAL,EDGERSHOWEDTHEFOLLOWINGBALANCES n '34#LEARING   n 3TOCK#ONTROL  n #REDITORS#ONTROL  THE#REDITORS,EDGERSHOWEDTHEFOLLOWINGBALANCES n 3HOCK%LECTRICS   n "RIGHT,IGHTS 

#2

$ONALD HAS RECORDED THE lRMS CREDIT PURCHASES FOR !PRIL  IN THE 0URCHASES *OURNAL Purchases Journal Date April 5

Creditor

Invoice

Stock

number

Control

GST

Creditors Control

Shock Electrics

I. 251

2 500

250

2 750

15

Bright Lights

CX 34

3 500

350

3 850

19

Shock Electrics

I. 268

2 000

200

2 200

26

Bright Lights

CX 40

4 000

400

4 400

12 000

1 200

13 200

Totals

Additional information: /N!PRIL 'LOW7ARMPAIDTO3HOCK%LECTRICS4HISWASTHEONLYPAYMENT TOCREDITORSFORTHEMONTHOF!PRIL Required

* *

a ExplainWHYTHEINVOICESINTHE0URCHASES*OURNALDONOTRUNINSEQUENCE b Post THE0URCHASES*OURNALTOTHE'ENERAL,EDGERAND#REDITORS,EDGERFOR'LOW 7ARM c StateTHEEFFECTOF'34ONCREDITPURCHASESONTHEFOLLOWINGITEMS s 3TOCK#ONTROL s #REDITORS#ONTROL s '34#LEARING d Record THEPAYMENTTO3HOCK%LECTRICSINTHE'ENERAL,EDGERAND#REDITORS,EDGER e BalanceTHECREDITORSCONTROLACCOUNT f Foot THE SUBSIDIARY LEDGER ACCOUNTS AND prepare A #REDITORS 3CHEDULE AS AT !PRIL

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CHAPTER 5

SPECIAL JOURNALS 1: CREDIT JOURNALS

EXERCISE 5.4 SALES JOURNAL

page 71

W B

0ICKWICK"OOKSISABOOKSHOPIN3OUTH-ELBOURNE4HEFOLLOWINGSOURCEDOCUMENTWAS HANDEDTOITSACCOUNTANTBYAMEMBEROFTHESALESSTAFF Additional information: 0ICKWICK"OOKSAPPLIESAMARKUPTOALLITSSTOCK

Pickwick Books

TAX INVOICE ABN: 09 990 656 432

1102 Clarendon St South Melbourne VIC 3205

Invoice: 46 Terms: 30 days

12/6/15

Duplicate

Charge to:

Grant Hugh

Item

Description

T01

Children’s Bible

19 Cobbam Drive, Glen Waverley VIC 3150 Qty

Unit Cost

$

5

50

250.00

GST Total

25.00 $

275.00

Required a IdentifyTHESOURCEDOCUMENTABOVE ANDdescribeTHETRANSACTIONITVERIlES b RecordTHISTRANSACTIONINTHEAPPROPRIATESPECIALJOURNALOF0ICKWICK"OOKS c ShowTHEDEBITANDCREDITENTRIESNECESSARYTORECORDTHISTRANSACTIONINTHE'ENERAL ,EDGEROF0ICKWICK"OOKS d Explain WHY '34 CHARGED ON CREDIT SALES INCREASES THE '34 LIABILITY OF 0ICKWICK "OOKS

EXERCISE 5.5 SALES JOURNAL

W B

page 72

0OLLY*UNIORSELLSCHILDRENSFURNITUREATAMARK UP ANDHASPROVIDEDTHEFOLLOWING LISTOFTRANSACTIONSFOR3EPTEMBER Sept.

5 11 16 23 29

Sold 2 bookcases on credit to Rydell Primary School for $240 (plus $24 GST) each (Inv. 75) Sold 3 children’s beds to Camp Somerset for $660 including $60 GST per bed (Inv. 76) Sold 6 desks on credit to Rydell Primary School, charging $900 plus GST (Inv. 77) Sold 4 children’s beds to Camp Somerset for a total invoice price of $2 640 (including GST) Sold 1 bookcase to 123 Playgroup for $240 plus $24 GST (Inv. 79)

Required

*

a StateTHEINVOICENUMBERFORTHETRANSACTIONON3EPTEMBER b RecordTHETRANSACTIONSFOR3EPTEMBERINTHE3ALES*OURNALOF0OLLY*UNIOR c PostTHE3ALES*OURNALTOTHERELEVANTACCOUNTSINTHE'ENERAL,EDGEROF0OLLY*UNIOR ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

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CAMBRIDGE VCE ACCOUNTING

102

UNITS 3&4

d PostTHE3ALES*OURNALTOTHERELEVANTACCOUNTSINTHE$EBTORS,EDGEROF0OLLY*UNIOR e ExplainHOWUSINGASYSTEMOFCONTROLACCOUNTSANDSUBSIDIARYLEDGERSCANIMPROVE THEMANAGEMENTOFDEBTORS

EXERCISE 5.6 SALES JOURNAL

W B

page 74

%RNIE 7ALSH IS THE OWNER OF %* (I&I (E SELLS STEREO EQUIPMENT AND HAS JUST WON A LUCRATIVECONTRACTTOlTOUTACHAINOFHOTELSWITHSTEREOEQUIPMENT!SAT*UNE s

s

THE'ENERAL,EDGERSHOWEDTHEFOLLOWINGBALANCES n '34#LEARING   #2 n $EBTORS#ONTROL  n 3TOCK#ONTROL  THE$EBTORS,EDGERSHOWEDTHEFOLLOWINGBALANCES n $*7AREHOUSE   n (OLDEN(OTELS

 4HElRMSCREDITSALESFOR*UNEARERECORDEDINTHE3ALES*OURNALBELOW Sales Journal Date

Debtor

Invoice

Cost of

number

Sales

Sales

GST

Debtors Control

June 4

Holden Hotels

86

1 000

1 500

150

1 650

15

Holden Hotels

87

2 000

3 000

300

3 300

21

DJ Warehouse

88

800

1 200

120

1 320

28

Holden Hotels

89

1 400

2 100

210

2 310

5 200

7 800

780

8 580

Totals

Additional information: s /N*UNE %*(I&IRECEIVEDFROM(OLDEN(OTELS s 4ERMSOFDAYSAREOFFEREDTOCREDITCUSTOMERS Required

* *

a State ONE REASON WHY THE INVOICE NUMBERS RECORDED IN THE 3ALES *OURNAL RUN IN SEQUENCE b PostTHE3ALES*OURNALTOTHE'ENERAL,EDGERAND$EBTORS,EDGEROF%*(I&I c StateTHEEFFECTOF'34ONCREDITSALESONTHEFOLLOWINGITEMS s 3ALES2EVENUE s $EBTORS#ONTROL s '34#LEARING d RecordTHERECEIPTFROM(OLDEN(OTELSINTHE'ENERAL,EDGERAND$EBTORS,EDGER e BalanceTHE$EBTORS#ONTROLACCOUNT f FootTHESUBSIDIARYLEDGERANDprepareA$EBTORS3CHEDULEASAT*UNE

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CHAPTER 5

SPECIAL JOURNALS 1: CREDIT JOURNALS

EXERCISE 5.7 CREDIT JOURNALS

W B

page 76

"EN(EWITTAND,AURA#ARTWRIGHTLEFTTHEIRFORMERCAREERSANDDECIDEDTOSTARTASMALL BUSINESSCALLED(#4ENNIS SELLINGTENNISEQUIPMENTFROMAFACTORYIN"ENTLEIGH4HE FOLLOWINGDOCUMENTSHAVENOTYETBEENRECORDEDINTHEJOURNALSFOR-AY DOCUMENT A

H&C Tennis

Invoice: 92 DUPLICATE Terms: 10/7, n/30 TAX INVOICE

120 Norman St Bentleigh VIC 3204 ABN: 94 863 021 005

Charge to: Elicia Molik 4 White Street, Elwood VIC 3184 C Date May 6

Details Racquets – Spaulding Brand

Qty

Price $

8

66.00

Total

528.00

GST included in total

48.00

DOCUMENT B

Top Quality Racquets

Invoice: A80

UA LI

ET

P

Q

ORIGINAL Terms: 10/7, n/30

U

TO

ABN: 66 090 786 511

S

254 Union Rd, Ascot Vale VIC 3032 Q T Y RAC

Charge to:

H&C Tennis Norman Street Bentleigh VIC 3204

Date

Details

May 9

30 Spaulding tennis racquets: $30 (plus GST) each

Total $990.00

Total invoice amount includes GST of $90

Required a 2EFERRING TO ONE QUALITATIVE CHARACTERISTIC explain THE IMPORTANCE OF SOURCE DOCUMENTSINTHEACCOUNTINGPROCESS b 2EFERRINGTOTHEINFORMATIONPROVIDED identifyTHESOURCEDOCUMENTTHATVERIlESA CREDITSALEJustifyYOURANSWER c 'IVENTHATSTOCKISSOLDATMARK UP record$OCUMENTS!AND"INTHESPECIAL JOURNALSOF(#4ENNIS d 2EFERRINGONLYTOTHEINFORMATIONPROVIDED stateWHETHER(#4ENNISWOULDHAVEA '34ASSETOR'34LIABILITYJustifyYOURANSWER ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

103

CAMBRIDGE VCE ACCOUNTING

104

UNITS 3&4

EXERCISE 5.8 CREDIT JOURNALS

page 77

W B

'LEN #OPPELL OPERATES A SPORTS STORE CALLED #OPPELL 3PORTS !T  -ARCH  HIS ACCOUNTINGRECORDSSHOWEDTHEFOLLOWINGBALANCES Stock Control Debtors Control – Gunter Basketball Club

$ 9 000

GST Clearing

$

200

6 490

Creditors Control

2 750

990

– München Sports

1 100

– AB Sports Gear

1 650

– Ruddersfield FC

2 200

– Central Warriors Soccer Club

3 300

CR

4HEFOLLOWINGOCCURREDDURING-ARCH March

1 4 7 10 12 16 20 23 28

Sold stock to Central Warriors for $770 (including $70 GST). The stock had a cost price of $420 (Inv. 35) Received $2 200 cash from Ruddersfield FC (Rec. 21) Purchased sporting goods on credit from München Sports (Inv. E93) worth $600 plus $60 GST Gunter Basketball Club purchased sporting goods worth $500 plus GST, with a cost price of $310 (Inv. 36) Paid AB Sports Gear $1 000 on account (Ch. 244) Sold stock to Central Warriors – total invoice price $880 (including GST). The stock was originally purchased for $600 plus $60 GST (Inv. 37). Purchased stock for $900 (plus GST) from AB Sports Gear (Inv. 82) Sold sporting goods to Ruddersfield FC for $1 650 (including GST). The stock had a cost price of $1 200 plus GST (Inv. 38). Purchased sporting goods from München Sports (Inv. E113) for $1 320 including GST.

Required

*

* *

a Record THE TRANSACTIONS FOR -ARCH  IN THE APPROPRIATE SPECIAL JOURNALS OF #OPPELL3PORTS b PostTHE3ALES*OURNALAND0URCHASES*OURNALTOTHE'ENERAL,EDGERANDSUBSIDIARY LEDGERSOF#OPPELL3PORTS c BalanceTHE$EBTORS#ONTROLAND#REDITORS#ONTROLACCOUNTS d Foot THE SUBSIDIARY LEDGER ACCOUNTS AND prepare A $EBTORS 3CHEDULE AND A #REDITORS3CHEDULEASAT-ARCH e Explain HOW '34 #LEARING WOULD BE REPORTED IN THE "ALANCE 3HEET OF #OPPELL 3PORTSASAT-ARCH f ExplainWHYTHERECORDSOF#OPPELL3PORTSWOULDSHOW'UNTER"ASKETBALL#LUBWITH ADEBITBALANCE WHEREASTHERECORDSOF'UNTER"ASKETBALL#LUBWOULDSHOW#OPPELL 3PORTSWITHACREDITBALANCE

EXERCISE 5.9 CREDIT JOURNALS

page 81

W B

)RVING#REESEOPERATESASTORECALLED3OFT3HIRTS WHICHHADTHEFOLLOWINGBALANCESAS AT!PRIL Stock Control

$ 3 000

GST Clearing

$

200 CR

Debtors Control

4 070

Creditors Control

4 730

– Daniel Jones

2 090

– Jade

3 190

– Mier Stores

1 980

– Country Style

1 540

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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CHAPTER 5

SPECIAL JOURNALS 1: CREDIT JOURNALS

4HETRANSACTIONSFOR!PRILHAVEBEENRECORDEDINTHEJOURNALSBELOW Sales Journal Invoice

Cost of

number

Sales

Sales

GST

Debtors

Date

Debtor

April 4

Mier Stores

85

1 000

1 500

150

1 650

Apr. 8

Daniel Jones

86

1 400

2 100

210

2 310

Apr. 15

Big X

87

500

750

75

825

Apr. 21

Daniel Jones

88

800

1 200

120

1 320

Apr. 28

Mier Stores

89

1 200

1 800

180

1 980

4 900

7 350

735

8 085

Totals

Control

Purchases Journal Date

Creditor

Invoice number

Stock

GST

Creditors Control

April 5

Jade

I. 251

2 400

240

2 640

Apr. 12

Country Style

CX 34

1 800

180

1 980

Apr. 19

Country Style

I. 268

2 300

230

2 530

Apr. 26

Jade

CX 40

1 100

110

1 210

7 600

760

8 360

Totals

Additional information: s /N!PRIL 3OFT3HIRTSPAIDTO*ADE s /N!PRIL 3OFT3HIRTSRECEIVEDFROM-IER3TORES Required

* *

a StateWHETHERSPECIALJOURNALSBELONGTOTHEINPUT PROCESSINGOROUTPUTSTAGEOF THEACCOUNTINGPROCESSJustifyYOURRESPONSE b PostTHEJOURNALSTOTHE'ENERAL,EDGERANDSUBSIDIARYLEDGERSOF3OFT3HIRTS c BalanceTHE$EBTORS#ONTROLAND#REDITORS#ONTROLACCOUNTS d Prepare A $EBTORS 3CHEDULE AND #REDITORS 3CHEDULE FOR 3OFT 3HIRTS AS AT !PRIL e ExplainHOW'34#LEARINGWOULDBEREPORTEDINTHE"ALANCE3HEETOF3OFT3HIRTSAS AT!PRIL f Explain TWO BENElTS THAT 3OFT 3HIRTS DERIVES BY ADOPTING A SYSTEM OF CONTROL ACCOUNTSANDSUBSIDIARYLEDGERSFORDEBTORSANDCREDITORS Additional information: /N  -AY  3OFT 3HIRTS PURCHASED OFlCE FURNITURE ON CREDIT FROM $ESK 7ORLD FOR PLUS'34)NV  Required g ExplainWHY)NVSHOULDnotBERECORDEDINTHE0URCHASES*OURNAL

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Where are we headed? After completing this chapter, you should be able to: s recordCASHPAYMENTSWITH '34ANDDISCOUNTS INTHE #ASH0AYMENTS*OURNAL s postTHE#ASH0AYMENTS *OURNALTOTHE'ENERAL,EDGER AND#REDITORS,EDGER s recordCASHRECEIPTSWITH '34ANDDISCOUNTS INTHE #ASH2ECEIPTS*OURNAL s postTHE#ASH2ECEIPTS *OURNALTOTHE'ENERAL,EDGER AND$EBTORS,EDGER

s identifyTHECOSTSAND BENElTSOFOFFERINGDISCOUNTS TOCUSTOMERS s calculateDISCOUNTEXPENSE ANDDISCOUNTREVENUE s identifyTHEEFFECTOF DISCOUNTSONTHEACCOUNTING EQUATION s identifyTHEEFFECTOF'34 ONTHERECORDINGOFCASH PAYMENTSANDCASHRECEIPTS s recordA'34REFUNDAND '34SETTLEMENTINTHECASH JOURNALSAND'ENERAL,EDGER

CHAPTER 6

SPECIAL JOURNALS 2: CASH JOURNALS KEY TERMS After completing this chapter, you should be familiar with the following terms: s #ASH0AYMENTS*OURNAL s #ASH2ECEIPTS*OURNAL s '34SETTLEMENT s '34REFUND s SETTLEMENTDISCOUNT s DISCOUNTREVENUE s DISCOUNTEXPENSE ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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CAMBRIDGE VCE ACCOUNTING

108

6.1

UNITS 3&4

THE CASH PAYMENTS JOURNAL

4HE SPECIAL JOURNALS DESCRIBED IN #HAPTER  DEALT SOLELY WITH CREDIT TRANSACTIONS THE 0URCHASES *OURNAL SUMMARISED ALL STOCK PURCHASED ON CREDIT AND THE 3ALES *OURNAL SUMMARISEDALLSTOCKSOLDONCREDIT"YSUMMARISINGTHESETRANSACTIONS ITWASPOSSIBLE TOPOSTTHE0URCHASES*OURNALTOTHE'ENERAL,EDGERINONLYTHREEENTRIES ANDTHE3ALES *OURNALINONLYlVE Purchases Journal

DR

Stock Control

DR

GST Clearing

CR Sales Journal

DR

Creditors Control* Debtors Control*

CR

Sales Revenue

CR

GST Clearing and

DR CR

Cost of Sales Stock Control

)NDIVIDUALTRANSACTIONSMUSTALSOBEPOSTEDTOTHEINDIVIDUALACCOUNTSINTHECREDITORS ANDDEBTORSSUBSIDIARYLEDGERS 4HESAMEAPPROACHTHATIS SUMMARISINGSIMILARTRANSACTIONSBEFOREPOSTINGTHEMTO THE'ENERAL,EDGER CANBEAPPLIEDTOCASHRECEIPTSANDCASHPAYMENTS WITHTHE#ASH 0AYMENTS*OURNALUSEDTOSUMMARISEALLCASHPAID ANDTHE#ASH2ECEIPTS*OURNALUSED TOSUMMARISEALLCASHRECEIVED

EXAMPLE

Consider the following list of transactions for June 2015 for Green Thumb Plants: June 1 5 8 10 13 15 22 24 29

Paid $200 (plus $20 GST) for stock (Cheque 22) Cash paid to creditor, Mills Bros $400 (Cheque 23) Paid $190 wages (Cheque 24) Paid electricity $150, plus GST (Cheque 25) Owner withdrew $100 cash (Cheque 26) Purchased stock for $242, including $22 GST (Cheque 27) Paid $190 wages (Cheque 28) Payment to creditor – Johnson Ltd $350 (Cheque 29) Purchased new vehicle for $13 200 including GST (Cheque 30)

4HIS LIST OF TRANSACTIONS IS FAR MORE DIVERSE THAN A STRAIGHT LIST OF CREDIT SALES OR CREDIT PURCHASES )T INCLUDES CASH PAYMENTS FOR STOCK PAYMENTS TO CREDITORS PAYMENTS FOR WAGES THECASHPURCHASEOFAVEHICLE ANDEVENCASHDRAWINGSBYTHEOWNER(OWCAN THESE TRANSACTIONS BE SUMMARISED IN A SINGLE JOURNAL )N TERMS OF DEBITS AND CREDITS WHATDOESEACHOFTHETRANSACTIONSABOVEHAVEINCOMMON 4HEANSWER OFCOURSE LIESINTHEFACTTHATEACHOFTHETRANSACTIONSABOVEISAcash payment ANDTHEREFOREEACHHASEXACTLYTHESAMEEFFECTONTHELEDGERACCOUNTFOR"ANK Each cash payment requires a credit to the Bank account.

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CHAPTER 6

SPECIAL JOURNALS 2: CASH JOURNALS

7HILEITISTRUETHATTHEdebit PARTOFEACHENTRYISDIFFERENT ANDONLYSOMEINVOLVE '34 EACHTRANSACTIONINVOLVESTHESAMEcredit ENTRY2ATHERTHANRECORDINGlVEORSIX CREDITS TO THE "ANK ACCOUNT OR IN THE CASE OF A REAL BUSINESS MANY MORE THAN THAT THESETRANSACTIONSCANBESUMMARISEDINACash Payments Journal

REVIEW QUESTIONS 6.1

109

Cash Payments Journal an accounting record summarising all cash paid during a month

1 ExplainTHEBENElTOFRECORDINGTRANSACTIONSINSPECIALJOURNALS 2 ListFOURTRANSACTIONSTHATWOULDBERECORDEDINTHE#ASH0AYMENTS*OURNAL 3 ExplainWHATEACHCASHPAYMENTHASINCOMMONINTERMSOFITSEFFECTONTHE 'ENERAL,EDGER

6.2

RECORDING TRANSACTIONS IN THE CASH PAYMENTS JOURNAL

!TYPICALMULTI COLUMN#ASH0AYMENTS*OURNALWOULDLOOKLIKETHEONEFOR'REEN4HUMB 0LANTSSHOWNIN&IGURE Figure 6.1 Cash Payments Journal

Date 1

Details 2

Cheque Creditors Stock Bank 4 Wages5 Sundries 6 GST 7 number 3 Control 5 Control 5

June 1 Stock Control

22

220

June5

Mills Bros

23

400

June8

Wages

24

190

June 10

Electricity

25

165

150

June 13

Drawings

26

100

100

June 15

Stock Control

27

242

June 22

Wages

28

190

June 24

Johnson Ltd

29

350

30

13 200

June 29 Vehicle Totals

15 057

200

20

400 190

220

15

22 190

350

750

420

380

12 000

1 200

12 250

1 257

Notes for recording in the Cash Payments Journal 1

Date !SWITHALLJOURNALS TRANSACTIONSARERECORDEDINDATEORDER ONTHEDATETHATTHEY OCCURALTHOUGHONLYTHETOTALSAREPOSTEDTOTHE'ENERAL,EDGERATTHEENDOFTHE MONTH

2 Details "ECAUSE EVERY CASH PAYMENT REQUIRES A CREDIT TO THE "ANK LEDGER ACCOUNT THE ONLYPARTOFTHEDOUBLEENTRYTHATMUSTBESPECIlEDFOREACHPAYMENTISTHEother ACCOUNTTHEACCOUNTTOBEdebited.OTEHOWTHENAMEOFEACHINDIVIDUALCREDITOR ISLISTEDWHENPAYMENTSAREMADETOCREDITORS4HETOTALPAIDTOCREDITORS WILL BEPOSTEDTOTHE#REDITORS#ONTROLACCOUNTINTHE'ENERAL,EDGER BUTTHEINDIVIDUAL TRANSACTIONS WILL BE POSTED TO THE INDIVIDUAL CREDITORS ACCOUNTS IN THE #REDITORS ,EDGER

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

3 Cheque number )N ORDER TO SATISFY THE DEMANDS OF Reliability THE SOURCE DOCUMENT IS IDENTIlED !CHEQUENUMBERISIDENTIlABLEFROMTHECHEQUEBUTT ANDBUSINESSESSHOULDBE ENCOURAGED TO MAKE PAYMENTS BY CHEQUE FOR ALL BUT THE SMALLEST AMOUNTS SEE #HAPTER !LLCHEQUENUMBERSSHOULDBERECORDEDINTHE#ASH0AYMENTS*OURNAL EVENIFTHECHEQUEISCANCELLED SOTHATALLCHEQUESAREACCOUNTEDFORANDTHEFTIS DISCOURAGEDOR IFITOCCURS DETECTED 4 Bank 4HEamount of the paymentMUSTBERECORDEDlRSTINTHE"ANKCOLUMN TOALLOW CALCULATIONOFTHETOTALCASHPAID7HERE'34ISINVOLVED THEAMOUNTRECORDEDIN THE"ANKCOLUMNincludes the GST amount4HISAMOUNTWILLBEPOSTEDTOTHE"ANK LEDGERACCOUNTASONETOTALATTHEENDOFTHEMONTH 5 Classification columns 4HEAMOUNTOFEACHTRANSACTIONISRECORDEDTWICEONCEINTHE"ANKCOLUMNTORECORD THECASHPAID ANDASECONDTIMEINACLASSIlCATIONCOLUMNTORECORDWHATTHECASH WASPAIDFOR4HESECLASSIlCATIONCOLUMNSALLOWFORFREQUENTCASHPAYMENTSTOBE SUMMARISED ANDTHETOTALPOSTEDTOTHEAPPROPRIATEACCOUNT4HEHEADINGSUSED FOREACHOFTHESECLASSIlCATIONCOLUMNSWILL OFCOURSE VARYBETWEENBUSINESSES AS THEIRTRANSACTIONSVARY)N&IGURE FREQUENTCASHPAYMENTSAREMADETOCREDITORS FOR STOCK AND FOR WAGES AND SO THESE TRANSACTIONS HAVE THEIR OWN CLASSIlCATION COLUMN 6 Sundries !NYCASHPAYMENTSTHATAREINFREQUENTMUSTBERECORDEDINTHESUNDRIESCOLUMN4HE CASHPURCHASEOFTHEVEHICLEISUNLIKELYTOOCCURMORETHANONCE ANDTHEPAYMENTOF ELECTRICITYISINFREQUENT SOTHEYDONOTWARRANTTHEIROWNCOLUMNS 7 GST &OR TRANSACTIONS THAT INCUR '34 THIS COLUMN IS WHERE THE '34 PAID  OF THE PURCHASE PRICE IS RECORDED 4HE '34 INCREASES THE AMOUNT PAID OUT OF THE "ANK ACCOUNT BUTDOESNOTAFFECTTHEVALUEOFWHATEVERHASBEENPURCHASEDWHICH IN THISCASE ISSTOCK ELECTRICITYANDAVEHICLE 

Double-checking mechanism !TTHEENDOFTHEMONTH EACHCOLUMNINTHE#ASH0AYMENTS*OURNALSHOULDBETOTALLED !SADOUBLE CHECKINGMECHANISM THETOTALOFTHE"ANKCOLUMNSHOULDEQUALTHESUM OFTHETOTALSOFTHEOTHERCOLUMNS5SINGTHElGURESFROM&IGURE THEDOUBLE CHECK WOULDSHOW

   

#REDITORS#ONTROL 3TOCK#ONTROL 7AGES 3UNDRIES '34#LEARING Total debits

     $15 057



Bank

15 057

Total credits

$15 057

)FTHESEAMOUNTSDONOTMATCH THENATRANSACTIONHASBEENRECORDEDINCORRECTLYINTHE #ASH0AYMENTS*OURNAL ANDTHEJOURNALCANNOTBEPOSTEDTOTHELEDGERUNTILTHEERROR ISRECTIlED

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CHAPTER 6

SPECIAL JOURNALS 2: CASH JOURNALS

REVIEW QUESTIONS 6.2

1 State WHY THE #ASH 0AYMENTS *OURNAL ONLY IDENTIlES THE ACCOUNT TO BE DEBITEDINTHE$ETAILSCOLUMN 2 IdentifyTHESOURCEDOCUMENTUSEDTOVERIFYTHETRANSACTIONSRECORDEDINTHE #ASH0AYMENTS*OURNAL 3 ExplainHOWTHEHEADINGSFORTHECLASSIlCATIONCOLUMNSINTHE#ASH0AYMENTS *OURNALAREDETERMINED 4 ExplainWHYTHENAMEOFEACHCREDITORISIDENTIlEDINTHE$ETAILSCOLUMN 5 ExplainTHEDOUBLE CHECKINGMECHANISMINTHE#ASH0AYMENTS*OURNAL 6 StateTHEEFFECTOF'34PAIDON s THEAMOUNTOFCASHPAIDFORPURCHASES s THEVALUEOFTHEASSETEXPENSEPURCHASED

6.3

POSTING THE CASH PAYMENTS JOURNAL TO THE GENERAL LEDGER

/NCETHECOLUMNSINTHE#ASH0AYMENTS*OURNALHAVEBEENTOTALLED THESETOTALSCAN BEPOSTEDTOTHE'ENERAL,EDGERACCOUNTSATTHEENDOFTHEMONTH5SINGTHE#ASH 0AYMENTS*OURNALIN&IGURE THE'ENERAL,EDGERENTRIESWOULDBE DR DR DR DR DR DR DR CR

Creditors Control Stock Control Wages Electricity Drawings Vehicle GST Clearing Bank

$ 750 420 380 150 100 12 000 1 257 15 057

!LTHOUGHTHEREISONLYONECREDITENTRYTOTHE"ANKACCOUNT ANDSEVENDEBITENTRIES THETOTALDEBITSANDCREDITSSTILLMATCH4HESEENTRIESFORMAMATCHINGDOUBLEENTRY 4HESEJOURNALTOTALSWOULDBEPOSTEDTOTHE'ENERAL,EDGERONLYATTHEENDOFTHE MONTHINTHISCASE *UNE %VENTHEENTRIESINTHE3UNDRIESCOLUMN WHICHMUST BEPOSTEDTOTHEINDIVIDUALACCOUNTSINTHISCASE %LECTRICITY $RAWINGSAND6EHICLE ARE POSTEDATTHEENDOFTHEMONTH4HISISSHOWNIN&IGURE Figure 6.2

General Ledger: posting the Cash Payments Journal General Ledger Bank (A)

Date June 1

Cross-reference Balance

Amount $

Date

Cross-reference

Amount $

5 000

June 30

Cash payments

15 057

Cross-reference

Amount $

Creditors Control (L) Date June 30

Cross-reference Bank

Amount $

Date

750

June 1

Balance

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900

Cambridge University Press

111

112

CAMBRIDGE VCE ACCOUNTING

Figure 6.2 (cont.)

UNITS 3&4

General Ledger: posting the Cash Payments Journal Stock Control (A)

Date June 1 30

Cross-reference Balance

"ANK

Amount $

Date

Cross-reference

Amount $

Cross-reference

Amount $

Cross-reference

Amount $

Cross-reference

Amount $

Cross-reference

Amount $

2 000 420 Wages (E)

Date June 30

Cross-reference Bank

Amount $

Date

380 Electricity (E)

Date

Cross-reference

June 30

Bank

Amount $

Date

150 Drawings (– OE)

Date June 30

Cross-reference Bank

Amount $

Date

100 Vehicle (A)

Date

Cross-reference

Amount $

Date

The Cash Payments Journal is posted to the General Ledger using the column totals at the end of the month.

June 30

Bank

12 000 GST Clearing (A or L)

Date June 30

Cross-reference Bank

Amount $

Date

Cross-reference

Amount $

1 257

Cross-references in the Bank account )N ALL THE LEDGER ACCOUNTS SHOWN IN THIS TEXT SO FAR THE CROSS REFERENCE HAS BEEN THE NAME OF THE OTHER LEDGER ACCOUNT AFFECTED BY EACH TRANSACTION %VEN WHEN POSTING THE#ASH0AYMENTS*OURNAL THECROSS REFERENCEINTHE#REDITORS#ONTROL 3TOCK#ONTROL 7AGES %LECTRICITY $RAWINGS 6EHICLEAND'34#LEARINGACCOUNTSWAS"ANK (OWEVER THECROSS REFERENCEINTHE"ANKACCOUNTITSELFDOESNOTFOLLOWTHISRULEIT ISNOTTHENAMEOFALEDGERACCOUNT4HISISBECAUSETHEREISNOSINGLEACCOUNTLINKED TOTHE $15 057PAIDOUTOFTHE"ANKACCOUNTITHASBEENPAIDFORANUMBEROFDIFFERENT PURPOSES&ORTHISREASON THECROSS REFERENCEINTHE"ANKACCOUNTMUSTSIMPLYBE#ASH 0AYMENTS TO INDICATE THAT THERE ARE A NUMBER OF OTHER ACCOUNTS LINKED TO THIS TOTAL PAYMENTSlGURE 4HEUSEOFTHISCROSS REFERENCEALSOMEANSANY'34PAID ISINCLUDEDINTHE TOTALCASHPAID ANDTHE'34#LEARINGACCOUNTDOESNOTNEEDTOBENOTEDINTHECROSS REFERENCE "ECAUSE IT IS THE ONLY ENTRY IN THE '34 #LEARING ACCOUNT THE DEBIT ENTRY MEANSTHATTHISBUSINESSCURRENTLYHASACURRENTASSETINRELATIONTO'34 ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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CHAPTER 6

SPECIAL JOURNALS 2: CASH JOURNALS

REVIEW QUESTIONS 6.3

1 ExplainHOWTHE#ASH0AYMENTS*OURNALISPOSTEDTOTHE'ENERAL,EDGER 2 Show THE DEBIT AND CREDIT ENTRIES NECESSARY TO POST THE #ASH 0AYMENTS *OURNALIN&IGURE TOTHE'ENERAL,EDGER 3 Explain WHY THE CROSS REFERENCE USED WHEN THE #ASH 0AYMENTS *OURNAL IS POSTEDTOTHE"ANKACCOUNTISNOTTHENAMEOFALEDGERACCOUNT 4 ExplainTHEEFFECTOF'34PAIDON s "ANK s '34#LEARING

6.4

POSTING THE CASH PAYMENTS JOURNAL TO THE CREDITORS (SUBSIDIARY) LEDGER

4HESAMEAPPROACHTHATWASTAKENTOPOSTINGTHE0URCHASES*OURNALIN#HAPTER MUST BETAKENWHENPOSTINGTHE#ASH0AYMENTS*OURNAL)NTHE'ENERAL,EDGER THETOTALPAID TOCREDITORSISDEBITEDTOTHE#REDITORS#ONTROLACCOUNTATTHEENDOFTHEMONTH)NTHE #REDITORS,EDGER HOWEVER THEINDIVIDUALTRANSACTIONSMUSTBEDEBITEDTOTHEACCOUNTOF EACHINDIVIDUALCREDITORONTHEDAYTHATTHEYOCCUR4HISISSHOWNIN&IGURE Figure 6.3 Creditors Ledger: posting the Cash Payments Journal Creditors Ledger Mills Bros (L) Date

Cross-reference

June 5

Bank

Amount $

Date

400

June 1

Cross-reference Balance

Amount $ 500

Johnson Ltd (L) Date

Cross-reference

June 24

Bank

Amount $

Date

350

June 1

Cross-reference Balance

Amount $ 400

The Cash Payments Journal is posted to the Creditors Ledger using individual transactions on the day they occur.

REVIEW QUESTIONS 6.4

1 IdentifyTWODIFFERENCESINTHEWAYTHE#ASH0AYMENTS*OURNALISPOSTEDTO THE#REDITORS,EDGERCOMPAREDTOTHEWAYITISPOSTEDTOTHE'ENERAL,EDGER  2 ExplainTHECROSS REFERENCEUSEDINTHEINDIVIDUALCREDITORSACCOUNTS

6.5

THE CASH RECEIPTS JOURNAL

4HETRANSACTIONSINTHE#ASH0AYMENTS*OURNALHADONELEDGERENTRYINCOMMONnTHEY ALLINVOLVEDACREDITTOTHE"ANKACCOUNTINTHE'ENERAL,EDGER4HESAMEPRINCIPLECAN BEAPPLIEDTOALLCASHRECEIPTS BUTFROMTHEOPPOSITEPERSPECTIVE Each cash receipt requires a debit to the Bank account.

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113

CAMBRIDGE VCE ACCOUNTING

114

Cash Receipts Journal an accounting record that summarises all cash received during a month

UNITS 3&4

7HILETHECREDITPARTOFEACHENTRYWILLVARYACCORDINGTOTHESOURCEOFTHECASHRECEIVED EACHCASHRECEIPTINVOLVESTHESAMEDEBITENTRYTO"ANK4HISISTRUEWHETHERTHECASH ISRECEIVEDFROMCASHSALES ADEBTOR THEOWNERVIAACAPITALCONTRIBUTION OREVENFROM THERECEIPTOFALOAN!SWITHTHE#ASH0AYMENTS*OURNAL RATHERTHANASEPARATEDEBITTO THE"ANKACCOUNTFOREACHINDIVIDUALTRANSACTIONANDTHESECOULDNUMBERORPER MONTH THESETRANSACTIONSCANBESUMMARISEDINACash Receipts Journal

REVIEW QUESTIONS 6.5

1 ListFOURTRANSACTIONSTHATWOULDBERECORDEDINTHE#ASH2ECEIPTS*OURNAL 2 ExplainWHATEACHCASHRECEIPTHASINCOMMONINTERMSOFITSEFFECTONTHE 'ENERAL,EDGER

6.6

RECORDING TRANSACTIONS IN THE CASH RECEIPTS JOURNAL

! MULTI COLUMN #ASH 2ECEIPTS *OURNAL WOULD TYPICALLY LOOK LIKE THE ONE FOR 'REEN 4HUMB0LANTSSHOWNIN&IGURE Figure 6.4 Cash Receipts Journal Details 2

June 1

Cash Sales

11

440

210

400

40

5

Cash Sales

12

550

270

500

50

8

G. Matthews

13

300

11

Cash Sales

14

660

600

60

14

T. May

15

200

19

Capital

16

10 000

22

Cash Sales

17

220

27

G. Matthews

18

100



$ 12 470



Totals

Receipt Bank 4 Debtors 3 number Control 5

Cost of Sales 6

Sales 5 Sundries 7 GST 8

Date 1

 330  10 000 120

200





20





Notes for recording in the Cash Receipts Journal 1

Date !SWITHALLJOURNALS TRANSACTIONSARERECORDEDINDATEORDER ONTHEDATETHATTHEY OCCURALTHOUGHTHETOTALSAREPOSTEDTOTHE'ENERAL,EDGERATTHEendOFTHEMONTH

2 Details "ECAUSEEVERYCASHRECEIPTREQUIRESADEBITTOTHE"ANKLEDGERACCOUNT THEONLY PARTOFTHEDOUBLEENTRYTHATMUSTBESPECIlEDFOREACHRECEIPTISTHEACCOUNTTO BE CREDITED .OTE HOW THE NAME OF EACH DEBTOR IS LISTED WHEN CASH IS RECEIVED FROMDEBTORS4HETOTALRECEIVEDFROMDEBTORS WILLBEPOSTEDTOTHE$EBTORS #ONTROLACCOUNTINTHE'ENERAL,EDGER BUTTHEINDIVIDUALTRANSACTIONSWILLBEPOSTED TOTHEINDIVIDUALDEBTORSACCOUNTSINTHE$EBTORS,EDGER 3 Receipt number 7ITHCASHRECEIPTS THESOURCEDOCUMENTITSELFSHOULDBEACASHRECEIPT GENERATED EITHERMANUALLYORBYCOMPUTERORCASHREGISTER"ECAUSETHESERECEIPTSAREISSUED BYTHElRMINTHISCASE 'REEN4HUMB0LANTS THERECEIPTNUMBERSSHOULDRUNIN SEQUENCE ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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CHAPTER 6

SPECIAL JOURNALS 2: CASH JOURNALS

115

4 Bank 4HEamount receivedMUSTBERECORDEDlRSTINTHE"ANKCOLUMN TOALLOWCALCULATION OFTHETOTALCASHRECEIVED7HERE'34ISINVOLVED THEAMOUNTRECORDEDINTHE"ANK COLUMNincludes the GST amount4HISAMOUNTWILLBEPOSTEDTOTHE"ANKLEDGER ACCOUNTASONETOTAL ATTHEendOFTHEMONTH 5 Classification columns !S WITH THE #ASH 0AYMENTS *OURNAL THE AMOUNT OF EACH TRANSACTION MUST BE RECORDEDTWICEnONCEINTHE"ANKCOLUMNTORECORDTHECASHRECEIVED ANDASECOND TIMEINACLASSIlCATIONCOLUMNTORECORDTHESOURCEOFTHATCASH4HESECLASSIlCATION COLUMNSALLOWFORFREQUENTCASHRECEIPTSTOBESUMMARISED ANDTHETOTALPOSTEDTO THELEDGERACCOUNT)NTHISEXAMPLE THEFREQUENTCASHRECEIPTSTHATHAVETHEIROWN CLASSIlCATIONCOLUMNARE$EBTORS#ONTROLAND3ALES 6 Cost of Sales /NEOFTHECOMPLICATINGFACTORSINRECORDINGCASHSALESISTHEFACTTHATEACHSALEWILL INVOLVETWODOUBLEENTRIESONEATSELLINGPRICEANDONEATCOSTPRICE4HEAMOUNTOF CASHRECEIVEDFROMTHESALERECORDEDATSELLINGPRICE ISRECORDEDINTHE"ANKAND3ALES COLUMNS"UTBECAUSEEACHSALEDECREASESSTOCKANDCREATESANEXPENSE#OSTOF3ALES ITISALSONECESSARYTOSHOWTHECOSTPRICEOFEACHSALEINTHE#ASH2ECEIPTS*OURNAL )NTHISCASE THISWILLBEPOSTEDTOTHE'ENERAL,EDGERAS DR CR

Cost of Sales (E)

$ 930

Stock Control (A)

930

7 Sundries 4HISCOLUMNFULlLSEXACTLYTHESAMEFUNCTIONINTHE#ASH2ECEIPTS*OURNALASITDOES IN THE #ASH 0AYMENTS *OURNAL )NFREQUENT CASH RECEIPTS MUST BE RECORDED IN THE 3UNDRIESCOLUMN 8 GST &ORCASHSALES THISISWHERETHE'34RECEIVEDOFTHESELLINGPRICE ISRECORDED 4HE'34INCREASESTHEAMOUNTRECEIVED ASSHOWNINTHE"ANKCOLUMN BUTDOESNOT AFFECTSALESREVENUEEARNED NORTHECOSTOFTHESALE

STUDY TIP

2EMEMBERTHAT'34 DOESNOTAFFECTTHE VALUATIONOFSTOCK NOR THEREVENUEEARNED FROMITSSALE

Double-checking mechanism )NCOMMONWITHTHE#ASH0AYMENTS*OURNAL THE#ASH2ECEIPTS*OURNALHASACHECKING MECHANISM BUTITISCOMPLICATEDBYONEFACTORTHEUSEOFTHE#OSTOF3ALESCOLUMN!T THEENDOFTHEMONTH EACHCOLUMNINTHE#ASH2ECEIPTS*OURNALSHOULDBETOTALLED!S ADOUBLE CHECKINGMECHANISM THETOTALOFTHE"ANKCOLUMNSHOULDEQUALTHESUMOF THETOTALSOFTHEOTHER#LASSIlCATIONAND3UNDRIES COLUMNS EXCEPT#OSTOF3ALES4HIS ISBECAUSE#OSTOF3ALESDOESNOTRECORDCASHRECEIVEDFROMSALESITONLYRECORDSTHE COSTPRICEOFTHESTOCKTHATHASBEENSOLD)TRECORDSANoutflow of stock RATHERTHANAN inflow of cash 5SINGTHEAMOUNTSFROM&IGURE THEDOUBLE CHECKWOULDSHOW Bank

Total debits

12 470

$12 470

=

Debtors Control

600

+

Sales

+

Sundries

1 700

+

GST Clearing

170

Total credits

$12 470

10 000

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UNITS 3&4

REVIEW QUESTIONS 6.6

1 StateWHYTHE#ASH2ECEIPTS*OURNALONLYIDENTIlESTHEACCOUNTTOBECREDITED INTHE$ETAILSCOLUMN 2 IdentifyTHESOURCEDOCUMENTUSEDTOVERIFYTHETRANSACTIONSRECORDED INA #ASH2ECEIPTS*OURNAL 3 ExplainHOWTHEHEADINGSFORTHECLASSIlCATIONCOLUMNSINTHE#ASH2ECEIPTS *OURNALAREDETERMINED 4 ExplainWHYTHENAMEOFEACHDEBTORISIDENTIlEDINTHE$ETAILSCOLUMN 5 ExplainWHYITISNECESSARYTOUSEA#OSTOF3ALESCOLUMNINTHE#ASH2ECEIPTS *OURNAL 6 ExplainTHEDOUBLE CHECKINGMECHANISMINTHE#ASH2ECEIPTS*OURNAL 7 StateTHEEFFECTOF'34RECEIVEDON s THEAMOUNTOFCASHRECEIVEDFROMCASHSALES s THEREVENUEEARNEDFROMCASHSALES

6.7

POSTING THE CASH RECEIPTS JOURNAL TO THE GENERAL LEDGER

/NCE THE COLUMNS IN THE #ASH 2ECEIPTS *OURNAL HAVE BEEN TOTALLED THESE TOTALS CAN BEPOSTEDTOTHE'ENERAL,EDGERACCOUNTS/NCEAGAIN THISISDONEONLYATTHEENDOF THEMONTHTHATIS *UNE5SINGTHE#ASH2ECEIPTS*OURNALIN&IGURE THE'ENERAL ,EDGERENTRIESWOULDBE DR

Bank

$12 470

CR

Debtors Control

CR

Sales

CR

Capital

CR

GST Clearing

600 1 700 10 000 170

4HISISAMATCHINGDOUBLEENTRY BUTITDOESNOTACCOUNTFORALLTHEINFORMATIONINTHE #ASH2ECEIPTS*OURNALWEMUSTALSORECORDTHECOSTPRICEOFTHESALESMADE4HISIS DONEBYPOSTINGANADDITIONALDOUBLEENTRY DR

Cost of Sales

CR

$ 930

Stock Control

930

&IGURESHOWSHOWTHE'ENERAL,EDGERACCOUNTSWOULDAPPEARAFTERPOSTINGTHE #ASH2ECEIPTS*OURNAL Figure 6.5 General Ledger: posting the Cash Receipts Journal General Ledger Bank (A) Date June 1 30

Cross-reference Balance Cash receipts

Amount $ 5 000

Date

Cross-reference

Amount $

June 30

Cash payments

15 057

Cross-reference

Amount $

12 470 Debtors Control (A)

Date

Cross-reference

June 1

Balance

Amount $

Date

1 100

June 30

Bank

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

600 Cambridge University Press

CHAPTER 6

SPECIAL JOURNALS 2: CASH JOURNALS

Sales (R) Date

Cross-reference

Amount $

Date June 30

Cross-reference Bank

Amount $ 1 700

Capital (OE) Date June 1

Cross-reference

Amount $

Date

42 000

June 30

Balance

Cross-reference Bank

Amount $ 10 000

GST Clearing (A or L) Date June 30

Cross-reference

Amount $

Date

1 257

June 30

Bank

Cross-reference Bank

Amount $ 170

Stock Control (A) Date June 1 30

Cross-reference

Amount $

Balance

2 000

Bank

Date June 30

Cross-reference Cost of Sales

Amount $ 930

420 Cost of Sales (E)

Date June 30

Cross-reference

Amount $

Stock Control

Date

Cross-reference

Amount $

930

The Cash Receipts Journal is posted to the General Ledger using the column totals at the end of the month.

Cross-references in the Bank account !SWITHTHE#ASH0AYMENTS*OURNAL THEAMOUNTPOSTEDTOTHE"ANKACCOUNT$12 470 ISNOTLINKEDTOONEACCOUNT BUTMANYINTHISCASE FOUR$EBTORS#ONTROL 3ALES #APITAL AND'34#LEARING 4HECROSS REFERENCEINTHE"ANKCANNOT THEREFORE BETHENAMEOF ONELEDGERACCOUNTITMUSTBE#ASH2ECEIPTSTOINDICATETHATTHEREAREANUMBEROF OTHERACCOUNTSLINKEDTOTHISTOTALRECEIPTSlGURE 4HE'34RECEIVED ISSIMPLYINCLUDEDINTHETOTALCASHRECEIVED ANDTHE'34 #LEARING ACCOUNT DOES NOT NEED TO BE NOTED IN THE CROSS REFERENCE "UT IN THE '34 #LEARING $EBTORS #ONTROL 3ALES AND #APITAL ACCOUNTS THE CROSS REFERENCE CAN AND THEREFOREMUST BETHENAMEOFTHEOTHERLEDGERACCOUNTINVOLVED"ANK

REVIEW QUESTIONS 6.7

1 ExplainHOWTHE#ASH2ECEIPTS*OURNALISPOSTEDTOTHE'ENERAL,EDGER 2 ShowTHEDEBITANDCREDITENTRIESNECESSARYTOPOSTTHE#ASH2ECEIPTS*OURNAL IN&IGURE TOTHE'ENERAL,EDGER 3 Explain WHY THE CROSS REFERENCE USED WHEN THE #ASH 2ECEIPTS *OURNAL IS POSTEDTOTHE"ANKACCOUNTISNOTTHENAMEOFALEDGERACCOUNT 4 ExplainTHEEFFECTOF'34RECEIVEDON s "ANK s '34#LEARING

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

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CAMBRIDGE VCE ACCOUNTING

118

6.8

UNITS 3&4

POSTING THE CASH RECEIPTS JOURNAL TO THE DEBTORS (SUBSIDIARY) LEDGER

!MONGOTHERFUNCTIONS &IGURERECORDSTHECASHRECEIVEDFROMTWODEBTORS 4-AY AND ' -ATTHEWS 4HE TOTAL RECEIVED FROM DEBTORS  IS CREDITED TO THE $EBTORS #ONTROL ACCOUNT AT THE END OF THE MONTH THAT IS  *UNE  BUT THE INDIVIDUAL TRANSACTIONSnON AND*UNEnMUSTBECREDITEDTOTHEACCOUNTOFEACHINDIVIDUAL DEBTORINTHE$EBTORS,EDGERONTHEDAYTHEYOCCUR4HISISSHOWNIN&IGURE Figure 6.6 Debtors Ledger: posting the Cash Receipts Journal Debtors Ledger G. Matthews (A) Date

Cross-reference

June 1

Balance

Amount $

Date

Cross-reference

Amount $

800

June 8

Bank

300

27

Bank

100

T. May (A) Date

Cross-reference

June 1

Balance

Amount $

Date

300

June 14

Cross-reference Bank

Amount $ 200

The Cash Receipts Journal is posted to the Debtors Ledger using individual transactions on the day they occur.

REVIEW QUESTIONS 6.8

1 IdentifyTWODIFFERENCESINTHEWAYTHE#ASH2ECEIPTS*OURNALISPOSTEDTOTHE $EBTORS,EDGERCOMPAREDTOTHEWAYITISPOSTEDTOTHE'ENERAL,EDGER  2 Explain HOW THE CROSS REFERENCE USED IN THE INDIVIDUAL DEBTOR ACCOUNTS IS DETERMINED

6.9

GST SETTLEMENT AND GST REFUND

!TTHEENDOFTHEREPORTINGPERIOD EACHBUSINESSWILLBALANCEITS'34#LEARINGACCOUNT TODETERMINEWHETHERITHASA'34LIABILITYORA'34ASSET!FTERTHEENDOFITS"USINESS !CTIVITY3TATEMENT"!3 PERIOD WHENITMUSTCOMPLETEANDSUBMITITS"!3 THEBUSINESS MUSTPAYANY'34OWINGTOTHE!4/ASA'34SETTLEMENT ORWILLRECEIVEA'34REFUND FROMTHE!4/FOREXCESS'34

GST settlement GST settlement a cash payment made to the ATO to settle the liability that occurs when GST on sales is greater than GST on purchases

)F'34ONSALESISGREATERTHAN'34ONPURCHASES THEBUSINESSWILLBEREQUIREDTOMAKE AGST settlementTHATIS SETTLETHE'34OWINGBYMAKINGACASHPAYMENTTOTHE!4/

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CHAPTER 6

SPECIAL JOURNALS 2: CASH JOURNALS

EXAMPLE

Holding Furniture has provided the following information about its GST transactions for September 2015: Opening balance – GST Clearing GST received on cash sales1 GST charged to debtors on credit sales2 GST paid on cash purchases3 GST charged by creditors on credit purchases4

$

600 1 200 2 400 1 700 1 100

119

CR

"ASEDONTHESElGURES THEBUSINESSHASCHARGEDANDRECEIVEDWORTHOF'34 ONITSSALES BUTONLYPAIDANDBEENCHARGEDWORTHOF'34ONITSPURCHASES/N TOPOFTHE$600 CROPENINGBALANCE THISMEANSTHATASAT3EPTEMBERITOWES THE!4/ WHICHWOULDBEREPORTEDINTHE"ALANCE3HEETASACURRENTLIABILITY3OME TIMEIN/CTOBER A'34SETTLEMENTOFWOULDNEEDTOBEPAIDTOTHE!4/ !SSUMING THIS '34 SETTLEMENT WAS PAID ON  /CTOBER  #H  IT WOULD BE RECORDEDINTHE#ASH0AYMENTS*OURNALASISSHOWNIN&IGURE Figure 6.7 Cash Payments Journal: recording a GST settlement Cash Payments Journal Date Oct. 4

Details

Cheque number

Bank

31

1400

GST Clearing

Creditors Control

Stock Control

Wages

Sundries

GST

1 400

.OTETHATALTHOUGHTHE'34SETTLEMENTISPAID ITISNOTRECORDEDINTHE'34COLUMN AS THIS COLUMN IS ONLY FOR '34 PAID to suppliers, on purchases "Y CONTRAST A '34 SETTLEMENT IS PAID TO THE !4/ ONLY INFREQUENTLY TO SETTLE A '34 DEBT !S A RESULT IT MUSTBEIDENTIlEDSEPARATELY ANDSOISRECORDEDINTHE3UNDRIESCOLUMN)TWILLALSOBE REPORTEDSEPARATELYINTHE#ASH&LOW3TATEMENTASWILLBEEXPLAINEDIN#HAPTER  4HE BALANCE OF THE '34 #LEARING ACCOUNT WOULD NOW BE SETTLED OR CLEARED AS IS SHOWNIN&IGURE Figure 6.8 GST Clearing account with GST settlement GST Clearing (A or L) Date Sept. 30

Cross-reference

Amount $

Date

Bank3

1 700

Sept. 1

Creditors Control4

1 100

30

Balance

1 400

Cross-reference Balance

Bank



600

Bank1

1 200

Debtors Control2

2 400

4 200 Oct. 31

Amount $

4 200 Oct. 1

Balance

1 400

2EMEMBERTHATALTHOUGHTHE'34SETTLEMENTWILLBERECORDEDINTHE#ASH0AYMENTS *OURNAL WHEN IT IS PAID ON  /CTOBER  THE #ASH 0AYMENTS *OURNAL WILL NOT BE POSTEDTOTHE'ENERAL,EDGERUNTIL/CTOBER

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UNITS 3&4

GST refund )F'34ONPURCHASESISGREATERTHAN'34ONSALES THEBUSINESSWILLBEENTITLEDTOAGST refundFROMTHE!4/

EXAMPLE

Garner Electronics has provided the following information about its GST transactions for June 2015:

GST refund a cash receipt from the ATO to refund the excess that occurs when GST on sales is less than GST on purchases

Opening balance – GST Clearing $ GST received on cash sales1 GST charged to debtors on credit sales2 GST paid on cash purchases3 GST charged by creditors on credit purchases4

200 3 200 1 600 3 900 2 000

CR

"ASED ON THESE lGURES THE BUSINESS HAS  WORTH OF '34 ON SALES BUT HAS WORTHOF'34ONPURCHASES%VENCOUNTINGTHE$200#2OPENINGBALANCE ITSTILL MEANSADEBITBALANCE WHICHWOULDBEREPORTEDASACURRENTASSETINTHE"ALANCE 3HEETASAT*UNE4HEN SOMETIMEDURING*ULY THEBUSINESSISDUETO RECEIVEA'34REFUNDFROMTHE!4/OF !SSUMINGTHIS'34REFUNDWASRECEIVEDON*ULY2EC ITWOULDBERECORDED INTHE#ASH2ECEIPTS*OURNALASISSHOWNIN&IGURE Figure 6.9 Cash Receipts Journal: recording a GST refund Cash Receipts Journal Date

Details

Receipt number

July 8

GST Clearing

40

Bank

Debtors Control

Cost of Sales

Sales

900

Sundries

GST

900

4HE'34COLUMNISONLYFOR'34RECEIVEDFROMCUSTOMERSFORCASHSALES WHEREASTHE '34REFUNDISRECEIVEDFROMTHE!4/ITSELF#ONSEQUENTLY ITISRECORDEDSEPARATELYIN THE3UNDRIESCOLUMN ANDWILLBEREPORTEDSEPARATELYINTHE#ASH&LOW3TATEMENTSEE #HAPTER  4HE'34REFUNDWOULDHAVETHESAMEEFFECTASA'34SETTLEMENTINTERMSOFCLEARING THEPREVIOUSBALANCEINTHE'34#LEARINGACCOUNT ASISSHOWNIN&IGURE Figure 6.10 GST Clearing account with GST settlement GST Clearing (A or L) Date June 30

Cross-reference Bank

3

Creditors Control4

Amount $

Date



June 1

2 000

30

Cross-reference Balance

3 200

Debtors Control2

1 600

5 900 Balance

900

200

Bank1

Balance

July 1

Amount $

900 

July 31

Bank

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

900

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CHAPTER 6

SPECIAL JOURNALS 2: CASH JOURNALS

121

GST cash flows 4HEPAYMENTOFA'34SETTLEMENTORRECEIPTOFA'34REFUNDMEANSTHATTHEREAREFOUR POTENTIALCASHmOWSRELATEDTO'34 s '34paidONCASHPURCHASESFROMTHE#ASH0AYMENTS*OURNAL s '34receivedONCASHSALESFROMTHE#ASH2ECEIPTS*OURNAL s '34settlementPAIDFROMTHE3UNDRIESCOLUMNOFTHE#ASH0AYMENTS*OURNAL s '34refundRECEIVEDFROMTHE3UNDRIESCOLUMNOFTHE#ASH2ECEIPTS*OURNAL  4HE'34CHARGEDTODEBTORSONCREDITSALESINCREASESTHE'34LIABILITY BUTITISNOT ACASHmOW4HESAMEAPPLIESTO'34CHARGEDBYCREDITORSONCREDITPURCHASES WHICH DECREASESTHE'34LIABILITY BUTDOESNOTINVOLVEAPAYMENTOFCASH

REVIEW QUESTIONS 6.9

1 ExplainTHECIRCUMSTANCESTHATWOULDLEADTHE'34#LEARINGACCOUNTTOHAVE ACREDITBALANCE 2 ExplainHOWACREDITBALANCEINTHE'34#LEARINGACCOUNTWOULDBEREPORTED INTHE"ALANCE3HEET 3 DefineTHETERM@'34SETTLEMENT 4 ExplainWHYA'34SETTLEMENTISNOTRECORDEDINTHE'34COLUMNINTHE#ASH 0AYMENTS*OURNAL 5 ExplainTHECIRCUMSTANCESTHATWOULDLEADTHE'34#LEARINGACCOUNTTOHAVE ADEBITBALANCE 6 ExplainHOWADEBITBALANCEINTHE'34#LEARINGACCOUNTWOULDBEREPORTED INTHE"ALANCE3HEET 7 DefineTHETERM@'34REFUND 8 ExplainWHYA'34REFUNDISNOTRECORDEDINTHE'34COLUMNINTHE#ASH 2ECEIPTS*OURNAL 9 IdentifyTHETWOTRANSACTIONSRELATINGTO'34THATINVOLVEACASHINmOW 10 IdentifyTHETWOTRANSACTIONSRELATINGTO'34THATINVOLVEACASHOUTmOW 11 IdentifyTHETWOTRANSACTIONSRELATINGTO'34THATdo notINVOLVEACASHmOW

6.10

DISCOUNTS

&ORABUSINESSTHATSELLSONCREDITTERMS THEISSUEOFHOWTOMAKESUREDEBTORSPAY EITHEREARLYORONTIMECANBEAVEXEDQUESTION/NEOFTHEMOREOBVIOUSOPTIONSIS TOOFFERAsettlement discount WHICHREWARDSDEBTORSWHOPAYEARLYBYREDUCINGTHE AMOUNT THAT THEY ARE REQUIRED TO PAY 4HE TERMS OF A SETTLEMENT DISCOUNT MUST BE STATEDONTHESALESINVOICE ANDAREUSUALLYEXPRESSEDINTHEFORMOF@7 N4HIS ISTRANSLATEDAS s 7DISCOUNTIFTHEINVOICEISPAIDWITHINDAYS s NTHENETAMOUNTMUSTBEPAIDWITHINDAYS )NTHISEXAMPLE THECUSTOMERHASDAYSTOPAYTHENETAMOUNTBALANCEOWING ON THEINVOICE BUTIFTHEFULLAMOUNTISPAIDEARLYnWITHINDAYSnTHECUSTOMERISENTITLED TOADISCOUNTOFOFTHEINVOICEAMOUNT4HISDISCOUNTAMOUNTWILLnotHAVETOBE PAID BUTWILLSTILLBEDEDUCTEDFROMTHEAMOUNTOWING 4HEDISCOUNTRATEANDTHENUMBEROFDAYSALLOWEDTOPAYWILLVARYBETWEENlRMS DEPENDING ON HOW QUICKLY THEY NEED THEIR CASH AND THE RELATIONSHIPS THEY DEVELOP WITHTHEIRCUSTOMERS BUTTHEFORMATFOREXPRESSINGTHECREDITTERMSISGENERALLYFAIRLY CONSISTENT

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

settlement discount a reduction in the amount repayable by a credit customer in return for early repayment

STUDY TIP

)NCREDITTERMS THE SECONDANDFOURTH NUMBERSTELLUSHOW MANYDAYSAREAVAILABLE

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UNITS 3&4

For a business that sells on credit terms, the issue of how to make sure debtors pay either early or on time can be a vexed question

Benefits s Cash is received faster from debtors.4HISWILLALLOWTHEBUSINESSTO n PAYITSDEBTSONTIME ALLOWINGITTOTAKEADVANTAGEOFANYDISCOUNTSOFFEREDBY CREDITORS n MAKEOTHERPAYMENTS SUCHASWAGESOROTHEREXPENSES s The possibility of bad debts is reduced.4HELONGERADEBTGOESUNPAID THEMORE LIKELYITISTHEDEBTORWILLNOTACTUALLYPAYATALL s Greater sales may be encouraged.#USTOMERSMAYBEMOREWILLINGTOBUYFROMA lRMTHATOFFERSDISCOUNTSTHANONETHATDOESNOT KNOWINGTHATTHEAMOUNTTHEYEND UPPAYINGWILLBELESS Costs s Less cash is received from debtors. "ECAUSE A DISCOUNT REDUCES THE AMOUNT THE DEBTORHASTOPAY LESSCASHISRECEIVED s Net profit is reduced.4HEAMOUNTOFTHEDISCOUNTISANEXPENSE ANDTHUSREDUCES NETPROlT /FCOURSE IFTHEDISCOUNTISRECEIVEDFROMACREDITORRATHERTHANGIVENTOADEBTOR THENTHESECOSTSBECOMEBENElTS!DISCOUNTMEANSLESSCASHISPAIDTOCREDITORS AND ASTHEDISCOUNTISAREVENUE PROlTINCREASES Note:!SETTLEMENTDISCOUNTDOESnotREDUCETHEAMOUNTOFREVENUEEARNEDFROM THE SALE )NSTEAD IT REDUCES THE CASH RECEIVED FROM THE DEBTOR AND BECAUSE IT IS AN EXPENSETOTHESELLER ALSOREDUCESPROlT

Calculating the discount 4HEDISCOUNTREVENUEOREXPENSEWILLDEPENDONTHECREDITTERMSOFFERED ANDWHENTHE CASHISPAIDRECEIVED

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CHAPTER 6

SPECIAL JOURNALS 2: CASH JOURNALS

EXAMPLE

During December 2015, Lomax Carpets had the following transactions: Dec. 3

Sold carpet on credit to V. Barbarino for $1 000 plus $100 GST (Inv. 43)

6

Received cash from V. Barbarino in full settlement of debt (Rec. 61)

123

Lomax Carpets offers credit terms of 7/10, n/30.

"ECAUSE 6 "ARBARINO HAS PAID WITHIN  DAYS HE IS ENTITLED TO A DISCOUNT OF  WHICHWOULDBECALCULATEDASISSHOWNIN&IGURE Figure 6.11 Calculating discount expense Discount expense

=

Discount rate x Amount owing

=

7% x $1 100

=

$77

STUDY TIP

4HEDEBTORRECEIVESADISCOUNTONTHEFULLBALANCEOWING)NTHISEXAMPLE ,OMAX WILLINCURADISCOUNTEXPENSEOF$77 ANDTHEREFORERECEIVEONLYINCASHFROMTHE DEBTOR(OWEVER 6"ARBARINOSBALANCEWILLBEREDUCEDBYTHETOTALAMOUNTOF$1 100 !NY'34EFFECTISSIMPLYABSORBEDBYTHEBUSINESSOFFERINGTHEDISCOUNT

'34CANBEADJUSTED SOTHATBUSINESSESDO NOTHAVETOABSORBTHE '34THEYDONOTCOLLECT BUTTHISISBEYONDTHE SCOPEOFTHISCOURSE

REVIEW QUESTIONS 6.10

1 2 3 4

6.11

DefineTHETERM@SETTLEMENTDISCOUNT ExplainWHATISMEANTBYTHENOTATION@ N ListTHEBENElTSOFOFFERINGASETTLEMENTDISCOUNT ListTHECOSTSOFOFFERINGASETTLEMENTDISCOUNT

RECORDING DISCOUNT REVENUE IN THE CASH PAYMENTS JOURNAL

7HEN A CREDITOR IS PAID EARLY AND A DISCOUNT IS received THE AMOUNT PAID TO THAT CREDITORISREDUCED4HEAMOUNTOFTHISREDUCTIONISKNOWNASdiscount revenue ASITIS AREDUCTIONINANOUTmOWOFECONOMICBENElTSLESSCASHISPAIDTOCREDITORS INTHEFORM OF A REDUCTION IN LIABILITIES CREDITORS THAT INCREASES OWNERS EQUITY &IGURE  USES THETRANSACTIONSFROM&IGURE BUTWITHTHETWOTRANSACTIONSINVOLVINGPAYMENTSTO CREDITORSnON*UNETO-ILLS"ROS AND*UNETO*OHNSON,TD nADJUSTEDTOREmECT ADISCOUNTREVENUE

June

5 24

Paid Mills Bros $360 (after discount of $40) Paid amount owing to Johnson Ltd ($350 less discount $35)

Ch. 23

discount revenue a revenue (in the form of a decrease in creditors) earned when creditors are paid early

EXAMPLE

Ch. 29

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STUDY TIP

4HECASHPAIDTO CREDITORSISTHE AMOUNTINTHE #REDITORSCOLUMNLESS THE$ISCOUNT2EVENUE

Figure 6.12 Cash Payments Journal (with discount) Cash Payments Journal Date

Cheque number

Details

June 1 Stock Control

Bank

22

220

Discount Creditors Stock Revenue Control Control

Wages Sundries

20

Mills Bros

23

360

8

Wages

24

190

10

Electricity

25

165

150

13

Drawings

26

100

100

15

Stock Control

27

242

22 Wages

28

190

24

29

315

30

13 200

Johnson Ltd

29 Vehicle Totals

GST

200

5

STUDY TIP

$UETOTHEDISCOUNT THEAMOUNTRECORDED INTHE#REDITORS #ONTROLCOLUMNSHOULD BELARGERTHANTHE AMOUNTRECORDEDIN THE"ANKCOLUMN

UNITS 3&4

40

400 190 15

220

22 190

35

350 12 000 1 200

14 982

75

750

420

380

12 250 1 257

/N*UNE ONLYHASBEENPAIDTOTHECREDITOR SOTHISAMOUNTISRECORDEDIN THE"ANKCOLUMN(OWEVER THEAMOUNTOWEDTOTHECREDITORHASALSOBEENREDUCEDBY THERECEIVEDASADISCOUNT4HETOTALREDUCTIONINCREDITORSISACTUALLY PAIDPLUSDISCOUNT ANDITISTHISTOTALTHATMUSTBERECORDEDINTHE#REDITORS#ONTROL COLUMN4HE#REDITORS#ONTROLCOLUMNRECORDSTHETOTALBYWHICH#REDITORS#ONTROLWILL DECREASE WITHTHE"ANKCOLUMNRECORDINGTHEAMOUNTOFACTUALCASHPAID Effect on the accounting equation 4HEEFFECTOFTHEPAYMENTTO-ILLS"ROSON*UNEWHEREADISCOUNTISINVOLVED IS Increase/Decrease/No effect

Amount $

Assets

$ECREASE"ANK



Liabilities

$ECREASE#REDITORS#ONTROL



Owner’s Equity

)NCREASE$ISCOUNT2EVENUEINCREASESPROlT



Double-checking mechanism 4HE RECORDING OF A DISCOUNT REVENUE MEANS THAT THE DOUBLE CHECKING MECHANISM IS SLIGHTLYDIFFERENT BUTTHEBASICPRINCIPLEREMAINSTHESAMETHETOTALOFTHE"ANKCOLUMN plus THE DISCOUNT REVENUE COLUMN SHOULD EQUAL THE SUM OF THE TOTALS OF THE OTHER CLASSIlCATION AND SUNDRIES COLUMNS 5SING THE lGURES FROM &IGURE  THE DOUBLE CHECKWOULDSHOW Creditors Control

750

+

Stock Control

420

+

Wages

380

+

Sundries

+

GST Clearing Total debits

=

Bank +

14 982

Discount Revenue

75

12 250 1 257 $15 057

Total credits

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

$15 057

Cambridge University Press

CHAPTER 6

SPECIAL JOURNALS 2: CASH JOURNALS

125

REVIEW QUESTIONS 6.11

1 DefineTHETERM@DISCOUNTREVENUE 2 ExplainWHYDISCOUNTREVENUEISCLASSIlEDASREVENUE 3 7HEREADISCOUNTISRECEIVEDONAPAYMENTTOACREDITOR stateTHEAMOUNTTHAT SHOULDBERECORDEDINTHEFOLLOWINGCOLUMNSOFTHE#ASH0AYMENTS*OURNAL s "ANK s #REDITORS#ONTROL 4 2EFERRINGTO&IGURE stateTHEEFFECTOFTHETRANSACTIONON*UNE ONTHEACCOUNTINGEQUATION

6.12

POSTING THE CASH PAYMENTS JOURNAL (WITH DISCOUNT REVENUE)

4AKING INTO ACCOUNT THE DISCOUNT REVENUE THE #ASH 0AYMENTS *OURNAL IN &IGURE  WOULDBEPOSTEDTOTHE'ENERAL,EDGERUSINGTHEFOLLOWINGENTRIES DR

Creditors Control

DR

Stock Control

DR

Wages

380

DR

Electricity

150

DR

Drawings

DR

Vehicle

DR

GST Clearing

CR

Bank

CR

Discount Revenue

$

750 420

100 12 000 1 257 14 982 75

4HISTIMEITTAKESTWOCREDITSTO"ANKAND$ISCOUNT2EVENUE ANDSEVENDEBITSTO FORMAMATCHINGDOUBLE ENTRY(OWEVER THISISSTILLFARFEWERTHANITWOULDTAKETOENTER THETRANSACTIONSDIRECTLYINTOTHE'ENERAL,EDGER &IGURESHOWSHOWTHE'ENERAL,EDGERACCOUNTSWOULDAPPEARAFTERTHE#ASH 0AYMENTS*OURNALHADBEENPOSTED Figure 6.13 General Ledger: posting the Cash Payments Journal (with discount) General Ledger Bank (A) Date June 1

Cross-reference

Amount $

Date

Cross-reference

Amount $

5 000

June 30

Cash Payments

14 982

Balance

Discount Revenue (R) Date

Cross-reference

Amount $

Date

Cross-reference

Amount $

June 30

Creditors Control

75

Creditors Control (L) Date

Cross-reference

June 30 Bank/Discount Revenue

Amount $ 750

Date June 1

Cross-reference

Amount $

Balance

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

900

STUDY TIP

4HE#REDITORS#ONTROL ACCOUNTHASTWO ENTRIESWITHADOUBLE CROSS REFERENCE"ANK $ISCOUNT2EVENUEON THEDEBITSIDE AND 3TOCK#ONTROL'34 #LEARINGONTHECREDIT SIDE

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126

UNITS 3&4

Cross-references .OTE HOW THE CROSS REFERENCE IN THE #REDITORS #ONTROL ACCOUNT NOW REFERS TO two ACCOUNTS "ANK AND $ISCOUNT 2EVENUE 4HIS IS BECAUSE THE AMOUNT DEBITED TO THE #REDITORS #ONTROL  ACCOUNT CONSISTS OF SOME CASH  AND SOME DISCOUNT REVENUE  /NTHEOTHERHAND THECROSS REFERENCEINTHE$ISCOUNT2EVENUEACCOUNTREFERSONLY TO#REDITORS#ONTROL4HEREISNOCONNECTIONBETWEENTHE"ANKAND$ISCOUNT2EVENUE ACCOUNTSAS BYDElNITION THEDISCOUNTISTHEAMOUNTTHATHASnotBEENPAID 4HESAMEPRINCIPLEAPPLIESINTHE#REDITORS,EDGER SHOWNIN&IGURE Figure 6.14 Creditors Ledgers: posting the Cash Payments Journal (with discount) Creditors Ledger Mills Bros (L) Date June 5

Cross-reference Bank/Discount Revenue

Amount $

Date

400

June 1

Cross-reference Balance

Amount $ 500

Johnson Ltd (L) Date

Cross-reference

June 24 Bank/Discount Revenue

Amount $

Date

350

June 1

Cross-reference Balance

Amount $ 400

REVIEW QUESTIONS 6.12

1 Show THE DEBIT AND CREDIT ENTRIES NECESSARY TO POST THE #ASH 0AYMENTS *OURNALTOTHE'ENERAL,EDGERWHENDISCOUNTREVENUEISINVOLVED 2 ExplainWHYTHEREARETWOACCOUNTSCROSS REFERENCEDINTHE#REDITORS#ONTROL ACCOUNTWHENADISCOUNTREVENUEISRECEIVEDONAPAYMENTTOACREDITOR

6.13

RECORDING DISCOUNT EXPENSE IN THE CASH RECEIPTS JOURNAL

7HEN CASH IS RECEIVED FROM A DEBTOR WHO PAYS EARLY AND A DISCOUNT IS GRANTED THE AMOUNTRECEIVEDFROMTHEDEBTORISREDUCED4HEAMOUNTOFTHISREDUCTIONISKNOWN discount expense ASdiscount expense ASITISAREDUCTIONINANINmOWOFECONOMICBENElTSLESSCASH an expense, in the form ISRECEIVEDFROMDEBTORS INTHEFORMOFAREDUCTIONINASSETSDEBTORS THATDECREASES of a decrease in debtors, OWNERS EQUITY &IGURE  USES THE TRANSACTIONS FROM &IGURE  BUT WITH THE THREE incurred when cash is TRANSACTIONSINVOLVINGRECEIPTSFROMDEBTORSnONAND*UNEFROM'-ATTHEWS AND received early from debtors *UNEFROM4-AY nADJUSTEDTOREmECTTHEDISCOUNTTERMSOF N

EXAMPLE

June

8 14 27

Received $270 from G. Matthews (discount $30) T. May paid $180 after $20 discount Receipt of cash from G. Matthews $90 ($10 discount granted)

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Rec. 13 Rec. 15 Rec. 18

Cambridge University Press

CHAPTER 6

SPECIAL JOURNALS 2: CASH JOURNALS

Figure 6.15 Cash Receipts Journal (with discount)

127

STUDY TIP

Cash Receipts Journal Date

Details

Receipt number

Bank

Discount Expense

Debtors Cost of Control Sales

Sales

Sundries

GST

June 1 Cash Sales

11

440

210

400

40

5 Cash Sales

12

550

270

500

50

8 G. Matthews

13

270

11 Cash Sales

14

660

330

600

60

14 T. May

15

180

19 Capital

16

10 000

22 Cash Sales

17

220

27 G. Matthews

18

90

10

100

12 410

60

600

Totals

30

20

300

$UETOTHEDISCOUNT THEAMOUNTRECORDED INTHE$EBTORS#ONTROL COLUMNSHOULDBE LARGERTHANTHEAMOUNT RECORDEDINTHE"ANK COLUMN

200 10 000 120

200

930

1 700

20

10 000

170

/N*UNE ONLYHASBEENRECEIVEDFROMTHEDEBTORASCASH SOTHISAMOUNT IS RECORDED IN THE "ANK COLUMN (OWEVER THE AMOUNT OWED BY THE DEBTOR HAS ALSO BEENREDUCEDBYTHEGRANTEDASADISCOUNT4HUS THETOTALREDUCTIONINDEBTORS ISRECEIVEDplusDISCOUNT ANDTHISISTHETOTALTHATMUSTBERECORDEDIN THE$EBTORS#ONTROLCOLUMN4HE$EBTORS#ONTROLCOLUMNRECORDSTHETOTALBYWHICH $EBTORS#ONTROLWILLDECREASE WHILETHE"ANKCOLUMNRECORDSTHEAMOUNTOFACTUALCASH RECEIVED

STUDY TIP

4HECASHRECEIVED FROMDEBTORSISTHE AMOUNTINTHE$EBTORS #ONTROLCOLUMNLESSTHE $ISCOUNT%XPENSE

Effect on the accounting equation 4HEEFFECTOFTHERECEIPTFROM'-ATTHEWSON*UNEWHEREADISCOUNTISINVOLVED IS Increase/Decrease/No effect

Amount $

Assets

$ECREASEINCREASE"ANK DECREASE$EBTORS#ONTROL

Liabilities

.OEFFECT

Owner’s Equity

$ECREASE$ISCOUNT%XPENSEDECREASESPROlT

30

30

Double-checking mechanism )NAFASHIONSIMILARTOTHE#ASH0AYMENTS*OURNAL THETOTALOFTHE"ANKCOLUMNplus THE $ISCOUNT%XPENSECOLUMN SHOULDEQUALTHESUMOFTHETOTALSOFTHEOTHER#LASSIlCATION AND3UNDRIES COLUMNSEXCEPTTHE#OSTOF3ALESCOLUMN WHICHRELATESTOASTOCKmOW NOTACASHmOW 5SINGTHElGURESFROM&IGURE THEDOUBLE CHECKWOULDSHOW Bank +

Discount Expense

Total debits

12 410 60

$12 470

=

Debtors Control

600

+

Sales

1 700

+

Sundries

+

GST Clearing

170

Total credits

$12 470

10 000

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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128

UNITS 3&4

REVIEW QUESTIONS 6.13

1 DefineTHETERM@DISCOUNTEXPENSE 2 ExplainWHYDISCOUNTEXPENSEISCLASSIlEDASANEXPENSE 3 7HEREADISCOUNTISGIVENONARECEIPTFROMADEBTOR stateTHEAMOUNTTHAT SHOULDBERECORDEDINTHEFOLLOWINGCOLUMNSOFTHE#ASH2ECEIPTS*OURNAL s "ANK s $EBTORS#ONTROL 4 2EFERRINGTO&IGURE stateTHEEFFECTOFTHETRANSACTIONON*UNE ONTHEACCOUNTINGEQUATION

6.14

POSTING THE CASH RECEIPTS JOURNAL (WITH DISCOUNT EXPENSE)

4AKING INTO ACCOUNT THE DISCOUNT EXPENSE THE #ASH 2ECEIPTS *OURNAL IN &IGURE  WOULDBEPOSTEDTOTHE'ENERAL,EDGERUSINGTHEFOLLOWINGENTRIES DR DR CR CR CR CR

Bank Discount Expense Debtors Control Sales Capital GST Clearing

$

Cost of Sales Stock Control

$

12 410 60 600 1 700 10 000 170

and DR CR

930 930

4HISTIMEITTAKESTWODEBITSTO"ANKAND$ISCOUNT%XPENSE ANDFOURCREDITSTOFORM AMATCHINGDOUBLE ENTRY&IGURESHOWSHOWTHE'ENERAL,EDGERACCOUNTSWOULD APPEARAFTERTHE#ASH2ECEIPTS*OURNALHADBEENPOSTED Figure 6.16 General Ledger: posting the Cash Receipts Journal (with discount) General Ledger Bank (A) Date STUDY TIP

June 1 30

,IKE#REDITORS#ONTROL THE$EBTORS#ONTROL ACCOUNTHASTWO ENTRIESWITHADOUBLE CROSS REFERENCE"ANK $ISCOUNTEXPENSEON THECREDITSIDE AND 3ALES'34#LEARINGON THEDEBITSIDE

Cross-reference Balance Cash Receipts

Amount $

Date

Cross-reference

Amount $

5 000

June 30

Cash Payments

14 982

Cross-reference

Amount $

12 410 Discount Expense (E)

Date

Cross-reference

Amount $

June 30

Debtors Control

60

Date

Debtors Control (A) Date June 1

Cross-reference Balance

Amount $ 1 100

Date June 30

Cross-reference Bank/Discount Expense

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Amount $ 600

Cambridge University Press

CHAPTER 6

SPECIAL JOURNALS 2: CASH JOURNALS

Cross-references !S WITH CASH PAYMENTS INVOLVING A DISCOUNT REVENUE A CASH RECEIPT FROM A DEBTOR THATALSOINVOLVESADISCOUNTEXPENSEISPOSTEDTOTHE$EBTORS#ONTROLACCOUNTUSING ONE lGURE THE TOTAL OF THE $EBTORS #ONTROL COLUMN FROM THE #ASH 2ECEIPTS *OURNAL  "UTTHISlGUREINCLUDESSOMECASHRECEIVEDINTHEPRECEEDINGEXAMPLE  PLUSSOMEDISCOUNTEXPENSE SOTHECROSS REFERENCEMUSTREFERTOBOTH"ANKAND $ISCOUNT%XPENSE /NTHEOTHERHAND THECROSS REFERENCEINTHE$ISCOUNT%XPENSEACCOUNTREFERSONLY TO$EBTORS#ONTROL ASTHEDISCOUNTISTHEAMOUNTNOTRECEIVED 4HESAMEPRINCIPLEAPPLIESINTHE$EBTORS,EDGER WHICHISSHOWNIN&IGURE Figure 6.17 Debtors Ledger: posting the Cash Receipts Journal (with discount) Debtors Ledger G. Matthews (A) Date June 1

Cross-reference

Amount $

Date

800

June 8

Bank/Discount Expense

300

27

Bank/Discount Expense

100

Balance

Cross-reference

Amount $

T. May (A) Date June 1

Cross-reference

Amount $

Date

300

June 14

Balance

Cross-reference

Amount $

Bank/Discount Expense

200

REVIEW QUESTIONS 6.14

1 ShowTHEDEBITANDCREDITENTRIESNECESSARYTOPOSTTHE#ASH2ECEIPTS*OURNAL TOTHE'ENERAL,EDGERWHENADISCOUNTEXPENSEISINVOLVED 2 State ONE REASON WHY THE AMOUNT POSTED TO THE $EBTORS #ONTROL ACCOUNT FROM THE #ASH 2ECEIPTS *OURNAL IS NOT THE SAME AS THE CASH RECEIVED FROM DEBTORS 3 ExplainWHYTWOACCOUNTSARECROSS REFERENCEDINTHE$EBTORS#ONTROLACCOUNT WHENADISCOUNTEXPENSEISINCURREDONARECEIPTFROMADEBTOR

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

129

130

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

WHERE HAVE WE BEEN? s 3PECIALJOURNALSSUMMARISESIMILARTRANSACTIONS ALLOWINGTOTALSTOBEPOSTEDTOTHE 'ENERAL,EDGERACCOUNTSUSINGFEWERDEBITANDCREDITENTRIES s !LLCASHPAIDISRECORDEDINTHE#ASH0AYMENTS*OURNALALLCASHPAYMENTSRESULTIN ACREDITTOTHE"ANKACCOUNT s !LLCASHRECEIVEDISRECORDEDINTHE#ASH2ECEIPTS*OURNALALLCASHRECEIPTSRESULTIN ADEBITTOTHE"ANKACCOUNT s &REQUENTCASHTRANSACTIONSAREGIVENTHEIROWNCOLUMNINTHECASHJOURNALINFREQUENT CASHTRANSACTIONSARERECORDEDINTHE3UNDRIESCOLUMN s *OURNALS ARE POSTED TO THE 'ENERAL ,EDGER AT THE END OF THE MONTH USING THE COLUMNTOTALS)NDIVIDUALTRANSACTIONSAREPOSTEDTOTHESUBSIDIARYLEDGERACCOUNTS ONTHEDAYTHEYOCCUR s 4HE"ANKACCOUNTISONEOFONLYTWOLEDGERACCOUNTSINWHICHTHECROSS REFERENCES ARENOTTHENAMESOFOTHERLEDGERACCOUNTS/NTHEDEBITSIDECash ReceiptsAND ONTHECREDITSIDECash Payments s 3ETTLEMENT DISCOUNTS ENCOURAGE CREDIT CUSTOMERS TO PAY EARLY BY REDUCING THE AMOUNT PAYABLE $ISCOUNTS OFFERED BY SUPPLIERSCREDITORS ARE KNOWN AS DISCOUNT REVENUESDISCOUNTSOFFEREDTOCUSTOMERSDEBTORSAREKNOWNASDISCOUNTEXPENSES s )NTHE#ASH0AYMENTS*OURNAL THE#REDITORS#ONTROLCOLUMNSHOWSTHETOTALAMOUNT BY WHICH CREDITORS WILL DECREASE THE CASH PAID TO THE CREDITOR plus THE DISCOUNT REVENUE s )NTHE#ASH2ECEIPTS*OURNAL THE$EBTORS#ONTROLCOLUMNSHOWSTHETOTALAMOUNT BYWHICHDEBTORSWILLDECREASETHECASHRECEIVEDFROMTHEDEBTORplusTHEDISCOUNT EXPENSE

Transaction Document

Journal

#REDIT PURCHASES OFSTOCK

0URCHASES $23TOCK#ONTROL *OURNAL $2'34#LEARING #2#REDITORS#ONTROL

0URCHASE INVOICE

General Ledger

Subsidiary ledger #2)NDIVIDUALCREDITORS ACCOUNTS

$2$EBTORS#ONTROL #23ALES #2'34#LEARING AND $2#OSTOF3ALES#0 #23TOCK#ONTROL#0

$2)NDIVIDUALDEBTORS ACCOUNTS

#ASHPAID

#HEQUEBUTT #ASH $2!LL5SESOF#ASH 0AYMENTS #2"ANK *OURNAL #2$ISCOUNT2EVENUE

$2)NDIVIDUALCREDITORS ACCOUNTS

#ASH RECEIVED

#ASHRECEIPT #ASH 2ECEIPTS *OURNAL

#REDITSALES 3ALESINVOICE 3ALES OFSTOCK *OURNAL

#2)NDIVIDUALDEBTORS $2"ANK $2$ISCOUNT%XPENSE ACCOUNTS #2!LL3OURCESOF#ASH AND $2#OSTOF3ALES#0 #23TOCK#ONTROL#0

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CHAPTER 6

SPECIAL JOURNALS 2: CASH JOURNALS

EXERCISE 6.1 RECORDING IN THE CASH PAYMENTS JOURNAL

W B

page 86

131

EXERCISES

'ABBY IS THE OWNER OF 'ABBYS #OMPUTERS WHICH HAD THE FOLLOWING BALANCES IN ITS LEDGERACCOUNTSASAT-ARCH Bank GST Clearing Stock Control Creditors Control – Mother Boards – Acep Parts

$

1 500 800 1 000 3 630 2 200 1 430

CR

'ABBYPROVIDEDTHEFOLLOWINGLISTOFTRANSACTIONSFOR-ARCH March 1 5 8 12 15 23 29 30

Paid wages of assistant – $750 (Ch. 176) Purchase of stock for $1 650 including $150 GST (Ch. 177) Paid creditor – Mother Boards $2 000 (Ch. 178) Paid $400 for electricity plus GST of $40 (Ch. 179) Paid wages of assistant – $750 (Ch. 180) Purchase of stock for $1 700 plus GST (Ch. 181) Gabby withdrew $700 cash for personal use (Ch. 182) Paid Acep Parts $500 off amount owing (Ch. 183)

Required

*

a ExplainONEBENElTOFRECORDINGTRANSACTIONSINSPECIALJOURNALS b RecordTHETRANSACTIONSFOR-ARCHINTHE#ASH0AYMENTS*OURNALOF'ABBYS #OMPUTERSTotalTHEJOURNAL c ShowTHEDEBITSANDCREDITSNECESSARYTOPOSTTHE#ASH0AYMENTS*OURNALTOTHE 'ENERAL,EDGEROF'ABBYS#OMPUTERS d PostTHE#ASH0AYMENTS*OURNALTOTHE'ENERAL,EDGEROF'ABBYS#OMPUTERS e PostTHE#ASH0AYMENTS*OURNALTOTHE#REDITORS,EDGEROF'ABBYS#OMPUTERS f ExplainHOWTHEHEADINGSOFTHECLASSIlCATIONCOLUMNSINTHE#ASH0AYMENTS*OURNAL AREDETERMINED

EXERCISE 6.2 POSTING THE CASH PAYMENTS JOURNAL

W B

page 89

!LEX-C+INNONOWNS-ANCHESTER5NION ABUSINESSSELLINGSHEETSANDOTHERMANCHESTER 4HEBUSINESSHADTHEFOLLOWINGBALANCESINITSLEDGERACCOUNTSASAT*ANUARY Bank GST Clearing Stock Control Creditors Control – Irish Linen – Sherman Sheets Shelving

$ 5 000 650 1 000 3 520 2 420 1 100 29 000

CR

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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CAMBRIDGE VCE ACCOUNTING

132

UNITS 3&4

!LEXHASPROVIDEDTHEFOLLOWINGJOURNALSFOR*ANUARY Cash Payments Journal Date

Cheque number

Bank

Drawings

501

800

Sherman Sheets

502

1 100

7

Shelving

503

3 960

9

Irish Linen

504

700

Wages

505

500

Jan. 18

Irish Linen

506

600

Jan. 24

Advertising

507

440

Jan. 27

Wages

508

500

Jan. 1 J5

13

Details

Totals

Creditors Control

Wages

Drawings

Sundries

GST

3 600

360

400

40

4 000

400

800 1 100

700 500 600

500

8 600

2 400

1 000

800

Purchases Journal Date Jan. 6

Creditor

Invoice number

Stock Control

GST

Creditors Control

Sherman Sheets

158

2 400

240

2 640

Jan. 12

Irish Linen

A206

2 300

230

2 530

Jan. 23

Sherman Sheets

163

3 000

300

3 300

7 700

770

8 470

Totals

Required

* *

a ExplainWHYTHE#ASH0AYMENTS*OURNALHASA3UNDRIESCOLUMN BUTTHE0URCHASES *OURNALDOESNOT b PostTHEJOURNALSTOTHE'ENERAL,EDGERAND#REDITORS,EDGEROF-ANCHESTER5NION c ExplainTHEEFFECTOF'34PAIDONTHEBALANCEOFTHE'34#LEARINGACCOUNT d BalanceTHE#REDITORS#ONTROLACCOUNTASAT*ANUARY e FootTHEACCOUNTSINTHE#REDITORS,EDGERANDprepareA#REDITORS3CHEDULEASAT *ANUARY f StateTWOBENElTSOFUSINGASYSTEMOFCONTROLACCOUNTSANDSUBSIDIARYLEDGERS

EXERCISE 6.3 RECORDING IN THE CASH RECEIPTS JOURNAL

W B

page 92

'ARY0ECKSISTHEOWNEROF'ARYS'YM%QUIPMENT WHICHHADTHEFOLLOWINGBALANCESIN ITSLEDGERACCOUNTSASAT-AY Bank GST Clearing Stock Control Debtors Control – Braun Co. – Power Station

$

900 350 4 600 2 990 1 650 1 340

CR CR

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CHAPTER 6

SPECIAL JOURNALS 2: CASH JOURNALS

'ARYPROVIDEDTHEFOLLOWINGLISTOFTRANSACTIONSFOR-AY May

3 5 9 15 24 28

Cash sales of $3 000 (cost price $2 000) plus $300 GST (Rec. 207) Received balance owing from debtor – Braun Co. (Rec. 208) Cash sales $1 980, including $180 GST; cost price $1 200 (Rec. 209) Bank statement indicated $15 interest received (BS) Received $500 owing from Power Station (Rec. 210) Cash sales $2 400 plus GST (Rec. 211)

Required

*

a ExplainWHYTHEINTERESTRECEIVEDON-AYSHOWS@"3INSTEADOFARECEIPT NUMBER b RecordTHETRANSACTIONSFOR-AYINTHE#ASH2ECEIPTS*OURNALOF'ARYS'YM %QUIPMENT TotalTHEJOURNAL c ShowTHEDEBITANDCREDITENTRIESREQUIREDTOPOSTTHE#ASH2ECEIPTS*OURNALTOTHE 'ENERAL,EDGEROF'ARYS'YM%QUIPMENT d PostTHE#ASH2ECEIPTS*OURNALTOTHE'ENERAL,EDGEROF'ARYS'YM%QUIPMENT e PostTHE#ASH2ECEIPTS*OURNALTOTHE$EBTORS,EDGEROF'ARYS'YM%QUIPMENT

EXERCISE 6.4 POSTING THE CASH RECEIPTS JOURNAL

W B

page 95

-ELANIE 7ONG IS THE OWNER OF #ENTRAL 3UPPLIERS WHICH IS RESPONSIBLE FOR SUPPLYING TOILETRIESTOANUMBEROFSMALLHOTELS!SAT3EPTEMBER THEBUSINESSHADTHE FOLLOWINGBALANCESINITSLEDGERACCOUNTS Bank GST Clearing Capital Stock Control Debtors Control – Wincup Hotels – Lloyds Inns

$

1 600 150 40 000 12 100 3 500 2 000 1 500

CR

-ELANIEHASPROVIDEDTHEFOLLOWINGJOURNALSFOR3EPTEMBER Cash Receipts Journal Date

Details

Receipt number

Bank

Sept. 3

Wincup Hotels

71

500

Sept. 5

Cash Sales

72

660

Sept. 10

Lloyds Inns

73

2 000

Sept. 20

Capital

74

500

Sept. 22

Cash Sales

75

990

Sept. 25

Lloyds Inns

76

3 000

Sept. 29

Cash Sales

77

1 320

Totals

8 970

Debtors Control

Cost of Sales

Sales

Sundries GST

500 400

600

60

2 000 500 600

900

90

800

1 200

120

1 800

2 700

3 000

5 500

500

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

270

Cambridge University Press

133

CAMBRIDGE VCE ACCOUNTING

134

UNITS 3&4

Sales Journal Date

Debtor

Invoice number

Cost of Sales

Sales

GST

Debtors Control

Sept. 2

Lloyds Inns

36

1 500

2 250

225

2 475

Sept. 9

Wincup Hotels

37

1 800

2 700

270

2 970

Sept. 16

Both Worlds Hotel

38

900

1 350

135

1 485

Sept. 23

Lloyds Inns

39

1 200

1 800

180

1 980

5 400

8 100

810

8 910

Totals

Required

* *

a ExplainTHEDOUBLE CHECKINGMECHANISMCONTAINEDINTHE#ASH2ECEIPTS*OURNAL b Post THE #ASH 2ECEIPTS *OURNAL AND 3ALES *OURNAL TO THE 'ENERAL ,EDGER AND $EBTORS,EDGEROF#ENTRAL3UPPLIERS c ExplainTHEEFFECTOF'34RECEIVEDONTHEBALANCEOFTHE'34#LEARINGACCOUNT d BalanceTHE$EBTORS#ONTROLACCOUNTASAT3EPTEMBER e Foot THE ACCOUNTS IN THE $EBTORS ,EDGER AND prepare A $EBTORS 3CHEDULE AS AT 3EPTEMBER f ExplainHOWUSINGASYSTEMOFCONTROLACCOUNTSANDSUBSIDIARYLEDGERSASSISTSINTHE PREPARATIONOFREPORTS

EXERCISE 6.5 GST CLEARING ACCOUNT

W B

page 98

4HEFOLLOWINGISASUMMARYOF'34TRANSACTIONSRECORDEDINTHEJOURNALSOF4ONYS4OWELS FOR*ULY Cash Receipts Journal:

GST received on cash sales

Cash Payments Journal:

GST settlement

$

640 1 620

GST paid on other cash payments

380

Sales Journal:

GST on credit sales

920

Purchases Journal:

GST on credit purchases

630

!SAT*ULY THE'34#LEARINGACCOUNTHADABALANCEOF#2 Required

*

a Explain WHY THE '34 SETTLEMENT IS not RECORDED IN THE '34 COLUMN OF THE #ASH 0AYMENTS*OURNAL b ShowTHEEFFECTOFTHE'34SETTLEMENTONTHEACCOUNTINGEQUATIONOF4ONYS4OWELS c Prepare THE '34 #LEARING ACCOUNT IN THE 'ENERAL ,EDGER AFTER ALL JOURNALS HAVE BEENPOSTEDBalanceTHEACCOUNTAT*ULY d ExplainHOWTHE'34#LEARINGACCOUNTWOULDBEREPORTEDINTHE"ALANCE3HEETOF 4ONYS4OWELSASAT*ULY e ExplainWHYITISMORELIKELYTHATABUSINESSWILLENDUPWITHACREDITBALANCEINITS '34#LEARINGACCOUNT

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CHAPTER 6

SPECIAL JOURNALS 2: CASH JOURNALS

EXERCISE 6.6 GST CLEARING ACCOUNT

W B

page 99

4HE FOLLOWING IS A SUMMARY OF '34 TRANSACTIONS RECORDED IN THE JOURNALS OF #ONCEPT 0APER3ALESFOR/CTOBER Cash Receipts Journal:

GST received on cash sales

$

800

GST refund

200

Cash Payments Journal:

GST paid on other cash payments

420

Sales Journal:

GST charged to debtors

650

Purchases Journal:

GST charged by creditors

370

!SAT3EPTEMBER THE'34#LEARINGACCOUNTHADABALANCEOF$2 Required

*

a ExplainHOWTHE'34#LEARINGACCOUNTWOULDBEREPORTEDINTHE"ALANCE3HEETOF #ONCEPT0APER3ALESASAT3EPTEMBER b SuggestONEREASONWHY#ONCEPT0APER3ALESHADMORE'34ONITSPURCHASESTHAN '34ONITSSALESINTHEQUARTERENDING3EPTEMBER c ShowHOWTHE'34REFUNDWOULDHAVEBEENRECORDEDINTHE#ASH2ECEIPTS*OURNAL OF#ONCEPT0APER3ALES d ExplainTHEEFFECTOFTHE'34REFUNDONTHE"ALANCE3HEETOF#ONCEPT0APER3ALES e PrepareTHE'34#LEARINGACCOUNTAFTERALLJOURNALSHAVEBEENPOSTEDBalanceTHE ACCOUNTAT/CTOBER

EXERCISE 6.7 RECORDING IN THE CASH PAYMENTS JOURNAL (DISCOUNTS)

W B

page 100

$IANA!DAMSISTHEOWNEROF$IANAS*EWELLERY WHICHHADTHEFOLLOWINGBALANCESINITS LEDGERACCOUNTSASAT&EBRUARY Bank

$ 12 900

GST Clearing

1 700

Stock Control

74 500

Creditors Control

15 950

– Beads and Stones

8 800

– Carter Diamonds

7 150

CR

4HE0URCHASES*OURNALFOR&EBRUARYSHOWEDTHEFOLLOWING Purchases Journal Date

Creditor

Feb. 4

Precious Inc.

Feb. 9

Invoice number

Stock Control

GST

Creditors Control

1702

5 100

510

5 610

Beads and Stones

65

4 000

400

4 400

Feb. 17

Carter Diamonds

c311

6 000

600

6 600

Feb. 22

Beads and Stones

78

7 200

720

7 920

Feb. 28

Carter Diamonds

c346

4 200

420

4 620

26 500

2 650

29 150

Totals

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

135

CAMBRIDGE VCE ACCOUNTING

136

UNITS 3&4

$IANAHASPROVIDEDTHEFOLLOWINGLISTOFCASHPAYMENTSFOR&EBRUARY Feb.

1 3 4 7 10 14 15 20 23 24 27

Paid GST owing to ATO $1 700 Paid Beads and Stones balance outstanding from January, less 5% discount Cash purchase of additional display cabinets for $16 500 including GST Paid Carter Diamonds full amount owing Paid for rent for Feb. – July 2015: $2 400 plus GST Paid wages $1 200 Paid Beads and Stones for Inv. 65 (after 5% discount on invoice price) Paid electricity bill of $110 including GST Paid Carter Diamonds $6 072 for Inv. C311 after receiving 8% discount Cash drawings $1 000 Paid wages $1 250

4HELASTCHEQUEWRITTENIN*ANUARYWASCHEQUENUMBER Required

*

* *

a RecordTHETRANSACTIONSFOR&EBRUARYINTHE#ASH0AYMENTS*OURNALOF$IANAS *EWELLERY b PostTHEJOURNALSTOTHE'ENERAL,EDGEROF$IANAS*EWELLERY c PostTHEJOURNALSTOTHE#REDITORS,EDGEROF$IANAS*EWELLERY d BalanceTHE#REDITORS#ONTROLACCOUNTASAT&EBRUARY e FootTHEACCOUNTSINTHE#REDITORS,EDGERANDprepareA#REDITORS3CHEDULEASAT &EBRUARY f StateTHEEFFECTOFTHECASHPAYMENTON&EBRUARYONTHEACCOUNTINGEQUATION OF$IANAS*EWELLERY

EXERCISE 6.8 POSTING THE CASH PAYMENTS JOURNAL (DISCOUNTS)

W B

page 104

0ETER /HM OWNS AND OPERATES A SMALL TRADING BUSINESS CALLED 3HOCK %LECTRICS /N *UNE THEBUSINESSHADTHEFOLLOWINGBALANCESINITSLEDGERACCOUNTS Bank GST Clearing Stock Control Creditors Control – Sparkwell – Electron – General PC

$ 2 075 300 10 600 25 500 5 700 15 000 4 800

CR

ISBN 978-1-107-64070-2 © Anthony SImmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CHAPTER 6

SPECIAL JOURNALS 2: CASH JOURNALS

4HEJOURNALSFOR*UNESHOWEDTHEFOLLOWING Cash Payments Journal Date

Details

Cheque number

Bank

*UNE

3PARKWELL





*UNE

$RAWINGS





*UNE

'ENERAL0#





*UNE

7AGES





*UNE

!DVERTISING





*UNE

3PARKWELL





*UNE

7AGES





*UNE

%LECTRON





Totals

Discount Creditors Wages Revenue Control

29 526



Sundries

GST

 



 







1 900

100

  

1 224

24 100

4 650

Purchases Journal Date

Creditor

Invoice number

*UNE

%LECTRON









*UNE

3PARKWELL

!







*UNE

'ENERAL0#

C







11 400

1 140

12 540

Totals

Stock Control

GST

Creditors Control

Required

* *

a b c d

CalculateTHEPERCENTAGEDISCOUNTOFFEREDBY3PARKWELL PostTHEJOURNALSTOTHE'ENERAL,EDGERAND#REDITORS,EDGEROF3HOCK%LECTRICS BalanceTHE#REDITORS#ONTROLACCOUNTASAT*UNE FootTHEACCOUNTSINTHE#REDITORS,EDGERANDprepareA#REDITORS3CHEDULEASAT *UNE e ExplainWHYTHEDISCOUNTRECEIVEDFROMCREDITORSISCLASSIlEDASREVENUE f Explain ONE CONTROL PROCEDURE 3HOCK %LECTRICS SHOULD USE TO DETECT ERRORS IN THE #REDITORS,EDGER

EXERCISE 6.9 RECORDING IN THE CASH RECEIPTS JOURNAL (DISCOUNTS)

W B

page 107

3PORTS"ONANZAISOWNEDBY*OE,ITTLE ANDON$ECEMBER THEBUSINESSHADTHE FOLLOWINGBALANCESINITSLEDGERACCOUNTS Bank Capital Stock Control Debtors Control – Emerald CC – St Carls PS GST Clearing

$

500 30 000 14 000 2 420 1 320 1 100 70

CR

DR

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137

CAMBRIDGE VCE ACCOUNTING

138

UNITS 3&4

4HE3ALES*OURNALFOR$ECEMBERSHOWEDTHEFOLLOWING Sales Journal Date

Debtor

Invoice number

Dec. 7

St Carls PS

904

Dec. 15

Emerald CC

Dec. 19 Dec. 22

Cost of Sales

Sales

GST

Debtors Control

800

1 300

130

1 430

905

450

750

75

825

East Bunbury SC

906

700

1 000

100

1 100

St Carls PS

907

550

900

90

990

2 500

3 950

395

4 345

Totals

*OEHASPROVIDEDTHEFOLLOWINGLISTOFTRANSACTIONSFOR$ECEMBER Dec.

1 3 6 9 10 13 18 21 24

Cash sales $132 including GST (cost price $95) Received amount outstanding from Emerald CC, after discount of 10% Received GST refund from ATO $70 Received $1 100 from debtor – St Carls PS Goods with a cost price of $120 sold for $200 plus GST Received $1 287 from St Carls PS; 10% discount given on Inv. 904 Cash sales of $400 plus GST (cost price $290) Joe Little contributed $5 000 cash East Bunbury SC paid for Inv. 906; 10% discount on invoice price

4HELASTRECEIPTISSUEDIN.OVEMBERWASNO Required

*

* *

a RecordTHETRANSACTIONSFOR$ECEMBERINTHE#ASH2ECEIPTS*OURNALOF3PORTS "ONANZA b PostTHEJOURNALSTOTHE'ENERAL,EDGEROF3PORTS"ONANZA c PostTHEJOURNALSTOTHE$EBTORS,EDGEROF3PORTS"ONANZA d BalanceTHEDEBTORSCONTROLACCOUNTASAT$ECEMBER e FootTHEACCOUNTSINTHE$EBTORS,EDGERANDprepareA$EBTORS3CHEDULEASAT $ECEMBER f StateTWOBENElTSOFOFFERINGDISCOUNTSTODEBTORS g ExplainWHYNO'34ISATTACHEDTOTHETRANSACTIONON$ECEMBER h StateTHEEFFECTOFTHETRANSACTIONON$ECEMBERONTHEACCOUNTINGEQUATION OF3PORTS"ONANZA

EXERCISE 6.10 POSTING THE CASH RECEIPTS JOURNAL (DISCOUNTS)

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page 111

-AX0OWERSOPERATESALAMPSHOPCALLED-OJO,TD WHICHSPECIALISESINTHESALEOFLAVA LAMPS/N!PRIL ITSLEDGERACCOUNTSSHOWEDTHEFOLLOWINGBALANCES GST Clearing Stock Control Debtors Control – Far Out Lights – Liquid Lamps Bank Capital

$

190 11 300 3 300 1 100 2 200 2 650 23 000

CR

DR

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CHAPTER 6

SPECIAL JOURNALS 2: CASH JOURNALS

139

4HEJOURNALSFOR!PRILSHOWEDTHEFOLLOWING Cash Receipts Journal Date

Details

Receipt Bank number

Discount Debtors Cost of Expense Control Sales

Sundries

GST

April 1 Far Out Lights

771

1 050

Apr. 5 Cash Sales

772

660

300

600

60

Apr. 8 Cash Sales

773

495

225

450

45

774

2 100

100

2 200

775

1 680

80

1 760

. 20 Capital contribution

776

500

. 22 Cash Sales

777

935

. 25 Liquid Lamps

778

3 150

. 29 Cash Sales

779

1 320

. 10 Liquid Lamps Apr. 17 Far Out Lights

Totals

50

Sales

1 100

500

150

11 890

380

425

850

85

600

1 200

120

1 550

3 100

3 300

8 360

500

310

Sales Journal Date

Debtor

Invoice number

Cost of Sales

April 4

Far Out Lights

63

800

1 600

160

1 760

Apr. 8

Liquid Lamps

64

1 000

2 000

200

2 200

Apr. 15

Liquid Lamps

65

1 500

3 000

300

3 300

Apr. 21

Far Out Lights

66

700

1 400

140

1 540

Apr. 28

Liquid Lamps

67

900

1 800

180

1 980

4 900

9 800

980

10 780

Totals

Sales

GST

Debtors Control

Required

* *

a StateONEREASONWHYTHETOTALOFTHE$EBTORS#ONTROLCOLUMNDOESnotREPRESENT THECASHRECEIVEDFROMDEBTORSDURING!PRIL b PostTHEJOURNALSTOTHE'ENERAL,EDGERANDA$EBTORS,EDGEROF-OJO,TD c BalanceTHE$EBTORS#ONTROLACCOUNTASAT!PRIL d Foot THE ACCOUNTS IN THE $EBTORS ,EDGER AND prepare A $EBTORS 3CHEDULE AS AT !PRIL e ExplainWHYTHEDISCOUNTGRANTEDTODEBTORSISCLASSIlEDASANEXPENSE

EXERCISE 6.11 POSTING SPECIAL JOURNALS

W B

page 114

+IT2EIDISTHEOWNEROF"OOK7ORMS ASHOPTHATSELLSRAREANDANTIQUEBOOKS)TS4RIAL "ALANCEASAT*ULYSHOWEDTHEFOLLOWING

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

Account

Debit

Bank

Credit

800

Debtors Control

7 000

Stock Control

3 100

Shop Fittings

23 000

Premises

190 000

GST Clearing

610

Creditors Control

9 000

Loan – VicFin

150 000

Capital – Reid

64 290

Total

$223 900

$223 900

4HEJOURNALSFOR*ULYSHOWEDTHEFOLLOWING Cash Receipts Journal Date

Details

Receipt number

Bank

Discount Debtors Cost of Expense Control Sales

Sales

#APITAL#ONTRIBUTION

Sundries GST



Totals

9 900

500

5 000 2 000 4 000

1 000

400

Sundries

GST

Cash Payments Journal Date

Details

Cheque Bank number

Discount Creditors Stock Wages Revenue Control Control

,OANn6IC&IN



)NTEREST%XPENSE



'34#LEARING



$RAWINGS Totals

 15 280

900

5 500

1 200

6 500

2 860

120

Sales Journal Date

Debtor

Totals

Invoice number

Cost of Sales 5 000

Sales

GST

Debtors Control

8 000

800

8 800

Purchases Journal Date

Creditor Totals

Invoice number

Stock Control 5 200

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GST 520

Creditors Control 5 720

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CHAPTER 6

SPECIAL JOURNALS 2: CASH JOURNALS

141

Required

* *

a PostTHEJOURNALSTOTHE'ENERAL,EDGEROF"OOK7ORMS b BalanceTHE"ANKAND'34#LEARINGACCOUNTSASAT*ULY c FootTHEOTHERLEDGERACCOUNTSANDprepareA4RIAL"ALANCEFOR"OOK7ORMSASAT *ULY d ExplainHOWTHE'34CLEARINGACCOUNTWOULDBEREPORTEDINTHE"ALANCE3HEETOF "OOK7ORMSASAT*ULY e +ITHASARGUEDTHATBECAUSEHISCAPITALCONTRIBUTIONANDDRAWINGSWEREBOTH HISCAPITALlGUREWILLNOTCHANGEExplainONEREASONWHY+ITISINCORRECT

EXERCISE 6.12 POSTING SPECIAL JOURNALS

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page 118

-ADDY-ERCURIOOWNSANDOPERATESASMALLTRADINGBUSINESSCALLED'REENDAY0LANTS SELLINGPLANTSANDGARDENORNAMENTS/N!UGUST THEBUSINESSHADTHEFOLLOWING BALANCESINITSLEDGERACCOUNTS Bank

$ 1 700

GST Clearing

640

Stock Control

5 900

Creditors Control

5 500

– Kris and Marnie’s

2 200

– Wombat Plants

3 300

Debtors Control

CR

2 860

– Glen Golf Club

2 200

– City of Yarra

660

Capital

18 000

Shelving

30 000

4HEJOURNALSFOR!UGUSTSHOWEDTHEFOLLOWING Cash Receipts Journal Date

Details

Rec. no.

Bank

Aug. 3 City of Yarra

51

600

Aug. 5 Cash Sales

52

880

53

2 100

54

2 000

55

1 100

56

1 050

57

1 650

10 Glen Golf Club . 20 Capital 22 Cash Sales Au25 Glen Golf Club 29 Cash Sales Totals

9 380

Discount Expense 60

Debtors Control

Cost of Sales

Sundries

GST

660 400

100

Sales

800

80

2 200 2 000

50

210

500

1 000

100

750

1 500

150

1 650

3 300

1 100

3 960

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2 000

330

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CAMBRIDGE VCE ACCOUNTING

142

UNITS 3&4

Cash Payments Journal Date

Details

Chq. no.

Bank

Discount Revenue

Creditors Control

Selling Expenses

Shelving

Sundries

Aug. 1

GST Clearing

900

640

640

Aug. 2

Drawings

901

1 000

1 000

Aug. 5

Wages

902

500

Aug. 9

Kris and Marnie’s

903

2 100

Interest

904

100

Aug.17

New Shelving

905

1 760

Au. 21

Advertising

906

440

Au. 25

Wombat Plants

907

3 300

13

Totals

9 840

GST

500 100

2 200 100 1 600

160

400

40

3 300 100

5 500

900

1 600

1 740

200

Sales Journal Date

Debtor

Invoice number

Cost of Sales

Sales

GST

Debtors Control

Aug. 4

City of Yarra

14

1 000

2 000

200

2 200

Aug. 8

Glen Golf Club

15

500

1 000

100

1 100

Aug. 15

Glen Golf Club

16

2 000

4 000

400

4 400

Aug. 21

City of Yarra

17

800

1 600

160

1 760

Aug. 28

Glen Golf Club

18

1 400

2 800

280

3 080

5 700

11 400

1 140

12 540

Totals

Purchases Journal Date Aug. 5

Creditor Wombat Plants

12

Kris and Marnie’s

19

Wombat Plants

26

Kris and Marnie’s Totals

Invoice number

Stock Control

GST

Creditors Control

W12

1 000

100

1 100

34

1 500

150

1 650

W29

1 300

130

1 430

40

2 000

200

2 200

5 800

580

6 380

Required

* *

a ExplainHOWRECORDINGTRANSACTIONSINSPECIALJOURNALSINCREASESTHEEFlCIENCYOFTHE ACCOUNTINGSYSTEM b StateTWOWEAKNESSESINTHEWAY-ADDYRECORDSCASHPAYMENTS c 5SINGTHEINFORMATIONASITISPROVIDED postTHEJOURNALSTOTHE'ENERAL,EDGERAND SUBSIDIARYLEDGERSOF'REENDAY0LANTS d BalanceTHE$EBTORS#ONTROLAND#REDITORS#ONTROLACCOUNTSASAT!UGUST e ExplainTHEROLEOFA$EBTORS3CHEDULE f Foot THE SUBSIDIARY LEDGERS AND prepare A $EBTORS 3CHEDULE AND A #REDITORS 3CHEDULEASAT!UGUST

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Cambridge University Press

Where are we headed? After completing this chapter, you should be able to: s explain the role of the General Journal s use the General Journal to record – commencing entries – non-cash transactions with the owner – bad debts – correcting entries s define the term ‘bad debt’

s explain the need to record and report bad debts, and their relationship to the accounting principles and qualitative characteristics s explain the effect of a bad debt on the accounting equation.

CHAPTER 7

THE GENERAL JOURNAL KEY TERMS After completing this chapter, you should be familiar with the following terms: s General Journal s narration s commencing entry s bad debt.

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7.1

UNITS 3&4

THE NEED FOR THE GENERAL JOURNAL

The great beauty of recording in special journals is that it allows us to summarise similar transactions, and then post only the totals to the General Ledger at the end of the month, reducing the number of ledger entries required. For instance, the Purchases Journal records all transactions involving the purchase of stock on credit, and the double entry for each of these transactions is exactly the same.

General Journal an accounting record used to record infrequent, non-cash transactions, which cannot be recorded in the special journals

STUDY TIP

If a transaction involves cash, it is recorded in either the Cash Receipts Journal or the Cash Payments Journal, whether or not it is infrequent.

DR

Stock Control

DR

GST Clearing

CR

Creditors Control

CR

(Each individual account in the Creditors Ledger)

The same principle applies to the Sales Journal, where each credit sale results in exactly the same entries. Even in the Cash Receipts Journal and the Cash Payments Journal, where a variety of cash transactions are recorded, all the transactions have something in common by virtue of requiring either a debit (for receipts) or credit (for payments) to Bank. There will, however, be some transactions that cannot be recorded in these special journals because they do not involve cash, and do not involve the purchase or sale of stock. For instance, what happens if the owner contributes her own vehicle for business purposes? This transaction is neither receipt nor payment, nor sale nor purchase. Transactions like this must still be recorded in a journal before they can be posted to the ledger, but they cannot be recorded in the special journals used so far. At the same time, because they are infrequent they do not justify their own special journal as there would be only one entry to summarise. Instead, they are recorded in a more general journal called, unsurprisingly, the General Journal. This General Journal is used to record infrequent, non-cash transactions, which cannot be recorded in any of the special journals.

Uses of the General Journal The main types of transactions that will be recorded in the General Journal are: s COMMENCINGENTRIES s NON CASHTRANSACTIONSWITHTHEOWNER s BADDEBTS s CORRECTINGENTRIES s USEOFSTOCKFORADVERTISINGPURPOSESCOVEREDIN#HAPTER s CLOSINGENTRIESCOVEREDIN#HAPTER s BALANCEDAYADJUSTMENTSCOVEREDIN#HAPTERSAND 

REVIEW QUESTIONS 7.1

1 Explain the role of special journals in the accounting process. 2 Explain the role of the General Journal. 3 List seven types of transactions that will be recorded in the General Journal.

7.2

FORMAT OF THE GENERAL JOURNAL

Because the General Journal is used to record a variety of transactions, it must have a fairly simple format. As a result, it has columns for date and details just like a special journal, but no classification columns; it simply has a debit column and a credit column to record amounts. This probably makes it easier to record in the General Journal than ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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CHAPTER 7

145

THE GENERAL JOURNAL

in the special journals, and easier to post the General Journal to the ledger. The basic FORMATOFTHE'ENERAL*OURNALISSHOWNIN&IGURE Figure 7.1 Format of the General Journal General Ledger Date

Details

Debit

Credit

Subsidiary Ledger Debit

Credit

The most obvious and immediate thing to notice is how closely the General Journal resembles the analysing charts we used when learning the ledger process (in Chapter 2). Basically, transactions are recorded in date order (as they occur), with the Details column used to record the name of each ledger account affected by the transaction. Then the amount is simply recorded in the debit or credit column as is necessary. The key thing to remember about the debit and credit columns in the General Journal is that, like all transactions, the debits must equal the credits. If the transaction does not balance in the General Journal, it cannot balance when it is posted to the ledger accounts. Transactions affecting General Ledger accounts are recorded in the debit and credit columns under the heading ‘General Ledger’. The debit and credit columns under the ‘subsidiary ledger’ heading are only used when a subsidiary debtor or creditor account is affected. (This will be covered in more detail later in this chapter.)

Narrations When transactions are recorded in special journals, there is no need to provide a written description of what has occurred because not only are all of a similar nature, but also they are described by the title of the journal in which they are recorded. For instance, the Sales Journal records credit sales, and the Cash Receipts Journal records cash receipts. However, because the General Journal records a wide variety of transactions, it is necessary to give a brief description of the transaction immediately after recording the debit and credit entries. This description is known as a narration. The narration should ‘tell the story’ of what has happened, and also note the source document involved.

REVIEW QUESTIONS 7.2

1 Explain why there are no classification columns in the General Journal. 2 Explain how the rules of double-entry accounting apply to the General Journal. 3 In relation to the General Journal, define the term ‘narration’. 4 Explain why narrations are necessary in the General Journal, but not in the special journals.

7.3

narration a brief description of a transaction recorded in the General Journal, including a reference to the relevant source document

COMMENCING ENTRIES

The first time the General Journal is likely to be used is when the double-entry recording system is established. This is known variously as an establishing, opening or commencing entry. The purpose of a commencing entry is to open or establish ledger accounts for any existing asset, liability and owner’s equity items. This may be when the business is just starting and the owner is contributing starting capital, or when the business has been operating for some time already, and the owner decides to switch from singleentry accounting to double-entry records. ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

commencing entry a General Journal entry to establish double-entry records by entering existing asset, liability and owner’s equity balances in the ledger account

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UNITS 3&4

EXAMPLE G. Petto is the owner of Toy Bonanza, a toyshop that has been running for three years using a single-entry recording system. On 1 July 2015, he decided to adopt a double-entry recording system (Memo 1). The assets and liabilities of the business at 1 July 2015 were: Assets

$

Bank Stock Control Vehicle

Liabilities

1 400 37 000 22 000

$

Loan GQC Finance GST Clearing

15 600 300

The General Journal entry to record the commencement of double-entry records is shown in Figure 7.2. Figure 7.2 General Journal: simple commencing entry General Journal General Ledger

STUDY TIP

Date

Details

July 1

Bank

Debit

Debit

Credit

1 400

Stock Control

37 000

Vehicle

22 000 Loan GQC Finance

Use the accounting equation (assets = liabilities + owner’s equity) to calculate the capital figure

Credit

Subsidiary ledger

GST Clearing Capital – G. Petto

15 600 300 44 500

Commencement of double-entry records (Memo 1)

By convention, the debit entries are recorded first, followed by the credit entries, with the accounts to be credited indented slightly. The three asset accounts – Bank, Stock Control and Vehicle – require a debit balance, while the liability accounts – Loan GQC Finance and GST Clearing – require a credit balance. But on their own, these five entries do not comprise a complete entry, because THEDEBITENTRIES DONOTMATCHTHECREDITENTRIES AFURTHERCREDITOF ) is required. This balancing amount becomes the owner’s Capital. As noted previously, the narration provides a brief description of the transaction, which in this case is the Commencement of double-entry records. It also identifies the source document that verifies the transaction: -EMO. This General Journal entry would be posted to the General Ledger accounts as shown opposite.

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CHAPTER 7

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THE GENERAL JOURNAL

General Ledger Bank (A) Date

Cross-reference

July 1

Balance

Amount $

Date

Cross-reference

Amount $

Cross-reference

Amount $

Cross-reference

Amount $

1 400 Stock Control (A)

Date

Cross-reference

July 1

Balance

Amount $

Date

37 000 Vehicle (A)

Date

Cross-reference

July 1

Balance

Amount $

Date

22 000 Loan GQC Finance (L)

Date

Cross-reference

Amount $

Date

Cross-reference

July 1

Balance

Amount $ 15 600

GST Clearing (A/L) Date

Cross-reference

Amount $

Date

Cross-reference

July 1

Balance

Amount $ 300

Capital – G. Petto (OE) Date

Cross-reference

Amount $

Date

Cross-reference

July 1

Balance

Amount $ 44 500

Commencing entries and subsidiary ledger accounts The basic principles of opening entries apply to all types of businesses, but for businesses using control accounts for creditors and debtors, a little more information is required. The balances of all existing asset, liability and owner’s equity accounts must still be entered in the General Ledger, but all individual debtor and creditor balances must also be entered in the subsidiary ledger accounts, and this must be recorded in the commencing entry in the General Journal.

On 1 August 2015, Harry Norman decided to establish a double-entry recording system for his business, Couch World (Memo 1). The firm already had the following assets and liabilities: Assets Bank Stock Control Debtors – A. Smietenko – S. Grant Shop Fittings

$ 4 200 54 000 2 300 3 500 32 000

Liabilities Creditors – Pine Products – Suede Effects – Steel Frame Co. Loan – Bank of Cicely GST Clearing

EXAMPLE

$ 1 300 4 100 2 900 40 000 500

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UNITS 3&4

The General Journal entry to record the commencement of the double-entry records is shown in Figure 7.3. Figure 7.3 General Journal: opening entry (including subsidiary ledger accounts) General Journal General Ledger

Subsidiary ledger Debit

Date

Details

Debit

Aug. 1

Bank

4 200

Stock Control

Credit

Credit

54 000

Debtors Control

5 800

Debtor – A. Smietenko

2 300

Debtor – S. Grant

3 500

Shop fittings

32 000

Creditors Control

8 300

Creditor – Pine Products

1 300

Creditor – Suede Effects

4 100

Creditor – Steel Frame Co.

2 900

Loan – Bank of Cicely

40 000

GST Clearing

500

Capital – Norman

47 200

Commencement of double-entry records (Memo 1)

Note how the double-entry process is preserved in the General Ledger columns (and thus in the General Ledger accounts) with the total debits matching the total credits. The total amount owed by debtors ) is recorded as the opening balance in the Debtors Control account, and the total amount owed to creditors () is recorded as the opening balance in the Creditors Control account. In addition, the accounting equation has been used to determine the amount of Capital (). However, in the subsidiary ledgers, the double-entry process is suspended; only the entry that affects the individual debtor or creditor is recorded. Thus, the entries in the subsidiary ledger columns of the General Journal do not have to be a matching double entry. The opening balances owed by the two individual debtors – A. Smietenko  and 3'RANT – are entered under the subsidiary ledger heading on the debit side, just as they would appear in the Debtors Ledger, while the amounts owed by the three creditors – 0INE0RODUCTS, 3UEDE%FFECTS and Steel Frame #O – are entered on the credit side, just as they would appear in the Creditors Ledger. The Debtors Control account would appear in the General Ledger as: General Ledger Debtors Control (A) Date

Cross-reference

Aug. 1

Balance

Amount $

Date

Cross-reference

Amount $

5 800

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CHAPTER 7

THE GENERAL JOURNAL

The individual debtor accounts would appear in the Debtors Ledger as: Debtors Ledger A. Smietenko (A) Date

Cross-reference

Aug. 1

Balance

Amount $

Date

Cross-reference

Amount $

Cross-reference

Amount $

2 300 S. Grant (A)

Date

Cross-reference

Aug. 1

Balance

Amount $

Date

3 500

Similarly, the Creditors Control account would appear in the General Ledger as: General Ledger Creditors’ Control (L) Date

Cross-reference

Amount $

Date

Cross-reference

Aug. 1

Balance

Amount $ 8 300

The individual creditor accounts would appear in the Creditors Ledger as shown: Creditors Ledger Pine Products (L) Date

Cross-reference

Amount $

Date

Cross-reference

Aug. 1

Balance

Amount $ 1 300

Suede Effects (L) Date

Cross-reference

Amount $

Date

Cross-reference

Aug. 1

Balance

Amount $ 4 100

Steel Frame Co. (L) Date

Cross-reference

Amount $

Date

Cross-reference

Aug. 1

Balance

Amount $ 2 900

REVIEW QUESTIONS 7.3

1 Define the term ‘commencing entry’. 2 State two reasons why a commencing entry may be necessary. 3 In reference to a commencing entry, explain how the entry to the Capital account is determined.

7.4

NON-CASH TRANSACTIONS WITH THE OWNER

Because the owner and business are assumed to be separate entities, transactions between the two must be recorded in the firm’s accounting records. Cash drawings will be recorded in the Cash Payments Journal and capital contributions of cash will be recorded in the Cash Receipts Journal, but drawings or capital contributions of other non-cash items (such as stock or equipment) will need to be recorded in the General Journal.

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149

150

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

Drawings of stock

EXAMPLE

On 16 July 2015, the owner withdrew $300 worth of stock (Memo 13).

4HISTRANSACTIONWOULDBERECORDEDINTHEJOURNALASSHOWNIN&IGURE Figure 7.4 General Journal: non-cash drawings General Journal General Ledger Date July 16

Details

Debit

Drawings

Credit

Subsidiary ledger Debit

Credit

300

Stock Control

300

Owner withdrew stock for personal use (Memo 13)

Ideally, a narration for drawings of this type would not just refer to ‘stock’, but rather would name the stock item (and/or its stock code) and the quantity withdrawn. However, as this information is unavailable in this example, a more general description will suffice. This entry would be posted to the General Ledger accounts as shown below. General Ledger Drawings (– OE) Date July 31

Cross-reference

Amount

Stock Control

Date

Cross-reference

Amount

Cross-reference

Amount

300 Stock Control (A)

STUDY TIP

The only dates you should see in the General Ledger are the start and the end of the month.

Date

Cross-reference

July 1

Balance

Amount

Date

32 000

July 31

Drawings

300

4HE TRANSACTION WAS RECORDED IN THE 'ENERAL *OURNAL ON  *ULY  THE DAY IT OCCURRED BUTISNOTPOSTEDTOTHE'ENERAL,EDGERUNTIL*ULY WHICHISTHEEND of the month. Although there are no totals to post, even the General Journal is posted to the General Ledger only at the end of the month. The General Journal is posted to the General Ledger at the end of the month.

Non-cash capital contributions Whereas assets withdrawn by the owner are debited to a separate Drawings account, assets that are contributed by the owner are credited straight to the Capital account.

EXAMPLE

On 23 July 2015, the owner contributed to the business her own vehicle, which had an agreed value of $23 000 (Memo 16).

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THE GENERAL JOURNAL

Remember that although the business and the owner are separate accounting entities, they are, in fact, the same person, so there can be no actual ‘sale’ of this vehicle by the owner to the business. As a result, the value of the asset cannot be identified by reference to a sales invoice or receipt. At the same time, the asset must be valued at the time it is acquired by the business, so its agreed value (of ) is used, and VERIlEDBYTHE-EMO4HISAGREEDVALUEBECOMESTHEHISTORICALCOSTTOBEUSEDBY the business. 4HISTRANSACTIONWOULDBERECORDEDINTHEJOURNALASSHOWNIN&IGURE Figure 7.5 General Journal: non-cash capital contributions General Journal General Ledger Date

Details

Debit

July 23

Vehicles

23 000

Capital

Subsidiary ledger

Credit

Debit

Credit

23 000

Owner contributed vehicle for business use – agreed value (Memo 16)

This entry would be posted to the General Ledger accounts as shown below. General Ledger Capital (OE) Date

Cross-reference

Amount $

Date

Cross-reference

Amount $

July 1

Balance

40 000

31

Vehicles

23 000

Vehicles (A) Date

Cross-reference

July 1

Balance

30 000

Capital

23 000

31

Amount $

Date

Cross-reference

Amount $

REVIEW QUESTIONS 7.4

1 2 3 4

Explain why drawings of stock must be recorded in the General Journal. Show the General Journal entries necessary to record drawings of stock. Show the effect of drawings on the accounting equation. Show the General Journal entries necessary to record a capital contribution of a vehicle. 5 Show the effect of a capital contribution on the accounting equation.

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CAMBRIDGE VCE ACCOUNTING

7.5

bad debt an expense incurred when a debt is written off because it is deemed to be irrecoverable

UNITS 3&4

BAD DEBTS

Unfortunately for small business owners, not all debtors can be counted on to repay the amounts they owe, and occasionally a debt may need to be written off as ‘bad’. According to the Conservatism principle, a bad debt should be recognised as an expense when the loss is probable, so that assets (in this case, Debtors Control) are not overstated. This will usually be when the debtor is in liquidation or has been declared bankrupt and the debt is deemed to be irrecoverable. Recognising a bad debt will ensure the reports contain all the information that is useful for decision-making – such as bad debts in the Income Statement and an updated amount for Debtors Control in the Balance Sheet. This ensures Relevance.

Not all debtors can be counted on to repay the amounts they owe, and occasionally a debt may need to be written off as ‘bad’

A bad debt is a good example of how an expense does not have to involve a cash payment. If a bad debt is incurred, the business will need to recognise an expense for the loss of an economic benefit in the form of a decrease in assets (Debtors Control), which decreases owner’s equity. At the same time as it records this expense, the business must record the decrease in Debtors Control (in the General Ledger) and the account of the individual debtor (in the Debtors Ledger).

EXAMPLE

On 16 March 2015, the business was informed that a debtor (A. Micari) was bankrupt, and of the $400 owed by Micari, only $40 would be received (Memo 41).

The  cash received from the debtor would be recorded in the Cash Receipts Journal in the usual way, but the remaining  would be written off in the General Journal as shown in Figure 7.6.

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CHAPTER 7

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Figure 7.6 General Journal: bad debt General Journal General Ledger Date March 16

Details

Debit

Bad debts

Subsidiary ledger

Credit

Debit

Credit

360

Debtors Control

360

Debtor – A. Micari

360

Debt written off as irrecoverable (Memo 41)

Note how the double entry is preserved in the General Ledger columns, but in the subsidiary ledger columns, a single entry – to the individual account of A. Micari – is necessary. The entry would be posted to the General Ledger as is shown in Figure 7.7. Figure 7.7 General Ledger: posting a bad debt General Ledger Bad Debts (E) Date

Cross-reference

Mar. 31

Debtors Control

Amount $

Date

Cross-reference

Amount $

Cross-reference

Amount $

360

Debtors Control (A) Date

Cross-reference

Mar. 1

Balance

Amount $ 8 000

Date Mar. 31 31

Bank/Discount Exp.

3 000

Bad Debts

360

Note that the  cash received would have been recorded in the ‘Debtors Control’ COLUMN OF THE #ASH 2ECEIPTS *OURNAL AND SO IS INCLUDED IN THE   CREDIT TO THE Debtors Control account (and cross-referenced to ‘Bank/Discount expense’). The individual debtor account in the Debtors Ledger would show the following. Debtors Ledger A. Micari (A) Date

Cross-reference

Mar. 1

Balance

Amount $ 400

Date Mar. 16

Cross-reference

Amount $

Bank

40

Bad Debts

360

Effect on the accounting equation A bad debt has the following effect on the accounting equation: Increase/Decrease/No effect Assets

Decrease (Debtors Control)

Liabilities

No effect

Owner’s Equity

Decrease (Bad debts expense decreases Net Profit)

Amount $ 360

360

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

REVIEW QUESTIONS 7.5

1 Define the term ‘bad debt’. 2 Referring to one accounting principle, explain when a bad debt should be recognised. 3 Show the General Journal entries necessary to record a bad debt. 4 Show the effect of a bad debt on the accounting equation.

STUDY TIP

The ‘See, Think, Solve’ approach may be used to determine how to correct an error.

EXAMPLE

7.6

CORRECTING ENTRIES

In an accounting system designed and run by humans, it is only natural that mitsakes mistakes will occur from time to time. Where these errors are detected before the journals are posted to the ledger, they can be corrected in the journals. However, if the journals have already been posted to the ledger, errors must be corrected using a General Journal entry. It is difficult to set rules for the correction of errors because such a wide variety of errors may need to be corrected. However, if the error involves recording a transaction in the wrong ledger account, the basic steps to take would be: 1 Undo the incorrect entry by reversing it; that is, record a debit entry to undo an incorrect credit, and vice versa. 2 Enter the correct entry.

On 31 July 2015, it was discovered that $400 in wages was incorrectly recorded as electricity (Memo 20), and that drawings of stock worth $250 had been recorded as stock used for advertising (Memo 21).

4HECORRECTINGENTRIESARESHOWNIN&IGURE Figure 7.8 General Journal: correcting entries General Journal General Ledger Date July 31

Details

Debit

Wages Expense

400

Electricity Expense

Credit

Subsidiary ledger Debit

Credit

400

Correcting entry – wages recorded as electricity (Memo 20) July 31

Drawings

250

Advertising

250

Correcting entry – drawings recorded as advertising (Memo 21)

Electricity is credited to undo the incorrect debit to that account when the error was made, and Wages is debited, as this is the correct entry that should have been recorded in the first place.

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CHAPTER 7

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The debit to Drawings is how the entry should have been recorded, with the remaining credit entry to Advertising undoing the error. Note that there is no entry to change the Stock Control account, as the stock was removed; the only difference being that it was the owner who took home the stock. If the error was the omission of a transaction, this could be corrected by simply making an additional entry in the General Journal. If the error involved the use of an incorrect amount, it could be corrected either by an additional entry using the additional amount or a reducing entry (to credit the account originally debited and vice versa) using the excess amount.

REVIEW QUESTIONS 7.6

1 Explain why in some situations errors may be corrected in the appropriate special journal, but in others a General Journal entry is required. 2 List three types of errors that may need to be corrected via the General Journal. 3 List the two basic steps for correcting an error involving the use of the wrong ledger account.

WHERE HAVE WE BEEN? s 4HE'ENERAL*OURNALISUSEDTORECORDINFREQUENT NON CASHTRANSACTIONSTHATCANNOT be recorded in any of the special journals, such as: – commencing entries – non-cash transactions with the owner – bad debts – correcting entries – use of stock for advertising purposes – closing entries – balance day adjustments. s !NARRATIONDESCRIBESEACH'ENERAL*OURNALENTRY INCLUDINGAREFERENCETOTHESOURCE document. s 4HE'ENERAL*OURNALISPOSTEDTOTHE'ENERAL,EDGERATTHEENDOFTHEMONTH

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

EXERCISE 7.1 COMMENCING ENTRIES

EXERCISES

W B

page 124

The owner of Quality Pool Sweepers has decided to convert his records to a double-entry RECORDINGSYSTEM4HEFOLLOWINGASSETANDLIABILITYBALANCESWERELISTEDIN-EMOON -ARCH Bank

$

Debtors Control

3 400 17 500

Stock Control

4 000

Creditors Control

14 000

GST owing to ATO

2 700

Required a Calculate/WNERS%QUITYASAT-ARCH b Show the General Journal entries necessary to record the opening balances on -ARCH c Post the General Journal to the General Ledger of Quality Pool Sweepers. d Explain why commencing entries must be recorded in the General Journal.

EXERCISE 7.2 COMMENCING ENTRIES

W B

page 126

Claire’s Carpets sells quality flooring and has decided to convert its records to a doubleentry recording system. The following asset and liability balances were determined on -AY Bank Overdraft

$

2 500

Debtors – RACV

4 000

– Borders

6 800

Stock Control

17 000

Creditors – Woolmark

5 000

– NZ Pile

3 000

Delivery Van GST Refund Due from ATO

23 000 450

Required

*

a Show the General Journal entries necessary to record the opening balances on -AY.ARRATIONnot required.) b Explain the role of a narration in a General Journal entry. c Post the General Journal to the General Ledger and subsidiary ledgers of Claire’s Carpets. d PrepareACLASSIlED"ALANCE3HEETFOR#LAIRES#ARPETSASAT-AY

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CHAPTER 7

THE GENERAL JOURNAL

EXERCISE 7.3 CONTRIBUTION OF ASSETS AND LIABILITIES

W B

page 129

/N  *ULY  $ANIELLE -ERCER COMMENCED BUSINESS UNDER THE NAME OF $ANIELLES Antiques by contributing: s s s s

CASH AVANWITHANAGREEDVALUEOF WORTHOFSTOCK ANINTEREST ONLYLOANOFDUE-ARCH

Required a Show THE JOURNAL ENTRIES NECESSARY TO RECORD THE CONTRIBUTIONS ON  *ULY  (Narration not required.) b Explain your treatment of the contribution of cash in the journals of Danielle’s Antiques. c Explain why the vehicle contributed by the owner was valued at its agreed vale.

EXERCISE 7.4 NON-CASH TRANSACTIONS WITH THE OWNER

W B

page 130

4OM-ATTHIASOWNS4OOL4OWN WHICHON3EPTEMBERHADWORTHOFSTOCK on hand. Tom has provided the following memo:

Tool Town

memo

73 Date:

16 September 2015

From: Stock Room To: Accounting Department $1 000 worth of stock was given to my son as a birthday present. Please update the records as necessary. Thanks, Tom

Required a Show the General Journal entries necessary to record Memo 73. b Post the General Journal to the General Ledger of Tool Town. c State the effect of Memo 73 on the accounting equation of Tool Town.

EXERCISE 7.5 NON-CASH TRANSACTIONS WITH THE OWNER

W B

page 131

Sybil Hilesio is the owner of Soap and Suds, and let her accountant know of two TRANSACTIONSTHATHADTAKENPLACEDURING*ULY July 2 10

Took office furniture home for personal use $100 (Memo 24) Contributed to the store new shelving worth $2 500 (Memo 25)

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

Required a ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORD-EMOSAND b Post the General Journal to the General Ledger of Soap and Suds. c Referring to one accounting principle, explain WHY -EMO  DECREASES OWNERS equity. d StateTHEEFFECTONTHEACCOUNTINGEQUATIONOF3OAPAND3UDSASAT*ULYIF -EMOISnot recorded.

EXERCISE 7.6 NON-CASH TRANSACTIONS WITH THE OWNER

W B

page 133

/N!UGUST 7ENDYDONATEDTOHERBUSINESS 7ENDYS7OOLLENS ACOMPUTER THATSHEHADPURCHASEDFORHERSELFAYEARAGOFOR4HECOMPUTER WHICHWILLBE USEDEXCLUSIVELYBYTHEBUSINESS HASANAGREEDVALUEOF BUT7ENDYHASARGUED THATACCOUNTINGPRINCIPLESDEMANDTHATITISVALUEDINTHEBUSINESSSRECORDSAT Required a Referring to one qualitative characteristic, explain why the computer must be valued ATINTHEBUSINESSRECORDS b Show the General Journal entries to record this transaction. (Narration not required.) c Referring to two accounting principles, discuss Wendy’s argument about the valuation of the computer.

EXERCISE 7.7 BAD DEBTS

W B

page 134

/N  3EPTEMBER  THE OWNER OF $ODGE $ISHWASHERS WENT TO VISIT ONE OF HIS CUSTOMERSn$ES4#HUTEnTORECOVERADEBT5PONARRIVAL THEOWNERFOUND that Chute had moved three months ago and left no forwarding address. He decided to WRITEOFFTHEDEBTASBAD-EMO  Required a b c d

Show the General Journal entries necessary to record the bad debt. Post the General Journal to the General Ledger of Dodge Dishwashers. State the effect of this transaction on the accounting equation of Dodge Dishwashers. Referring to one qualitative characteristic, explain why bad debts must be reported in the Income Statement.

EXERCISE 7.8 BAD DEBTS

W B

page 135

4RAVIS-ILTONOWNS4ERRIFIC4ELLIES/N-ARCH HERECEIVEDALETTERFROMASOLICITOR stating that one of the firm’s debtors (Ian Solvent) was declaring bankruptcy and would ONLYBEABLETOPAYCOFEVERYDOLLAROWED-EMO 4HELETTERWASACCOMPANIED BYACHEQUEFROM)AN3OLVENTFORWHICH4RAVISISSUED2EC/N-ARCH TOTAL DEBTORSOWED WITHOFTHATAMOUNTOWEDBY)AN3OLVENT

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CHAPTER 7

THE GENERAL JOURNAL

Required a ShowTHEJOURNALENTRIESNECESSARYTORECORDTHEINFORMATIONON-ARCH b Show how the Debtors Control and Bad Debts accounts would appear after this information was posted to the General Ledger of Terrific Tellies. c Complete the account of Ian Solvent in the Debtors Ledger of Terrific Tellies as at -ARCH d State the effect on the accounting equation of Terrific Tellies if the bad debt was not recorded.

EXERCISE 7.9 CORRECTING ENTRIES

W B

page 137

/N*UNE "ARRY0OWERSDISCOVEREDTHEFOLLOWINGERRORSJUSTPRIORTOPREPARING the financial reports for his business, Powers Tools: s 4ELEPHONE CHARGES OF  PLUS  '34 WERE INCORRECTLY DEBITED TO )NSURANCE -EMO  s  RECORDED AS )NTEREST %XPENSE WAS ACTUALLY INTEREST ON 0OWERSS HOME LOAN -EMO  s !PAYMENTFOR7AGESOFWASINCORRECTLYRECORDEDINTHE#ASH0AYMENTS*OURNAL AS-EMO  s !RECEIPTOFFROMADEBTORn""ILLITENnHADBEENINCORRECTLYRECORDEDASA PAYMENTTOACREDITORn""OLTON-EMO  Required a Show the General Journal entries necessary to correct each error. b Explain why the entries to correct the error regarding telephone charges do not affect the GST Clearing account. c Suggest one way the error regarding wages could have been detected. d State the effect on the accounting equation of Power Tools if the error regarding B. Billeten and B. Bolton had not been corrected.

EXERCISE 7.10 CORRECTING ENTRIES

W B

page 139

/N*UNE THEFOLLOWINGERRORSWEREFOUNDINTHE'ENERAL,EDGEROF"LUE,INES s OFEQUIPMENTWASINCORRECTLYDEBITEDTO#LEANING%XPENSES s 3TOCKTHATHADBEENUSEDFORADVERTISINGWORTH HADBEENINCORRECTLYRECORDED as Drawings. s !PAYMENTOFINTERESTWASINCORRECTLYDEBITEDTO,OANn("- s ! DEBT OF  OWED BY " 1UICK THAT HAD BEEN WRITTEN OFF WAS RECORDED IN THE ledger account of B. Quack. s !PAYMENTOFWAGESOFWASINCORRECTLYRECORDEDINTHE#ASH0AYMENTS*OURNAL ASAPAYMENTTOACREDITORn.3MYTHEnFOR Required a Show the General Journal entries necessary to correct each error. (Narrations not required.) b ExplainTHEEFFECTONTHE.ET0ROlTOF"LUE,INESFOR*UNEIFTHEERRORREGARDING equipment had not been corrected. c Explain the effect on owner’s equity of the entries to correct the error regarding stock. d State the effect on the accounting equation of Blue Lines if the error regarding the interest had not been corrected. ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

EXERCISE 7.11 DOCUMENTS AND THE GENERAL JOURNAL

W B

page 140

Jorge Nielson owns and operates a small trading business called Nordic Supplies, SELLINGARANGEOFSNOWBOARDS SKISANDCLOTHING/N&EBRUARY THEBALANCEOF THE'34#LEARINGACCOUNTWAS#2 The only documents relating to debtor I.C. Tusche, which have yet to be recorded in the books of Nordic Supplies, are shown below: DOCUMENT A TAX INVOICE Invoice: B905

Nordic Supplies

Mansfield Hwy Mansfield VIC 3724

ABN: 36 701 410 302 Charge to: Date Mar. 2

5/7, n/30

I.C. Tusche Treetops Chalet, Mt Buller

Details

Qty

Thriller Snow Board

Unit Price $

1

800

Total $ 800

GST

80

$

Total

880

Note:.ORDIC3UPPLIESPURCHASEDTHE4HRILLER3NOW"OARDFORPLUS'34 DOCUMENT B

MEMO 7

To:

The Accountant

From:

Jorge Nielson

Date:

29 March 2015

Subject:

I.C. Tusche

Today we received 25 cents in the dollar of the outstanding debt of I.C. Tusche (Rec. 77). However, the insolvency firm representing I.C. Tusche has advised us that the remainder of the debt is irrecoverable.

Nielsen is reluctant to write off the debt, believing that with time the debtor may be able to pay. Required a Referring to one accounting principle, explain why the bad debt must be recognised ON-ARCH b State the journals in which Document A and Document B would be recorded. c State the effect on the accounting equation of Nordic Supplies if Document A was not recorded. d Show how the account of I.C. Tusche would appear in the Debtors Ledger after all journals are posted. e Referring to the definitions, explain why a ‘bad debt’ is reported as an expense. ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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CHAPTER 7

161

THE GENERAL JOURNAL

EXERCISE 7.12 POSTING FROM THE JOURNALS

W B

page 141

Jamie Tape operates a sports store called Omni Sports. His main customers are the Eston Football Club, and the Eagles Soccer Club, both of whom use the credit facilities *AMIEOFFERS ANDTHEYFREQUENTLYRECEIVEADISCOUNTFOREARLYPAYMENT/N3EPTEMBER  THELEDGERACCOUNTSCONTAINEDTHEFOLLOWINGBALANCES Stock Control Debtors Control

$ 9 000 3 080

– Eston Football Club

1 100

– Eagles SC

1 980

GST Clearing

150

CR

4HEJOURNALSFOR3EPTEMBERSHOWEDTHEFOLLOWING Cash Receipts Journal Date

Details

Sept. 1

Rec. no.

Bank

Disc. Exp.

Debtors Control

50

1 100

Cost of Sales

Sales

Sundries

GST

Eston Football Club

451

1 050

5

Cash Sales

452

1 320

600

1 200

120

8

Cash Sales

453

990

450

900

90

10

Eagles SC

454

1 880

100

1 980

17

Eston Football Club

455

1 800

70

1 870

20

Capital Contribution

456

1 500

22

Cash Sales

457

715

25

Eagles SC

458

5 060

29

Cash Sales

459

1 100

1 500 650

65

500

1 000

100

1 875

3 750

5 060

15 415

Totals

325

220

10 010

1 500

375

Sales Journal Date

Debtor

Invoice Cost of number Sales

Sales

GST

Debtors Control

Sept. 4

Eston Football Club

66

850

1 700

170

1 870

Sept. 8

Eagles SC

67

1 000

2 000

200

2 200

Sept. 13

Eagles SC

68

1 300

2 600

260

2 860

Sept. 21

Eston Football Club

69

700

1 400

140

1 540

Sept. 28

Eagles SC

70

550

1 100

110

1 210

4 400

8 800

880

9 680

Totals

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

General Journal General Ledger Date Sept. 30

Details Drawings

Debit

Credit

Subsidiary ledger Debit

Credit

70

Stock Control

70

Jamie took home stock (Memo 3) Sept. 30

Bad debts

1 210

Debtors Control Debtor – Eagles SC

1 210 1 210

Eagles SC declared bankrupt – debt written off (Memo 4)

Additional information: s !LL PURCHASES OF STOCK ARE MADE ON CREDIT #REDIT PURCHASES FOR 3EPTEMBER  AMOUNTEDTOINCLUDING'34  s '34PAIDFOR3EPTEMBERWAS s *AMIEHASSTATEDTHATBADDEBTSAREREDUCINGHISREVENUE SOTHEYARELEAVINGHIM with less cash. Required

*

a Identify one part of Jamie’s statement that is correct. Justify your answer. b Identify one part of Jamie’s statement that is incorrect. Justify your answer. c Referring to one qualitative characteristic, explain why Jamie’s Drawings must be recorded in the accounting records of Omni Sports. d Post the journals to the following accounts in the General Ledger of Omni Sports: Stock Control, Debtors Control, GST Clearing, Sales, Bad Debts, Discount Expense. e BalanceTHE3TOCK#ONTROLACCOUNTASAT3EPTEMBER f Complete the account of Eagles SC in the Debtors Ledger of Omni Sports. g Explain the effect of the bad debt from Eagles SC on the Balance Sheet of Omni 3PORTSASAT3EPTEMBER

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Where are we headed? After completing this chapter, you should be able to: s defineANDidentifySTOCK ANDexplainITSIMPORTANCE TOATRADINGlRM s explainTHEROLEOFASTOCK CARD ANDITSRELATIONSHIPTO THE3TOCK#ONTROLACCOUNT s recordTRANSACTIONSINSTOCK CARDS s explainANDapplyTHE &IRST)N &IRST/UT&)&/ ASSUMPTIONTOSALESOFSTOCK s explainTHERELATIONSHIP BETWEENSTOCKCARDSAND THESPECIALJOURNALS s explainTHEROLEOFA PHYSICALSTOCKTAKE s stateTHEREASONSFORASTOCK LOSSORSTOCKGAIN

s recordASTOCKLOSSAND STOCKGAININTHESTOCK CARD 'ENERAL*OURNALAND 'ENERAL,EDGER s record THEUSEOFSTOCKFOR ADVERTISINGPURPOSESINTHE STOCKCARD 'ENERAL*OURNAL AND'ENERAL,EDGER s distinguishBETWEEN#OST OF3ALESAND#OSTOF'OODS 3OLD s prepareAN)NCOME 3TATEMENTSHOWING'ROSS 0ROlTAND!DJUSTED'ROSS 0ROlT s explainTHEBENElTSOF USINGAPERPETUALSYSTEMTO ACCOUNTFORSTOCK

CHAPTER 8

ACCOUNTING FOR STOCK KEY TERMS After completing this chapter, you should be familiar with the following terms: s TRADINGlRM

s STOCKLOSS

s STOCK

s STOCKGAIN

s STOCKCARD

s #OSTOF'OODS3OLD #/'3

s COSTPRICE

s &IRST)N &IRST/UT&)&/ s PERPETUAL SYSTEM OF STOCK RECORDING s STOCKTAKE ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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164

8.1 trading firm a firm that purchases goods in order to resell them at a profit

stock goods purchased by a trading firm for the purpose of resale at a profit

UNITS 3&4

TRADING FIRMS AND STOCK

4HROUGHOUT THIS TEXT WE HAVE DISCUSSED THE PROCEDURES TO RECORD AND REPORT THE TRANSACTIONSOFA trading firmnAlRMTHATBUYSSTOCKWITHTHEINTENTIONOFRESELLINGITFOR APROlT7HATDOWEMEANBYSTOCK

Definition of stock #ONSIDER THE EXAMPLE OF A PLANT NURSERY !MONG THE ASSETS UNDER ITS CONTROL WOULD BE VARIOUS PLANTS POTS GARDEN SUPPLIES AND GARDENING TOOLS AS WELL AS OTHER ITEMS SUCHASSHELVING ABUSINESSVEHICLEANDOFlCEEQUIPMENT7HICHOFTHESESHOULDBE CONSIDEREDTOBEstock /BVIOUSLY ANYPLANTSANDPOTSTHATAREHELDFORRESALESHOULDBECONSIDEREDASSTOCK )NFACT ANYGOODSTHATAREPURCHASEDBYATRADINGlRMWITHTHEINTENTIONOFBEINGRESOLD ATALATERDATEFORPROlT SHOULDBECONSIDEREDSTOCK4HISMAYMEANTHATTHEGARDEN SUPPLIESANDGARDENINGTOOLSARESTOCKIFTHEYAREHELDFORRESALE BUTNOTCONSIDERED STOCKIFTHEYAREHELDFORUSEWITHINTHEBUSINESSTOTENDTHEPLANTSANDMAINTAINTHE APPEARANCE OF THE NURSERY  4HE SHELVING BUSINESS VEHICLE AND OFlCE EQUIPMENT ON THEOTHERHAND WOULDNOTBECONSIDEREDSTOCK4HISISNOTTOSAYTHATTHESEITEMSWILL NEVERBESOLD BUTTHEINTENTIONBEHINDTHEIRPURCHASEWASUSE NOTRESALE SOTHEYARE NOTSTOCK

Any goods that are purchased by a trading firm with the intention of being resold at a later date for profit, should be considered stock

4HIS POTENTIAL FOR RESALE n AT A PROlT n SOME TIME IN THE FUTURE MEANS THAT STOCK REPRESENTSAfuture economic benefit ANDBECAUSETHESTOCKISALSOUNDERTHEcontrol OFTHETRADINGlRM STOCKlTSPERFECTLYTHEDElNITIONOFANASSET'IVENTHATTHElRMS INTENTIONWOULDBETORESELLTHESTOCKwithin the next 12 months ITMEANSTHATSTOCKIS ACURRENTASSET

The importance of stock &ORATRADINGlRM STOCKISOFPARAMOUNTIMPORTANCE&IRST STOCKISITSMAINSOURCEOF REVENUE ANDTHUSTHEKEYTOITSABILITYTOEARNPROlT!TRADINGlRMTHATCANNOTSELLITS STOCKWILLNOTSURVIVE3ECOND STOCKISLIKELYTOBEONEOFTHEMOSTSIGNIlCANTASSETSTHE lRMCONTROLS$ESPITETHE PERHAPSIMMENSE VALUEOFPROPERTYANDPREMISES ITISSTILL POSSIBLEFORSTOCKTOBETHELARGESTSINGLEASSETLISTEDINTHElRMS"ALANCE3HEET ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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ACCOUNTING FOR STOCK

165

Despite the, perhaps immense, value of property and premises, it is still possible for stock to be the largest single asset listed in the firm’s Balance Sheet

5NFORTUNATELY STOCKISNOTONLYONEOFTHEMOSTIMPORTANTASSETSFORATRADINGlRM BUTALSOONEOFTHEMOSTVULNERABLE3TOCKISSUSCEPTIBLETODAMAGE SPOILAGE THEFTAND EVENCHANGESINTASTESANDFASHIONS EACHOFWHICHCANUNDERMINEITSVALUE 'IVENITSIMPORTANCEANDVULNERABILITY ITISVITALTHATTHEACCOUNTINGSYSTEMISABLETO PROVIDEACCURATEINFORMATIONABOUTSTOCK REVIEW QUESTIONS 8.1

1 2 3 4 5

Define THETERM@TRADINGlRM Define THETERM@STOCK Explain HOWSTOCKSHOULDBECLASSIlEDINTHE"ALANCE3HEET State TWOREASONSWHYSTOCKISIMPORTANTTOATRADINGlRM State THREEREASONSWHYSTOCKISCONSIDEREDTOBEAVULNERABLEASSET

8.2

THE STOCK CONTROL ACCOUNT

!LL MOVEMENTS OF STOCK ARE SUMMARISED IN THE 3TOCK #ONTROL ACCOUNT WITH STOCK @IN PRIMARILYTHROUGHPURCHASES RECORDEDONTHEDEBITSIDE ANDSTOCK@OUTMAINLYTHROUGH SALES RECORDEDONTHECREDITSIDE Stock Control (A) Stock IN

Stock OUT Stock Control (A)

Date Aug. 1 Aug. 31

Cross-reference

Amount $

Date

Balance

4 900

Aug. 31

Bank Creditors Control

Cross-reference

Amount $

Cost of Sales

3 500

1 500

Cost of Sales

2 200

3 700

Drawings

200

Advertising

100

Balance 10 100 Sept. 1

Balance

4 100 10 100

4 100

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UNITS 3&4

4HE3TOCK#ONTROLACCOUNTSHOWSASUMMARYOFTOTALCASHANDCREDITPURCHASESONTHE DEBITSIDE WITHTOTALCASHANDCREDITSALESRECORDEDATCOSTPRICE ANDCROSS REFERENCED TO #OST OF 3ALES STOCK WITHDRAWALS BY THE OWNER AND STOCK USED FOR ADVERTISING PURPOSESRECORDEDONTHECREDITSIDE4HEBALANCEOFTHE3TOCK#ONTROLACCOUNT REPRESENTSTHETOTALVALUEOFallSTOCKONHAND The Stock Control account summarises all stock transactions.

REVIEW QUESTIONS 8.2

1 Explain THEROLEOFTHE3TOCK#ONTROLACCOUNT 2 Identify TWOTRANSACTIONSTHATWOULDAPPEARONTHEDEBITSIDEOFTHE3TOCK #ONTROLACCOUNT 3 Identify FOURTRANSACTIONSTHATWOULDAPPEARONTHECREDITSIDEOFTHE3TOCK #ONTROLACCOUNT

8.3

stock card a subsidiary accounting record that records each individual transaction involving the movement in and out of the business of a particular line of stock

STOCK CARDS

!LTHOUGH THE 3TOCK #ONTROL ACCOUNT IN THE 'ENERAL ,EDGER PROVIDES AN IMPORTANT SUMMARYOFALLMOVEMENTSOFSTOCKINANDOUTOFTHElRM THISACCOUNTALONEWILLNOT PROVIDESUFlCIENTINFORMATIONTOMANAGESTOCKEFFECTIVELY-OSTTRADINGlRMSWILLCARRY ANUMBEROFDIFFERENTLINESOFSTOCKDIFFERENTITEMS DIFFERENTCOLOURS DIFFERENTSIZES)TIS VITALTHATTHEOWNERHASDETAILEDINFORMATIONRELATINGTOEACHLINEOFSTOCK FROMBASICS SUCHASITSDESCRIPTION LOCATIONINTHEWAREHOUSEANDSUPPLIER TOlNANCIALINFORMATION SUCHASTHECOSTPRICEOFEACHUNIT THENUMBEROFUNITSPURCHASEDANDSOLD ANDTHE NUMBEROFUNITSONHANDATANYPOINTDURINGTHEPERIOD  4HISINFORMATIONMUSTALSOBERECORDED ANDTHISMUSTBEDONEINFARMOREDETAILTHAN THE3TOCK#ONTROLACCOUNTCANPROVIDE&ORTHISREASON A3TOCK#ONTROLACCOUNTISUSED TOSUMMARISEALLTRANSACTIONSAFFECTINGSTOCK WITHINFORMATIONRELATINGTOINDIVIDUALLINES OFSTOCK INCLUDINGDETAILSOFSTOCKTRANSACTIONS RECORDEDINstock cards!TRADINGlRM WILLONLYEVERHAVEONE3TOCK#ONTROLACCOUNTINTHE'ENERAL,EDGER BUTCOULDHAVEA HUGENUMBEROFSTOCKCARDS WITHONESTOCKCARDFOREVERYDIFFERENTLINEOFSTOCK

Stock cards detail the individual transactions affecting each individual line of stock.

4HISRELATIONSHIPBETWEENTHE3TOCK#ONTROLACCOUNTANDTHESTOCKCARDSISSIMILAR TO THE RELATIONSHIP BETWEEN THE $EBTORS #ONTROL ACCOUNT AND THE $EBTORS ,EDGER OR THE #REDITORS #ONTROL ACCOUNT AND THE #REDITORS ,EDGER 4HE CONTROL ACCOUNT IN THE 'ENERAL ,EDGER PROVIDES A SUMMARY OF ALL TRANSACTIONS WITH SPECIlC DETAILED INFORMATIONRELATINGTOEACHINDIVIDUALTRANSACTIONRECORDEDINTHESUBSIDIARYRECORDS )NTHISWAY SUMMARYINFORMATIONISAVAILABLEFORREPORTS WITHSPECIlCDETAILSAVAILABLE FORMANAGINGDEBTORS CREDITORSANDSTOCK!TYPICALSTOCKCARDISSHOWNIN&IGURE

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Figure 8.1

ACCOUNTING FOR STOCK

167

Stock card

Stock item:

Plant pot – terracotta, 60 cm

Location:

Row 16, Bay C3

Stock code:

PTC60

Supplier:

Potty 4 You

IN Date

Details

Qty

Cost

OUT Total

Qty

Cost

BALANCE Total

Qty

Cost

Total

Top portion: details of item 4HETOPPORTIONOFTHESTOCKCARDSHOWSTHEDETAILSRELATINGTOTHESTOCKITEMITSELF INCLUDING ADESCRIPTIONOFTHEITEMINTHISCASE A@0LANTPOTnTERRACOTTA CM )TSCODE04# IS ALSOIDENTIlEDFOREASYREFERENCEWITHINTHElRM4HELOCATION2OW "AY# CANALSOBE VERYIMPORTANT PARTICULARLYFORSTOCKSTOREDINALARGEWAREHOUSEWITHMANYDIFFERENTSTORAGE BAYS,ASTLY THENAMEOFTHESUPPLIER0OTTY9OU ISIDENTIlEDTOASSISTREORDERING )FTHElRMSELLSPLANTPOTSINDIFFERENTsizes EACHDIFFERENT SIZEDPOTWILLNEEDITSOWN STOCKCARD)NADDITION IFTHElRMSELLSPOTSINDIFFERENTcolours EACHOFTHESEWILLALSO REQUIREADIFFERENTSTOCKCARD WITHADIFFERENTONEFOREACHsizeOFEACHcolour

Bottom portion: transactions 4HEBOTTOMPORTIONOFTHESTOCKCARDISUSEDTORECORDTHETRANSACTIONS ANDISDIVIDED INTOFOURMAINSECTIONS$ATEAND$ETAILSANDTHE)NCOLUMN/UTCOLUMNAND"ALANCE COLUMN Date and Details 4HElRSTSECTIONISUSEDTORECORDSTANDARDINFORMATIONRELATINGTOTHEDATEANDDETAILSOF EACHSTOCKTRANSACTION@$ETAILS INTHISCASE REFERSTOTHESOURCEDOCUMENTTHATVERIlES EACHTRANSACTION In, Out and Balance columns 4HESECOLUMNSRECORDEXACTLYWHATTHEYSTATE s 4HE)NCOLUMNRECORDSALLSTOCKCOMINGINTOTHEBUSINESS MAINLYTHROUGHPURCHASES s 4HE /UT COLUMN RECORDS ALL STOCK LEAVING THE BUSINESS THROUGH SALES OR PERHAPS DRAWINGSORADVERTISING s 4HE "ALANCE COLUMN SHOWS THE STOCK ON HAND AND AVAILABLE FOR SALE VALUED AT cost price 7HEREASTHE3TOCK#ONTROLACCOUNTSHOWSTRANSACTIONSINDOLLARTERMSONLY THESTOCK CARDALSOSHOWSTHEQUANTITY ORNUMBER OFITEMSOFSTOCKANDTHEIRUNITCOSTTHATIS THE COSTPRICEOFEACHINDIVIDUALSTOCKITEM4HETOTALCOSTOFEACHTRANSACTIONISCALCULATED BYMULTIPLYINGTHEQUANTITYBYTHECOST

Total

=

Quantity

x

cost price the original purchase price of stock

Cost

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UNITS 3&4

REVIEW QUESTIONS 8.3

1 Explain THE RELATIONSHIP BETWEEN THE 3TOCK #ONTROL ACCOUNT AND THE STOCK CARDS 2 Identify FOURDETAILSTHATWILLBEPROVIDEDINTHETOPPORTIONOFASTOCKCARDBUT NOTINTHE3TOCK#ONTROLACCOUNT 3 Identify THREEDETAILSTHATAREPROVIDEDWHENTRANSACTIONSARERECORDEDINTHE STOCKCARDBUTARENOTPROVIDEDINTHE3TOCK#ONTROLACCOUNT 4 State HOWMANYSTOCKCARDSATYPICALTRADINGlRMWOULDREQUIREBeware:4HIS ISATRICKQUESTION


8.4

RECORDING TRANSACTIONS IN STOCK CARDS

Where cost prices are constant STUDY TIP

Purchases Aug.

2EMEMBERTHAT'34 DOESNOTAFFECTTHE VALUATIONOFSTOCK NOR THEREVENUEEARNED FROMITSSALE

5

Purchased 6 terracotta pots (60 cm) on credit from Potty 4 You @ $60 (plus $6 GST) each (Inv. 364)

!PURCHASEMEANSTHATSTOCKISCOMINGINTOTHEBUSINESS SOTHISTRANSACTIONMUSTBE RECORDEDINTHE)NCOLUMNASQUANTITY COST TOTALX 4HEEFFECTISTO INCREASETHENUMBEROFITEMSONHANDINTHE"ALANCECOLUMNTOPOTSFOURONHAND plusTHESIXJUSTPURCHASED AT FORACOSTOF Sales Aug.

12

Cash sale of 3 terracotta pots (60 cm) for $100 (plus $10 GST) each (Rec. 23)

!SALEMEANSTHATSTOCKISLEAVINGORMOVINGOUTOFTHEBUSINESS SOTHISTRANSACTIONMUST BERECORDEDINTHE/UTCOLUMN(OWEVER WEHAVEADILEMMAREGARDINGTHEUNITPRICE TOBERECORDEDTHEPRICEOFTHEPOTSISGIVENONTHESOURCEDOCUMENT2EC AS$100 BUTNO$100POTSARELISTEDINTHESTOCKCARD(OWCANTHISBE 2EMEMBERTHATTHEPRICEONTHESOURCEDOCUMENT($100 each WILLBETHEselling price BUT THE STOCK CARD SHOWS THE COST PRICE WHICH IS  EACH 4HE COST PRICE OF THESTOCKISNOTREVEALEDTOTHECUSTOMERASTHISPROTECTSTHE'ROSS0ROlTONTHESALE CUSTOMERSWHOAREAWAREOFTHEMARK UPHAVEATENDENCYTOHAGGLEHARDERFORPRICE REDUCTIONS4HECOSTPRICEISREVEALEDONLYWHENTHETRANSACTIONISRECORDEDINTHESTOCK CARD SOTHISSALEISRECORDEDASQUANTITY COSTnot$100 TOTALX 4HE EFFECTISTODECREASETHENUMBEROFITEMSONHANDINTHE"ALANCECOLUMNTOSEVENPOTS ONHANDLESSTHETHREEJUSTSOLD AT FORACOSTOF4HISISSHOWNIN&IGURE

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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CHAPTER 8

Figure 8.2

ACCOUNTING FOR STOCK

Stock card: constant prices STOCK CARD

Stock item:

Plant pot – terracotta, 60 cm

Location:

Row 16, Bay C3

Stock code:

PTC60

Supplier:

Potty 4 You

IN Date

Details

Qty

Aug. 1

Balance

5

Inv. 364

12

Rec. 23

6

Cost

60

OUT Total

Qty

Cost

BALANCE Total

360 3

60

180

Qty

Cost

Total

4

60

240

10

60

600

7

60

420

Cost of Sales and Gross Profit 4HEAMOUNTRECORDEDINTHE/UT4OTALCOLUMNREPRESENTSTHE#OSTOF3ALESlGUREFOR THETRANSACTION&ORTHISSALE 3ALESREVENUEWOULDBE$300THREEPOTSAT$100 selling price AND#OSTOF3ALESWOULDBETHREEPOTSATCOSTPRICE LEAVINGA'ROSS 0ROlT OF  THAT IS Sales revenue ($300) LESS #OST OF 3ALES   'ROSS 0ROlT  

Where cost prices are changing &REQUENTLY THE COST PRICE CHARGED BY THE SUPPLIER WILL CHANGE DURING THE 2EPORTING 0ERIOD4HATIS THEITEMSONHANDMAYHAVETHESAMESELLINGPRICEANDBEIDENTICALIN THEEYESOFTHECUSTOMER BUTMAYHAVEDIFFERENTCOSTPRICES4HESEDIFFERINGCOSTPRICES MUSTBERECORDEDINTHESTOCKCARDS Purchases Aug.

17

Purchased 8 terracotta pots (60 cm) on credit from Potty 4 You @ $70 (plus $7 GST) each (Inv. 370)

!S THIS IS A PURCHASE AND WILL INCREASE THE STOCK ON HAND THIS TRANSACTION MUST BE RECORDEDINTHE)NCOLUMNASQUANTITY COST TOTALX 4HEREARENOW POTSONHANDANDTHE"ALANCECOLUMNMUSTREmECTTHIS BUTWECANNOTSIMPLYAGGREGATE THESTOCKASUNITSATONEPARTICULARUNITCOST3OMEOFTHEPOTSWEREPURCHASEDAT ANDOTHERSWEREPURCHASEDAT SOWHICHUNITCOSTSHOULDBEUSEDFORTHEBALANCE 4HESHORTANSWERISboth %VENTHOUGHTHEPOTSAREIDENTICALINTHEEYESOFTHECUSTOMERS THECOSTPRICESOF THESTOCKBATCHESDIFFERSEVENWEREPURCHASEDFOREACH WHILETHEEIGHTNEWPOTS WEREPURCHASEDFOREACH4HEREFORE THEYMUSTBELISTEDSEPARATELYINTHE"ALANCE COLUMNOFTHESTOCKCARD Sales Aug.

23

Credit sale of 10 terracotta pots (60 cm) for $110 (including $10 GST) each (Inv. 56)

4HISSALEMEANSTHATSTOCKISMOVINGOUTOFTHEBUSINESS SOTHISTRANSACTIONMUSTBE RECORDEDINTHE/UTCOLUMNAND ONCEAGAIN THECOSTPRICEMUSTBEUSED(OWEVER THE BALANCEBEFORETHISTRANSACTIONISSHOWNATTWODIFFERENTCOSTPRICESSEVENUNITSAT EACH ANDEIGHTUNITSATEACH7HICHSTOCKHASBEENSOLD

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CAMBRIDGE VCE ACCOUNTING

170

UNITS 3&4

Identified cost /NEOPTIONISTOPHYSICALLYMARKORLABELEACHPOTINSOMEWAYSUCHASASTICKERWITH ACOLOURCODE LETTERCODEORBARCODE ANDTHENKEEPARECORDOFTHECOSTPRICETHAT RELATESTOTHATCODE)NTHISWAY THEBUSINESSCOULDSIMPLYMATCHTHECODEONTHEITEM TOTHEPRICEINITSRECORDSTOIDENTIFYTHEEXACTCOSTPRICEOR OFEVERYPOT (OWEVER NOTALLBUSINESSESWILLIDENTIFYTHECOSTPRICEOFTHEIRSTOCKINTHISWAY FORA VARIETYOFREASONS &IRST THEREWILLBESOMETYPESOFSTOCKFORWHICHITISnot possibleTOLABELEVERYITEM TOIDENTIFYITSCOST)NTHISCATEGORYWOULDBEPETROLATASERVICESTATION WHICHMAYBE BOUGHTATDIFFERENTCOSTPRICES BUTMIXESINTHESAMETANKANDISTHEREFOREIMPOSSIBLE TOLABEL 3ECOND FOROTHERITEMSOFSTOCKITMAYBEPOSSIBLE BUTnot practicalAFRUITSHOP couldLABELEVERYGRAPE BUTTHISISUNLIKELYTOBETHEBESTUSEOFTHESTAFFSSKILLSAND TIME ESPECIALLYSINCEGRAPESARESOLDBYTHEBUNCH RATHERTHANINDIVIDUALLY 4HIRD EVENWHEREIDENTIFYINGTHECOSTISBOTHPOSSIBLEANDPRACTICAL THEOWNERMAY STILLDECIDEITISNOTWORTHTHETIME EFFORTAND PERHAPSMOSTIMPORTANTLY costTOLABEL EVERYITEMOFSTOCK ANDTHENRECORDEACHCODEANDCOSTPRICEINTHEACCOUNTINGRECORDS 4HISAPPEARSTOBETHECASEINTHEEXAMPLE WHERETHEREISNOCODE LABELORMARKERTO IDENTIFYTHECOSTPRICEOFEACHPOT First In, First Out (FIFO)

First In, First Out (FIFO) the assumption that the stock that is purchased first will be sold first

7HERE STOCK IS NOT LABELLED OR MARKED n BECAUSE IT IS IMPOSSIBLE OR IMPRACTICAL OR DEEMEDBYTHEOWNERTOBENOTWORTHTHETIME EFFORTANDCOSTnTHECOSTPRICECANNOT BEIDENTIlED4HEREFORE WHENTHESTOCKISSOLD ANassumptionMUSTBEMADEABOUTITS COSTPRICE5NDERTHEFirst In, First Out (FIFO)ASSUMPTION WEassumeTHATTHESTOCK THATWASPURCHASEDlRSTWILLBESOLDlRST EVENTHOUGHWEHAVENOWAYOFKNOWINGFOR CERTAIN )N THE EXAMPLE PROVIDED &)&/ MEANS THAT FROM THE STOCK STILL ON HAND WE WILL ASSUMETHATTHESEVENPOTSVALUEDATWHICHWEREPURCHASEDlRST WILLBESOLDlRST FOLLOWEDBYTHREEPOTSTOMAKEUPTHEPOTSSOLD ASSUMEDTOBEFROMTHEBATCH 4HISISSHOWNIN&IGURE Figure 8.3

Stock card: FIFO STOCK CARD

Stock item:

Plant pot – terracotta, 60 cm

Location:

Row 16, Bay C3

Stock code:

PTC60

Supplier:

Potty 4 You

IN Date STUDY TIP

/RDERDOESMATTERIN ASTOCKCARD!LWAYS LISTTHEUNITCOSTINTHE "ALANCECOLUMNINTHE ORDERINWHICHTHESTOCK ENTEREDTHEBUSINESS

Details

Aug. 1

Balance

5

Inv. 364

12

Rec. 23

17

Inv. 370

23

Inv. 56

Qty

6

Cost

60

OUT Total

Qty

70

Total

360 3

8

Cost

BALANCE

60

180

560 7

60

420

3

70

210

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Qty

Cost

Total

4

60

240

10

60

600

7

60

420

7

60

420

8

70

560

5

70

350

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171

&)&/MUSTBEAPPLIEDTOALLTRANSACTIONSRECORDEDINTHE/UTCOLUMNINCLUDINGSALES DRAWINGS ADVERTISINGANDSTOCKLOSSES BUTITISANASSUMPTIONONLYITMAYNOTMATCH THEACTUALmOWOFGOODS ANDCUSTOMERSMAYBUYTHEPOTSTHATWEREPURCHASEDMORE RECENTLY RATHERTHANTHOSETHATWERElRSTIN7ITHOUTMARKINGSTOCK THEREISNOWAYOF KNOWINGTHECOSTPRICEOFTHESTOCKTHATHASBEENSOLD MAKING&)&/ANACCEPTABLEAND NECESSARYASSUMPTION

REVIEW QUESTIONS 8.4

1 Explain WHY'34DOESNOTAFFECTTHEVALUATIONOFASTOCKPURCHASE 2 State THEEFFECTONTHEBALANCEOFATRANSACTIONRECORDEDINTHE s )NCOLUMN s /UTCOLUMN 3 Explain WHYTHECOSTPRICEISNOTSHOWNONTHESOURCEDOCUMENTTHATPROVIDES THEEVIDENCEOFASALE 4 Explain HOWTHESTOCKCARDISUSEDTODETERMINETHE#OSTOF3ALESFOREACH TRANSACTION 5 StateTHREEREASONSWHYASMALLBUSINESSMIGHTCHOOSETOVALUEITSSTOCKUSING THE&)&/&IRST)N &IRST/UT ASSUMPTION 6 ExplainTHE&)&/ASSUMPTIONASITAPPLIESTOSTOCKCARDS 7 IdentifyTHREETRANSACTIONSTOWHICHTHE&)&/ASSUMPTIONMUSTBEAPPLIED

8.5

STOCK CARDS AND JOURNALS

%ARLIER WE NOTED THAT THE PRICE ON THE SOURCE DOCUMENT WILL BE THE SELLING PRICE BECAUSETHECOSTPRICEOFTHESTOCKISNOTREVEALEDTOTHECUSTOMER"UTWHENCASHSALES ARERECORDEDINTHE#ASH2ECEIPTS*OURNAL ANDCREDITSALESARERECORDEDINTHE3ALES *OURNAL WE MUST IDENTIFY BOTH THE selling price AND THE cost price 4HIS MAKES THE STOCKCARDSAVITALSOURCEOFINFORMATIONWHENTRANSACTIONSARERECORDEDINTHEJOURNALS BECAUSEITISTHESTOCKCARDSTHATWILLDETERMINETHECOSTPRICEOFEACHSALE The selling price of each sale is detailed on the invoice/receipt. The cost price of each sale is determined in the stock card.

Woolly Good Jumpers has provided the following transactions for July 2015: July 2 5 9

EXAMPLE

Credit sale of 6 jumpers to Noogee: $300 (plus $30 GST) each (Inv. 49) Purchase of 12 jumpers @ $35 (plus $3.50 GST) each (Ch. 142) Cash sale of 10 jumpers for $600 (plus $60 GST) in total (Rec. 23)

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

4HETRANSACTIONSWOULDBERECORDEDINTHESTOCKCARDASSHOWNBELOW STOCK CARD Stock Item:

Woollen jumpers

Location:

Aisle 16

Stock Code:

WJ

Supplier:

Merino Mills

IN Date

Details

July 1

Qty

Cost

OUT Total

Qty

Cost

BALANCE Total

Qty

Balance

2

Inv. 49

5

Ch. 142

9

6 12

35

30

180

420

Rec. 23

2

30

60

8

35

280

Cost

Total

8

30

240

2

30

60

2

30

60

12

35

420

4

35

140

4HESELLINGPRICEOFTHECREDITSALETO.OOGEEON*ULYCANBESEENONTHE SOURCEDOCUMENTn)NVOICEnAS$300PLUS'34 AND FROMTHESTOCKCARD THE COST PRICE HAS BEEN CALCULATED AS  4HIS COST PRICE CAN THEN BE USED WHEN THE TRANSACTIONISRECORDEDINTHE3ALES*OURNAL ASISSHOWNIN&IGURE Figure 8.4

Sales Journal showing Cost of Sales Sales Journal

Date

Debtor

July 2

Noogee

Invoice number

Cost of Sales

49

180

Sales

GST

300

30

Debtors Control 330

3IMILARLY THE RECEIPT FOR THE CASH SALE ON  *ULY  SHOWED THE SELLING PRICE AS $600PLUS'34 BUTITISTHESTOCKCARDTHATHASBEENUSEDTODETERMINETHECOST PRICEOF&)&/HASBEENAPPLIEDTOTHESALE ASSUMINGTHATALLTHEJUMPERSWITHA COSTPRICEOFARESOLDlRST FOLLOWEDBYTHEJUMPERSWITHACOSTPRICEOF4HE SELLINGPRICEANDCASHPRICEWOULDBERECORDEDINTHE#ASH2ECEIPTS*OURNAL ASISSHOWN IN&IGURE Figure 8.5

Cash Receipts Journal showing Cost of Sales Cash Receipts Journal

Date July 9

Details Cash Sales

Receipt Bank number 23

660

Discount Expense

Debtors Cost of Sales Control Sales 340

600

Sundries

GST 60

4HEAMOUNTSINTHE4OTALCOLUMNOFTHE/UTSECTIONOFTHESTOCKCARDREPRESENTTHE COSTPRICEOFTHESALE4HESEAMOUNTSREPRESENTTHEEXPENSEINCURREDWHENTHESTOCK ISSOLD ORTHE#OSTOF3ALES4HEYWILLBERECORDEDINTHE#OSTOF3ALESCOLUMNINTHE SPECIALJOURNALS ANDTHENPOSTEDTOTHE#OSTOF3ALESACCOUNTINTHE'ENERAL,EDGERTO SHOWTHEVALUEOFSTOCKCONSUMEDDURINGEACHMONTH

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REVIEW QUESTIONS 8.5

1 Explain THEIMPORTANCEOFSTOCKCARDSWHENSALESARERECORDEDINTHESPECIAL JOURNALS 2 Explain THE IMPORTANCE OF STOCK CARDS WHEN PURCHASES ARE RECORDED IN THE SPECIALJOURNALS 3 Identify TWO MEANS OF VERIFYING THE AMOUNTS RECORDED IN THE #OST OF 3ALES ACCOUNTINTHE'ENERAL,EDGER

8.6

THE PHYSICAL STOCKTAKE

"ECAUSETHESTOCKCARDSAREUPDATEDAFTEREVERYTRANSACTION THEYPROVIDEACONTINUOUS ORPERPETUAL RECORDOFSTOCKONHAND4HATIS ATANYSTAGE THENUMBEROFUNITSSHOWNIN THE"ALANCECOLUMNSHOULDREmECTTHEQUANTITYOFSTOCKONHANDINTHESHOP SHOWROOM OR WAREHOUSE (OWEVER JUST BECAUSE THE STOCK CARD says THERE SHOULD BE A CERTAIN NUMBEROFITEMSONHANDDOESNOTMEANTHISWILLBETHECASE4HEREFORE THENUMBER OFUNITSONHANDSHOULDBECHECKEDPERIODICALLYBYCONDUCTINGAPHYSICALstocktake! STOCKTAKEINVOLVESAPHYSICALCOUNTOFTHENUMBEROFUNITSOFEACHLINEOFSTOCKONHAND 4HISCOUNTCANTHENBECOMPAREDAGAINSTTHEBALANCESINTHESTOCKCARDSTOCHECKTHEIR ACCURACY ANDDETECTANYSTOCKLOSSESORGAINS

stocktake a physical count of the number of units of each line of stock on hand

A stocktake involves a physical count of the number of units of each line of stock on hand

STUDY TIP

The role of the stocktake is to verify the accuracy of the stock cards and, in the process, detect any stock losses and Stock Gains. !LTHOUGHTHESTOCKTAKECANBEDONEATANYTIME ITISATIME CONSUMINGANDCOSTLY PROCESS!SACONSEQUENCE ASTOCKTAKEISLIKELYTOBEDONEONLYINFREQUENTLY!TTHEVERY LEAST THISWOULDBEATTHEENDOFTHE2EPORTING0ERIOD

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

)FTHESTOCKTAKEAND STOCKCARDSDIFFER ASSUMETHESTOCKTAKE ISCORRECT

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174

UNITS 3&4

REVIEW QUESTIONS 8.6

1 Define THETERM@STOCKTAKE 2 Explain THEROLEOFASTOCKTAKE

8.7 stock loss an expense incurred when the stocktake shows a figure for stock on hand that is less than the balance shown in the stock card

STOCK LOSSES

7HENEVERTHENUMBEROFUNITSCOUNTEDATSTOCKTAKEISlessTHANTHEQUANTITYSHOWNIN THEBALANCEOFTHESTOCKCARD Astock lossHASOCCURRED4HISMAYBEFORAVARIETYOF REASONS INCLUDING s THEFT s DAMAGEBREAKAGES s UNDERSUPPLY FROM A SUPPLIER n A SUPPLIER HAS DELIVERED LESS STOCK THAN HAS BEEN CHARGEDFOR s OVERSUPPLYTOACUSTOMERnSTOCKHASBEENSUPPLIEDTOCUSTOMERSINEXCESSOFWHAT THEYHAVEBEENCHARGEDFOR

Whenever the number of units counted at stocktake is less than the quantity shown in the balance of the stock card, a stock loss has occurred. This may be for a variety of reasons, including damage/breakages.

Recording a stock loss !STOCKLOSSMEANSTHATTHEREISLESSSTOCKAVAILABLEFORSALETHANISCURRENTLYSHOWNINTHE STOCKCARDAND3TOCK#ONTROLACCOUNT SOTHEQUANTITYMISSINGORLOST MUSTBERECORDED INTHE/UTCOLUMNOFTHESTOCKCARD ANDASACREDITINTHE3TOCK#ONTROLACCOUNT)N ADDITION THE3TOCK,OSSITSELFISANEXPENSEANOUTmOWOFANECONOMICBENElT3TOCK IN THE FORM OF A DECREASE IN ASSETS 3TOCK #ONTROL LEADING TO A DECREASE IN OWNERS EQUITY4HISMUSTALSOBESHOWNINTHELEDGER

EXAMPLE

On 31 August 2015, the stocktake showed 3 terracotta pots on hand (Memo 19). Comparing this figure against the balance on the stock card (5 pots on hand) revealed a stock loss of 2 pots.

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ACCOUNTING FOR STOCK

175

4HISSTOCKLOSSWOULDBERECORDEDINTHE/UTCOLUMNOFTHESTOCKCARD ASSHOWNIN &IGURE Figure 8.6

Stock card: stock loss STOCK CARD

Stock item:

Plant pot – terracotta, 60 cm

Location:

Row 16, Bay C3

Stock code:

PTC60

Supplier:

Potty 4 You

IN Date

Details

Aug. 1

Balance

5

Inv. 364

12

Rec. 23

17

Inv. 370

23

31

Qty

6

Cost

60

OUT Total

Qty

70

Total

360 3

8

Cost

BALANCE

60

180

560

Inv. 56

Memo 19

Qty

Cost

Total

4

60

240

10

60

600

7

60

420

7

60

420

8

70

560

7

60

420

3

70

210

5

70

350

2

70

140

3

70

210

STUDY TIP

&)&/MUSTAPPLYTO STOCKLOSSJUSTAS ITAPPLIESTOSALES 3HOULDMORETHANONE COSTPRICEBELISTED INTHESTOCKCARD THE EARLIESTSTOCKSHOULDBE ASSUMEDTOBELOST

4HENEWBALANCEINTHESTOCKCARDnPOTSnISTHESAMEASTHESTOCKTAKE 4HEMEMONOTEDTHENUMBEROFUNITSONHAND ANDTHUSTHENUMBEROFUNITSMISSING BUTITISTHESTOCKCARDTHATPUTSAVALUEONTHOSEITEMSINTHISCASE  ALLOWINGIT TOBERECORDEDINTHELEDGERACCOUNTS4HISISDONEBYCREATINGA3TOCK,OSSEXPENSE ACCOUNT ANDDECREASINGTHEBALANCEOFSTOCKONHANDBYCREDITINGTHE3TOCK#ONTROL ACCOUNT4HE'ENERAL*OURNALENTRYTOADJUSTTHELEDGERACCOUNTSISSHOWNIN&IGURE Figure 8.7

General Journal: recording a stock loss General Journal General Ledger

Date Aug. 31

Details Stock Loss Stock Control

Debit

Credit

Subsidiary ledger Debit

Credit

140 140

Stocktake revealed stock loss of 2 pots – PTC60 (Memo 19)

4HENARRATIONHEREISQUITEDETAILED IDENTIFYINGTHESPECIlCSTOCKLINEINVOLVEDINTHIS CASE USINGTHEPRODUCTCODEn04# ANDTHEQUANTITYOFPOTSLOST )NTHECASEOF RECORDINGSTOCKLOSSESFORANUMBEROFDIFFERENTLINESOFSTOCK THISLEVELOFDETAILWOULD BEIMPOSSIBLETOINCLUDE#ONSEQUENTLY ITISTHESOURCEDOCUMENT-EMO THATIS MOSTIMPORTANTTOINCLUDEINTHENARRATION ASITWOULDCONTAINALLTHENECESSARYDETAILS RECORDEDINTHESTOCKCARDS 4HE'ENERAL*OURNALENTRYFORTHESTOCKLOSSWOULDBEPOSTEDTOTHE'ENERAL,EDGER ASSHOWNIN&IGURE

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176

Figure 8.8

UNITS 3&4

General Ledger: stock loss General Ledger Stock Control (A)

Date

Cross-reference

Aug. 1 31

Amount $

Date

Balance

4 900

Aug. 31

Bank Creditors Control

Cross-reference

Amount $

Cost of Sales

3 500

1 500

Cost of Sales

2 200

3 700

Drawings

100

Stock Loss

140

Stock Loss (E) Date

Cross-reference

Aug. 31

Amount $

Stock Control

Date

Cross-reference

Amount $

140

Effect on the accounting equation 4HEEFFECTOFASTOCKLOSSONTHEACCOUNTINGEQUATIONIS Increase/Decrease/No effect

Amount $

Assets

Decrease (Stock Control)

Liabilities

No effect

Owner’s Equity

Decrease (Stock Loss expense decreases Net Profit)

140

140

REVIEW QUESTIONS 8.7

1 2 3 4 5 stock gain a revenue earned when the stocktake shows a figure for stock on hand that is more than the balance shown in the stock card

STUDY TIP

3TOCKGAINISAGOOD REMINDERTHATREVENUE DOESNOTNEEDTOBE CASHINTHISCASE STOCK ISTHEASSETTHATHAS INCREASED WITHNO EFFECTONCASH

8.8

Explain WHYASTOCKLOSSISCLASSIlEDASANEXPENSE Identify THREEREASONSFORASTOCKLOSS ExplainHOWTHECOSTPRICEOFASTOCKLOSSISDETERMINED ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDASTOCKLOSS StateTHEEFFECTOFASTOCKLOSSONTHEACCOUNTINGEQUATION

STOCK GAINS

7HERETHENUMBEROFUNITSCOUNTEDBYTHESTOCKTAKEISmoreTHANTHEQUANTITYSHOWNIN THEBALANCEOFTHESTOCKCARD Astock gain HASOCCURRED4HISMAYBEDUETO s oversupply from a suppliernASUPPLIERHASSENTUSSTOCKFORWHICHWEHAVENOTBEEN CHARGED s undersupply to a customer nWEHAVECHARGEDACUSTOMERFORSTOCKTHATWEHAVENOT DELIVEREDANDTHECUSTOMERHASNOTREALISED 

Recording a stock gain !STOCKGAINMEANSTHATTHEREISMORESTOCKAVAILABLEFORSALETHANISCURRENTLYSHOWNIN THESTOCKCARDAND3TOCK#ONTROLACCOUNT SOTHEQUANTITYGAINEDMUSTBERECORDEDIN THE)NCOLUMNOFTHESTOCKCARD ANDASADEBITINTHE3TOCK#ONTROLACCOUNT)NADDITION THESTOCKGAINITSELFISAREVENUEITEMnANINmOWOFANECONOMICBENElTMORESTOCK IN THEFORMOFANINCREASEINASSETS3TOCK#ONTROL LEADINGTOANINCREASEINOWNERSEQUITY ANDTHISMUSTALSOBESHOWNINTHELEDGER

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CHAPTER 8

ACCOUNTING FOR STOCK

177

EXAMPLE

On 31 October 2015, the stocktake revealed 35 pairs of gardening gloves on hand (Memo 31). The stock card for gloves showed a balance of 27 pairs, so a stock gain of eight pairs was detected.

4HISSTOCKGAINWOULDBERECORDEDINTHE)NCOLUMNOFTHESTOCKCARD ASSHOWNIN &IGURE Figure 8.9

Stock card: stock gain STOCK CARD

Stock item: Stock code:

Gardening Gloves G10

Location: Supplier: IN

Date

Details

Oct. 1

Balance

Oct. 15

Inv. 30A

Oct. 23 Oct. 31

Qty

30

Cost

12

OUT Total

8

12

Qty

Cost

BALANCE Total

360

Rec. 30 Memo 31

Row 21, Bay A5 Amsten Products

22

10

220

3

12

36

96

Qty

Cost

Total

22

10

220

22

10

220

30

12

360

27

12

324

35

12

420

)NORDERTOSATISFYTHEDEMANDSOFConservatism ANYSTOCKTHATMUSTBEPUTBACK INTOTHESTOCKCARDMUSTBEVALUEDATTHElowest cost price still on hand4HISENSURES THEASSET3TOCK#ONTROL ANDTHEREVENUESTOCKGAIN ARENOTOVERSTATED)NTHISCASE THELOWESTCOSTPRICESTILLONHANDIS SOTHESTOCKGAINOFEIGHTPAIRSISVALUEDAT INTOTAL4HISLEAVESTHEBALANCEOFSTOCKONHANDASPAIRSASWASDETECTEDINTHE STOCKTAKE EACHWORTH FORATOTALVALUEOF )NTHE'ENERAL*OURNAL THEBALANCEOF3TOCK#ONTROLISINCREASEDVIAADEBITENTRY TOTHATACCOUNT ANDASTOCKGAINREVENUEACCOUNTISCREATEDVIAACREDITENTRY4HISIS SHOWNIN&IGURE Figure 8.10

STUDY TIP

&ORASTOCKGAIN STOCK SHOULDBEVALUEDATTHE LOWESTCOSTPRICESTILL ONHAND

General Journal: stock gain General Journal General Ledger

Date Oct. 31

Details Stock Control stock gain

Debit

Credit

Subsidiary ledger Debit

Credit

96 96

Stocktake revealed stock gain of 8 pairs of gloves – G10 (Memo 31)

4HE'ENERAL*OURNALENTRYFORTHESTOCKGAINWOULDBEPOSTEDTOTHE'ENERAL,EDGER ASSHOWNIN&IGURE

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178

Figure 8.11

UNITS 3&4

General Ledger: stock gain General Ledger Stock Control (A)

Date

Cross-reference

Oct. 1 31

Amount $

Date

Balance

4 300

Oct. 31

Bank

1 700

Creditors Control

3 900

stock gain

Cross-reference

Amount $

Cost of Sales

3 800

Cost of Sales

1 900

96 Stock Gain (R)

Date

Cross-reference

Amount $

Date Oct. 31

Cross-reference

Amount $

Stock Control

96

Effect on the accounting equation 4HEEFFECTOFASTOCKGAINONTHEACCOUNTINGEQUATIONISTHUS Increase/Decrease/No effect

Amount $

Assets

Increase (Stock Control)

Liabilities

No effect

Owner’s Equity

Increase (stock gain revenue increases Net Profit)

96

96

REVIEW QUESTIONS 8.8

1 2 3 4 5

8.9

ExplainWHYASTOCKGAINISCLASSIlEDASREVENUE IdentifyTWOREASONSFORASTOCKGAIN ExplainHOWTHECOSTPRICEOFASTOCKGAINISDETERMINED ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDASTOCKGAIN StateTHEEFFECTOFASTOCKGAINONTHEACCOUNTINGEQUATION

USE OF STOCK FOR ADVERTISING PURPOSES

/NElNALTRANSACTIONTHATMAYAFFECTBOTHTHESTOCKCARDSANDTHE3TOCK#ONTROLACCOUNT ISWHERESTOCKISUSEDFORADVERTISINGPURPOSES3OMETIMESSTOCKCANBETAKENOUTOFTHE STORETOBEUSEDFORDISPLAYPURPOSES ANDSMALLBUSINESSESFREQUENTLYDONATESTOCKTO LOCALCOMMUNITYORGANISATIONSSUCHASSCHOOLS CHURCHGROUPSORCHARITIES WHOUSETHE STOCKASPRIZESINRAFmESORFUNDRAISINGEVENTS)NEITHERCASE THEBUSINESSDONATINGTHE STOCKCANLEGITIMATELYCLAIMTHATTHESTOCKHASBEENUSEDFORTHEPURPOSEOFADVERTISING )FSTOCKISUSEDFORTHISPURPOSEITMUSTBERECORDEDINTHE/UTCOLUMNOFTHESTOCK CARD ANDASANEXPENSEANDAREDUCTIONIN3TOCK#ONTROLINTHE'ENERAL,EDGER

EXAMPLE

On 15 August 2015, 3 wheelbarrows were donated to the local fete (Memo 16).

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CHAPTER 8

ACCOUNTING FOR STOCK

4HISUSEOFSTOCKFORADVERTISINGPURPOSESWOULDBERECORDEDINTHE/UTCOLUMNOF THESTOCKCARD ASSHOWNIN&IGURE Figure 8.12

Stock card: advertising STOCK CARD

Stock Item: Stock Code:

Wheelbarrows FD100

Location: Supplier: IN

Date

Aug. 1 15

Details

Qty

Cost

Store room Nickwell

OUT Total

Qty

Cost

BALANCE Total

Qty

Cost

Total

2

80

160

10

95

950

9

95

855

Balance Memo 16

2

80

160

1

95

95

!SITISRECORDEDINTHE/UTCOLUMN THESTOCKUSEDFORADVERTISINGISVALUEDACCORDING TO&)&/JUSTLIKEASALE DRAWINGSORSTOCKLOSS SOTWOOFTHEWHEELBARROWSAREVALUED ATEACH BEFOREONEVALUEDAT )N THE 'ENERAL *OURNAL THE BALANCE OF 3TOCK #ONTROL DECREASES VIA A CREDIT ENTRY TOTHATACCOUNT AND!DVERTISINGEXPENSEINCREASESVIAADEBITENTRY4HISISSHOWNIN &IGURE Figure 8.13

General Journal: advertising General Journal General Ledger

Date Aug. 15

Details

Debit

Advertising

Credit

Subsidiary ledger Debit

Credit

255

Stock Control

255

3 wheelbarrows donated to local fete (Memo 16)

4HE'ENERAL*OURNALENTRYFORADVERTISINGWOULDBEPOSTEDTOTHE'ENERAL,EDGER AS SHOWNIN&IGURE Figure 8.14

General Ledger: advertising General Ledger Stock Control (A)

Date Aug. 1 31

Cross-reference Balance Bank Creditors Control

Amount $

Date

10 000

Aug. 31

3 200 19 800

Cross-reference

Amount $

Cost of Sales

8 500

Cost of Sales

4 900

Advertising

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255

Cambridge University Press

179

180

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

Advertising (E) Date

Cross-reference

Aug. 31

Amount $

Bank

480

Stock Control

255

Date

Cross-reference

Amount $

!LTHOUGHTHETRANSACTIONWASRECORDEDINTHE'ENERAL*OURNALONTHEDAYTHESTOCK WASDONATED!UGUST THE'ENERAL*OURNALISNOTPOSTEDTOTHE'ENERAL,EDGER UNTILTHEENDOFTHEMONTH!UGUST  Effect on the accounting equation 4HEEFFECTOFSTOCKUSEDFORADVERTISINGPURPOSESONTHEACCOUNTINGEQUATIONISTHUS Increase/Decrease/No effect

Amount $

Assets

Decrease (Stock Control)

Liabilities

No effect

Owner’s Equity

Decrease (Advertising expense decreases Net Profit)

255

255

REVIEW QUESTIONS 8.9

1 2 3 4

StateTWOREASONSWHYASMALLBUSINESSMAYUSESTOCKFORADVERTISINGPURPOSES ExplainWHYSTOCKUSEDFORADVERTISINGPURPOSESISCLASSIlEDASANEXPENSE ExplainHOWTHECOSTOFSTOCKUSEDFORADVERTISINGPURPOSESISDETERMINED Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO RECORD STOCK USED FOR ADVERTISINGPURPOSES 5 State THE EFFECT OF STOCK USED FOR ADVERTISING PURPOSES ON THE ACCOUNTING EQUATION

8.10 STOCK AND INFORMATION FLOWS &IGURESANDSUMMARISETHEWAYINFORMATIONABOUTSTOCKTRANSACTIONSmOWS THROUGHTHEACCOUNTINGSYSTEM Figure 8.15

Purchases: In column

Credit purchase Purchase invoice

Purchases Journal

General Ledger

Stock card

Creditors Ledger

Cash Payments Journal

General Ledger

Cash purchase

Cheque butt

Stock card

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CHAPTER 8

Figure 8.16

ACCOUNTING FOR STOCK

181

Sales: Out column

Credit sale

Sales invoice

(Selling price)

Sales Journal

General Ledger

Stock card (cost price)

Debtors Ledger

Cash sale

Cash receipt

(Selling price)

Cash Receipts Journal

General Ledger

General Journal

General Ledger

Stock card (cost price)

Drawings, stock losses/gains and advertising

Memo

Stock card

8.11 REPORTING FOR STOCK /NCESTOCKTRANSACTIONSAREENTEREDINTHESTOCKCARDSANDRECORDEDINTHEJOURNALS THE JOURNALSMUSTBEPOSTEDTOTHELEDGERACCOUNTS!TTHISPOINT THELEDGERACCOUNTSWILL CONTAINALLTHEINFORMATIONTHATISNECESSARYTOPREPAREREPORTS

Balance Sheet 2ELEVANCESAYSTHATTHEREISLITTLEPOINTINIDENTIFYINGTHEQUANTITYOFEVERYLINEOFSTOCK IN THE "ALANCE 3HEET AS THIS LEVEL OF DETAIL WILL NOT AFFECT DECISION MAKING 4HE ONLY ITEMSPECIlCTOSTOCKTHATMUSTBEREPORTEDINTHE"ALANCE3HEETIS3TOCK#ONTROL4HE BALANCEOFTHIS'ENERAL,EDGERACCOUNTMUSTBEREPORTEDASACURRENTASSETASTHESTOCK ISARESOURCECONTROLLEDBYTHEBUSINESSTHATISEXPECTEDTOPROVIDEAFUTUREECONOMIC BENElTINTHENEXTMONTHSWHENITISSOLD 

Income Statement 4HE MAIN REASON ANY BUSINESS EXISTS IS TO GENERATE PROlTS FOR ITS OWNER 4HE )NCOME 3TATEMENTDETAILSTHATPROlTBYREPORTINGREVENUESANDEXPENSES3OHOWDOESSTOCK AFFECTTHEREPORT Sales revenue 1 3ALESOFSTOCKWILLBETHEMAINSOURCEOFREVENUEFORATRADINGlRM ANDTHIS WILLBERECORDEDINTHEJOURNALSANDSHOWNASTHEBALANCEOFTHE3ALESACCOUNTINTHE 'ENERAL,EDGER)TISIMPORTANTTONOTETHAT3ALESREVENUEMUSTBEREPORTEDSEPARATELY TO/THER2EVENUES SUCHASDISCOUNTREVENUE WHICHDONOTRELATESPECIlCALLYTOSTOCK

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182

UNITS 3&4

Cost of Goods Sold

Cost of Goods Sold (COGS) all costs incurred in getting stock into a condition and location ready for sale

2 !SWASEXPLAINEDEARLIERINTHISCHAPTER THESTOCKCARDSARENECESSARYTOCALCULATE THECOSTPRICEOFEACHSALE ANDTHISINFORMATIONISTHENRECORDEDINTHEAPPROPRIATE SPECIALJOURNALBEFOREITISPOSTEDTOTHE#OSTOF3ALESACCOUNT4HISACCOUNTRECORDS THEEXPENSEINCURREDWHENSTOCKISSOLDOR INTHEPARLANCEOFTHEDElNITION CONSUMED 3PECIlCALLY ITISTHESUPPLIERSPRICEFORTHEGOODSTHATWERESOLD(OWEVER #OSTOF 3ALESMAYBEONLYONEOFANUMBEROFEXPENSESRELATEDTOSTOCK ASOTHERCOSTSMAY HAVEBEENINCURREDBEFORETHESTOCKWASREADYFORSALE4HETERMCost of Goods Sold (COGS)ISUSEDTODESCRIBEallCOSTSINCURREDINGETTINGGOODSINTOACONDITION ANDLOCATIONREADYFORSALE WITH#OSTOF3ALESSIMPLYONEOFTHEITEMSTHATMAYBE REPORTEDUNDERTHISHEADING%XPENSESSUCHAS#USTOMS$UTYAND&REIGHT)NAREALSO PARTOFTHETOTAL#/'3 WHICHMUSTBEDEDUCTEDFROM3ALESREVENUETODETERMINE 'ROSS0ROlT Gross Profit 3 )NMATHEMATICALTERMS 'ROSS0ROlTISTHEDIFFERENCEBETWEENTHE3ALESREVENUEAND #OSTOF'OODS3OLD"ECAUSE'ROSS0ROlTEXPRESSESTHERELATIONSHIPBETWEENTHE lRMSSELLINGANDCOSTPRICES ITISIMPORTANTTHATTHISlGUREISIDENTIlEDWITHITSOWN HEADING TOALLOWTHEOWNERTOASSESSTHEADEQUACYOFTHEIRMARK UP Adjusted Gross Profit 4 !NYSTOCKLOSSMUSTBEDEDUCTEDFROM'ROSS0ROlTTOSHOW!DJUSTED'ROSS0ROlT WHILEANYSTOCKGAINWOULDBEADDED)SOLATINGTHESTOCKLOSSORGAINBRINGSITTOTHE ATTENTIONOFTHEOWNERSOTHATSTRATEGIESMAYBEDEVELOPEDTOADDRESSANYPROBLEMS THATAREIDENTIlED ! STANDARD )NCOME 3TATEMENT FOR A TRADING lRM WOULD BE SIMILAR TO THE ONE SHOWNIN&IGURE Figure 8.17

Income Statement showing Gross Profit and Adjusted Gross Profit MARCONI ELECTRONIC PRODUCTS Income Statement (extract) for August 2015

Revenue

$

Sales

$ 30 000

Less Cost of Goods Sold2

STUDY TIP

Cost of Sales

17 000

Customs Duty

2 000

Freight In/Delivery from Suppliers

1 000

Gross Profit3 Less Stock Loss

$ISCOUNTREVENUEIS NOTREPORTEDHERE ASITISEARNEDNOTBY SELLINGSTOCKBUTBY PAYINGCREDITORSEARLY 4HESAMEAPPLIESTO DISCOUNTEXPENSE ITAFFECTSTHEAMOUNT PAID NOTTHEAMOUNT INCURREDFORSTOCK

Adjusted Gross Profit4

10 000 500 9 500

4HISISOBVIOUSLYNOTACOMPLETE)NCOME3TATEMENT ASITDOESNOTSHOWANYOTHER @GARDENVARIETYEXPENSES SUCHASWAGES RENTORADVERTISING ANDITDOESNOTSHOW.ET 0ROlT4HESEWILLBECOVEREDIN#HAPTERWHENTHE)NCOME3TATEMENTISADDRESSEDIN DETAIL (OWEVER THIS TOP SECTION OF THE )NCOME 3TATEMENT SOMETIMES REFERRED TO AS A 4RADING3TATEMENT DETAILSTHEEFFECTOFSTOCKTRANSACTIONSONPROlT ANDTHISINFORMATION ISVITALTORUNNINGASUCCESSFULTRADINGBUSINESS

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CHAPTER 8

ACCOUNTING FOR STOCK

183

REVIEW QUESTIONS 8.11

1 2 3 4

DefineTHETERM@#OSTOF'OODS3OLD StateTWOREASONSWHY#OSTOF'OODS3OLDMAYBEGREATERTHAN#OSTOF3ALES ExplainWHYITISIMPORTANTTOIDENTIFY'ROSS0ROlTINTHE)NCOME3TATEMENT Explain WHY IT IS IMPORTANT TO IDENTIFY !DJUSTED 'ROSS 0ROlT IN THE )NCOME 3TATEMENT

8.12 BENEFITS OF THE PERPETUAL SYSTEM 4HESTOCKRECORDINGSYSTEMNOWCONSISTSOFSTOCKCARDS A3TOCK#ONTROLACCOUNTINTHE 'ENERAL,EDGER ANDAPHYSICALSTOCKTAKETHESEARETHEKEYELEMENTSOFWHATISKNOWNAS THEperpetual system of stock recording4HEPERPETUALORCONTINUOUS SYSTEMINVOLVES RECORDINGINDIVIDUALSTOCKTRANSACTIONSINSTOCKCARDSASTHEYOCCUR THENCONDUCTINGA PHYSICALSTOCKTAKEATTHEENDOFTHE2EPORTING0ERIODTOVERIFYTHEBALANCESOFTHOSE STOCKCARDS)NTHEPROCESS ANYSTOCKLOSSESORGAINSWILLBEDETECTED 4HEKEYBENElTSOFADOPTINGAPERPETUALSYSTEMFORRECORDINGSTOCKTRANSACTIONSARE ASFOLLOWS s Reordering of stock is assisted by maintaining a continuous record of the number of units of stock on hand.7ITHOUTACONTINUOUSRECORDOFSTOCKAVAILABLEFORSALE IT ISPOSSIBLETHATTHEONLYWAYTHEBUSINESSWILLKNOWTHATITNEEDSTOREORDERSTOCK IS WHEN THE CUSTOMERS OR STAFF NOTICE THAT THE SHELVES ARE EMPTY 4HIS COULD BE DISASTROUSINTERMSOFLOSTSALES s Stock losses and gains can be detected by comparing the balances of the stock cards against the physical stocktake.4HESTOCKCARDSSTATEWHATSHOULDBEINSTOCK THESTOCKTAKESTATESWHATACTUALLYISONHAND!NYDISCREPANCYMEANSASTOCKLOSSOR GAIN s Fast and slow moving lines of stock can be identified so that stock can be rotated or the stock mix adjusted."YEXAMININGTHEFREQUENCYOFSALESRECORDEDINTHE/UT COLUMN OF EACH STOCK CARD THE OWNER CAN IDENTIFY WHICH LINES ARE SELLING WELL OR NOTSOWELL 3TOCKLINESCANTHENBEMOVEDWITHINTHESHOP ORTHESTOCKMIXTHE KINDANDPROPORTIONSOFSTOCKONHAND CANBEADJUSTEDTOSTOCKMOREKINDSOFHIGH SELLINGSTOCKANDLESSOFTHESTOCKTHATISNOTSELLING 

perpetual system of stock recording recording stock transactions in stock cards, then conducting a physical stocktake at the end of the Reporting Period to verify the balances of those stock cards

REVIEW QUESTIONS 8.12

1 Explain THEOPERATIONOFTHEPERPETUALSYSTEMOFSTOCKRECORDING 2 ExplainTHEBENElTSOFTHEPERPETUALSYSTEMOFSTOCKRECORDING

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CAMBRIDGE VCE ACCOUNTING

184

UNITS 3&4

WHERE HAVE WE BEEN? s 3TOCKISDElNEDASGOODSHELDBYATRADINGlRMFORTHEPURPOSEOFRESALE s 3TOCKISOFPARAMOUNTIMPORTANCETOATRADINGlRM ASITISITSMAINSOURCEOFREVENUE ANDONEOFITSMOSTSIGNIlCANTASSETS s 4HE 3TOCK #ONTROL ACCOUNT SUMMARISES ALL STOCK TRANSACTIONS STOCK CARDS DETAIL INDIVIDUALTRANSACTIONSAFFECTINGEACHLINEOFSTOCK s &IRST)N &IRST/UT&)&/ ASSUMESTHATSTOCKTHATISPURCHASEDlRSTWILLBESOLDlRST s 3TOCKCARDSAREUSEDTODETERMINETHECOSTPRICEOFSALESTHE#OSTOF3ALES ASTHE SOURCEDOCUMENTSWILLONLYSHOWTHESELLINGPRICE s !PHYSICALSTOCKTAKEISCONDUCTEDATTHEENDOFTHE2EPORTING0ERIODTOVERIFYTHE BALANCESINTHESTOCKCARDSAND INTHEPROCESS DETECTANYSTOCKLOSSESORGAINS s 4HE )NCOME 3TATEMENT REPORTS FOR STOCK BY IDENTIFYING BOTH 'ROSS 0ROlT AND ADJUSTED'ROSS0ROlT

EXERCISES

EXERCISE 8.1 STOCK CARDS: CONSTANT COST PRICES

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page 146

-ARKS -ATTRESSES COMMENCED /CTOBER  WITH THE FOLLOWING STOCK FOR 3UPER 3OFT MATTRESSES No. of units

Cost

Total

60

$130

$7 800

$URINGTHATMONTHTHEFOLLOWINGTRANSACTIONSTOOKPLACE Oct.

4

Purchased 25 mattresses at $130 (plus $13 GST) each (Chq. 567)

6

Sold 20 mattresses for $200 (plus $20 GST) each (Rec. 62)

12

Purchased 30 mattresses at $130 (plus GST) each (Chq. 577)

18

Sold 40 mattresses for $200 (plus GST) each (Rec. 64)

20

Purchased 20 mattresses at $143 (including $13 GST) each (Chq. 580)

31

Sold 30 mattresses for $220 (including GST) each (Rec. 68)

Required a RecordTHETRANSACTIONSFOR/CTOBERINTHESTOCKCARDFOR3UPER3OFTMATTRESSES b CalculateTHEVALUEOF3UPER3OFTMATTRESSESONHANDASAT/CTOBER c State WHY YOUR ANSWER TO PART @B IS UNLIKELY TO BE THE AMOUNT REPORTED IN THE "ALANCE3HEETFOR-ARKS-ATTRESSESASAT/CTOBER d CalculateTHE#OSTOF3ALESOF3UPER3OFTMATTRESSESFOR/CTOBER e ExplainTHEIMPACTOF'34ONTHERECORDINGOFTRANSACTIONSINTHESTOCKCARDS

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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CHAPTER 8

ACCOUNTING FOR STOCK

EXERCISE 8.2 FIRST IN, FIRST OUT

W B

page 147

$ARRENS$ESKSSUPPLIESOFlCESANDHOMESWITHSOLIDWOODDESKS$ARRENSMOSTPOPULAR BRANDISTHE%XECUTIVE/N-ARCH THEBUSINESSHADTHEFOLLOWINGSTOCK ONHAND

Executive 1000 Desk

Quantity

Cost

Total

4

$290

$1 160

15

300

4 500

10

320

3 200

$URING-ARCH $ARRENS$ESKSSOLDDESKSFORPLUS'34 EACH Required a CalculateTHE#OSTOF3ALESOF%XECUTIVEDESKSFOR-ARCHUSING&)&/ b 2EFERRINGTOYOURANSWERTOPART@A explainTHEAPPLICATIONOFTHE&)&/METHODOF STOCKVALUATION c Calculate'ROSS0ROlTON%XECUTIVEDESKSFOR-ARCH d CalculateTHEVALUEOF%XECUTIVEDESKSONHANDASAT-ARCH

EXERCISE 8.3 STOCK CARDS: CHANGING COST PRICES

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page 148

#ASEYS #ABINETS COMMENCED -AY  WITH THE FOLLOWING STOCK OF GLASS FRONTED CABINETS No. of units

Cost

Total

40

$240

$9 600

$URING-AYTHEFOLLOWINGTRANSACTIONSTOOKPLACE May

2

Purchased 20 cabinets for $240 (plus $24 GST) each (Inv. 745)

4

Sold 35 cabinets at a selling price of $500 (plus $50 GST) each (Rec. 76)

7

Casey took from stock 2 cabinets to give to her niece (Memo 34)

19

Purchased 25 cabinets at $250 (plus GST) each (Inv. 758)

24

Purchased 30 cabinets at $286 (including GST) each (Inv. 786)

31

Sold 15 cabinets at a selling price of $550 (including GST) (Rec. 86)

Required a b c d e f

RecordTHETRANSACTIONSFOR-AYINTHESTOCKCARDFORGLASS FRONTEDCABINETS ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORD-EMO ShowHOW)NVOICEWOULDBERECORDEDINTHE3ALES*OURNAL CalculateTHEVALUEOFGLASS FRONTEDCABINETSONHANDASAT-AY CalculateTHE#OSTOF3ALESOFGLASS FRONTEDCABINETSFOR-AY ExplainHOWTHE&)&/METHODOFSTOCKVALUATIONCANOVERSTATETHEVALUEOFSTOCK ONHAND

EXERCISE 8.4 STOCK CARDS: CHANGING COST PRICES

W B

page 150

/N*ANUARY %CLIPSE4RADINGHADWORTHOFPICTUREFRAMESONHAND4HIS WASMADEUPOFFRAMESATANDFRAMESAT4HEFRAMESVALUEDAT EACHHADBEENPURCHASEDlRST

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Cambridge University Press

185

186

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

$URING*ANUARYTHEFOLLOWINGTRANSACTIONSOCCURRED Jan.

3

Purchased 100 frames at $50 (plus GST of $5) each (Ch. 243)

8

Sold 900 frames at $100 (plus GST of $10) each (Inv. 44)

12

Sold 400 frames at $110 (including GST of $10) each (Rec. 68)

16

Took 10 frames from stock to be used in a display at the local shopping

20

Purchased 200 frames at $60 (plus GST) each (Inv. A10)

22

Sold 300 frames at $110 (including GST) each (Inv. 49)

31

Purchased 250 frames at $77 (including GST) each (Inv. 990)

centre (Memo 14)

Required a b c d e f

RecordTHETRANSACTIONSFOR*ANUARYINTHESTOCKCARDFORFRAMES ShowHOW2ECEIPTWOULDBERECORDEDINTHE#ASH2ECEIPTS*OURNAL ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORD-EMO CalculateTHE#OSTOF3ALESFORFRAMESFOR*ANUARY Calculate'ROSS0ROlTONFRAMESFOR*ANUARY ExplainTHEIMPACTOF&)&/ON#OSTOF3ALESAND.ET0ROlTINTIMESOFRISINGPRICES

EXERCISE 8.5 FIFO AND STOCK LOSS

W B

page 152

&0%LECTRICALSPECIALISESINTHESALEOFDISHWASHERSFORSMALLRESTAURANTS)TSMOSTPOPULAR LINEOFSTOCKISTHE&0!STOCKCARDFORTHEDISHWASHERISMAINTAINEDUNDERTHE &)&/ASSUMPTION/N*ANUARY THElRMHADTHEFOLLOWINGSTOCKONHAND

FP 2000 dishwashers

Quantity

Cost price

Total

6

$600

$3 600

15

620

9 300

3

650

1 950

$URING*ANUARY NODISHWASHERSWEREPURCHASED BUTUNITSOFTHE&0 MODELWERESOLD!STOCKTAKEON*ANUARYSHOWEDASTOCKLOSSOFONEDISHWASHER -EMO  Required a b c d e

ExplainTHEROLEOFSTOCKCARDSINANACCOUNTINGSYSTEM 2EFERRINGTOONEQUALITATIVECHARACTERISTIC explainTHEROLEOFAPHYSICALSTOCKTAKE !PARTFROMTHEFT suggestTWOPOSSIBLEREASONSFORTHESTOCKLOSSOFONEDISHWASHER ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORD-EMO Explain THE EFFECT OF THE STOCK LOSS ON THE "ALANCE 3HEET OF &0 %LECTRICAL AS AT *ANUARY

EXERCISE 8.6 STOCK CARDS AND STOCK LOSSES/GAINS

W B

page 153

/N-ARCH #LINNICK-USICHADONHANDTHEFOLLOWINGSTOCKOF-0PLAYERS Quantity

Cost

Total

14

$80

$1 120

7

90

630

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Cambridge University Press

CHAPTER 8

ACCOUNTING FOR STOCK

$URING-ARCHTHEFOLLOWINGTRANSACTIONSTOOKPLACE March

8

3 players were taken home by the owner (Memo 4)

12

Sold 12 players at $176 (including GST) each (Rec. 555–561)

19

Purchased 20 players at $80 (plus GST) each (Inv. 76)

22

Sold 8 players at $160 (plus GST) each (Rec. 564–566)

28

Purchased 15 players at $99 (including GST) each (Chq. 880)

30

Sold 14 players at $176 (including GST) each (Inv. 43)

Required a RecordTHETRANSACTIONSFOR-ARCHINTHESTOCKCARDFOR-0PLAYERS b !PHYSICALSTOCKTAKEON-ARCHREVEALEDTHAT-0PLAYERSWEREONHAND -EMO CalculateTHEVALUEOFSTOCKLOSSORGAINON-0PLAYERSFOR-ARCH c RecordTHESTOCKLOSSORGAININTHESTOCKCARDFOR-0PLAYERS d ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDTHESTOCKLOSSORGAINON-0 PLAYERS e Calculate'ROSS0ROlTAND!DJUSTED'ROSS0ROlTON-0PLAYERSFOR-ARCH f ExplainTHEEFFECTONOWNERSEQUITYASAT-ARCHIF-EMOHADnotBEEN RECORDED

EXERCISE 8.7 STOCK CARDS AND STOCK LOSSES/GAINS

W B

page 155

$URING/CTOBER "AYSIDE3OUNDHADTHEFOLLOWINGTRANSACTIONSREGARDINGSTEREO SYSTEM Oct.

1

Balance on hand – 4 systems at $600 each

4

Purchased 7 systems at $650 (plus GST) each (Inv. D34)

10

Sold 5 systems for $990 (including GST) each (Rec. 87)

14

Sold 2 systems for $900 (plus GST) each (Inv. B101)

20

Purchased 5 systems at $770 (including GST) each (Inv. D45)

26

Donated 1 system to the local school fete (Memo 41)

Required a RecordTHETRANSACTIONSFOR/CTOBERINTHESTOCKCARDFORSTEREO b /N/CTOBER APHYSICALSTOCKTAKEREVEALEDNINEUNITSONHANDOFITEM -EMO SuggestTWOPOSSIBLEREASONSFORTHEDIFFERENCEBETWEENTHESTOCKTAKE ANDTHESTOCKCARD c RecordTHESTOCKLOSSORGAININTHESTOCKCARDFORSTEREO d ExplainHOWTHESTOCKLOSSORGAINWASVALUEDIdentifyONEACCOUNTINGPRINCIPLETO SUPPORTYOURANSWER e Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO RECORD THE STOCK LOSS OR GAIN ON STEREO f Calculate'ROSS0ROlTAND!DJUSTED'ROSS0ROlTFORSTEREOFOR/CTOBER g Explain HOW -EMO  WOULD BE REPORTED IN THE )NCOME 3TATEMENT FOR "AYSIDE 3OUNDFOR/CTOBER

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Cambridge University Press

187

CAMBRIDGE VCE ACCOUNTING

188

UNITS 3&4

EXERCISE 8.8 REPORTING FOR STOCK

W B

page 157

7ARRENS7OKSHASPROVIDEDTHEFOLLOWING4RIAL"ALANCEASAT3EPTEMBER WARREN’S WOKS Trial Balance as at 30 September 2015 Account

Debit

Bank Cost of Sales

Credit

4 300 40 000

Creditors Control

9 200

GST Clearing

3 400

Debtors Control

13 100

Drawings

3 000

Prepaid Advertising

1 100

Customs Duty

2 200

Sales

80 000

Capital – Warren

59 400

Mortgage – BH Bank

90 000

Shelving

17 000

Premises

120 000

Advertising Stock Control

4 900 19 500

Interest Wages Totals

600 16 300 $242 000

$242 000

Additional information: s !PHYSICALSTOCKTAKEON3EPTEMBERSHOWEDSTOCKONHANDWORTH s 4HEPRINCIPALOFTHE-ORTGAGEn"("ANKISREPAYABLEATPERMONTH Required

*

*

a StateWHETHERINTERESTISAREVENUEOREXPENSEITEMFOR7ARRENS7OKSFOR3EPTEMBER JustifyYOURANSWER b PrepareAN)NCOME3TATEMENTFOR7ARRENS7OKSFOR3EPTEMBER c 2EFERRINGTOYOURANSWERTOPART@B justifyYOURTREATMENTOF#USTOMS$UTY d ExplainTHEIMPORTANCEOFSHOWING'ROSS0ROlTINTHE)NCOME3TATEMENTOFATRADING lRM e 2EFERRINGTOTHEDElNITIONS explainWHYSTOCKLOSSISCONSIDEREDTOBEANEXPENSE f PrepareA"ALANCE3HEETFOR7ARRENS7OKSASAT3EPTEMBER

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CHAPTER 8

ACCOUNTING FOR STOCK

EXERCISE 8.9 REPORTING FOR STOCK

W B

page 159

0OTSN0ANSHASPROVIDEDTHEFOLLOWING4RIAL"ALANCEASAT*UNE POTS ’N’ PANS Trial Balance as at 30 June 2015 Account

Debit

Credit

Bank

1 500

Capital – Pamela Cartage In Cost of Sales

41 000 1 900 60 000

Creditors Control

6 300

Debtors Control

4 600

Delivery to Customers

2 500

Drawings

5 000

GST Clearing

500

Loan – QuickFin. Rent

20 000 14 000

Sales

90 000

Shop Fittings

40 000

Stock Control

19 300

Wages

12 000

Totals

$159 300

$159 300

Additional information: s !PHYSICALSTOCKTAKEON*UNESHOWEDA3TOCK'AINOF s 4HE,OANn1UICK&INISANINTERESTONLYLOANDUEFORREPAYMENTON*ULY Required

* *

a b c d e

PrepareAN)NCOME3TATEMENTFOR0OTSN0ANSFOR*UNE 2EFERRINGTOYOURANSWERTOPART@A explainYOURTREATMENTOF$ELIVERYTO#USTOMERS 2EFERRINGTOTHEDElNITIONS explainWHYA3TOCK'AINISCONSIDEREDTOBEREVENUE PrepareA"ALANCE3HEETFOR0OTSN0ANSASAT*UNE StateONEREASONWHYTHE$RAWINGSlGUREMAYBECONSIDEREDTOBETOOHIGH

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Cambridge University Press

189

190

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

EXERCISE 8.10 INTERPRETING STOCK CARDS

W B

page 161

-ICHAEL#ONLONOWNS4HE'OOD/IL WHICHIMPORTSOLIVEOILFROM3ICILYANDSELLSITTO RETAILSTORESTHROUGHOUT-ELBOURNE!LLSTOCKISSOLDATAMARK UP 4HESTOCKCARDFOR6IRGIN/LIVE/ILFOR.OVEMBERISSHOWNBELOW STOCK CARD Stock item: Virgin Olive Oil Stock code: VO01

Location: Supplier: IN

Date

Details

Nov. 1

Balance

Nov. 9

Inv. L63

Nov. 13

Inv. X70

Nov. 16

Nov. 22

Nov. 30

Qty

Cost

OUT Total

Qty

40 50

40

Aisle 17 Familia Oil Co.

Cost

BALANCE Total

30

1 200

2 000

Memo 63

4

Rec. 19

Memo 64

30

120

Qty

Cost

Total

50

30

1 500

10

30

300

10

30

300

50

40

2 000

6

30

180

50

40

2 000

6

30

180

24

40

960

26

40

1 040

3

40

120

23

40

920

Required a DescribeTHETRANSACTIONON.OVEMBER b IdentifyTHESPECIALJOURNALINWHICHTHETRANSACTIONON.OVEMBERWOULD BERECORDEDJustifyYOURANSWER c SuggestTWOPOSSIBLEREASONSFORTHETRANSACTIONON.OVEMBER d RecordTHETRANSACTIONON.OVEMBERINTHEAPPROPRIATEJOURNAL e 4HE STOCK MANAGER SENT -EMO  AFTER THE STOCKTAKE WAS COMPLETED Show THE 'ENERAL*OURNALENTRIESNECESSARYTORECORDTHETRANSACTIONON.OVEMBER f Calculate#OSTOF3ALESFOR6IRGIN/LIVE/ILFOR.OVEMBER g 2EFERRINGTOYOURANSWERTOPART@F stateTWOREASONSWHYTHISMAYnotBETHElGURE REPORTEDAS#OSTOF'OODS3OLDFOR.OVEMBER

EXERCISE 8.11 SOURCE DOCUMENTS AND STOCK CARDS

W B

page 163

(UGH'LOWOWNS'LARE AlRMTHATSELLSLIGHTlTTINGSANDBEDSIDELAMPSFROMASMALL SHOPINTHECITY/N&EBRUARY THElRMHADTHEFOLLOWINGSTOCKOFBEDSIDELAMPS ONHAND Quantity

Cost

Total

4

$40

$160

7

50

350

4HEFOLLOWINGTRANSACTIONSOCCURREDDURING&EBRUARY

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CHAPTER 8

ACCOUNTING FOR STOCK

DOCUMENT A

Bright Lights

TAX INVOICE

Invoice:

!". A"UCKLEY3T #OLLINGWOOD6)#

ORIGINAL 4ERMS  N

Charge to: Glare Block Arcade ABN: 65 980 706 511

Date Feb. 2

Details

Qty

Bedside lamps

20

Unit Price $

Total $

50

1 000

GST

100

$

Total

1 100

GL

DOCUMENT B

ARE

TAX INVOICE

Invoice: DUPLICATE

!". "LOCK!RCADE -ELBOURNE6)#

4ERMS  N

Charge to: The Hilton Country Inn ABN: 66 009 963 451

Date Feb. 12

Details

Qty

Bedside lamps

10

Unit Price $ 66

660

$

Total

Total $

660

Includes GST of $60

GL

DOCUMENT C

ARE

Charge to:

Order form # G35 !". "LOCK!RCADE -ELBOURNE6)#

DUPLICATE

"RIGHT,IGHTS A"UCKLEY3TREET #OLLINGWOOD6)#

0LEASESUPPLYTHEFOLLOWING Date

Details

&EB

"EDSIDELAMPS

0LEASEDELIVERWITHINWORKINGDAYS

Quantity 

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

191

CAMBRIDGE VCE ACCOUNTING

192

UNITS 3&4

GL

DOCUMENT D

MEMO 73

ARE

28/2/15

Stocktake determined that there were 18 bedside lamps in stock Required a 2EFERRINGTOONEQUALITATIVECHARACTERISTIC explainTHEROLEOFSOURCEDOCUMENTSIN THEACCOUNTINGPROCESS b RecordTHERELEVANTTRANSACTIONSINTHESTOCKCARDFORBEDSIDELAMPS c ExplainYOURTREATMENTOF$OCUMENT# d RecordTHERELEVANTTRANSACTIONSINTHEAPPROPRIATESPECIALJOURNALSOF'LARE e ExplainTHEEFFECTOF$OCUMENT!ONTHE"ALANCE3HEETOF'LAREASAT&EBRUARY  f StateTHEEFFECTONTHEACCOUNTINGEQUATIONOF'LAREIF$OCUMENT$ISnotRECORDED

EXERCISE 8.12 STOCK AND THE GENERAL LEDGER

W B

page 165

-ATTHEW &AREWELL OWNS -ATTS -ATS A STORE THAT SPECIALISES IN SELLING WELCOME MATS TO CARPET AND GENERAL STORES 4HE BUSINESS USES THE PERPETUAL INVENTORY SYSTEM AND ALLSTOCKMOVEMENTSARERECORDEDUSINGTHE&)&/METHODOFCOSTASSIGNMENT0HYSICAL STOCKTAKESARECARRIEDOUTATTHEENDOFEACHMONTHTOUPDATETHERECORDS 4HESPECIALJOURNALSFOR!PRILSHOWEDTHEFOLLOWINGTOTALS Cash Receipts Journal Date

Details

Rec. no.

Bank

Discount Expense

Debtors Control

Cost of Sales

Sales

Sundries

Capital Contribution

GST

1 400

Totals

36 600

900

13 000

11 500

21 000

1 400

2 100

Cash Payments Journal Date

Details

Chq. no.

Bank

Discount Revenue

Creditors Control

Stock Control

Wages

Sundries

Electricity

GST

500

Totals

30 750

300

14 300

12 000

3 000

500

1 250

Sales Journal Date

Debtor Totals

Invoice number

Cost of Sales 15 000

Sales

GST

Debtors Control

30 000

3 000

33 000

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

CHAPTER 8

ACCOUNTING FOR STOCK

PURCHASES JOURNAL Date

Invoice number

Creditor

Stock Control

Totals

GST

20 000

2 000

Creditors Control 22 000

4HE STOCK CARD FOR PLAIN WELCOME MATS SHOWED THE FOLLOWING TRANSACTIONS FOR !PRIL STOCK CARD Stock item:

Plain welcome mat

Location:

Shelf 7

Stock code:

PWM

Supplier:

Coir Industries

Date

Details

IN Qty

April 1

April 9

April 17

April 25

April 30

Cost

OUT Total

Qty

Cost

BALANCE Total

Balance

Memo 71

3

Inv. 72

Inv. B72

Memo 72

60

3

45

40

2 700

120

30

90

7

30

210

8

40

320

Qty

Cost

Total

10

30

300

50

40

2 000

7

30

210

50

40

2 000

42

40

1 680

42

40

1 680

60

45

2 700

45

40

1 800

60

45

2 700

Additional information: s -EMORELATEDTOSTOCKWITHDRAWNBYTHEOWNER-EMORELATEDTOTHEPHYSICAL STOCKTAKE4HESEWERETHEONLYMEMOSWRITTENIN!PRIL s !SAT!PRIL THE$EBTORS#ONTROLACCOUNTSHOWEDABALANCEOFANDTHE 3TOCK#ONTROLACCOUNTABALANCEOF Required

* *

a IdentifyTHENUMBEROFPLAINWELCOMEMATSDETECTEDBYTHEPHYSICALSTOCKTAKEON !PRIL b ExplainHOWAPHYSICALSTOCKTAKEMAYIMPROVETHEReliabilityOFTHEREPORTSOF-ATTS -ATS c ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORD-EMOAND-EMO d 5SINGALLTHEINFORMATIONPROVIDED completeTHE3TOCK#ONTROLAND$EBTORS#ONTROL ACCOUNTSINTHE'ENERAL,EDGEROF-ATTS-ATS e PrepareAN)NCOME3TATEMENTFOR-ATTS-ATSFOR!PRIL f ExplainHOWTHEUSEOF&)&/WILLAFFECTTHEACCOUNTINGEQUATIONINTIMESOFRISING PRICES

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Cambridge University Press

193

Where are we headed? After completing this chapter, you should be able to: s

defineREVENUE EXPENSES ANDPROlT

s

calculatePROlT

s

explainTHEROLEOF ACCOUNTINGPRINCIPLESAND QUALITATIVECHARACTERISTICSIN THEDETERMINATIONOFPROlT

s

explainTHEREASONSFOR @CLOSINGTHELEDGER

s

recordCLOSINGENTRIESIN THE'ENERAL*OURNALAND 'ENERAL,EDGER

s

prepareTHE0ROlTAND,OSS 3UMMARYACCOUNT

s

recordTHETRANSFEROF DRAWINGSTOTHE#APITAL ACCOUNTINTHE'ENERAL *OURNALAND'ENERAL,EDGER

s

prepareAN)NCOME 3TATEMENTFORATRADINGlRM

s

explainANDinterpretTHE INFORMATIONPRESENTEDINAN )NCOME3TATEMENT

CHAPTER 9

DETERMINING PROFIT OR LOSS KEY TERMS After completing this chapter, you should be familiar with the following terms: s

CLOSINGTHELEDGER

s

)NCOME3TATEMENT

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Cambridge University Press

196

CAMBRIDGE VCE ACCOUNTING

9.1

UNITS 3&4

DETERMINING PROFIT OR LOSS

4HEMOSTBASICFUNCTIONOFANYSMALLBUSINESSISTOEARNAPROlTFORTHEOWNER SOFROM TIMETOTIMETHEACCOUNTANTMUSTCALCULATEWHETHERAprofitORlossHASBEENGENERATED 4HECALCULATIONOFPROlTISSIMPLEENOUGHPROlTISWHATISLEFTOVERAFTEREXPENSESARE DEDUCTEDFROMREVENUES

Profit

=

Revenues

– Expenses

)N THIS EQUATION REVENUES ARE DElNED AS INmOWS OF ECONOMIC BENElTS OR SAVINGS IN OUTmOWS IN THE FORM OF INCREASES IN ASSETS OR REDUCTIONS IN LIABILITIES THAT LEAD TO AN INCREASE IN OWNERS EQUITY %XPENSES ARE DElNED AS OUTmOWS OR CONSUMPTIONS OF ECONOMIC BENElTS OR REDUCTIONS IN INmOWS IN THE FORM OF DECREASES IN ASSETS OR INCREASESINLIABILITIES THATLEADTOADECREASEINOWNERSEQUITY

Accounting principles and qualitative characteristics 4HEQUESTIONOFwhen TOCALCULATEPROlTDEPENDSONTHENEEDSOFTHEOWNERS2EMEMBER THAT THE 'OING #ONCERN PRINCIPLE ASSUMES THAT THE LIFE OF A BUSINESS IS CONTINUOUS OR NEVER ENDING SO TO FOLLOW THIS PRINCIPLE ALONE MEANS THAT PROlT COULD NEVER BE DETERMINED!SARESULT OWNERSWOULDNOTHAVEINFORMATIONABOUTTHETRADINGACTIVITIES OFTHEIRlRMUNTILITWASTOOLATETODOANYTHINGABOUTIT4HISISWHYTHE2EPORTING0ERIOD PRINCIPLE IS SO IMPORTANT IT ALLOWS US TO DIVIDE THE LIFE OF THE BUSINESS INTO ARBITRARY PERIODSINORDERTODETERMINEPROlT .OTETHATTHELENGTHOFTHESE2EPORTING0ERIODSISARBITRARY ORSUBJECTIVEITISUP TOTHEOWNERSTODECIDEHOWOFTENTHEYWANTPROlTTOBEDETERMINED3OMEOWNERS WILLWANTPROlTCALCULATEDEVERYMONTH WHILEOTHERSWILLBESATISlEDWITHSEASONALOR QUARTERLY PROlT REPORTS )N SOME INDUSTRIES SUCH AS FAST FOOD HOURLY BREAKDOWNS OF SALESANDEXPENSESMAYBEUSEFUL4HELENGTHOFTHE2EPORTING0ERIODCANBEASSHORT ORASLONGASTHEOWNERDESIRESALTHOUGHTAXATIONREQUIREMENTSMEANTHATITMUSTBE NOLONGERTHANONEYEAR /NCE THE LENGTH OF THE 2EPORTING 0ERIOD IS DETERMINED IT IS IMPORTANT THAT THE CALCULATION OF PROlT INCLUDES ONLY REVENUES AND EXPENSES AND ONLY THOSE REVENUES AND EXPENSES THAT HAVE OCCURRED during THE CURRENT 2EPORTING 0ERIOD 4HIS ENSURES THAT THE REPORTS CONTAIN THE QUALITATIVE CHARACTERISTIC OF Relevance BY INCLUDING ONLY INFORMATIONTHATISUSEFULFORDECISION MAKING)FWEINCLUDEDITEMSOTHERTHANREVENUES ANDEXPENSESSUCHASDRAWINGSORLOANREPAYMENTS ORINCLUDEDREVENUESOREXPENSES THATOCCURREDoutsideTHECURRENTPERIODSUCHASLASTYEARSWAGES THEREPORTSWOULD CONTAIN INFORMATION THAT WOULD not BE USEFUL FOR DECISION MAKING 4HE INFORMATION WOULDTHUSDISTORTDECISION MAKING ANDPROBABLYLEADTONEGATIVECONSEQUENCESFOR THEBUSINESSANDITSOWNER REVIEW QUESTIONS 9.1

1

2 3

DefineTHEFOLLOWINGTERMS s REVENUES s EXPENSES s PROFIT Explain HOWTHE2EPORTING0ERIODPRINCIPLEASSISTSINTHECALCULATIONOFPROlT ExplainHOWTHE2EPORTING0ERIODPRINCIPLELEADSTORelevanceINACCOUNTING REPORTS

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 9

9.2

DETERMINING PROFIT OR LOSS

197

CLOSING THE LEDGER

/NCETHELENGTHOFTHE2EPORTING0ERIODISESTABLISHED PROlTCANBECALCULATEDSIMPLY BY COMPARING THE REVENUES AND EXPENSES THAT OCCURRED IN THAT PERIOD !ND AS EACH REVENUE AND EXPENSE ITEM HAS ITS OWN LEDGER ACCOUNT THIS INFORMATION IS ALREADY AVAILABLEINTHE'ENERAL,EDGER4HUSTHEPROlTCANBECALCULATEDBYTRANSFERRINGTHE BALANCESFROMALLTHESEREVENUEANDEXPENSEACCOUNTSTOASPECIALACCOUNTCALLEDTHE 0ROlTAND,OSS3UMMARYACCOUNT4HISISKNOWNASclosing the ledger THE 0ROlT AND ,OSS 3UMMARY ACCOUNT IS LIKE A FUNNEL THAT CHANNELS ALL REVENUE ANDEXPENSESINTOONEACCOUNT WITHASOLElGUREnTHEPROlTORLOSSFORTHECURRENT PERIODnPRODUCEDATTHEEND)NTHEPROCESS THEREVENUEANDEXPENSEACCOUNTSWILL BE@EMPTIED ORRESETTOZEROINREADINESSFORTHENEXTPERIOD4HUS THETWOKEYREASONS FORCLOSINGTHELEDGERARETO s TRANSFERREVENUESANDEXPENSESTOTHE0ROlTAND,OSS3UMMARYACCOUNTINORDER TOCALCULATEPROlTFORTHEcurrent2EPORTING0ERIOD s RESETREVENUEANDEXPENSEACCOUNTSTOZEROINPREPARATIONFORTHEnext2EPORTING 0ERIOD )TISONLYREVENUEANDEXPENSEACCOUNTSTHATARECLOSED BECAUSEONLYREVENUESAND EXPENSESAREUSEDTODETERMINEPROlT)NADDITION REVENUESANDEXPENSESEXISTONLY DURINGAPARTICULAR2EPORTING0ERIOD WHEREASASSETSANDLIABILITIESANDOWNERSEQUITY FORTHATMATTER WILLEXISTINTOTHEFUTURE4HATIS "ALANCE3HEETITEMSINVOLVEAfuture BENElTORfutureSACRIlCEANDSOSHOULDNOTBERESETTOZERO BUTTHEIRBALANCESSHOULD CARRYFORWARDINTOTHENEXTnOR@FUTUREn2EPORTING0ERIOD

closing the ledger transferring balances from revenue and expense ledger accounts to the Profit and Loss Summary account so that profit can be calculated

REVIEW QUESTIONS 9.2

1 ExplainTHEPROCESSOFCLOSINGTHELEDGER 2 ExplainTWOREASONSFORCLOSINGTHELEDGER 3 ExplainWHYASSETANDLIABILITYACCOUNTSAREnotCLOSED

9.3

CLOSING ENTRIES AND THE PROFIT AND LOSS SUMMARY ACCOUNT

Closing revenue accounts !S ACCOUNTS THAT INCREASE OWNERS EQUITY REVENUE ACCOUNTS USUALLY HAVE A CREDIT BALANCE)NORDERTOTRANSFERBALANCESFROMTHESEACCOUNTS THEREVENUEACCOUNTSMUST BEdebitedTOREDUCETHEACCOUNTTOZERO WITHACORRESPONDINGCREDITTOTHE0ROlTAND ,OSS3UMMARYACCOUNT4HISENTRYISlRSTRECORDEDINTHE'ENERAL*OURNAL THENPOSTED TOTHE'ENERAL,EDGERACCOUNTS

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

198

EXAMPLE

UNITS 3&4

Pulse Music supplied the following Trial Balance as at 30 September 2015: PULSE MUSIC SHOP Trial Balance as at 30 September 2015 Account

Debit

Bank

Credit

2 300

Stock Control

40 000

Shop Fittings

11 000

Debtors Control

13 000

Creditors Control

6 000

Loan – Markos Bank

30 000

Capital – B. Pressure

25 000

Sales Revenue

34 000

Stock Gain

200

Discount Revenue

500

Cost of Sales

21 000

Wages

5 400

Advertising

1 300

Discount Expense

700

Rent Expense

1 000

Totals

$95 700

$95 700

4HE'ENERAL*OURNALENTRYTOCLOSETHEREVENUEACCOUNTSASAT3EPTEMBERIS SHOWNIN&IGURE Figure 9.1

General Journal: closing revenue accounts

STUDY TIP

General Journal 0,3UMMARYISAN ACCEPTEDABBREVIATION

General Ledger Date Sept. 30

Details

Debit

Sales Revenue

34 000

Stock Gain

200

Discount Revenue

500

Profit and Loss Summary

Credit

Subsidiary Ledger Debit

Credit

34 700

Closing revenue accounts to P&L Summary account

!TlRSTITMAYSEEMODDTODEBITAREVENUEACCOUNT BUTREMEMBERTHATWEARETRYING TOreduceTHEREVENUEACCOUNTSBECAUSETHEYHAVEACREDITBALANCE ADEBITENTRYIS NECESSARYTOREDUCETHEMTOZERO

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 9

DETERMINING PROFIT OR LOSS

199

!LSO NOTEHOWALLTHEREVENUEACCOUNTSARECLOSEDINONE'ENERAL*OURNALENTRY WITH EACHINDIVIDUALREVENUEACCOUNTDEBITED ANDONECREDITFORTHETOTALREVENUElGURE POSTED TO THE 0ROlT AND ,OSS 3UMMARY ACCOUNT 4HIS ENTRY WOULD BE POSTED TO THE 'ENERAL,EDGERASISSHOWNIN&IGURE Figure 9.2

General Ledger: closing revenue accounts General Ledger Sales (R)

Date

Cross-reference

Sept. 30 Profit and Loss Summary

Amount $

Date

34 000

Sept. 30

Cross-reference

Amount $

Bank

19 000

Debtors Control

15 000

34 000

34 000

Stock Gain (R) Date

Cross-reference

Amount $ Date

Sept. 30 Profit and Loss Summary

200

Sept. 30

Cross-reference Stock Control

200

Amount $ 200 200

Discount Revenue (R) Date

Cross-reference

Amount $ Date

Sept. 30 Profit and Loss Summary

500

Sept. 30

Cross-reference

Amount $

Creditors Control

500

500

500 STUDY TIP

Profit and Loss Summary (OE) Date

Cross-reference

Amount $

Date Sept. 30

Cross-reference Revenues

Amount $ 34 700

!LLREVENUESHAVENOWBEENTRANSFERREDINTOTHE0ROlTAND,OSS3UMMARYACCOUNTSO THATPROlTCANBECALCULATEDFOR3EPTEMBER)NADDITION EACHREVENUEACCOUNTHAS NOWBEENRESETTOZEROITHASAZEROBALANCE INREADINESSFORTHENEXT2EPORTING0ERIOD )NOTHERWORDS ONLYTHEREVENUEEARNEDIN/CTOBERTHENEXTMONTH WILLBESHOWN INTHEREVENUEACCOUNTSATTHEENDOFTHENEXT2EPORTING0ERIODTHATIS /CTOBER

0,3UMMARYIS ATEMPORARY/% ACCOUNTITISNOT REPORTEDANYWHERE

Cross-references in the Profit and Loss Summary account )N#HAPTER WESAWTHATTHE"ANKACCOUNTISONEOFONLYTWOLEDGERACCOUNTSWHERE THECROSS REFERENCEMAYBESOMETHINGOTHERTHANTHENAMEOFALEDGERACCOUNT4HE SECONDIS0ROlTAND,OSS3UMMARY)NTHECASEOFTHE0ROlTAND,OSS3UMMARYACCOUNT ABOVE THECREDITENTRYOFISLINKEDTOTHE3ALES2EVENUE $ISCOUNT2EVENUE AND3TOCK'AINACCOUNTS2ATHERTHANLISTEACHANDEVERYONEOFTHESEACCOUNTNAMES THECROSS REFERENCEISSIMPLY2EVENUESTOINDICATETHATTHEREAREANUMBEROFREVENUE ACCOUNTSLINKEDTOTHISTOTALREVENUElGURE

Closing expense accounts 4HESAMEPRINCIPLEAPPLIESWHENCLOSINGEXPENSEACCOUNTSALLEXPENSEACCOUNTSARE CLOSEDUSINGONE'ENERAL*OURNALENTRY WITHTHETOTALEXPENSESlGUREPOSTEDTOTHE 0ROlT AND ,OSS 3UMMARY ACCOUNT 5SING THE SAME INFORMATION SUPPLIED IN THE 4RIAL "ALANCEOF0ULSE-USICASAT3EPTEMBER THE'ENERAL*OURNALWOULDAPPEARAS ISSHOWNIN&IGURE ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Cambridge University Press

200

CAMBRIDGE VCE ACCOUNTING

Figure 9.3

UNITS 3&4

General Journal: closing expense accounts General Journal General Ledger

Date Sept. 30

Details

Debit

Profit and Loss Summary

29 400

Cost of Sales

Credit

Subsidiary ledger Debit

Credit

21 000

Wages

5 400

Advertising

1 300

Discount Expense

700

Rent Expense

1 000

Closing expense accounts to P&L Summary account

4HISENTRYWOULDBEPOSTEDTOTHE'ENERAL,EDGERASISSHOWNIN&IGURE Figure 9.4

General Ledger: closing expense accounts General Ledger Cost of Sales (E)

Date Sept. 30

Cross-reference

Amount $

Date

Stock Control

12 000

Sept. 30

Stock Control

9 000

Cross-reference Profit and Loss Summary

21 000

Amount $ 21 000

21 000

Wages (E) Date Sept. 30

Cross-reference Bank

Amount $

Date

5 400

Sept. 30

Cross-reference Profit and Loss Summary

5 400

Amount $ 5 400 5 400

Advertising (E) Date Sept. 30

Cross-reference

Amount $

Bank

800

Stock Control

500

Date Sept. 30

Cross-reference Profit and Loss Summary

1 300

Amount $ 1 300

1 300

Discount Expense (E) Date

Cross-reference

Amount $

Date

Sept. 30

Debtors Control

700

Sept. 30

Cross-reference Profit and Loss Summary

700

Amount $ 700 700

Rent Expense (E) Date Sept. 30

Cross-reference Bank

Amount $

Date

1 000

Sept. 30

1 000

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Cross-reference Profit and Loss Summary

Amount $ 1 000 1 000

Cambridge University Press

CHAPTER 9

DETERMINING PROFIT OR LOSS

201

Profit and Loss Summary (OE) Date

Cross-reference

Sept. 30

Amount $

Date

29 400

Sept. 30

Expenses

Cross-reference

Amount $

Revenues

34 700

!LLEXPENSESHAVENOWBEENTRANSFERREDINTOTHE0ROlTAND,OSS3UMMARYACCOUNT SOTHATPROlTCANBECALCULATEDFORTHEcurrent2EPORTING0ERIOD3EPTEMBER %ACH EXPENSEACCOUNTHASNOWBEENRESETTOZEROITHASAZEROBALANCE INREADINESSFORTHE next2EPORTING0ERIODTHATIS /CTOBER

Cross-references in the Profit and Loss Summary account !SWITHREVENUES BECAUSETHEREISNOSINGLE accountLINKEDTOTHETOTALEXPENSESlGURE IN THIS CASE   THE CROSS REFERENCE IN THE 0ROlT AND ,OSS 3UMMARY ACCOUNT MUSTBE%XPENSESINPREFERENCETOLISTING#OSTOF3ALES 7AGES !DVERTISING $ISCOUNT %XPENSE AND2ENTSEPARATELY 

Closing the Profit and Loss Summary account 7ITH ALL REVENUES AND EXPENSES NOW TRANSFERRED TO THE 0ROlT AND ,OSS 3UMMARY ACCOUNT THE ONLY STEP REMAINING IS TO CALCULATE PROlT BY DEDUCTING EXPENSES FROM REVENUES  4HIS PROlT n OR LOSS n MUST BE TRANSFERRED TO THE OWNERS #APITAL ACCOUNT LEAVINGTHE0ROlTAND,OSS3UMMARYACCOUNTWITHAZEROBALANCE READYFORTHENEXT 2EPORTING0ERIOD&IGURESHOWSTHE'ENERAL*OURNALENTRIESTOCLOSETHE0ROlTAND ,OSS3UMMARYACCOUNT Figure 9.5

General Journal: closing the Profit and Loss Summary account General Journal General Ledger

Date Sept. 30

Details

Debit

Profit and Loss Summary

5 300

Credit

Capital – B. Pressure

Subsidiary ledger Debit

Credit

5 300

Transfer of Net Profit from P&L Summary account to Capital account

4HISWOULDBEPOSTEDTOTHE'ENERAL,EDGERASISSHOWNIN&IGURE Figure 9.6

General Ledger: closing the Profit and Loss Summary account General Ledger Profit and Loss Summary (OE)

Date Sept. 30

Cross-reference Expenses Capital

Amount $

Date

29 400

Sept. 30

Cross-reference Revenues

STUDY TIP

Amount $ 34 700

5 300 34 700

34 700

Capital – B. Pressure (OE) Date

Cross-reference

Amount $

Date Sept. 1 30

Cross-reference Balance Profit and Loss Summary

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Amount $ 25 000

!LTHOUGHTHE ISPROlT RESISTTHE TEMPTATIONTOLABELIT AS@0ROlTINTHE0ROlT AND,OSS3UMMARY ACCOUNT4HEREISNO LEDGERACCOUNTCALLED @0ROlTTHENAMEOFTHE OTHERLEDGERACCOUNTIS @#APITAL

5 300

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CAMBRIDGE VCE ACCOUNTING

202

STUDY TIP

4HEREWILLONLYEVER BETHREEENTRIESIN THE0ROlTAND,OSS 3UMMARYACCOUNT 2EVENUES %XPENSES ANDTHETRANSFERTOTHE #APITALACCOUNTFORTHE PROlTORLOSS 

UNITS 3&4

)NTHISCASE REVENUES AREGREATERTHANEXPENSES MEANINGTHAT APROlTOFHASBEENEARNED4HISPROlTREPRESENTSANINCREASEINOWNERSEQUITY ANDSOLEADSTOACREDITTOTHE#APITALACCOUNT)NTHECASEOFALOSS THE#APITALACCOUNT WOULD BE DEBITED TO SHOW THE DECREASE IN OWNERS EQUITY WITH THE 0ROlT AND ,OSS 3UMMARYACCOUNTCLOSEDWITHACREDITENTRY 4HE0ROlTAND,OSS3UMMARYACCOUNTOPENSWHENTHEREVENUESANDEXPENSESARE TRANSFERREDin ANDCLOSESWHENTHEPROlTORLOSSISTRANSFERREDout ONTHESAMEDAY 4HEACCOUNTITSELFLASTSFORONLYASLONGASITTAKESTOPOSTTHESETHREEENTRIESJUSTAS APIECEOFSCRAPPAPERISUSEDTOMAKEACALCULATIONANDTHENTHROWNAWAYWHENTHE ANSWERISKNOWN)TISNEVERLISTEDINANACCOUNTINGREPORT ASITSFUNCTIONISSIMPLYTO FACILITATETHECALCULATIONOFPROlT

REVIEW QUESTIONS 9.3

1 2 3 4



Identify THETHREEENTRIESTHATWILLBERECORDEDINTHE0ROlTAND,OSS3UMMARY ACCOUNT 2EFERRINGTOREVENUESANDEXPENSES explainWHYTHECROSS REFERENCESINTHE 0ROlTAND,OSS3UMMARYACCOUNTARENOTLEDGERACCOUNTNAMES ExplainHOWTHE0ROlTAND,OSS3UMMARYACCOUNTWOULDBECLASSIlEDINTHE "ALANCE3HEET"EWARE
Show THE'ENERAL*OURNALENTRIESNECESSARYTOCLOSE s REVENUEACCOUNTSTOTHE0ROFITAND,OSS3UMMARYACCOUNT s EXPENSEACCOUNTSTOTHE0ROFITAND,OSS3UMMARYACCOUNT s THE0ROFITAND,OSS3UMMARYACCOUNTTOTHE#APITALACCOUNT

9.4

TRANSFERRING DRAWINGS

)TISCUSTOMARYTORECORDDRAWINGSBYTHEOWNERINASEPARATELEDGERACCOUNTSOTHAT THE OWNERS TRANSACTIONS FOR A PARTICULAR 2EPORTING 0ERIOD CAN BE ISOLATED (OWEVER AT THE END OF THE 2EPORTING 0ERIOD THE BALANCE OF THE $RAWINGS ACCOUNT MUST BE TRANSFERREDTOTHE#APITALACCOUNTSOTHATTHE#APITALACCOUNTCANREmECTTHENETEFFECT OFALLTRANSACTIONSWITHTHEOWNER4HE$RAWINGSACCOUNTISTRANSFERREDTOTHE#APITAL ACCOUNTINMUCHTHESAMEWAYASTHE0ROlTAND,OSS3UMMARYACCOUNTISCLOSED ASIS SHOWNIN&IGURE Figure 9.7

General Journal: transferring Drawings to Capital General Journal General Ledger

Date Sept. 30

Details Capital – B. Pressure Drawings

Debit

Credit

Subsidiary Ledger Debit

Credit

3 000 3 000

Transfer of Drawings account to Capital account

&IGURE  SHOWS HOW THE LEDGER ACCOUNTS WOULD APPEAR AFTER TRANSFERRING THE $RAWINGSTO#APITAL

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 9

Figure 9.8

DETERMINING PROFIT OR LOSS

203

General Ledger: transferring Drawings to Capital General Ledger Drawings (– OE)

Date Sept. 30

Cross-reference

Amount $

Bank

2 500

Stock Control

Date Sept. 30

Cross-reference Capital

Amount $ 3 000

500 3 000

3 000

Capital – B. Pressure (OE) Date

Cross-reference

Sept. 30

Drawings

Amount $ Date 3 000

Cross-reference

Sept. 1 30

Balance Profit and Loss Summary

Amount $ 25 000 5 300

!LTHOUGHTHE$RAWINGSACCOUNTISTRANSFERREDTOTHE#APITALACCOUNT ITISnotCLOSED THROUGHTHE0ROlTAND,OSS3UMMARYACCOUNT4RANSACTIONSWITHTHEOWNERAREEXPRESSLY EXCLUDED FROM THE DElNITIONS OF REVENUES AND EXPENSES AND MUST not BE COUNTED INTHECALCULATIONOFPROlT4OINCLUDEDRAWINGSINTHECALCULATIONOFPROlTWOULDBEA DIRECTBREACHOFRelevance

REVIEW QUESTIONS 9.4

1 StateONEREASONWHYTRANSACTIONSWITHTHEOWNERARERECORDEDSEPARATELYIN THE$RAWINGSACCOUNTRATHERTHANDIRECTLYINTHE#APITALACCOUNT  2 StateONEREASONWHYTHE$RAWINGSACCOUNTISCLOSEDTOTHE#APITALACCOUNT 3 2EFERRINGTOTHEDElNITIONOFANEXPENSE explainWHYTHE$RAWINGSACCOUNT ISnotCLOSEDTOTHE0ROlTAND,OSS3UMMARYACCOUNT 4 2EFERRING TO ONE QUALITATIVE CHARACTERISTIC explain WHY $RAWINGS ARE not INCLUDEDINTHECALCULATIONOFPROlT 5 ShowTHE'ENERAL*OURNALENTRIESNECESSARYTOCLOSETHE$RAWINGSACCOUNTTO THE#APITALACCOUNT

9.5

THE INCOME STATEMENT

(AVINGCLOSEDTHELEDGER THEPROlTlGUREWILLBEKNOWNINTHERECORDS BUTITMUSTSTILL BEREPORTEDTOTHEOWNERINANAPPROPRIATEFORMAT+NOWINGTHE.ET0ROlTlGUREISALL WELLANDGOOD BUTPERHAPSTHEMOSTOBVIOUSQUESTIONFORTHEOWNERTOASKABOUTPROlT IS @(OWWASTHEPROlTGENERATED4HISQUESTIONISANSWEREDBYTHEPREPARATIONOFAN Income Statement WHICHDETAILSTHEREVENUESEARNEDANDEXPENSESINCURREDDURING THEPERIODAND INTHEPROCESS SHOWSBOTH'ROSS0ROlTAND.ET0ROlT /BVIOUSLYTHE.ET0ROlTREPORTEDINTHE)NCOME3TATEMENTSHOULDBETHESAMEASTHE lGUREDETERMINEDINTHE0ROlTAND,OSS3UMMARYACCOUNT BUTTHESTATEMENTWILLSHOW THE REASONS WHY THAT PROlT OR LOSS OCCURRED GIVING THE OWNER FAR MORE INFORMATION ONWHICHTOBASEHISORHERDECISIONS4HISlTSWITHTHEBASICFUNCTIONOFALLACCOUNTING REPORTSTOCOMMUNICATElNANCIALINFORMATIONTHATWILLASSISTTHEOWNERINMAKINGBETTER DECISIONS

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Income Statement an accounting report that details the revenues earned and expenses incurred during the current Reporting Period

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204

EXAMPLE

UNITS 3&4

Bookworms is a book shop and has presented its Trial Balance as at 30 November 2015: BOOKWORMS Trial Balance as at 30 November 2015 Account

Debit

Advertising

Credit

1 200

Bank

3 000

Capital – Isaac Read

8 780

Cash Sales

9 000

Cost of Sales

14 500

Credit Sales

20 000

Creditors Control

11 000

Customs Duty

270

Debtors Control

1 000

Discount Expense

100

Discount Revenue

600

Freight In

520

Freight Out

140

Loan – International Bank

25 000

Rent Expense

3 000

Shop Fittings and Fixtures

12 000

Stock Control

38 000

Stock Loss

350

Wages

6 300

Totals

$77 380

$77 380

!FTER ALL CLOSING ENTRIES HAVE BEEN MADE FOR .OVEMBER  THE 0ROlT AND ,OSS 3UMMARYACCOUNTFOR"OOKWORMSWOULDSHOW Profit and Loss Summary (OE) Date Nov. 30

Cross-reference Expenses Capital

Amount $

Date

26 380

Nov. 30

Cross-reference Revenues

Amount $ 29 600

3 220 29 600

29 600

4HE)NCOME3TATEMENTMUSTSHOWTHESAME.ET0ROlTOF BUTINDOINGSOWILL DETAILALLTHEREVENUESEARNEDANDEXPENSESINCURREDINEARNINGTHATPROlT&IGURE SHOWSTHE)NCOME3TATEMENTFOR"OOKWORMSFOR.OVEMBER

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 9

Figure 9.9

DETERMINING PROFIT OR LOSS

Income Statement

205

STUDY TIP

BOOKWORMS

0RESENTATIONMATTERS INACCOUNTINGREPORTS ITEMSMUSTBEREPORTED UNDERTHECORRECT HEADINGSFORTHE STATEMENTTOBECORRECT

Income Statement for November 2015 Revenue1

$

Cash Sales

9 000

Credit Sales

20 000

$

29 000

Less Cost of Goods Sold2 Cost of Sales

14 500

Customs Duty

270

Freight In

520

Gross Profit3

15 290 13 710

Less Stock Loss

350

Adjusted Gross Profit4

13 360

Add Other Revenues5 Discount Revenue

600 13 960

Less Other Expenses6 Wages

6 300

Advertising

1 200

Discount Expense

100

Freight Out

140

Rent Expense Net Profit7

3 000

10 740 3 220

)NCOMMONWITHALLACCOUNTINGREPORTS THIS)NCOME3TATEMENTBEGINSBYIDENTIFYING who whatANDwhenTHEwhoREFERRINGTO"OOKWORMSTHEENTITYFORWHOMTHEREPORT WASPREPARED THEwhatREFERRINGTOTHEREPORTASAN)NCOME3TATEMENT ANDTHEwhen REFERRINGTO.OVEMBERTHE2EPORTING0ERIODCOVEREDBYTHEREPORT  .OTETHATTHEwhenREFERSNOTTOas at BUTRATHERfor ASTHEINFORMATIONITREPORTS ISNOTCONlNEDTOASINGLEDAY BUTCOVERSAPERIODOFTIMEINTHISCASE THEMONTHOF .OVEMBER 4HEINFORMATIONINTHEREPORTISPRESENTEDUNDERTHEFOLLOWINGHEADINGS  Revenue 4HISSECTIONLISTSONLYTHOSEREVENUESEARNEDASAdirect result of selling stock NAMELY 3ALESREVENUE)NTHISBUSINESS THEOWNERHASREQUESTEDSEPARATElGURESFORCASH AND CREDITSALES SOTHEYARERECORDEDINSEPARATELEDGERACCOUNTS ANDREPORTED SEPARATELYINTHE)NCOME3TATEMENT)NOTHERBUSINESSES BOTHCASHANDCREDITSALES COULD BE COMBINED IN ONE LEDGER ACCOUNT PERHAPS SIMPLY KNOWN AS 3ALES AND REPORTEDASONElGURE  Cost of Goods Sold !SEXPLAINEDIN#HAPTER #OSTOF'OODS3OLDISAHEADINGREFERRINGTOallCOSTS INCURREDINGETTINGGOODSINTOACONDITIONANDLOCATIONREADYFORSALE WITH#OSTOF 3ALESSIMPLYONEOFTHEITEMSTHATMAYBEREPORTEDUNDERTHISHEADING)NTHISCASE #USTOMS$UTYAND&REIGHT)NAREALSOINCLUDEDASPARTOF#OSTOF'OODS3OLD ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

 Gross Profit !S THE DIFFERENCE BETWEEN 3ALES 2EVENUE AND #OST OF 'OODS 3OLD 'ROSS 0ROlT REmECTSTHERELATIONSHIPBETWEENTHElRMSSELLINGANDCOSTPRICES)DENTIFYINGTHIS lGUREWITHITSOWNHEADING ALLOWSTHEOWNERTOASSESSTHEADEQUACYOFTHElRMS MARK UP  Adjusted Gross Profit 3TOCKLOSSESMUSTBEDEDUCTEDFROM'ROSS0ROlT WHILESTOCKGAINSMUSTBEADDED INORDERTODETERMINE!DJUSTED'ROSS0ROlT  Other Revenues !NYREVENUESOTHERTHAN3ALESREVENUEAREREPORTEDAFTERTHE!DJUSTED'ROSS0ROlT INORDERTOPROTECT'ROSS0ROlTASAMEASUREOFTHEMARK UP)NTHISEXAMPLE ONLY $ISCOUNT2EVENUEISIDENTIlEDAS/THER2EVENUE BUTINTERESTREVENUEORCOMMISSION REVENUEWOULDALSOBEREPORTEDHERE 4HElGUREDERIVEDBYADDING/THER2EVENUETO!DJUSTED'ROSS0ROlTn$13 960 IN&IGUREnHASNOTITLE BUTITMUSTBESHOWNNONETHELESS,EAVINGOUTTHISTOTAL MAYRESULTINFAILINGTOACCOUNTFOR@/THER2EVENUESWHEN.ET0ROlTISCALCULATED  Other Expenses /THER%XPENSESREFERSTOALLEXPENSESOTHERTHAN#OSTOF'OODS3OLD INCLUDINGDAY TO DAYEXPENSES SUCHAS7AGES 2ENT !DVERTISINGAND"AD$EBTS.OTETHATTHISIS WHEREFREIGHToutTHECOSTOFDELIVERYtoCUSTOMERS ISREPORTED ASTHISISINCURRED AFTERTHESALE WHEREAS&REIGHTInTHECOSTOFDELIVERYfromTHESUPPLIER ISINCURRED INTHEPROCESSOFGETTINGGOODSREADYFORSALE ANDSOISPARTOF#OSTOF'OODS3OLD  Net Profit 4HIS IS THE BOTTOM LINE SO FREQUENTLY TALKED ABOUT IN BUSINESS CIRCLES THE OVERALL PROlTORLOSSEARNEDBYTHEBUSINESSINTHECURRENT2EPORTING0ERIOD)TISCALCULATED BY DEDUCTING /THER %XPENSES FROM THE PREVIOUS TOTAL IN THIS CASE   LESS  ORBYDEDUCTINGTOTALEXPENSESFROMTOTALREVENUES)FTHECLOSINGENTRIES HAVE BEEN RECORDED CORRECTLY AND THE )NCOME 3TATEMENT PREPARED CORRECTLY THIS .ET0ROlTlGURESHOULDBEIDENTICALTOTHElGURECALCULATEDINTHE0ROlTAND,OSS 3UMMARYACCOUNT 

REVIEW QUESTIONS 9.5

1 ExplainWHYITISNECESSARYTOPREPAREAN)NCOME3TATEMENTEVENWHENTHE PROlTlGUREISKNOWN 2 ExplainTHERELATIONSHIPBETWEENTHE0ROlTAND,OSS3UMMARYACCOUNTAND THE)NCOME3TATEMENT 3 ExplainWHYTHE)NCOME3TATEMENTISTITLEDforTHEPERIODRATHERTHANas atA PARTICULARDATE 4 ExplainTHEDIFFERENCEBETWEEN#OSTOF3ALESAND#OSTOF'OODS3OLD 5 IdentifyTWOREVENUESTHATWOULDBECLASSIlEDAS@/THER2EVENUE

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 9

9.6

DETERMINING PROFIT OR LOSS

USES OF THE INCOME STATEMENT

!S WAS STATED EARLIER AN )NCOME 3TATEMENT MUST BE PREPARED EVEN WHEN THE PROlT IS ALREADY KNOWN IN ORDER TO PROVIDE MORE INFORMATION FOR THE BUSINESS OWNER !FTER ALL CLOSINGTHELEDGERWILLTELLUSTHE.ET0ROlTlGURE ANDEVENTHETOTALREVENUEAND EXPENSElGURES BUTNOTTHEINDIVIDUALAMOUNTSFROMWHICHTHESElGURESWEREDERIVED "YDETAILINGTHEINDIVIDUALREVENUEANDEXPENSEITEMS ANDIDENTIFYING'ROSSAND.ET 0ROlT THEREPORTISMOREUSEFULASADECISION MAKINGTOOL 4HESPECIlCPURPOSESOFPREPARINGAN)NCOME3TATEMENTARE s To aid decision-making about the firm’s trading operations.3PECIlCALLY THE)NCOME 3TATEMENTALLOWSTHEOWNERTOASSESS n THEFIRMSABILITYTOEARNREVENUESODECISIONSCANBEMADEABOUTTHETYPESOF STOCKTHATAREHELDFORSALE THELEVELANDORTYPEOFADVERTISING ORTHELEVELOF SELLINGPRICES n THEADEQUACYOFTHEFIRMSMARK UPSODECISIONSCANBEMADEABOUTADJUSTING SELLINGPRICESORCONTROLLINGCOSTPRICES n THEFIRMSABILITYTOCONTROLITSEXPENSESSODECISIONSCANBEMADEABOUTMANAGING STAFF WAGES PROTECTING STOCK FROM STOCK LOSS OR OPERATING MORE EFFICIENTLY TO CONTROLOPERATINGCOSTS s To assess the firm’s performance in meeting its sales and expense targets. 4HE )NCOME3TATEMENTCANBECOMPAREDAGAINSTBUDGETED OREXPECTED PERFORMANCE ASSHOWNINTHE"UDGETED)NCOME3TATEMENT WHICHWOULDHAVEBEENPREPAREDIN ADVANCE 4HIS COMPARISON WILL HIGHLIGHT WHERE PERFORMANCE WAS BETTER OR WORSE THANEXPECTED#ORRECTIVEACTIONCANTHENBETAKEN4HISWILLBEEXPLOREDINMORE DETAILIN#HAPTER s To assist in planning for future trading activities."YPROVIDINGABASISFORTHENEXT BUDGET THE )NCOME 3TATEMENT WILL AID IN THE SETTING OF TARGETS FOR THE FUTURE 4HIS MAY INCLUDE STOCK LEVELS STAFlNG REQUIREMENTS OR ADVERTISING EXPENDITURE 4HISWILLBEEXPLOREDINMOREDETAILIN#HAPTER s To facilitate the calculation of financial indicators for analysis and interpretation. 4HESEINDICATORSCANBEUSEDNOTONLYTOUNCOVERWHATHASHAPPENED BUTTOHELP EXPLAINWHY4HISWILLBECOVEREDIN#HAPTER

REVIEW QUESTIONS 9.6

1 ExplainTHEPURPOSEOFPREPARINGAN)NCOME3TATEMENT 2 Explain HOW THE PREPARATION OF AN )NCOME 3TATEMENT CAN ASSIST DECISION MAKING 3 ExplainHOWTHEPREPARATIONOFAN)NCOME3TATEMENTCANASSISTPLANNINGFOR THEFUTURE

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Cambridge University Press

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CAMBRIDGE VCE ACCOUNTING

208

UNITS 3&4

WHERE HAVE WE BEEN? s s

s

s s

s

EXERCISES

0ROlTISCALCULATEDBYMATCHINGREVENUESEARNEDAGAINSTEXPENSESINCURREDINTHAT 2EPORTING0ERIOD #LOSINGTHELEDGERISNECESSARYTO n TRANSFER REVENUE AND EXPENSE AMOUNTS TO CALCULATE PROFIT FOR THE current 2EPORTING0ERIOD n RESET THE REVENUE AND EXPENSE ACCOUNTS TO ZERO IN READINESS FOR THE next 2EPORTING0ERIOD 2EVENUE AND EXPENSE ACCOUNTS MUST BE CLOSED TO THE 0ROlT AND ,OSS 3UMMARY ACCOUNTATTHEENDOFTHE2EPORTING0ERIOD4HE0ROlTAND,OSS3UMMARYACCOUNTIS THENCLOSEDTOTHE#APITALACCOUNT 4HE $RAWINGS ACCOUNT IS TRANSFERRED TO THE #APITAL ACCOUNT AT THE END OF THE 2EPORTING0ERIOD 4HE)NCOME3TATEMENTAIDSDECISION MAKINGBYDETAILINGTHEREVENUESEARNEDAND EXPENSESINCURREDDURINGTHE2EPORTING0ERIOD ANDINTHEPROCESSSHOWINGBOTH 'ROSS0ROlTAND.ET0ROlT 4HE)NCOME3TATEMENTAND0ROlTAND,OSS3UMMARYACCOUNTSHOULDBOTHCALCULATE THESAME.ET0ROlTlGURE

EXERCISE 9.1 CLOSING THE LEDGER

W B

page 168

2UGGED2UGSHASPROVIDEDTHEFOLLOWINGLEDGERACCOUNTSFOR!UGUST General Ledger Stock Control (A) Date Aug. 1 31

Cross-reference

Amount $

Date

Cross-reference

Amount $

Balance

10 000

Aug. 31 Cost of Sales

17 000

Creditors Control

34 000

Cost of Sales

15 000

Advertising

400

Stock Loss

500

Sales (R) Date

Cross-reference

Amount $

Date

Cross-reference

Aug. 31 Bank

Amount $ 34 000

Debtors Control

28 000

Cross-reference

Amount $

Interest Revenue (R) Date

Cross-reference

Amount $

Date

Aug. 31 Bank

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

1 500

Cambridge University Press

CHAPTER 9

DETERMINING PROFIT OR LOSS

Cost of Sales (E) Date

Cross-reference

Amount $

Aug. 31 Stock Control

17 000

Stock Control

15 000

Date

Cross-reference

Amount $

Cross-reference

Amount $

Cross-reference

Amount $

Cross-reference

Amount $

Cross-reference

Amount $

Wages (E) Date

Cross-reference

Amount $

Aug. 31 Bank

Date

12 000 Rent Expense (E)

Date

Cross-reference

Amount $

Aug. 31 Bank

Date

9 000 Advertising (E)

Date

Cross-reference

Amount $

Aug. 31 Bank

Date

8 000

Stock Control

400 Stock Loss (E)

Date

Cross-reference

Amount $

Aug. 31 Stock Control

Date

500

Required a ExplainWHYTHE3TOCK#ONTROLACCOUNTISBALANCEDRATHERTHANCLOSED b Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO CLOSE THE REVENUE AND EXPENSE ACCOUNTSTOTHE0ROlTAND,OSS3UMMARYACCOUNT-EMO  c ShowTHE'ENERAL*OURNALENTRIESNECESSARYTOCLOSETHE0ROlTAND,OSS3UMMARY ACCOUNTTOTHE#APITALACCOUNT-EMO  d PostTHE'ENERAL*OURNALTOTHE'ENERAL,EDGEROF2UGGED2UGS

EXERCISE 9.2 CLOSING THE LEDGER

W B

page 171

*IGSAW 7ORLD HAS PROVIDED THE FOLLOWING LEDGER ACCOUNTS FOR THE YEAR ENDED $ECEMBER General Ledger Cash Sales (R) Date

Cross-reference

Amount $

Date Dec. 31

Cross-reference Bank

Amount $ 50 000

Credit Sales (R) Date

Cross-reference

Amount $

Date

Cross-reference

Amount $

Dec. 31

Debtors Control

30 000

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209

210

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

Freight Inwards (E) Date Dec. 31

Cross-reference Bank

Amount $

Date

Cross-reference

Amount $

1 600 Cost of Sales (E)

Date Dec. 31

Cross-reference

Amount $

Stock Control

25 000

Stock Control

15 000

Date

Cross-reference

Amount $

Wages (E) Date Dec. 31

Cross-reference Bank

Amount $

Date

Cross-reference

Amount $

Cross-reference

Amount $

Cross-reference

Amount $

30 500 Rent Expense (E)

Date Dec. 31

Cross-reference Bank

Amount $

Date

8 500 Discount Expense (E)

Date

Cross-reference

Amount $

Dec. 31

Debtors Control

1 300

Date

Required a Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO CLOSE THE REVENUE AND EXPENSE ACCOUNTSTOTHE0ROlTAND,OSS3UMMARYACCOUNT-EMO  b ShowTHE'ENERAL*OURNALENTRIESNECESSARYTOCLOSETHE0ROlTAND,OSS3UMMARY ACCOUNTTOTHE#APITALACCOUNT-EMO  c PostTHE'ENERAL*OURNALTOTHE'ENERAL,EDGEROF*IGSAW7ORLD d Calculate'ROSS0ROlTFOR*IGSAW7ORLDFORTHEYEARENDED$ECEMBER e ExplainHOWCLOSINGTHELEDGERENSURESRelevanceINTHElNANCIALREPORTS

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CHAPTER 9

DETERMINING PROFIT OR LOSS

EXERCISE 9.3 CLOSING THE LEDGER AND TRANSFERRING DRAWINGS

W B

page 174

/N*UNE THE4RIAL"ALANCEOF7OMBAT0LANTSSHOWEDTHEFOLLOWING WOMBAT PLANTS Trial Balance as at 30 June 2015 Account Bank

Debit 1 700

Capital – Withered Cost of Sales

30 900 50 000

Creditors Control Debtors Control Discount Expense

4 000 5 000 400

Discount Revenue Drawings

Credit

500 2 000

GST Clearing

1 000

Loan – ANZ (repayable $2 000 per annum)

16 000

Sales

80 000

Shop Fittings

17 000

Stock Control

45 000

Stock Loss Wages Totals

300 11 000 $132 400

$132 400

Required

*

a Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO CLOSE THE REVENUE AND EXPENSE ACCOUNTSTOTHE0ROlTAND,OSS3UMMARYACCOUNT.ARRATIONSAREnotREQUIRED b ShowTHE'ENERAL*OURNALENTRIESNECESSARYTOCLOSETHE0ROlTAND,OSS3UMMARY ACCOUNTANDTRANSFERDRAWINGSTOTHE#APITALACCOUNT.ARRATIONSAREnotREQUIRED c Show HOW THE 0ROlT AND ,OSS 3UMMARY #APITAL AND $RAWINGS ACCOUNTS WOULD APPEAR IN THE 'ENERAL ,EDGER AFTER ALL CLOSING AND BALANCING ENTRIES HAVE BEEN MADE d ExplainWHY$RAWINGSISnotCLOSEDTOTHE0ROlTAND,OSS3UMMARYACCOUNT e Prepare THE EQUITIES SIDE OF THE "ALANCE 3HEET OF 7OMBAT 0LANTS AS AT  *UNE 

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CAMBRIDGE VCE ACCOUNTING

212

UNITS 3&4

EXERCISE 9.4 INCOME STATEMENT

W B

page 176

/N*UNE THE'ENERAL*OURNALOF&ROSTY&RIDGESSHOWEDTHEFOLLOWINGCLOSING ENTRIES General Journal General Ledger Date June 30

Details

Debit

Sales

Subsidiary Ledger

Credit

Debit

Credit

120 000

Discount Revenue

1 800

Profit and Loss Summary

121 800

Closing revenue accounts to P&L Summary account June 30

Profit and Loss Summary

97 800

Cost of Sales

60 000

Stock Loss

500

Wages

19 000

Advertising

3 000

Customs Duty

2 000

Discount Expense

1 300

Rent Expense

12 000

Closing expense accounts to P&L Summary account June 30

Profit and Loss Summary

24 000

Capital – B. Ding

24 000

Transfer of Net Profit from P&L Summary to Capital account June 30

Capital – B. Ding Drawings

5 600 5 600

Transfer of Drawings to Capital account

Required

*

a ShowHOWTHE0ROlTAND,OSS3UMMARYAND#APITALACCOUNTSWOULDAPPEARINTHE 'ENERAL,EDGERASAT*UNEAFTERALLRELEVANTACCOUNTSHAVEBEENCLOSEDAND BALANCED b PrepareAN)NCOME3TATEMENTFOR&ROSTY&RIDGESFORTHEYEARENDED*UNE c 2EFERRINGTOYOURANSWERTOPART@B explainYOURTREATMENTOF#USTOMS$UTY d ExplainONEREASONWHY&ROSTY&RIDGESSHOULDSTILLPREPAREAN)NCOME3TATEMENT EVENWHENITKNOWSTHE.ET0ROlTFORTHEPERIOD e 4HEOWNERHASSTATEDTHATASOWNERSEQUITYINCREASED THElRMSASSETSMUSTALSO HAVEINCREASEDStateONEREASONWHYTHISMAYBEINCORRECT

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CHAPTER 9

DETERMINING PROFIT OR LOSS

EXERCISE 9.5 INCOME STATEMENT

page 178

W B

/N-AY THE4RIAL"ALANCEOF2EST%ASY"EDSSHOWEDTHEFOLLOWING REST EASY BEDS Trial Balance as at 31 May 2015 Account Advertising

Debit 230

Bank Buying Expenses

3 410 900

Capital – J. Snooze Cost of Sales

25 190 8 380

Creditors Control Debtors Control

3 000 1 000

Discount Revenue Drawings

250 1 500

GST Clearing

350

Loan – Bank of Hope (repayable $5 000 p.a.)

15 000

Office Furniture

7 650

Prepaid Rent

1 920

Rent Expense

1 800

Sales

12 000

Shop Fittings

20 000

Stock Control

14 000

Stock Gain Wages Totals

Credit

300 2 120 $59 500

$59 500

Required

*

*

a Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO CLOSE THE REVENUE AND EXPENSE ACCOUNTSTOTHE0ROlTAND,OSS3UMMARYACCOUNT.ARRATIONSAREnotREQUIRED b Show THE'ENERAL*OURNALENTRIESNECESSARYTOCLOSETHE0ROlTAND,OSS3UMMARY ACCOUNTANDTRANSFER$RAWINGSTOTHE#APITALACCOUNT.ARRATIONSAREnotREQUIRED c Show HOW THE 0ROlT AND ,OSS 3UMMARY $RAWINGS AND #APITAL ACCOUNTS WOULD APPEAR IN THE 'ENERAL ,EDGER OF 2EST %ASY "EDS AFTER ALL CLOSING AND BALANCING ENTRIESHAVEBEENMADE d PrepareAN)NCOME3TATEMENTFOR2EST%ASY"EDSFOR-AY e ExplainWHYTHEOWNERSHOULDBECONCERNEDABOUTTHElRMSABILITYTOCONTROL#OST OF'OODS3OLD f SuggestONEACTIONTHEOWNERMIGHTTAKETOIMPROVE.ET0ROlT g PrepareACLASSIlED"ALANCE3HEETFOR2EST%ASY"EDSASAT-AY

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CAMBRIDGE VCE ACCOUNTING

214

UNITS 3&4

EXERCISE 9.6 INCOME STATEMENT

W B

page 181

%DU4OYSPROVIDEDTHEFOLLOWING4RIAL"ALANCEASAT$ECEMBER EDUTOYS Trial Balance as at 31 December 2015 Account

Debit

Credit

Advertising

8 000

Bank

2 500

Capital – A.Teacher Cost of Sales

69 430 62 000

Creditors Control Debtors Control Discount Expense

13 000 15 000 600

Discount Revenue

700

Drawings

4 000

Electricity

3 400

GST Clearing Import Duties

270 1 200

Loan – ANZ Bank (repayable $500 per month) Premises

84 000 97 000

Sales

99 000

Shop Fittings

36 000

Stock Control

14 800

Stock Loss Wages Totals

900 21 000 $266 400

$266 400

Required

*

*

a 2EFERRINGTOONEACCOUNTINGPRINCIPLE explainWHYTHELEDGERMUSTBECLOSED b ShowHOWTHE0ROlTAND,OSS3UMMARYAND#APITALACCOUNTSWOULDAPPEARINTHE 'ENERAL,EDGERAFTERALLCLOSINGANDBALANCINGENTRIESHAVEBEENMADE c Prepare AN)NCOME3TATEMENTFOR%DU4OYSFORTHEYEARENDED$ECEMBER d SuggestTWOACTIONSTHEOWNERCOULDTAKETOIMPROVE!DJUSTED'ROSS0ROlTWITHOUT AFFECTING'ROSS0ROlT e Explain HOW REDUCING THE DISCOUNT OFFERED TO DEBTORS MIGHT CAUSE .ET 0ROlT TO DECREASE f Prepare ACLASSIlED"ALANCE3HEETFOR%DU4OYSASAT$ECEMBER

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CHAPTER 9

DETERMINING PROFIT OR LOSS

EXERCISE 9.7 INCOME STATEMENT

W B

page 184

4HE4RIAL"ALANCEFOR0RECIOUS0AINTINGSASAT/CTOBERSHOWEDTHEFOLLOWING PRECIOUS PAINTINGS Trial Balance as at 31 October 2015 Account

Debit

Advertising

450

Capital – Lovegood

14 200

Cash at Bank

3 520

Cost of Sales

9 600

Creditors Control

6 350

Debtors Control

1 000

Delivery Vehicle

20 000

Discount Expense

70

Discount Revenue

50

Drawings

1 500

Freight In

610

Freight Out

800

GST Clearing

350

Loan – Commonwealth Bank (repayable $5 000 p.a.)

20 000

Prepaid Rent

1 800

Rent Expense

2 400

Sales Stock Control

17 500 14 000

Stock Loss

400

Wages Totals

Credit

2 300 $58 450

$58 450

Additional information: s

0RECIOUS0AINTINGSEMPLOYSONEFULL TIMESHOPASSISTANT

Required

*

*

a Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO CLOSE THE REVENUE AND EXPENSE ACCOUNTSTOTHE0ROlTAND,OSS3UMMARYACCOUNT.ARRATIONSAREnotREQUIRED b ShowTHE'ENERAL*OURNALENTRIESNECESSARYTOCLOSETHE0ROlTAND,OSS3UMMARY ACCOUNTANDTRANSFER$RAWINGSTOTHE#APITALACCOUNT.ARRATIONSAREnotREQUIRED c Prepare AN)NCOME3TATEMENTFOR0RECIOUS0AINTINGSFOR/CTOBER d 2EFERRINGTOYOURANSWERTOPART@C explainYOURTREATMENTOF&REIGHT/UT e StateTWOREASONSWHYTHEOWNERMAYBEDISAPPOINTEDWITH.ET0ROlTFOR/CTOBER  f ExplainHOWANINCREASEIN/THER%XPENSESMIGHTLEADTOANINCREASEIN.ET0ROlT g Prepare ACLASSIlED"ALANCE3HEETFOR0RECIOUS0AINTINGSASAT/CTOBER

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CAMBRIDGE VCE ACCOUNTING

216

UNITS 3&4

EXERCISE 9.8 INCOME STATEMENT

page 187

W B

/N*ULY THE4RIAL"ALANCEOF(OT3TUFF/VENSSHOWEDTHEFOLLOWING HOT STUFF OVENS Trial Balance as at 31 July 2015 Account Advertising

Debit

Credit

6 800

Bank

1 200

Capital – Phyre Cost of Sales

74 500 88 500

Creditors Control Debtors Control Discount Expense

44 000 25 000 750

Discount Revenue Drawings

160 1 700

GST Clearing Import Duties

390 1 500

Mortgage – ANQ Bank (repayable $12 000 p.a.) Premises

95 000 120 000

Prepaid Rent

12 000

Rent Expense

6 000

Sales

150 000

Shop Fittings

15 000

Stock Control

65 000

Wages

23 000

Totals

$365 250

$365 250

!DDITIONALINFORMATION s s s

$RAWINGSCONSISTEDOFCASHANDSTOCK OFWAGESWASINCORRECTLYDEBITEDTOTHE!DVERTISINGACCOUNT-EMO  !PHYSICALSTOCKTAKEDETERMINEDTHEREWASOFSTOCKONHAND-EMO 

Required

* *

a ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDTHECORRECTINGENTRYANDTHE STOCKLOSSORGAIN b Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO CLOSE THE REVENUE AND EXPENSE ACCOUNTS.ARRATIONSAREnotREQUIRED c Show HOW THE 0ROlT AND ,OSS 3UMMARY $RAWINGS AND #APITAL ACCOUNTS WOULD APPEAR IN THE 'ENERAL ,EDGER AS AT  *ULY  AFTER ALL RELEVANT CLOSING AND BALANCINGENTRIESHAVEBEENMADE d PrepareAN)NCOME3TATEMENTFOR(OT3TUFF/VENSFORTHEYEARENDED*ULY e ExplainONEUSEOFTHE)NCOME3TATEMENT f PrepareACLASSIlED"ALANCE3HEETFOR(OT3TUFF/VENSASAT*ULY

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Cambridge University Press

Where are we headed? After completing this chapter, you should be able to: s

defineREVENUE EXPENSES ANDPROlT

s

explainHOWTHE2EPORTING 0ERIODPRINCIPLEANDTHE QUALITATIVECHARACTERISTIC OFRelevanceAFFECTTHE CALCULATIONOFPROlT

s

defineTHETERM@BALANCE DAYADJUSTMENT

s

explainTHEPURPOSEOFA BALANCEDAYADJUSTMENT

s

identifyANDrecord EXPENSESPAIDINADVANCEIN THE#ASH0AYMENTS*OURNAL AND'ENERAL,EDGER

s

recordBALANCEDAY ADJUSTMENTSFORPREPAID ANDACCRUEDEXPENSESIN THE'ENERAL*OURNALAND 'ENERAL,EDGER

s

stateTHEEFFECTOFBALANCE DAYADJUSTMENTSONTHE ACCOUNTINGEQUATION

s

identifyANDrecordTHE PAYMENTOFANACCRUED EXPENSEINASUBSEQUENT PERIOD

s

distinguishBETWEENAN ACCRUEDEXPENSEANDA SUNDRYCREDITOR

s

reportPREPAIDANDACCRUED EXPENSESINTHE"ALANCE 3HEET

s

explainTHEPURPOSEOF A0OST ADJUSTMENT4RIAL "ALANCE

s

prepareA0OST ADJUSTMENT 4RIAL"ALANCE

CHAPTER 10

BALANCE DAY ADJUSTMENTS: EXPENSES KEY TERMS After completing this chapter, you should be familiar with the following terms: s

ACCRUALACCOUNTING

s

BALANCEDAYADJUSTMENT

s

PREPAIDEXPENSE

s

ACCRUEDEXPENSE

s

0RE ADJUSTMENT4RIAL"ALANCE

s

0OST ADJUSTMENT4RIAL"ALANCE

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

10.1 THE NEED FOR BALANCE DAY ADJUSTMENTS

STUDY TIP

%XPENSESSHOULDBE RECOGNISEDWHENTHEY AREINCURRED4HISISTHE SAMEASSAYINGTHEY SHOULDBERECOGNISED WHENTHEYARE@USEDUP ORCONSUMED

#HAPTER  INTRODUCED THE IDEA OF CLOSING THE LEDGER BY TRANSFERRING THE BALANCES OF ALL REVENUE AND EXPENSE ACCOUNTS INTO A NEW ACCOUNT THE 0ROlT AND ,OSS 3UMMARY ACCOUNT INORDERTOCALCULATEPROlT2EMEMBERTHEDElNITIONSOFREVENUESANDEXPENSES OUTLINEDIN#HAPTER 2EVENUES INmOWS OF ECONOMIC BENElTS OR SAVINGS IN OUTmOWS IN THE FORM OF INCREASESINASSETSORREDUCTIONSINLIABILITIESTHATLEADTOANINCREASEIN OWNERSEQUITY %XPENSES OUTmOWS OR CONSUMPTIONS OF ECONOMIC BENElTS OR REDUCTIONS IN INmOWS INTHEFORMOFDECREASESINASSETSORINCREASESINLIABILITIESTHAT LEADTOADECREASEINOWNERSEQUITY .OTE THAT THE DElNITION OF REVENUES DOES NOT REFER TO @CASH RECEIVED BUT RATHER @INmOWS OF ECONOMIC BENElTS 4HE BENElT may BE CASH BUT DOES NOT HAVE TO BE IT COULD BE DEBTORS FOR A CREDIT SALE OR SOME OTHER ASSET SUCH AS STOCK FOR A STOCK GAIN )NTHECASEOFDISCOUNTREVENUE THEBENElTISACTUALLYAREDUCTIONINANOUTmOW WHERENOCASHmOWISINVOLVEDATALL4HISMEANSTHATREVENUESHOULDBERECOGNISEDNOT WHENTHECASHISRECEIVED BUTWHENTHEeconomicbenefitISRECEIVEDTHATIS WHENTHE REVENUEISearned NOTWHENITISRECEIVED !SIMILARPRINCIPLEAPPLIESTOEXPENSESEXPENSESSHOULDBERECOGNISEDWHENTHE ECONOMICBENElTISconsumedORINCURRED NOTWHENTHECASHISPAID 4HUS WHENWESPEAKOFDETERMININGPROlT WEAREACTUALLYCOMPARINGTHEREVENUE EARNED IN THE CURRENT 2EPORTING 0ERIOD AGAINST THE EXPENSES INCURRED IN THE CURRENT 2EPORTING0ERIODTHATIS

Profit

=

Revenue earned in the current Reporting Period less Expenses incurred in the current Reporting Period

accrual accounting calculating profit by comparing revenues earned against expenses incurred in a particular Reporting Period

balance day adjustment (BDA) a change made to a revenue or expense account on balance day so that revenue accounts show revenues earned and expense accounts show expenses incurred in a particular Reporting Period

4HISISTHEESSENCEOF accrual accounting.

Adjusting before closing 4HE ASSUMPTION WE MADE BEFORE CLOSING THE LEDGER IN #HAPTER  WAS THAT REVENUE ACCOUNTS ALREADY SHOWED THE AMOUNT earned AND EXPENSE ACCOUNTS ALREADY SHOWED THE AMOUNT incurred 4HUS WHEN WE CALCULATED PROlT WE ASSUMED IT WOULD BE THE CORRECTlGURE 5NFORTUNATELY THISISNOTALWAYSTHECASE)FATBALANCEDAYTHEENDOFTHE2EPORTING 0ERIOD THERE IS REVENUE THAT HAS BEEN earned BUT NOT YET received SUCH AS INTEREST REVENUESTILLOWINGTOTHEBUSINESS THISMAYNOTAPPEARINTHEREVENUEACCOUNTS3IMILARLY IFTHEREAREEXPENSESTHATHAVEBEENincurredBUTNOTYETpaidSUCHASELECTRICITYTHAT HASBEENCONSUMEDBUTWILLNOTBEPAIDFORUNTILTHENEXTPERIOD THISMAYNOTAPPEAR INTHEEXPENSEACCOUNTS!SSUCH ALTHOUGHCLOSINGTHELEDGERCALCULATIONWOULDALLOW FORTHECALCULATIONOFPROlT THATPROlTWOULDBEINACCURATE )N EACH SITUATION SUCH AS THESE A balance day adjustment (BDA) IS NECESSARY TO CHANGEORADJUST THELEDGERACCOUNTSSOTHATTHEREVENUEACCOUNTSINCLUDEALLREVENUES EARNEDANDTHEEXPENSEACCOUNTSINCLUDEALLEXPENSESINCURREDINTHECURRENT2EPORTING 0ERIOD4HISWILLENSURETHATCLOSINGTHELEDGERWILLNOTONLYALLOWFORTHECALCULATIONOF PROlT BUTALSOTHATTHEPROlTlGUREWILLBEACCURATE

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CHAPTER 10

219

B A L A N C E D AY A D J U S T M E N T S : E X P E N S E S

The purpose of a balance day adjustment is to ensure that profit can be calculated accurately, by comparing revenues earned against expenses incurred in the current Reporting Period. 4HISAPPLICATIONOFTHE2EPORTING0ERIODPRINCIPLELEADSTORelevanceINTHEACCOUNTING REPORTSBYENSURINGTHATTHE)NCOME3TATEMENTAND FORTHATMATTER THE"ALANCE3HEET INCLUDESALLINFORMATIONTHATISUSEFULFORDECISION MAKING WHILEEXCLUDINGINFORMATION THATISNOT)NFORMATIONTHATWOULDNOTBEUSEFULINCLUDESREVENUEOREXPENSESTHATWERE EARNEDORINCURREDoutsideTHECURRENT2EPORTING0ERIOD

STUDY TIP

!DJUSTINGENTRIESMUST BEMADEBEFORECLOSING ENTRIES*USTREMEMBER !"#!DJUST"EFORE #LOSING

Types of balance day adjustments 4HEBALANCEDAYADJUSTMENTSTOBECOVEREDINTHISUNITREFERMAINLYTOEXPENSESWITH STOCKGAINBEINGTHEOBVIOUSEXCEPTION ANDINCLUDE

STUDY TIP

s STOCKLOSSESANDGAINSCOVEREDIN#HAPTER s PREPAIDEXPENSES s ACCRUEDEXPENSES s DEPRECIATIONTOBECOVEREDIN#HAPTER  4HESE BALANCE DAY ADJUSTMENTS MUST BE RECORDED IN THE 'ENERAL *OURNAL BEFORE BEINGPOSTEDTOTHE'ENERAL,EDGERACCOUNTS

/THERADJUSTMENTS RELATINGTOREVENUE ACCOUNTS WILLNOT BEEXAMINEDUNTIL SECONDSEMESTERAND SOARECOVEREDINLATER CHAPTERS

REVIEW QUESTIONS 10.1

1 Explain WHY PROlT MAY BE INACCURATE IF BALANCE DAY ADJUSTMENTS ARE not RECORDED 2 ExplainTHEPURPOSEOFABALANCEDAYADJUSTMENT 3 Explain HOW BALANCE DAY ADJUSTMENTS ENSURE 2ELEVANCE IN THE ACCOUNTING REPORTS 4 ListTHEFOURBALANCEDAYADJUSTMENTSTHATRELATETOEXPENSES

10.2 PREPAID EXPENSES &REQUENTLY ANAMOUNTWILLBEPAIDFORANITEMTHATISNOTCONSUMEDATTHETIMETHE PAYMENTISMADE&ORINSTANCE WHENABUSINESSPAYSFORRENTORINSURANCETHEYUSUALLY PAYINADVANCE COVERINGTHENEXTMONTHOREVENTHEFORTHCOMINGYEAR4HESAMECOULD BESAIDFORSUPPLIESANDMATERIALSSUCHASOFlCESUPPLIES WHICHAREPURCHASEDINBULK Frequently, amounts are BUTARENOTUSEDIMMEDIATELY4HESEARECOMMONPAYMENTS BUTATTHETIMETHEYARE paid for items such as rent, insurance and office PAIDSHOULDWECONSIDERTHEMTOBEEXPENSES

supplies that are not used immediately. Should these be considered expenses or assets?

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CAMBRIDGE VCE ACCOUNTING

prepaid expense an expense paid in advance but yet to be consumed

UNITS 3&4

#ONSIDER THE DElNITION OF AN EXPENSE )T REFERS TO A consumption OR outflow OF ECONOMICBENElTS9ETATTHETIMEOFTHEPAYMENT HOWMUCHOFTHERENT INSURANCE OROFlCESUPPLIESHASBEENCONSUMED4HEANSWERISNONE)NFACT EACHWILLNOTBE CONSUMED UNTIL SOME TIME in the future 4HEREFORE THEY ARE NOT consumptions OF ECONOMICBENElTS BUTRATHERfutureECONOMICBENElTS)NOTHERWORDS THEYAREASSETS 4HISMEANSTHATWHENANEXPENSEISPAIDINADVANCE ITSHOULDBEPROPERLYRECORDED ASACURRENTASSETCALLEDprepaid expenseINTHISCASE 0REPAID2ENT 0REPAID)NSURANCE OR0REPAID/FlCE3UPPLIES 

Recording expenses paid in advance

EXAMPLE

On 1 October 2015, Wendell Windows paid $1 200 (plus $120 GST) for insurance for the next 12 months (Ch. 63).

4HISPAYMENTWOULDBERECORDEDINTHE#ASH0AYMENTS*OURNALASISSHOWNIN&IGURE Figure 10.1

Cash Payments Journal: prepaid expense Cash Payments Journal

Date

Details

Oct. 1 Prepaid Insurance

Chq. no.

Bank

63

1 320

Totals

16 020

Discount Revenue

400

Creditors Control

5 000

Wages

Drawings

8 000

2 100

Sundries

GST

1 200

120

1 200

120

0OSTINGTHISTOTHE'ENERAL,EDGERWOULDSHOW General Ledger Bank (A) Date

Cross-reference

Oct. 1

Balance

Amount $

Date

Cross-reference

Amount $

35 000

Oct. 31

Cash payments

16 020

Cross-reference

Amount $

Amount $

Prepaid Insurance (A) Date Oct. 31

Cross-reference Bank

Amount $

Date

1 200 GST Clearing (A/L)

Date Oct. 31

Cross-reference Bank

Amount $

Date

Cross-reference

120

Oct. 1

Balance

400

4HEPAYMENTWILLBERECORDEDINTHE#ASH0AYMENTS*OURNALONTHEDAYITISPAID /CTOBER BUTTHEJOURNALWILLBEPOSTEDTOTHE'ENERAL,EDGERONLYATTHEEND OFTHEMONTH/CTOBER 

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CHAPTER 10

221

B A L A N C E D AY A D J U S T M E N T S : E X P E N S E S

2EMEMBERTHATTHISPAYMENTWILLBEONLYONEOFANUMBEROFPAYMENTSDURINGTHE MONTH SOTHElGUREFORtotalCASHPAYMENTS($16 020 WILLBECREDITEDTOTHEBank ACCOUNT /FTHE$1 320PAID WAS'34 WHICHISDEBITEDTOTHE'34#LEARINGACCOUNTTO REDUCETHELIABILITYTOTHE!4/4HISMEANSTHATONLYnTHEAMOUNTRELATINGTO THEINSURANCEITSELFnISDEBITEDTO0REPAID)NSURANCEASTHEVALUEOFTHECURRENTASSET Effect on the accounting equation !SARESULTOFTHEpaymentOFPREPAIDINSURANCE Increase/Decrease/No effect

Amount $

Assets

Decrease (decrease Bank $1 320, increase Prepaid Insurance $1 200)

120

Liabilities

Decrease (GST Clearing)

120

Owner’s Equity

No effect

!TTHISPOINT THEREISNOEXPENSEAMOUNTRECORDEDINTHE'ENERAL,EDGERACCOUNTS ITISALLRECORDEDASACURRENTASSET

Adjusting for the consumption of a prepaid expense 0REPAIDEXPENSESARERECORDEDASCURRENTASSETSBECAUSEATTHETIMEOFPAYMENT NONE OF THE AMOUNT HAS BEEN CONSUMED IT IS ALL A future ECONOMIC BENElT (OWEVER BY THE TIME BALANCE DAY ARRIVES THE DAY ON WHICH THE LEDGER IS CLOSED AND REPORTS ARE PREPARED ATLEASTPARTOFTHISPREPAIDEXPENSEISLIKELYTOHAVEBEENconsumed)NOTHER WORDS PARTOFTHEASSETHASBECOMEANEXPENSE )TISTHEREFORENECESSARYTOADJUSTTHELEDGERACCOUNTSSOTHAT s THEAMOUNTCONSUMEDINTHECURRENT2EPORTING0ERIODISTRANSFERREDTOANEXPENSE ACCOUNT s THE0REPAID%XPENSEACCOUNTONLYSHOWSTHEAMOUNTREMAININGTHATIS UNUSED OR TOBEUSEDUPINAFUTURE2EPORTING0ERIOD ,ETSREFERBACKTOOUREARLIEREXAMPLE WHENINSURANCEWASPAIDON/CTOBER BUTPAIDINADVANCEFORTHENEXTMONTHS!T/CTOBER s (OWMUCHINSURANCEHASBEENCONSUMEDDURING/CTOBER  s (OWMUCHPREPAIDINSURANCEISLEFTUNUSEDATTHEENDOF/CTOBER  )FTHEPAYMENTMADEON/CTOBERCOVERSMONTHS $1 200 prepaid insurance

=

$100 insurance per month

12 months 4HEPREPAIDINSURANCEISCONSUMEDATPERMONTH SOBYBALANCEDAYOF/CTOBER  ONEMONTHSWORTH OFPREPAIDINSURANCEHASBEENCONSUMED 4HE BALANCE DAY ADJUSTMENT TO RECORD THE INSURANCE CONSUMED IS SHOWN IN THE 'ENERAL*OURNALENTRYIN&IGURE

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

STUDY TIP

#ALCULATETHEAMOUNT CONSUMEDUSED UPINCURRED4HISIS THEAMOUNTTOUSE INTHEBALANCEDAY ADJUSTMENT

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CAMBRIDGE VCE ACCOUNTING

Figure 10.2

UNITS 3&4

General Journal: BDA for consumption of prepaid expense General Journal General Ledger

Date Oct. 31

Details

Debit

Insurance Expense

Subsidiary Ledger

Credit

Debit

Credit

100

Prepaid Insurance

100

Adjusting entry to record one month insurance incurred (Memo 9)

4HISENTRYDEBITSTHE)NSURANCE%XPENSEACCOUNTTORECOGNISETHEEXPENSEINCURRED IN THE CURRENT 2EPORTING 0ERIOD WHILE THE 0REPAID )NSURANCE ACCOUNT IS CREDITED TO REDUCETHECURRENTASSETBYTHEAMOUNTCONSUMED4HESOURCEDOCUMENTIS-EMO REmECTINGTHEFACTTHATTHISINFORMATIONHASCOMEFROMWITHINTHEBUSINESS !FTERPOSTING THISENTRYWOULDAPPEARINTHE'ENERAL,EDGERASISSHOWNIN&IGURE  Figure 10.3

General Ledger: BDA for consumption of prepaid expense General Ledger

STUDY TIP

Prepaid Insurance (A)

7HENADJUSTINGA PREPAIDEXPENSE @TAKEAWAYTHEAMOUNT INCURREDFROMTHE CURRENTASSET 

Date Oct. 31

Cross-reference Bank

Amount $

Date

1 200

Oct. 31

Cross-reference Insurance Expense

Amount $ 100

1 100 Insurance Expense (E) Date Oct. 31

Cross-reference

Amount $

Prepaid Insurance

Date

Cross-reference

Amount $

100

.OTETHATTHE'ENERAL*OURNALENTRYTORECORDTHEBALANCEDAYADJUSTMENTIN&IGURE  USESTHEAMOUNTCONSUMEDINTHECURRENT2EPORTING0ERIOD 4HEBALANCE OFLEFTINTHE0REPAID)NSURANCEACCOUNTn REPRESENTSTHEAMOUNT unused ORTHEAMOUNTTHATWILLBECONSUMEDINAfuture2EPORTING0ERIOD4HISISTHE NEWCURRENTASSETBALANCE Effect on the accounting equation !SARESULTOFTHEADJUSTMENTFORTHECONSUMPTIONOF0REPAID)NSURANCE Increase/Decrease/No effect

Amount $

Assets

Decrease (Prepaid Insurance)

100

Liabilities

No effect

Owner’s Equity

Decrease (increase Insurance Expense decreases Net Profit)

100

4HIS ADJUSTMENT DOES NOT CHANGE "ANK NOR DOES IT AFFECT '34 #LEARING BUT IT DECREASESPROlT ANDDECREASESASSETSINTHE"ALANCE3HEET

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Closing the ledger .OWTHATTHELEDGERACCOUNTSHAVEBEENADJUSTEDnSOTHATTHEEXPENSEACCOUNTSHOWS THEAMOUNTINCURREDINTHECURRENT2EPORTING0ERIODnTHEEXPENSEACCOUNTISREADYTO BECLOSEDTOTHE0ROlTAND,OSS3UMMARYACCOUNT2EMEMBERTHATALLEXPENSEACCOUNTS ARECLOSEDINONE'ENERAL*OURNALENTRY WITHEACHEXPENSEACCOUNTCREDITED ANDONE DEBITTOTHE0ROlTAND,OSS3UMMARYACCOUNT !FTERITHASBEENCLOSED THE)NSURANCE%XPENSEACCOUNTWOULDSHOW General Ledger Insurance Expense (E) Date Oct. 31

Cross-reference

Amount $

Date

100

Oct. 31

Prepaid Insurance

Cross-reference Profit and Loss Summary

100

Amount $ 100 100

REVIEW QUESTIONS 10.2

1 ExplainWHYAPREPAIDEXPENSEISCLASSIlEDASACURRENTASSET 2 State THE EFFECT ON THE ACCOUNTING EQUATION OF A PAYMENT FOR A PREPAID EXPENSE 3 Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO RECORD THE BALANCE DAY ADJUSTMENTFORTHECONSUMPTIONOFAPREPAIDEXPENSE 4 StateTHEEFFECTONTHEACCOUNTINGEQUATIONOFTHEBALANCEDAYADJUSTMENTFOR THECONSUMPTIONOFAPREPAIDEXPENSE

10.3 ACCRUED EXPENSES 0REPAID EXPENSES ARE PAID before THEY ARE CONSUMED BUT IT IS ALSO LIKELY THAT SOME EXPENSESWILLBEPAIDafterTHEYARECONSUMED&OREXAMPLE ATBALANCEDAYTHEREMAY BEWAGESOWINGTOEMPLOYEESFORWORKTHATHASALREADYBEENDONE ORELECTRICITYTHAT HASBEENCONSUMEDBUTNOTPAIDFOR"ECAUSETHISAMOUNTHASALREADYBEENINCURREDOR INTHELANGUAGEOFTHEDElNITION consumed INTHECURRENT2EPORTING0ERIOD ITMUSTBE ADDEDTOTHEEXPENSEAMOUNT)NADDITION THEAMOUNTOWINGSHOULDALSOBERECORDED ASALIABILITY4HEAMOUNTSTILLOWINGFORANEXPENSETHATHASALREADYBEENCONSUMEDIS CALLEDANaccrued expense

Adjusting for an accrued expense

accrued expense an expense that has been incurred but not yet paid

0RIOR TO MAKING ANY BALANCE DAY ADJUSTMENTS EXPENSE ACCOUNTS WILL ONLY SHOW THE AMOUNTSPAID&ORINSTANCE THE7AGESACCOUNTWILLSHOWTHEAMOUNTPAIDTOEMPLOYEES THE )NTEREST %XPENSE ACCOUNT WILL SHOW INTEREST PAID TO THE BANK AND %LECTRICITY WILL SHOWTHEAMOUNTPAIDFORELECTRICITY&ORINSTANCE ATBALANCEDAY/CTOBER THE %LECTRICITYACCOUNTMAYSHOW General Ledger Electricity (E) Date Oct. 31

Cross-reference Bank

Amount $

Date

Cross-reference

Amount $

1 500

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

4HECURRENTLYSHOWNINTHE%LECTRICITYACCOUNTREPRESENTSTHEAMOUNTACTUALLY PAIDFORELECTRICITYDURING/CTOBER"UTISTHISTHETOTALEXPENSEINCURREDINTHE PERIOD "EFORE THE REPORTS CAN BE PREPARED THE ACCOUNTANT MUST ASCERTAIN WHETHER ANY ADDITIONAL AMOUNTS HAVE BEEN CONSUMED BUT NOT YET PAID )F THERE ARE THESE MUST BEADDEDTOTHEEXPENSEACCOUNTSBEFORETHECLOSINGENTRIESAREMADE)TISTHEREFORE NECESSARYTOADJUSTTHELEDGERACCOUNTSSOTHAT s THEEXTRAAMOUNTCONSUMEDINTHECURRENT2EPORTING0ERIODISADDEDTOTHEEXPENSE ACCOUNT s ACURRENTLIABILITYACCOUNTn!CCRUED%XPENSEnISCREATEDTOSHOWTHEAMOUNTOWING UNPAID WHICHWILLBEPAIDINTHENEXT2EPORTING0ERIOD

EXAMPLE

At 31 October 2015, $300 electricity was owing (Memo 15).

4HEBALANCEDAYADJUSTMENTTORECORDTHEACCRUEDELECTRICITYISSHOWNINTHE'ENERAL *OURNALENTRYIN&IGURE Figure 10.4

General Journal: BDA for accrued expense General Journal General Ledger

Date

Details

Debit $

Oct. 31 Electricity Expense

Credit $

Subsidiary Ledger Debit $

Credit $

300

Accrued Electricity

300

Adjusting entry to record electricity consumed but not yet paid (Memo 15)

4HIS ENTRY DEBITS THE %LECTRICITY %XPENSE ACCOUNT TO RECOGNISE THE EXTRA AMOUNT INCURRED IN THE CURRENT 2EPORTING 0ERIOD !T THE SAME TIME THE !CCRUED %LECTRICITY ACCOUNTISCREDITEDTORECOGNISETHELIABILITYTHEOBLIGATIONTOTHEELECTRICITYSUPPLIER &ORANACCRUEDEXPENSE THEAMOUNTUSEDINTHEADJUSTMENT ISnotTHETOTAL EXPENSEFORTHEPERIOD2ATHER ITISSIMPLYTHEEXTRAAMOUNTTHEAMOUNTTHATHASBEEN CONSUMEDBUTNOTYETPAID)TISADDEDTOTHEAMOUNTPAIDTOCALCULATETHETOTALEXPENSE INCURREDFORTHE2EPORTING0ERIOD !FTERPOSTING THISENTRYWOULDAPPEARINTHE'ENERAL,EDGERASISSHOWNIN&IGURE  Figure 10.5

General Ledger: BDA for accrued expense General Ledger Electricity Expense (E)

Date Oct. 31

Cross-reference Bank Accrued Electricity

Amount $

Date

Cross-reference

Amount $

1 500 300

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Accrued Electricity (L) Date

Cross-reference

Amount $

Date

Cross-reference

Oct. 31

Amount $

Electricity Expense

300

STUDY TIP

Effect on the accounting equation !SARESULTOFTHEADJUSTMENTFOR!CCRUED%LECTRICITY Increase/Decrease/No effect

Amount $

Assets

No effect

Liabilities

Increase (Accrued Electricity)

300

Owner’s Equity

Decrease (increase Electricity Expense decreases Net Profit)

300

7HENADJUSTINGAN ACCRUEDEXPENSE @ADD ONTHEEXTRAAMOUNT INCURREDTOTHE EXPENSE 

!SWITHTHEADJUSTMENTFORTHECONSUMPTIONOFAPREPAIDEXPENSE THISADJUSTMENT DOESNOTCHANGE"ANK NORDOESITAFFECT'34#LEARING2ATHER ITDECREASESPROlTAND INCREASESLIABILITIESINTHE"ALANCE3HEET

Closing the ledger !SACURRENTLIABILITY THE!CCRUED%LECTRICITYACCOUNTWILLBEBALANCED BUTTHE%LECTRICITY %XPENSEACCOUNTWILLBECLOSEDTOTHE0ROlTAND,OSS3UMMARYACCOUNT!FTERITHAS BEENCLOSED THE%LECTRICITY%XPENSEACCOUNTWOULDSHOW ELECTRICITY EXPENSE (E) Date

Cross-reference

Oct. 31

Bank Accrued Electricity

Amount $ 1 500

Date Oct. 31

Cross-reference

Amount $

Profit and Loss Summary

1 800

300 1 800

1 800

.OTEHOWTHEAMOUNTCLOSED ISGREATERTHANTHEAMOUNTOFTHEADJUSTMENT  ASTHETOTALEXPENSEINCURREDINCLUDESBOTHTHEPAID ANDTHESTILL OWINGATTHEENDOFTHEPERIOD2EMEMBER FORANITEMTOBERECOGNISEDASANEXPENSE THEDElNITIONREQUIRESANITEMTOBECONSUMEDPAYMENTISNOTNECESSARY

Payment of accrued expenses in subsequent periods 3OMETIMEINTHENEXT2EPORTING0ERIOD THEAMOUNTOWINGASANACCRUEDEXPENSEWILL BEPAID4HEREFORE THENEXTTIMEACHEQUEISWRITTENTOPAYFORTHEEXPENSE WEMUST RECOGNISETHATWHILESOMEOFTHEAMOUNTPAIDMAYREPRESENTANEXPENSEOFTHECURRENT 2EPORTING0ERIOD ATLEASTSOMEOFTHEPAYMENTRELATESTOTHEPREVIOUS2EPORTING0ERIOD )NOTHERWORDS SOMEOFTHEAMOUNTPAIDREDUCESTHELIABILITYFORACCRUEDEXPENSESn EXPENSESINCURREDANDACCRUEDlastperiod

On 4 November 2015, a cheque for $1 500 (plus $150 GST) was sent to the electricity company (Ch. 77).

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

EXAMPLE

Cambridge University Press

226

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

4HEPAYMENTOFELECTRICITYON.OVEMBERWOULDBERECORDEDINTHE#ASH 0AYMENTS*OURNALASSHOWNIN&IGURE Figure 10.6

Cash Payments Journal: payment of accrued expense in a subsequent period CASH PAYMENTS JOURNAL

Date Nov. 4

Details

Chq. no.

Accrued Electricity/

77

Bank

Discount Revenue

Creditors Control

Wages

Drawings

1 650

Electricity Expense

Sundries

GST

300

150

1 200

Totals

$

16 350

300

4 000

8 000

3 000

1 500

150

4HEFULLAMOUNTPAIDn$1 650nISRECORDEDINTHE"ANKCOLUMN ASTHISISTHEAMOUNT WRITTENONTHECHEQUE(OWEVER THISISNOTALL%LECTRICITY%XPENSEINCURREDIN.OVEMBER &ORASTART ITINCLUDESWORTHOF'34 WHICHMUSTBEDEBITEDTO'34#LEARING 4HISLEAVESUSWITHTHATHASBEENPAIDFORELECTRICITY"UTHOWMUCHRELATESTO ELECTRICITYTHATWASCONSUMEDIN.OVEMBER 2EMEMBERTHATON/CTOBER WEMADEABALANCEDAYADJUSTMENTTORECORD OFELECTRICITYTHATHADBEENCONSUMEDIN/CTOBER BUTWASNOTYETPAID4HAT IS AT/CTOBER WASOWEDFOR!CCRUED%LECTRICITY3OWHENTHEPAYMENT ISMADEON.OVEMBER SOMEOFTHEISBEINGUSEDTOPAYOFFTHISEARLIER DEBT4HATIS ISPAIDTODECREASETHE!CCRUED%LECTRICITYLIABILITY SOONLY REPRESENTS%LECTRICITY%XPENSECONSUMEDDURING.OVEMBER /NCE THE #ASH 0AYMENTS *OURNAL HAS BEEN POSTED TO THE 'ENERAL ,EDGER THE ACCOUNTSWOULDAPPEARASSHOWNIN&IGURE Figure 10.7

General Ledger: payment of accrued expense in a subsequent period General Ledger Bank (A)

Date Nov. 30

Cross-reference Balance

Amount $

Date

4 000

Nov. 30

Cross-reference Cash payments

Amount $ 16 350

Electricity Expense (E) Date Nov. 30

Cross-reference Bank

Amount $

Date

Cross-reference

Amount $

1 200 Accrued Electricity (L)

Date Nov. 30

Cross-reference Bank

Amount $

Date

Cross-reference

300

Nov. 1

Balance

Amount $ 300

GST Clearing (A/L) Date Nov. 30

Cross-reference Bank

Amount $

Date

Cross-reference

150

Nov. 1

Balance

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Amount $ 850

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CHAPTER 10

B A L A N C E D AY A D J U S T M E N T S : E X P E N S E S

!SWASNOTEDIN#HAPTER NOTALLEXPENSESARESUBJECTTO'34 SOWHENPAYINGA NON '34ITEMSUCHASWAGESORINTERESTEXPENSE INASUBSEQUENTPERIOD ITWILLNOTBE NECESSARYTOACCOUNTFORTHE'34(OWEVER ITISLIKELYTHATITWILLSTILLBENECESSARYTOSPLIT THEPAYMENTASPARTWAGESEXPENSE PARTACCRUEDWAGES ORASPARTINTERESTEXPENSE PARTACCRUEDINTEREST Effect on the accounting equation !SARESULTOFTHEPAYMENTOF%LECTRICITYAND!CCRUED%LECTRICITY Increase/Decrease/No effect Assets

Decrease (Bank)

Liabilities

Decrease (Accrued Electricity $300, GST Clearing $150)

Owner’s Equity

Decrease (increase Electricity Expense decreases Net Profit)

Amount $ 1 650 450 1 200

Accrued expense versus sundry creditor )TISIMPORTANTTODISTINGUISHBETWEENAMOUNTSOWEDASACCRUEDEXPENSESANDAMOUNTS OWED TO SUNDRY CREDITORS !N ACCRUED EXPENSE OCCURS WHEN AN EXPENSE HAS BEEN INCURRED BUT THE PAYMENT HAS NOT YET BEEN MADE ! SUNDRY CREDITOR OCCURS WHEN ITEMSOTHERTHANSTOCKAREPURCHASED BUTTHEPAYMENTHASNOTBEENMADE#REDITORS #ONTROLONLYRECORDSCREDITPURCHASESOFSTOCK 'IVENTHEOBVIOUSSIMILARITY WHATISTHE DIFFERENCE7HENSHOULDANAMOUNTOWINGBERECORDEDASANACCRUEDEXPENSE7HEN SHOULDITBERECORDEDASASUNDRYCREDITOR 4OSTART ACCRUEDEXPENSESMUSTRELATESPECIlCALLYTOEXPENSES4HEAMOUNTSMUSTBE OWINGFORITEMSTHATHAVEBEENCONSUMED RATHERTHANFORASSETS"UT MOREIMPORTANTLY ACCRUEDEXPENSESARENOTDUEFORREPAYMENTATBALANCEDAY BECAUSENOINVOICEHAS BEENRECEIVED!CCRUEDEXPENSESOCCURWHENBALANCEDAYFALLSBEFOREANITEMHASBEEN PAID BUTALSOBEFOREITISDUEFORPAYMENT4HUS ANACCRUEDEXPENSEWILLBEVERIlED NOTBYANINVOICE BUTBYSOMETHINGLIKEAMEMO)FANINVOICEHASBEENRECEIVED THE TRANSACTIONISSIMPLYACREDITTRANSACTION ANDTHEAMOUNTOWINGSHOULDBESHOWNASA SUNDRYCREDITOR

REVIEW QUESTIONS 10.3

1 ExplainWHYANACCRUEDEXPENSEISCLASSIlEDASACURRENTLIABILITY 2 ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDANACCRUEDEXPENSE 3 StateTHEEFFECTONTHEACCOUNTINGEQUATIONOFTHEBALANCEDAYADJUSTMENTFOR ANACCRUEDEXPENSE 4 Explain WHY THE PAYMENT OF AN ACCRUED EXPENSE IN A SUBSEQUENT PERIOD REQUIRESTHEPAYMENTTOBESPLITINTHE#ASH0AYMENTS*OURNAL 5 State THE EFFECT ON THE ACCOUNTING EQUATION OF THE PAYMENT OF AN ACCRUED EXPENSEINASUBSEQUENTPERIOD 6 DistinguishBETWEENANACCRUEDEXPENSEANDASUNDRYCREDITOR

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228

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

10.4 THE POST-ADJUSTMENT TRIAL BALANCE Pre-adjustment Trial Balance a list of all General Ledger accounts and their balances before balance day adjustments have been made Post-adjustment Trial Balance a list of all General Ledger accounts and their balances after balance day adjustments have been made

4HE IDEA OF PREPARING A 4RIAL "ALANCE WAS INTRODUCED IN #HAPTER  AS PART OF THE LEDGERRECORDINGPROCESS)TSFUNCTIONWASTOCHECKTHATTOTALDEBITSEQUALTOTALCREDITS 4ECHNICALLY THISSHOULDHAVEBEENTITLEDAPre-adjustment Trial Balance ASITISPREPARED BEFOREANYBALANCEDAYADJUSTMENTSHAVEBEENRECORDED (OWEVER BALANCEDAYADJUSTMENTSCHANGETHE'ENERAL,EDGERACCOUNTS AFTERTHE 4RIAL "ALANCE HAS ALREADY BEEN PREPARED THEY INCREASE CERTAIN EXPENSES DECREASE CERTAIN CURRENT ASSETS AND INCREASE CERTAIN CURRENT LIABILITIES 4HIS MEANS IT MAY BE USEFULTOPREPAREAPost-adjustment Trial Balance TOCHECKTHATEVENAFTERTHEBALANCE DAYADJUSTMENTSHAVEBEENMADE THETOTALDEBITSEQUALTHETOTALCREDITS

KINGSTON HOMEWARES Pre-adjustment Trial Balance as at 30 June 2015

EXAMPLE

Account

Debit

Stock Control

34 000

Debtors Control

12 000

Prepaid Rent

Credit

6 000

Fixtures and Fittings

50 000

Bank

1 000

Creditors Control

19 000

Loan – Wonderbucks

45 000

Capital – Gemeika

29 000

Sales Revenue

100 000

Cost of Sales

60 000

Wages

20 000

Electricity

8 000

Advertising

4 000

Totals

$194 000

$194 000

Additional information as at 30 June 2015:

s Stock loss

$ 1 000

s Rent incurred

$

700

s Accrued wages

$

200

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

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CHAPTER 10

B A L A N C E D AY A D J U S T M E N T S : E X P E N S E S

4HE ENTRIES TO RECORD THESE BALANCE DAY ADJUSTMENTS WITH THE NARRATIONS OMITTED WOULDBERECORDEDINTHE'ENERAL*OURNALASISSHOWNBELOW General Journal General Ledger Date June 30

Details

Debit

Stock Loss

1 000

Stock Control June 30

Rent Expense

Credit

Debit

Credit

1 000 700

Prepaid Rent June 30

Subsidiary Ledger

Wages

700 200

Accrued Wages

200

!FTER THESE BALANCE DAY ADJUSTMENTS WERE POSTED TO THE LEDGER ACCOUNTS A 0OST ADJUSTMENT4RIAL"ALANCEWOULDBEPREPARED ASISSHOWNIN&IGURE Figure 10.8

Post-adjustment Trial Balance KINGSTON HOMEWARES Post-adjustment Trial Balance as at 30 June 2015

Account

Debit

Stock Control

33 000

Debtors Control

12 000

Prepaid Rent Fixtures and Fittings

Credit

5 300 50 000

Bank

1 000

Creditors Control

19 000

Loan – Wonderbucks

45 000

Capital – Gemeika

29 000

Sales Revenue

100 000

Cost of Sales

60 000

Wages

20 200

Electricity

8 000

Advertising

4 000

Stock Loss

1 000

Rent Expense

700

Accrued Wages Total

200 $194 200

$194 200

/BVIOUSLYTHEBALANCEDAYADJUSTMENTSWEREPOSTEDCORRECTLYnATLEASTINTERMSOF DEBITSMATCHINGCREDITSnBECAUSETHIS0OST ADJUSTMENT4RIAL"ALANCESTILLBALANCESATA NEWTOTALOF $194 200  0REPARINGTHE0OST ADJUSTMENT4RIAL"ALANCEALSOASSISTSINENSURINGTHATTHECLOSING ENTRIES AND THE )NCOME 3TATEMENT USE THE CORRECT AMOUNTS THE adjusted lGURES FOR THEAMOUNTSincurredRATHERTHANTHEUNADJUSTEDlGURES WHICHDIDNOTACCOUNTFORANY BALANCEDAYADJUSTMENTS ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

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230

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

REVIEW QUESTIONS 10.4

1 Explain THE DIFFERENCE BETWEEN A 0RE ADJUSTMENT 4RIAL "ALANCE AND A 0OST ADJUSTMENT4RIAL"ALANCE 2 ExplainHOWA0OST ADJUSTMENT4RIAL"ALANCECANASSISTINTHECALCULATIONOFAN ACCURATEPROlTlGURE

WHERE HAVE WE BEEN? s s

s s s s

EXERCISES

"ALANCEDAYADJUSTMENTSARENECESSARYSOTHATANACCURATEPROlTISCALCULATEDBY COMPARINGREVENUEEARNEDANDEXPENSESINCURREDINTHECURRENT2EPORTING0ERIOD "ALANCEDAYADJUSTMENTSMAYBENECESSARYFOR n STOCKLOSSESANDGAINSCOVEREDIN#HAPTER n PREPAIDEXPENSES n ACCRUEDEXPENSES n DEPRECIATIONTOBECOVEREDIN#HAPTER  %ACHBALANCEDAYADJUSTMENTFORANEXPENSEINCREASESTHEEXPENSE THUSDECREASING PROlTANDOWNERSEQUITY !DJUSTMENTS FOR PREPAID EXPENSES DECREASE ASSETS ADJUSTMENTS FOR ACCRUED EXPENSESINCREASELIABILITIES "ALANCEDAYADJUSTMENTSHAVENOEFFECTONCASH BUTWILLCHANGE.ET0ROlTANDTHE ITEMSINTHE"ALANCE3HEET ! 0OST ADJUSTMENT 4RIAL "ALANCE SHOULD BE PREPARED AFTER THE BALANCE DAY ADJUSTMENTSHAVEBEENPOSTEDTOTHELEDGERTOCHECKTHATTOTALDEBITSSTILLEQUAL TOTALCREDITS

EXERCISE 10.1 PREPAID EXPENSE

W B

page 192

/N-ARCH $OMS,ARGE'OODSPAIDPLUS'34 TOCOVERTHENEXT SIXMONTHSRENT#H 4HElRMCLOSESITSLEDGERACCOUNTSANDPREPARESITSlNANCIAL REPORTSON*UNEEACHYEAR Required a Record#HEQUEINTHE#ASH0AYMENTS*OURNALOF$OMS,ARGE'OODS b 2EFERRINGTOONEACCOUNTINGPRINCIPLE explainWHYSOMEOFTHERENTPAIDSHOULDBE REPORTEDASANEXPENSEFORTHEYEARENDING*UNE c CalculateRENTEXPENSEFORTHEYEARENDING*UNE d Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO RECORD RENT EXPENSE FOR THE YEAR ENDING*UNE.ARRATIONis notREQUIRED e StateTHEEFFECTOFTHEADJUSTMENTFORRENTEXPENSEONTHEACCOUNTINGEQUATIONOF $OMS,ARGE'OODS f ShowHOWTHE2ENT%XPENSEAND0REPAID2ENT%XPENSEACCOUNTSWOULDAPPEARIN THE'ENERAL,EDGEROF$OMS,ARGE'OODSASAT*UNEAFTERALLCLOSINGAND BALANCINGENTRIESHAVEBEENMADE

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B A L A N C E D AY A D J U S T M E N T S : E X P E N S E S

EXERCISE 10.2 PREPAID EXPENSE

W B

page 194

/N&EBRUARY 2ONNIES#AR0ARTSPAIDPLUS'34 FOROFlCESUPPLIES#H  /N&EBRUARY WORTHOFOFlCESUPPLIESWASSTILLONHAND-EMO  Required a RecordTHEPAYMENTFOROFlCESUPPLIESINTHE#ASH0AYMENTS*OURNAL b CalculateOFlCESUPPLIESEXPENSEFOR&EBRUARY c ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDOFlCESUPPLIESEXPENSEFOR &EBRUARY d ShowHOWTHE/FlCE3UPPLIES%XPENSEAND0REPAID/FlCE3UPPLIESACCOUNTSWOULD APPEARINTHE'ENERAL,EDGEROF2ONNIES#AR0ARTSASAT&EBRUARYAFTERALL CLOSINGANDBALANCINGENTRIESHAVEBEENMADE e Show HOW 0REPAID /FlCE 3UPPLIES WOULD BE REPORTED IN THE "ALANCE 3HEET OF 2ONNIES#AR0ARTSASAT&EBRUARY

EXERCISE 10.3 PREPAID EXPENSE

W B

page 196

-AXWELLS3HOESPRESENTEDTHEFOLLOWINGEXTRACTFROMITS"ALANCE3HEETASAT-ARCH  Current assets:

Prepaid Insurance

$1800

4HEYEARLYINSURANCEPREMIUMWASPAIDINADVANCEON*ANUARY4HEBUSINESS PREPARESREPORTSMONTHLY ANDTHENEXTBALANCEDAYOCCURSON!PRIL Required a 2EFERRINGTOONEQUALITATIVECHARACTERISTIC explainWHYBALANCEDAYADJUSTMENTSARE NECESSARY b CalculateTHEINSURANCEEXPENSEFOR!PRIL c ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDINSURANCEEXPENSEFOR!PRIL .ARRATIONis notREQUIRED d StateTHEEFFECTONTHEACCOUNTINGEQUATIONOF-AXWELLS3HOESIFTHEADJUSTMENTFOR INSURANCEEXPENSEWASnotMADE e ShowHOW0REPAID)NSURANCEWOULDBEREPORTEDINTHE"ALANCE3HEETOF-AXWELLS 3HOESASAT*ULY

EXERCISE 10.4 PREPAID EXPENSE

W B

page 197

/N*UNE (ALIFAX&URNITURE3ALESPAIDINCLUDING'34 FORADVERTISINGIN Furniture TraderMAGAZINE#H 4HEADVERTISEMENTSWILLAPPEARONCEAMONTHFOR lVEMONTHS WITHTHElRSTADVERTISEMENTAPPEARINGIN*ULY-EMO  Required a Record#HEQUEINTHE#ASH0AYMENTS*OURNAL b Explain HOW THE AMOUNT PAID FOR ADVERTISING WOULD BE REPORTED IN THE "ALANCE 3HEETOF(ALIFAX&URNITURE3ALESASAT*UNE c CalculateADVERTISINGEXPENSEFORTHEQUARTERENDED3EPTEMBER d ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDADVERTISINGEXPENSEFORTHE QUARTERENDED3EPTEMBER

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232

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

e ShowHOWTHE!DVERTISING%XPENSEAND0REPAID!DVERTISINGACCOUNTSWOULDAPPEAR INTHE'ENERAL,EDGEROF(ALIFAX&URNITURE3ALESASAT3EPTEMBERAFTERALL CLOSINGANDBALANCINGENTRIESHAVEBEENMADE f StateTHEEFFECTONTHE.ET0ROlTOF(ALIFAX&URNITURE3ALESFORTHEQUARTERENDED 3EPTEMBERIFTHEADJUSTMENTFORADVERTISINGEXPENSESWASnotMADE

EXERCISE 10.5 PREPAID EXPENSE

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page 199

$URING #LIVE2APOPENEDHISOWN#$SHOPCALLED(ARD-#/N!UGUST #LIVEPAIDINCLUDING'34 TOCOVERRENTFORTHESIXMONTHSFROM3EPTEMBER TO&EBRUARY#H $URING$ECEMBER THElRMWASINFORMEDTHAT BEGINNINGIN-ARCH RENTWOULDINCREASE SOON&EBRUARY THElRMPAID PLUS'34 FORRENTFORTHESIXMONTHSFROM-ARCHTO!UGUST#H  4HElRMPREPARESITSREPORTSON*UNEEACHYEAR Required a CalculateRENTPAIDFORTHEYEARENDED*UNE b CalculateRENTEXPENSEFORTHEYEARENDED*UNE c 2EFERRINGTOYOURANSWERSTOPARTS@AAND@B explainWHYRENTPAIDANDRENTEXPENSE AREDIFFERENTAMOUNTS d Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO RECORD RENT EXPENSE FOR THE YEAR ENDED*UNE.ARRATIONIS notREQUIRED e ShowHOWTHE2ENT%XPENSEAND0REPAID2ENT%XPENSEACCOUNTSWOULDAPPEARIN THE'ENERAL,EDGEROF(ARD-#ASAT*UNEAFTERALLCLOSINGANDBALANCING ENTRIESHAVEBEENMADE f StateTHEEFFECTONTHEACCOUNTINGEQUATIONOF(ARD-#IFTHEADJUSTMENTFORRENT EXPENSEWASnotMADE

EXERCISE 10.6 ACCRUED EXPENSE

W B

page 201

$URING  3TRONG !RM 3ECURITY $EVICES PAID   INCLUDING  '34 FOR ADVERTISING BUTASAT$ECEMBERAFURTHERWASSTILLOWING-EMO  Required a CalculateADVERTISINGEXPENSEFOR b 2EFERRINGTOONEQUALITATIVECHARACTERISTIC explainWHYTHEADVERTISINGOWINGSHOULD BEINCLUDEDINTHEADVERTISINGEXPENSEFOR c Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO RECORD ADVERTISING OWING AS AT $ECEMBER d StateTHEEFFECTONTHEACCOUNTINGEQUATIONOF3TRONG!RM3ECURITY$EVICESOFTHE ADJUSTMENTFORADVERTISINGOWING e ShowHOWTHE!DVERTISING%XPENSEAND!CCRUED!DVERTISINGACCOUNTSWOULDAPPEAR INTHE'ENERAL,EDGEROF3TRONG!RM3ECURITY$EVICESASAT$ECEMBERAFTER ALLCLOSINGANDBALANCINGENTRIESHAVEBEENMADE f ExplainHOW!CCRUED!DVERTISINGWOULDBEREPORTEDINTHE"ALANCE3HEETOF3TRONG !RM3ECURITY$EVICESASAT$ECEMBER

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

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CHAPTER 10

EXERCISE 10.7 ACCRUED EXPENSE

B A L A N C E D AY A D J U S T M E N T S : E X P E N S E S

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!FTERASERIESOFBREAK INS *IMS'EMSEMPLOYEDASECURITYGUARDON*UNE4HE SECURITYGUARDWORKSSEVENDAYSPERWEEK ANDISPAIDWAGESOFPERFORTNIGHT 7AGES WERE LAST PAID TO COVER THE FORTNIGHT FROM  *UNE TO  *UNE  INCLUSIVE -EMO  Required a CalculateACCRUEDWAGESASAT*UNE b ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDACCRUEDWAGESASAT*UNE  c ShowHOWTHE7AGES%XPENSEAND!CCRUED7AGESACCOUNTSWOULDAPPEARINTHE 'ENERAL,EDGEROF*IMS'EMSASAT*UNEAFTERALLCLOSINGANDBALANCING ENTRIESHAVEBEENMADE d Record THE PAYMENT OF WAGES ON  *ULY  #H  IN THE #ASH 0AYMENTS *OURNAL e 2EFERRINGTOONEACCOUNTINGPRINCIPLE explainWHYONLYSOMEOFTHEWAGESPAIDON *ULYSHOULDBEREPORTEDASANEXPENSEFOR*ULY

EXERCISE 10.8 ACCRUED EXPENSE

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/N.OVEMBER -ILLIE(ALLBORROWEDTOSETUPHERBUSINESS (ALL!NTIQUES )TISANINTERESTONLYLOAN DUETOBEPAIDBACKINlVEYEARSTIME)NTERESTISCALCULATEDAT PAANDISPAYABLEINTWOSEPARATEPAYMENTSON!PRILAND/CTOBEREACHYEAR Required a CalculateINTERESTEXPENSEINCURREDFORTHEYEARENDED*UNE b ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDACCRUEDINTERESTEXPENSEAS AT*UNE.ARRATIONIS notREQUIRED c Show HOW THE )NTEREST %XPENSE AND !CCRUED )NTEREST %XPENSE ACCOUNTS WOULD APPEARINTHE'ENERAL,EDGEROF(ALL!NTIQUESASAT*UNEAFTERALLCLOSING ANDBALANCINGENTRIESHAVEBEENMADE d StateTHEEFFECTONTHE.ET0ROlTOF(ALL!NTIQUESFORTHEYEARENDED*UNE IFTHEADJUSTMENTFORACCRUEDINTERESTWASnotMADE e RecordTHEPAYMENTOFINTERESTON/CTOBERINTHE#ASH0AYMENTS*OURNAL f State THE EFFECT ON THE ACCOUNTING EQUATION OF (ALL !NTIQUES OF THE PAYMENT OF INTERESTON/CTOBER

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EXERCISE 10.9 ACCRUED EXPENSE

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page 207

$URING !PRIL  "RIGHT ,IGHTS PAID ELECTRICITY WORTH   INCLUDING '34 BUT INCURRED ELECTRICITY WORTH   -EMO   /N  -AY  THE lRM PAID  PLUS'34 FORELECTRICITY#H  Required a CalculateACCRUEDELECTRICITYASAT!PRIL b ShowTHE'ENERAL*OURNALENTRIESTORECORDACCRUEDELECTRICITYASAT!PRIL c ShowHOWTHE%LECTRICITY%XPENSEAND!CCRUED%LECTRICITYACCOUNTSWOULDAPPEAR IN THE 'ENERAL ,EDGER OF "RIGHT ,IGHTS AS AT  !PRIL  AFTER ALL CLOSING AND BALANCINGENTRIESHAVEBEENMADE d State THE EFFECT ON THE ACCOUNTING EQUATION OF "RIGHT ,IGHTS IF THE BALANCE DAY ADJUSTMENTFORACCRUEDELECTRICITYISnotRECORDED e Record#HEQUEINTHE#ASH0AYMENTS*OURNAL

EXERCISE 10.10 ACCRUED EXPENSE

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!SAT*ULY THE'ENERAL,EDGEROF"ROOKE)RRIGATION3UPPLIESSHOWEDACCRUED CLEANINGEXPENSESOF/N!UGUST THEBUSINESSPAIDINCLUDING'34 FORCLEANING#H 4HISWASTHEONLYPAYMENTFORCLEANINGDURING!UGUST!S AT!UGUST WASOWINGFORCLEANINGEXPENSES-EMO  Required a Record#HEQUEINTHE#ASH0AYMENTS*OURNAL b CalculateCLEANINGEXPENSESFOR!UGUST c ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDACCRUEDCLEANINGEXPENSEAS AT!UGUST d CompleteTHE!CCRUED#LEANING%XPENSESACCOUNTINTHE'ENERAL,EDGEROF"ROOKE )RRIGATION3UPPLIESASAT!UGUST e State THE EFFECT ON THE ACCOUNTING EQUATION OF "ROOKE )RRIGATION 3UPPLIES IF THE BALANCEDAYADJUSTMENTFORACCRUEDCLEANINGISnotRECORDED f StateONEACCOUNTINGPRINCIPLETHATWOULDBEBREACHEDIFTHEADJUSTMENTFORACCRUED CLEANINGEXPENSEWASnotMADEJustifyYOURANSWER

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B A L A N C E D AY A D J U S T M E N T S : E X P E N S E S

EXERCISE 10.11 REPORTING PREPAID AND ACCRUED EXPENSES

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page 211

0ICKFORD0AINTSHASPROVIDEDTHEFOLLOWING0RE ADJUSTMENT4RIAL"ALANCEASAT*UNE PICKFORD PAINTS Pre-adjustment Trial Balance as at 30 June 2015 Account

Debit

Advertising

3 850

Bank

1 050

Capital – Pickford Cost of Sales

27 050 57 000

Creditors Control Debtors Control Discount Expense

Credit

30 400 23 100 250

Discount Revenue

200

Drawings

4 300

Freight In

600

GST Clearing Interest Expense

120 220

Loan – Bank of Wilco

40 000

Office Equipment

7 900

Prepaid Rent

4 500

Sales

96 000

Shop Fittings

15 800

Stock Control

45 600

Wages

29 600

Totals

$193 770

$193 770

Additional information: s s s s s

4HE,OANn"ANKOF7ILCOISREPAYABLEATPA !PHYSICALSTOCKTAKEON*UNESHOWEDSTOCKONHANDWORTH -ONTHLYRENTEXPENSEIS WAGESREMAINEDOWINGTOEMPLOYEESAT*UNE 2EPORTSAREPREPAREDMONTHLY

Required

* * *

a 2EFERRINGTOONEACCOUNTINGPRINCIPLE explainTHEPURPOSEOFMAKINGBALANCEDAY ADJUSTMENTS b ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDTHEBALANCEDAYADJUSTMENTS ON*UNE.ARRATIONSARE notREQUIRED c PrepareA0OST ADJUSTMENT4RIAL"ALANCEFOR0ICKFORD0AINTSASAT*UNE d Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO CLOSE THE LEDGER AND TRANSFER DRAWINGSTOTHE#APITALACCOUNT.ARRATIONSARE notREQUIRED e PrepareAN)NCOME3TATEMENTFOR0ICKFORD0AINTSFOR*UNE f PrepareACLASSIlED"ALANCE3HEETFOR0ICKFORD0AINTSASAT*UNE ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

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EXERCISE 10.12 REPORTING PREPAID AND ACCRUED EXPENSES

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-ARANELLI 3PORTS HAS PROVIDED THE FOLLOWING 0RE ADJUSTMENT 4RIAL "ALANCE AS AT  $ECEMBER MARANELLI SPORTS Pre-adjustment Trial Balance as at 31 December 2015 Account Advertising

Debit 8 200

Bank Buying Expenses

2 300 3 000

Capital – Maranelli Cost of Sales

85 430 92 000

Creditors Control Debtors Control Discount Expense

18 300 12 400 1 230

Discount Revenue

580

Drawings

31 000

Fittings and Fixtures

26 800

GST Clearing Interest Expense

320 1 800

Mortgage – HH Finance Premises Prepaid Insurance

180 000 240 000 1 500

Sales Stock Control Wages Totals

Credit

190 000 32 000 9 000 $476 930

$476 930

Additional information: s !PHYSICALSTOCKTAKEON$ECEMBERSHOWEDSTOCKONHANDWORTH s !SAT$ECEMBER PREPAIDINSURANCEAMOUNTEDTO s 9EARLY REPAYMENTS OF   ARE MADE ON THE PRINCIPAL OF THE -ORTGAGE n (( &INANCE)NTERESTISCHARGEDATPA ANDPAYABLEON&EBRUARYAND!UGUST EACHYEAR s 4HELEDGERWASLASTCLOSEDANDREPORTSPREPAREDON*UNE Required

*

a ExplainHOWBALANCEDAYADJUSTMENTSENSURERelevanceINTHElNANCIALREPORTS b ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDTHEBALANCEDAYADJUSTMENTS ON$ECEMBER.ARRATIONSARE notREQUIRED c Prepare A 0OST ADJUSTMENT 4RIAL "ALANCE FOR -ARANELLI 3PORTS AS AT  $ECEMBER  d Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO CLOSE THE LEDGER AND TRANSFER DRAWINGSTOTHE#APITALACCOUNT.ARRATIONSARE notREQUIRED

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CHAPTER 10

*

*

B A L A N C E D AY A D J U S T M E N T S : E X P E N S E S

e Prepare AN )NCOME 3TATEMENT FOR -ARANELLI 3PORTS FOR THE SIX MONTHS ENDED $ECEMBER f Assess THE SALES MARK UP APPLIED BY -ARANELLI 3PORTS FOR THE SIX MONTHS ENDED $ECEMBER g PrepareACLASSIlED"ALANCE3HEETFOR-ARANELLI3PORTSASAT$ECEMBER h 2EFERRINGTOYOURANSWERTOPART@G explainYOURTREATMENTOFINTERESTOWING

EXERCISE 10.13 REPORTING FOR PREPAID AND ACCRUED EXPENSES

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!LANNAH &ASHIONS HAS PROVIDED THE FOLLOWING 0RE ADJUSTMENT 4RIAL "ALANCE AS AT -ARCH ALANNAH FASHIONS Pre-adjustment Trial Balance as at 31 March 2015 Account Advertising

Debit 1 750

Bank

4 100

Capital – Alannah Cost of Sales

48 350 24 800

Creditors Control Debtors Control Discount Expense

40 600 21 700 140

Discount Revenue Drawings GST Clearing Interest Expense

310 21 700 400 90

Loan – FinCo.

15 000

Office Equipment Prepaid Office Supplies Prepaid Rent

6 300 180 6 000

Sales

62 000

Shop Fittings

40 000

Stock Control

39 000

Wages Totals

Credit

9 000 $170 360

$170 360

Additional information: s 4HE,OANn&INCOISANINTERESTONLYLOAN DUEFORREPAYMENTON$ECEMBER s !S AT  -ARCH  THERE WAS   STOCK ON HAND BUT !LANNAH DECIDED TO INCREASE IT ! PHYSICAL STOCKTAKE ON  -ARCH  SHOWED STOCK ON HAND WORTH  s 9EARLYRENTISPAIDON!UGUSTEACHYEAR

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s /N&EBRUARY ACCRUEDWAGESWAS!SAT-ARCH WAS OWINGTOEMPLOYEESINUNPAIDWAGES4HENEXTPAYMENTOFFORWAGESISDUE ON!PRIL s !T-ARCH OFOFlCESUPPLIESWERESTILLONHAND Required

*

* *

a CalculateTHETOTALCASHPAIDFORWAGESDURING-ARCH b 'IVENTHATREPORTSAREPREPAREDMONTHLY showTHE'ENERAL*OURNALENTRIESTORECORD THEBALANCEDAYADJUSTMENTSON-ARCH.ARRATIONSARE notREQUIRED c PrepareA0OST ADJUSTMENT4RIAL"ALANCEFOR!LANNAH&ASHIONSASAT-ARCH d Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO CLOSE THE LEDGER AND TRANSFER $RAWINGSTOTHE#APITALACCOUNT.ARRATIONSARE notREQUIRED e CompleteTHE0ROlTAND,OSS3UMMARYACCOUNT f PrepareAN)NCOME3TATEMENTFOR!LANNAH&ASHIONSFOR-ARCH g PrepareACLASSIlED"ALANCE3HEETFOR!LANNAH&ASHIONSASAT-ARCH h 2EFERRINGTOTHEINFORMATIONSUPPLIED suggestONEREASONWHYTHE'34#LEARING ACCOUNTHASADEBITBALANCEJustifyYOURANSWER i Record THE PAYMENT OF WAGES ON  !PRIL  IN THE #ASH 0AYMENTS *OURNAL #H  j State THE EFFECT OF THE PAYMENT ON  !PRIL  ON THE ACCOUNTING EQUATION OF !LANNAH&ASHIONS

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Where are we headed? After completing this chapter, you should be able to: s IDENTIFYTHECHARACTERISTICS OFADEPRECIABLENON CURRENT ASSET s DElNEDEPRECIATION AND OTHERRELATEDTERMS s EXPLAINTHEPURPOSEOF DEPRECIATION ANDITS RELATIONSHIPTOTHEACCOUNTING PRINCIPLESANDQUALITATIVE CHARACTERISTICS s CALCULATEDEPRECIATION EXPENSEUSINGTHESTRAIGHT LINEMETHOD

s RECORDDEPRECIATIONINTHE 'ENERAL*OURNALAND'ENERAL ,EDGER s REPORTFORDEPRECIATIONIN THE)NCOME3TATEMENTAND "ALANCE3HEET s EXPLAINTHEEFFECTOF DEPRECIATIONONTHE ACCOUNTINGEQUATION s DElNETHETERM@COSTASIT REFERSTONON CURRENTASSETS

CHAPTER 11

DEPRECIATION OF NON-CURRENT ASSETS KEY TERMS After completing this chapter, you should be familiar with the following terms: s DEPRECIABLEASSET

s DEPRECIABLEVALUE

s lNITELIFE

s CARRYINGVALUE

s DEPRECIATION

s RESIDUALVALUE

s DEPRECIATIONEXPENSE

s USEFULLIFE

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UNITS 3&4

11.1 ASSETS AND EXPENSES 4HERESEEMSTOBEASCHOOLOFTHOUGHTTHATLOOKSUPONASSETSAS@GOOD ANDEXPENSES AS @BAD !CCORDING TO THIS MISGUIDED ANALYSIS ASSETS ARE GOOD BECAUSE THEY HELP COMPANIESTOEARNPROlT BUTEXPENSESAREBADBECAUSETHEYREDUCETHATPROlT"UTIF THISWERETHECASE WHYWOULDABUSINESSHAVEEXPENSESATALL7HYPUTUPWITHPAYING WAGES ORRENT ORADVERTISINGORELECTRICITYEXPENSESWHENALLTHEYDOISLOWERPROlT 4HESIMPLEANSWERISTHAT JUSTLIKEASSETS THESEEXPENSESARENECESSARYnNECESSARYTO HELPEARNREVENUEANDGENERATEPROlT!BUSINESSTHATHADNOEMPLOYEES NOPREMISES NO ADVERTISING AND NO ELECTRICITY COULD SIMPLY NOT DO ITS JOB )N THIS WAY ASSETS AND EXPENSESHAVESOMETHINGINCOMMONTHEYBOTHASSISTINTHEEARNINGOFREVENUE4HIS ISREmECTEDINTHEDElNITIONS !SSET

A RESOURCE CONTROLLED BY THE ENTITY AS A RESULT OF PAST EVENTS FROM WHICH FUTUREECONOMICBENElTSAREEXPECTEDTOmOWTOTHEENTITY

%XPENSE ACONSUMPTIONOROUTmOWORREDUCTIONINANINmOW OFANECONOMICBENElT INTHEFORMOFADECREASEINASSETSORINCREASEINLIABILITIES WHICHRESULTSINA DECREASEINOWNERSEQUITYEXCEPTDRAWINGS  "OTH DElNITIONS REFER TO THE economic benefit THAT IS BROUGHT TO THE BUSINESS (OWEVER THE DElNITIONS ALSO HIGHLIGHT THE KEY DIFFERENCE BETWEEN AN ASSET AND AN EXPENSEANASSETISDElNEDASAfutureECONOMICBENElT WHILEANEXPENSEISDElNED AS THE consumption OF AN ECONOMIC BENElT 4HAT IS EXPENSES REFER TO ECONOMIC BENElTSTHATHAVEalready been consumedINTHECURRENT2EPORTING0ERIOD WHEREAS ASSETSREFERTOECONOMICBENElTSTHATAREyet to be consumedANDWILLBECONSUMED INFUTURE2EPORTING0ERIODS 

$EPRECIABLEASSETS )TEMS SUCH AS VEHICLES OFlCE EQUIPMENT AND SHOP lTTINGS WHICH ARE CONTROLLED BY THEBUSINESS WILLPROVIDEAFUTUREECONOMICBENElTFORMORETHANMONTHS ANDSO SHOULDBERECORDEDASNON CURRENTASSETSWHENTHEYAREPURCHASED

Assets such as vehicles, office equipment and shop fittings are depreciable assets. Over time, their ability to earn revenue is reduced.

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CHAPTER 11

D E P R E C I AT I O N O F N O N - C U R R E N T A S S E T S

!TTHESAMETIME JUSTBECAUSEASSETSSUCHASTHESEWILLLASTFORMORETHANMONTHS DOESNOTMEANTHEYWILLLASTFOREVER!STHEYAGE THEYWEAROUT ANDASTHEIRLIFEEXPIRES SOTOODOESTHEIRABILITYTOEARNREVENUE4HISMEANSTHEYAREDEPRECIABLEASSETSnTHEY HAVEAlNITELIFE ANDWILLBEUSEFULFORAlXEDPERIODOFTIME!TSOMEPOINTINTHEFUTURE THEYWILLBENOLONGERABLETOEARNREVENUE )NEFFECT DEPRECIABLEASSETSAREconsumed over time7EMAYNOTBEABLETOSEE THISCONSUMPTION BUTTHATDOESNOTMEANTHATITISNOTHAPPENING%VERYYEAR partOF THEVALUEOFTHEASSETISCONSUMED UNTILnATTHEENDOFITSLIFEnTHEASSETSREVENUE EARNINGCAPACITYISWHOLLYCONSUMED ANDITISUNABLETOEARNREVENUEANYLONGER!S WEALREADYKNOW AconsumptionOFANECONOMICBENElTISANexpense MEANINGTHAT EACHYEARpartOFTHEASSETSVALUEISCONSUMED SOpartOFITSVALUEBECOMESANEXPENSE 4HISPROCESSOFCALCULATINGhow muchVALUEHASBEENCONSUMEDINEACHPERIODISCALLED @DEPRECIATION

241

DEPRECIABLEASSET a non-current asset that has a finite life, and must be depreciated over its life lNITELIFE the limited period of time (usually measured in years) for which a non-current asset will exist

EXAMPLE

On 1 January 2015, Lane Grove Furniture paid $32 000 (plus $3 200 GST) for a new delivery vehicle. It is expected that it will be kept for five years.

STUDY TIP

)NTHISEXAMPLE LETUSDEALlRSTWITHTHE'34)TISEXCLUDEDFROMOURCONSIDERATIONOF DEPRECIATIONBECAUSEITISNOTINCLUDEDINTHECOSTOFTHEVEHICLEITACTUALLYREPRESENTSA REDUCTIONINTHE'34LIABILITYOWEDTOTHE!4/"UTWHATABOUTTHEVEHICLEITSELF !T PURCHASE DATE  January  THE VEHICLE IS CLEARLY A non-current asset 4HE ENTIRE   IS A FUTURE ECONOMIC BENElT IN TERMS OF THE DELIVERIES IT CAN DO  IS CONTROLLEDBYTHElRMANDTHATBENElTWILLBEPROVIDEDFORMORETHANMONTHSUNTIL THEVEHICLECANNOLONGERMAKEDELIVERIES  "UTHOWSHOULDTHEVEHICLEBEREPORTEDASATDecember !SSUMINGTHATTHEBUSINESSSTILLHASTHEVEHICLE ITHASNOTBEENconsumed SOTHE SHOULDNOTBEREPORTEDASANEXPENSEFORTHEYEARENDED$ECEMBER )NDEED THE VEHICLE WILL STILL BE AVAILABLE TO PROVIDE AN ECONOMIC BENElT IN future 2EPORTING0ERIODSANDONWARDS ANDSOSHOULDSTILLBEREPORTEDASANON CURRENT ASSET (OWEVER THEVEHICLEISADEPRECIABLEASSETWITHAlNITELIFESLOWLYBUTSURELY THE PRODUCTIVE CAPACITY OF THE VEHICLE WILL BE CONSUMED 4HIS WILL NOT HAPPEN IN ONE 2EPORTING0ERIOD BUTRATHEROVERANUMBEROF2EPORTING0ERIODS SOpartOFTHEASSETS VALUESHOULDBEREPORTEDASANEXPENSEFORTHEYEARENDED$ECEMBER4HE REMAINDERnTHEPARTYETTOBECONSUMEDnSHOULDBEREPORTEDASANON CURRENTASSET THATIS LESSTHEAMOUNTCONSUMEDSOFAR )N ORDER TO CALCULATE THAT PART OF THE COST OF THE VEHICLE CONSUMED IN THE CURRENT 2EPORTING0ERIODTHEYEARENDED$ECEMBER ITISNECESSARYTODEPRECIATETHE ASSET .OTE!SSETSTHATHAVEANINlNITEORNEVER ENDINGLIFEWHERETHEECONOMICBENElT WILLCONTINUEFOREVER SHOULDNOTBEDEPRECIATED ASTHEYMAYBEused BUTARENEVER @used up OR CONSUMED 4HIS MAY APPLY TO AN ASSET SUCH AS LAND BUT VERY FEW OTHER ITEMS

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

)FTHE'34CLEARING ACCOUNTSTARTSOUT WITHADEBITBALANCE '34PAIDWILLINCREASE THISASSET RATHERTHAN DECREASEALIABILITY

Cambridge University Press

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UNITS 3&4

REVIEW QUESTIONS 11.1

1 2EFERRINGTOTHEDElNITIONS IDENTIFYTHECHARACTERISTICCOMMONTOBOTHASSETS ANDEXPENSES 2 %XPLAINTHEKEYDIFFERENCEBETWEENANASSETANDANEXPENSE 3 )DENTIFYTHECHARACTERISTICSOFADEPRECIABLENON CURRENTASSET 4 %XPLAIN WHY IT IS NOT NECESSARY TO CALCULATE DEPRECIATION FOR ASSETS SUCH AS LAND 5 2EFERRINGTOONEACCOUNTINGPRINCIPLE EXPLAINWHYTHEENTIRECOSTOFANON CURRENTASSETSHOULDNOTBEREPORTEDASANEXPENSE 6 %XPLAINWHY'34ISEXCLUDEDFROMTHECONSIDERATIONOFDEPRECIATION

11.2 DEPRECIATION OF NON-CURRENT ASSETS

DEPRECIATION the allocation of the cost of a non-current asset over its useful life DEPRECIATIONEXPENSE that part of the cost of a non-current asset that has been consumed in the current Reporting Period

!LTHOUGHTHETERMDEPRECIATIONISFREQUENTLYUSEDTODESCRIBETHEEXPENSE ITACTUALLY REFERSTOTHEprocessnTHEACCOUNTINGPROCEDUREnTHATCREATESDEPRECIATIONEXPENSE )NTERMSOFTHEPROCESS DEPRECIATIONISTHEALLOCATIONOFTHECOSTOFANON CURRENTASSET OVERITSUSEFULLIFE "ECAUSEANON CURRENTASSETISNOTCONSUMEDENTIRELYWITHINONE2EPORTING0ERIOD depreciation IS AN ATTEMPT TO CALCULATE HOW MUCH OF THE ASSETS VALUE HAS BEEN CONSUMEDINTHECURRENT2EPORTING0ERIOD)TTHEREFOREspreads outORallocatesTHECOST OFTHEASSETOVERTHEYEARSINWHICHITISUSEFULFOREARNINGREVENUE RATHERTHANTREATING ALLOFTHECOSTASANEXPENSEINANYONEYEAR !SARESULTOFTHISPROCESS depreciation expenseISCREATED REPRESENTINGTHATPARTOF THECOSTOFANON CURRENTASSETTHATHASBEENCONSUMEDINTHECURRENT2EPORTING0ERIOD

4HEPURPOSEOFDEPRECIATION *USTLIKEADJUSTMENTSFORACCRUEDORPREPAIDEXPENSES DEPRECIATIONISABALANCEDAY ADJUSTMENT AND CONSEQUENTLY THE PURPOSE OF DEPRECIATING NON CURRENT ASSETS IS THE SAMEASTHEPURPOSEOFANYOTHERBALANCEDAYADJUSTMENT!LLBALANCEDAYADJUSTMENTS DEPRECIATION INCLUDED ARE MADE TO ENSURE THAT AN ACCURATE PROlT IS CALCULATED BY COMPARINGREVENUESEARNEDAGAINSTEXPENSESINCURREDINTHEcurrent2EPORTING0ERIOD $EPRECIATIONDOESTHISBYRECOGNISINGASANEXPENSEONLYTHATPARTOFTHECOSTOFANON CURRENTASSETTHATISCONSUMEDINCURREDINTHECURRENT2EPORTING0ERIOD4HISWILLALSO ENSURETHATTHE)NCOME3TATEMENTUPHOLDS2ELEVANCEBYINCLUDINGALLINFORMATIONTHAT ISUSEFULFORDECISION MAKING $EPRECIATIONDOESNOTINVOLVEANYPAYMENTOFCASH4HECASHPAYMENTRELATINGTO EACHNON CURRENTASSETWILLBERECORDEDONLYATTHETIMEWHENTHEASSETISPURCHASED $EPRECIATIONAFFECTSONLYTHE)NCOME3TATEMENTANDTHE"ALANCE3HEET

REVIEW 11.2

1 $ElNETHETERM@DEPRECIATION 2 $ElNETHETERM@DEPRECIATIONEXPENSE 3 2EFERRINGTOONEACCOUNTINGPRINCIPLE EXPLAINTHEPURPOSEOFDEPRECIATINGA NON CURRENTASSET 4 %XPLAINTHEEFFECTOFDEPRECIATIONONAlRMSBANKBALANCE

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CHAPTER 11

D E P R E C I AT I O N O F N O N - C U R R E N T A S S E T S

243

11.3 CALCULATING DEPRECIATION EXPENSE 4HEREAREANUMBEROFDIFFERENTWAYSTOCALCULATEDEPRECIATIONEXPENSE EACHOFWHICH MAKESDIFFERENTASSUMPTIONSABOUTTHEWAYASSETSARECONSUMED5NITCONCENTRATES ONONLYONEMETHODTHESTRAIGHT LINEMETHODOFDEPRECIATION!NALTERNATIVEMETHOD ISDISCUSSEDIN#HAPTER BUTTHATISPARTOF5NIT

3TRAIGHT LINEMETHODOFDEPRECIATION 4HE STRAIGHT LINE METHOD OF CALCULATING DEPRECIATION ASSUMES THAT NON CURRENT ASSETS CONTRIBUTE EVENLY TO REVENUE DOING THE SAME JOB IN THE LAST YEAR OF THEIR LIFE AS THEY DID IN THEIR lRST !S A RESULT IT ASSUMES THAT THE VALUE OF A NON CURRENT ASSET IS CONSUMEDEVENLYOVERITSLIFE SOTHEDEPRECIATIONEXPENSEISTHESAMEEVERYYEAR)FTHIS DEPRECIATIONEXPENSEWASPLOTTEDONAGRAPH THELINEWOULDBEASTRAIGHTLINE GIVING THEMETHODITSNAME $EPRECIATIONEXPENSEFORMULA $EPRECIATIONEXPENSEPERANNUM



(#n26 ,IFE

Where:

HC



Historical Cost: THEORIGINALPURCHASE PRICEOFTHENON CURRENTASSET

RV



residual value: THEESTIMATEDVALUEOF THENON CURRENTASSETATTHEENDOFITS USEFULLIFE

Life



useful life: THEESTIMATEDPERIODOF TIMEFORWHICHTHENON CURRENTASSET WILLBEUSEDBYTHECURRENTENTITYTO EARNREVENUE4HISISUSUALLYMEASURED INYEARS

4HEBASICPREMISEISTODIVIDETHECOSTOFTHEASSETBYTHENUMBEROFYEARSFORWHICH ITISUSED THUSDETERMININGHOWMUCHOFTHATCOSTISCONSUMEDPERYEAR"ECAUSEEACH NON CURRENTDEPRECIABLEASSETISDIFFERENTINTERMSOFITSUSEFULLIFEANDRESIDUALVALUE EACHMUSTBEDEPRECIATEDINDIVIDUALLY

On 1 January 2015, Big Cycles purchased Office Furniture for $5 000 (plus $500 GST). The furniture will be kept for three years, at which time it will have an estimated residual value of $800.

$EPRECIATIONEXPENSE









n

YEARS











PERANNUM

EXAMPLE

(#n26 ,IFE

$4 200 

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)NTHISEXAMPLE THEDEPRECIATIONPROCESSCALCULATESTHATTHEBUSINESSISCONSUMING WORTHOFTHEFURNITURESVALUEEACHYEAR4HISAMOUNTWOULDBERECORDEDASAN EXPENSE AND WOULD ALSO DECREASE THE VALUE AT WHICH THE FURNITURE IS VALUED IN THE "ALANCE3HEET Depreciable value

DEPRECIABLEVALUE the total value of the asset that will be consumed by the current entity, and so must be allocated over its useful life

)FWEPLANTOUSETHEASSETUNTILITISUTTERLYWORTHLESS THENTHERESIDUALVALUEWILLSIMPLY BEZERO ANDTHEENTIRECOSTOFTHEASSETWILLBECONSUMEDBYOURBUSINESS (OWEVER WEMAYDISPOSEOFTHEASSETWHILEITSTILLHASSOMEVALUE4HISAMOUNTWILL THENNOTBECONSUMEDBYourBUSINESS BUTBYanother entity4HUS THERESIDUALVALUE MUSTBEDEDUCTEDFROMTHE(ISTORICAL#OST BECAUSETHISISTHEAMOUNTTHATWILLnot be consumed by our business)NTHISEXAMPLE WORTHOFVALUEWILLSTILLEXISTWHENWE ARElNISHEDWITHTHEASSETTHISAMOUNTWILLBECONSUMEDBYTHENEXTOWNER THEASSET WASPURCHASEDFOR BUTONLY$4 200WILLBECONSUMEDBY"IG#YCLES 4HEAMOUNTCALCULATEDBYDEDUCTINGRESIDUALVALUEFROM(ISTORICAL#OSTINTHETOP LINEOFTHEEQUATION ISKNOWNASTHEdepreciable valueITISTHETOTALVALUEOFTHEASSET THATWILLBECONSUMEDBYTHECURRENTOWNERENTITY ANDSOMUSTBEALLOCATEDOVERITS USEFULLIFE Time or use? .OTEALSOTHATWEARENOTDEPRECIATINGTHEASSETMOREORLESSDEPENDINGONUSEYOUR DESKDOESNOTDETERIORATEANYFASTERORSLOWERDEPENDINGONHOWLONGYOUARESITTING THERE)NFACT STRAIGHT LINEDEPRECIATIONASSUMESTHATTHEASSETISCONSUMEDOVERtime NOTACCORDINGTOUSE!NDTHISISREmECTEDINTHEFORMULA WHICHUSES@USEFULLIFERATHER THANSOMEMEASUREOFUSE 4HESTRAIGHT LINEMETHODMAYBELESSSUITABLEFORASSETSTHATDONOTCONTRIBUTEEVENLY TOREVENUE BUTUNTILTHISISCOVEREDIN5NIT allASSETSIN5NITAREDEPRECIATEDUSING THESTRAIGHT LINEMETHOD

REVIEW 11.3

1 %XPLAINTHEASSUMPTIONTHATUNDERLIESTHESTRAIGHT LINEMETHODOFDEPRECIATION RECIAT ON INRELATIONTOHOWASSETSCONTRIBUTETOREVENUE 2 3TATETHEFORMULAFORCALCULATINGDEPRECIATIONUSINGTHESTRAIGHT LINEMETHOD 3 $ElNETHEFOLLOWINGTERMS s (ISTORICAL#OST s RESIDUALVALUE s USEFULLIFE 4 %XPLAINWHYEACHNON CURRENTASSETMUSTBEDEPRECIATEDINDIVIDUALLYRATHER THANASATOTAL 5 2EFERRINGTOONEACCOUNTINGPRINCIPLE EXPLAINWHYRESIDUALVALUEISDEDUCTED FROM (ISTORICAL #OST WHEN CALCULATING DEPRECIATION USING THE STRAIGHT LINE METHOD

11.4 RECORDING DEPRECIATION !SWASNOTEDEARLIER DEPRECIATIONISABALANCEDAYADJUSTMENT!SARESULT ITISRECORDED INTHE'ENERAL*OURNALONBALANCEDAYnATTHEENDOFTHE2EPORTING0ERIODnINCOMMON WITHASTOCKLOSS PREPAIDRENTORACCRUEDWAGES

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EXAMPLE

On 1 January 2015, Mixwell Paints purchased a new van for  plus $3 200 GST. Depreciation on the van has been calculated as $1 200 per year (Memo 5).

!TBALANCEDAY$ECEMBER THEBALANCEDAYADJUSTMENTFORDEPRECIATION WOULDBERECORDEDINTHE'ENERAL*OURNALASSHOWNIN&IGURE Figure 11.1

General Journal: depreciation of NCA 'ENERAL*OURNAL 'ENERAL,EDGER

$ATE

$ETAILS

$EBIT

31/12/15 Depreciation of Van

#REDIT

3UBSIDIARYLEDGER $EBIT

#REDIT

1 200

Accumulated Depreciation of Van

1 200

Yearly depreciation on van – s/line method (Memo 5)

2EMEMBER DEPRECIATIONCALCULATESTHATPARTOFTHECOSTOFANON CURRENTASSETTHAT HASBEENCONSUMEDINTHEcurrent2EPORTING0ERIOD4HISAMOUNTWOULDBERECORDEDAS ANEXPENSE BYDEBITINGANEWACCOUNTCALLED$EPRECIATIONOF6AN !TTHESAMETIME DEPRECIATIONALSODECREASESTHEVALUEATWHICHTHEASSETISREPORTED INTHE"ALANCE3HEET!FTERALL THENON CURRENTASSETISAFUTUREECONOMICBENElT BUT BYDEPRECIATINGTHEASSETWEARERECOGNISINGTHATSOMEOFTHISBENElTHASNOWBEEN CONSUMED 4HIS REDUCTION IN THE VALUE OF AN ASSET WOULD NORMALLY BE RECORDED AS A CREDITENTRY BUTRATHERTHANCREDITTHEASSETACCOUNTDIRECTLY THECREDITENTRYISMADE TOANEWACCOUNTCALLED!CCUMULATED$EPRECIATIONOF6AN4HISACCOUNTISANEGATIVE ASSETACCOUNT .OTETHATTHEACCOUNTSARETITLED@$EPRECIATIONofVanAND@!CCUMULATED$EPRECIATION of VanRATHERTHANJUST@$EPRECIATIONOR@!CCUMULATED$EPRECIATION'IVENTHATMOST BUSINESSESWILLDEPRECIATEMORETHANONENON CURRENTASSET ITISIMPERATIVETOIDENTIFY PRECISELYWHICHASSETISBEINGDEPRECIATED 4HE'ENERAL*OURNALENTRYIN&IGUREWOULDBEPOSTEDTOTHE'ENERAL,EDGERAS SHOWNIN&IGURE Figure 11.2

General Ledger: depreciation of NCA 'ENERAL,EDGER $EPRECIATIONOF6AN%

$ATE 31/12/15

#ROSS REFERENCE

!MOUNT

Acc. Dep. of Van

1 200

$ATE

#ROSS REFERENCE

!MOUNT

!CCUMULATED$EPRECIATIONOF6ANn! $ATE

#ROSS REFERENCE

!MOUNT

$ATE 

#ROSS REFERENCE $EPOF6AN

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

!MOUNT 

STUDY TIP

$EPRECIATIONISAN AREAWHEREINTELLIGENT ABBREVIATIONSCANMAKE YOURLIFEMUCHEASIER

Cambridge University Press

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246

UNITS 3&4

%FFECTONTHEACCOUNTINGEQUATION $EPRECIATIONHASTHEFOLLOWINGEFFECTONTHEACCOUNTINGEQUATION )NCREASE$ECREASE.OEFFECT

!MOUNT

!SSETS

$ECREASE)NCREASE!CCUMULATED$EPRECIATIONOF6AN

,IABILITIES

.OEFFECT

/WNERS%QUITY

$ECREASE$EPRECIATIONOF6ANEXPENSEDECREASES .ET0ROlT

1 200

1 200

$EPRECIATIONVERSUS!CCUMULATED$EPRECIATION ACCUMULATEDDEPRECIATION the value of a non-current asset that has been consumed/incurred over its life thus far

4HEKEYTOUNDERSTANDINGACCUMULATEDDEPRECIATIONLIESINTHETITLE7HEREASDEPRECIATION EXPENSEREFERSTOTHEAMOUNTCONSUMEDINTHEcurrent2EPORTING0ERIOD accumulated depreciationREFERSTODEPRECIATIONTHATHASACCUMULATEDORBUILTUP over the life of the asset so far!CCUMULATEDDEPRECIATIONWILLGROWEVERYYEARASTHEDEPRECIATIONEXPENSE FOREACH2EPORTING0ERIODISADDEDTOIT !SANEXPENSE THE$EPRECIATIONOF6ANACCOUNTMUSTBECLOSEDTOTHE0ROlTAND ,OSS3UMMARYACCOUNTATTHEENDOFEACH2EPORTING0ERIOD)NFACT ITWILLOPENAND CLOSE ON THE VERY SAME DAY LEAVING IT WITH A ZERO BALANCE AT THE END OF THE PERIOD !CCUMULATED$EPRECIATIONOF6AN ONTHEOTHERHAND ISANONGOINGACCOUNTITWILLBE BALANCEDATTHEENDOFTHEPERIOD WITHITSBALANCECARRIEDFORWARDTOTHENEXT !FTER THE $EPRECIATION OF 6AN ACCOUNT HAS BEEN CLOSED AND THE !CCUMULATED $EPRECIATIONOF6ANACCOUNTHASBEENBALANCED THELEDGERACCOUNTSWOULDSHOW 'ENERAL,EDGER $EPRECIATIONOF6AN% $ATE

#ROSS REFERENCE

!MOUNT

31/12/15

Acc. Dep. of Van

1 200

$ATE

#ROSS REFERENCE

31/12/15 Profit and Loss Summary

1 200

!MOUNT 1 200 1 200

!CCUMULATED$EPRECIATIONOF6ANn! $ATE 31/12/15

#ROSS REFERENCE Balance

!MOUNT

$ATE

1 200

31/12/15

#ROSS REFERENCE Dep. of Van

1 200

!MOUNT 1 200 1 200

1/1/16

Balance

1 200

.OTETHATTHEENTRYTOCLOSETHE$EPRECIATIONOF6ANACCOUNTISMADEINTHE'ENERAL *OURNAL AT THE SAME TIME THAT ALL THE EXPENSE ACCOUNTS INCLUDING EXPENSES SUCH AS #OSTOF3ALES 7AGESAND!DVERTISING ARECLOSED!LLTHEEXPENSEACCOUNTSARECREDITED INDIVIDUALLYINORDERTOTRANSFERTHEAMOUNTSOTHATPROlTORLOSSCANBECALCULATED AND RESETTHEMTOZEROFORTHENEXT2EPORTING0ERIOD(OWEVER ONLYONEDEBITENTRYISMADE TO THE 0ROlT AND ,OSS 3UMMARY 4HE DEPRECIATION EXPENSE ACCOUNT WOULD NEVER BE CLOSEDONITSOWN3EE#HAPTERFORAREMINDER

3UBSEQUENTPERIODS ,ETUSCONTINUETODEPRECIATETHEVAN!TTHEENDOFTHENEXTYEAR ANOTHEROF DEPRECIATIONMUSTBERECORDED4HISREPRESENTSTHEVALUEOFTHEASSETCONSUMED DURING  AND SO IS ONCE AGAIN DEBITED TO $EPRECIATION OF 6AN AND CREDITED TO !CCUMULATED$EPRECIATIONOF6AN

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'ENERAL*OURNAL 'ENERAL,EDGER $ATE 31/12/16

$ETAILS

$EBIT

Depreciation of Van

1 200

Accumulated Depreciation of Van

#REDIT

3UBSIDIARYLEDGER $EBIT

#REDIT

1 200

Yearly depreciation on van – s/line method (Memo 12)

!FTER DEPRECIATION FOR  HAS BEEN RECORDED IN THE 'ENERAL ,EDGER AND THE ACCOUNTSHAVEBEENCLOSEDORBALANCED THELEDGERACCOUNTSWOULDSHOW 'ENERAL,EDGER $EPRECIATIONOF6AN% $ATE

#ROSS REFERENCE

!MOUNT

31/12/16 Acc. Dep. of Van

1 200

$ATE

#ROSS REFERENCE

31/12/16 Profit and Loss Summary

1 200

!MOUNT 1 200 1 200

!CCUMULATED$EPRECIATIONOF6ANn! $ATE

#ROSS REFERENCE

!MOUNT

$ATE





31/12/16 Balance

#ROSS REFERENCE "ALANCE

31/12/16 Dep. of Van 2 400

!MOUNT  1 200 2 400

1/1/17

Balance

2 400

4HE $EPRECIATION OF 6AN ACCOUNT HAD BEEN CLOSED AT THE END OF  SO THE DEPRECIATIONEXPENSEFORWILLBETHEONLYENTRYINTHATACCOUNTUNTILITISCLOSED AGAINON$ECEMBER (OWEVER THE!CCUMULATED$EPRECIATIONOF6ANACCOUNTALREADYHADAbalance of $1 200THEAMOUNTACCUMULATEDFROMLASTYEAR 7HENDEPRECIATIONOF FORTHECURRENTYEAR ISRECORDED THEBALANCEOFTHISACCOUNTINCREASESTO /NCEAGAIN THEACCOUNTWOULDBEBALANCEDINREADINESSFORTHENEXTPERIOD 

REVIEW QUESTIONS 11.4

1 3HOWTHE'ENERAL*OURNALENTRIESTORECORDTHEBALANCEDAYADJUSTMENTFOR DEPRECIATIONEXPENSE 2 3TATE ONE REASON WHY THE LEDGER ACCOUNTS MUST NAME THE ASSET BEING DEPRECIATED 3 3TATETHEEFFECTOFDEPRECIATIONONTHEACCOUNTINGEQUATION 4 2EFERRING TO ONE ACCOUNTING PRINCIPLE EXPLAIN THE DIFFERENCE BETWEEN DEPRECIATIONEXPENSEANDACCUMULATEDDEPRECIATION 5 3TATETWOREASONSWHYTHE$EPRECIATIONEXPENSEACCOUNTMUSTBECLOSEDAT THEENDOFTHE2EPORTING0ERIOD 6 3TATEONEREASONWHYTHE!CCUMULATED$EPRECIATIONACCOUNTISBALANCEDAT THEENDOFTHE2EPORTING0ERIOD

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247

248

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

11.5 REPORTING DEPRECIATION 4HE)NCOME3TATEMENT 2EPORTING DEPRECIATION IN THE )NCOME 3TATEMENT IS PROBABLY THE EASIEST PART OF ACCOUNTINGFORDEPRECIATION"ECAUSEDEPRECIATIONISANEXPENSE ITISREPORTEDINTHE )NCOME3TATEMENTWITHALLTHE@OTHEREXPENSES SUCHASWAGES ADVERTISINGANDRENT Figure 11.3

Income Statement: depreciation MIXWELL PAINTS )NCOME3TATEMENTFOR

2EVENUE





3ALES



,ESS#OSTOF'OODS3OLD #OSTOF3ALES



"UYING%XPENSES



'ROSS0ROlT

 

,ESS3TOCK,OSS



!DJUSTED'ROSS0ROlT



,ESS/THER%XPENSES 7AGES



!DVERTISING



$ISCOUNT%XPENSE



$EPRECIATIONOF6AN



2ENT



.ET0ROlT

 

2EMEMBER THAT IT IS ONLY THE DEPRECIATION expense THE AMOUNT CONSUMED IN THE current 2EPORTING 0ERIOD THAT IS REPORTED IN THE )NCOME 3TATEMENT !CCUMULATED DEPRECIATIONISANEGATIVEASSET NOTANEXPENSE ANDSOMUSTNOTBEREPORTEDINTHE )NCOME3TATEMENT

4HE"ALANCE3HEET 4HElRSTEFFECTOFDEPRECIATIONONTHE"ALANCE3HEETISVIAOWNERSEQUITY!SWEHAVE ALREADYSEEN DEPRECIATIONEXPENSEDECREASES.ET0ROlT)NTERMSOFTHE"ALANCE3HEET THISDECREASESOWNERSEQUITY4HESECONDEFFECTOCCURSONTHEASSETSIDE!CCUMULATED DEPRECIATIONREPORTSTHEVALUEOFTHEASSETTHATHASBEENCONSUMEDOVERITSLIFESOFAR )TISREPORTEDDIRECTLYUNDERTHEASSETITSELF ASSHOWNIN&IGURE Figure 11.4

Balance Sheet: accumulated depreciation MIXWELL PAINTS "ALANCE3HEETEXTRACT ASAT$ECEMBER

.ON CURRENTASSETS 6AN ,ESS!CCUMULATED$EPRECIATION

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.OTETHATNOWINSTEADOFJUSTREPORTINGTHEASSETASONElGURE THREEAREINVOLVED  Historical Cost $32 000 4OKEEPTHEREPORTSFREEFROMBIASANDTHEREFORE2ELIABLE THEASSETMUSTALWAYSBE REPORTEDINITIALLYATITS(ISTORICAL#OSTITSORIGINALPURCHASEPRICE ASTHISAMOUNTIS VERIlABLEBYREFERENCETOTHESOURCEDOCUMENT  !CCUMULATEDDEPRECIATION  "ECAUSESOMEOFTHEASSETSVALUEHASBEENCONSUMED ITISNOLONGERAPPROPRIATETO REPORTITATITS(ISTORICAL#OSTALONEINORDERTOENSURE2ELEVANCE THE"ALANCE3HEET MUSTALSOREPORTTHEASSETSACCUMULATEDDEPRECIATION!CCUMULATEDDEPRECIATION REPRESENTSTHETOTALVALUEOFTHEASSETTHATHASBEENCONSUMEDOVERITSLIFESOFAR PERYEARFOREACHOFTHETWOYEARSTHEASSETHASBEENUNDERTHElRMSCONTROL  #ARRYINGVALUE  4HEcarrying valueISCALCULATEDBYDEDUCTINGANYACCUMULATEDDEPRECIATIONFROM THE(ISTORICAL#OSTOFTHEASSET)TREPRESENTSTHEUNALLOCATEDCOSTOFTHEASSETTHAT IS THE VALUE OF THE ASSET THAT IS YET TO BE CONSUMED AND YET TO BE ALLOCATED AS DEPRECIATION EXPENSE PLUS ANY RESIDUAL VALUE "ECAUSE THIS CARRYING VALUE IS YET TOBECONSUMED ITREPRESENTSAfutureECONOMICBENElT WHICHSHOULDBYNOWBE OBVIOUSASTHEDElNITIONOFANASSET


CARRYINGVALUE the value of a non-current asset that is yet to be consumed/allocated as an expense, plus any residual value

!S THE ASSET IS DEPRECIATED IT WILL BE THE ACCUMULATED DEPRECIATION lGURE THAT INCREASES THUSDECREASINGTHECARRYINGVALUE&OREXAMPLE THEVANOWNEDBY-IXWELL 0AINTSWILLAPPEARINSUCCESSIVE"ALANCE3HEETSASSHOWNIN&IGURE Figure 11.5

Balance Sheet: successive periods MIXWELL PAINTS

STUDY TIP

"ALANCE3HEETEXTRACT ASAT$ECEMBER .ON CURRENTASSETS 6AN ,ESS!CCUMULATED$EPRECIATION









32 000

32 000

32 000

32 000

















#ARRYINGVALUEISALSO KNOWNASCARRYINGCOST WRITTEN DOWNVALUE UNALLOCATEDCOSTAND BOOKVALUE

2EPRESENTINGDEPRECIATIONGRAPHICALLY )NORDERTOSATISFYUnderstandability REPORTSMUSTBEPREPAREDINAMANNERTHATISREADILY UNDERSTANDABLEBYTHEUSER WITHTHEPREPARATIONOFGRAPHSONESIMPLESTRATEGYTHATCAN BEEMPLOYED0REPARINGAGRAPHCANMAKEITEASIERFORTHEOWNERTOUNDERSTANDBOTH THEIDEAOFDEPRECIATIONANDITSEFFECTONTHEACCOUNTINGREPORTS&OREXAMPLE &IGURE SHOWSHOWTHEDEPRECIATIONEXPENSE ACCUMULATEDDEPRECIATIONANDCARRYINGVALUE COULDBEREPRESENTEDGRAPHICALLY $35 000

Figure 11.6

$30 000

Depreciation

Graphing depreciation

$25 000

Accumulated depreciation

$20 000 $15 000

Carrying value

$10 000 $5 000 $0 2015

2016

2017

2018

2019

Year © Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

250

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

4HISGRAPHCLEARLYSHOWSWHYITISCALLEDTHE@STRAIGHT LINEMETHOD ASTHEAMOUNTOF DEPRECIATIONEXPENSEISCONSTANTEVERYYEAR CREATINGASTRAIGHTLINEACROSSTHELIFEOF THEASSET 4HEACCUMULATEDDEPRECIATIONSTARTSATZEROANDGROWSATACONSTANTRATE INCREASED EVERYYEARBYTHEAMOUNTOFTHEDEPRECIATIONEXPENSE!TTHESAMETIME THECARRYING VALUESTARTSATTHE(ISTORICAL#OSTANDMOVESINEXACTLYTHEOPPOSITEDIRECTION DECREASING EVERYYEAR BYTHEAMOUNTOFTHEDEPRECIATIONEXPENSE ENDINGATTHERESIDUALVALUE IF THEGRAPHSHOWSTHEASSETSENTIREUSEFULLIFE

REVIEW QUESTIONS 11.5

1 2EFERRINGTOONEACCOUNTINGPRINCIPLE EXPLAINWHYTHEORIGINALPURCHASEPRICE OFANON CURRENT ASSETMUSTBEDISCLOSEDINTHE"ALANCE3HEET 2 $ElNETHETERM@CARRYINGVALUE 3 2EFERRING TO ONE QUALITATIVE CHARACTERISTIC EXPLAIN WHY NON CURRENT ASSETS MUSTBEREPORTEDATTHEIRCARRYINGVALUEINTHE"ALANCE3HEET

11.6 THE RATE OF DEPRECIATION 4HEFORMULAUSEDSOFARCALCULATESTHEamountOFDEPRECIATIONEXPENSE EXPRESSEDIN DOLLARTERMS BUTDEPRECIATIONCANALSOBEEXPRESSEDASArateAPERCENTAGEOFTHECOST $EPRECIATIONRATEFORMULA $EPRECIATIONRATEPERANNUM



$EPRECIATIONEXPENSE (ISTORICAL#OST

X



5SING THE lGURES FROM THE EARLIER EXAMPLE REGARDING THE /FlCE &URNITURE THE DEPRECIATIONRATEWOULDBECALCULATEDAS Historical Cost Residual value Useful life Depreciation expense

   

  YEARS PERYEAR

$EPRECIATIONRATEPERANNUM  $EPRECIATIONEXPENSE

(ISTORICAL#OST

X







 

X





PERANNUM

4HISMEANSPERANNUMOFTHEASSETSCOSTWILLBECONSUMEDeach yearFORTHE THREEYEARSOFITSLIFE 4HEMOREMATHEMATICALLYAWAREREADERSMAYATTHISPOINTBEALITTLEPUZZLED FORTHREEYEARSMEANSONLYOFTHEASSETSCOSTWILLBECONSUMEDTHATIS  X  YEARS7HATHAPPENSTOTHEREMAININGOFTHECOST7HYISITNOTALLOCATED ASDEPRECIATION

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4HEANSWERISRESIDUALVALUETHEREMAINING OROF WILLBECONSUMED BYADIFFERENTENTITYWHENITTAKESCONTROLOFTHEASSET SOTHISAMOUNTCANNOTBEALLOCATED ASDEPRECIATION

#ALCULATINGDEPRECIATIONUSINGTHERATE )NSOMECASES ITMAYBETHERATEOFDEPRECIATIONTHATISGIVENRATHERTHANTHE(ISTORICAL #OST RESIDUALVALUEANDUSEFULLIFE)NTHESECASES THEDEPRECIATIONEXPENSEINDOLLAR TERMS CANBECALCULATEDBYSIMPLYMULTIPLYINGTHERATEBYTHE(ISTORICAL#OST $EPRECIATIONEXPENSERATEFORMULA $EPRECIATIONEXPENSEPERANNUM $EPRECIATIONRATEX(ISTORICAL#OST

EXAMPLE

On 1 July 2015, Carlton Clothing purchased shop fittings for $9 000 (plus $900 GST). The shop fittings are to be depreciated at 15% p.a. Balance day is 30 June 2016.

$EPRECIATIONEXPENSEPERANNUM $EPRECIATIONRATEX(ISTORICAL#OST

 X  PERANNUM

5SINGTHEFORMULAORTHERATETOCALCULATEDEPRECIATIONEXPENSEWILLPRODUCEEXACTLY THESAMEANSWERTHECHOICEOFMETHODDEPENDSONLYONTHEINFORMATIONAVAILABLE

2%6)%715%34)/.3

1 3HOWTHEFORMULAFORCALCULATINGTHERATEOFDEPRECIATION 2 3HOW THE FORMULA FOR CALCULATING DEPRECIATION EXPENSE USING THE RATE OF DEPRECIATION

 THE COST OF A NON-CURRENT ASSET !SWASSTATEDATTHEBEGINNINGOFTHISCHAPTER DEPRECIATIONINVOLVESALLOCATINGTHECOST OFANON CURRENTASSETOVERITSUSEFULLIFE3OFAR WEHAVEONLYEXAMINEDASSETSWHOSE COSTISTHEIRPURCHASEPRICE(OWEVER ITISQUITECOMMONFORABUSINESSTOMODIFYAN ASSET ORINCURCOSTSFORITSINSTALLATION THATMUSTALSOBEINCLUDEDINTHISDElNITIONOF COST!FTERALL IFTHESEOTHERCOSTSWILLPROVIDEAFUTUREECONOMICBENElTover the life of the asset THENTHEYSHOULDBECLASSIlEDASNON CURRENTASSETS ANDDEPRECIATED4HE cost of a non-current assetISTHUSDElNEDASALLCOSTSINCURREDINORDERTOBRINGTHE ASSETINTOALOCATIONANDCONDITIONREADYFORUSE WHICHWILLPROVIDEABENEFITFORTHELIFE OFTHEASSET s s s s

4HECOSTOFANON CURRENTASSETMAYTHEREFOREINCLUDE THEPURCHASEPRICESUPPLIERSPRICE DELIVERYCOSTS MODIlCATIONCOSTS INSTALLATIONCOSTS

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

COSTOFANON CURRENT ASSET all costs incurred in order to bring the asset into a location and condition ready for use, which will provide a benefit for the life of the asset.

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252

EXAMPLE

UNITS 3&4

On 1 March 2015 Danny’s Donuts paid $26 000 (plus $2 600 GST) to purchase a new oven (Ch. 32). The payment covered the following costs: Supplier’s price for the oven

$22 000

Installation costs

3 000

Maintenance fee

1 000 per year

GST

2 600

Total paid

$28 600

7EHAVEALREADYNOTEDTHATTHE'34ISNOTPARTOFTHECOSTOFTHEASSET BUTWHATOF THEOTHERCOSTS "OTHTHESUPPLIERSPRICE ANDTHEINSTALLATIONCOSTS ARENECESSARYTO BRINGTHEASSETINTOACONDITIONANDLOCATIONREADYFORUSE"UTJUSTASIMPORTANTLY THEY WILLNOTBECONSUMEDINONEYEAR BUTWILLBRINGABENElTOVERTHELIFEOFTHEASSET4HIS MEANSTHEYMUSTBEINCLUDEDINTHECOSTOFTHEASSET WHICHWOULDBE

0LUS

3UPPLIERSPRICEFORTHEOVEN )NSTALLATIONCOSTS #OSTOFOVEN

  

4HIS lGURE OF   IS THE AMOUNT TO BE USED AS THE COST IN THE CALCULATION OF DEPRECIATION 4HE MAINTENANCE FEE  MAY ALSO BE A NECESSARY COST BUT IT IS A YEARLY FEE ITSBENElTWILLBECONSUMEDWITHINAYEAR4HISMEANSITISNOTPARTOFTHEVALUEOFA NON CURRENT ASSET BUT RATHER A current ASSET 0REPAID -AINTENANCE )T SHOULD NOT BE RECORDEDASPARTOFTHECOSTOFTHEOVEN BUTRATHERINITSOWNSEPARATELEDGERACCOUNT )TWOULDTHENBESUBJECTTOABALANCEDAYADJUSTMENTATTHEENDOFTHE2EPORTING0ERIOD TO CALCULATE THE MAINTENANCE INCURRED !NY COSTS WHERE THE BENElT DOES NOT EXTEND FOR THE LIFE OF THE ASSET ARE NOT INCLUDED IN THE COST OF THE ASSET BUT RATHER TREATED SEPARATELYASEXPENSESORPREPAIDEXPENSES 4HEPURCHASEOFTHEOVENWOULDBERECORDEDINTHE#ASH0AYMENTS*OURNALASSHOWN IN&IGURE Figure 11.7

Cash Payments Journal: cash purchase of a non-current asset #ASH0AYMENTS*OURNAL

$ATE

$ETAILS

#HQ NO

March 1

/VEN

32

"ANK

$ISCOUNT #REDITORS 2EVENUE #ONTROL

7AGES $RAWINGS

28 600

Prepaid Maintenance 4OTALS

3UNDRIES

GST





1 000 





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4HISPURCHASEWOULDBEPOSTEDTOTHELEDGERASSHOWNBELOW 'ENERAL,EDGER "ANK! $ATE March 1 

#ROSS REFERENCE

!MOUNT

Balance

2 700

Cash Receipts

$ATE

#ROSS REFERENCE

!MOUNT

-ARCH

#ASHPAYMENTS



83 000 /VEN!

$ATE -ARCH

#ROSS REFERENCE

!MOUNT

"ANK

$ATE

#ROSS REFERENCE

!MOUNT

#ROSS REFERENCE

!MOUNT

 0REPAID-AINTENANCE!

$ATE March 31

#ROSS REFERENCE Bank

!MOUNT

$ATE

1 000 '34#LEARING!,

$ATE

#ROSS REFERENCE

March 31

Creditors Control Bank

!MOUNT

$ATE

700

March 1

2 600

31

#ROSS REFERENCE

!MOUNT

Balance

800

Bank

1 600

Debtors Control

1 300

2EMEMBERTHATTHEPAYMENTWOULDBERECORDEDINTHE#ASH0AYMENTS*OURNALON THEDATEITOCCURRED-ARCH BUTNOTPOSTEDTOTHE'ENERAL,EDGERUNTILTOTALS ARECALCULATEDATTHEENDOFTHEMONTH-ARCH 

2%6)%715%34)/.3

1 2 3 4

11.8

$ElNETHETERM@COSTASITREFERSTONON CURRENTASSETS )DENTIFYTHREECOSTSTHATMIGHTBEINCLUDEDINTHECOSTOFANON CURRENTASSET %XPLAINWHY'34ISEXCLUDEDFROMTHECOSTOFANON CURRENTASSET %XPLAINWHYYEARLYCOSTSAREEXCLUDEDFROMTHECOSTOFANON CURRENTASSET

DEPRECIATING A NON-CURRENT ASSET FOR LESS THAN A YEAR

"ECAUSE THE LIFE OF THE ASSET IS USUALLY MEASURED IN YEARS THE FORMULA WILL CALCULATE DEPRECIATIONINTERMSOFYEARS)FBYTHEENDOFTHE2EPORTING0ERIODTHElRMHASHAD CONTROLOFTHEASSETFORless than a year THEDEPRECIATIONlGUREWILLNEEDTOBEAPPLIED ONAPRO RATABASISIFTHEBUSINESSHASHADTHEASSETFORONLYONEMONTH THENONLYONE MONTHSWORTHOFDEPRECIATIONOFAYEAR SHOULDBECHARGEDASANEXPENSE

On 31 March 2015, Ferguson Plants paid $21 000 (plus $2 100 GST) for a new vehicle. It has an estimated useful life of eight years, at which point it will be disposed of for $1 800. Balance day is 30 June 2015.

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

STUDY TIP

0AYVERYCAREFUL ATTENTIONTOTHEDATE ONWHICHTHEASSET ISACQUIRED ASTHIS WILLDETERMINEHOW MANYMONTHSWORTHOF DEPRECIATIONNEEDTO BEAPPLIED

EXAMPLE

Cambridge University Press

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254

UNITS 3&4

9EARLYDEPRECIATIONWOULDBECALCULATEDASUSUAL

STUDY TIP

2ATHERTHANMULTIPLY BYFRACTIONS SUCHAS OR ITISSAFER TOMULTIPLYBYTHE NUMBEROFMONTHSOUT OFFOREXAMPLE OR(OW MANYMONTHSISOF AYEAR$IDYOUTHINK THREE4HEANSWERIS FOUR


$EPRECIATIONEXPENSE





(#n26 ,IFE





n 

YEARS











PERANNUM

 

(OWEVER THISVEHICLEWASPURCHASEDON-ARCH SOATBALANCEDAY*UNE  THE VEHICLE HAS BEEN UNDER THE CONTROL OF THE BUSINESS FOR ONLY THREE MONTHS !PRIL -AYAND*UNE !SARESULT ONLYTHREEMONTHSWORTHOFDEPRECIATIONSHOULDBE CHARGEDASANEXPENSEFORTHEPERIODENDING*UNE

$EPRECIATIONEXPENSE

= =

$2 400 per annum $600

X

3/12 months

4HEDEPRECIATIONEXPENSEFORTHETHREEMONTHSFROMPURCHASEUNTILBALANCEDAYIS  ANDONLYTHISAMOUNTSHOULDBEREPORTEDINTHE)NCOME3TATEMENTFORTHEYEAR ENDED*UNE4HEFOLLOWINGYEAR THElRMWILLHAVECONTROLOFTHEVEHICLEFORTHE FULLMONTHS ANDSOFORTHEYEARENDED*UNEDEPRECIATIONEXPENSESHOULD BEREPORTEDAS

2%6)%715%34)/.3

1 2EFERRINGTOONEACCOUNTINGPRINCIPLE EXPLAINWHYITISNOTALWAYSACCURATETO REPORTDEPRECIATIONEXPENSEPERANNUM 2 %XPLAINTHEPROCESSFORCALCULATINGDEPRECIATIONOFANASSETWHENTHElRMHAS HADCONTROLOFTHEASSETFORLESSTHANAYEAR

11.9 USE OF ESTIMATES IN CALCULATING DEPRECIATION /NEOFTHEKEYISSUESINCALCULATINGDEPRECIATIONISESTIMATINGTHEASSETSRESIDUALVALUE ANDUSEFULLIFEWITHOUTTHESEESTIMATES DEPRECIATIONCANNOTBECALCULATED(OWEVER BECAUSETHERESIDUALVALUEANDUSEFULLIFEAREestimates USINGTHEMINTHECALCULATIONOF DEPRECIATIONMEANSTHATTHEREPORTSWILLNOTBEFREEFROMBIAS4OSOMEEXTENTTHISWILL UNDERMINETHEReliabilityOFTHEACCOUNTINGREPORTS 4HE OBVIOUS QUESTION THEN ARISES WHY DEPRECIATE NON CURRENT ASSETS IF WE ARE UNDERMININGAKEYQUALITATIVECHARACTERISTIC4HEANSWERLIESINADIFFERENTQUALITATIVE CHARACTERISTICRelevance$EPRECIATIONENSURESTHATTHE)NCOME3TATEMENTINCLUDESALL INFORMATIONTHATISUSEFULFORDECISION MAKINGABOUTPROlT BYSHOWINGTHECONSUMPTION OFNON CURRENTASSETSINTHECURRENT2EPORTING0ERIOD3IMILARLY BYSHOWINGACCUMULATED

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 11

D E P R E C I AT I O N O F N O N - C U R R E N T A S S E T S

255

DEPRECIATION IN THE "ALANCE 3HEET IT ENSURES THAT ASSETS ARE SHOWN AT THEIR CARRYING VALUE WHICHISVITALFORDECISION MAKINGABOUTTHEIRREPLACEMENT )NTHISSENSE RelevanceOVERRIDESReliabilitySOTHATTHEACCOUNTINGREPORTSFULlLTHEIR FUNCTIONOFPROVIDINGUSEFULlNANCIALINFORMATIONNOTACCOUNTINGFORANYDEPRECIATIONAT ALLWOULDBEMOREINCORRECTTHANACCOUNTINGFORDEPRECIATIONUSINGESTIMATES

2%6)%715%34)/.3

1 %XPLAINHOWDEPRECIATIONCANUNDERMINETHEReliability OFACCOUNTINGREPORTS 2 %XPLAINHOWDEPRECIATIONENSURESRelevance INTHE s )NCOME3TATEMENT s "ALANCE3HEET

7(%2%(!6%7%"%%. s $EPRECIATIONISTHEALLOCATIONOFTHECOSTOFANON CURRENTASSETOVERITSUSEFULLIFE s 4HE PURPOSE OF DEPRECIATION IS TO ENSURE THAT AN ACCURATE PROlT IS CALCULATED BY COMPARING REVENUES EARNED AGAINST EXPENSES INCURRED IN THE CURRENT 2EPORTING 0ERIOD s 4HE STRAIGHT LINE METHOD ASSUMES THAT NON CURRENT ASSETS CONTRIBUTE EVENLY TO REVENUEOVERTHEIRLIFE!SARESULT DEPRECIATIONEXPENSEISALLOCATEDEVENOVERTHE ASSETSLIFE s 4HE COST OF AN ASSET INCLUDES ALL COSTS INCURRED IN ORDER TO BRING THE ASSET INTO A LOCATIONANDCONDITIONREADYFORUSE WHICHWILLPROVIDEABENElTFORTHELIFEOFTHE ASSET s "ECAUSE RESIDUAL VALUE AND USEFUL LIFE ARE ESTIMATES DEPRECIATION MEANS THAT THE REPORTSWILLBELESSFREEFROMBIASReliability  s 7ITHOUTDEPRECIATION THEREPORTSWILLNOTINCLUDEALLINFORMATIONTHATISUSEFULFOR DECISION MAKINGRelevance 

EXERCISE 11.1 CALCULATION OF DEPRECIATION

W B

page 224

EXERCISES

/N*ULY 3HOVELAND3HIFTPURCHASEDNEW/FlCE&URNITUREFORPLUS'34 )TISEXPECTEDTHATTHEOFlCEFURNITUREWILLHAVEAUSEFULLIFEOFlVEYEARS ANDWILLBE DISPOSEDOFATTHATTIMEFOR Required a $ElNETHETERM@DEPRECIATION B #ALCULATEDEPRECIATIONOFTHEOFlCEFURNITUREFORTHEYEARENDED*UNE C %XPLAINWHYTHE'34PAIDONTHEPURCHASEOFTHEOFlCEFURNITUREISNOTINCLUDEDIN THECALCULATIONOFDEPRECIATION

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

EXERCISE 11.2 CALCULATION OF DEPRECIATION

W B

page 225

/N*ULY &RAGRANT0ERFUMESPURCHASEDSHELVINGFORPLUS'34 4HESHELVINGHASANESTIMATEDUSEFULLIFEOFEIGHTYEARS WITHARESIDUALVALUEOF Required a 2EFERRINGTOONEACCOUNTINGPRINCIPLE EXPLAINWHYITISNECESSARYTODEPRECIATENON CURRENTASSETS B #ALCULATEDEPRECIATIONOFTHESHELVINGFORTHEYEARENDED*UNE C %XPLAINWHYTHERESIDUALVALUEOFTHESHELVINGISDEDUCTEDFROMITS(ISTORICAL#OSTIN THECALCULATIONOFDEPRECIATIONEXPENSE d %XPLAINTHEEFFECTOFDEPRECIATIONONTHElRMSBANKBALANCE

EXERCISE 11.3 RECORDING DEPRECIATION

W B

page 226

/N*ULY 2OAMIN"LINDSPURCHASEDNEWBLIND CUTTINGEQUIPMENT PAYING CASHINCLUDING'344HEEQUIPMENTISEXPECTEDTOLASTFORSIXYEARS ATWHICHTIMEITWILL HAVEARESIDUALVALUEOF/N*UNE THEACCOUNTINGDEPARTMENTRECEIVED -EMOTOSAYTHATDEPRECIATIONONTHEEQUIPMENTHADNOTYETBEENRECORDED Required a #ALCULATEDEPRECIATIONOFTHEEQUIPMENTFORTHEYEARENDED*UNE B 3HOWTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDDEPRECIATIONOFEQUIPMENT FORTHEYEARENDED*UNE C 0OST THE 'ENERAL *OURNAL ENTRIES FROM PART @B TO THE RELEVANT ACCOUNTS IN THE 'ENERAL,EDGEROF2OAMIN"LINDS d 3HOWHOW%QUIPMENTWOULDBEREPORTEDINTHE"ALANCE3HEETOF2OAMIN"LINDSAS AT*UNE e 2EFERRINGTOONEQUALITATIVECHARACTERISTIC EXPLAINWHYTHEASSETMUSTBESHOWNIN THE"ALANCE3HEETATITSCARRYINGVALUE

EXERCISE 11.4 DEPRECIATION AND THE BALANCE SHEET

W B

page 228

*UNGLE*ANESELLSGYMEQUIPMENT)TSOWNERHASPRESENTEDTHEFOLLOWINGEXTRACTFROM THElRMS"ALANCE3HEET *5.',%*!.% "ALANCE3HEETEXTRACT ASAT*UNE

.ON #URRENT!SSETS /FlCE&URNITURE n!CCUMULATED$EPRECIATION

  

 

Additional information: s 4HE/FlCE&URNITUREHASANESTIMATEDRESIDUALVALUEOF s 4HE)NCOME3TATEMENTFORTHEYEARENDED*UNESHOWED$EPRECIATIONOF /FlCE&URNITUREOF

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 11

D E P R E C I AT I O N O F N O N - C U R R E N T A S S E T S

Required a %XPLAINWHATISREPRESENTEDBYTHEAMOUNTSLABELLED AND B 3HOWTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDDEPRECIATIONOFOFlCEFURNITURE FORTHEYEARENDED*UNE.ARRATIONIS NOT REQUIRED C 0OST THE 'ENERAL *OURNAL ENTRIES FROM PART @B TO THE RELEVANT ACCOUNTS IN THE 'ENERAL,EDGER d 3HOWHOW/FlCE&URNITUREWOULDBEREPORTEDINTHE"ALANCE3HEETASAT*UNE  e #ALCULATETHEUSEFULLIFEOFTHE/FlCE&URNITURE

EXERCISE 11.5 DEPRECIATION RATE

W B

page 230

/N  *ULY  +NIGHTS 0RAWNS PURCHASED NEW CABINETS FOR   PLUS  '34 )TISDECIDEDTHATTHECABINETSWILLBEDEPRECIATEDUSINGTHESTRAIGHT LINEMETHODAT PERANNUM-EMO  Required a #ALCULATEDEPRECIATIONOFTHECABINETSFORTHEYEARENDED*UNE B 3HOWTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDDEPRECIATIONOFCABINETSFOR THEYEARENDED*UNE C 3HOWHOWTHE$EPRECIATIONOF#ABINETSAND!CCUMULATED$EPRECIATIONOF#ABINETS ACCOUNTSWOULDAPPEARINTHE'ENERAL,EDGERAFTERALLBALANCEDAYADJUSTMENTS AND CLOSINGANDBALANCINGENTRIESHAVEBEENMADE d 3TATETHEEFFECTONTHEACCOUNTINGEQUATIONASAT*UNEIFTHEADJUSTMENTFOR DEPRECIATIONWASNOTMADE e 3HOWHOWTHE#ABINETSWOULDBEREPORTEDINTHE"ALANCE3HEETASAT*UNE

EXERCISE 11.6 COST OF A NON-CURRENT ASSET

W B

page 232

/N*ULY %ILEENS,ADDERSPURCHASEDACOMPUTER LINKEDCASHREGISTERSYSTEMFOR PLUS'34 ANDPAIDANADDITIONALCOSTOFPLUS'34FORANANNUALSOFTWARE LICENCEFEE%ILEENDECIDEDTOUSETHESTRAIGHT LINEMETHODOFDEPRECIATION DETERMINING THATTHESYSTEMWILLHAVEAUSEFULLIFEOFlVEYEARSANDARESIDUALVALUEOF Required a %XPLAINWHYTHESOFTWARELICENCEFEESHOULDNOTBEINCLUDEDINTHECOSTOFTHECASH REGISTER B 3HOWHOWTHESOFTWARELICENCEFEEWOULDBEREPORTEDINTHE"ALANCE3HEETASAT *ULY C #ALCULATEDEPRECIATIONOFTHECASHREGISTERFORTHEYEARENDED*UNE d #ALCULATETHERATEOFDEPRECIATIONONTHECASHREGISTER e 3HOWHOWTHE#ASH2EGISTERWOULDBEREPORTEDINTHE"ALANCE3HEETASAT*UNE  F 3TATETHEEFFECTOFTHEDEPRECIATIONOFTHECASHREGISTERONTHEACCOUNTINGEQUATION OF%ILEENS,ADDERSASAT*UNE

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

%8%2#)3% COST OF AN NCA, DEPRECIATION FOR LESS THAN ONE YEAR

W B

page 233

/N!PRIL -ATTS-ATSPAIDCASHFORANEWDELIVERYVAN4HEDOCUMENTFORTHE PURCHASEISSHOWNBELOW

Dan’s Vans

TAX INVOICE: X36

Dan’s Vans

105 Blackburn Rd Nunawading VIC 3110 ABN: 173 254 009

CASH SALE:

-ATTS-ATS .AISMITH3T "LACKBURN6)# !".

Details

!PRIL 2015

$ELIVERYVAN &ITTINGOFSHELVES 3ERVICECONTRACTMONTHS '34

Total    

4OTALPRICE

$26 070

!MOUNTRECEIVED

$26 070

"ALANCEOWING

NIL

-ATTEXPECTSTOHAVETHEDELIVERYVANFORlVEYEARSANDTHENDISPOSEOFITFOR Required a B C d e

#ALCULATETHECOSTOFTHEDELIVERYVAN 2EFERRINGTOYOURANSWERTOPART@A EXPLAINYOURTREATMENTOF@lTTINGOFSHELVES #ALCULATEDEPRECIATIONOFTHEVANFORTHEYEARENDED*UNE #ALCULATETHERATEOFDEPRECIATIONONTHEVAN 3HOWHOWTHESERVICECONTRACTWOULDBEREPORTEDINTHE"ALANCE3HEETOF-ATTS -ATSASAT*UNE F 3HOWHOWTHE6ANWOULDBEREPORTEDINTHE"ALANCE3HEETOF-ATTS-ATSASAT *UNE

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

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CHAPTER 11

D E P R E C I AT I O N O F N O N - C U R R E N T A S S E T S

EXERCISE 11.8 DEPRECIATION FOR LESS THAN ONE YEAR

W B

page 235

3CRATCHAND$ENT$ISCOUNTERSPRESENTTHEFOLLOWINGEXTRACTFROMTHEIR"ALANCE3HEETAS AT*ULY SCRATCH AND DENT DISCOUNTERS "ALANCE3HEETEXTRACT ASAT*ULY

.ON #URRENT!SSETS /FlCE&URNITURE n!CCUMULATED$EPRECIATION

  

 

Additional information: s ! SPECIALLY DESIGNED OFlCE CHAIR WAS PURCHASED ON  *ANUARY  FOR  PLUS'34 s /FlCE &URNITURE IS DEPRECIATED AT  PER ANNUM USING THE STRAIGHT LINE METHOD -EMO  Required a 2EFERRINGTOONEACCOUNTINGPRINCIPLE EXPLAINWHYTHE/FlCE&URNITURESHOULDBE DEPRECIATED B #ALCULATEDEPRECIATIONOFTHE/FlCE&URNITUREFORTHEYEARENDED*UNE C 3HOWTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDDEPRECIATIONOFOFlCEFURNITURE FORTHEYEARENDED*UNE d 3HOWHOWTHE$EPRECIATIONOF/FlCE&URNITUREAND!CCUMULATED$EPRECIATIONOF /FlCE&URNITUREACCOUNTSWOULDAPPEARINTHE'ENERAL,EDGERAFTERALLCLOSINGAND BALANCINGENTRIESAREMADE e 3HOWHOW/FlCE&URNITUREWOULDBEREPORTEDINTHE"ALANCE3HEETOF3CRATCHAND $ENTASAT*UNE

EXERCISE 11.9 DEPRECIATION FOR LESS THAN A YEAR

W B

page 237

!SAT*UNE &ROST&RIDGESHADSHOPlTTINGSTHATHADBEENPURCHASEDFOR BUTHADACURRENTCARRYINGVALUEOF/N-ARCH INCLUDING'34 WASPAIDFORADDITIONALSHOPlTTINGS$EPRECIATIONISALLOCATEDUSINGTHESTRAIGHT LINE METHODATTHERATEOFPERANNUM-EMO  Required a #ALCULATETHE ACCUMULATEDDEPRECIATIONOFTHESHOPlTTINGSASAT*UNE B #ALCULATEDEPRECIATIONOFTHESHOPlTTINGSFORTHEYEARENDED*UNE C 3HOWTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDDEPRECIATIONOFSHOPlTTINGS FORTHEYEARENDED*UNE d 3HOW HOW THE $EPRECIATION OF 3HOP &ITTINGS AND !CCUMULATED $EPRECIATION OF 3HOP &ITTINGS ACCOUNTS WOULD APPEAR IN THE 'ENERAL ,EDGER AFTER ALL CLOSING AND BALANCINGENTRIESAREMADE e 2EFERRINGTOONEACCOUNTINGPRINCIPLE EXPLAIN WHYTHEORIGINALPURCHASEPRICEOF THEASSETISDISCLOSEDINTHE"ALANCE3HEET F 3HOWHOWTHE3HOP&ITTINGSWOULDBEREPORTEDINTHE"ALANCE3HEETOF&ROST&RIDGES ASAT*UNE

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

259

CAMBRIDGE VCE ACCOUNTING

260

UNITS 3&4

%8%2#)3% REPORTING DEPRECIATION

W B

page 239

4IM"ARROWNS(ACKAND3AW ASTORESPECIALISINGINTHESALEOFSAWS CHAINSAWSANDAXES 4HEBUSINESSHASPROVIDEDITS0RE ADJUSTMENT4RIAL"ALANCEASAT*UNE HACK AND SAW 0RE ADJUSTMENT4RIAL"ALANCEASAT*UNE !CCOUNT

$EBIT

!CCUMULATED$EPRECIATIONn$ISPLAY%QUIPMENT !DMINISTRATIVE%XPENSES

 

"ANK



#APITALn"ARR #OSTOF3ALES

 

#REDIT3ALES



$EBTORS#ONTROL



$ISPLAY%QUIPMENT



$RAWINGS



'34#LEARING )NTEREST%XPENSE

 

,OANn$2&INANCEREPAYABLEPERMONTH 0REPAID!DVERTISING

 

2ENT%XPENSE



3TOCK#ONTROL



7AGES



4OTALS

#REDIT





Additional information: s s s s s

!PHYSICALSTOCKTAKEON*UNESHOWEDSTOCKONHAND 4HEDISPLAYEQUIPMENTISTOBEDEPRECIATEDATPA !SEVEN MONTHADVERTISINGCAMPAIGNWASPAIDINADVANCEON&EBRUARY !PAYMENTOFADMINISTRATIVEEXPENSESHASBEENINCORRECTLYPOSTEDTO7AGES 2EPORTSAREPREPAREDYEARLY

Required

* *

*

a %XPLAINTHEPURPOSEOFBALANCEDAYADJUSTMENTS B 3HOW THE 'ENERAL *OURNAL ENTRIES NECESSARY TO RECORD THE ADDITIONAL INFORMATION .ARRATIONSARE NOTREQUIRED C 0REPAREA0OST ADJUSTMENT4RIAL"ALANCEFOR(ACKAND3AWASAT*UNE d 3HOW THE 'ENERAL *OURNAL ENTRIES NECESSARY TO CLOSE THE LEDGER AND TRANSFER $RAWINGSTOTHE#APITALACCOUNT.ARRATIONSNOTREQUIRED e 0REPAREAN)NCOME3TATEMENTFOR(ACKAND3AWFORTHEYEARENDED*UNE F !SSESSTHEMARK UPAPPLIEDBY(ACKAND3AWFORTHEYEARENDED*UNE G 3TATETWOACTIONS(ACKAND3AWCOULDTAKETOIMPROVE.ET0ROlTWITHOUTCHANGING !DJUSTED'ROSS0ROlT h 0REPAREACLASSIlED"ALANCE3HEETFOR(ACKAND3AWASAT*UNE I $ISCUSSWHETHERTHEAMOUNTOFDRAWINGSTAKENBYTHEOWNERINTHEYEARENDED *UNEISAPPROPRIATE

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 11

D E P R E C I AT I O N O F N O N - C U R R E N T A S S E T S

EXERCISE 11.11 REPORTING DEPRECIATION

W B

page 243

.GUYEN 3KI 'EAR HAS PROVIDED THE FOLLOWING 0RE ADJUSTMENT 4RIAL "ALANCE AS AT $ECEMBER NGUYEN SKI GEAR 0RE ADJUSTMENT4RIAL"ALANCEASAT$ECEMBER !CCOUNT

$EBIT

Accumulated Depreciation – Vehicle Bank

8 000 2 400

Capital – Nguyen Cost of Sales

32 620 48 000

Creditors Control Debtors Control Discount Expense

#REDIT

18 000 16 000 820

Discount Revenue Drawings

300 14 000

GST Clearing Interest Expense

700 1 400

Loan – NAB (repayable $9 000 p.a.) Prepaid Rent

21 000 18 000

Sales

120 000

Stock Control

24 000

Vehicle

40 000

Wages

36 000

4OTALS





Additional information: s s s s s

!PHYSICALSTOCKTAKEON$ECEMBERSHOWEDSTOCKONHAND 4HEVEHICLEISTOBEDEPRECIATEDATPA !SAT$ECEMBER WAGESWERESTILLOWINGTOEMPLOYEES 0REPAIDRENTASAT$ECEMBERWAS 4HELASTREPORTSWEREPREPAREDON*UNE

Required

*

*

a 3HOW THE 'ENERAL *OURNALENTRIES NECESSARY TO RECORD THE ADDITIONALINFORMATION .ARRATIONSARE NOTREQUIRED B 0REPAREA0OST ADJUSTMENT4RIAL"ALANCEFOR.GUYEN3KI'EARASAT$ECEMBER  C 2EFERRINGTOONEACCOUNTINGPRINCIPLE EXPLAINTHEPURPOSEOFCLOSINGENTRIES d 3HOW THE 'ENERAL *OURNAL ENTRIES NECESSARY TO CLOSE THE LEDGER AND TRANSFER $RAWINGSTOTHE#APITALACCOUNT.ARRATIONSNOTREQUIRED e 0REPARE AN )NCOME 3TATEMENT FOR .GUYEN 3KI 'EAR FOR THE SIX MONTHS ENDED  $ECEMBER F %XPLAIN WHAT THE )NCOME 3TATEMENT REVEALS ABOUT THE REPUTATION OF .GUYEN 3KI 'EAR

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

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*

UNITS 3&4

G 0REPAREACLASSIlED"ALANCE3HEETFOR.GUYEN3KI'EARASAT$ECEMBER h 2EFERRINGTOYOURANSWERTOPART@G IDENTIFYONEITEMTHATCANBEUSEDTOSUPPORT THEVIEWTHATTHElRMSlNANCIALPOSITIONISSOUND*USTIFYYOURANSWER

EXERCISE 11.12 ACCOUNTING FOR NON-CURRENT ASSETS

W B

page 247

/N-ARCH THESHOPlTTINGSOF&UNK&ASHIONSWEREDESTROYEDINAlRE SOTHE OWNER#OLIN-ILLER CONTRIBUTEDSOMElTTINGSTHATHEHADPURCHASEDFORHISOWNHOME -EMO #OLINHADPURCHASEDTHElTTINGSIN PAYING BUTATTHEENDOF &EBRUARYHADTHEMPROFESSIONALLYVALUEDAT(ECALCULATESTHATTHEYWILLBE OFUSEFORFOURYEARS ANDBYTHEENDOFTHEIRUSEFULLIFEHEEXPECTSTOSELLTHEMFOR Required a 3HOWTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDTHECONTRIBUTIONOFTHESHOP lTTINGSBYTHEOWNERON-ARCH B 2EFERRINGTOONEQUALITATIVECHARACTERISTIC JUSTIFYYOURVALUATIONOFTHESHOPlTTINGS ASAT-ARCH C #ALCULATEDEPRECIATIONOFTHESHOPlTTINGSFORTHEYEARENDED*UNE d 3HOWTHE'ENERAL*OURNALENTRIESNECESSARYTORECORD$EPRECIATIONOF3HOP&ITTINGS FORTHEYEARENDED*UNE.ARRATIONIS NOT REQUIRED e 3HOW HOW THE FOLLOWING ACCOUNTS WOULD APPEAR IN THE 'ENERAL ,EDGER AS AT  *UNE AFTERALLBALANCINGANDCLOSINGENTRIESHAVEBEENMADE3HOP&ITTINGS $EPRECIATIONOF3HOP&ITTINGS AND!CCUMULATED$EPRECIATIONOF3HOP&ITTINGS F 3HOWHOW3HOP&ITTINGSWOULDAPPEARINTHE"ALANCE3HEETOF&UNK&ASHIONSASAT *UNEAND

EXERCISE 11.13 ACCOUNTING FOR NON-CURRENT ASSETS

W B

page 249

/N  /CTOBER  -ARK 2ENDLE PURCHASED A NEW DELIVERY VAN FOR HIS BUSINESS 2ENDLE #LOTHING 4HE VAN WAS ADVERTISED FOR  PLUS '34 BUT -ARK BARGAINED WITHTHESALESPERSONWHOAGREEDTOPROVIDETHEVANANDWORTHOFON ROADCOSTS FORINCLUDING'34)NSTALLATIONOFHEAVY DUTYSUSPENSIONCOSTAFURTHERPLUS '34 AND-ARKHASINSUREDTHEVANFORlREANDTHEFTWITH//-9)NSURANCEATANANNUAL COSTOFPLUS'344HEVANISEXPECTEDTOHAVEAUSEFULLIFEOFlVEYEARS AFTER WHICH-ARKCANTRADEITINONANEWONE)TWILLHAVEATRADE INVALUEOFAPPROXIMATELY  Required a #ALCULATETHECOSTOFTHEVANPURCHASEDON/CTOBER B 2EFERRINGTOYOURANSWERTOPART@A EXPLAINYOURTREATMENTOF s THEHEAVY DUTYSUSPENSION s INSURANCE C 2EFERRINGTOONEACCOUNTINGPRINCIPLE EXPLAINWHYTHEENTIRECOSTOFTHEVANCANNOT BETREATEDASANEXPENSEINTHEYEARENDED*UNE d #ALCULATE DEPRECIATION OF THE VAN FOR THE YEAR ENDED  *UNE  USING THE STRAIGHT LINEMETHOD e 3HOWTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDTHEDEPRECIATIONOFTHEVAN FORTHEYEARENDED*UNE.ARRATIONIS NOTREQUIRED F 2EFERRINGTOONEQUALITATIVECHARACTERISTIC EXPLAINWHYTHEVANSHOULDNOTBEVALUED ONLYATITS(ISTORICAL#OSTINTHE"ALANCE3HEETASAT*UNE G )N*ULY THEDELIVERYDRIVERFELLILL SOTHEVANWASNOTUSEDFORDELIVERIESFORTWO MONTHS%XPLAINWHETHERTHEVANSHOULDBEDEPRECIATEDFOR*ULYAND!UGUST © Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

Where are we headed? After completing this chapter, you should be able to: s EXPLAINTHENEEDTOREPORTFOR CASH s PREPAREA3TATEMENTOF 2ECEIPTSAND0AYMENTS s EXPLAINTHEROLEOFCASH JOURNALSINREPORTINGFORCASH s DElNETHETERMS@CASH SURPLUSAND@CASHDElCIT s DElNEANDIDENTIFY /PERATING )NVESTINGAND &INANCINGCASHmOWS

s PREPAREA#ASH&LOW 3TATEMENT s EXPLAINTHEUSESOFTHE#ASH &LOW3TATEMENT s EXPLAINTHEDIFFERENCE BETWEENCASHANDPROlT AND IDENTIFYREASONSWHYAlRMS CASHANDPROlTPERFORMANCE MAYDIFFER

CHAPTER 12

THE CASH FLOW STATEMENT KEY TERMS After completing this chapter, you should be familiar with the following terms: s 3TATEMENTOF2ECEIPTSAND0AYMENTS s CASHSURPLUS s CASHDElCIT s #ASH&LOW3TATEMENT s /PERATING!CTIVITIES s )NVESTING!CTIVITIES s &INANCING!CTIVITIES © Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

264

UNITS 3&4

12.1 THE NEED TO REPORT FOR CASH !CCOUNTINGEXISTSASANINFORMATIONSYSTEM!SPARTOFTHATSYSTEM ACCOUNTINGREPORTS HAVE THE FUNCTION OF COMMUNICATING lNANCIAL INFORMATION TO THE OWNER TO ASSIST DECISION MAKING4HELASTFEWCHAPTERSFROMDETERMININGPROlTORLOSSIN#HAPTERTO DEPRECIATIONIN#HAPTER HAVEBEENCONCERNEDMAINLYWITHREPORTINGFORPROlTAND GIVENTHATEARNINGAPROlTISTHEPRIMARYREASONFORBEINGINBUSINESS THISISCERTAINLY AVALIDCONCERN!FTERALL OWNERSMUSTHAVEACCURATEINFORMATIONABOUTREVENUESAND EXPENSESIFTHEYARETOIMPROVETHETRADINGPERFORMANCEOFTHEIRlRMS (OWEVER MANYPROlTABLEBUSINESSESSTILLFAILBECAUSETHEYHAVENOTPAIDSUFlCIENT ATTENTIONTOMANAGINGTHEIRCASH-ANYSMALLBUSINESSOWNERSINCORRECTLY ASSUMETHAT CASHANDPROlTARETHESAMETHING ANDTHATIFTHEYCANSELLTHEIRPRODUCTSATAPROlTTHEN THEYWILLAUTOMATICALLYHAVECASHAVAILABLETOPAYTHEIRDEBTS5NFORTUNATELY THISISNOT THECASE#ASHANDPROlTAREDIFFERENTMEASURESOFPERFORMANCE ANDTHEREAREMANY POSSIBLEREASONSWHYAlRMTHATISEARNINGAPROlTCANSTILLSUFFERFROMALACKOFCASH 'IVENTHATCASHANDPROlTAREDIFFERENT ITISIMPORTANTTHATTHEOWNERISPROVIDED WITHDIFFERENTINFORMATIONONBOTHITEMS)FYOUARESTILLQUESTIONINGWHETHERCASHAND PROlTAREACTUALLYDIFFERENTTHINGS SKIPAHEADTO@#ASHVERSUSPROlTONPAGE TOMAKESURE 7ITHOUTINFORMATIONONBOTHCASHANDPROlT THEOWNERWILLNOTBEABLE TO MANAGE BOTH EFFECTIVELY #HAPTER  CONSIDERED REPORTING FOR PROlT THIS CHAPTER CONSIDERSREPORTINGFORCASH Cash and profit are different measures of performance, and there are many possible reasons why a firm that is earning a profit can still suffer from a lack of cash

REVIEW QUESTIONS 12.1

1 %XPLAINTHEBASICFUNCTIONOFALLACCOUNTINGREPORTS 2 %XPLAINWHYITISIMPORTANTTOREPORTONBOTHCASHANDPROlT

3TATEMENTOF2ECEIPTS AND0AYMENTS an accounting report that details cash received and paid during a Reporting Period, and the change in the firm’s bank balance over that period

12.2 THE STATEMENT OF RECEIPTS AND PAYMENTS 4HEMOSTBASICWAYOFREPORTINGONCASHISTODETAILCASHreceivedANDCASHpaidDURING THEPERIOD ANDTHENIDENTIFYTHECHANGEINTHElRMSBANKBALANCE4HISISACHIEVEDBY PREPARINGAStatement of Receipts and Payments ! TYPICAL 3TATEMENT OF 2ECEIPTS AND 0AYMENTS WOULD LOOK LIKE THE ONE SHOWN IN &IGURE )N COMMON WITH ALL ACCOUNTING REPORTS THIS STATEMENT IDENTIlES THE who -AKRIS -ANCHESTER THEwhat3TATEMENTOF2ECEIPTSAND0AYMENTS ANDTHEwhenTHEQUARTER ENDED$ECEMBER ABOUTWHICHITISREPORTING!SWITHTHE)NCOME3TATEMENT THEWHENREFERSTOAPERIODOFMORETHANONEDAY ANDSOSTATESTHATITISforTHEQUARTER RATHERTHANas at WHICHAPPLIESTOTHE"ALANCE3HEET 

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 12

Figure 12.1

T H E C A S H F L O W S TAT E M E N T

265

Statement of Receipts and Payments MAKRIS MANCHESTER

3TATEMENTOF2ECEIPTSAND0AYMENTSFORTHEQUARTERENDED$ECEMBER $

#ASH2ECEIPTS Cash Sales

43 000

Receipts from Debtors

41 500

Loan – Aust. Bank

25 000

Capital Contribution

5 000

GST Received

4 300

$

118 800

,ESS#ASH0AYMENTS Payments to Creditors

61 400

Wages

31 000

Drawings

12 700

GST Paid

1 170

Electricity

500

Prepaid Insurance

1 200

Shelving

10 000

Interest Expense

600

Loan – Aust. Bank

2 000

Office Equipment

4 500

125 070

3URPLUS$ElCIT



!DD"ANK"ALANCEATSTART/CTOBER



"ANK"ALANCEATEND$ECEMBER



"YLISTINGTHESOURCESOFCASHCASHRECEIPTS ANDUSESOFTHATCASHCASHPAYMENTS THISREPORTALLOWSTHEOWNERTOIDENTIFYWHETHERTHElRMSCASHBALANCEHASINCREASEDOR DECREASED ANDTHEMAINREASONSWHYTHISHASOCCURRED

2OLEOFTHECASHJOURNALS 4HEINFORMATIONREPORTEDINTHESTATEMENTABOVECOULDBEGARNEREDDIRECTLYFROMTHE SOURCEDOCUMENTSCASHRECEIPTSANDCHEQUEBUTTS BUTTHISINFORMATIONWOULDNOTBE CLASSIlEDORSUMMARISEDINANYWAY)NSTEAD THE3TATEMENTOF2ECEIPTSAND0AYMENTSIS BASEDONTHECASHJOURNALSTHE#ASH2ECEIPTS*OURNALPROVIDESTHEINFORMATIONRELATING TOCASHRECEIVED ANDTHE#ASH0AYMENTS*OURNALDETAILSCASHPAID &URTHER THE3TATEMENTOF2ECEIPTSAND0AYMENTSDOESNOTREPORTINDIVIDUALAMOUNTS BUTRATHERCOLUMN TOTALS SUCHAStotalCASHRECEIVEDFROMDEBTORSANDtotalCASHSALES ORtotalCASHPAIDTOCREDITORSANDtotalCASHDRAWINGS4HEOBVIOUSEXCEPTIONISTHE SUNDRIESCOLUMN"YDElNITION THETRANSACTIONSRECORDEDINTHISCOLUMNAREINFREQUENT ANDSOMUSTBEREPORTEDINDIVIDUALLY

3URPLUSDElCIT "YDEDUCTINGPAYMENTSFROMRECEIPTS THEcash surplusORcash deficitCANBECALCULATED Surplus (Deficit)

=

Cash Receipts

–

Cash Payments

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

CASHSURPLUS an excess of cash receipts over cash payments, leading to an increase in the bank balance CASHDElCIT an excess of cash payments over cash receipts, leading to a decrease in the bank balance

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

266

UNITS 3&4

!CASHSURPLUSOCCURSWHENCASHRECEIVEDISgreaterTHANCASHPAIDDURINGTHEPERIOD ANDWILLLEADTOANOVERALLINCREASEINTHEBANKBALANCE!CASHDElCITOCCURSWHENCASH RECEIVEDISlessTHANCASHPAID ANDWILLLEADTOANOVERALLDECREASEINTHEBANKBALANCE

REVIEW QUESTIONS 12.2

1 %XPLAINTHEFUNCTIONOFA3TATEMENTOF2ECEIPTSAND0AYMENTS 2 %XPLAIN WHY THE INFORMATION REPORTED IN THE 3TATEMENT OF 2ECEIPTS AND 0AYMENTSISTAKENFROMTHECASHJOURNALSRATHERTHANDIRECTLYFROMTHESOURCE DOCUMENTS  $ElNETHEFOLLOWINGTERMS s CASHSURPLUS s CASHDElCIT 4 2EFERRING TO &IGURE  STATE ONE REASON WHY THE OWNER MIGHT NOT BE CONCERNEDABOUTTHElRMS#ASH0OSITION  2EFERRING TO &IGURE  EXPLAIN ONE REASON WHY THE OWNER SHOULD BE CONCERNEDABOUTTHElRMSCASHPERFORMANCE

#ASH&LOW3TATEMENT an accounting report that details all cash inflows and outflows from Operating, Investing and Financing activities, and the overall change in the firm’s cash balance /PERATINGACTIVITIES cash flows related to dayto-day trading activities )NVESTINGACTIVITIES cash flows related to the purchase and sale of noncurrent assets &INANCINGACTIVITIES cash flows related to changes in the financial structure of the firm

STUDY TIP

 THE CASH FLOW STATEMENT 7HILETHE3TATEMENTOF2ECEIPTSAND0AYMENTSISAGOODSTARTINGPOINTFORASSESSING CHANGESINTHElRMS#ASH0OSITION ITISSOMEWHATLIMITEDINITSUSES BECAUSEITONLY CLASSIlES THE CASH TRANSACTIONS AS RECEIPTS OR PAYMENTS )NFORMATION ABOUT CASH IS MOREUSEFULFORDECISION MAKINGIFITCLASSIlESCOMMONSOURCESANDUSESOFCASH AND SEPARATELYIDENTIlESTHEIREFFECTONTHEBANKBALANCE4HE Cash Flow StatementREPORTS ON CASH INmOWS CASH RECEIVED AND CASH OUTmOWS CASH PAID SEPARATELY IDENTIFYING CASHmOWSRELATINGTO/PERATINGACTIVITIES )NVESTINGACTIVITIESAND&INANCINGACTIVITIES

/PERATINGACTIVITIES Operating activities REFERS TO ALL CASH mOWS RELATED TO THE lRMS DAY TO DAY TRADING ACTIVITIESOperating inflowsMAYINCLUDECASHSALES RECEIPTSFROMDEBTORS '34RECEIVED ANDANYOTHERCASHREVENUESOperating outflowsMAYINCLUDEALLPAYMENTSRELATEDTO EXPENSESINCLUDINGINTEREST PAYMENTSTOCREDITORS '34PAID PREPAIDEXPENSES AND ANYPAYMENTSFOREXPENSESINCURREDINPREVIOUSPERIODSSUCHASACCRUEDWAGES 

)NVESTINGACTIVITIES Investing activitiesARECASHmOWSRELATINGTOTHEPURCHASEORSALEOFNON CURRENTASSETS )NPRACTICETHISWILLMEANTHEREAREONLYTWOPOSSIBLE)NVESTINGITEMSCASHRECEIVEDFROM THESALEOFANON CURRENTASSETInvesting inflow ANDCASHPAIDFORTHEPURCHASEOFANON CURRENTASSETInvesting outflow 

&INANCINGACTIVITIES 'IVENTHAT5NITOF THISCOURSEDOESNOT INCLUDETHESALEOFNON CURRENTASSETS THEONLY )NVESTINGACTIVITYWE ARELIKELYTOSEEINTHE MID YEAREXAMISTHE CASHPURCHASEOFANON CURRENTASSET

Financing activitiesARECASHmOWSTHATARETHERESULTOFCHANGESINTHElRMSlNANCIAL STRUCTURE)NESSENCE THISWILLMEANONLYCASHTRANSACTIONSTHATCHANGELOANSANDOWNERS EQUITY SUCH AS RECEIVING OR REPAYING THE PRINCIPAL OF A LOAN OR CASH CONTRIBUTIONS OR DRAWINGSBYTHEOWNER 5SING THE SAME INFORMATION THAT WAS REPORTED IN THE 3TATEMENT OF 2ECEIPTS AND 0AYMENTSIN&IGURE THE#ASH&LOW3TATEMENTFOR-AKRIS-ANCHESTERWOULDAPPEAR ASISSHOWNIN&IGURE

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 12

Figure 12.2

T H E C A S H F L O W S TAT E M E N T

Cash Flow Statement

267

STUDY TIP

MAKRIS MANCHESTER

2ESISTTHETEMPTATION TOCLASSIFYINTERESTAS @&INANCING)NTEREST ISAPAYMENTFORAN EXPENSE SOINTERESTIS ALWAYS@/PERATING

#ASH&LOW3TATEMENTFORTHEQUARTERENDED$ECEMBER $

$

CASH FLOW FROM OPERATING ACTIVITIES #ASH)NmOWS Cash Sales

43 000

Receipts from Debtors

41 500

GST Received

4 300

88 800

,ESS#ASH/UTmOWS Payments to Creditors

61 400

Wages

31 000

GST Paid Electricity Prepaid Insurance Interest Expense

1 170 500 1 200 600

.ET#ASH&LOWSFROM/PERATIONS

95 870 STUDY TIP



CASH FLOW FROM INVESTING ACTIVITIES #ASH)NmOWS Nil

)FNOINmOWEXISTS THIS INFORMATIONMAYBE OMITTED

0

,ESS#ASH/UTmOWS Shelving Office Equipment

10 000 4 500

.ET#ASH&LOWSFROM)NVESTING!CTIVITIES

14 500 

CASH FLOW FROM FINANCING ACTIVITIES #ASH)NmOWS Loan – Aust. Bank Capital Contribution

25 000 5 000

STUDY TIP

30 000

,ESS#ASH/UTmOWS Drawings Loan – Aust. Bank

12 700 2 000

14 700

.ET#ASH&LOWSFROM&INANCING!CTIVITIES

15 300

.ET)NCREASE$ECREASE IN#ASH0OSITION



!DD"ANK"ALANCEATSTART/CTOBER



"ANK"ALANCEATEND$ECEMBER

)FTHEREAREINSUFlCIENT LINESTOINCLUDETHE HEADINGS@#ASHINmOWS OR@#ASHOUTmOWS ITEMSMAYJUSTBELISTED BUTOUTmOWSSHOULDBE INBRACKETS



.ETINCREASEDECREASE IN#ASH0OSITION 4HENETINCREASEOR INTHISCASE DECREASE IN#ASH0OSITIONOF $6 270 ISCALCULATEDBY ADDINGTOGETHERTHE.ET#ASH&LOWSFROMEACHACTIVITY

.ET#ASH&LOWSFROM/PERATIONS





.ET#ASH&LOWSFROM)NVESTING!CTIVITIES





.ET#ASH&LOWSFROM&INANCING!CTIVITIES



© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

268

STUDY TIP

7HENCLASSIFYINGCASH mOWS WORKFROMTHE BOTTOMUPIDENTIFY THE&INANCINGAND )NVESTINGACTIVITIESlRST SOYOUKNOWTHATTHE REMAINDERMUSTBE /PERATINGACTIVITIES

UNITS 3&4

)T CAN ALSO BE CALCULATED BY DEDUCTING TOTAL PAYMENTS AS SHOWN IN THE #ASH 0AYMENTS*OURNAL FROMTOTALRECEIPTSASSHOWNINTHE#ASH2ECEIPTS*OURNAL %ITHER WAY THEANSWERSHOULDBETHESAME ANDREmECTTHETOTAL ORNET CHANGEINTHElRMS BANKBALANCEFROMTHESTARTOFTHEPERIODTOTHEEND .OTETHATTHElNALlGUREINTHISSTATEMENTnBank Balance at EndnISEXACTLYTHE SAMEASTHATGENERATEDINTHE3TATEMENTOF2ECEIPTSAND0AYMENTS$7 230!FTERALL BOTHSTATEMENTSREPORTEXACTLYTHESAMEITEMSTHEONLYDIFFERENCEISTHATTHE#ASH&LOW 3TATEMENTclassifiesTHECASHmOWSAS/PERATING )NVESTINGAND&INANCINGACTIVITIES

5SESOFTHE#ASH&LOW3TATEMENT 0OORMANAGEMENTOFCASHISONEOFTHEMAINREASONSWHYSMALLBUSINESSESFAIL)NTHIS REGARD THE #ASH &LOW 3TATEMENT IS A VITAL TOOL FOR IMPROVING THE OWNERS DECISION MAKINGINRELATIONTOCASHMANAGEMENT 4HESPECIlCUSESOFA#ASH&LOW3TATEMENTARE s To aid decision-making about the firm’s cash activities by detailing the sources and uses of cash in a particular period. )N PARTICULAR THE OWNER WOULD WANT TO ASSESS WHETHER THE BUSINESS IS GENERATING ENOUGH CASH FROM ITS /PERATING ACTIVITIES TO FUNDITS)NVESTINGAND&INANCINGACTIVITIES!lRMWITHNEGATIVE.ET#ASH&LOWSFROM /PERATIONS SUCH AS -AKRIS -ANCHESTER IN &IGURE  WILL BE UNABLE TO MEET ITS OTHERPAYMENTSWITHOUTCONTRIBUTIONSFROMTHEOWNEROREXTERNALlNANCE s To assess the firm’s performance in meeting its cash targets. 4HE#ASH&LOW3TATEMENT CAN BE COMPARED AGAINST BUDGETED OR EXPECTED PERFORMANCE AS SHOWN IN THE "UDGETED#ASH&LOW3TATEMENT WHICHWOULDHAVEBEENPREPAREDINADVANCE4HIS COMPARISON WILL HIGHLIGHT WHERE PERFORMANCE WAS BETTER OR WORSE THAN EXPECTED #ORRECTIVE ACTION CAN THEN BE TAKEN 4HIS WILL BE EXPLORED IN GREATER DETAIL IN #HAPTER s To assist in planning for future cash activities. "YPROVIDINGABASISFORTHENEXTBUDGET THE #ASH &LOW 3TATEMENT WILL AID IN THE SETTING OF TARGETS FOR THE FUTURE 4HIS MAY INCLUDECASHRECEIVEDFROMSALESORDEBTORS PAYMENTSFORSTOCKOREXPENSES CASH PURCHASESOFNON CURRENTASSETS CASHDRAWINGS ANDREPAYMENTOFLOANS4HISWILLBE EXPLOREDINMOREDETAILIN#HAPTER s To facilitate the calculation of financial indicators for analysis and interpretation. 4HESEINDICATORSCANBEUSEDNOTONLYTOUNCOVERWHATHASHAPPENED BUTALSOTO HELPEXPLAINWHY4HISWILLBECOVEREDIN#HAPTER

'RAPHINGCASHmOWS 4HEUnderstandabilityOFTHE#ASH&LOW3TATEMENTMAYBEENHANCEDFURTHERIF.ET#ASH &LOWSnFROM/PERATIONS )NVESTINGACTIVITIESAND&INANCINGACTIVITIESnAREREPRESENTED GRAPHICALLY&IGURESHOWSHOWTHECASHmOWSOF-AKRIS-ANCHESTERFORTHEQUARTER ENDED$ECEMBERCOULDBEREPRESENTED Figure 12.3

Graphing Net Cash Flows

$20 000

Net Cash Flows from Operations

$12 000 $4 000

Net Cash Flows from Investing Activities

– $4 000 – $12 000

Net Cash Flows from Financing Activities

– $20 000

Net Decrease in Cash Position

Net cash flows © Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 12

T H E C A S H F L O W S TAT E M E N T

269

&ROM THIS GRAPH IT IS CLEAR THAT CASH mOWS ARE NEGATIVE FOR BOTH /PERATING AND )NVESTINGACTIVITIES BUTTHAT&INANCINGACTIVITIESHAVEMADEASIGNIlCANTCONTRIBUTIONTO CASHONHAND(OWEVER THEOVERALLRESULTISNEGATIVETHEREHASBEENANet Decrease in Cash Position4HISMEANSTHEREISLESSCASHONHAND

REVIEW QUESTIONS 12.3

1 $ElNETHEFOLLOWINGTERMSASTHEYRELATETOTHE#ASH&LOW3TATEMENT s /PERATINGACTIVITIES s )NVESTINGACTIVITIES s &INANCINGACTIVITIES 2 %XPLAIN ONE REASON WHY IT MAY BE MORE BENElCIAL TO PREPARE A #ASH &LOW 3TATEMENTTHANJUSTA3TATEMENTOF2ECEIPTSAND0AYMENTS  %XPLAINHOWTHEPREPARATIONOFA#ASH&LOW3TATEMENTCANASSISTINDECISION MAKING 4 %XPLAINHOWTHEPREPARATIONOFA#ASH&LOW3TATEMENTCANASSISTINPLANNING FORTHEFUTURE  2EFERRINGTO&IGURE a %XPLAINONEREASONWHYTHEOWNERMIGHTBECONCERNEDABOUTTHElRMS .ET#ASH&LOWSFROM/PERATIONS B $ISCUSS WHETHER THE lRMS &INANCING ACTIVITIES WILL HAVE A POSITIVE OR NEGATIVEEFFECTONITSFUTURECASHACTIVITIES  2EFERRINGTO&IGURE EXPLAINONEWAYTHEOWNERMIGHTUSETHISGRAPHTO AIDDECISION MAKING

12.4 USING THE CASH JOURNALS 7HENUSINGTHECASHJOURNALSTOPREPARETHE#ASH&LOW3TATEMENT ITISIMPORTANTTO REMEMBERTHATNOTALLTHEINFORMATIONRECORDEDINEACHJOURNALRELATESTOANACTUALCASH mOW3OMECAREMUSTBETAKENTOENSURETHATONLYCASHmOWINFORMATIONISREPORTEDIN THE#ASH&LOW3TATEMENT

#ASH2ECEIPTS*OURNAL 4HE#ASH2ECEIPTS*OURNALSHOWSALLcash inflows BUTALSOOTHERINFORMATIONTHATDOES NOTINVOLVECASH

EXAMPLE

Williams Windscreens has provided the following Cash Receipts Journal (totals only) for December 2015: #ASH2ECEIPTS*OURNAL $ATE

$ETAILS

2ECEIPT "ANK NUMBER

$ISCOUNT $EBTORS #OSTOF %XPENSE #ONTROL 3ALES

3ALES

Capital 4OTALS

3UNDRIES

GST

30 000 70 700



  18 000

30 000

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

1 800

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

270

STUDY TIP

$ISCOUNTEXPENSEISNOT ACASHmOWITISACTUALLY THEabsenceOFACASH mOWnANAMOUNTTHAT THEDEBTORSDIDnot HAVETOPAY

UNITS 3&4

4HElGUREFORTOTALCASHRECEIVEDISSHOWNINTHE"ANKCOLUMNAS WITHMOST OFTHEOTHERCOLUMNSSHOWINGTHESOURCESOFTHATCASH(OWEVER NOTALLOFTHEOTHER COLUMNTOTALSREFERTOCASHmOWS s #OSTOF3ALES 4HISCOLUMNDOESNOTRECORDAcashmOW BUTRATHERAstockmOWITRECORDSTHECOST PRICEOFSTOCKSOLD RATHERTHANTHECASHRECEIVEDFROMTHESALE4HISlGURESHOULDnot BEREPORTEDINTHE#ASH&LOW3TATEMENT ASITDOESNOTINVOLVECASH s Debtors Control: $21 500AND$ISCOUNT%XPENSE 2EMEMBER THAT THE Debtors Control COLUMN RECORDS THE total AMOUNT BY WHICH DEBTORS WILL DECREASE AND IN MOST CASES THIS lGURE WILL COMPRISE SOME CASH BUT ALSOSOMEDISCOUNTEXPENSE(OWEVER THE#ASH&LOW3TATEMENTONLYREPORTSCASH mOWS n SPECIlCALLY CASH 2ECEIPTS FROM $EBTORS !S A RESULT THE DISCOUNT EXPENSE  MUSTBEdeductedFROMTHElGUREINTHEDebtors ControlCOLUMN$21 500 TODETERMINERECEIPTSFROMDEBTORS 2ECEIPTSFROM$EBTORS

  

Debtors Control $21 500 

n n

$ISCOUNT%XPENSE 

4HEONLYCASHmOWIS2ECEIPTSFROM$EBTORSOF SOONLYTHISAMOUNTSHOULD BEREPORTEDINTHE#ASH&LOW3TATEMENT

#ASH0AYMENTS*OURNAL 4HEISSUESRELATINGTOTHE#ASH0AYMENTS*OURNALAREALITTLESIMPLER4HE#ASH0AYMENTS *OURNALSHOWSALLcash outflows ANDTHEONLYREALISSUEISTHETREATMENTOFPAYMENTSTO CREDITORS

EXAMPLE

Williams Windscreens has provided the following Cash Payments Journal for December 2015: #ASH0AYMENTS*OURNAL $ATE

$ETAILS

#HEQUE NUMBER

"ANK

$ISCOUNT #REDITORS 3TOCK 2EVENUE #ONTROL #ONTROL

7AGES

Dec. 31 Advertising

3UNDRIES 1 300

Office Supplies

200

GST Clearing

900

Vehicle

32 000

Drawings

400

Loan – Q Bank 4OTALS

GST

1 500 $

94 250



 24 000

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

2 500

36 300 5 750

Cambridge University Press

CHAPTER 12

T H E C A S H F L O W S TAT E M E N T

4HElGUREFORTOTALCASHPAIDISSHOWNINTHE"ANKCOLUMNAS WITHMOSTOF THEOTHERCOLUMNSSHOWINGTHEUSESOFTHATCASH(OWEVER NOTALLOFTHEOTHERCOLUMN TOTALSREFERTOCASHmOWS s Creditors Control: $26 000AND$ISCOUNT2EVENUE 4HE Creditors Control COLUMN INCLUDES BOTH THE CASH PAYMENTS TO CREDITORS andTHEDISCOUNTREVENUE BUTONLYTHECASHpaidSHOULDBEREPORTEDINTHE#ASH &LOW3TATEMENT!SWITHRECEIPTSFROMDEBTORS THEDISCOUNTMUSTBEDEDUCTEDTO DETERMINETHECASHmOW 0AYMENTSTO#REDITORS

  

Creditors Control n $26 000 n 

$ISCOUNT2EVENUE 

4HEONLYCASHmOWIS0AYMENTSTO#REDITORSOF SOONLYTHISAMOUNTSHOULD BEREPORTEDINTHE#ASH&LOW3TATEMENT

'34PAIDANDRECEIVED !LLCASHTRANSACTIONSRELATINGTO'34MUSTBEREPORTEDAS/PERATINGCASHmOWS BUTTHERE ISANIMPORTANTDIFFERENCEINTHEREPORTINGOFTHE'34PAIDANDRECEIVEDONEVERYDAY PURCHASESANDSALES ANDTHE'34PAIDTOORRECEIVEDFROMthe ATO )NTHE#ASH2ECEIPTS*OURNAL THE'34COLUMNRECORDSTHE'34RECEIVEDFROMCASH SALESINTHISEXAMPLE  ANDSOSHOULDSIMPLYBEREPORTEDAS'34RECEIVED'34 COLLECTEDISALSOACCEPTABLE (OWEVER ASANINFREQUENTCASHRECEIPT A'34REFUNDFROM THE!4/WOULDBERECORDEDINTHE3UNDRIESCOLUMN4HISAMOUNTISSTILLAN/PERATING INmOW BUTASITCOMESFROMADIFFERENTSOURCEnTHE!4/RATHERTHANCUSTOMERSnITMUST BEREPORTEDSEPARATELYINTHE#ASH&LOW3TATEMENTAS'34REFUND2EMEMBERTHAT'34 RECEIVEDFROMSALESREPRESENTSTAXCOLLECTEDBYTHElRMONBEHALFOFTHEGOVERNMENT WHICH INCREASES THE LIABILITY OWED TO THE !4/ )F '34 REFUND IS CONFUSED WITH '34 RECEIVEDFROMSALES THElRMWOULDOWETHEREFUNDTOTHE!4/ 4HESAMEPRINCIPLEAPPLIESTO'34PAYMENTSRECORDEDINTHE#ASH0AYMENTS*OURNAL 4HE'34PAIDTOSUPPLIERS ISRECORDEDINTHE'34COLUMN ANDCANBEREPORTED AS '34 PAID (OWEVER '34 PAYMENTS RECORDED IN THE 3UNDRIES COLUMN  ARE MADETOCLEARA'34LIABILITYWITHTHE!4/ ANDSOMUSTBEREPORTEDSEPARATELYAS'34 SETTLEMENT"OTHPAYMENTSRELATETO'34 BUTARERECORDEDANDREPORTEDSEPARATELYAS THEYAREPAIDTODIFFERENTENTITIES4HISMEANSTHEREAREFOURPOTENTIALCASHmOWSRELATED TO'34 /PERATINGINmOWS

/PERATINGOUTmOWS

GST received

GST paid

GST refund

GST settlement

'34PAIDAND'34RECEIVEDWILLBEREPORTEDEACHPERIOD BUTNOTEVERY#ASH&LOW 3TATEMENTWILLNEEDTOINCLUDEALLFOUR'34ITEMS AS'34REFUNDOR'34SETTLEMENTARE UNLIKELYTOOCCUREVERYMONTH

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

271

272

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

4HE#ASH&LOW3TATEMENTFOR7ILLIAMS7INDSCREENSFOR$ECEMBERWOULDTHUS BE WILLIAMS WINDSCREENS #ASH&LOW3TATEMENTFOR$ECEMBER $

$

CASH FLOW FROM OPERATING ACTIVITIES #ASH)NmOWS Cash Sales

18 000

Receipts from Debtors

20 900

GST Received

1 800

40 700

,ESS#ASH/UTmOWS Payments to Creditors

25 700

Cash Purchase of Stock

24 000

Wages

2 500

GST Paid

5 750

Advertising

1 300

Office Supplies

200

GST Settlement

900

.ET#ASH&LOWSFROM/PERATIONS

60 350 

CASH FLOW FROM INVESTING ACTIVITIES #ASH/UTmOWS Vehicle

32 000

.ET#ASH&LOWSFROM)NVESTING!CTIVITIES



CASH FLOW FROM FINANCING ACTIVITIES #ASH)NmOWS Capital Contribution

30 000

,ESS#ASH/UTmOWS Loan – Q Bank Drawings

1 500 400

1 900

.ET#ASH&LOWSFROM&INANCING!CTIVITIES



.ET)NCREASE$ECREASE IN#ASH0OSITION



!DD"ANK"ALANCEATSTART$ECEMBER "ANK"ALANCEATEND$ECEMBER

 

REVIEW QUESTIONS 12.4

1 %XPLAINWHY#OSTOF3ALESISNOTREPORTEDINTHE#ASH&LOW3TATEMENT  3TATEONEREASONWHYTHETOTALOFTHE$EBTORS#ONTROLCOLUMNOFTHE#ASH 2ECEIPTS*OURNALMAYNOTREPRESENTCASHRECEIVEDFROMDEBTORS  3HOW HOW RECEIPTS FROM DEBTORS IS CALCULATED WHEN DISCOUNT EXPENSE HAS BEENRECORDEDINTHE#ASH2ECEIPTS*OURNAL 4 %XPLAINWHYTHETOTALOFTHE#REDITORS#ONTROLCOLUMNOFTHE#ASH0AYMENTS *OURNALISNOTREPORTEDINTHE#ASH&LOW3TATEMENT  )DENTIFYTHEFOUR'34ITEMSTHATMAYBEREPORTEDINTHE#ASH&LOW3TATEMENT

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 12

T H E C A S H F L O W S TAT E M E N T

273

 CASH VERSUS PROFIT 4HEINTRODUCTIONTOTHISCHAPTERHIGHLIGHTEDTHEFACTTHATMANYPROlTABLESMALLBUSINESSES STILL END UP FAILING LARGELY DUE TO AN INABILITY TO MANAGE CASH EFFECTIVELY )T IS ALL TOO COMMON TO HEAR OF BUSINESSES THAT ARE SELLING THEIR PRODUCTS AT A PROlT BUT END UP BEINGUNABLETOPAYTHEIRDEBTSBECAUSETHEYCANTMANAGETHEIRCASH ANDULTIMATELY ENDUPGOINGOUTOFBUSINESS "UTHOWCANTHISBE(OWCANAlRMTHATISEARNINGAPROlTSUFFERFROMALACKOFCASH TOPAYITSBILLS#ONVERSELY HOWCANAlRMTHATISTRADINGATALOSSSTILLBOASTAHEALTHY BANKBALANCE 4HESIMPLEANSWERISTHATCASHANDPROlTAREDIFFERENTRESOURCES ANDBUSINESSOWNERS NEEDTOUNDERSTANDTHISDIFFERENCEINORDERTOMANAGEBOTHEFFECTIVELY4HECHANGEIN A lRMS BANK BALANCE IS CALCULATED BY COMPARING CASH INmOWS AND CASH OUTmOWS IN APERIOD WHEREASPROlTISDETERMINEDBYCOMPARINGREVENUESEARNEDANDEXPENSES INCURREDINTHATPERIODAND ASWEHAVESEENANUMBEROFTIMES THESEITEMSARENOT NECESSARILYTHESAME4HEMAINDIFFERENCESARE s SOMECASHITEMSDONOTAFFECTPROlT s SOMEPROlTITEMSDONOTAFFECTCASH s SOMEITEMSAFFECTBOTHCASHANDPROlT BUTBYDIFFERINGAMOUNTS

#ASHITEMSTHATDONOTAFFECTPROlT 3OMEITEMSAREREPORTEDONLYINTHE#ASH&LOW3TATEMENT ASTHEYONLYAFFECTCASHON HANDBECAUSETHEYARENOTREVENUESOREXPENSES THEYARENOTREPORTEDINTHE)NCOME 3TATEMENT Some cash inflows are not revenues at all#APITALCONTRIBUTIONSANDLOANSRECEIVED ARECASHINmOWSTHATINCREASE"ANK BUTARENOTREVENUESANDSOHAVENOEFFECTONPROlT )TEMSSUCHASTHESEWILLEXPLAINWHYAlRMHASBEENABLETOGENERATEANINCREASEINITS CASHBALANCEEVENIFITHASINCURREDA.ET,OSS 3IMILARLY some cash outflows are not expenses #ASH DRAWINGS LOAN REPAYMENTS ANDCASHOUTmOWSFORNON CURRENTASSETSAREPAYMENTSTHATWILLDECREASE"ANK BUTARE NOTEXPENSESANDSOLEAVEPROlTUNCHANGED4HISMAYEXPLAINWHYAlRMHASSUFFERED ADECREASEINCASHDESPITEEARNINGAPROlT

STUDY TIP

!LTHOUGHTHESEARE THEGENERALREASONS WHYCASHANDPROlT PERFORMANCEMAYDIFFER THEYARENOTNEARLY SPECIlCENOUGHINAN EXAMSITUATION2EFERTO THESPECIlCEXAMPLES BELOW

STUDY TIP

#ASHINmOWSTHATARENOTREVENUES

#ASHOUTmOWSTHATARENOTEXPENSES

Capital contribution

Cash drawings

Loan received

Loan repayments Cash payments for non-current assets

GST received (including GST refund)

GST paid (including GST settlement)

)NTHECASEOF'34CASHmOWS IFTHETOTAL'34RECEIVEDINCLUDINGANY'34REFUND IS GREATERTHANTHETOTAL'34PAIDINCLUDINGANY'34SETTLEMENT THEREWILLBEANINCREASE INCASHIFTHEOPPOSITEOCCURS THEREWILLBEADECREASEINCASH)NEITHERCASE THEREWILL BENOEFFECTONPROlT AS'34ISNEITHERAREVENUENORANEXPENSE

%XCEPTFOR'34 THESE DIFFERENCESWOULD BEREPORTEDASEITHER )NVESTINGOR&INANCING ACTIVITIESINTHE#ASH &LOW3TATEMENTTHIS ISTHEBESTPLACETO STARTWHENLOOKING FORREASONSWHYCASH ANDPROlTRESULTSARE DIFFERENT

0ROlTITEMSTHATDONOTAFFECTCASH *UST AS SOME ITEMS ARE REPORTED ONLY IN THE #ASH &LOW 3TATEMENT OTHER ITEMS ARE REPORTEDONLYINTHE)NCOME3TATEMENT

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UNITS 3&4

&IRST some revenues are not cash inflows3TOCKGAINISAGOODEXAMPLE ASITISA REVENUETHATINCREASESPROlT BUTASITREPRESENTSAGAINOFSTOCK NOTCASH ITWILLNOT AFFECT CASH ON HAND 4HIS MAY EXPLAIN WHY A lRM CAN EARN A PROlT BUT STILL SUFFER A DECREASEINCASH /N THE OTHER HAND some expenses are not cash outflows AND AS A RESULT WILL DECREASEPROlT WHILELEAVINGCASHUNCHANGED$EPRECIATION BADDEBTSANDSTOCKLOSS ALLFALLINTOTHISCATEGORY%XPENSESSUCHASTHESEMAYEXPLAINWHYAlRMCANGENERATE MORECASHWITHOUTEARNINGAPROlT STUDY TIP

-OREEXAMPLESOFTHIS KINDWILLCOMETOLIGHT IN5NIT

2EVENUESTHATARENOTCASHINmOWS

%XPENSESTHATARENOTCASHOUTmOWS

Stock gain

Stock loss Bad debts Depreciation

)TEMSTHATAFFECTBOTHPROlT ANDCASH 7EHAVESOFARCONSIDEREDITEMSTHATAFFECTONEREPORT BUTNOTTHEOTHERTHATIS THEY HAVEACASHEFFECTorAPROlTEFFECT BUTNOTBOTH"UTMANYITEMSAFFECTBOTHCASHAND PROlT7HERETHEITEMAFFECTSBOTH BUTBYdiffering amounts, THElRMSPROlTWILLNOTBE THESAMEASITSCASHPERFORMANCE Credit sales and receipts from debtors 3ELLINGGOODSONCREDITWILLINCREASEPROlTIMMEDIATELY BUTMAYNOTINVOLVEACASHmOW UNTILMUCHLATER#ONVERSELY WHENTHECASHISRECEIVEDFROMTHEDEBTORITWILLINCREASE "ANK BUTITISNOTREVENUE4HUS THEDIFFERENTAMOUNTSREPORTEDAS#REDIT3ALESAND RECEIPTSFROMDEBTORSCOULDEXPLAINWHYCASHANDPROlTARENOTTHESAME)F#REDIT3ALES ISgreaterTHANRECEIPTSFROMDEBTORS THElRMMAYHAVEMOREPROlTTHANCASH)F#REDIT 3ALESISlessTHANRECEIPTSFROMDEBTORS THElRMMAYVERYWELLHAVELESSPROlTTHANCASH Cost of Sales and payments for stock 4HEWAYSTOCKISPAIDFORCANALSOMEANTHATCASHANDPROlTARENOTTHESAME#OSTOF 3ALESREPRESENTSTHEVALUEOFSTOCKSOLD BUTTHISMAYNOTBETHESAMEASTHEAMOUNTTHAT HASBEENPAIDFORTHATSTOCKASCASHPURCHASESORPAYMENTSTOCREDITORS 2EMEMBER #OSTOF3ALESREPRESENTSASTOCKmOW NOTACASHmOW)F#OSTOF3ALESISgreaterTHAN PAYMENTSFORSTOCK ITWILLREDUCEPROlTMORETHANITREDUCESCASH)F#OSTOF3ALESISless THANPAYMENTSFORSTOCK ITWILLMEANAGREATERREDUCTIONINCASHTHANINPROlT Expenses: amount incurred versus amount paid $UETOBALANCEDAYADJUSTMENTS THEAMOUNTPAIDFOREXPENSESISFREQUENTLYDIFFERENT FROMTHEAMOUNTINCURRED7HENEXPENSESAREPAIDINADVANCEFORTHENEXT2EPORTING 0ERIOD SUCHASPREPAIDRENTORPREPAIDINSURANCE THEAMOUNTPAIDWILLBEgreaterTHAN THEAMOUNTINCURRED MEANINGTHATCASHDECREASESMORETHANPROlT/NTHEOTHERHAND IFEXPENSESAREACCRUEDATTHEENDOFTHE2EPORTING0ERIOD THEAMOUNTINCURREDWILLBE greaterTHANTHEAMOUNTPAID MEANINGPROlTDECREASESMORETHANCASH 2EVENUEEXPENSE

#ASHINmOWOUTmOW

Credit Sales

Receipts from debtors

Cost of Sales

Payments to creditors/Cash purchases

Other expense incurred

Other expense paid (may be titled Accrued and/or Prepaid)

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T H E C A S H F L O W S TAT E M E N T

275

)NREALITY THEREWILLUSUALLYBEACOMBINATIONOFREASONSWHYAlRMSCASHANDPROlT PERFORMANCEDIFFER !lRMMAYEARNA.ET0ROlTBUTSUFFERADECREASEINCASHDUETO 2EASON

%XAMPLES

Cash outflows that decrease cash but are not expenses and so do not affect profit

Cash drawings Loan repayments Cash payments for non-current assets Overall more GST paid than received, including GST settlement

Revenues that increase profit but are not cash inflows and so do not affect cash

Stock gain

Revenue items that increase profit more than the corresponding cash inflow increases cash

Credit Sales greater than Receipts from Debtors

Expense items that decrease profit less than the corresponding cash outflow decreases cash

Cost of Sales less than payments for stock Other expense incurred less than paid

!lRMMAYSUFFERA.ET,OSSBUTGENERATEANINCREASEINCASHDUETO 2EASON

%XAMPLES

Cash inflows that increase cash but are not revenues and so do not affect profit

Capital contribution Loan received Overall more GST received than paid (including GST refund)

Expenses that decrease profit but are not cash outflows and so do not affect cash

Stock loss Bad debts Depreciation

Revenue items that increase profit less than the corresponding cash inflow increases cash

Credit Sales less than Receipts from Debtors

Expense items that decrease profit more than the corresponding cash outflow decreases cash

Cost of Sales greater than Payments for Stock

STUDY TIP

Other expense incurred greater than paid

7HENLOOKINGFOR REASONSTOEXPLAINTHE DIFFERENCEBETWEENCASH ANDPROlTPERFORMANCE REMEMBEROPPOSITES CAPITALCONTRIBUTION VERSUSDRAWINGSLOAN RECEIVEDVERSUSREPAID STOCKLOSSVERSUSGAIN ANDEXPENSESPREPAID VERSUSACCRUED

REVIEW QUESTIONS 12.5

1 )DENTIFYTHETHREEMAINREASONSWHYTHECHANGEINAlRMS#ASH0OSITIONMAY BEDIFFERENTFROMITSPROlTOVERTHESAMEPERIOD 2 )DENTIFYTWOCASHINmOWSTHATARENOTREVENUES%XPLAINTHEEFFECTTHESEITEMS WILLHAVEONBOTHCASHAND.ET0ROlT  )DENTIFYTHREECASHOUTmOWSTHATARENOTEXPENSES%XPLAINTHEEFFECTTHESE ITEMSWILLHAVEONBOTHCASHAND.ET0ROlT 4 %XPLAIN HOW A STOCK GAIN MAY BE THE REASON WHY A lRM CAN EARN A PROlT DESPITESUFFERINGACASHDElCIT

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UNITS 3&4

 )DENTIFYTHREEITEMSTHATWILLBEREPORTEDASEXPENSESINTHE)NCOME3TATEMENT BUTWILLNOTBEREPORTEDASCASHOUTmOWSINTHE#ASH&LOW3TATEMENT  %XPLAINTHEEFFECTONBOTHCASHANDPROlTIF s #REDIT3ALESISGREATERTHAN2ECEIPTSFROM$EBTORS s #REDIT3ALESISLESSTHAN2ECEIPTSFROM$EBTORS s #OSTOF3ALESISGREATERTHAN0AYMENTSFOR3TOCK s #OSTOF3ALESISLESSTHAN0AYMENTSFOR3TOCK s EXPENSESAREACCRUEDATTHEENDOFTHE2EPORTING0ERIOD s EXPENSESAREPREPAIDFORTHENEXT2EPORTING0ERIOD

WHERE HAVE WE BEEN? s 4HE3TATEMENTOF2ECEIPTSAND0AYMENTSREPORTSCASHRECEIVEDANDPAID ANDTHE CHANGEINTHElRMSBANKBALANCEOVERA2EPORTING0ERIOD s 4HE #ASH &LOW 3TATEMENT REPORTS CASH INmOWS AND CASH OUTmOWS RELATING TO /PERATINGACTIVITIES )NVESTINGACTIVITIESAND&INANCINGACTIVITIES ANDTHECHANGEIN THElRMSBANKBALANCEOVERA2EPORTING0ERIOD s /PERATINGACTIVITIESARECASHmOWSRELATEDTODAY TO DAYTRADINGACTIVITIES s )NVESTINGACTIVITIESARECASHmOWSRELATEDTOTHEPURCHASEANDSALEOFNON CURRENT ASSETS s &INANCING ACTIVITIES ARE CASH mOWS RELATED TO CHANGES IN THE lNANCIAL STRUCTURE OF THElRM s 4HE#ASH&LOW3TATEMENTISUSEDTOAIDDECISION MAKINGANDPLANNING s 4HEREAREFOURPOTENTIALCASHmOWSRELATEDTO'344HESEARETHE/PERATINGINmOWS OF'34RECEIVEDAND'34REFUNDANDTHE/PERATINGOUTmOWSOF'34PAIDAND'34 SETTLEMENT s #ASHANDPROlTAREDIFFERENTMEASURESOFPERFORMANCE ANDTHEREAREMANYPOSSIBLE REASONSWHYAlRMTHATISEARNINGAPROlTCANSTILLSUFFERFROMALACKOFCASH n 3OMECASHINmOWSARENOTREVENUES n 3OMECASHOUTmOWSARENOTEXPENSES n 3OMEREVENUESARENOTCASHINmOWS n 3OMEEXPENSESARENOTCASHOUTmOWS n 3OMEITEMSAFFECTBOTHCASHANDPROlT BUTBYDIFFERINGAMOUNTS

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Cambridge University Press

CHAPTER 12

T H E C A S H F L O W S TAT E M E N T

EXERCISE 12.1 STATEMENT OF RECEIPTS AND PAYMENTS

W B

page 252

277

EXERCISES

#RAFTY#ABINETSHASPROVIDEDTHEFOLLOWINGINFORMATIONRELATINGTOITSCASHTRANSACTIONS FOR*ULY #ASH2ECEIPTS Cash Sales Receipts from Debtors GST Received Capital Contribution

$ 100 000 50 000 10 000 15 000

#ASH0AYMENTS Payments to Creditors Electricity Interest Office Expenses Wages Purchase of Equipment Drawings GST Paid Loan Repayment Prepaid Rent

$ 70 000 2 400 600 5 000 30 000 5 600 40 000 3 100 6 000 18 000

Additional information: s 4HEBANKBALANCEOF#RAFTY#ABINETSASAT*UNEWAS$2 s 2ENTISPAIDINADVANCEIN*ULYEACHYEAR Required

* *

a #OMPLETETHE"ANKACCOUNTINTHE'ENERAL,EDGEROF#RAFTY#ABINETSASAT*ULY B 0REPAREA3TATEMENTOF2ECEIPTSAND0AYMENTSFOR#RAFTY#ABINETSFOR*ULY C 3TATEONEREASONWHYTHEOWNERWOULDBEUNHAPPYWITHTHECASHPERFORMANCEOF THElRMDURING*ULY d %XPLAINONEWAYTOIMPROVETHEINFORMATIONREPORTEDTOTHEOWNERABOUTTHElRMS CASHPERFORMANCE

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278

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

EXERCISE 12.2 CASH FLOW STATEMENT

W B

page 254

"OOF(AIR#ARE0RODUCTSHASPROVIDEDITS3TATEMENTOF2ECEIPTSAND0AYMENTSFORTHE YEARENDING*UNE BOOF HAIR CARE PRODUCTS 3TATEMENTOF2ECEIPTSAND0AYMENTSFORTHEYEARENDED*UNE #ASH2ECEIPTS

$

Cash Sales

50 000

Receipts from Debtors

25 000

Capital Contribution

10 000

GST Received

5 000

$

90 000

,ESS#ASH0AYMENTS Payments to Creditors

24 000

Wages

28 000

Drawings

12 000

GST Paid

930

Electricity

1 500

Prepaid Insurance

1 800

Display Cabinets

6 000

74 230

3URPLUS$ElCIT

15 770

!DD"ANK"ALANCEATSTART*ULY

(13 500)

"ANK"ALANCEATEND*UNE

2 270

Required a 0REPARE A #ASH &LOW 3TATEMENT FOR "OOF (AIR #ARE 0RODUCTS FOR THE YEAR ENDED *UNE B 2EFERRINGTOYOURANSWERTOPART@A EXPLAINYOURTREATMENTOF$RAWINGS C 3UGGESTONEREASONWHYTHEOWNERMADETHECAPITALCONTRIBUTIONOF d %XPLAINONEBENElTOFPREPARINGA#ASH&LOW3TATEMENTRATHERTHANA3TATEMENTOF 2ECEIPTSAND0AYMENTS

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Cambridge University Press

CHAPTER 12

T H E C A S H F L O W S TAT E M E N T

%8%2#)3% CASH FLOW STATEMENT

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page 256

&LIP&LOPSSPECIALISESINTHESALESOFTHONGS ANDHASPROVIDEDITS3TATEMENTOF2ECEIPTS AND0AYMENTSFORTHEQUARTERENDING3EPTEMBER FLIP FLOPS 3TATEMENTOF2ECEIPTSAND0AYMENTSFORTHEQUARTERENDED3EPTEMBER #ASH2ECEIPTS Cash Sales Receipts from Debtors Loan – Bodgey Bank GST Received

$

$

10 000 7 000 25 000 1 000

43 000

,ESS#ASH0AYMENTS Payments to Creditors

14 000

Cash Purchase of Stock

5 000

Wages

6 000

Drawings

2 000

GST Paid

950

Electricity

500

Prepaid Rent

2 400

Shelving

1 600

Loan Repayment

1 000

Interest Expense

550

34 000

3URPLUS$ElCIT

9 000

!DD"ANK"ALANCEATSTART*ULY

1 500

"ANK"ALANCEATEND3EPTEMBER

10 500

4HEOWNER +ARL7INEFELD ISHAPPYTHATTHEBANKBALANCEHASINCREASEDSOMUCHOVER THEQUARTER Required a 0REPAREA#ASH&LOW3TATEMENTFOR&LIP&LOPSFORTHEQUARTERENDED3EPTEMBER  B %XPLAIN ONE REASON WHY THE OWNER SHOULD BE CONCERNED ABOUT THE lRMS CASH PERFORMANCEFORTHEQUARTERENDED3EPTEMBER

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Cambridge University Press

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280

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

EXERCISE 12.4 OPERATING ACTIVITIES

W B

page 258

+ATHERINE 1UINN OWNS -IGHTY 7INDS A SHOP SPECIALISING IN ELECTRIC FANS AND HAS PROVIDEDTHEFOLLOWINGDATAFROMHERlNANCIALRECORDSFOR GST Paid Loan Repayment – Principal Electricity Paid Discount Expense Wages Paid GST Settlement Payments to Creditors

$

380 12 000 1 200 2 400 6 000 3 000 45 000

Cash Sales Interest Paid GST Received Wages Owing GST Charged on Credit Sales Cash Purchase of Office Furniture Accrued Interest Paid

$ 60 000 150 6 000 1 600 10 000 2 600 1 700

Required a #ALCULATE.ET#ASH&LOWSFROM/PERATIONSFOR-IGHTY7INDSFOR B 2EFERRINGTOYOURANSWERTOPART@A EXPLAINYOURTREATMENTOF!CCRUED)NTEREST0AID C %XPLAIN THE IMPORTANCE OF .ET #ASH &LOWS FROM /PERATIONS TO THE SUCCESS OF A TRADINGBUSINESS

%8%2#)3% OPERATING ACTIVITIES

W B

page 259

'OT)T#OVEREDSELLSCARSEATCOVERSANDHASPROVIDEDTHEFOLLOWINGDATAFROMITSlNANCIAL RECORDSFOR!PRIL Credit Sales Interest Expense Paid Discount Expense Credit Purchase Of Stock GST on Credit Purchases GST Paid Depreciation of Vehicle

$ 28 000 4 800 850 32 000 3 200 1 900 600

GST Refund Receipts from Debtors Drawings Cash Sales Rent Expense Incurred Prepaid Rent Paid GST Received on Cash Sales

$

300 15 000 1 800 16 000 12 000 15 000 1 600

Required a #ALCULATE.ET#ASH&LOWSFROM/PERATIONSFOR'OT)T#OVEREDFOR!PRIL B 2EFERRINGTOYOURANSWERTOPART@A EXPLAINYOURTREATMENTOF$ISCOUNT%XPENSE C %XPLAINWHYTHE'34RECEIVEDAND'34REFUNDMUSTBEREPORTEDSEPARATELYINTHE #ASH&LOW3TATEMENT

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Cambridge University Press

CHAPTER 12

T H E C A S H F L O W S TAT E M E N T

%8%2#)3% INVESTING ACTIVITIES

W B

page 260

2AG$OLL&ASHIONSHASPROVIDEDTHEFOLLOWINGDATAFROMITSlNANCIALRECORDSFORTHESIX MONTHSENDING$ECEMBER Cash Sales Cash Purchase of Stock Cash Purchase of Fittings Deposit Paid on Furniture

$ 47 000 15 000 5 600 800

GST Received GST Paid on Purchase of Stock GST Paid on Purchase of Fittings Drawings of Stock

$ 4 700 1 500 560 2 800

Required a )NTERMSOFTHE#ASH&LOW3TATEMENT EXPLAINWHATISMEANTBYTHETERM@)NVESTING !CTIVITIES B #ALCULATE.ET#ASH&LOWSFROM)NVESTING!CTIVITIESFOR2AG$OLL&ASHIONSFORTHESIX MONTHSENDED$ECEMBER C 2EFERRING TO YOUR ANSWER TO PART @B EXPLAIN YOUR TREATMENT OF #ASH 0URCHASE OF 3TOCK d %XPLAINWHYTHE'340AIDON0URCHASEOF&ITTINGSISNOTREPORTEDASAN)NVESTING ACTIVITY

%8%2#)3% INVESTING ACTIVITIES

W B

page 261

.EIL .G %NTERPRISES HAS PROVIDED THE FOLLOWING DATA FROM ITS lNANCIAL RECORDS FOR .OVEMBER Loan Repayment Interest Expense Cash Purchase of Vehicle GST Paid

$ 12 000 4 800 32 000 5 600

Depreciation of Vehicle Cash Purchase of Shelving Receipt of Loan GST Settlement

$ 2 100 10 000 20 000 1 200

Required a #ALCULATE .ET #ASH &LOWS FROM )NVESTING !CTIVITIES FOR .EIL .G %NTERPRISES FOR .OVEMBER B 3TATEONEREASONWHY'34PAIDISGREATERTHANOF.ET#ASH&LOWSFROM)NVESTING !CTIVITIESFOR.OVEMBER C 3UGGESTTHREEWAYSTHEPURCHASEOFTHENEWVEHICLEMAYHAVEBEENlNANCED d %XPLAIN HOW NEGATIVE .ET #ASH &LOWS FROM )NVESTING !CTIVITIES MAY LEAD TO A REDUCTIONIN.ET0ROlT

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Cambridge University Press

281

282

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

EXERCISE 12.8 FINANCING ACTIVITIES

W B

page 262

%DEN -ONARO-OTORSHASPROVIDEDTHEFOLLOWINGDATAFROMITSlNANCIALRECORDSFORTHE YEARENDING*UNE Credit Sales Receipt of Loan – NAB Accrued Wages Paid Payments to Creditors

$ 100 000 12 000 800 35 000

Interest Paid Net Profit Cash Drawings Drawings of Stock

$ 1 800 16 000 25 000 700

Required a )NTERMSOFTHE#ASH&LOW3TATEMENT EXPLAINWHATISMEANTBYTHETERM@&INANCING !CTIVITIES B #ALCULATE.ET#ASH&LOWSFROM&INANCING!CTIVITIESFOR%DEN -ONARO-OTORSFORTHE YEARENDED*UNE C 2EFERRINGTOYOURANSWERTOPART@B EXPLAINYOURTREATMENTOF)NTEREST0AID d #OMPLETETHE#APITALACCOUNTINTHE'ENERAL,EDGEROF%DEN -ONARO-OTORSASAT *UNE

%8%2#)3% FINANCING ACTIVITIES

W B

page 263

&LASH$ANCE7EARHASPROVIDEDTHEFOLLOWINGDATAFROMITSlNANCIALREPORTSFORTHE MONTHSENDED$ECEMBER Repayment of Loan Principal Cash Drawings Receipts from Debtors Credit Purchase of Stock

$ 15 000 8 700 20 000 32 000

Cash Sales Cash Purchase of Shop Fittings Cash Contribution by Owner Contribution of Vehicle by Owner

$ 50 000 6 500 30 000 3 800

Required a #ALCULATE.ET#ASH&LOWSFROM&INANCING!CTIVITIESFOR&LASH$ANCE7EARFORTHESIX MONTHSENDED$ECEMBER B %XPLAINWHYACAPITALCONTRIBUTIONISNOTREPORTEDINTHE)NCOME3TATEMENT C %XPLAIN HOW POSITIVE .ET #ASH &LOWS FROM &INANCING !CTIVITIES MAY LEAD TO A REDUCTIONIN.ET0ROlT

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CHAPTER 12

T H E C A S H F L O W S TAT E M E N T

%8%2#)3% CASH VERSUS PROFIT

283

page 264

W B

"UZZ7AX0RODUCTSHASPROVIDEDTHEFOLLOWINGJOURNALTOTALSFOR!UGUST 3ALES*OURNAL $ATE

$EBTOR

Aug.

Totals

)NVOICE NUMBER

#OSTOF 3ALES

3ALES

GST

1 000

2 000

200

$EBTORS #ONTROL 2 200

#ASH2ECEIPTS*OURNAL $ATE

$ETAILS

Aug.

Capital contribution

2ECNO

"ANK

$ISCOUNT $EBTORS %XPENSE #ONTROL

#OSTOF 3ALES

3ALES

3UNDRIES

GST

5 000

Totals

19 420

380

3 800

3 500

10 000

5 000

7AGES

3UNDRIES

1 000

#ASH0AYMENTS*OURNAL #HQ NO

"ANK

$ISCOUNT #REDITORS 3TOCK 2EVENUE #ONTROL #ONTROL

$ATE

$ETAILS

Aug.

Computer

1 000

Drawings

2 450

Interest Totals

GST

750 17 450

400

4 700

3 000

5 000

4 200

400

Additional information: s !SAT!UGUSTTHElRMSBANKACCOUNTWASOVERDRAWN s $URING!UGUSTTHEBUSINESSINCURREDA.ET,OSSOF Required

*

a 3TATEONEREASONWHYTHETOTALOFTHE$EBTORS#ONTROLCOLUMNINTHE#ASH2ECEIPTS *OURNALDOESNOTEQUALRECEIPTSFROMDEBTORS B 0REPAREA#ASH&LOW3TATEMENTFOR"UZZ7AX0RODUCTSFOR!UGUST C 2EFERRINGTOYOURANSWERTOPART@B EXPLAINWHYTHEOWNERSHOULDBECONCERNED ABOUT THE lRMS #ASH 0OSITION BUT LESS CONCERNED ABOUT ITS CASH PERFORMANCE IN !UGUST d )DENTIFYTWOEXAMPLESFROMTHE#ASH&LOW3TATEMENTTHATEXPLAINHOW"UZZ7AX 0RODUCTSWASABLETORECORDANINCREASEINCASHDESPITESUFFERINGA.ET,OSS%XPLAIN YOURRESPONSE e %XPLAINHOWTHE#ASH&LOW3TATEMENTCANAIDDECISION MAKING

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CAMBRIDGE VCE ACCOUNTING

284

UNITS 3&4

EXERCISE 12.11 CASH VERSUS PROFIT

W B

page 266

3AW-ILLER&URNITUREHASPROVIDEDTHEFOLLOWINGJOURNALTOTALSFORTHEQUARTERENDED *UNE 3ALES*OURNAL $ATE

)NVOICE NUMBER

$EBTOR Totals

#OSTOF 3ALES

3ALES

GST

$EBTORS #ONTROL

11 000

22 000

2 200

24 200

#ASH2ECEIPTS*OURNAL $ATE

2EC NO

$ETAILS Totals

"ANK

$ISCOUNT %XPENSE

90 000

3UNDRIESINCLUDES s ,OANn')."ANK s #APITAL

$EBTORS #OSTOF 3ALES #ONTROL 3ALES

3UNDRIES

GST

38 000

26 000*

2 500

1 500

12 500

25 000

  #ASH0AYMENTS*OURNAL

$ATE

$ETAILS

#HQ NO

Totals

"ANK

3TOCK #ONTROL

96 350

40 700

!DMINISTRATION $RAWINGS %XPENSE 3 000

13 500

7AGES 11 500

3UNDRIES

GST

21 300* 6 350

3UNDRIESINCLUDES s 0OLISHINGEQUIPMENT  s 0REPAIDINSURANCE  MONTHPOLICYBEGINNING!PRIL s 2EPAYMENTOFLOANPRINCIPAL  s !CCRUEDWAGES  Additional information: s !LLSTOCKISPURCHASEDUSINGCASH s 4HEBANKBALANCEAT!PRILWASOVERDRAFT 4HEBUSINESSHASNEGOTIATED ANOVERDRAFTLIMITOF s 4HEREWERENOBADDEBTSDURINGTHEQUARTERENDED*UNE Required

*

a 3TATEWHETHERTHEBALANCEOF$EBTORS#ONTROLASAT*UNEWOULDBEHIGHER ORLOWERTHANTHEBALANCEASAT!PRIL*USTIFYYOURANSWER B 0REPARE A #ASH &LOW 3TATEMENT FOR 3AW -ILLER &URNITURE FOR THE QUARTER ENDED *UNE C 3TATEWHYTHEOWNERHADTOCONTRIBUTEADDITIONALCAPITALDURINGTHEQUARTER d 3AW-ILLER&URNITUREREPORTEDAPROlTOFFORTHEQUARTERENDED*UNE 5SINGTWOEXAMPLESOTHERTHANDRAWINGS EXPLAINHOW3AW-ILLER&URNITUREWASABLE TOEARNA.ET0ROlTDESPITEASIGNIlCANTFALLINCASHDURINGTHESAMEPERIOD

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CHAPTER 12

EXERCISE 12.12 CASH VERSUS PROFIT

T H E C A S H F L O W S TAT E M E N T

W B

page 268

&ULL #OLLECTION COMMENCED BUSINESS ON  *ANUARY  WHEN THE OWNER DEPOSITED INTOTHEBUSINESSBANKACCOUNT/NTHESAMEDAYABANKLOANOFWAS RECEIVEDFROMTHE+YNETON"ANK)NTERESTONTHELOANISPERANNUM ANDREPAYMENTS OFINTERESTANDPRINCIPALWILLOCCURONTHElRSTOFEVERYMONTH BEGINNINGON&EBRUARY  $URING*ANUARYTHEFOLLOWINGTRANSACTIONSOCCURRED s !WAREHOUSEWASRENTEDANDSIXMONTHSRENTWASPAIDINADVANCE TOTALLING INCLUDING'34 s PLUS'34 WASPAIDFOROFlCEEQUIPMENT4HEBUSINESSUSESTHESTRAIGHT LINE METHOD FOR DEPRECIATION )T WILL USE THE OFlCE EQUIPMENT FOR FOUR YEARS AND THEN EXPECTSTODISPOSEOFITFOR s !LL SALES ARE ON CREDIT AT A MARK UP OF  $URING *ANUARY  THE BUSINESS INVOICEDCUSTOMERSFORPLUS'34!SAT*ANUARY OF THISWASSTILLOWING s 3TOCKISPURCHASEDONCREDITANDPAIDFORINTHEMONTHFOLLOWINGPURCHASE s 7AGESOFWEREPAID s !DMINISTRATIONEXPENSESOFPLUS'34WEREPAID s !DVERTISINGOFWASINCURREDBUTNOTYETPAID s $RAWINGSWERE CONSISTINGOFCASHANDWORTHOFSTOCK Required

* *

a B C d

#ALCULATE'34PAIDFOR&ULL#OLLECTIONFOR*ANUARY 0REPAREA#ASH&LOW3TATEMENTFOR&ULL#OLLECTIONFOR*ANUARY 0REPAREAN)NCOME3TATEMENTFOR&ULL#OLLECTIONFOR*ANUARY %XPLAIN PROVIDINGTWOEXAMPLES WHY&ULL#OLLECTIONHASMADEA.ET,OSSYETAT THESAMETIMEGENERATEDACASHSURPLUSFOR*ANUARY e 4HEOWNERBELIEVESTHATTHE#ASH&LOW3TATEMENTISABETTERINDICATOROFBUSINESS PERFORMANCE THAN THE )NCOME 3TATEMENT %XPLAIN WHY THE OWNER IS INCORRECT IN MAKINGTHISSTATEMENT

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CAMBRIDGE VCE ACCOUNTING

286

UNITS 3&4

%8%2#)3% CASH FLOWS

page 270

W B

'IACOMO "ATUSTA OWNS 4HE 'LASS (OUSE A lRM THAT SELLS GLASSWARE FROM A SHOP AT 7ATERGARDENS 3HOPPING #ENTRE AND HAS PROVIDED THE FOLLOWING JOURNAL TOTALS FOR /CTOBER #ASH2ECEIPTS*OURNAL $ATE

$ETAILS

Oct.

GST Refund

2EC NO

$ISCOUNT %XPENSE

"ANK

$EBTORS #OSTOF 3ALES #ONTROL 3ALES

3UNDRIES

GST

500

4OTALS















7AGES

3UNDRIES

GST

#ASH0AYMENTS*OURNAL

$ATE

$ETAILS

Oct.

Interest

#HQ NO

"ANK

$ISCOUNT #REDITORS $RAWINGS 2EVENUE #ONTROL

100

Drawings

2 110

Shelving

1 600

4OTALS















Additional information: s !SAT/CTOBERTHElRMSBANKACCOUNTWASOVERDRAWN Required

* *

a 0REPAREA#ASH&LOW3TATEMENTFOR4HE'LASS(OUSEFOR/CTOBER B #OMPLETE THE "ANK ACCOUNT IN THE 'ENERAL ,EDGER OF 4HE 'LASS (OUSE AS AT /CTOBER C 'IACOMOISCONCERNEDTHATTHEBANKOVERDRAFTHASINCREASEDDESPITETHEBUSINESS GENERATINGPOSITIVE.ET#ASH&LOWSFROM/PERATIONS%XPLAIN GIVINGTWOEXAMPLES FROMTHE#ASH&LOW3TATEMENT HOWTHISOCCURRED d %XPLAINONEBENElTOFPREPARINGA#ASH&LOW3TATEMENT 'IACOMO PROVIDED THE FOLLOWING GRAPH REPRESENTING THE lRMS CASH ACTIVITIES FOR .OVEMBER $ 10 000

Net Cash Flows from Operations

$ 6 000 $ 2 000

Net Cash Flows from Investing Activities

– $ 2 000

Net Cash Flows from Financing Activities

– $ 6 000 – $ 10 000

Net Cash Flows

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 12

T H E C A S H F L O W S TAT E M E N T

287

Required e 3TATEWHETHERTHElRMSBANKBALANCEWILLINCREASEORDECREASEDURING.OVEMBER *USTIFYYOURANSWER F %XPLAINONEREASONWHY'IACOMOSHOULDBECONCERNEDABOUTTHElRMS.ET#ASH &LOWSFROM/PERATIONSFOR.OVEMBER G $ISCUSSWHETHER'IACOMOSHOULDBECONCERNEDABOUTTHElRMS.ET#ASH&LOWS FROM)NVESTING!CTIVITIESFOR.OVEMBER

EXERCISE 12.14 CASH VERSUS PROFIT

W B

page 273

2UBY)CEOWNS"LING2INGS AREPUTABLEJEWELLERYSTORE ANDHASPROVIDEDTHEFOLLOWING JOURNALTOTALSFORTHEYEARENDED*UNE 3ALES*OURNAL $ATE

)NV NO

$EBTOR 4OTALS

#OSTOF 3ALES 

GST

3ALES 

4OTAL $EBTORS





$EBTORS #ONTROL

3UNDRIES

#ASH2ECEIPTS*OURNAL $ATE

2EC NO

$EBTOR

"ANK

$ISCOUNT %XPENSE

Loan – QZ FinCo.



4OTALS









#ASH0AYMENTS*OURNAL $ATE

$ETAILS

#HQ NO

"ANK

$ISCOUNT 2EVENUE

#REDITORS #ONTROL

$RAWINGS

7AGES

3UNDRIES

Admin. Expenses

1 000

Display Cabinets

8 000

Rent Expense

11 000

Prepaid Insurance

4 200

Interest Expense

3 000

GST Settlement

1 100

4OTALS

GST















Additional information: s !LLSALESANDPURCHASESAREMADEONCREDIT ANDALLDEBTORSRECEIVEADISCOUNT!SAT *ULYTHEBALANCEOFTHE$EBTORS#ONTROLACCOUNTWAS$2 s "ADDEBTSFORTHEYEARENDED*UNEAMOUNTEDTO s !SAT*ULYTHElRMHADABANKBALANCEOF$2 s )NSURANCEFOR*UNEn!UGUSTWASPAIDINADVANCEON-AY

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

288

UNITS 3&4

Required

* *

a )DENTIFYTWOEFFECTSONTHEFORMATOFTHE#ASH2ECEIPTS*OURNALOFTHEDECISIONTO MAKEALLSALESONCREDIT B #ALCULATETHEPERCENTAGEDISCOUNTGRANTEDTODEBTORS C #OMPLETETHE$EBTORS#ONTROLACCOUNTINTHE'ENERAL,EDGEROF"LING2INGSASAT *UNE d 0REPAREA#ASH&LOW3TATEMENTFOR"LING2INGSFORTHEYEARENDED*UNE e 5SINGTWOEXAMPLES EXPLAINHOW"LING2INGSWASABLETOEARNA.ET0ROlTDESPITE SUFFERINGNEGATIVE.ET#ASH&LOWSFROM/PERATIONS

© Anthony Simmons, Richard Hardy 2012 ISBN 978-1-107-64070-2 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

UNIT

4

CONTROL AND ANALYSIS OF BUSINESS PERFORMANCE

In Unit 4 of the VCE Accounting course, we will cover the following chapters: 291

CHAPTER 13

RETURNS OF STOCK

CHAPTER 14

STOCK VALUATION

CHAPTER 15

ACCOUNTING FOR NON-CURRENT ASSETS

333

CHAPTER 16

BALANCE DAY ADJUSTMENTS: REVENUES

367

CHAPTER 17

BUDGETS

CHAPTER 18

EVALUATING PROFITABILITY

CHAPTER 19

EVALUATING LIQUIDITY

309

387 427

455

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

Where are we headed? After completing this chapter, you should be able to: s IDENTIFY a return of stock FROMACREDITNOTE s LIST possible reasons for a return of stock s DISTINGUISH between a PURCHASERETURNANDASALES return s record a purchase return INTHESTOCKCARD 'ENERAL *OURNAL 'ENERAL,EDGERAND #REDITORS,EDGER s IDENTIFY the effect of a purchase return on the accounting equation

s record a sales return in the STOCKCARD 'ENERAL*OURNAL 'ENERAL,EDGERAND$EBTORS ,EDGER s EXPLAIN the role of the stock CARDINDETERMININGTHECOST price of a sales return s IDENTIFY the effect of a sales return on the accounting equation s REPORT a sales return in the )NCOME3TATEMENT

CHAPTER 13

RETURNS OF STOCK KEY TERMS After completing this chapter, you should be familiar with the following terms: s PURCHASERETURN s SALESRETURN s CREDITNOTE s .ET3ALES

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Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

292

UNITS 3&4

13.1 RETURNS OF STOCK

PURCHASERETURN the return of stock by our firm to a trade creditor SALESRETURN the return of stock to our firm by a trade debtor

4HEMAINOBJECTIVEOFATRADINGlRMISTOEARNAPROlTBYPURCHASINGSTOCK THENRESELLING ITATAHIGHERPRICE(OWEVER GIVENTHESHEERNUMBEROFTRANSACTIONSATRADINGlRMWILL HAVEWITHITSCUSTOMERSANDSUPPLIERS ITISONLYLOGICALTOEXPECTTHATNOTEVERYITEMOF STOCKSOLDORPURCHASEDWILLPROVETOBESUITABLE4HISMEANSTHATINTHENORMALCOURSE OFBUSINESS/PERATIONS ACERTAINNUMBEROFRETURNSOFSTOCKCANBEEXPECTED 4HEREAREBASICALLYTWOTYPESOFRETURNS s PURCHASERETURNS s 3ALES2ETURNS A purchase returnOCCURSWHENSTOCKISRETURNEDby our firmTOASUPPLIER!sales return OCCURSWHENSTOCKISRETURNEDto our firmBYACUSTOMER4HISCHAPTERCONCENTRATES ONHOWTORECORDANDREPORTPURCHASERETURNSTOTRADECREDITORS AND3ALES2ETURNSBY TRADEDEBTORS Note:2ETURNSFORACASHREFUNDAREBEYONDTHESCOPEOFTHISCOURSE

2EASONSFORRETURNSOFSTOCK 4HEREAREPROBABLYASMANYREASONSFORRETURNINGSTOCKASTHEREAREFORPURCHASINGIT Some of the more common reasons to return stock are because: s THESTOCKISFAULTYDAMAGED s THESTOCKISTHEWRONGSIZECOLOURSHAPEMODEL s TOOMANYITEMSOFSTOCKWEREPURCHASED s THECUSTOMERSHAVESIMPLYCHANGEDTHEIRMIND

There are probably as many reasons for returning stock as there are for purchasing it. One of the most common reasons is that the stock is faulty or damaged.

$AMAGEDORFAULTYSTOCKMUSTBEACCEPTEDFORRETURN PROVIDEDTHECUSTOMERHAS THESOURCEDOCUMENTSUCHASTHESALESINVOICE ASPROOFOFPURCHASE ANDTHEBUSINESS IS SATISlED THE FAULT LIES WITH THE PRODUCT RATHER THAN WITH HOW IT WAS USED "USINESS OWNERSSHOULDOBTAINADVICEREGARDINGTHEIRLEGALOBLIGATIONSINTHISAREA )T IS UP TO INDIVIDUAL BUSINESSES TO DECIDE WHETHER THEY WILL ACCEPT RETURN FROM CUSTOMERSWHOHAVECHANGEDTHEIRMINDS&ORSOMEBUSINESSESnANDSOMEPRODUCTSn ITMAYBEINAPPROPRIATETOACCEPTRETURNSCUTMATERIALAND PERHAPS UNDERWEARMAYFALL INTOTHISCATEGORY (OWEVER BUSINESSESTHATDOACCEPTRETURNSMAYACTUALLYGENERATE GREATER SALES WITH CUSTOMERS MORE WILLING TO BUY IF THEY KNOW THEY CAN RETURN THE PRODUCTIFITTURNSOUTTOBEUNSUITABLE

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 13

RETURNS OF STOCK

293

REVIEW QUESTIONS 13.1

1 %XPLAINTHEDIFFERENCEBETWEENAPURCHASERETURNANDASALESRETURN 2 3TATEFOURREASONSWHYSTOCKMAYBERETURNEDTOASUPPLIER 3 %XPLAINONEBENElTTHATMAYBEDERIVEDBYACCEPTINGRETURNSFROMCUSTOMERS WHOCHANGETHEIRMIND

13.2 CREDIT NOTES !SWITHALLTRANSACTIONS THEPROCESSOFRECORDINGANDREPORTINGRETURNSOFSTOCKMUST BEGINWITHASOURCEDOCUMENT)NFORMATIONTHATCANNOTBEVERIlEDBYASOURCEDOCUMENT WILL UNDERMINE THE Reliability OF THE lNANCIAL REPORTS !S THIS COURSE DEALS ONLY WITH CREDITRETURNSTOTRADECREDITORSANDBYTRADEDEBTORS THEONLYDOCUMENTTOPROVIDETHE EVIDENCEOFARETURNWILLBEA credit note SUCHASTHEONESHOWNIN&IGURE Figure 13.1

Credit note

Marcon Tool Co.

23 Aug. 2015

TAX INVOICE

ABN 98 756 458 751 ϯϯ'ĂīŶĞLJ^ƚ Coburg VIC 3058



Returned by:

Qty 4

Credit note: 85

Hardware Plus Johnson St, Collingwood VIC 3066 Item Arcwell electric drills

STUDY TIP

Unit price

Total cost

120

480

GST (10%)

Transactions in this COURSEWILLIDENTIFY WHETHER'34APPLIES BUTNOTNECESSARILYTHE '34AMOUNT

48 528

Reason

CREDITNOTE a source document that verifies the return of stock either to a trade creditor or by a trade debtor

Wrong stock items ordered

%VERYCREDITNOTEMUSTIDENTIFYTHETYPEANDQUANTITYOFSTOCKRETURNEDTHENAMEOF THECUSTOMERWHOISRETURNINGTHESTOCKANDTHEREASONFORTHERETURN&IGURESHOWS ARETURNOFFOUR!RCWELLELECTRICDRILLSto-ARCON4OOL#Oby(ARDWARE0LUS BECAUSETHE WRONGSTOCKITEMSWEREORDERED !CREDITNOTESUCHASTHISISNOTSTORECASH ASITMIGHTBEIFSTOCKWASRETURNEDTO A DEPARTMENT STORE IT CANNOT BE USED TO PAY FOR MORE STOCK 2ATHER IT PROVIDES THE EVIDENCETHATSTOCKHASBEENRETURNED ANDTHATTHEDEBTOWEDBYTHEDEBTORORTOTHE CREDITORHASBEENREDUCED

0URCHASEORSALESRETURN 'IVEN THAT A CREDIT NOTE WILL PROVIDE THE EVIDENCE OF BOTH A PURCHASE RETURN and a SALESRETURN HOWARETHETWOTOBEDISTINGUISHED.OTEHOWSIMILARACREDITNOTEISIN APPEARANCETOANINVOICEAND JUSTLIKEANINVOICE THENAMEOFTHESELLERISIDENTIlED ATTHETOPOFTHEDOCUMENT)NTHECASEOFARETURN THESELLERISALSOTHEBUSINESSTHAT ISRECEIVINGTHESTOCKASARETURN4HEBUSINESSRETURNINGTHESTOCKISIDENTIlEDINTHE MIDDLEOFTHECREDITNOTE4HISMEANSTHATIFOURBUSINESSNAMEISINTHEmiddle of the CREDITNOTE WEARERETURNINGTHESTOCK ANDTHETRANSACTIONISApurchase return)FOUR business name is at the topOFTHECREDITNOTE WEARERECEIVINGTHESTOCKINRETURN SO the transaction is a sales return ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

294

UNITS 3&4

REVIEW QUESTIONS 13.2

1 Referring to one qualitative characteristic, EXPLAIN the importance of source DOCUMENTSINTHEACCOUNTINGPROCESS 2 3TATETHElVEPIECESOFDATATHATMUSTBENOTEDONACREDITNOTE 3 %XPLAINHOWTHECREDITNOTECANBEUSEDTODISTINGUISHAPURCHASERETURNFROM ASALESRETURN

13.3 RECORDING PURCHASE RETURNS TO TRADE CREDITORS !PURCHASERETURNOCCURSWHENOURlRMRETURNSSTOCKTOATRADECREDITOR4HISWILLREDUCE THEQUANTITYOFSTOCKONHANDANDTHEAMOUNTOWEDTOTHETRADECREDITOR)TWILLALSO AFFECTTHEBALANCEOFTHE'34#LEARINGACCOUNT

EXAMPLE

On 28 March 2015, Pete’s Tyre Mart returned 20 tyres to Billstone Tyres because they were the wrong type. The tyres were purchased for $80 each, plus $8 GST (Credit note 11).

4HESTOCKCARD !SWITHALLTRANSACTIONSAFFECTINGSTOCK APURCHASERETURNMUSTBERECORDEDINTHESTOCK CARDOFTHEAPPROPRIATESTOCKITEM)NTHEACCOUNTINGRECORDSFOR0ETES4YRE-ARTTHIS PURCHASERETURNWOULDBERECORDEDINTHESTOCKCARD ASSHOWNIN&IGURE Figure 13.2

Stock card: purchase return STOCK CARD

3TOCKITEM Tyres

,OCATION

Bay 17

3TOCKCODE BST

3UPPLIER

Billstone Tyres

IN $ATE

March 25

28

$ETAILS

1TY

#OST

OUT 4OTAL

1TY

#OST

BALANCE 4OTAL

Balance

Cr. note 11

20

80

1 600

1TY

#OST

4OTAL

60

75

4 500

90

80

7 200

60

75

4 500

70

80

5 600

!STHESTOCKLEAVESTHElRMTORETURNTOTHESUPPLIER ITISRECORDEDINTHE/UTCOLUMN OFTHESTOCKCARD WHICHDECREASESTHEQUANTITYOFSTOCKONHAND/NLYTHECOSTPRICEOF THESTOCKPERTYRE ISRECORDEDINTHESTOCKCARDTHE'34COMPONENTISEXCLUDED Purchase returns and FIFO )TISNECESSARYTOAPPLY&IRST)N &IRST/UT&)&/ TOSALESBECAUSETHECASHRECEIPTORSALES INVOICEWILLNOTIDENTIFYTHECOSTPRICEOFTHESTOCKTHATHASBEENSOLDTHECOSTPRICECAN ONLYBEDETERMINEDBYREFERENCETOTHESTOCKCARD4HESAMEISnot true for purchase RETURNSTHECREDITNOTEMUSTIDENTIFYTHECOSTPRICEOFTHESTOCKTHATISBEINGRETURNED 4HISMEANSTHATRETURNSMAYCOMEFROMTHESTOCKTHATWASPURCHASEDlRSTBUT EQUALLY MAY COME FROM NEWER BATCHES OF STOCK %FFECTIVELY &)&/ IS NOT APPLIED TO PURCHASE RETURNS ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 13

RETURNS OF STOCK

295

4HE'ENERAL*OURNAL 'ENERAL,EDGERAND#REDITORS,EDGER 7HILETHEREISASPECIALJOURNALDEDICATEDTORECORDINGCREDITpurchasesOFSTOCKTHE 0URCHASES*OURNAL PURCHASEreturnsARERECORDEDINTHE'ENERAL*OURNALBECAUSETHEY DONTINVOLVECASHAND HOPEFULLY AREINFREQUENT4HEPURCHASERETURNTHATISRECORDED INTHESTOCKCARDIN&IGUREWOULDBERECORDEDINTHE'ENERAL*OURNALASSHOWNIN &IGURE Figure 13.3

General Journal: purchase return

STUDY TIP

'ENERAL*OURNAL 'ENERAL,EDGER $ATE

$ETAILS

$EBIT

March 28

Creditors Control

1 760

#REDIT

Creditor – Billstone Tyres

3UBSIDIARYLEDGER $EBIT

#REDIT

A purchase return is the EXACTREVERSEOFACREDIT PURCHASE

1 760

Stock Control

1 600

GST Clearing

160

20 tyres returned to supplier – wrong type (Cr. note 11)

)TISIMPORTANTTHATTHENARRATIONIDENTIlESTHESOURCEDOCUMENT#REDITNOTE SO THESTOCKITEMCANBEIDENTIlEDANDRECORDEDINTHESTOCKCARD )NTERMSOFTHE'ENERAL,EDGER APURCHASERETURNISSIMPLYTHEREVERSALOFAPURCHASE 4OBEGINWITH RETURNINGTHESTOCKTOTHESUPPLIERREDUCESTHEAMOUNTTHATISOWEDTOTHAT SUPPLIER4HISISRECORDEDASADEBITTO#REDITORS#ONTROL2EMEMBERTHATTHEORIGINAL AMOUNT OWING TO THE CREDITOR CONSISTED OF TWO AMOUNTS THE COST PRICE OF THE STOCK $1 600 PLUSTHE'34$160 2ETURNINGTHESTOCKDECREASESTHECREDITORBYTHESUM OFTHESETWOlGURES$1 760 4HISDEBITENTRYMUSTALSOBERECORDEDINTHESUBSIDIARY LEDGERTODECREASETHEBALANCEOWEDTO#REDITORn"ILLSTONE4YRES "ECAUSE THE STOCK LEVEL DECREASES Stock Control DECREASES VIA A CREDIT TO THIS ACCOUNT BUTTHISISONLYFORTHEAMOUNTTHATRELATESTOSTOCK$1 600 *USTLIKETHESTOCK CARD THEAMOUNTINTHE3TOCK#ONTROLACCOUNTEXCLUDESTHE'34COMPONENT 4HE'34AMOUNT$160 ISRECORDEDASASEPARATECREDITTO'34#LEARING, increasing THE LIABILITY TO THE !4/ OR POSSIBLY REDUCING THE ASSET 7HEREAS '34 ON THE CREDIT PURCHASEOFSTOCKREDUCEDTHE'34LIABILITYnBECAUSETHESUPPLIERWILLFORWARDTHE'34 TOTHE!4/nTHISENTRYISREINSTATINGTHAT'34LIABILITYBECAUSETHESUPPLIERWILLNOLONGER COLLECTIT 4HETRANSACTIONIN&IGUREWOULDBEPOSTEDTOTHE'ENERAL,EDGERACCOUNTSAS SHOWNIN&IGURE Figure 13.4

General Ledger: purchase return 'ENERAL,EDGER

STUDY TIP

'34ONAPURCHASE RETURNUNDOESTHE DECREASEINTHE'34 LIABILITYCAUSEDBYA CREDITPURCHASE

STUDY TIP

Resist the temptation to use the cross- reference @0URCHASE2ETURNSIN THE#REDITOR#ONTROL account as there is no SUCHLEDGERACCOUNT

#REDITOR#ONTROL, $ATE March 31

#ROSS REFERENCE Bank/Discount Revenue Stock Control/GST Clearing

!MOUNT

$ATE

32 900

March 1

1 760

31

#ROSS REFERENCE

!MOUNT

Balance

24 000

Stock Control/GST Clearing

38 500

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

296

CAMBRIDGE VCE ACCOUNTING

Figure 13.4 (cont.)

UNITS 3&4

General Ledger: purchase return 3TOCK#ONTROL!

$ATE

#ROSS REFERENCE

March 31

!MOUNT

$ATE

14 000

March 31

Balance

31

Bank

6 500

Creditors Control

#ROSS REFERENCE Cost of Sales Creditors Control

!MOUNT 41 000 1 600

35 000 '34#LEARING!,

$ATE

#ROSS REFERENCE

March 31 Creditors Control Bank

!MOUNT

$ATE

#ROSS REFERENCE

3 500

March 1

2 400

31

Balance

!MOUNT 600

Debtors Control

4 000

Bank

2 900

Creditors Control

160

.OTEHOWTHECROSS REFERENCEFORTHEDEBITENTRYINTHE#REDITORS#ONTROLACCOUNT is not @0URCHASE 2ETURNS ALTHOUGH THIS DESCRIBES THE TRANSACTION THERE IS NO LEDGER ACCOUNT CALLED @0URCHASE 2ETURNS SO THIS CANNOT BE THE CROSS REFERENCE 2ATHER THE DEBITENTRYOF$1 760 is a combinationPARTSTOCKANDPART'347ENOLONGEROWETHE CREDITORFORTHESTOCK ANDWENOLONGEROWETHECREDITORFORTHE'34ONTHATSTOCK4HE cross-reference is Stock Control'34#LEARING .OTE ALSO THAT THE CROSS REFERENCE @#REDITORS #ONTROL NOW APPEARS ON BOTH SIDES OFTHE'34#LEARINGACCOUNTTHE'34ONCREDITPURCHASES ISONTHEDEBITSIDE AS A REDUCTION IN THE '34 LIABILITY AND THE '34 ON PURCHASE RETURNS $160 IS ON THE CREDITSIDE &IGURESHOWSHOWTHEPURCHASERETURNWOULDBEPOSTEDTOTHE#REDITORS,EDGER Figure 13.5

Creditors Ledger: purchase return CREDITORS,EDGER #REDITORn"ILLSTONE4YRES,

$ATE

!MOUNT

$ATE

Bank/ Discount Revenue

5 000

March 1

22

Bank

2 000

28

Stock Control/ GST Clearing

1 760

March 9

#ROSS REFERENCE

#ROSS REFERENCE

!MOUNT

Balance

5 000

12

Stock Control/ GST Clearing

3 300

27

Stock Control/ GST Clearing

2 750

!SHASALWAYSBEENTHECASE THECROSS REFERENCESUSEDINTHESUBSIDIARYLEDGERARE IDENTICALTOTHOSEUSEDINTHE#ONTROLACCOUNTS BUTINSTEADOFJOURNALTOTALS THISACCOUNT USESINDIVIDUALTRANSACTIONDATESANDAMOUNTS Effect on the accounting equation "ECAUSE A PURCHASE RETURN IS THE OPPOSITE OF A CREDIT PURCHASE ITS EFFECT ON THE ACCOUNTINGEQUATIONISALSOTHEOPPOSITE7HEREASACREDITPURCHASEWILLINCREASESTOCK CREDITORSAND'34#LEARING APURCHASERETURNHASTHEFOLLOWINGEFFECTONTHEACCOUNTING equation:

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 13

RETURNS OF STOCK

)NCREASE$ECREASE.OEFFECT

297

!MOUNT

!SSETS

Decrease (Stock Control)

1 600

,IABILITIES

Decrease (decrease Creditors Control $1 760, increase GST Clearing $160)

1 600

/WNERS%QUITY

No effect

)FTHE'34#LEARINGACCOUNTHASADEBITBALANCE ANDISANASSET THENAPURCHASE RETURN WILL DECREASE THAT ASSET 4HIS WILL CHANGE THE OVERALL EFFECT ON THE ACCOUNTING EQUATION ASSET AND LIABILITIES WILL STILL DECREASE BUT BY THE TOTAL ON THE CREDIT NOTE INCLUDINGTHE'34

2EPORTINGPURCHASERETURNS "ECAUSE A PURCHASE RETURN DOES NOT AFFECT ANY REVENUE OR EXPENSE ITEMS AND DOES NOT INVOLVE A CASH mOW IT WILL NOT BE REPORTED IN EITHER THE #ASH &LOW 3TATEMENT OR THE )NCOME 3TATEMENT )N FACT IT WILL NOT BE REPORTED ANYWHERE ! PURCHASE RETURN WILLCHANGETHEBALANCESOF3TOCK#ONTROL #REDITORS#ONTROLAND'34#LEARINGINTHE "ALANCE3HEET BUTWILLNOTBEREPORTEDASASEPARATEITEM REVIEW QUESTIONS 13.3

1 %XPLAINHOWTHECOSTPRICEOFSTOCKISDETERMINEDWHENAPURCHASERETURN ISRECORDEDINTHESTOCKCARD 2 ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDAPURCHASERETURN 3 3TATEONEREASONWHYTHETERM@0URCHASE2ETURNISNOTUSEDASACROSS REFERENCEINTHE#REDITORS#ONTROLACCOUNT 4 3TATETHEEFFECTOFAPURCHASERETURNONTHEACCOUNTINGEQUATION 5 %XPLAINHOWAPURCHASERETURNISREPORTEDINTHElNANCIALSTATEMENTS

13.4 RECORDING SALES RETURNS FROM TRADE DEBTORS 7HEREASAPURCHASERETURNOCCURSWHENSTOCKISRETURNED by our firm to a trade creditor, ASALESRETURNOCCURSWHENSTOCKISRETURNEDto our firm by a trade debtor!SALESRETURN WILLINCREASESTOCKONHAND BUTREDUCEDEBTORSANDALSOPROlT4HEBALANCEOFTHE'34 #LEARINGACCOUNTWILLALSOBEAFFECTED

EXAMPLE

On 23 May 2015, Books By Gosh received a sales return of three books from M.S. Howard worth $30 (plus $3 GST) each (Credit note 21). The books had been sold on 4 May 2015.

4HESTOCKCARD !SSTOCKISCOMINGBACKINTOOURBUSINESS ASALESRETURNMUSTBERECORDEDINTHE)N COLUMNOFTHERELEVANTSTOCKCARD)NTHEACCOUNTINGRECORDSFOR"OOKS"Y'OSH THIS SALESRETURNWOULDBERECORDEDINTHESTOCKCARDASSHOWNIN&IGURE

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

298

CAMBRIDGE VCE ACCOUNTING

Figure 13.6

UNITS 3&4

Stock card: sales return STOCK CARD

3TOCKITEM Books 3TOCKCODE 171

,OCATION 3UPPLIER IN

$ATE

May 1 4 10

13

15

18

23

$ETAILS

1TY

#OST

Shelf next to front counter Cambridge Publishing

OUT 4OTAL

1TY

#OST

BALANCE 4OTAL

Balance Inv. 30 Ch. 901

7 15

12

20

14

2

10

20

5

12

60

280

Inv. 32

Cr. note 21

60

180

Inv. 31

Ch. 904

10

10

12

120

2

14

28

1TY

#OST

4OTAL

9

10

80

2

10

20

2

10

20

15

12

180

10

12

120

10

12

120

20

14

280

18

14

252

1

12

12

1

12

12

2

14

28

20

14

280

!LTHOUGHTHECREDITNOTEIDENTIlEDTHEPRICEOFEACHBOOKAS$30, this is the selling price4RANSACTIONSMUSTBERECORDEDINTHESTOCKCARDATcost price, but which cost price SHOULDBEUSED)N&IGURE THEORIGINALSALEON-AYVALUEDTHESTOCKATA cost price of $10 per book7HY THEN ISNTTHISCOSTPRICEUSEDINTHESALESRETURNON -AY 4HEKEYPRINCIPLEBEHINDRECORDINGASALESRETURNISTHATTHESTOCKCARDSHOULDBE RETURNEDTOTHEPOSITIONITWOULDHAVEBEENINIFTHESALEHADNEVERTAKENPLACE)FTHE sale on  -AY  HAD not TAKEN PLACE THEN WE WOULD ASSUME THAT THE  STOCK WOULDSTILLBEONHAND(OWEVER THEAPPLICATIONOF&)&/WOULDASSUMETHATTHISSTOCK WOULDBEPARTOFTHEnextSALEON-AY )NPRACTICE THISMEANSTHAT3ALES2ETURNSSHOULDVALUESTOCKATTHECOSTPRICEUSED INTHEMOSTRECENTTRANSACTIONINTHE/UTCOLUMN)FTHEMOSTRECENTSALEINVOLVEDTWO DIFFERENTCOSTPRICES THENAREVERSALOF&)&/ASSUMESTHATTHElastSTOCKOUTISTHElRST STOCKTOBERETURNED A sales return should value stock at the cost price used in the most recent transaction in the Out column. Using the cost price in the most recent transaction in the Out column means that the sales return on -AYSHOULDUSETHECOSTPRICESFROMTHESALEON-AY valuing two of the items at $14EACHTHELASTTWOBOOKSSOLD WITHTHEOTHERVALUEDAT 4HETOTALCOSTPRICEOFTHERETURN$40 WILLBEUSEDINTHE'ENERAL*OURNALENTRY

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 13

RETURNS OF STOCK

4HE'ENERAL*OURNAL 'ENERAL,EDGERAND$EBTORS,EDGER #REDIT3ALESARERECORDEDINTHEIROWNJOURNALTHE3ALES*OURNAL BUT INCOMMONWITH PURCHASERETURNS 3ALES2ETURNSARERECORDEDINTHE'ENERAL*OURNAL4HESALESRETURN RECORDEDINTHESTOCKCARDIN&IGUREWOULDBERECORDEDINTHE'ENERAL*OURNALAS SHOWNIN&IGURE Figure 13.7

General Journal: sales return 'ENERAL*OURNAL 'ENERAL,EDGER

$ATE

$ETAILS

$EBIT

May 23

Sales Returns

90

GST Clearing

9

#REDIT

3UBSIDIARYLEDGER $EBIT

#REDIT

99

$EBTORS#ONTROL

$EBTORn-3(OWARD

99

Stock Control

40

Cost of Sales

40

3 books returned by customer – too many supplied (Cr. note 21)

4HEORIGINALCREDITSALEWASRECORDEDASACREDITTOTHE3ALESREVENUEACCOUNT SO A SALES RETURN REQUIRES THE OPPOSITE "UT RATHER THAN SIMPLY DEBIT THE 3ALES REVENUE ACCOUNT ASEPARATELEDGERACCOUNTISUSEDTORECORDSales Returns4HISACCOUNTISA negative revenue account ANDISDEBITED$90TORECORDTHEREDUCTIONINREVENUE'34 ClearingISALSODEBITED BY$9 TOREDUCETHE'34LIABILITYOWEDTOTHE!4/4HISIS'34 WEWILLNEVERRECEIVE ANDTHEREFORENOWDONOTOWETOTHE!4/ 2EVERSINGTHESALEALSOMEANSTHATTHEDEBTOWEDBYTHEDEBTORISREDUCED4HIS IS ACHIEVED BY CREDITING THE Debtors Control ACCOUNT IN THE 'ENERAL ,EDGER AND SIMULTANEOUSLYCREDITINGTHEINDIVIDUALACCOUNTDebtor – M.S. Howard INTHE$EBTORS ,EDGER4HEDEBTOROWEDUSBOTHTHESELLINGPRICE$90 ASWELLASTHE'34ONTHESALE $9 SO BY RETURNING THE STOCK THE FULL AMOUNT $99 IS DEDUCTED FROM THE DEBTORS BALANCE *USTASACREDITSALEINVOLVESTWODOUBLEENTRIESONEATcost priceANDONEATselling price SODOESASALESRETURN4HECOSTPRICEOF$40 ASDETERMINEDVIATHESTOCKCARD ISDEBITEDTOTHEStock Control account to reflect that the stock is coming back in to THE BUSINESS !S A CONSEQUENCE THE EXPENSE Cost of Sales IS REDUCED VIA A CREDIT ENTRY BECAUSETHESALEHASBEENRETURNED!GAIN THEENTRIESAFFECTINGTHE3TOCK#ONTROL ACCOUNTDONOTINCLUDE'34 4HETRANSACTIONIN&IGUREWOULDBEPOSTEDTOTHELEDGERACCOUNTSASSHOWNIN &IGURE Figure 13.8

General Ledger: sales return 'ENERAL,EDGER $EBTORS#ONTROL!

$ATE

#ROSS REFERENCE

May 1 May 31

!MOUNT

$ATE

Balance

16 500

May 31

Sales/GST Clearing

37 400

#ROSS REFERENCE Bank/Discount Expense Sales Returns/GST Clearing

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

!MOUNT 32 900 99

Cambridge University Press

299

300

CAMBRIDGE VCE ACCOUNTING

Figure 13.8 (cont.)

UNITS 3&4

General Ledger: sales return '34#LEARING!,

$ATE

#ROSS REFERENCE

May 31

Creditors Control Bank

!MOUNT

$ATE

#ROSS REFERENCE

2 700

May 1

Balance

2 100

31

Debtors Control

9

!MOUNT 800

Debtors Control

3 400

Bank

1 700

3ALES2ETURNSn2 $ATE

#ROSS REFERENCE

May 31

Debtors Control

!MOUNT

$ATE

#ROSS REFERENCE

!MOUNT

90 3TOCK#ONTROL!

$ATE

#ROSS REFERENCE

May 1

Balance

14 000

Creditors Control

11 000

31

!MOUNT

Cost of Sales

$ATE

#ROSS REFERENCE

March 31

Cost of Sales

!MOUNT 24 000

40 #OSTOF3ALES%

$ATE May 31

#ROSS REFERENCE Stock Control

!MOUNT

$ATE

24 000

May 31

#ROSS REFERENCE Stock Control

!MOUNT 40

4HE CROSS REFERENCE FOR THE CREDIT ENTRY IN BOTH DEBTOR ACCOUNTS IN THE 'ENERAL ,EDGERAND$EBTORS,EDGER ISSales Returns'34#LEARING, reflecting the fact that both THESELLINGPRICEOFTHESTOCK$90 ANDTHE'34COMPONENT$9 HAVEBEENDEDUCTED FROMTHEDEBTORSBALANCE Note also thatTHECROSS REFERENCE@$EBTORS#ONTROLAPPEARSONBOTHSIDESOFTHE '34#LEARINGACCOUNT'34CHARGEDON#REDIT3ALESINCREASESTHE'34LIABILITYVIAAN ENTRYONTHECREDITSIDE BUT'34ON3ALES2ETURNSDECREASESTHATLIABILITYVIAANENTRY ONTHEDEBITSIDE &IGURESHOWSHOWASALESRETURNWOULDBEPOSTEDTOTHE$EBTORS,EDGER Figure 13.9

Debtors Ledger: sales return DEBTORS LEDGER $EBTORn-3(OWARD!

$ATE

#ROSS REFERENCE

May 1 4

!MOUNT

$ATE

Balance

200

May 12

Sales/GST Clearing

231

23

#ROSS REFERENCE Bank/Discount expense Sales Returns/ GST Clearing

!MOUNT 200 99

Effect on the accounting equation ! CREDIT SALE OF STOCK AFFECTS ASSETS BY INCREASING DEBTORS AND DECREASING STOCK ITINCREASESTHE'34LIABILITYANDITINCREASESOWNERSEQUITYVIATHEPROlTONTHESALE A sales return reverses this effect:

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 13

RETURNS OF STOCK

)NCREASE$ECREASE.OEFFECT

301

!MOUNT

Assets

Decrease (decrease Debtors Control $99, increase Stock Control $40)

Liabilities

Decrease (GST Clearing)

Owner’s Equity

Decrease (Sales Returns $90 less decrease Cost of Sales $40 = less profit)

59 9 50

REVIEW QUESTIONS 13.4

1 %XPLAINHOWTHECOSTPRICEOFSTOCKISDETERMINEDWHENASALESRETURNIS RECORDEDINTHESTOCKCARD 2 ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDASALESRETURN 3 %XPLAINWHYASALESRETURNLEADSTOAREDUCTIONINTHE'34LIABILITY 4 3TATETHEEFFECTOFASALESRETURNONTHEACCOUNTINGEQUATION

13.5 REPORTING SALES RETURNS 4HEVALUEANDNUMBEROF3ALES2ETURNSCANBEANIMPORTANTINDICATOROFTHEQUALITYAND SUITABILITYOFTHESTOCKTHATISBEINGTRADED)F3ALES2ETURNSAREHIGH ITMAYINDICATE CUSTOMERDISSATISFACTIONWITHTHEGOODSTHATAREBEINGSOLD4HISMAYBEBECAUSETHE GOODS ARE OF INFERIOR QUALITY OR SIMPLY BECAUSE CUSTOMERS HAVE BEEN PROVIDED WITH GOODSTHATDIDNOTSUITTHEIRPURPOSE )NORDERTOINVESTIGATETHECAUSEOFHIGH3ALES2ETURNS THEOWNERMUSTlRSTBEAWARE THAT3ALES2ETURNSAREINDEEDAPROBLEM4HISISWHY3ALES2ETURNSARERECORDEDINTHEIR OWNSEPARATELEDGERACCOUNT ANDREPORTEDSEPARATELYINTHE)NCOME3TATEMENT /FCOURSE THEOWNERSHOULDNOTRELYSOLELYONTHE)NCOME3TATEMENTFORINFORMATION ABOUT THE SUITABILITY OF STOCK 3TOCK MOVEMENTS SHOULD BE ASSESSED REGULARLY BY CONSULTINGWITHSTAFFANDCUSTOMERS ANDBYEXAMININGTHESTOCKCARDS &IGURESHOWSHOW3ALES2ETURNSAREREPORTEDINTHE)NCOME3TATEMENT Figure 13.10

Income Statement: Sales Returns BOOKS BY GOSH )NCOME3TATEMENTEXTRACT FOR-AY

2EVENUE Sales Less Sales Returns





51 000 90

50 910

Less Cost of Goods Sold Cost of Sales Freight In

23 960 1 200

Gross Profit

25 160 25 750

As a negative revenue 3ALES2ETURNSISREPORTEDASADEDUCTIONFROMSALES LEAVING Net Sales)N&IGURE THIS.ET3ALESlGUREIS 4HE#OSTOF3ALESISNOTREPORTEDANYDIFFERENTLY ASTHEEFFECTOFANY3ALES2ETURNS WILLHAVEALREADYBEENRECORDEDINTHE#OSTOF3ALESACCOUNT ANDACCOUNTEDFORINTHE lGURECLOSEDTOTHE0ROlTAND,OSS3UMMARYACCOUNT)N&IGURE THECOSTPRICEOF THESALESRETURNHASALREADYBEENDEDUCTEDTOLEAVEANOVERALLlGUREOF ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

.ET3ALES sales revenue after the deduction of Sales Returns; that is, Sales less Sales Returns

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

302

UNITS 3&4

REVIEW QUESTIONS 13.5

1 2 3 4

%XPLAINWHY3ALES2ETURNSAREREPORTEDSEPARATELYINTHE)NCOME3TATEMENT 3UGGESTTWOREASONSFORHIGH3ALES2ETURNS Show HOW.ET3ALESISREPORTEDINTHE)NCOME3TATEMENT %XPLAIN WHY THE COST PRICE OF A SALES RETURN IS NOT REPORTED SEPARATELY IN THE )NCOME3TATEMENT

WHERE HAVE WE BEEN? s 2ETURNSOFSTOCKAREVERIlEDBYACREDITNOTE ANDRECORDEDINTHE'ENERAL*OURNAL s !PURCHASERETURNISTHERETURNOFSTOCKBYOURlRM TOATRADECREDITOR s 0URCHASERETURNSARERECORDEDINTHE/UTCOLUMNOFTHESTOCKCARD ANDDECREASE STOCKONHAND s !SALESRETURNISTHERETURNOFSTOCKTOOURlRM BYATRADEDEBTOR s 3ALES2ETURNSARERECORDEDINTHE)NCOLUMNOFTHESTOCKCARD ANDINCREASESTOCK ONHAND s 3ALES2ETURNSSHOULDVALUESTOCKATTHECOSTPRICEUSEDINTHEMOSTRECENTTRANSACTION INTHE/UTCOLUMNOFTHESTOCKCARD s 3ALES2ETURNSAREREPORTEDSEPARATELYINTHE)NCOME3TATEMENTSOTHATTHEOWNERIS ALERTEDTOPOTENTIALPROBLEMSANDCUSTOMERDISSATISFACTIONWITHSTOCK

EXERCISES

EXERCISE 13.1 RECORDING A PURCHASE RETURN

W B

page 278

/N3EPTEMBER *OSEPH"OAT3UPPLIESHADPAIRSOFOARSONHAND EACHPAIR WITHACOSTPRICEOFPLUS'34 /N3EPTEMBER FOURPAIRSOFOARSWERE RETURNEDTO/ARS25SBECAUSETHEYWERETHEWRONGSIZE#REDITNOTE  Required a Record#REDITNOTEINTHESTOCKCARDFOR/ARS B ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORD#REDITNOTE c 3TATE THE EFFECT OF #REDIT NOTE  ON THE ACCOUNTING EQUATION OF *OSEPH "OAT 3UPPLIES

EXERCISE 13.2 PURCHASE RETURNS AND THE CREDITORS LEDGER

W B

page 279

"ENNY %LECTRICALS PURCHASES A PARTICULAR TYPE OF FRIDGE FROM &REEZING &RIDGES )TS TRANSACTIONSFOR!PRILWEREASFOLLOWS April

6 11 18 26 29

Purchased 5 fridges from Freezing Fridges at $400 (plus GST) each (Inv. 45) Paid $7 600 to Freezing Fridges, and received $400 discount Sold 12 fridges for $1 100 (including GST) each (Inv. 74) Purchased 8 fridges from Freezing Fridges at $420 (plus GST) each (Inv. 51) One of the fridges purchased on 26 April 2015 was returned (Cr. note 38)

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 13

RETURNS OF STOCK

Additional information: "ALANCESAT!PRIL

Required

*

#REDITORn&REEZING&RIDGES 3TOCKOFFRIDGES

  EACH

a B c d e

3TATETHESOURCEDOCUMENTTHATWOULDVERIFYTHETRANSACTIONON!PRIL Record THETRANSACTIONSFOR!PRILINTHESTOCKCARDFOR&RIDGES %XPLAINWHY#REDITNOTEMUSTBERECORDEDINTHE'ENERAL*OURNAL ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORD#REDITNOTE #OMPLETE THE ACCOUNT FOR &REEZING &RIDGES IN THE #REDITORS ,EDGER OF "ENNY %LECTRICALS F !SSUMINGTHEREWERENOOTHERTRANSACTIONSINVOLVING'34 CALCULATETHE'34LIABILITY OF"ENNY%LECTRICALSASAT!PRIL

EXERCISE 13.3 RECORDING A SALES RETURN

page 281

W B

/N*ULY 2ICH%ARTHFURNITUREHADTABLESONHAND EACHWITHACOSTPRICEOF /N*ULY 4.ICOLERETURNEDATABLETHATSHEHADPURCHASEDONCREDITON *ULYFORPLUS'34 BECAUSEITDIDNTMATCHHEROTHERFURNITURE #REDITNOTEWASISSUEDTO.ICOLEFORTHERETURN Required a B c d

Record#REDITNOTEINTHESTOCKCARDFORTABLES Show THE'ENERAL*OURNALENTRIESNECESSARYTORECORD#REDITNOTE 3TATETHEEFFECTOF#REDITNOTEONTHEACCOUNTINGEQUATIONOF2ICH%ARTH !SSUMINGTHE3ALESACCOUNTHADACREDITBALANCEOF SHOW how the sales RETURNWOULDBEREPORTEDINTHE)NCOME3TATEMENTOF2ICH%ARTHFOR*ULY e %XPLAINONEBENElTOFOFFERING3ALES2ETURNSTOCUSTOMERSWHOCHANGETHEIRMINDS

EXERCISE 13.4 SALES RETURNS AND THE DEBTORS LEDGER

W B

page 283

.ICKOF4IMEISACLOCKSHOP)TSTRANSACTIONSFOR!UGUSTWEREASFOLLOWS Aug.

4

Sold 4 clocks to Mega World for $150 (plus GST) each (Inv. 12)

7

Purchased 10 clocks from TimeStar Clocks for $90 (plus GST) each (Inv. 202)

9

Received $1 000 from Mega World

13

Sold 5 clocks to Mega World for $165 (including GST) each (Inv. 13)

20

Purchased 12 clocks from TimeStar Clocks for $110 (including GST) each (Inv. 211)

25

Mega World returned 2 clocks (Cr. note 4)

Additional information: "ALANCESAT!UGUST

Required

* *

$EBTORn-EGA7ORLD 3TOCKOFCLOCKS

  EACH

a 3TATETHESPECIALJOURNALTHATWOULDBEUSEDTORECORDTHETRANSACTIONON!UGUST  B RecordTHETRANSACTIONSINTHESTOCKCARDFORCLOCKS c ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDTHERETURNOFSTOCK d #OMPLETETHEACCOUNTFOR-EGA7ORLDINTHE$EBTORS,EDGEROF.ICKOF4IME e Assuming there were no other sales, prepare an Income Statement for Nick of Time FOR!UGUSTSHOWING'ROSS0ROlT!FULL)NCOME3TATEMENTISNOTREQUIRED ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

303

CAMBRIDGE VCE ACCOUNTING

304

UNITS 3&4

EXERCISE 13.5 PURCHASE RETURNS AND THE GENERAL LEDGER

W B

page 285

4HOMMOS4OYSPRESENTEDTHEFOLLOWINGSUMMARYOFITSTRANSACTIONSFOR/CTOBER Stock Control – balance 1 October 2015 Creditors Control – balance 1 October 2015

$42 000 34 000

GST Clearing – balance 1 October 2015 Credit purchases for October 2015

800 50 000

CR (plus GST $5 000)

Cash paid to creditors plus discount revenue

59 400

Credit Sales

66 000

(incl. GST); cost price $30 000

Cash sales

30 000

(plus GST); cost price $15 000

GST paid

2 500

Additional information: s /N  /CTOBER  STOCK WORTH  PLUS '34 WAS RETURNED TO A SUPPLIER 7ILSON)NDUSTRIES Required

*

a 3TATE THE SOURCE DOCUMENT THAT WOULD VERIFY THE RETURN OF STOCK ON  /CTOBER  B 3TATETWOREASONSWHYSTOCKMAYBERETURNEDTOASUPPLIER c Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO RECORD THE RETURN OF STOCK ON  /CTOBER.ARRATIONNOTREQUIRED d #OMPLETETHE3TOCK#ONTROL #REDITORS#ONTROLAND'34#LEARINGACCOUNTSINTHE 'ENERAL,EDGEROF4HOMMOS4OYSASAT/CTOBER e 3TATETWOOTHERPIECESOFINFORMATIONTHATWOULDBENECESSARYTORECORDTHERETURN OFSTOCKINTHESTOCKCARD

EXERCISE 13.6 SALES RETURNS AND THE GENERAL LEDGER

W B

page 287

$REW#URTAINSPRESENTEDTHEFOLLOWINGSUMMARYOFITSTRANSACTIONSFOR.OVEMBER Stock Control – balance 1 November 2015 Debtors Control – balance 1 November 2015

$13 000 25 000

GST Clearing – balance 1 November 2015 Credit Sales

950 40 000

GST paid Credit purchases for November 2015

1 500 39 600

CR (plus GST); cost price: $25 000 (plus $3 600 GST) (including GST)

Cash Receipts Journal column totals: Debtors Control

38 000

Cash sales

12 000

Cost of Sales

8 000

GST

1 200

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 13

RETURNS OF STOCK

Additional information: s /N.OVEMBER ADEBTOR +$OWLING RETURNEDSTOCKBECAUSEITWASFAULTY 4HESTOCKHADASELLINGPRICEOFPLUS'34 ANDACOSTPRICEOF#RNOTE  s $REWHASSTATEDTHATDISCOUNTSWEREGRANTEDTODEBTORSDURING.OVEMBER Required

* *

a Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO RECORD THE RETURN OF STOCK ON  .OVEMBER B 3TATE THE EFFECT OF THE RETURN OF STOCK ON  .OVEMBER  ON THE ACCOUNTING EQUATIONOF$REW#URTAINS c #OMPLETE THE $EBTORS #ONTROL 3ALES 2ETURNS '34 #LEARING 3TOCK #ONTROL AND #OSTOF3ALESACCOUNTSINTHE'ENERAL,EDGEROF$REW#URTAINSASAT.OVEMBER  d Assuming there are no other transactions, prepare an Income Statement for Drew #URTAINSFOR.OVEMBER SHOWING'ROSS0ROlT!FULL)NCOME3TATEMENTISNOT REQUIRED

EXERCISE 13.7 RETURNS AND THE STOCK CARD

page 289

W B

%LIZABETH*EWELLERYSELLSNECKLACES RINGSANDOTHERJEWELLERY)TSSTOCKCARDFORNECKLACES SHOWEDTHEFOLLOWINGTRANSACTIONSFOR*ANUARY STOCK CARD 3TOCKITEM Necklaces, 60cm 3TOCKCODE AU60cm

,OCATION 3UPPLIER IN

$ATE

$ETAILS

1TY

#OST

Front cabinet Gems Warehouse

OUT 4OTAL

1TY

#OST

BALANCE 4OTAL

1TY

#OST

4OTAL

Jan. 3

Memo 32

1

120

120

8

120

960

Jan. 9

Inv. 30

3

120

360

5

120

600

5

120

600

10

130

1 300

9

130

1 170

9

130

1 170

10

140

1 400

Jan. 13

Jan. 17

Jan. 22

Inv. A91

10

130

1 300

Rec. 009

Inv. A98

10

140

1 400

5

120

600

1

130

130

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

305

306

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

Additional information: 4HEFOLLOWINGTRANSACTIONSHAVENOTYETBEENRECORDED

Elizabeth Jewellery

25/1/2015

Little Bourke St Melbourne VIC 3000

TAX INVOICE

Credit note: 29

ABN 07 012 000 070 Returned by: Qty 2

M. Brooke Beach St, Frankston VIC 3199 Item Necklaces

Unit price

Total cost

200

400

GST (10%)

40 440

Reason

Damaged

s /N*ANUARY THEDAMAGEDNECKLACESWERERETURNEDTOTHESUPPLIER 'EMS 7AREHOUSE FORACREDITOFPLUS'34#RNOTE  s /N  *ANUARY  A STOCKTAKE REVEALED THAT THERE WERE  NECKLACES ON HAND -EMO  s !LLNECKLACESHAVEASELLINGPRICEOFINCLUDING'34 Required a 3UGGESTTWOPOSSIBLEREASONSFORTHETRANSACTIONON*ANUARY B RecordTHEADDITIONALINFORMATIONINTHESTOCKCARDFORNECKLACES c %XPLAINHOWTHEAPPLICATIONOF&)&/AFFECTSTHERECORDINGOFASALESRETURNINTHE STOCKCARD d ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDTHEADDITIONALINFORMATION e #ALCULATE#OSTOF3ALESFORNECKLACESFOR*ANUARY F #ALCULATE!DJUSTED'ROSS0ROlTONNECKLACESFOR*ANUARY

EXERCISE 13.8 POSTING JOURNALS TO THE LEDGER

W B

page 291

'ARRYS 'ARDEN 3UPPLIES BUYS AND SELLS PLANTS )TS "ALANCE 3HEET AS AT  *UNE  INCLUDEDTHEFOLLOWINGITEMS #URRENTASSETS Stock Control

$ 5 000

Debtors Control

3 080

s -ACARTHUR0ARKS



s *AMES'REVILLE



#URRENTLIABILITIES Bank GST Clearing

2 000

CR

300

Creditors Control

1 430

s #ITYOF(UME



s #HASAND-ARYS0LANTS



)TSOWNER 'ARRY HASPROVIDEDTHEFOLLOWINGSPECIALJOURNALSRELATINGTOITSTRADING ACTIVITIESFOR*UNE

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 13

RETURNS OF STOCK

307

#ASH2ECEIPTS*OURNAL 2ECEIPT NUMBER

"ANK

Cash Sales

20

1 056

James Greville

21

1 881

10

Cash Sales

22

858

14

Growth Solutions

23

1 254

19

Capital

24

5 000

24

Macarthur Park

25

400

25

Cash Sales

26

726

$ATE June 1 6

$ETAILS

$ISCOUNT %XPENSE

99

3ALES

640

960

96

520

780

78

3UNDRIES

GST

1 980

66

1 320 5 000 400

11 175

4OTALS

$EBTORS #OSTOF #ONTROL 3ALES

165



440

660





66 



3UNDRIES

GST

#ASH0AYMENTS*OURNAL $ATE

$ETAILS

#HEQUE NUMBER

June 1

GST Clearing

112

300

3

Stock Control

113

715

4

Chas and Mary’s Plants

114

836

8

Advertising

115

3 960

10

City of Hume

116

550

11

Stock Control

117

1 540

13

Wages

118

500

18

City of Hume

119

2 508

22

Drawings

120

1 000

27

Wages

121

500

4OTALS

$ISCOUNT 2EVENUE

"ANK

#REDITORS 3TOCK #ONTROL #ONTROL

7AGES

300 650 44

65

880 3 600

360

550 1 400

140 500

132

2 640 1 000 500

176











565

PURCHASES *OURNAL $ATE June 12

)NVOICE NUMBER

#REDITOR

3TOCK #ONTROL

GST

#REDITORS #ONTROL

City of Hume

90

2 400

240

2 640

17

Chas and Mary’s Plants

91

3 040

304

3 344

20

City of Hume

92

1 540

154

1 694



698

7 678

4OTALS 3ALES*OURNAL $ATE June 6

$EBTOR

)NVOICE NUMBER

#OSTOF 3ALES

3ALES

GST

$EBTORS #ONTROL

Macarthur Parks

65

900

1 350

135

1 485

11

Growth Solutions

66

800

1 200

120

1 320

18

James Greville

67

1 400

2 100

210

2 310

25

Growth Solutions

68

1 200

1 800

180

1 980





645



4OTALS

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

308

UNITS 3&4

Additional information: s /N*UNE 'ARRYRETURNEDSTOCKTHATHADORIGINALLYCOSTINCLUDING'34 TO#ITYOF(UME s /N*UNE -ACARTHUR0ARKSRETURNEDSTOCKTO'ARRYS'ARDEN3UPPLIES WHICH HADORIGINALLYBEENSOLDFORPLUS'344HESTOCKHADACOSTPRICEOF s /N*UNE ALETTERWASRECEIVEDINFORMING'ARRYTHAT-ACARTHUR0ARKSWAS BANKRUPT ANDITSBALANCEOFSHOULDBEWRITTENOFF Required

*

* *

a Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO RECORD THE ADDITIONAL INFORMATION .ARRATIONSARENOTREQUIRED B #OMPLETETHEFOLLOWING'ENERAL,EDGERACCOUNTSASAT*UNE s Debtors Control s #REDITORS#ONTROL s Stock Control s Cost of Sales s '34#LEARING c #OMPLETETHEACCOUNTOF-ACARTHUR0ARKSINTHE$EBTORS,EDGERASAT*UNE d #OMPLETETHEACCOUNTOF#ITYOF(UMEINTHE#REDITORS,EDGERASAT*UNE e PrepareAN)NCOME3TATEMENTFOR'ARRYS'ARDEN3UPPLIESFOR*UNE F %XPLAINHOWTHE'34#LEARINGACCOUNTWOULDBEREPORTEDINTHE"ALANCE3HEETOF 'ARRYS'ARDEN3UPPLIESASAT*UNE

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

Where are we headed? After completing this chapter, you should be able to: s defineANDcalculateTHE COSTOFSTOCK s explainTHEIMPORTANCEOF ACCOUNTINGPRINCIPLESAND QUALITATIVECHARACTERISTICSIN THEVALUATIONOFSTOCK s defineANDidentifyPRODUCT ANDPERIODCOSTS s recordPRODUCTANDPERIOD COSTSINTHEJOURNALS STOCK CARDSAND'ENERAL,EDGER s reportPRODUCTAND PERIODCOSTSINTHE)NCOME 3TATEMENTAND"ALANCE 3HEET

s explainTHEEFFECTOFPERIOD COSTINGONTHEACCOUNTING EQUATIONANDACCOUNTING REPORTS s defineANDapplyTHELOWER OFCOSTAND.ET2EALISABLE 6ALUE.26 RULE s statePOSSIBLEREASONSFORA 3TOCK7RITE DOWN s recordA3TOCK7RITE DOWN INTHE'ENERAL*OURNAL STOCK CARDSAND'ENERAL,EDGER s reportA3TOCK7RITE DOWN INTHE)NCOME3TATEMENT s stateTHEEFFECTOFA 3TOCK7RITE DOWNONTHE ACCOUNTINGEQUATION

CHAPTER 14

STOCK VALUATION KEY TERMS After completing this chapter, you should be familiar with the following terms: s COSTOFSTOCK s UNITCOST s PRODUCTCOST s PERIODCOST s .ET2EALISABLE6ALUE.26 s 3TOCK7RITE DOWN ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

310

UNITS 3&4

14.1 THE COST OF STOCK (OW MUCH IS OUR STOCK WORTH )T SEEMS LIKE A FAIRLY OBVIOUS QUESTION FOR A BUSINESS OWNERTOASK ANDTHEOWNERWOULDEXPECTTHEACCOUNTANTTOBEABLETOANSWERITWITH ABSOLUTECERTAINTY!FTERALL STOCKISOFTENTHEMOSTSIGNIlCANTASSETATRADINGBUSINESS WILLHOLDAND JUSTASIMPORTANTLY ITISITSMAINSOURCEOFREVENUE3OHOWSHOULDWE VALUEOURSTOCK )FYOUUNDERSTANDTHEACCOUNTINGPRINCIPLESANDQUALITATIVECHARACTERISTICS THENTHE ANSWER SEEMS EASY ENOUGH !PPLYING THE (ISTORICAL #OST PRINCIPLE MEANS THAT STOCK SHOULD BE VALUED AT ITS ORIGINAL PURCHASE PRICE AS THIS IS VERIlABLE BY REFERENCE TO A SOURCEDOCUMENT)NTURN THISENSURESReliabilityINTHEREPORTS BECAUSETHISVALUATION WILLBEFREEFROMERRORANDBIAS )NESSENCETHEN STOCKISVALUEDBYCALCULATINGITSCOST)NMANYCASES THISWILLSIMPLY BETHEPRICECHARGEDTOUSBYOURSUPPLIER"UTINOTHERCASES THEREMAYBEOTHERCOSTS ASSOCIATEDWITHTHEPURCHASE ANDTHESEMUSTBEACCOUNTEDFORINDETERMININGTHECOST PRICEOFTHESTOCK

EXAMPLE

Sleepworld sell beds and bedroom furniture. On 18 October 2015, it purchased a new item of stock, a king-size waterbed, and incurred the following costs: Waterbed – supplier’s price Delivery to Sleepworld from supplier GST on purchase and delivery

$800 100 90

Total invoice price

$990

The bed will have a selling price of $1 200 plus $120 GST.

cost of stock all costs incurred in order to bring stock into a condition and location ready for sale

7HATISTHE@COSTOFTHEBED,ETSSTARTBYELIMINATINGTHESELLINGPRICEASAPOSSIBILITY BECAUSETHISlGUREISNOTTHEPURCHASEPRICE!VALUATIONBASEDONSELLINGPRICEWOULD DIRECTLY BREACH THE (ISTORICAL #OST PRINCIPLE (OWEVER THERE IS AN ADDITIONAL REASON NOT TO VALUE THE STOCK AT ITS SELLING PRICE THERE IS NO GUARANTEE THAT THE BED CAN BE SOLDFORTHISAMOUNT4OVALUETHEBEDATITSSELLINGPRICEWOULDBREACHTHEPRINCIPLE OF#ONSERVATISMBECAUSEITWOULDRECOGNISEAGAINTHEPROlTONTHESALEOFTHESTOCK BEFOREITISCERTAIN WHICHWOULDOVERSTATETHEVALUEOFASSETSNAMELY STOCK#LEARLY THE SELLINGPRICESHOULDnotBEUSEDTOVALUETHESTOCK 'IVENTHATWEMUSTUSETHEpurchasePRICE WHICHAMOUNTSSHOULDBEINCLUDED ,ETSSTARTWITHWHATISnotINCLUDEDTHE'34!NY'34ONTHEPURCHASEOFSTOCKWILL BEDEBITEDTOTHE'34#LEARINGACCOUNT ANDWILLSIMPLYREDUCETHELIABILITYTHEBUSINESS OWESTOTHE!4/)TDOESNOTAFFECTTHEECONOMICBENElTTOBEGAINEDWHENTHESTOCK ISSOLD "YCONTRAST THESUPPLIERSPRICEOF$800isINCLUDEDASTHISISTHEKEYCOSTOFTHEBED (OWEVER WE MUST ALSO CONSIDER THAT WITHOUT THE DELIVERY CHARGES OF $100 THE STOCK WOULDNOTBEAVAILABLETOSELLTOCUSTOMERSITISPARTOFTHEPURCHASEPRICE ANDMUSTBE INCLUDEDINTHE cost of stock

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S T O C K VA L U AT I O N

)NFACT ANYCOSTSINCURREDINORDERTOBRINGTHESTOCKINTOACONDITIONANDLOCATION READYFORSALEMUSTBEINCLUDEDINITSCOSTPRICE4HESEMAYINCLUDE s THESUPPLIERSPRICE s FREIGHTINDELIVERYTOTHElRMFROMTHESUPPLIER s MODIlCATIONS s CUSTOMSIMPORTDUTIES s ANYOTHERBUYINGEXPENSES !DDINGTOGETHERTHESUPPLIERSPRICEANDTHEDELIVERYCHARGES THECOSTOFTHEBEDIS $900OR PUTANOTHERWAY THEBEDISworth$900

The importance of an accurate calculation of cost price #ALCULATINGANACCURATECOSTPRICEFORSTOCKISIMPORTANTNOTONLYINTERMSOFVALUINGSTOCK INTHE"ALANCE3HEET BUTALSOINTERMSOFEARNINGPROlT-ANYBUSINESSESDETERMINE THEIRSELLINGPRICEBYAPPLYINGSOMESORTOFMARK UP WHICHISITSELFBASEDONTHECOST PRICE&OREXAMPLE IFAlRMAPPLIESAMARK UP ITSSELLINGPRICEWILLBETWICEITS COSTPRICE)FTHElRMCALCULATESTHECOSTPRICEOFITSSTOCKINCORRECTLY THENITMAYSET ITSSELLINGPRICESTOOHIGH LEADINGTOALOSSOFSALESVOLUME ORTOOLOW LEADINGTOAN INSUFlCIENTMARK UP 4HEUSEOFTHECOSTPRICEINSETTINGSELLINGPRICESMEANSTHATITISESSENTIALTHATTHE OWNER HAVE ACCURATE INFORMATION RELATING TO THE COST PRICE OF EACH INDIVIDUAL UNIT OF STOCK4HISISSOMETIMESKNOWNASITSunit cost

REVIEW QUESTIONS 14.1

311

STUDY TIP

)TEMSSUCHAS ADVERTISING WAGESOR FREIGHTOUTTHECOST OFDELIVERINGSTOCKTO OURCUSTOMERS ARE EXCLUDED ASTHEYARE ONLYINCURREDafter THESALE

unit cost the cost price of each individual item/unit of stock

1 DefineTHE(ISTORICAL#OSTPRINCIPLE 2 2EFERRINGTOONEQUALITATIVECHARACTERISTIC explainWHYSTOCKSHOULDBEVALUED ATITS(ISTORICAL#OST 3 ExplainWHYVALUINGSTOCKATITSSELLINGPRICEWOULDBREACH#ONSERVATISM 4 ExplainWHY'34ISEXCLUDEDFROMTHECALCULATIONOFTHECOSTOFSTOCK 5 DefineTHETERM@COSTASITISUSEDINREFERENCETOSTOCK 6 StateTHREECOSTS OTHERTHANTHESUPPLIERSPRICE WHICHMAYBEINCLUDEDIN THECOSTPRICEOFSTOCK 7 StateTWOREASONSWHYITISIMPORTANTTOHAVEANACCURATECALCULATIONOFTHE COSTPRICEOFSTOCK

14.2 PRODUCT COSTS 7EHAVEALREADYESTABLISHEDTHATTHECOSTOFSTOCKINCLUDESALLCOSTSINCURREDINORDERTO BRINGSTOCKINTOACONDITIONANDLOCATIONREADYFORSALE"UTTOCALCULATETHEUNITCOSTn THECOSTper itemnITISALSONECESSARYTHATWEAREABLETOallocateTHOSECOSTSTOEACH INDIVIDUALUNITOFSTOCK

Identifying product costs )NCLUDINGAPARTICULAREXPENSEINTHECALCULATIONOFTHEUNITCOSTOFANINDIVIDUALITEMOF STOCKREQUIRESTHATTHECOSTlTSTHEDElNITIONOFAproduct cost;THATIS ACOSTINCURREDIN ORDERTOBRINGSTOCKINTOACONDITIONANDLOCATIONREADYFORSALE WHICHCANBEALLOCATED TOINDIVIDUALUNITSOFSTOCKONALOGICALBASIS 4HISIS INEFFECT ATWO WAYTEST&IRST THECOSTMUSTBEINCURREDINORDERTOBRINGTHE STOCKINTOACONDITIONANDLOCATIONREADYFORSALE)FTHISTESTISNOTMET THECOSTCANNOT BEINCLUDEDINTHEUNITCOSTOFTHESTOCK4HISWOULDINCLUDECOSTSSUCHASTHESUPPLIERS

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party

product cost a cost incurred in order to bring stock into a condition and location ready for sale, which can be allocated to individual units of stock on a logical basis

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!NABSENCEOFALOGICAL BASISTOALLOCATECOSTS WOULDMEANTHATACOST CANNOTBETREATEDASA PRODUCTCOST ANDMUST BETREATEDASAPERIOD COSTSEEPAGE 

EXAMPLE

UNITS 3&4

PRICE FREIGHTINANDMODIlCATIONS#OSTSINCURREDONLYafterTHESTOCKISREADYFORSALE SUCHASADVERTISINGANDWAGES WOULDBEEXCLUDED /NCEITHASBEENESTABLISHEDTHATTHECOSTISINCURREDTOGETSTOCKREADYFORSALE WE MUSTDETERMINEIFITCANBEALLOCATEDTOINDIVIDUALUNITSOFSTOCKONALOGICALBASIS4HIS MEANSTHECOSTMUSTBEDIRECTLYTRACEABLETOAPARTICULARLINEOFSTOCK ANDAper item COSTCANBECALCULATEDONSOMELOGICALBASIS

On 15 April 2015, MacEvoy Golf Gear purchased 15 golf bags from Bear Industries (Ch. 51). The purchase of the golf bags showed the following: Golf bags – supplier’s price Cartage in Total – before GST GST (10%)

(15 bags @ $190 each)

Total

2 850 150 3 000 300 $3 300

4HEUNITCOSTTHATIS THECOSTPRICEOFONEGOLFBAG WOULDBECALCULATEDAS Supplier’s price Cartage in Unit cost of one bag

190 10

($150/15 bags)

$ 200

4HESUPPLIERSPRICEISOBVIOUSLYAPRODUCTCOSTITISINCURREDTOGETTHESTOCKREADY FORSALE ANDCANEASILYBEALLOCATEDTOINDIVIDUALUNITSOFSTOCKONALOGICALBASISASITIS ALREADYEXPRESSEDAS$190per bag #ARTAGEINISALSOINCURREDTOGETSTOCKREADYFORSALE BUTITAPPLIESTOTHEWHOLE PURCHASE#ANITBEALLOCATED'IVENTHATTHECARTAGEAPPLIESONLYTOTHISPURCHASE AND BAGSWEREORDERED ITISLOGICALTODIVIDETHETOTALCOST BYTHENUMBEROFBAGS PURCHASED TOCALCULATETHECOSTOFCARTAGEper bag$10 4HUS BOTHTHESUPPLIERS PRICEANDTHECARTAGEINCANBETREATEDASPRODUCTCOSTS ANDINCLUDEDINTHECOSTOF EACHBAG OR@PRODUCTHENCETHETERMPRODUCTCOST

Recording product costs "ECAUSEPRODUCTCOSTSARETREATEDASPARTOFTHEUNITCOSTOFEACHITEMOFSTOCK THEYARE NOTRECORDEDSEPARATELY BUTRATHERASPARTOFTHEVALUEOFSTOCKINTHESTOCKCARDANDTHE 3TOCK#ONTROLACCOUNT4HEYARETREATEDASPARTOFTHEASSET STOCK Stock cards )NTHESTOCKCARD THEGOLFBAGSWOULDBEVALUEDUSINGTHEPRODUCTCOSTOF$200EACH $190SUPPLIERSPRICEPLUS$10CARTAGEIN ASISSHOWNIN&IGURE

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party

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CHAPTER 14

Figure 14.1

S T O C K VA L U AT I O N

313

Stock card: product costs STOCK CARD

Stock item:

Golf bags

Location:

Storeroom

Stock code:

B140332

Supplier:

Bear Industries

IN Date

April 1 15

Details

Qty

Cost

OUT Total

Qty

Cost

BALANCE Total

Balance Ch. 51

15

200

3 000

Qty

Cost

Total

10

180

1 800

10

180

1 800

15

200

3 000

4HESUPPLIERSPRICEANDCARTAGEINARENOTIDENTIlEDSEPARATELYTHEYARENOWJUST PARTOFTHESAMECOSTPRICEOF$200 Cash Payments Journal and General Ledger *USTASTHEPRODUCTCOSTSARERECORDEDASPARTOFTHEVALUEOFSTOCKINTHESTOCKCARD SO ARETHEYRECORDEDTOGETHER ASONElGURE INTHEJOURNALSAND'ENERAL,EDGER &IGURESHOWSHOWTHEPURCHASEOFTHEGOLFBAGSWOULDBERECORDEDINTHE#ASH 0AYMENTS*OURNAL Figure 14.2

Cash Payments Journal: product costs Cash Payments Journal

Date April 15

Details

Chq. no.

Bank

Stock Control

51

3 300

Totals

25 000

Discount Revenue

Creditors Control

Stock Control

Drawings Sundries

3 000 800

19 000

3 000

GST 300

3 500

–

300

!SWITHALLPAYMENTS THEENTIREAMOUNTPAID$3 300 WOULDBEENTEREDINTHE"ANK COLUMN4HEAMOUNTINTHE3TOCK#ONTROLCOLUMN INCLUDESBOTHTHESUPPLIERS PRICE ANDTHECARTAGEIN 4HEREISNOSEPARATELEDGERACCOUNTFORCARTAGE IN ASTHISAMOUNTISINCLUDEDASPARTOFTHEVALUEOFSTOCKRECORDEDINTHE3TOCK#ONTROL ACCOUNT 4HE#ASH0AYMENTS*OURNALWOULDBEPOSTEDTOTHE'ENERAL,EDGERASUSUAL LEAVING THE3TOCK#ONTROLACCOUNTSHOWINGTHEFOLLOWING General Ledger Stock Control (A) Date

Cross-reference

April 1

Balance

30

Bank

Amount $

Date

Cross-reference

Amount $

18 000 3 000

)F THE PURCHASE WAS ON CREDIT THE EFFECT ON THE STOCK CARD AND THE 3TOCK #ONTROL ACCOUNTWOULDBETHESAME BUTTHETRANSACTIONWOULDBERECORDEDINTHE0URCHASES *OURNAL ANDCREDITEDTO#REDITORS#ONTROLINSTEADOF"ANK

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314

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

Product costs from other suppliers 4HETREATMENTOFPRODUCTCOSTSISTHESAMEEVENWHENADIFFERENTSUPPLIERPROVIDESTHE SERVICEOFDELIVERINGORMODIFYINGOURSTOCK&ORINSTANCE LETSCONTINUETOASSUMETHAT THEGOLFBAGSWEREPURCHASEDFROM"EAR)NDUSTRIES BUTASSUMETHATTHECARTAGEINWAS PROVIDEDBY'REEN3QUAREDELIVERYCOMPANY ANDPAIDFORUSING#HEQUE 4HETWOPAYMENTSAREMADETODIFFERENTSUPPLIERSBUT ASSUMINGTHECARTAGECANBE TRACEDDIRECTLYTOTHEGOLFBAGS BOTHAREFORTHESAMEORDEROFSTOCK ANDSOCANSTILL BETREATEDASPRODUCTCOSTS4HEREFORE THECOSTPRICEOFEACHGOLFBAGISSTILL$200 THE ONLYDIFFERENCEBEINGTHENEEDTORECOGNISETHATtwo paymentsWEREINVOLVEDINTHE PURCHASEOFTHESTOCK&IGURESHOWSHOWTHISWOULDBERECORDEDINTHESTOCKCARD Figure 14.3

Stock card: product costs – more than one supplier STOCK CARD

Stock item:

Golf bags

Location:

Storeroom

Stock code:

B140332

Supplier:

Bear Industries

IN Date

Details

Qty

Cost

OUT Total

Qty

Cost

BALANCE Total

April 1 Balance 15 Ch. 51/Ch. 52

15

200

3 000

Qty

Cost

Total

10

180

1 800

10

180

1 800

15

200

3 000

!SLONGASTHEYRELATETOTHESAMEITEMSOFSTOCK ALLPRODUCTCOSTSMUSTBERECORDED INTHESTOCKCARDBYADDINGTOTHECOSTPRICEOFEACHUNITOFSTOCK)NTHISEXAMPLE THE EXTRAPRODUCTCOSTTHECARTAGEIN WASINCURREDONTHEDAYTHESTOCKWASPURCHASED AND SO CAN BE RECORDED AS PART OF THE SAME LINE IN THE STOCK CARD WITH THE @$ETAILS COLUMNIDENTIFYINGBOTHSOURCEDOCUMENTS#HEQUEAND#HEQUE (ADTHESETWOPAYMENTSBEENMADEONDIFFERENTDATESSUCHAS!PRILAND!PRIL  THETRANSACTIONSWOULDBEREPORTEDSEPARATELY BUTTHEVALUEOFSTOCKWOULDSTILLEND UPAS$200 ASISSHOWNIN&IGURE Figure 14.4

Stock card: product costs – more than one supplier (different dates) STOCK CARD

Stock item:

Golf bags

Location:

Storeroom

Stock code:

B140332

Supplier:

Bear Industries

IN Date

April 1 15

17

Details

Qty

Cost

OUT Total

Qty

Balance Ch. 51

Ch. 52

15

15

190

10

2 850

150

Cost

BALANCE Total

Qty

Cost

Total

10

180

1 800

10

180

1 800

15

190

2 850

10

180

1 800

15

200

3 000

4HETRANSACTIONON!PRILDOESNOTINCREASETHEquantityOFSTOCKONHAND JUST ITSvalueFROM$190TO$200PERUNIT 

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S T O C K VA L U AT I O N

315

!SSUMINGTHEORIGINALSCENARIOnWITHBOTHPAYMENTSMADEON!PRILn&IGURE SHOWSHOWTHETWOPAYMENTSWOULDBERECORDEDINTHE#ASH0AYMENTS*OURNAL Figure 14.5

Cash Payments Journal: product costs – more than one supplier Cash Payments Journal

Date

Details

Apr. 15

Chq. no.

Bank

Discount Revenue

Creditors Control

Stock Control

Drawings

Sundries

GST

Stock Control

51

3 135

2 850

285

Stock Control

52

165

150

15

Totals

25 000

800

19 000

3 000

3 500

–

300

)F THE PURCHASE WAS MADE ON CREDIT WITH ADDITIONAL COSTS PAID IN CASH OR ALSO ON CREDIT SIMPLY RECORD THE TWO TRANSACTIONS IN THEIR APPROPRIATE JOURNAL AND SHOW THEMBOTHINTHESTOCKCARDASISSHOWNIN&IGUREORUSINGWHATEVERSOURCE DOCUMENTWOULDBEAPPROPRIATE REVIEW QUESTIONS 14.2

1 2 3 4

DefineTHETERM@PRODUCTCOST ExplainHOWPRODUCTCOSTSARERECORDEDINTHESTOCKCARDS ExplainHOWPRODUCTCOSTSARERECORDEDINTHE'ENERAL,EDGER ExplainHOWTHERECORDINGOFPRODUCTCOSTSDIFFERSIFMORETHANONESUPPLIERIS INVOLVED

14.3 PERIOD COSTS AND OTHER EXPENSES Identifying period costs )NTHEEXAMPLECONCERNINGTHEGOLFBAGS THEREWASALOGICALBASISONWHICHTOALLOCATE THECARTAGEIN SOITCOULDBEEXPRESSEDASCARTAGEper unitANDTREATEDASAPRODUCTCOST )NOTHERCASESWHERETHEREISnoLOGICALBASISFORALLOCATION THISMAYNOTBEPOSSIBLE )NCASESSUCHASTHIS THECOSTMUSTBETREATEDASAperiod cost

On 23 May 2015, MacEvoy Golf Gear purchased golf clothing from Nickwell Clothing (Ch. 65). The order showed the following: Golf shirts – supplier’s price Golf hats – supplier’s price Cartage in

(20 shirts @ $23 each) (10 hats @ $8 each)

Total – before GST GST (10%) Total

460 80 50

period cost a cost incurred in order to bring stock into a condition and location ready for sale that is not allocated to individual units of stock because there is no logical basis to do so

EXAMPLE

590 59 $649

)NTHISCASE THEREISNOLOGICALBASISTOALLOCATETHECARTAGEINOF BECAUSETHERE ARETWOdifferentTYPESOFSTOCKORDEREDGOLFSHIRTSANDGOLFHATS BOTHOFWHICHWOULD INCURCARTAGE7ECANNOTASSUMETHATTHECARTAGEINWOULDBETHESAMEFORSHIRTSAS ITISFORHATS ANDSIMPLYDIVIDETHECOSTBETWEENTHEITEMSSHIRTSANDHATS 4HEREFORE WEDONOTKNOWTHEper itemCOSTOFTHECARTAGE ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party

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STUDY TIP

"OTHPERIODAND PRODUCTCOSTSARE INCURREDTOGETSTOCK READYFORSALE SOTHIS CHARACTERISTICWILLNOT DISTINGUISHBETWEEN THETWO)TWILLONLY DISTINGUISHBETWEEN COSTSRELATEDTOSTOCK AND/THER%XPENSES SEEPAGE 

UNITS 3&4

!SARESULT WEHAVENOCHOICEBUTTOTREATTHECARTAGEINASAPERIODCOST ANDVALUE THESTOCKONLYATTHEPRICECHARGEDBYTHESUPPLIER WHICHISPERSHIRTAND$8PERHAT 4HEDISTINCTIONBETWEENPERIODANDPRODUCTCOSTSRESTSPRIMARILYONTHEEXISTENCE OFAlogical basis for allocation)FACOSTCANBEALLOCATEDONAPERUNITBASIS ITMUSTBE TREATEDASAPRODUCTCOST/NLYWHENTHISALLOCATIONISNOTPOSSIBLESHOULDTHEITEMBE TREATEDASAPERIODCOST

Recording period costs 0ERIODCOSTSAREUNABLETOBETREATEDASPARTOFTHEUNITCOSTOFEACHITEMOFSTOCK SO THEYMUSTBERECORDEDANDREPORTEDSEPARATELYFROMTHESTOCKITSELF)NFACT THEYARE TREATEDASANEXPENSE)NTERMSOFTHESTOCKCARDS THEGOLFSHIRTSWOULDBEVALUEDONLYAT THEIRSUPPLIERSPRICEOFEACH ANDTHEGOLFHATSAT$8EACH ASISSHOWNIN&IGURE Figure 14.6

Stock card: period costs STOCK CARD

Stock item:

Golf Shirt, 40 inch, Yellow

Location:

Storeroom

Stock code:

NCS40iY

Supplier:

Nickwell Clothing

IN Date

Details

May 1

Qty

OUT

Cost

Total

Qty

Cost

BALANCE Total

Balance

23

Ch. 67

20

23

460

Qty

Cost

Total

8

20

160

8

20

160

20

23

460

STOCK CARD Stock item:

Golf Hats, Large

Location:

Storeroom

Stock code:

NCHL

Supplier:

Nickwell Clothing

IN Date

Details

May 1 23

Qty

Cost

OUT Total

Qty

Cost

BALANCE Total

Balance Ch. 67

10

8

80

Qty

Cost

Total

20

7

140

20

7

140

10

8

80

"ECAUSETHECARTAGEINISNOTRECORDEDINTHESTOCKCARDS ITMUSTBERECORDEDINITS OWNSEPARATELEDGERACCOUNT&IGURESHOWSHOWTHEPURCHASEOFTHEGOLFSHIRTSAND HATSWOULDBERECORDEDINTHE#ASH0AYMENTS*OURNAL Figure 14.7

Cash Payments Journal: period costs Cash Payments Journal

Date May 23

Details

Chq. no.

Stock Control

67

Bank

Discount Revenue

Creditors Control

Stock Control

649

Drawings

GST 59

540

Cartage In Totals

Sundries

50 31 000

200

26 500

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party

540

4 051

50

59

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4HISSHOWSTHATOFTHE$649PAIDFORTHECLOTHING WASFORTHESTOCK WASFOR THECARTAGEIN ANDWAS'34"ECAUSETHECARTAGEINCANNOTBEITEMISED ITCANNOT BEINCLUDEDINTHESTOCKlGURE ANDMUSTBERECORDEDASASEPARATEEXPENSE)NTHE 'ENERAL,EDGERTHEREWOULDBEASEPARATELEDGERACCOUNTFORCARTAGEIN ASISSHOWN BELOW General Ledger Stock Control (A) Date

Cross-reference

May 1

Balance

31

Amount $

Bank

Date

Cross-reference

Amount $

Cross-reference

Amount $

18 000 540 Cartage In (E)

Date May 31

Cross-reference Bank

Amount $

Date

50

Other Expenses

STUDY TIP

/NLYCOSTSTHATAREINCURREDTOGETSTOCKREADYFORSALECANBECLASSIlEDASPRODUCTOR PERIODCOSTS#OSTSTHATAREnotRELATEDTOTHEPURCHASEOFSTOCKARENEITHERPRODUCT COSTSNORPERIODCOSTS)NSTEAD THEYARECLASSIlEDAS/THER%XPENSES &ORTHESE/THER%XPENSES THEISSUEOFALOGICALBASISFORALLOCATIONDOESNOTAPPLY !SACONSEQUENCE ITSHOULDNOTBEGIVENASAREASONFOREXCLUDINGAPARTICULARITEM FROMTHECALCULATIONOFAUNITCOSTFORSTOCK4HEIRDElNINGCHARACTERISTICISTHATRATHER THANBEINGINCURREDTOBRINGSTOCKINTOACONDITIONANDLOCATIONREADYFORSALE THEYARE INCURREDAFTERTHESALE

)TCOULDBEARGUEDTHAT ANYCOSTTHATISNOTA PRODUCTCOSTISAPERIOD COST BUTTHISCOURSE DISTINGUISHESBETWEEN PERIODCOSTSAND/THER %XPENSES

REVIEW QUESTIONS 14.3

1 DefineTHETERM@PERIODCOST 2 #OMPAREDTOPRODUCTCOSTS explainONEDIFFERENCEINTHEWAYPERIODCOSTS ARERECORDEDIN s THESTOCKCARD s THE'ENERAL,EDGER 3 ExplainWHYDELIVERYTOCUSTOMERSISNOTCONSIDEREDTOBEPARTOFTHECOST OFSTOCK

14.4 REPORTING PRODUCT AND PERIOD COSTS !SWEHAVENOTED TREATINGCOSTSASPRODUCTCOSTSISPREFERRED BECAUSEallTHECOSTS INCURREDTOGETSTOCKREADYFORSALEAREALLOCATEDDIRECTLYTOTHEITEMSOFSTOCKTHEMSELVES )FTHESTOCKISUNSOLD THEPRODUCTCOSTSAREINCLUDEDINTHEVALUEOFTHEASSET 3TOCK #ONTROL7HENTHESTOCKISSOLD THEPRODUCTCOSTSARESIMPLYINCLUDEDINTHE#OSTOF 3ALESlGURE)NFACT PRODUCTCOSTSARERECOGNISEDASBEINGINCURRED ANDTHEIRBENElT CONSUMED INTHE2EPORTING0ERIODwhen stock is sold 0ERIODCOSTS ONTHEOTHERHAND ARERECORDEDSEPARATELYINTHELEDGER ANDREPORTED UNDER THE HEADING @#OST OF 'OODS 3OLD IN THE )NCOME 3TATEMENT &URTHER THEY ARE RECOGNISEDASBEINGINCURREDINTHEPERIODINWHICHTHEstock is purchased REGARDLESS

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UNITS 3&4

OFWHETHERORNOTTHESTOCKISSOLD5NLESSALLTHESTOCKISSOLD THISWILLOVERSTATE#OSTOF 'OODS3OLDANDUNDERSTATEPROlTANDTHEREFOREOWNERSEQUITY ANDUNDERSTATEASSETS BYUNDERSTATINGTHEVALUEOFSTOCKONHAND

EXAMPLE

During October 2015, HiFi Central imported 10 CD players for $120 (plus GST) each, incurring $350 (plus GST) to have the items modified to Australian specifications. The CD players will sell for $250 (plus GST) each.

Product costing !SSUMINGTHEMODIlCATIONSWERECORRECTLY TREATEDASPRODUCTCOSTS THECOSTOFONE #$PLAYERWOULDBE Supplier’s price Plus Modifications

120 35

Unit cost of one CD player

($350/10 CD players)

$155

!SSUMINGFOUR#$PLAYERSWERESOLDDURING/CTOBER THE)NCOME3TATEMENT EXTRACT WOULDAPPEARASSHOWNIN&IGURE Figure 14.8

Income Statement: product costs HIFI CENTRAL Income Statement (extract) for October 2015

Revenue

$

Sales

$ 1 000

(4 CD players x $250)

Less Cost of Goods Sold Cost of Sales

(4 CD players x $155)

620

Gross Profit

380

0RODUCT COSTING RECOGNISES THE EXPENSE AS BEING INCURRED ONLY IN THE 2EPORTING 0ERIODWHENTHESTOCKISSOLD"ECAUSEONLYFOUROUTOF#$PLAYERSHAVEBEENSOLD ONLY 10OFTHESPENTONMODIlCATIONSHASBEENRECOGNISEDASBEINGINCURREDIN /CTOBER4HISISINCLUDEDINTHE#OSTOF3ALESlGUREOF 4HEREMAINING 10OFTHEMODIlCATIONSCOSTnyet to be incurredBECAUSETHESTOCK HASNOTYETSOLDnISINCLUDEDINTHEVALUEOFSTOCKONHANDINTHE"ALANCE3HEETATTHE ENDOF/CTOBERASISSHOWNIN&IGURE Figure 14.9

Balance Sheet: product costs HIFI CENTRAL Balance Sheet (extract) as at 31 October 2015

Current Assets Stock Control

$ (6 CD players x $155)

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930

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Period costing !SSUMINGTHESAMEDATABUTUSINGPERIODCOSTINGWOULDPRODUCEVERYDIFFERENTREPORTS 0ERIODCOSTINGWOULDnotALLOCATETHEMODIlCATIONSTOEACH#$PLAYER ANDHENCEVALUE THEMATONLYTHEIRSUPPLIERSPRICEOF$120EACH(OWEVER ITWOULDRECOGNISETHEENTIRE SPENTONMODIlCATIONSASINCURREDINTHEPERIODWHENTHESTOCKISPURCHASED4HAT IS THEENTIREWOULDBEREPORTEDASANEXPENSEIN/CTOBER SOTHE)NCOME 3TATEMENTEXTRACT WOULDAPPEARASISSHOWNIN&IGURE Figure 14.10

Income Statement: period costs HIFI CENTRAL Income Statement (extract) for October 2015

Revenue

$

Sales

$ 1 000

(4 CD players x $250)

Less Cost of Goods Sold Cost of Sales

(4 CD players x $120)

480

Modifications

350

Gross Profit

830 170

5NDERPERIODCOSTING THEENTIRECOSTOFTHEMODIlCATIONSHASBEENRECOGNISEDASAN EXPENSE EVENTHOUGHSIXREMAINUNSOLDONLY10OFTHE#$PLAYERSHAVEBEENSOLD BUT 10 10OFTHEHASBEENRECOGNISEDASBEINGINCURRED4HESIXREMAININGUNSOLD #$ PLAYERSWILLBEVALUEDONLYATTHEIRSUPPLIERSPRICEOF$120 ANDTHUSWOULDBESHOWNIN THE"ALANCE3HEETASISSHOWNIN&IGURE Figure 14.11

Balance Sheet: period costs HIFI CENTRAL Balance Sheet (extract) as at 31 October 2015

Current Assets Stock Control

$ (6 CD players x $120)

720

!COMPARISONOFPRODUCTANDPERIODCOSTINGTHUSSHOWS Product costing Income Statement Sales Cost of Goods Sold Cost of Sales Plus Period Costs Gross Profit Balance Sheet Stock Control

4 units @ $250 4 units @ $155*

Period costing $ 1 000 620

$ 4 units @ $250 4 units @ $120 Modifications

380 6 units @ $155

930

6 units @ $120

480 350

$ 1 000

830 170 720

)NCLUDESpartOFCOSTOFMODIlCATIONS

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party

Cambridge University Press

320

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

)NTHISEXAMPLE PERIODCOSTINGHASOVERSTATED#OSTOF'OODS3OLDAND ASARESULT HASUNDERSTATEDPROlTANDTHUSOWNERSEQUITY BY10UNSOLDX !TTHESAME TIME ITHASUNDERSTATED3TOCK#ONTROLANDTHUSASSETS BYTHESAMEAMOUNT BECAUSE THESIXREMAINING#$PLAYERSWILLBEONLYBEVALUEDATTHEIRSUPPLIERSPRICEOF 0ERIOD COSTING RECOGNISES THE ENTIRE COST AS AN EXPENSE IN THE 2EPORTING 0ERIOD WHENTHESTOCKISpurchased WHEREASPRODUCTCOSTINGINCLUDESTHECOSTASANEXPENSE ONLYINTHEPERIODINWHICHTHESTOCKIS sold!SARESULT UNLESSALLSTOCKISSOLD AND THISISANIMPORTANTCAVEAT PERIODCOSTINGWILLUNDERSTATE#OSTOF'OODS3OLDANDTHUS UNDERSTATE PROlT AND OWNERS EQUITY AND UNDERSTATE 3TOCK #ONTROL AND ASSETS 4HE EXACTAMOUNTBYWHICHTHESEITEMSWILLBEDIFFERENTCANBECALCULATEDBYMULTIPLYINGTHE PERIODCOSTBYTHEFRACTIONOFITEMSOFSTOCKREMAININGUNSOLD

Conclusion )FACOSTISINCURREDTOGETSTOCKREADYFORSALE ANDCANBEALLOCATEDTOINDIVIDUALUNITS ONALOGICALBASIS THENITisAPRODUCTCOST%XCEPTWHERETHECOSTISINSIGNIlCANTSEE BELOW TREATINGAPRODUCTCOSTASAPERIODCOSTLEADSTOTHEOMISSIONOFINFORMATIONTHAT WOULDBEUSEFULFORDECISION MAKING ANDTHUSBREACHESRelevance 7HERE THERE IS no LOGICAL BASIS ON WHICH TO ALLOCATE THE COST TO INDIVIDUAL UNITS PERIODCOSTINGmustBEUSED)NTHISSITUATION TREATINGAPERIODCOSTASAPRODUCTCOST WOULDLEADTOTHEINCLUSIONOFINFORMATIONTHATISnotUSEFULFORDECISION MAKING "UT EQUALLY PERIOD COSTING may BE USED IF THE COST CONCERNED CAN BE ALLOCATED BUT IS too small TO AFFECT DECISION MAKING THAT IS IS IMMATERIAL (ERE WE ARE TALKING ABOUTCOSTSTHATWOULDOTHERWISEBE CORRECTLY TREATEDASPRODUCTCOSTS BUTDUETOTHEIR INSIGNIlCANCEMAYBETREATEDASPERIODCOSTS4HEINSIGNIlCANCEOFSUCHITEMSMEANS THATITSHOULDNOTREALLYMATTERHOWTHEYARETREATED BECAUSE BYDElNITION THEYWILL NOTAFFECTDECISION MAKING REVIEW QUESTIONS 14.4

1 #OMPAREDTOPRODUCTCOSTS explainONEDIFFERENCEINTHEWAYPERIODCOSTS AREREPORTEDINTHE)NCOME3TATEMENT 2 ExplainTHEEFFECTONPROlTIFPERIODCOSTINGISUSEDINSTEADOFPRODUCTCOSTING 3 ExplainTHEEFFECTONTHE"ALANCE3HEETIFPERIODCOSTINGISUSEDINSTEADOF PRODUCTCOSTING 4 StateTWOCIRCUMSTANCESINWHICHITWOULDBEACCEPTABLETOUSEPERIODCOSTING 5 2EFERRING TO ONE QUALITATIVE CHARACTERISTIC explain WHY THE CORRECT STOCK VALUATIONMETHODSHOULDBEAPPLIED

14.5 THE LOWER OF COST AND NET REALISABLE VALUE (NRV) RULE )NTHEVASTMAJORITYOFCASES VALUINGSTOCKATITSCOSTPRICEENSURESTHATBOTHTHE(ISTORICAL #OSTAND#ONSERVATISMPRINCIPLESAREUPHELD)TISUSUALFORTHECOSTPRICEOFTHESTOCK TOBElessTHANITSSELLINGPRICE SORECORDINGITINTHESTOCKCARDSATITSORIGINALPURCHASE PRICE WHICH IS REQUIRED BY THE (ISTORICAL #OST PRINCIPLE ALSO MEANS THE STOCK IS NOT OVERSTATED WHICHISTHEGOALOF#ONSERVATISM )N SOME SITUATIONS HOWEVER THE SELLING PRICE OF THE STOCK WILL FALL below THE COST PRICEAND INSTEADOFGENERATINGAPROlTONTHESALE ITISPROBABLETHATALOSSWILLOCCUR &OR INSTANCE IF STOCK IS DAMAGED IT MAY END UP BEING SOLD FOR LESS THAN ITS ORIGINAL PURCHASEPRICE)NCASESSUCHASTHESE CONTINUINGTOVALUESTOCKATITSCOSTPRICEWOULD BREACH#ONSERVATISMINTWOWAYSITWOULDNOTRECOGNISETHELOSSTHATISPROBABLEON THESALEOFTHESTOCKANDITWOULDOVERSTATETHEASSETSTOCK INTHE"ALANCE3HEET ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party

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S T O C K VA L U AT I O N

321

4OAVOIDBREACHING#ONSERVATISM STOCKMUSTBEVALUEDATWHICHEVERISLOWERITSCOST PRICE ORWHATISKNOWNASITS.ET2EALISABLE6ALUE4HISISKNOWNASTHELOWEROFCOST AND.ET2EALISABLE6ALUE.26 RULE Stock must be valued at the lower of ‘cost’ and ‘Net Realisable Value’.

Net Realisable Value 4HESELLINGPRICEOFSTOCKISALSOKNOWNASITSREALISABLEVALUEWHATITCANREALISEINDOLLAR TERMSONITSSALE4HEOWNERMUST HOWEVER TAKEINTOACCOUNTTHATTHEREAREDIRECTCOSTS INVOLVEDINTHESALEOFPARTICULARSTOCKITEMS SUCHASMARKETINGANDDISTRIBUTION4HESE MUSTBESUBTRACTEDTODETERMINEAPARTICULARSTOCKITEMSNETWORTH HENCETHETERMNet Realisable Value (NRV).26ISTHEESTIMATEDSELLINGPRICEOFTHESTOCKLESSANYCOSTS INVOLVEDINITSSELLING MARKETINGORDISTRIBUTION)NESSENCE ITMEANSWHATWECANSELLIT FORlessWHATITWILLCOSTUSTOCARRYOUTTHESELLING

Net Realisable Value (NRV) = Estimated selling – Direct selling price expenses

Net Realisable Value (NRV) the estimated selling price of stock less any costs involved in its selling, marketing or distribution

STUDY TIP

'34 ASITAPPLIESTOEITHERTHESELLINGPRICEORTHECOSTPRICE ISNOTAFACTORTOBE CONSIDEREDINTHEVALUATIONOFSTOCK ASITAFFECTS'34CLEARING NOTSTOCKORPROlT#OST ISCALCULATEDWITHTHE'34EXCLUDED ANDSOIS.26 Reasons why NRV may fall below cost 4RADINGlRMSAIMTOGENERATEPROlTBYSETTINGTHEIRSELLINGPRICESHIGHERTHANTHECOST PRICE3O INNORMALCIRCUMSTANCES THECOSTOFTHESTOCKWOULDBElowerTHANITS.26 ANDSTOCKWILLCONTINUETOBEVALUEDACCORDINGTOITSCOSTPURCHASEPRICE (OWEVER IN SOMESITUATIONSTHE.26MAYFALLbelowCOST DUETO s physical deteriorationBECAUSETHESTOCKISDAMAGED ORSHOPSOILED MEANINGITCAN NOLONGERBESOLDATAPROlT s a purposeful decrease in selling price PERHAPSEVENBELOWCOSTPRICE ASADELIBERATE MARKETINGPLOYTOATTRACTNEWCUSTOMERSORFORCEACOMPETITOROUTOFTHEMARKET s a decrease in demandBECAUSETHEITEMISNOLONGERINFASHION ORISOUTOFSEASON #ONSEQUENTLY CUSTOMERS MAY NOT BE WILLING TO PAY HIGH PRICES 4HIS APPLIES PARTICULARLYTOCLOTHES SPORTINGEQUIPMENTANDFADS s obsolescenceBECAUSETHEITEMISTECHNICALLYOBSOLETE SUPERSEDEDBYANEWMODEL OR INTHECASEOFFOODITEMS OUTOFDATE)TEMSSUCHASTHESEWILLBEDIFlCULTTOSELL FORMORETHANTHEIRCOSTPRICE !PPLYING THE LOWER OF COST AND .26 RULE UPHOLDS #ONSERVATISM BY RECOGNISING LOSSES ON THE STOCK AS SOON AS THEY ARE PROBABLE IT ENSURES THAT STOCK AN ASSET IS NOTOVERSTATED)NTHEPROCESS AMOREREALISTICVALUATIONOFSTOCKWILLBEDERIVED AND Relevance WILL BE UPHELD AS THE INFORMATION IN THE REPORTS WILL BE MORE USEFUL FOR DECISION MAKING 4HISRULEMUSTBEAPPLIEDONANINDIVIDUALBASIS BECAUSETHECOSTPRICEOFSOMELINES OFSTOCKMAYSTILLBELOWERTHANTHEIR.264HESEITEMSWILLNEEDTOREMAINVALUEDATTHEIR COSTPRICE ANDSHOULDNOTBEWRITTENDOWN

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party

4HECOSTPRICEOFSTOCK ISITSORIGINALPURCHASE PRICEplusANYCOSTTO GETITREADYFORSALE .26ISTHEESTIMATED SELLINGPRICElessANY COSTSINVOLVEDINITSSALE

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

322

UNITS 3&4

REVIEW QUESTIONS 14.5

1 2EFERRINGTOONEQUALITATIVECHARACTERISTIC explainWHYSTOCKISUSUALLYVALUED ATITS(ISTORICAL#OST 2 ExplainTHECIRCUMSTANCESUNDERWHICHVALUINGSTOCKATITS(ISTORICAL#OSTMAY BREACH#ONSERVATISM 3 Defi[email protected] 4 ExplainWHYSTOCKWOULDNORMALLYBEVALUEDATITSCOST RATHERTHANITS.26 5 StateFOURREASONSWHY.26MAYFALLBELOWCOST 6 Explain HOW THE APPLICATION OF THE LOWER OF COST AND .26 RULE SUPPORTS #ONSERVATISM 7 ExplainWHYTHELOWEROFCOSTAND.26RULESHOULDBEAPPLIEDTOINDIVIDUAL STOCKLINES

14.6 STOCK WRITE-DOWN

Stock Write-down the expense incurred when the NRV of an item of stock falls below its original purchase price

EXAMPLE

7HENTHE.26OFASTOCKITEMFALLSbelowITSCOSTPRICE s ANEXPENSEWILLBEINCURRED INTHEFORMOFALOSSONTHESALEOFTHESTOCK s THEASSETSTOCKMUSTBE@WRITTENDOWNTOREmECTITSLOWERVALUE 4HIS IS RECOGNISED BY RECORDING A Stock Write-down WHICH IS THE EXPENSE THAT IS INCURREDWHENTHE.26OFANITEMFALLSBELOWITSCOSTPRICE4HEAMOUNTOFTHE3TOCK 7RITE DOWNCANBECALCULATEDASTHEDIFFERENCEBETWEENITSCOSTANDITS.26

During August 2015, Dave’s Discount Appliance Store had the following transactions: Aug.

1 8 23 31

Purchased 10 ‘Clarity’ dishwashers for $500 (plus GST) each (Inv. 29) Sold 4 dishwashers for $650 (plus GST) each (Rec. 17) Release of new dishwasher model – ‘Clarity Plus’ Dave decided to reduce the selling price of the remaining ‘Clarity’ dishwashers to $550 (plus GST) each, and spend $720 (plus GST) on a special advertising campaign to promote the sale (Memo 31)

'34DOESNOTAFFECTPROlTORTHEVALUATIONOFSTOCK SOITCANBEIGNOREDWHENCALCULATING BOTHTHECOSTAND.26

Calculating the NRV 4HE.26OFTHESIXREMAININGDISHWASHERSWOULDBECALCULATEDAS NRV

= = =

Estimated selling price $550 $430 per dishwasher

– –

Direct selling expenses per unit $120 ($720/6 dishwashers)

7HEN THE DISHWASHERS WERE PURCHASED ON  !UGUST  EACH WAS VALUED AT ITS COSTPRICEOF ASTHISWASNOTONLYTHE(ISTORICAL#OST BUTALSOlowerTHANTHE.26 THATIS THESELLINGPRICEOF$6504HISISTHEVALUEATWHICHEACHWOULDCONTINUETOBE SHOWNINTHESTOCKCARD ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party

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CHAPTER 14

S T O C K VA L U AT I O N

323

"Y  !UGUST  THE .26 OF EACH DISHWASHER  HAS FALLEN BELOW ITS COST  "ECAUSESTOCKMUSTBEVALUEDATTHELOWEROFCOSTAND.26 EACHDISHWASHER MUSTBEWRITTENDOWNFROMITSCOST TOITS.26 VIAA3TOCK7RITE DOWN Calculating the Stock Write-down STUDY TIP

4HE3TOCK7RITE DOWNOFEACHDISHWASHERWOULDBECALCULATEDAS Stock Write-down

= = =

Historical Cost $500 $70 per dishwasher

– –

NRV $430

'IVEN THAT THERE ARE SIX DISHWASHERS STILL ON HAND EACH OF WHICH MUST BE WRITTEN DOWNBY$70 THETOTAL3TOCK7RITE DOWNISX$70 

)FTHE3TOCK7RITE DOWN lGURETURNSOUTTOBE NEGATIVE THE.26IS greaterTHANTHECOST SO A3TOCK7RITE DOWNIS NOTNECESSARY


Recording the Stock Write-down 2EMEMBER ATTHETIMEOFPURCHASESTOCKISRECORDEDATITSCOST)FTHESTOCKMUSTBE WRITTEN DOWN TO ITS .26 THEN BOTH THE STOCK CARD AND THE 'ENERAL ,EDGER MUST BE ADJUSTED 4HE STOCK CARD FOR DISHWASHERS MUST RECORD THE WRITE DOWN per item AS IS SHOWNIN&IGURE Figure 14.12

Stock card: Stock Write-down STOCK CARD

Stock item:

Dishwasher, Clarity

Location:

Row 5, Bay 2

Stock code:

CD3000

Supplier:

Fusher and Pake

IN Date

Aug. 31 31

Details

Qty

Cost

OUT Total

Qty

Cost

BALANCE Total

Balance Memo 31

6

70

420

Qty

Cost

Total

6

500

3 000

6

430

2 580

.OTICETHATEVENTHOUGHTHISENTRYISRECORDEDINTHE/UTCOLUMNOFTHESTOCKCARD NOUNITSOFSTOCKAREACTUALLYLEAVINGTHEBUSINESSSTOCKHASBEENREDUCEDINvalue NOT INquantity%ACHDISHWASHERISWRITTENDOWNBY$70 LEAVINGEACHONEVALUEDATITS.26 OFCOSTPRICELESS$703TOCK7RITE DOWN  4HE'ENERAL*OURNALENTRYTORECORDTHEWRITE DOWNOFSTOCKATITS.26ISSHOWNIN &IGURE Figure 14.13

General Journal: Stock Write-down General Journal

Date Aug. 31

Details Stock Write-down Stock Control

General Ledger

Subsidiary ledger

Debit

Debit

Credit

Credit

420 420

Write down of 6 dishwashers to NRV – release of new model (Memo 31)

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

324

STUDY TIP

4HEAMOUNTUSEDINTHE 'ENERAL*OURNALENTRYIS THEAMOUNTOFTHE3TOCK 7RITE DOWN NOTTHE NEWBALANCEOFSTOCK ONHAND

UNITS 3&4

3TOCK 7RITE DOWN IS DEBITED TO RECOGNISE THE EXPENSE THE LOSS OF AN ECONOMIC BENElTINTHEFORMOFAREDUCTIONINASSETSSTOCK WHICHDECREASESOWNERSEQUITY!T THE SAME TIME THE ASSET 3TOCK #ONTROL IS CREDITED TO RECOGNISE THAT THE ASSET IS NO LONGERWORTHITS(ISTORICAL#OST 4HIS'ENERAL*OURNALENTRYWOULDBEPOSTEDTOTHE'ENERAL,EDGERASISSHOWNIN &IGURE Figure 14.14

General Ledger: Stock Write-down General Ledger Stock Write-down (E)

Date Aug. 31

Cross-reference

Amount $

Date

420

Aug. 31

Stock Control

Cross-reference Profit and Loss Summary

420

Amount $ 420 420

Stock Control (A) Date Aug. 1

Cross-reference

Amount $ Date

Balance

10 000

Creditors Control

11 000

Aug. 31

Cross-reference Cost of Sales

5 600

Cost of Sales

3 400

Stock Write-down Balance $21 000 Sept. 1

Balance

Amount $

420 11 580 $21 000

11 580

!SANEXPENSEACCOUNT 3TOCK7RITE DOWN WOULDBECLOSEDTOTHE0ROlTAND ,OSS3UMMARYACCOUNTATTHEENDOFTHE2EPORTING0ERIOD WITHALLTHE/THER%XPENSE ACCOUNTS)TISTHENEWSTOCKBALANCE THATMUSTBEREPORTEDINTHE"ALANCE 3HEET Effect on the accounting equation 4HEOVERALLEFFECTOFA3TOCK7RITE DOWNIS Increase/Decrease/No effect

Amount $

Assets

Decrease (Stock Control)

Liabilities

No effect

Owner’s Equity

Decrease (Stock Write-down expense decreases Profit)

420

420

REVIEW QUESTIONS 14.6

1 2 3 4

DefineTHETERM@3TOCK7RITE DOWN ShowHOWTHEAMOUNTOFA3TOCK7RITE DOWNISCALCULATED ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDA3TOCK7RITE DOWN ExplainWHYA3TOCK7RITE DOWNISRECORDEDINTHE/UTCOLUMNOFTHESTOCK CARD 5 StateTHEEFFECTOFA3TOCK7RITE DOWNONTHEACCOUNTINGEQUATION

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party

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CHAPTER 14

S T O C K VA L U AT I O N

325

14.7 REPORTING A STOCK WRITE-DOWN "ECAUSE3TOCK7RITE DOWNISNOTACOSTINVOLVEDINGETTINGTHESTOCKINTOAPOSITIONOR CONDITIONREADYFORSALE ITSHOULDNOTBECLASSIlEDUNDER#OSTOF'OODS3OLDITWILLNOT AFFECTTHEMARK UPONSTOCKWHICHISREmECTEDIN'ROSS0ROlT(OWEVER ITISrelatedTO STOCK ANDWILLAFFECTTHEOVERALLMARGINTHATTHEBUSINESSWILLEARNFROMTHESALEOFSTOCK )NTHISWAY A3TOCK7RITE DOWNHASTHESAMEEFFECTASASTOCKLOSSORGAIN ANDSOITIS REPORTEDASADEDUCTIONFROM'ROSS0ROlT TODETERMINE!DJUSTED'ROSS0ROlT &IGURESHOWSHOW3TOCK7RITE DOWNWOULDAPPEARINTHE)NCOME3TATEMENT Figure 14.15

Income Statement: Stock Write-down DAVE’S DISCOUNT APPLIANCE STORE Income Statement for August 2015

Revenue

$

$

Sales

18 500

Less Cost of Goods Sold Cost of Sales

9 000

Customs Duty

1 000

10 000

Gross Profit

8 500

Less Stock Write-down

420

Adjusted Gross Profit

8 080

STUDY TIP

.OWTHATTHEDISHWASHERSHAVEBEENWRITTENDOWN ALLSTOCKISVALUEDATTHELOWEROF COSTAND.26 ANDTHEBALANCEOFSTOCKONHANDWILLBEREPORTEDINTHE"ALANCE3HEET ASITNORMALLYWOULD

!3TOCK7RITE DOWNIS REPORTEDINTHESAME PLACEASASTOCKLOSS ORGAIN

DAVE’S DISCOUNT APPLIANCE STORE Balance Sheet (extract) as at 31 August 2015 Current Assets

$

Bank

1 200

Debtors Control

5 600

Stock Control

11 580

$

18 380

REVIEW QUESTIONS 14.7

1 ExplainWHY3TOCK7RITE DOWNISNOTREPORTEDASPARTOF#OSTOF'OODS3OLD INTHE)NCOME3TATEMENT 2 ExplainHOWA3TOCK7RITE DOWNAFFECTS!DJUSTED'ROSS0ROlT

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

326

UNITS 3&4

WHERE HAVE WE BEEN? s 4HE (ISTORICAL #OST PRINCIPLE STATES THAT STOCK SHOULD BE VALUED AT ITS ORIGINAL PURCHASEPRICE ASTHISISVERIlABLEBYREFERENCETOASOURCEDOCUMENT s 4HE COST OF STOCK INCLUDES ALL COSTS INCURRED IN ORDER TO BRING THE STOCK INTO A CONDITIONANDLOCATIONREADYFORSALE s 0RODUCTCOSTSCANBEALLOCATEDTOINDIVIDUALUNITSOFSTOCKONALOGICALBASISPERIOD COSTSCANNOT s 0RODUCTCOSTSARERECORDEDASINCREASESTOTHEUNITCOSTOFSTOCKINTHESTOCKCARDS PERIODCOSTSARERECORDEDSEPARATELYINTHELEDGER s 0RODUCTCOSTSARERECOGNISEDASBEINGINCURREDONLYINTHEPERIODINWHICHSTOCKIS SOLDPERIODCOSTSARERECOGNISEDASBEINGINCURREDINTHEPERIODINWHICHTHESTOCK ISPURCHASED s 4OAVOIDBREACHING#ONSERVATISM STOCKMUSTBEVALUEDATTHELOWEROFCOSTAND.ET 2EALISABLE6ALUE.26  s .26ISTHEESTIMATEDSELLINGPRICEOFTHESTOCKLESSANYCOSTSINVOLVEDINITSSELLING MARKETINGORDISTRIBUTION s 3TOCK7RITE DOWNISCALCULATEDBYDEDUCTING.26FROMHISTORICAL COST s 4HE OVERALL EFFECT OF A 3TOCK 7RITE DOWN IS TO DECREASE BOTH ASSETS AND OWNERS EQUITY

EXERCISES

EXERCISE 14.1 COST OF STOCK

W B

page 296

/N-ARCH %L&RESCO,IVINGHADBARBECUESONHANDWORTHEACH/N -ARCH THEBUSINESSPURCHASEDBARBECUESATACOSTOFPLUS'34 EACH WITH CARTAGEINCOSTINGPLUS'34 PERBARBECUE#H 4HEBARBECUESWILLHAVEA SELLINGPRICEOFPLUS'34 EACH Required a ExplainWHYTHE'34ONTHEPURCHASEISnotINCLUDEDINTHECALCULATIONOFTHECOST PRICEOFSTOCK b CalculateTHECOSTPRICEOFONEOFTHEBARBECUESPURCHASEDON-ARCH c 2EFERRINGTOYOURANSWERTOPART@B explainYOURTREATMENTOF@CARTAGEIN d RecordTHEPURCHASEON-ARCHINTHESTOCKCARDFORBARBECUES e Record#HEQUEINTHE#ASH0AYMENTS*OURNALOF%L&RESCO,IVING

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party

Cambridge University Press

CHAPTER 14

EXERCISE 14.2 COST OF STOCK

S T O C K VA L U AT I O N

W B

page 297

!SAT*ANUARY #OMFY#OUCHESHADEIGHTCOUCHESONHANDWITHACOSTPRICEOF EACH /N*ANUARY THEBUSINESSPURCHASEDCOUCHESFROM7ILSON0RODUCTS)NV  WITHTHEDETAILSOFTHEPURCHASEPROVIDEDASFOLLOWS Supplier’s price

15 000

Anti-stain treatment

1 300

Sub-total

16 300

GST Total invoice cost

1 630 $17 930

%ACHCOUCHHASASELLINGPRICEOFPLUS'34 WITHASPECIALADVERTISINGCAMPAIGN TOSELLTHECOUCHESCOSTINGINCLUDING'34 Required a 2EFERRINGTOONEACCOUNTINGPRINCIPLE explainWHYTHECOUCHESCANNOTBEVALUEDAT THEIRSELLINGPRICE b CalculateTHECOSTPRICEOFONEOFTHECOUCHESPURCHASEDON*ANUARY c 2EFERRING TO YOUR ANSWER TO PART @B explain YOUR TREATMENT OF THE ADVERTISING CAMPAIGN d RecordTHEPURCHASEON*ANUARYINTHESTOCKCARDFOR#OUCHES e RecordTHEPURCHASEON*ANUARYINTHEAPPROPRIATEJOURNALOF#OMFY#OUCHES

EXERCISE 14.3 PRODUCT VERSUS PERIOD COSTING

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page 298

"EN3COTTOWNSANELECTRICALSHOPCALLED(IGH6OLTAGE WHICHISTHESOLEDISTRIBUTOROFA NEWCOMBINEDWASHERDRYER4HEDETAILSOFTHENEWWASHERDRYERARE Invoice price

900

per unit

Freight in

10%

of invoice price

Modification costs

$25

per unit

Insurance of stock

$400

per month

)N.OVEMBER "ENPURCHASEDWASHERDRYERS"Y.OVEMBER OF THEWASHERDRYERSHADBEENSOLDFORPLUS'34 EACH Required a b c d e

ExplainWHYTHEMODIlCATIONCOSTSSHOULDBETREATEDASPRODUCTCOSTS ExplainWHYINSURANCEOFSTOCKMUSTBETREATEDASAPERIODCOST CalculateTHEUNITCOSTOFONEWASHERDRYER Calculate'ROSS0ROlTONWASHERDRYERSFOR.OVEMBER 2EFERRINGTOONEQUALITATIVECHARACTERISTIC explainWHYITISIMPORTANTTHATTHECOST PRICEOFSTOCKISCALCULATEDACCURATELY

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party

Cambridge University Press

327

328

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

EXERCISE 14.4 PRODUCT VERSUS PERIOD COSTS

W B

page 299

!S AT  &EBRUARY  &0 "ICYCLES HAD FOUR MOUNTAIN BIKES ON HAND THAT IT HAD PURCHASEDFORPLUS'34 EACH/N&EBRUARY &0"ICYCLESPURCHASED MOUNTAINBIKESFORATOTALCOSTOFINCLUDING'34 FROM7ONDER#YCLES)NV!  /NTHESAMEDAY &0"ICYCLESPAIDAFURTHERPLUS'34 FORSIGNWRITINGONTHE NEWBIKES#H !TTHEENDOF&EBRUARY EIGHTMOUNTAINBIKESREMAINEDON HAND Required a CalculateTHECOSTOFONEOFTHEMOUNTAINBIKESPURCHASEDON&EBRUARY b 2EFERRINGTOYOURANSWERTOPART@A explainYOURTREATMENTOFTHECOSTOFSIGNWRITING c RecordTHEPURCHASEOFSTOCKON&EBRUARYINTHESTOCKCARDFORMOUNTAIN BIKES d RecordTHEPURCHASEOFSTOCKON&EBRUARYINTHEAPPROPRIATEJOURNALSOF&0 "ICYCLES e CalculateTHEVALUEOFMOUNTAINBIKESONHANDASAT&EBRUARY f CalculateTHEVALUEOFMOUNTAINBIKESONHANDASAT&EBRUARYIFTHECOSTOF THESIGNWRITINGHADBEENTREATEDASAPERIODCOST g StateTHEEFFECTONTHEVALUATIONOFSTOCKONHANDASAT&EBRUARYIFTHECOST OFSIGNWRITINGHADBEENTREATEDASAPERIODCOST

EXERCISE 14.5 PRODUCT VERSUS PERIOD COSTS

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page 301

3TATIC 3OUND AND 6ISION COMMENCED /PERATIONS ON  !PRIL  SELLING TELEVISIONS AND STEREO SYSTEMS 4HE OWNER HAS PROVIDED THE FOLLOWING DOCUMENT RELATING TO THE PURCHASEOFSTOCKON!PRIL

Wired Electronics

TAX INVOICE Invoice 201

ABN: 66 765 400 008 89 Mill St Bendigo VIC 3550 Charge to:

Terms: 5/7, n/30

Static Sound and Vision (ABN: 12 500 438 966) Bell St, Coburg VIC 3058

Date

Details

Apr. 1

60 inch television Mini stereo system

Qty

Unit price $

$

12

650

7 800

5

300

1 500

Freight

300

Subtotal

9 600

GST

960 Total

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party

Total

$

10 560

Cambridge University Press

CHAPTER 14

S T O C K VA L U AT I O N

$URING!PRIL THREETELEVISIONSWERESOLDFORINCLUDING'34 EACH AND TWOSTEREOSYSTEMSWERESOLDFORINCLUDING'34 EACH/NETELEVISIONWASWRITTEN OFFAS3TOCK,OSSDUEAFTERITWASDROPPEDINTHESHOWROOM Required

*

a Record )NVOICEINTHEJOURNALSOF3TATIC3OUNDAND6ISION b 2EFERRINGTOYOURANSWERTOPART@A explainYOURTREATMENTOFFREIGHT c PrepareAN)NCOME3TATEMENTFOR3TATIC3OUNDAND6ISIONFOR!PRIL SHOWING 'ROSS0ROlTAND!DJUSTED'ROSS0ROlT!FULL)NCOME3TATEMENTISnotREQUIRED d ExplainHOWPERIODCOSTSCANUNDERSTATEPROlT

EXERCISE 14.6 PRODUCT VERSUS PERIOD COSTS

W B

page 303

.ORDIC3UPPLIESPURCHASESSKIGOGGLESINSHIPMENTSOFUNITS4HEYARESOLDUNDER .ORDIC 3UPPLIES OWN BRAND NAME AND FREE DELIVERY IS OFFERED TO CUSTOMERS 4HE FOLLOWINGDETAILSHAVEBEENPROVIDEDFORAPURCHASEON*ULYAMOUNTSDOnot INCLUDE'34  Supplier’s invoice price Attachment of brand badges Packaging and delivery to Nordic Supplies Cost of delivery to customers Insurance of stock in Nordic Supplies store

$9 000 80 1 600 9 1 800

per unit per annum

Additional information: s $URING*ULY PAIRSOFGOGGLESWERESOLD s 4HEACCOUNTANTHASDECIDEDTOTREATTHECOSTOFATTACHINGTHEBRANDBADGESASA PERIODCOST Required a DiscussTHEACCOUNTANTSDECISIONTOTREATTHECOSTOFATTACHINGTHEBRANDBADGESAS APERIODCOST b CalculateTHECOSTPRICEOFEACHPAIROFGOGGLESPURCHASEDON*ULY c 2EFERRINGTOYOURANSWERTOPART@B explainYOURTREATMENTOFINSURANCEOFSTOCK d Calculate#OSTOF'OODS3OLDFORGOGGLESFOR*ULY e Calculate#OSTOF'OODS3OLDFORGOGGLESFOR*ULYIFPACKAGINGANDDELIVERY HADBEENTREATEDASAPERIODCOST f StateTHEEFFECTONTHEACCOUNTINGEQUATIONOF.ORDIC3UPPLIESIFPACKAGINGAND DELIVERYHADBEENTREATEDASAPERIODCOST

EXERCISE 14.7 LOWER OF COST AND NRV

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page 304

$URING  -ALCOLMS -EMORABILIA PURCHASED COMMEMORATIVE PLATES OF !USTRALIAS lRST7ORLD#UPQUALIlCATIONINYEARS!SAT-AYITSTILLHADPLATESONHAND EACHWITHACOSTPRICEOF4HEPLATESWEREORIGINALLYSOLDFORPLUS'34 BUTON  -AY  THE OWNER ESTIMATED THEY COULD BE SOLD FOR ONLY  PLUS '34 EACH -EMO  Required a CalculateTHEVALUEOFPLATESONHANDASSHOWNINTHESTOCKCARDAT-AY b 2EFERRINGTOONEACCOUNTINGPRINCIPLE explainWHYTHEPLATESSHOULDBEVALUEDAT THELOWEROFCOSTAND.26 ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party

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c CalculateTHETOTAL3TOCK7RITE DOWNONTHEPLATESASAT-AY d ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDTHE3TOCK7RITE DOWNOFTHE PLATES e RecordTHE3TOCK7RITE DOWNINTHESTOCKCARDFORPLATES f Explain HOW THE 3TOCK 7RITE DOWN WILL AFFECT THE "ALANCE 3HEET OF -ALCOLMS -EMORABILIAASAT-AY

EXERCISE 14.8 LOWER OF COST AND NRV

W B

page 306

3UKHVEER 'UNERATNE OWNS 3IR 6AYLANCE A SHOP THAT SELLS SECURITY CAMERAS !S AT 3EPTEMBER THElRMHAD6IEWMASTERVIDEOCAMERASINSTOCK VALUEDAT EACH/N3EPTEMBER SIXVIDEOCAMERASWERESOLDFORPLUS'34 EACH 2EC /N3EPTEMBER THEOWNERDECIDEDTOLOWERTHESELLINGPRICEOFTHE REMAININGCAMERASTOPLUS'34 EACH-EMO 4OENCOURAGETHESALEOFTHESE CAMERASTOMAKEWAYFORNEWSTOCKSHEHASOFFEREDHERSALESSTAFFCOMMISSIONON EACHSALE Required

*

a Defi[email protected].26  b CalculateTHETOTAL.26OFTHECAMERAS c ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDTHE3TOCK7RITE DOWNOFTHE CAMERAS d RecordTHETRANSACTIONSFOR3EPTEMBERINTHESTOCKCARDFORCAMERAS e PrepareAN)NCOME3TATEMENTFOR3IR6AYLANCEFOR3EPTEMBER WHICHSHOWS 'ROSS0ROlTAND!DJUSTED'ROSS0ROlT!FULL)NCOME3TATEMENTISnotREQUIRED

EXERCISE 14.9 LOWER OF COST AND NRV

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page 308

'IRLFRIEND&ASHIONSHASPROVIDEDTHEFOLLOWINGINFORMATIONAFTERCONDUCTINGASTOCKTAKE ON$ECEMBER-EMO  Cost price per unit

Estimated selling price per unit

Direct selling expenses per unit

Stock item

Qty

Jeans

200

$50

$75

$5

Shirts

50

$35

$40

$8

Hats

400

$20

$28

$3

Required a CalculateTHEVALUEOFSTOCKONHANDASAT$ECEMBERASWOULDBESHOWNIN THESTOCKCARDS b CalculateTHEVALUEOFSTOCKONHANDASAT$ECEMBERBYAPPLYINGTHELOWER OFCOSTAND.26RULE c State THREE REASONS THAT MAY EXPLAIN WHY THE .26 OF THE STOCK HAS FALLEN BELOW ITSCOST d Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO WRITE DOWN THE VALUE OF STOCK ON $ECEMBER.ARRATIONIS notREQUIRED e RecordTHE3TOCK7RITE DOWNINTHEAPPROPRIATESTOCKCARD f StateTHEEFFECTONTHEACCOUNTINGEQUATIONOF'IRLFRIEND&ASHIONSIFTHESTOCKISnot WRITTENDOWN ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party

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CHAPTER 14

S T O C K VA L U AT I O N

EXERCISE 14.10 LOWER OF COST AND NRV

W B

page 310

(IGH#OUNTRY#AMPINGHASPRODUCEDTHEFOLLOWINGINFORMATIONREGARDINGITSSTOCKOF SNOWJACKETSASAT/CTOBER Snow jackets:

Stock on hand

50 @ $70

3 500

20 @ $72

1 440

4HE NORMAL SELLING PRICE OF EACH JACKET IS  PLUS  '34 EACH BUT AS IT IS NEARINGTHEENDOFTHESKISEASON THEOWNERESTIMATESEACHJACKETWILLONLYSELLFOR PLUS'34 EACH-EMO 4HISWILLREQUIREEXTRASELLINGEXPENSESCOSTING PLUS'34  Required a ReferringTOONEACCOUNTINGPRINCIPLE explainWHYITWOULDBEINCORRECTTOVALUE THEJACKETSATEACH b ReferringTOONEQUALITATIVECHARACTERISTIC explainWHYTHEJACKETSSHOULDNOLONGER BEVALUEDATTHEIR(ISTORICAL#OST c CalculateTHE3TOCK7RITE DOWNONSNOWJACKETSASAT/CTOBER d ShowTHE'ENERAL*OURNALENTRIESNECESSARYTOWRITEDOWNTHESNOWJACKETSASAT /CTOBER e RecordTHE3TOCK7RITE DOWNINTHESTOCKCARDFORSNOWJACKETS

EXERCISE 14.11 PRODUCT VERSUS PERIOD COSTS

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page 312

/N!UGUST 3UAVE3UITSHADPUREWOOLSUITSONHAND WHICHITHADPURCHASED FORPLUS'34 EACHDURING*ULY4HEFOLLOWINGTRANSACTIONSOCCURREDDURING !UGUST

Woollen Mills Australia

TAX INVOICE Invoice: 85

Quality Clothing

Original ABN: 45 111 981 342 Charge to:

Date 3/8/15

less

Woollen Mills Australia Terms: 10/7, n/30

Suave Suits (ABN: 44 505 612 349) Geelong VIC 3220 Details

Qty

Unit price $

Total $

Pure wool suits

16

175

2 800

Tailoring costs

480

Sales discount

80

Subtotal plus

3 200

GST Total

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party

320 $

3 520

Cambridge University Press

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/N!UGUST 3UAVE3UITSPAID7OOLLEN-ILLS!USTRALIA RECEIVINGA DISCOUNTFOREARLYPAYMENT!TTHEENDOF!UGUST FOUROFTHESUITSPURCHASEDON !UGUSTREMAINEDONHAND Required a CalculateTHECOSTOFONEOFTHESUITSPURCHASEDON!UGUST b RecordTHEPURCHASEOFSTOCKON!UGUSTINTHESTOCKCARDFORWOOLSUITS c ReferringTOYOURANSWERTOPART@B explainYOURTREATMENTOFTHEDISCOUNTFOREARLY PAYMENT d RecordTHEPURCHASEOFSTOCKON!UGUSTINTHEAPPROPRIATEJOURNAL e ExplainTHEEFFECTONTHE"ALANCE3HEETOF3UAVE3UITSASAT!UGUSTIFTHE TAILORINGCOSTSHADBEENTREATEDASPERIODCOSTS f 'IVENTHATTHEDISCOUNTAND'34AREBOTHAPPLIEDATARATEOF explainWHYTHE DOLLARAMOUNTOFTHEDISCOUNTISGREATERTHANTHEDOLLARAMOUNTOF'34

EXERCISE 14.12 RECORDING AND REPORTING FOR STOCK

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page 314

:IPPY 3COOTERS SELLS ONE TYPE OF SCOOTER TO SELECTED RETAIL STORES 4HE SCOOTERS ARE MANUFACTUREDBY"8"IKESIN7ANGARATTAANDDELIVEREDTOTHESHOPIN#ARLTONINLOTSOF lVE4HEFOLLOWINGTRANSACTIONSTOOKPLACEDURING*ULY July 1 5 12

Stock on hand: 16 scooters valued at $1 800 each Credit sale of 9 scooters for $3 000 (plus GST) each (Inv. V23) Purchase of 5 scooters at $1 400 each plus $2 000 freight (Inv. 42). Total GST on the purchase amounted to $900. A local mechanic was paid $110 (including GST) per scooter to fit each one with a sports kit (Ch. 188)

14

A customer, J. Fangio, returned a scooter due to a faulty engine (CN 17) and received a credit for $3 000 plus GST

16

Faulty scooter returned to the manufacturer; Zippy Scooters received a credit note for $1 980 including GST (CN 922)

26

Credit sale of 9 scooters for $3 300 (including GST) per bike (Inv. V24)

31

Stocktake revealed three scooters on hand, but one is scratched and damaged, and can only be sold for $1 200 (Memo 36)

Required

*

a CalculateTHECOSTPRICEOFEACHSCOOTERPURCHASEDON*ULY b 2EFERRING TO YOUR ANSWER TO PART @A explain YOUR TREATMENT OF THE COST OF THE SPORTSKIT c 2EFERRINGTOONEACCOUNTINGPRINCIPLE explainWHY-EMOSHOULDBERECOGNISED INTHElNANCIALREPORTSOF:IPPY3COOTERS d RecordTHETRANSACTIONSFOR*ULYINTHESTOCKCARDFORSCOOTERS e Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO RECORD THE TRANSACTIONS ON   AND*ULY f PrepareAN)NCOME3TATEMENTFOR:IPPY3COOTERSFOR*ULY WHICHSHOWS'ROSS 0ROlTAND!DJUSTED'ROSS0ROlT!FULL)NCOME3TATEMENTISnotREQUIRED g StateTHEEFFECTONTHE"ALANCE3HEETOF:IPPY3COOTERSASAT*ULYIFTHECOST OFTHESPORTSKITHADBEENTREATEDASAPERIODCOST h Discuss WHETHERTHEDAMAGEDSCOOTERSHOULDBERECORDEDINASEPARATESTOCKCARD

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party

Cambridge University Press

Where are we headed? After completing this chapter, you should be able to: s identifyAND record THE CREDITPURCHASEOFANON CURRENTASSETINTHE'ENERAL *OURNALAND'ENERAL,EDGER s distinguishBETWEEN #REDITORS#ONTROLANDA SUNDRYCREDITOR s record APAYMENTTOASUNDRY CREDITORINTHE#ASH0AYMENTS *OURNALAND'ENERAL,EDGER s reportAPAYMENTTOASUNDRY CREDITORINTHE#ASH&LOW 3TATEMENT s defineANDidentifyTHECOST OFANON CURRENTASSET s define ‘DEPRECIATIONAND OTHERRELATEDTERMS s explain THEPURPOSE OFDEPRECIATIONANDITS RELATIONSHIPTOACCOUNTING PRINCIPLESANDQUALITATIVE CHARACTERISTICS s calculate DEPRECIATIONUSING THEREDUCINGBALANCEMETHOD

s justify THESELECTIONOFA PARTICULARDEPRECIATION METHOD s explain THEEFFECTONTHE ACCOUNTINGREPORTSOFUSING DIFFERENTDEPRECIATION METHODS s recordACASHSALEOFA DEPRECIABLENON CURRENTASSET INTHEJOURNALSAND'ENERAL ,EDGER s recordATRADE INOFA DEPRECIABLENON CURRENTASSET INTHE'ENERAL*OURNALAND 'ENERAL,EDGER s reportAPROlTORLOSS ONTHEDISPOSALOFANON CURRENTASSETINTHE)NCOME 3TATEMENT s identifyANDexplainTHE REASONSFORAPROlTORLOSSON THEDISPOSALOFANON CURRENT ASSET

CHAPTER 15

ACCOUNTING FOR NON-CURRENT ASSETS KEY TERMS After completing this chapter, you should be familiar with the following terms: s DEPRECIATION s DEPRECIATIONEXPENSE s LOSSONDISPOSALOFASSET s PROlTONDISPOSALOFASSET s TRADE IN s UNDER DEPRECIATION s OVER DEPRECIATION ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

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15.1 CREDIT PURCHASES OF NON-CURRENT ASSETS 'IVENTHELARGEOUTLAYSOFCASHTHATARESOMETIMESNECESSARYTOPURCHASENON CURRENT ASSETS SUCH AS VEHICLES FURNITURE OR EQUIPMENT MANY BUSINESSES NOW CHOOSE TO PURCHASETHESEITEMSONCREDIT4HISALLOWSTHEMTOREPAYTHECREDITORININSTALMENTS RATHERTHANINONELARGEPAYMENT

Given the large outlays of cash that are sometimes required to purchase noncurrent assets, such as vehicles, many businesses now choose to purchase these items on credit

7HEREABUSINESSPURCHASESANON CURRENTASSETONCREDIT THETRANSACTIONMUSTBE RECORDEDINTHE'ENERAL*OURNALBEFOREITISPOSTEDTOTHE'ENERAL,EDGER

EXAMPLE

On 4 July 2015 an invoice for $1 650 was received from Max’s Mart for $1 500 worth of office furniture, plus $150 GST (Inv. A13).

4HISTRANSACTIONWOULDBERECORDEDINTHE'ENERAL*OURNALASSHOWNIN&IGURE Figure 15.1

General Journal: credit purchase of a non-current asset General Journal General Ledger

Date

Details

July 4

Office Furniture GST Clearing Sundry Creditor – Max’s Mart

Debit

Credit

Subsidiary ledger Debit

Credit

1 500 150 1 650

Credit purchase of office furniture (Inv. A13)

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

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CHAPTER 15

ACCOUNTING FOR NON-CURRENT ASSETS

335

!S THE BUSINESS HAS ACQUIRED A NEW ASSET /FlCE &URNITURE IS DEBITED   TO INCREASETHISASSET AND'34#LEARINGISDEBITED TODECREASETHELIABILITYOWED TOTHE!4/"OTHTHECOSTOFTHE/FlCE&URNITUREANDTHE'34AREOWEDTO-AXS-ART SOTHESUMOFTHESETWOlGURES ISCREDITEDTOANEWLIABILITY ACCOUNTCALLED3UNDRY#REDITORn-AXS-ART 4HISENTRYWOULDBEPOSTEDTOTHE'ENERAL,EDGERACCOUNTSASSHOWNIN&IGURE Figure 15.2

General Ledger: credit purchase of a non-current asset General Ledger Office Furniture (A)

Date

Cross-reference

July 1

Balance

31

Sundry Creditor – Max’s Mart

Amount $

Date

Cross-reference

Amount $

Date

Cross-reference

Amount $

Balance

26 000 1500 GST Clearing (A/L)

Date July 31

Cross-reference

Amount $

Bank

600

July 1

Creditors Control

800

31

Sundry Creditor – Max’s Mart

150

690

Bank

1 100

Debtors Control

1 900

Sundry Creditor – Max’s Mart (L) Date

Cross-reference

Amount $

Date

Cross-reference

Amount $

July 31

Office Furniture/ GST Clearing

1 650

4HE CROSS REFERENCE ON THE CREDIT SIDE OF THE SUNDRY CREDITOR ACCOUNT REFERS TO /FlCE &URNITURE/'34 #LEARING TO REmECT THAT THE CREDITOR IS OWED AN AMOUNT FOR THE ASSET ANDALSOTHE'34ONTHEPURCHASEOFTHATASSET

Sundry creditors )N THE EXAMPLE ABOVE THE AMOUNT OWING WAS NOT CREDITED TO THE #REDITORS #ONTROL ACCOUNT BUTRATHERTOANEWLIABILITYACCOUNTCALLED3UNDRY#REDITORn-AXS-ART4HISIS BECAUSETHE#REDITORS#ONTROLACCOUNTISUSEDONLYFORAMOUNTSOWEDFORTHEPURCHASE OFSTOCK7HEREAlRMPURCHASESANASSETOTHERTHANSTOCK ASEPARATESUNDRYCREDITOR ACCOUNT WHICHNAMESTHESUNDRYCREDITOR MUSTBECREATEDINTHE'ENERAL,EDGER4HE SUNDRYCREDITORISSTILLACURRENTLIABILITY BUTHASITSOWNACCOUNTINTHE'ENERAL,EDGER ANDWOULDBEREPORTEDSEPARATELYINTHE"ALANCE3HEET "ECAUSE THEY ARE SEPARATE TO THE #REDITORS #ONTROL ACCOUNT PAYMENTS MADE TO THESE SUNDRY CREDITORS MUST BE RECORDED IN THE 3UNDRIES RATHER THAN THE #REDITORS #ONTROL COLUMNOFTHE#ASH0AYMENTS*OURNAL!NDBECAUSESUCHAPAYMENTWOULDBE ACASHOUTmOWRELATEDTOTHEPURCHASEOFANON CURRENTASSET ITWOULDBEREPORTEDAS AN)NVESTINGOUTmOWINTHE#ASH&LOW3TATEMENT

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

STUDY TIP

!BUSINESSMAYHAVE MORETHANONESUNDRY CREDITOR SOTHENAME OFEACHSUNDRYCREDITOR MUSTALWAYSBE IDENTIlED

STUDY TIP

7ENOWHAVETWO )NVESTINGOUTmOWSIN THE#ASH&LOW 3TATEMENTCASH PURCHASEOFNON CURRENT ASSET ANDPAYMENTTO SUNDRYCREDITOR

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CAMBRIDGE VCE ACCOUNTING

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UNITS 3&4

The cost of a non-current asset !SWEALREADYKNOW THECOSTOFANASSETINCLUDESALLCOSTSINCURREDINORDERTOBRINGTHE ASSETINTOALOCATIONANDCONDITIONREADYFORUSETHATWILLPROVIDEABENElTFORTHELIFE OFTHEASSET3EE#HAPTERFORAREMINDER 4HISWILLOBVIOUSLYINCLUDETHESUPPLIERS PRICE BUTMAYALSOINCLUDECOSTSSUCHASDELIVERY MODIlCATIONANDINSTALLATION7HERE THESEOTHERCOSTSEXIST THEYMUSTBEINCLUDEDINTHECOSTPRICEOFTHEASSETRECORDEDIN THE'ENERAL*OURNAL

EXAMPLE

On 12 March 2015, Johnson’s Deliveries purchased a new delivery van on credit from Jane Motors. The invoice (Inv. 42) showed: Delivery van Shelving (installed) Service contract (12 months) GST Invoice total

$21 000 500 800 2 230 $24 530

Costs such as delivery, modification and installation are included in the cost of a non-current asset if they will bring a benefit over its useful life

!SITISANON CURRENTASSET THECOSTOFTHEVANINCLUDESALLCOSTSTHATWILLEXTENDOVER ITSLIFE Delivery van Plus Shelving

$21 000 500

Cost of van

$21 500

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 15

ACCOUNTING FOR NON-CURRENT ASSETS

)NCONTRAST THESERVICECONTRACTDOESNOTEXTENDFORTHELIFEOFTHEASSET SOITISNOT PARTOFTHECOSTOFTHEDELIVERYVAN!SAMONTHCONTRACT ITISINSTEADACURRENTASSET Prepaid Service Contract )T MAY NOT YET BE PAID BUT WHEN THE CASH IS PAID TO THE CREDITORTOSETTLETHEDEBT WILLBEFORTHEPURCHASEOFTHISCURRENTASSET 4HE'ENERAL*OURNALENTRYTORECORDTHECREDITPURCHASEOFTHEDELIVERYVANISSHOWN IN&IGURE Figure 15.3

General Journal: credit purchase of a non-current asset (with other costs) General Journal General Ledger

Date

Details

March 12

Delivery Van

Debit

Credit

Subsidiary ledger Debit

Credit

21 500

Prepaid Service Contract

800

GST Clearing

2 230

Sundry Creditor – Jane Motors

24 530

Credit purchase of delivery van (Inv. 42)

4HISENTRYWOULDBEPOSTEDTOTHE'ENERAL,EDGERACCOUNTSASSHOWNIN&IGURE Figure 15.4

General Ledger: credit purchase of a non-current asset (with other costs) General Ledger Delivery Van (A)

Date Mach 31

Cross-reference

Amount $

Sundry Creditor – Jane Motors

Date

Cross-reference

Amount $

Cross-reference

Amount $

21 500 Prepaid Service Contract (A)

Date March 31

Cross-reference

Amount $

Sundry Creditor – Jane Motors

Date

800 GST Clearing (A/L)

Date March 31

Cross-reference

Amount $

Date

Cross-reference

Bank

610

March 1

Creditors Control

950

31

Sundry Creditor – Jane Motors

2 230

Balance

Amount $ 720

Bank

1 320

Debtors Control

1 640

Sundry Creditor – Irene Motors (L) Date

Cross-reference

Amount $

Date

Cross-reference

July 31

Van/Prepaid Service Contract/ GST Clearing

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Amount $ 24 530

Cambridge University Press

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UNITS 3&4

4HEFULLCOSTOFTHEVANISDEBITEDTO$ELIVERY6AN THEPrepaid Service ContractISDEBITED$800 ANDTHETOTAL'34ONTHEVAN SHELVINGANDSERVICECONTRACT IS DEBITED TO '34 #LEARING    4HE TOTAL INVOICE PRICE   IS CREDITED TO 3UNDRY#REDITORn*ANE-OTORSTOSHOWTHETOTALOWINGFORTHEVAN THESERVICECONTRACT ANDTHE'34

REVIEW QUESTIONS 15.1

1 ExplainONEREASONWHYAlRMMAYCHOOSETOUSECREDITTOPURCHASEANON CURRENTASSET 2 ExplainWHYACREDITPURCHASEOFANON CURRENTASSETMUSTBERECORDEDINTHE 'ENERAL*OURNAL 3 ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDACREDITPURCHASEOFA NON CURRENTASSET 4 ExplainTHEDIFFERENCEBETWEEN#REDITORS#ONTROLANDASUNDRYCREDITOR 5 ExplainHOWAPAYMENTTOASUNDRYCREDITORWOULDBE s RECORDEDINTHE#ASH0AYMENTS*OURNAL s REPORTEDINTHE#ASH&LOW3TATEMENT 6 Define THETERM@COSTASITREFERSTONON CURRENTASSETS

15.2 DEPRECIATION OF NON-CURRENT ASSETS depreciation the allocation of the cost of a non-current asset over its useful life depreciation expense that part of the cost of a non-current asset that has been consumed in the current Reporting Period

#HAPTERINTRODUCEDTHEPROCESSOFdepreciationFORNON CURRENTASSETS4HISPROCESS IS APPLIED BECAUSE ALTHOUGH NON CURRENT ASSETS PROVIDE AN ECONOMIC BENElT FOR MORE THAN  MONTHS THROUGH THEIR CONTRIBUTION TO REVENUE MOST DO NOT PROVIDE AN ECONOMIC BENElT FOREVER THEY HAVE A lNITE USEFUL LIFE 4HIS MEANS THAT GRADUALLY OVER THEIR USEFUL LIFE THEIR VALUE IS BEING CONSUMED BY THE BUSINESS 4HE PROCESS OF DEPRECIATIONISAPPLIEDASAMECHANISMFORCALCULATING depreciation expense WHICHIS THATPARTOFTHECOSTOFANON CURRENTASSETTHATHASBEENCONSUMED ORINCURRED INTHE CURRENT2EPORTING0ERIOD 4HE'ENERAL*OURNALENTRIESTORECORDDEPRECIATIONEXPENSEARE $2 #2

carrying value the value of a non-current asset that is yet to be consumed/allocated as an expense, plus any residual value

$EPRECIATIONn.ON #URRENT!SSET% !CCUMULATED$EPRECIATIONn.ON #URRENT!SSETn!

4HIS BALANCE DAY ADJUSTMENT HAS THE EFFECT OF INCREASING EXPENSES IN THE )NCOME 3TATEMENT)TALSODECREASESTHEcarrying valueOFTHENON CURRENTASSETINTHE"ALANCE 3HEET BYINCREASINGTHENEGATIVEASSETOF accumulated depreciation !S A RESULT DEPRECIATION EXPENSE ENSURES THE ACCURATE CALCULATION OF PROlT BY COMPARINGREVENUESEARNEDAGAINSTEXPENSESINCURREDINTHECURRENT2EPORTING0ERIOD )TALSOENSURESTHATTHEREPORTSTHE)NCOME3TATEMENTANDTHE"ALANCE3HEET INCLUDEALL INFORMATIONTHATISUSEFULFORDECISION MAKING THEREFOREUPHOLDING2ELEVANCE

accumulated depreciation the value of a non-current asset that has been consumed/incurred over its life thus far

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

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CHAPTER 15

ACCOUNTING FOR NON-CURRENT ASSETS

REVIEW QUESTIONS 15.2

1 DefineTHEFOLLOWINGTERMS s DEPRECIATION s DEPRECIATIONEXPENSE s ACCUMULATEDDEPRECIATION s CARRYINGVALUE 2 ShowTHE'ENERAL*OURNALENTRIESTORECORDTHEBALANCEDAYADJUSTMENTFOR DEPRECIATIONEXPENSE 3 StateTHEEFFECTOFDEPRECIATIONONTHEACCOUNTINGEQUATION 4 2EFERRINGTOONEACCOUNTINGPRINCIPLE explainTHEPURPOSEOFDEPRECIATINGA NON CURRENTASSET

15.3 METHODS OF DEPRECIATION #HAPTERINTRODUCEDONLYONEMETHODOFDEPRECIATIONTHESTRAIGHT LINEMETHOD

Straight-line method 5NDERTHESTRAIGHT LINEMETHOD DEPRECIATIONEXPENSEISCALCULATEDUSINGTHESTRAIGHT LINEFORMULA Depreciation expense: straight-line formula $EPRECIATIONEXPENSEPERANNUM



(#n26 ,IFE

Where:

HC



Historical Cost: THEORIGINALPURCHASE PRICEOFTHENON CURRENTASSET

RV



residual value: THEESTIMATEDVALUEOF THENON CURRENTASSETATTHEENDOFITS USEFULLIFE

Life



useful life: THEESTIMATEDPERIODOF TIMEFORWHICHTHENON CURRENTASSET WILLBEUSEDBYTHECURRENTENTITYTO EARNREVENUE4HISISUSUALLYMEASURED INYEARS

!LTERNATIVELY STRAIGHT LINE DEPRECIATION COULD BE CALCULATED USING THE STRAIGHT LINE RATEFORMULA

Depreciation expense: straight-line rate formula $EPRECIATIONEXPENSEPERANNUM (ISTORICAL#OSTX$EPRECIATION RATE

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

339

340

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

4HE ASSUMPTION MADE BY THIS METHOD OF DEPRECIATION IS THAT THE ASSET BEING DEPRECIATED WILL contribute evenly to revenue DOING THE SAME JOB WHEN IT IS OLD AS WHENITISNEW4YPICALLY THISWOULDINCLUDEASSETSWITHFEWMOVINGPARTS SUCHAS/FlCE &URNITURE ANDlXTURESANDlTTINGS4HEVALUEOFANASSET ASMEASUREDBYITSCOST THAT CONTRIBUTESEVENLYTOREVENUEISTHEREFOREconsumed evenly over its useful life. 4HISIS RECOGNISEDBYTHEFACTTHATOVERTHELIFEOFTHEASSETTHESTRAIGHT LINEMETHODALLOCATES DEPRECIATIONEVENLYTHATIS BYTHESAMEAMOUNTEACHYEAR)NTHISWAY THESTRAIGHT LINE METHODATTEMPTSTOMATCHTHEDEPRECIATIONEXPENSEINCURREDAGAINSTTHEREVENUETHAT THENON CURRENTASSETHASEARNEDINEACH2EPORTING0ERIOD

Reducing balance method .OT ALL ASSETS CONTRIBUTE TO REVENUE EVENLY OVER THEIR LIVES !N ASSET WITH MOVING PARTSSUCHASEQUIPMENT APHOTOCOPIERORAVEHICLE ISLIKELYTOBEMOREEFlCIENTAND PRODUCTIVEWHENITISNEW ANDTHEREFOREcontribute more to revenue at the start of its useful life THANATITSEND4HEVALUECOST OFANASSETTHATCONTRIBUTESMORETOREVENUE WHENITISNEWANDLESSASITAGES ISTHEREFOREconsumed more at the start of its useful lifeTHANATITSEND ANDTHISMUSTBEREmECTEDBYTHEDEPRECIATIONEXPENSE 4HEREDUCINGBALANCEMETHODOFDEPRECIATIONASSUMESTHATTHEASSETWILLCONTRIBUTE MORE TO REVENUE AT THE START OF ITS LIFE WHEN IT IS NEW EFlCIENT AND PRODUCTIVE !S A CONSEQUENCE THIS METHOD ALLOCATES MORE DEPRECIATION EXPENSE AT THE START OF THE ASSETSLIFE5NDERTHISMETHOD ASTHEASSETAGES ITSCONTRIBUTIONTOREVENUEDECREASES ANDSOTOODOESTHEDEPRECIATIONEXPENSE 5SINGTHEREDUCINGBALANCEMETHODENSURESTHATTHEDEPRECIATIONEXPENSEANDTHE REVENUETHEASSETEARNSAREMATCHEDINEACH2EPORTING0ERIOD"OTHAREHIGHERATTHE START BUTREDUCEOVERTHELIFEOFTHEASSET

REVIEW QUESTIONS 15.3

1 ShowTHEFORMULAFORCALCULATINGDEPRECIATIONUNDERTHESTRAIGHT LINEMETHOD USINGTHE s USEFULLIFE s RATEOFDEPRECIATION 2 StateTHEASSUMPTIONTHATUNDERLIESTHESTRAIGHT LINEMETHODOFDEPRECIATION INRELATIONTOHOWASSETSCONTRIBUTETOREVENUE 3 State THE ASSUMPTION THAT UNDERLIES THE REDUCING BALANCE METHOD OF DEPRECIATIONINRELATIONTOHOWASSETSCONTRIBUTETOREVENUE 4 Identify THREE NON CURRENT ASSETS THAT SHOULD BE DEPRECIATED USING THE REDUCINGBALANCEMETHODOFDEPRECIATION 5 Explain HOW THE REDUCING BALANCE METHOD OF DEPRECIATION ALLOCATES DEPRECIATIONEXPENSE

15.4 CALCULATING DEPRECIATION EXPENSE USING THE REDUCING BALANCE METHOD 5NDERTHESTRAIGHT LINEMETHOD DEPRECIATIONEXPENSEISTHESAMEEACHYEARBECAUSEITIS CALCULATEDASAPERCENTAGEOFTHE Historical CostOFTHEASSET"YCONTRAST THEREDUCING BALANCEMETHODCALCULATESDEPRECIATIONEXPENSEASAPERCENTAGEOFTHECARRYINGVALUE

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341

EXAMPLE

On 1 January 2015, Finch Fabrics purchased a cutting machine for $10 000 plus $1 000 GST. The asset is expected to have a useful life of five years and a residual value of $2 000, and is to be depreciated at 27.52% per annum using the reducing balance method.

Reducing balance rate of depreciation 4HElRSTTHINGTHATMAYSTRIKEYOUABOUTTHEEXAMPLEABOVEISTHATTHERATEISNOTGIVEN ASASIMPLElGURE BUTRATHERAS!SARULEOFTHUMB THEREDUCINGBALANCERATE ISAPPROXIMATELYTIMESTHESTRAIGHT LINERATE(OWEVER THEWORDapproximatelyIS IMPORTANTITISNOTexactlyTIMES4HEFORMULAFORCALCULATINGTHERATEOFDEPRECIATION UNDERTHEREDUCINGBALANCEMETHODISQUITECOMPLICATED Depreciation expense: reducing balance rate Depreciation rate

=

100 1 —

n

STUDY TIP

Residual value Historical Cost

4HEREDUCINGBALANCE RATEWILLALWAYSBE SPECIlEDINTHISCOURSE

Where ‘n’ refers to the ‘number’ of years for which the non-current asset will be used to earn revenue; that is, its useful life.

+NOWLEDGEOFTHISFORMULAISBEYONDTHEREQUIREMENTSOFTHISCOURSETHERATEWILL ALWAYSBEPROVIDED SOTHEREISNONEEDTOREMEMBERIT)FTHERATEISKNOWN WHICHIN THISCOURSEITWILLBE CALCULATINGDEPRECIATIONEXPENSESIMPLYINVOLVESMULTIPLYINGTHE CARRYINGVALUEBYTHERATE

Depreciation expense: reducing balance formula Depreciation expense: reducing balance rate $EPRECIATIONEXPENSEPERANNUM #ARRYINGVALUEX$EPRECIATIONRATE WHERECARRYINGVALUEHistorical Cost nACCUMULATEDDEPRECIATION

"ECAUSETHISFORMULACALCULATESDEPRECIATIONEXPENSEASAPERCENTAGEOFTHECARRYING VALUE ANDTHECARRYINGVALUEREDUCESEVERYPERIOD SOTOOWILLTHEDEPRECIATIONEXPENSE Depreciation expense for the year ended 31 December 2015 5SINGTHEREDUCINGBALANCEFORMULA THEDEPRECIATIONEXPENSEFOR&INCH&ABRICSCUTTING MACHINEFORTHEYEARENDED$ECEMBERWOULDBECALCULATEDASSHOWN Depreciation expense

=

Carrying value

x

Depreciation rate

=

$10 000

x

27.52%

=

$2 752

&ORTHElRSTYEAROFTHEASSETSLIFE ITSCARRYINGVALUEWILLBETHESAMEASITSHistorical Cost THAT IS $10 000 AND DEPRECIATION EXPENSE WILL BE   !S IT IS THE lRST YEAROFTHEASSETSLIFE ITSDEPRECIATIONEXPENSEWOULDTHENBECOMEITSACCUMULATED DEPRECIATIONATTHEENDOFTHEYEAR4HEASSETWOULDTHUSBEREPORTEDINTHE"ALANCE 3HEETASISSHOWNONTHENEXTPAGE ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

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CAMBRIDGE VCE ACCOUNTING

342

UNITS 3&4

FINCH FABRICS Balance Sheet (extract) as at 31 December 2015 Non-current Assets

$

Cutting Machine

$

10 000

Less Accumulated Depreciation

2 752

7 248

Depreciation expense for the year ended 31 December 2016 &ORTHEsecondYEAROFTHEASSETSLIFE ITSCARRYINGVALUEWOULDBEREDUCEDBYTHE VALUEOFACCUMULATEDDEPRECIATIONFROM5SINGTHISNEWCARRYINGVALUE THE Depreciation expense

=

Carrying value

x

Depreciation rate

=

$7 248

x

27.52%

=

$1 995

DEPRECIATIONEXPENSEFORWOULDBECALCULATEDASSHOWN "ECAUSEOFTHEACCUMULATEDDEPRECIATIONFROM THECARRYINGVALUEFOR HASDECREASEDFROMTO RESULTINGINAdecreaseINDEPRECIATION EXPENSE FROM  TO   4HUS THE REDUCING BALANCE METHOD ALLOCATES MORE DEPRECIATIONEXPENSEATTHESTARTOFTHEASSETSLIFE ANDLESSASITAGES4HISPATTERNWILL CONTINUEFORTHELIFEOFTHEASSET ASISSHOWNIN&IGURE Figure 15.5

STUDY TIP

Reducing balance depreciation over time*

Historical Cost Less Accumulated Depreciation

3EE3ECTION ONPAGEFORA REMINDEROFHOWTO ADJUSTFORDEPRECIATION FORLESSTHANAYEAR 2EMEMBERTOUSE THEREDUCINGBALANCE FORMULATOCALCULATE DEPRECIATIONEXPENSE INTHElRSTPLACE

Carrying Value Depreciation Expense

2015

2016

2017

2018

2019

10 000

10 000

10 000

10 000

10 000

Nil

2 752

4 747

6 193

7 241

10 000

7 248

5 253

3 807

2 759

2 752

1 995

1 446

1 048

759

3OMElGURESADJUSTEDFORROUNDINGPURPOSES

Calculating depreciation for less than a year *USTLIKETHESTRAIGHT LINEMETHOD THEREDUCINGBALANCEMETHODCALCULATESDEPRECIATION FORAYEAR3HOULDTHEASSETBEUNDERTHECONTROLOFTHElRMFORLESSTHANAYEAR ORTHE 2EPORTING0ERIODBELESSTHANAYEAR THEAMOUNTWOULDNEEDTOBEADJUSTED4HESAFEST WAYTODOTHISISTODIVIDETHEYEARLYDEPRECIATIONEXPENSEBYMONTHS THENMULTIPLY BYTHENUMBEROFMONTHSAPPROPRIATETOTHE2EPORTING0ERIOD

REVIEW QUESTIONS 15.4

1 Explain HOW THE STRAIGHT LINE AND REDUCING BALANCE METHODS DIFFER IN THEIR CALCULATIONOFDEPRECIATIONEXPENSE 2 Show THE FORMULA FOR CALCULATING DEPRECIATION UNDER THE REDUCING BALANCE METHOD 3 2EFERRINGTOTHEFORMULA explainWHYTHEREDUCINGBALANCEMETHODALLOCATES LESSDEPRECIATIONEXPENSEOVERTHELIFEOFTHEASSET

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ACCOUNTING FOR NON-CURRENT ASSETS

343

15.5 COMPARING DEPRECIATION METHODS !LTHOUGHTHEMETHODOFCALCULATIONWILLCHANGETHEAMOUNTOFDEPRECIATIONEXPENSE SOMEASPECTSremain the sameREGARDLESSOFWHICHMETHODISCHOSEN4HESEINCLUDE s THE'ENERAL*OURNALENTRIESREQUIREDTORECORDDEPRECIATIONEXPENSETHATIS $2 #2

$EPRECIATIONn.ON #URRENT!SSET% !CCUMULATED$EPRECIATIONn.ON #URRENT!SSETn!

s THEREPORTINGOFDEPRECIATIONEXPENSEINTHE)NCOME3TATEMENTAS@/THER%XPENSE ANDACCUMULATEDDEPRECIATIONINTHE"ALANCE3HEETASANEGATIVEASSET s THEEFFECTONTHEACCOUNTINGEQUATIONAND"ALANCE3HEETTHATIS n ANINCREASEINACCUMULATEDDEPRECIATIONLEADINGTOADECREASEINASSETS n AN INCREASE IN EXPENSES LEADING TO A DECREASE IN .ET 0ROlT AND DECREASE IN OWNERSEQUITY 7HATwillDIFFERDEPENDINGONTHEDEPRECIATIONMETHODISTHEAMOUNTOFDEPRECIATION EXPENSECHARGEDINEACH2EPORTING0ERIOD s 5SINGTHESTRAIGHT LINEMETHOD DEPRECIATIONEXPENSEWILLBETHEsame each year 4HISDOESNOTMEANTHATTHEASSETISNOTAGEING ORTHATITSPRODUCTIVECAPACITYISNOT BEINGCONSUMED JUSTTHATITISBEINGCONSUMEDEVENLY s 5SINGTHEREDUCINGBALANCEMETHOD DEPRECIATIONEXPENSEWILLBEhigher at the start and decrease as the asset ages )FTHEFABRICCUTTINGMACHINEFROMTHEEXAMPLEONPAGE HADBEENDEPRECIATED USINGTHESTRAIGHT LINEMETHOD DEPRECIATIONEXPENSEWOULDBEPERYEARnARATE OFOFTHEHistorical Cost 4HISCOMPARESWITHAREDUCINGBALANCERATEOF OFTHECARRYINGVALUE  &IGURESHOWSHOWTHESTRAIGHT LINEANDREDUCINGBALANCEMETHODSWILLGENERATE DIFFERING AMOUNTS FOR DEPRECIATION EXPENSE AND AS A RESULT DIFFERENT RESULTS IN THE )NCOME3TATEMENTAND"ALANCE3HEET OVERTHELIFEOFTHEASSET Figure 15.6

Comparison of straight-line and reducing balance methods Straight-line method (Historical Cost x 16%)

Year

Reducing balance method (carrying value x 27.52%)

Historical Accumulated Carrying Depreciation Cost depreciation value expense

Historical Cost

Accumulated Carrying depreciation value

Depreciation expense

2015

10 000

Nil

10 000

1 600

10 000

Nil

10 000

2 752

2016

10 000

1 600

8 400

1 600

10 000

2 752

7 248

1 995

2017

10 000

3 200

6 800

1 600

10 000

4 747

5 253

1 446

2018

10 000

4 800

5 200

1 600

10 000

6 193

3 807

1 048

2019

10 000

6 400

3 600

1 600

10 000

7 241

2 759

759

Total

8 000

Total

8 000

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

4HISDIFFERENCEINDEPRECIATIONEXPENSECANBEREPRESENTEDGRAPHICALLY ASISSHOWN IN&IGURE Figure 15.7

Depreciation expense: graphical comparison

$3 000 $2 500 $2 000

Depreciation expense: straight line

$1 500

Depreciation expense: reducing balance

$1 000 $500 $0 2015

2016

2017

2018

2019

Year 4HESTRAIGHT LINEMETHODALLOCATESDEPRECIATIONEXPENSEPERYEAR FOREVERY YEAR OF THE ASSETS USEFUL LIFE )N COMPARISON THE REDUCING BALANCE METHOD ALLOCATES MORE DEPRECIATION EXPENSE THAN THE STRAIGHT LINE METHOD IN   AND   BUTLESSIN AND 4HEREFORE INTHEEARLYYEARSTHEREDUCINGBALANCEMETHODWILLCAUSE.ET0ROlTTOBE LOWERTHANITWOULDBEUSINGTHESTRAIGHT LINEMETHOD BUTINLATERYEARS.ET0ROlTWOULD BEHIGHERTHANIFTHESTRAIGHT LINEMETHODWASUSED )NTERMSOFTHE"ALANCE3HEET THEREDUCINGBALANCEMETHODWILLMEANTHECARRYING VALUEOFTHEASSETDECREASESFASTERTHANUSINGTHESTRAIGHT LINEMETHOD4HISISSHOWNIN &IGURE

Figure 15.8

Carrying value: graphical comparison

$12 000 $10 000 $8 000

Carrying value: straight line

$6 000

Carrying value: reducing balance

$4 000 $2 000 $0 2015

2016

2017

2018

2019

Year !LTHOUGH&IGURESHOWSTHEDIFFERENCEATTHEENDOFEACHINDIVIDUAL2EPORTING 0ERIOD ITALSOSHOWSTHATBOTHMETHODSENDUPATTHESAMEPOINTACARRYINGVALUEAT THEENDOFTHEASSETSLIFEOF WHICHISITSRESIDUALVALUE4HISISBECAUSEALTHOUGH EACH METHOD GIVES A DIFFERENT DEPRECIATION EXPENSE IN each Reporting Period BOTH METHODS WILL IF THE RATES HAVE BEEN CALCULATED ACCURATELY CALCULATE THE SAME TOTAL DEPRECIATIONEXPENSEover the life of the asset)NTHISEXAMPLE BOTHMETHODSRESULTIN ATOTALDEPRECIATIONOF

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ACCOUNTING FOR NON-CURRENT ASSETS

Selecting a depreciation method 4HEKEYFACTORTOCONSIDERINCHOOSINGADEPRECIATIONMETHODISTHEREVENUE EARNING PATTERNOFTHEASSET s )FTHEASSETCONTRIBUTESEVENLYTOREVENUE ANDITSCOSTISCONSUMEDEVENLY OVERITS LIFE THESTRAIGHT LINEMETHODSHOULDBEUSED s )FTHEASSETCONTRIBUTESMORETOREVENUE ANDITSCOSTISCONSUMEDMORE ATTHESTART OFITSLIFEANDLESSASITAGES THEREDUCINGBALANCEMETHODSHOULDBEUSED )TISTHEASSETITSELF ANDHOWITCONTRIBUTESTOREVENUE THATDETERMINESWHICHMETHOD OFDEPRECIATIONISAPPROPRIATE4HEREFORE ABUSINESSMAYUSETHESTRAIGHT LINEMETHOD FORSOMEASSETS ANDTHEREDUCINGBALANCEMETHODFOROTHERS 7HILETHISCHOICEEXISTS THEACCOUNTINGPRINCIPLEOF#ONSISTENCYDEMANDSTHATONCE A METHOD IS CHOSEN THAT METHOD SHOULD BE USED FROM ONE PERIOD TO THE NEXT 4HIS ALLOWSREPORTSTOBECOMPAREDFROMONEPERIODTOTHENEXT MAINTAINING#OMPARABILITY #HANGINGDEPRECIATIONMETHODSISPOSSIBLE BUTTHECHANGEMUSTBECLEARLYDISCLOSED INTHEREPORTS

REVIEW QUESTIONS 15.5

1 StateTHREEWAYSINWHICHTHEEFFECTOFDEPRECIATIONISTHESAMEUNDERBOTH THESTRAIGHT LINEANDREDUCINGBALANCEMETHODS 2 #OMPARED TO THE STRAIGHT LINE METHOD explain HOW THE REDUCING BALANCE METHODOFDEPRECIATIONWILLAFFECT.ET0ROlTDURINGEACH2EPORTING0ERIOD 3 ExplainHOWTHEMETHODOFDEPRECIATIONAFFECTSTOTALDEPRECIATIONOVERTHE LIFEOFTHEASSET 4 Explain THEMAINFACTORTOBECONSIDEREDINSELECTINGAMETHODOFDEPRECIATION 5 Identify THE ACCOUNTING PRINCIPLE THAT PREVENTS CHANGES OF DEPRECIATION METHODBETWEENPERIODS 6 2EFERRINGTOONEQUALITATIVECHARACTERISTIC explainWHYDEPRECIATIONMETHODS SHOULDnotBECHANGEDFROMONEPERIODTOTHENEXT

15.6 RECORDING THE CASH SALE OF A NON-CURRENT ASSET 4RADINGlRMSEARNPROlTBYPURCHASINGSTOCKANDTHENMARKINGITUPBEFORESELLINGIT!S ARESULT RECORDINGACASHSALEOFSTOCKINTHELEDGERINVOLVESRECORDINGTHELOSSOFSTOCK ATONEAMOUNTTHECOSTPRICE ANDRECORDINGTHECASHRECEIVEDATADIFFERENTAMOUNT THESELLINGPRICE )TIS INFACT TWODOUBLEENTRIES ! SIMILAR PRINCIPLE APPLIES TO THE SALE OR DISPOSAL OF NON CURRENT ASSETS WE MUST RECORDTHEVALUEOFTHENON CURRENTASSETTHATHASBEENDISPOSEDOFITSCOSTPRICE AND THE REVENUE THAT HAS BEEN EARNED FROM ITS DISPOSAL ITS SELLING PRICE  4HE DIFFERENCE BETWEENTHESETWOAMOUNTSWILLPRODUCEAPROlTORLOSSONTHEDISPOSALOFTHEASSET !LTHOUGHNON CURRENTASSETSWILLFREQUENTLYBESOLD THEYWILLSOMETIMESBETRADED IN SOWEWILLREFERTOTHEdisposalRATHERTHANTHESALEOFTHEASSET 2ECORDINGTHEDISPOSALOFANON CURRENTASSETINVOLVESTHREESTEPS  TRANSFERRINGTHECARRYINGVALUETHECOSTPRICEOFTHEASSET  RECORDINGTHEPROCEEDSFROMTHESALETHESELLINGPRICEOFTHEASSET  TRANSFERRINGTHEPROlTORLOSSONDISPOSALOFTHEASSET

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CAMBRIDGE VCE ACCOUNTING

346

UNITS 3&4

Step 1: transferring the carrying value (the cost price of the asset) 7HEN A NON CURRENT ASSET IS DISPOSED OF THE lRM LOSES THE ASSET IN MUCH THE SAME WAYTHATITLOSESSTOCKORPREPAIDRENTASITISCONSUMED)TISINCURRINGANEXPENSEBY INCURRINGANOUTmOW ORLOSS OFANECONOMICBENElT INTHEFORMOFADECREASEINASSETS THEASSETTHATHASBEENSOLD 4HISALSODECREASESOWNERSEQUITYHOWEVER THEBUSINESS IS NOT LOSING THE (ISTORICAL #OST OF THE ASSET AS IT WILL HAVE ALREADY CONSUMED SOME OFTHEASSETSVALUE VIADEPRECIATION4HISMEANSTHATTHEVALUETHATISLOSTWHENTHE ASSETISDISPOSEDOFISMEASUREDBYITSCARRYINGVALUETHATIS ITS(ISTORICAL#OSTlessITS ACCUMULATEDDEPRECIATION4HISLOSSOFTHEASSETVALUEDATITSCARRYINGVALUE ISTHElRST THINGTHATMUSTBERECORDEDWHENTHEASSETISDISPOSEDOF

EXAMPLE

On 31 January 2015, Duke Industries sold some equipment for $1 100 cash (Rec. 17). The equipment had originally been valued at $12 000, but accumulated depreciation amounted to $10 000 when it was sold.

4HE 'ENERAL *OURNAL ENTRIES TO TRANSFER THE CARRYING VALUE OF THE EQUIPMENT ARE SHOWNIN&IGURE Figure 15.9

General Journal: transferring the carrying value General Journal General Ledger

Date Jan. 31

Details

Debit

Disposal of Equipment

12 000

Equipment Accumulated Depreciation – Equipment

Credit

Subsidiary Ledger Debit

Credit

12 000 10 000

Disposal of Equipment

10 000

"ECAUSE THE EQUIPMENT HAS BEEN SOLD IT IS NO LONGER IN THE lRMS POSSESSION OR CONTROL SOITISREMOVEDFROMTHEACCOUNTSBYCREDITINGTHE%QUIPMENTACCOUNT4HISENTRY ISRECORDEDAT(ISTORICAL#OST 3IMULTANEOUSLY THEACCUMULATEDDEPRECIATION THAT ACCOMPANIES THE EQUIPMENT IS ALSO REMOVED BY DEBITING THE !CCUMULATED $EPRECIATIONn%QUIPMENTACCOUNT "OTHAMOUNTSARETRANSFERREDTOANEW ACCOUNT$ISPOSALOF%QUIPMENT !LTHOUGHTHISEXAMPLEREFERSTOAsaleOFANON CURRENTASSET THEENTRIESWOULDBE IDENTICALIFTHEASSETWERETRADEDIN2EGARDLESSOFHOWTHEASSETISDISPOSEDOF THElRM HAS@LOSTTHEASSET WHICHMUSTBEVALUEDATITSCARRYINGVALUE 4HE'ENERAL*OURNALENTRYISPOSTEDTOTHE'ENERAL,EDGERASSHOWNIN&IGURE

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CHAPTER 15

Figure 15.10

ACCOUNTING FOR NON-CURRENT ASSETS

347

General Ledger: transferring the carrying value General Ledger Equipment (A)

Date

Cross-reference

Jan. 1

Balance

Amount $ 12 000

Date Jan. 31

Cross-reference

Amount $

Disposal of Equipment

12 000

Accumulated Depreciation – Equipment (– A) Date Jan. 31

Cross-reference Disposal of Equipment

Amount $ 10 000

Date Jan. 31

Cross-reference

Amount $

Balance

10 000

Disposal of Equipment (OE) Date Jan. 31

Cross-reference Equipment

Amount $ 12 000

Date Jan. 31

Cross-reference

Amount $

Acc. Dep. – Equipment

10 000

!T THIS STAGE THE $ISPOSAL OF %QUIPMENT ACCOUNT HAS A DEBIT BALANCE OF   REPRESENTINGTHECARRYINGVALUEOF ANDTHEEXPENSEINCURREDFOR THEEQUIPMENTSOLD STUDY TIP

Step 2: recording the proceeds on disposal (the selling price of the asset) !TTHESAMETIMEASTHEASSETISLOST THElRMWILLALSORECEIVESOMEFORMOFREVENUE FROMWHOEVERISTAKINGTHEASSET)NTHECASEOFACASHSALE THEPROCEEDSFROMTHESALE OFTHEASSETAREANINmOWOFANECONOMICBENElTCASH INTHEFORMOFANINCREASEIN ASSETS"ANK WHICHINCREASESOWNERSEQUITY 4HEPROCEEDSRECEIVEDFROMTHECASHSALEOFANON CURRENTASSETWILLBERECORDEDIN THE#ASH2ECEIPTS*OURNALASSHOWNIN&IGURE Figure 15.11

Cash Receipts Journal: proceeds on cash sale

4HISMAKESATOTALOF THREETYPESOF)NVESTING ITEMSTOREPORTINTHE #ASH&LOW3TATEMENT INmOWSCASHPROCEEDS ONTHEDISPOSALOFANON CURRENTASSET OUTmOWS CASHPURCHASEOFANON CURRENTASSET ANDCASH PAIDTOSUNDRYCREDITOR

Cash Receipts Journal Date Jan. 31

Details Disposal of Equip. Totals

Rec. no. 17

Bank

Discount Expense

Debtors Control

Cost of Sales

Sales

1 100 42 100

Sundries

GST

1 100 500

14 000

16 000

25 000

1 100

2 500

4HIS AMOUNT  WOULD BE REPORTED AS AN )NVESTING INmOW IN THE #ASH &LOW 3TATEMENTBECAUSEACASHINmOWWASRELATEDTOTHESALEOFTHENON CURRENTASSET 4HE PROCEEDS FROM THE SALE WOULD BE POSTED TO THE 'ENERAL ,EDGER AS SHOWN IN &IGURE

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CAMBRIDGE VCE ACCOUNTING

348

Figure 15.12

UNITS 3&4

General Ledger: proceeds on cash sale General Ledger

STUDY TIP

Bank (A)

2EMEMBER THETOTALS OFTHE#ASH2ECEIPTS *OURNALAREPOSTEDTO THE'ENERAL,EDGERAT THEENDOFTHEMONTH

Date

Cross-reference

Jan. 1

Balance

31

Amount $ 4 000

Cash Receipts

Date

Cross-reference

Amount $

Jan. 31

Cash Payments

35 000

42 100 Disposal of Equipment (OE)

Date Jan. 31

Cross-reference

Amount $

Equipment

12 000

Date Jan. 31

Cross-reference Acc. Dep. – Equipment Bank

Amount $ 10 000 1 100

7HEREAS TRANSFERRING THE CARRYING VALUE INTO THE $ISPOSAL OF %QUIPMENT ACCOUNT RECOGNISES THE EXPENSE RELATED TO THE DISPOSAL RECORDING THE PROCEEDS RECOGNISES THEREVENUEEARNEDFROMTHEDISPOSAL7ITHTHISINFORMATION THEPROlTORLOSSONTHE DISPOSALCANBECALCULATED

Step 3: transferring the profit or loss on disposal 4HE$ISPOSALOF!SSETACCOUNTSHOWSINFORMATIONABOUTBOTHTHEREVENUEEARNEDFROM THEDISPOSALTHEPROCEEDSFROMTHESALE ANDTHEEXPENSEINCURREDBYTHEDISPOSALTHE CARRYINGVALUEOFTHEASSET (OWEVER ONLYTHENETEFFECTTHEOVERALLPROlTORLOSSON DISPOSAL WILLBEREPORTEDINTHE)NCOME3TATEMENT4HUS THE$ISPOSALOF!SSETACCOUNT MUSTBECLOSED ANDITSBALANCETRANSFERREDTOASEPARATEACCOUNTCALLEDEITHER@0ROlTON $ISPOSALOF!SSETOR@,OSSON$ISPOSALOF!SSET Transferring a loss on disposal 4HEEXAMPLESHOWSTHEFOLLOWINGINFORMATIONRELATINGTOTHESALEOFTHEEQUIPMENT

loss on disposal of asset where the proceeds from the disposal of an asset is less than its carrying value

2EVENUE 0ROCEEDSONSALE 

,ESS %XPENSE #ARRYINGVALUE

 (ISTORICAL#OSTn!CC$EP



0ROlT,OSS ONDISPOSAL

)NTHISCASE THEPROCEEDSFROMTHESALEOFTHEEQUIPMENT ISLESSTHANITS CARRYINGVALUE MEANINGAloss on disposal of asset  HASOCCURRED4HIS LOSSISALSOREmECTEDBYTHE$ISPOSALOF%QUIPMENTACCOUNTIN&IGURE WHICHHAS

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ADEBITBALANCEOF JUSTLIKEANEXPENSEACCOUNT4HISCONlRMSTHATTHEREHASBEEN ALOSSONDISPOSALOFEQUIPMENT 4HE'ENERAL*OURNALENTRYTOTRANSFERTHELOSSONTHEDISPOSALOFTHEEQUIPMENTIS SHOWNIN&IGURE Figure 15.13

General Journal: transferring a loss on disposal of asset General Journal General Ledger

Date Jan. 31

Details

Debit

Loss on Disposal of Equipment

Credit

Subsidiary ledger Debit

Credit

900

Disposal of Equipment

900

Disposal of equipment at a loss (Rec. 17)

!LTHOUGHHERETHEDISPOSALHASBEENSHOWNASTHREESEPARATECOMPONENTS ITISONE TRANSACTION!LLTHREECOMPONENTSTHETRANSFEROFTHECARRYINGVALUE THERECORDINGOF THEPROCEEDSONDISPOSALANDTHETRANSFEROFTHELOSSONDISPOSAL FORMONEENTRY TO RECORDTHEONETRANSACTION!SACONSEQUENCE THENARRATIONISMADEONLYATTHEENDOF THE'ENERAL*OURNALENTRY !SARESULT THE'ENERAL,EDGERACCOUNTSWOULDAPPEARASSHOWNIN&IGURE Figure 15.14

General Ledger: transferring a loss on disposal of asset General Ledger Disposal of Equipment (OE)

Date Jan. 31

Cross-reference Equipment

Amount $ 12 000

Date Jan. 31

Cross-reference Acc. Dep. – Equipment Bank Loss on Disp. of Equip.

12 000

Amount $ 10 000 1 100 900 12 000

Loss on Disposal of Equipment (E) Date Jan. 31

Cross-reference Disposal of Equipment

Amount $

Date

Cross-reference

Amount $

900

4HE$ISPOSALOF%QUIPMENTACCOUNTHASBEENEMPTIEDITNOWHASAZEROBALANCE 4HE,OSSON$ISPOSALOF%QUIPMENTACCOUNTSHOWSTHEOVERALLLOSSINCURREDONTHESALE  WHICHWILLBECLOSEDTOTHE0ROlTAND,OSS3UMMARYACCOUNTATTHEENDOFTHE PERIOD ANDREPORTEDINTHE)NCOME3TATEMENTASAN@/THER%XPENSE

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350

UNITS 3&4

Transferring a profit on disposal )FTHE$ISPOSALOF!SSETACCOUNTHASACREDITBALANCE LIKEAREVENUEACCOUNT ITWOULD REPRESENT A PROlT BECAUSE THE PROCEEDS FROM THE SALE WOULD BE GREATER THAN THE CARRYINGVALUE)NTHISCASE THE$ISPOSALOF!SSETACCOUNTWOULDBECLOSEDTOTHE0ROlT ON$ISPOSALOF!SSETACCOUNT

EXAMPLE

The accounts of Mallacoota Wines showed the following: General Ledger Disposal of Furniture (OE) Date

Cross-reference

Amount $

Oct. 31 Furniture

8 000

Date

Cross-reference

Amount $

Oct. 31 Acc. Dep. – Furniture Bank

profit on disposal of asset where the proceeds from the disposal of an asset are greater than its carrying value

6 000 2 300

4HISACCOUNTCURRENTLYHASACREDITBALANCEOF REPRESENTINGAprofit on disposal of asset INTHISCASE FURNITURE4HISPROlTWOULDBETRANSFERREDASSHOWNIN&IGURE Figure 15.15

General Journal: transferring a profit on disposal of asset General Journal

Date Oct. 31

Details

General Ledger

Subsidiary ledger

Debit

Debit

Disposal of Furniture

Credit

Credit

300

Profit on Disposal of Furniture

300

Disposal of furniture at a profit (Rec. 41)

!SARESULT THE'ENERAL,EDGERACCOUNTSWOULDAPPEARASSHOWNIN&IGURE Figure 15.16

General Ledger: transferring a profit on disposal of asset General Ledger Disposal of Furniture (OE)

Date Oct. 31

Cross-reference

Amount $

Furniture

8 000

Profit on Disp. of Furn.

Date

Cross-reference

Oct. 31

Acc. Dep. – Furniture

6 000

Bank

2 300

300 8 300

Amount $

8 300

Profit on Disposal of Furniture (R) Date

Cross-reference

Amount $

Date Oct. 31

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Cross-reference Disposal of Furniture

Amount $ 300

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ACCOUNTING FOR NON-CURRENT ASSETS

351

!SAREVENUEACCOUNT 0ROlTON$ISPOSALOF&URNITUREWOULDBECLOSEDTOTHE0ROlT AND ,OSS 3UMMARY ACCOUNT AT THE END OF THE 2EPORTING 0ERIOD WITH OTHER REVENUES SUCHAS3ALES STOCKGAINANDDISCOUNTREVENUE)NTHE)NCOME3TATEMENT ITWOULDBE REPORTEDWITHDISCOUNTREVENUE AS/THER2EVENUE REVIEW QUESTIONS 15.6

1 ListTHETHREESTEPSINVOLVEDINRECORDINGTHEDISPOSALOFANON CURRENTASSET 2 StateONEREASONWHYTHEASSETISMEASUREDBYITSCARRYINGVALUERATHERTHAN ITS(ISTORICAL#OSTWHENITISSOLDORTRADEDIN 3 ShowTHE'ENERAL*OURNALENTRIESNECESSARYTOTRANSFERTHECARRYINGVALUEOFA NON CURRENTASSETTHATHASBEENSOLD 4 State THE JOURNAL USED TO RECORD THE PROCEEDS FROM THE CASH SALE OF A NON CURRENTASSET 5 ExplainHOWTHEPROCEEDSFROMTHECASHSALEOFANON CURRENTASSETWOULDBE REPORTEDINTHE#ASH&LOW3TATEMENT 6 DefineTHETERMS s LOSSONDISPOSALOFANON CURRENTASSET s PROlTONDISPOSALOFANON CURRENTASSET 7 StateWHATISINDICATEDIFTHE$ISPOSALOF!SSETACCOUNTHASA s DEBITBALANCE s CREDITBALANCE 8 Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO CLOSE THE $ISPOSAL OF !SSET ACCOUNTIFITHASA s DEBITBALANCE s CREDITBALANCE

15.7

RECORDING THE TRADE-IN OF A NON-CURRENT ASSET

)NSOMESITUATIONSAlRMWILLNOTSELLANASSETFORCASH BUTRATHERUSETHATASSETASA trade-inONANEWERMODEL4HISWOULDMEANTHATRATHERTHANRECEIVINGCASHFORTHESALE OFTHEASSET THElRMWOULDRECEIVEAREDUCTIONINTHEAMOUNTPAYABLETOTHESUNDRY CREDITOR FORTHEPURCHASEOFANEWASSET

On 30 April 2015, Lexis Midnight Runners purchased a new delivery van worth $30 000 (plus $3 000 GST) from IQ Motors (Inv. 65). As part of the purchase, the firm traded in an old delivery van with a carrying value of $1 200 (cost $26 000 less accumulated depreciation $24 800) for $700.

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

trade-in when a firm uses the proceeds from the sale of a non-current asset to reduce the amount payable for the purchase of a new non-current asset

EXAMPLE

Cambridge University Press

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UNITS 3&4

&IGURESHOWSHOWTHETRADE INOFTHEOLDVANWOULDBERECORDEDINTHE'ENERAL *OURNAL Figure 15.17

General Journal: trade-in of a non-current asset General Journal General Ledger

Date April 30

Details

Debit

Disposal of Van

26 000

Van

Credit

Subsidiary ledger Debit

Credit

26 000

Accumulated Dep. – Van

24 800

Disposal of Van

24 800

Sundry Creditor – IQ Motors

700

Disposal of Van

700

Loss on Disposal of Van

500

Disposal of Van

500

4HEENTRIESTOTRANSFERTHECARRYINGCOSTOFTHEASSETANDTRANSFERTHELOSSONTHESALE AREEXACTLYTHESAMEFORATRADE INASTHEYWOULDBEIFTHEASSETHADBEENSOLDFORCASH 4OVERIFYTHIS GOBACKANDCHECK&IGURESAND 4HEONLYDIFFERENCEISTHATFORATRADE IN THEPROCEEDSFROMTHEDISPOSALARERECORDED ASADECREASEINALIABILITY3UNDRY#REDITORn)1-OTORS RATHERTHANASANINCREASETO ANASSET"ANK ASWOULDBETHECASEFORACASHSALE!SACONSEQUENCE THEPROCEEDS FROMATRADE INWILLBERECORDEDINTHE'ENERAL*OURNALRATHERTHANTHE#ASH2ECEIPTS *OURNAL  4HETRADE INISSTILLREVENUEASITISASAVINGOFANOUTmOWOFECONOMICBENElTAS LESSCASHMUSTBEPAIDTOTHECREDITOR INTHEFORMOFAREDUCTIONINALIABILITY3UNDRY #REDITORn)1-OTORS WHICHINCREASESOWNERSEQUITY(OWEVER THEREISNOCASHmOW SO THEPROCEEDSTHETRADE IN AREnotREPORTEDINTHE#ASH&LOW3TATEMENT 4HEONLYREMAININGSTEPISTORECORDTHEPURCHASEOFTHENEWVAN WHICHWASCOVERED EARLIERINTHISCHAPTER3ECTION ANDISSHOWNBELOW General Journal General Ledger Date April 30

Details

Debit

Van

30 000

GST Clearing Sundry Creditor – IQ Motors

Credit

Subsidiary ledger Debit

Credit

3 000 33 000

Credit purchase of van (Inv. 65)

!FTERTHETRADE INANDPURCHASEHAVEBEENPOSTEDTOTHE'ENERAL,EDGER ANDTHE $ISPOSALOF6ANACCOUNTHASBEENCLOSED THEACCOUNTSWOULDAPPEARASSHOWNIN&IGURE 

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 15

Figure 15.18

ACCOUNTING FOR NON-CURRENT ASSETS

353

General Ledger: trade-in and credit purchase of a non-current asset General Ledger Van (A)

Date

Cross-reference

April 1 30

Amount $

Date

Cross-reference

Amount $

Balance

26 000

April 30

Disposal of Van

26 000

Sundry Cred. – IQ Motors

30 000

Accumulated Depreciation – Van (– A) Date

Cross-reference

Amount $

Date

April 30

Disposal of Van

24 800

April 30

Cross-reference Balance

Amount $ 24 800

GST Clearing (A/L) Date April 30

Cross-reference

Amount $

Date

3 000

April 1

Sundry Cred. – IQ Motors

Cross-reference Balance

Amount $ 4 900

Sundry Creditor – IQ Motors (L) Date

Cross-reference

Amount $

Date

April 30

Disposal of Van

700

April 30

Cross-reference Van/GST Clearing

Amount $ 33 000

Disposal of Van (OE) Date April 30

Cross-reference

Amount $

Date

Cross-reference

26 000

April 30

Acc. Dep. – Van

Van

Amount $ 24 800

Sundry Cred. – IQ Motors

700

Loss on Disposal of Van

500

26 000

26 000

Loss on Disposal of Van (E) Date

Cross-reference

Amount $

Date

April 30

Disposal of Van

500

April 30

Cross-reference Profit and Loss Summary

500

Amount $

STUDY TIP

500 500

4HE ACCOUNTS SHOW THAT THE OLD VEHICLE IS GONE AND THE NEW VEHICLE VALUED AT $30 000 IS RECORDED IN THE 6AN ACCOUNT 4HE 3UNDRY #REDITOR n )1 -OTORS SHOWS A CREDITBALANCEOFTHATIS $30 000FORTHENEWVANPLUS'34 lessTHE TRADE INONTHEOLDONE4HE$ISPOSALOF6ANACCOUNTHASBEENCLOSED ANDTHE LOSSHASBEENTRANSFERREDTOTHE,OSSON$ISPOSALOF6ANACCOUNT WHICHITSELFHAS BEENCLOSEDTOTHE0ROlTAND,OSS3UMMARYACCOUNT

)FTHENEWASSETIS PURCHASEDUSINGCASH THEENTRYTORECORDTHE PROCEEDSONTHESALE WOULDDEBITTHEASSET ACCOUNTDIRECTLY RATHER THANTHESUNDRYCREDITOR 4HECREDITENTRYWOULD STILLBE$ISPOSALOF !SSET

REVIEW QUESTIONS 15.7

1 ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDTHETRADE INOFANON CURRENTASSET 2 ExplainHOWATRADE INISREPORTEDINTHE#ASH&LOW3TATEMENT"ECAREFUL


ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

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UNITS 3&4

15.8 REPORTING A PROFIT OR LOSS ON DISPOSAL IN THE INCOME STATEMENT !SYOUALREADYKNOW ONLYTHEOVERALLPROlTORLOSSONTHEDISPOSALOFANON CURRENTASSET ISREPORTEDINTHE)NCOME3TATEMENT

Reporting a loss on disposal )F THE PROCEEDS FROM THE SALE ARE less THAN THE CARRYING VALUE OF THE ASSET THEN THE ASSETWILLBESOLDATALOSS"ECAUSEALOSSONDISPOSALOFANASSETISANEXPENSE ITMUST BECLOSEDTOTHE0ROlTAND,OSS3UMMARYACCOUNTATTHEENDOFTHE2EPORTING0ERIOD ALONGWITHALLTHE/THER%XPENSESSUCHAS#OSTOF3ALES 7AGESAND2ENT TOHELPINTHE DETERMINATIONOF.ET0ROlT3EE#HAPTERFORCLOSINGREVENUEANDEXPENSEACCOUNTS )N THE )NCOME 3TATEMENT ,OSS ON $ISPOSAL OF !SSET WILL BE REPORTED AS AN /THER %XPENSE ASISSHOWNIN&IGURE Figure 15.19

Income Statement: loss on disposal of a non-current asset LEXIS MIDNIGHT RUNNERS Income Statement for quarter ended 30 April 2015

Revenue

$

Sales

$ 60 000

Less Cost of Goods Sold Cost of Sales Freight In

35 000 2 000

Gross Profit

37 000 23 000

Less Stock Loss

300

Stock Write Down

100

Adjusted Gross Profit

400 22 600

Add Other Revenue Discount Revenue

800 23 400

Less Other Expenses Wages Advertising

14 050 2 700

Discount Expense

350

Loss on Disposal of Van

500

Rent Expense Net Profit

4 000

21 600 1 800

Reporting a profit on disposal /BVIOUSLYTHEOPPOSITEISTRUEFORAPROlTONDISPOSALOFANASSETACCOUNTITWOULDBE CLOSEDTOTHE0ROlTAND,OSS3UMMARYACCOUNTWITHTHEOTHERREVENUEACCOUNTS SUCHAS 3ALESAND$ISCOUNT2EVENUE ANDREPORTEDINTHE)NCOME3TATEMENTAS/THER2EVENUE 4HISISSHOWNIN&IGURE

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 15

Figure 15.20

ACCOUNTING FOR NON-CURRENT ASSETS

Income Statement: profit on disposal of a non-current asset MALLACOOTA WINES Income Statement for year ended 31 December 2015

Revenue

$

$

Sales

145 000

Less Cost of Goods Sold Cost of Sales

39 000

Customs Duty

2 000

Gross Profit

41 000 104 000

Less Stock Loss

1 000

Adjusted Gross Profit

103 000

Add Other Revenue Discount Revenue

500

Profit on Disposal of Vehicle

300

800 103 800

Less Other Expenses Wages

53 000

Advertising

11 500

Discount Expense Rent Expense Net Profit

1 300 16 000

81 800

$

22 000

REVIEW QUESTIONS 15.8

1 ExplainHOWALOSSONTHEDISPOSALOFANON CURRENTASSETWOULDBEREPORTED INTHE)NCOME3TATEMENT 2 ExplainHOWAPROlTONTHEDISPOSALOFANON CURRENTASSETWOULDBEREPORTED INTHE)NCOME3TATEMENT

15.9 REASONS FOR PROFIT OR LOSS ON DISPOSAL 'IVENTHATDEPRECIATIONISANATTEMPTTOCALCULATETHEVALUEOFANON CURRENTASSETTHAT HASBEENCONSUMEDINEACHPERIODOFITSLIFE THECARRYINGVALUEOFTHATASSETISALSOAN ATTEMPTTOGAUGETHEASSETSVALUETOTHEBUSINESS ATANYPOINTINTIME4HISISnot ITS MARKET VALUE !ND BECAUSE THE PROCEEDS ARE BASED ON THE SALE DOCUMENT AND THEREFORECANNOTBE@INCORRECT APROlTORLOSSONTHEDISPOSALOFTHEASSETINDICATES THATTHISCARRYINGVALUEANDTHEDEPRECIATIONTHATLEADTOITSCARRYINGVALUE WASINSOME WAYINCORRECT

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

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UNITS 3&4

Reasons for a loss on disposal !LOSSONTHEDISPOSALOFANON CURRENTASSETOCCURSWHENTHECARRYINGVALUEOFTHEASSET ISgreaterTHANTHEPROCEEDSFROMITSSALEITSRESALEVALUE 4HATIS WEHADVALUEDTHE ASSETATmoreTHANITWASREALLYWORTH Under-depreciation under-depreciation occurs when insufficient depreciation has been allocated over the life of the asset, so that the carrying value of the asset is overstated

STUDY TIP

@0OORESTIMATESISA BADEXPLANATION ASIT DOESNOTDISTINGUISH BETWEENOVER DEPRECIATIONAND UNDER DEPRECIATION

)F THE CARRYING VALUE OF THE ASSET IS OVERSTATED IT IS BECAUSE IT HAS BEEN underdepreciatedWEHAVENOTWRITTENOFFENOUGHDEPRECIATIONOVERTHEASSETSLIFE)NTERMS OFTHECALCULATIONS THISMAYBEBECAUSE s THEESTIMATEDRESIDUALVALUEWASTOOHIGHOROVERSTATED ANDOR s THEESTIMATEDUSEFULLIFEWASTOOHIGHOVERSTATED  "OTHTHESEFACTORSWOULDBEREmECTEDINADEPRECIATIONRATETHATWASTOOLOW 4HEREAREAVARIETYOFREASONSWHYTHERESIDUALVALUEANDORUSEFULLIFEOFTHEASSET MAYBEOVERSTATED&OREXAMPLE s 4HE ORIGINAL ESTIMATES DID NOT ANTICIPATE THAT THE ASSET WOULD BE damaged 4HIS WOULDAUTOMATICALLYREDUCEITSRESALERESIDUAL VALUE ANDCOULDALSODECREASEITS USEFULLIFEBELOWWHATWASORIGINALLYANTICIPATED s 4HE ORIGINAL ESTIMATES DID NOT ANTICIPATE THAT THE ASSET WOULD BE outdated OR supersededBYANEWER TECHNOLOGICALLYSUPERIORMODEL4HISWOULDALSOREDUCEITS RESALEVALUE /VERSTATINGTHERESIDUALVALUEORUSEFULLIFEWOULDMEANNOTENOUGHDEPRECIATION WOULDHAVEBEENALLOCATEDOVERTHELIFEOFTHEASSET!SARESULT THECARRYINGVALUEOF THEASSETWOULDBEgreaterTHANITSRESALEVALUE 4HUS ALOSSONDISPOSALOCCURSWHENTHEASSETSCARRYINGVALUEISGREATERTHANTHE PROCEEDS FROM ITS DISPOSAL 4HIS COULD BE CAUSED BY UNDER DEPRECIATION WHERE THE RESIDUALVALUEORUSEFULLIFEWASOVERSTATEDPERHAPSBECAUSETHEASSETWASDAMAGED SUPERSEDEDBYANEWERMODELORNOTINDEMAND 

Reasons for a profit on disposal )N CONTRAST TO A LOSS A PROlT ON THE DISPOSAL OF A NON CURRENT ASSET OCCURS WHEN THE CARRYINGVALUEOFTHEASSETISlessTHANTHEPROCEEDSFROMITSSALE4HISMEANSTHEASSET WASVALUEDATlessTHANITWASWORTH Over-depreciation over-depreciation occurs when excess depreciation has been allocated over the life of the asset, so that the carrying value of the asset is understated

)F THE CARRYING VALUE OF THE ASSET IS UNDERSTATED IT IS BECAUSE IT HAS BEEN overdepreciatedWEHAVEWRITTENOFFTOOMUCHDEPRECIATIONOVERTHEASSETSLIFE)NTERMSOF THECALCULATIONS THISMAYBEBECAUSE s THEESTIMATEDRESIDUALVALUEWASTOOLOWORUNDERSTATED ANDOR s THEESTIMATEDUSEFULLIFEWASTOOLOWUNDERSTATED  "OTHTHESEFACTORSWOULDBEREmECTEDINADEPRECIATIONRATETHATWASTOOHIGH 4HEACTUALRESIDUALVALUEANDORUSEFULLIFEOFTHEASSETMAYBEUNDERSTATEDBECAUSE s 4HEORIGINALESTIMATESDIDNOTANTICIPATETHATTHEASSETWOULDBEIN good condition 4HISWOULDINCREASEITSRESALERESIDUAL VALUE ANDCOULDALSOINCREASEITSUSEFULLIFE s 4HEORIGINALESTIMATESDIDNOTANTICIPATETHATTHEASSETWOULDBEin high demand 4HISMAYBEBECAUSEITISrare ANDWOULDALSOINCREASEITSRESALEVALUE 5NDERSTATINGTHERESIDUALVALUEORUSEFULLIFEWOULDMEANTHATTOOMUCHDEPRECIATION WOULDHAVEBEENALLOCATEDOVERTHELIFEOFTHEASSET!SARESULT THECARRYINGVALUEOF THEASSETWOULDBElessTHANITSRESALEVALUE

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 15

ACCOUNTING FOR NON-CURRENT ASSETS

4HUS A PROlT ON DISPOSAL OCCURS WHEN THE ASSETS CARRYING VALUE IS LESS THAN THE PROCEEDS FROM ITS DISPOSAL 4HIS COULD BE CAUSED BY OVER DEPRECIATION WHERE THE RESIDUALVALUEORUSEFULLIFEWASUNDERSTATEDPERHAPSBECAUSETHEASSETWASINGOOD CONDITION RAREORINHIGHDEMAND 

REVIEW QUESTIONS 15.9

1 2 3 4 5 6 7 8

DefineTHETERM@UNDER DEPRECIATION StateTWOCAUSESOFUNDER DEPRECIATION StateTWOREASONSWHYTHERESIDUALVALUEMAYBEOVERSTATED ExplainHOWUNDER DEPRECIATIONMAYLEADTOALOSSONTHEDISPOSALOFANON CURRENTASSET DefineTHETERM@OVER DEPRECIATION StateTWOCAUSESOFOVER DEPRECIATION StateTWOREASONSWHYTHERESIDUALVALUEMAYBEUNDERSTATED ExplainHOWOVER DEPRECIATIONMAYLEADTOAPROlTONTHEDISPOSALOFANON CURRENTASSET

357

STUDY TIP

4HEREASONSFORAPROlT ARETHEOPPOSITEOFTHE REASONSFORALOSSLEARN ONESETOFREASONSAND SIMPLYREVERSETHEMFOR THEOTHERRESULT

WHERE HAVE WE BEEN? s !SUNDRYCREDITORACCOUNTISUSEDTORECORDAMOUNTSOWEDFORPURCHASESOTHERTHAN STOCK s 4HE COST OF AN ASSET INCLUDES ALL COSTS INCURRED IN ORDER TO BRING THE ASSET INTO A LOCATION AND CONDITION READY FOR USE THAT WILL PROVIDE A BENElT FOR THE LIFE OF THE ASSET s 4HEREDUCINGBALANCEMETHODOFDEPRECIATIONASSUMESTHATTHEASSETCONTRIBUTES MORETOREVENUEATTHESTARTOFITSLIFE ANDLESSASITAGES s 4HEREDUCINGBALANCEMETHODCALCULATESDEPRECIATIONEXPENSEASAPERCENTAGEOF THEASSETSCARRYINGVALUE s /VER THE LIFE OF THE ASSET THE STRAIGHT LINE AND REDUCING BALANCE METHODS WILL ALLOCATETHESAMETOTALDEPRECIATIONEXPENSE s #ONSISTENCYDEMANDSTHATDEPRECATIONMETHODSARENOTCHANGEDFROMPERIODTO PERIOD ENSURING#OMPARABILITYINTHEREPORTS s 2ECORDINGTHEDISPOSALOFANON CURRENTASSETINVOLVESTHREESTEPS n TRANSFERRINGTHECARRYINGVALUEOFTHEASSET n RECORDINGTHEPROCEEDSFROMTHEDISPOSAL n TRANSFERRINGTHEPROlTORLOSSONDISPOSAL s 4HECASHRECEIVEDFROMTHESALEOFANON CURRENTASSETISAN)NVESTINGCASHINmOW WHILEAPAYMENTTOASUNDRYCREDITORISAN)NVESTINGOUTmOW s /NLYTHEOVERALLPROlTORLOSSONTHEDISPOSALOFANON CURRENTASSETISREPORTEDIN THE)NCOME3TATEMENT AS/THER2EVENUEFORAPROlT OR/THER%XPENSEFORALOSS  s !LOSSONTHEDISPOSALOFANON CURRENTASSETOCCURSWHENTHECARRYINGVALUEOFTHE ASSETISmoreTHANTHEPROCEEDSFROMITSSALE s !PROlTONTHEDISPOSALOFANON CURRENTASSETOCCURSWHENTHECARRYINGVALUEOFTHE ASSETISlessTHANTHEPROCEEDSFROMITSSALE

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358

EXERCISES

UNITS 3&4

EXERCISE 15.1 CREDIT PURCHASE OF A NON-CURRENT ASSET

W B

page 320

/N-AY 3HOWCASE7ORLDHADWORTHOFDISPLAYCABINETS/N-AY  ITPURCHASEDMOREDISPLAYCABINETSATACOSTOFINCLUDING'34 FROM #ARLS#ABINETS)NV /N-AY 3HOWCASE7ORLDPAIDTHEAMOUNTOWINGTO #ARLS#ABINETS#H  Required a ExplainWHY)NVOICEWOULDnotBERECORDEDINTHE0URCHASES*OURNALOF3HOWCASE 7ORLD b ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDTHEPURCHASEOFTHEDISPLAY CABINETS c Record#HEQUEINTHE#ASH0AYMENTS*OURNALOF3HOWCASE7ORLD d Show HOW THE $ISPLAY #ABINETS AND 3UNDRY #REDITOR n #ARLS #ABINETS ACCOUNTS WOULDAPPEARAFTERALLJOURNALSHAVEBEENPOSTEDTOTHE'ENERAL,EDGER

EXERCISE 15.2 CREDIT PURCHASE OF A NON-CURRENT ASSET

W B

page 321

/N!PRIL .EIL$OWNEPURCHASEDANEWCOMPUTERFORHISBUSINESS +NIBSAND 0ENS4HEDOCUMENTRELATINGTOTHEPURCHASEISSHOWNBELOW

Debit to:

Date April 30

CRASH COMPUTERS

Invoice: X.24

ABN: 34 354 365 887 Wells Rd Frankston VIC 3199

TA X I N V O I C E

Knibs and Pens (ABN: 56 575 334 102) Elizabeth St, Dandenong VIC 3175 Details Computer System and Software Installation Subtotal GST Total invoice price

Total 2 400 250 2 650 265 $2 915

+NIBSAND0ENSPAID#RASH#OMPUTERSINTHElRSTWEEKOF-AY#H  Required a ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDTHISPURCHASE b 2EFERRINGTOYOURANSWERTOPART@A explainYOURTREATMENTOFINSTALLATION c ShowHOWTHE#OMPUTERACCOUNTWOULDAPPEARAFTERTHE'ENERAL*OURNALHASBEEN POSTEDTOTHE'ENERAL,EDGEROF+NIBSAND0ENSASAT!PRIL d ShowHOWTHEAMOUNTOWINGTO#RASH#OMPUTERSWOULDBEREPORTEDINTHE"ALANCE 3HEETOF+NIBSAND0ENSASAT!PRIL e ShowHOWTHEPAYMENTTO#RASH#OMPUTERSWOULDBEREPORTEDINTHE#ASH&LOW 3TATEMENTOF+NIBSAND0ENSFOR-AY ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 15

ACCOUNTING FOR NON-CURRENT ASSETS

EXERCISE 15.3 CREDIT PURCHASE OF A NON-CURRENT ASSET

W B

page 322

/N!PRIL -ATTS-OWERSPURCHASEDANEWPHOTOCOPIER4HEDOCUMENTRELATING TOTHEPURCHASEISSHOWNBELOW

Phil’s Photocopiers Main St Mornington VIC 3931 Debit to:

Invoice: 36 ABN: 35 444 000 121

Matt’s Mowers (ABN: 65 555 760 012) Ferntree Gully VIC 3156

Date

Details

Total

1/4/15

Photocopier T – 1000

21 000

Fitting of card-identification system

1 500

Technical assistance (12-month period)

1 200

Subtotal

23 700

GST

2 370

Total invoice price

$26 070

Required a DefineTHETERM@COSTASITAPPLIESTONON CURRENTASSETS b Show THE'ENERAL*OURNALENTRIESNECESSARYTORECORD)NVOICEINTHEACCOUNTSOF -ATTS-OWERS c Show HOWTHECOSTOFTECHNICALASSISTANCEWOULDBEREPORTEDINTHE"ALANCE3HEET OF-ATTS-OWERSASAT!PRIL d ExplainTHEDIFFERENCEBETWEEN#REDITORS#ONTROLANDASUNDRYCREDITOR

EXERCISE 15.4 DEPRECIATION BASICS

W B

page 323

/N3EPTEMBER +RISTINES+ITESPURCHASEDNEWSHELVINGFORANDANEW SEWINGMACHINEFORFROM4ROJAN0RODUCTS)NV '34CHARGEDONTHEINVOICE AMOUNTEDTO+RISTINEHASNOTYETSELECTEDADEPRECIATIONMETHOD Required a ShowTHE'ENERAL*OURNALENTRIESTORECORDTHEPURCHASEON3EPTEMBER b 2EFERRINGTOONEACCOUNTINGPRINCIPLE explainWHYITISNECESSARYTODEPRECIATENON CURRENTASSETS c ExplainWHYTHESTRAIGHT LINEMETHODSHOULDBEUSEDTODEPRECIATETHESHELVING d ExplainWHYTHEREDUCINGBALANCEMETHODSHOULDBEUSEDTODEPRECIATETHESEWING MACHINE e ShowTHE'ENERAL*OURNALENTRIESTORECORDDEPRECIATIONEXPENSE!MOUNTSAND NARRATIONSAREnotREQUIRED

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

359

360

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UNITS 3&4

EXERCISE 15.5 REDUCING BALANCE DEPRECIATION

W B

page 324

/N*ULY "ENANEE2UBBERPURCHASEDANEWDELIVERYVANFORPLUS'34 4HEVANISTOBEDEPRECIATEDATPERANNUMUSINGTHEREDUCINGBALANCEMETHOD -EMO  Required a StateTHEASSUMPTIONTHATUNDERLIESTHEREDUCINGBALANCEMETHODOFDEPRECIATION INRELATIONTOHOWASSETSCONTRIBUTETOREVENUE b CalculateDEPRECIATIONOFTHEVANFORTHEYEARENDED*UNE c Show THE 'ENERAL *OURNAL ENTRIES TO RECORD DEPRECIATION OF THE VAN FOR THE YEAR ENDED*UNE d Show HOW THE VAN WOULD APPEAR IN THE "ALANCE 3HEET OF "ENANEE 2UBBER AS AT *UNE e CalculateTHEDEPRECIATIONOFTHEVANFORTHEYEARENDED*UNE

EXERCISE 15.6 REDUCING BALANCE DEPRECIATION

W B

page 325

!SAT*UNE THE"ALANCE3HEETOF(EAVENLY$ESIGNSSHOWEDTHEFOLLOWINGNON CURRENTASSETS $ Computers Less Accumulated Depreciation

$

10 000 1 800

Shop Fittings

40 000

Less Accumulated Depreciation

13 104

8 200 26 896

"OTHASSETSAREDEPRECIATEDATPERANNUMUSINGTHEREDUCINGBALANCEMETHOD Required a CalculateDEPRECIATIONOFTHECOMPUTERSFORTHEYEARENDED*UNE b ShowTHE'ENERAL*OURNALENTRIESTORECORDDEPRECIATIONOFTHECOMPUTERSFORTHE YEARENDED*UNE.ARRATIONISnotREQUIRED  c Show HOW THE #OMPUTERS WOULD BE REPORTED IN THE "ALANCE 3HEET OF (EAVENLY $ESIGNSASAT*UNE d ExplainONEREASONWHYTHEOWNERSHOULDCHANGETHEMETHODOFDEPRECIATIONUSED FORTHESHOPlTTINGS e 2EFERRINGTOONEQUALITATIVECHARACTERISTIC explainONEREASONWHYTHEOWNERSHOULD not CHANGETHEMETHODOFDEPRECIATIONUSEDFORTHESHOPlTTINGS f 'IVEN THAT THEY WERE PURCHASED ON  *ULY calculate THE YEAR IN WHICH THE SHOP lTTINGSWEREPURCHASED

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 15

ACCOUNTING FOR NON-CURRENT ASSETS

EXERCISE 15.7 COMPARING DEPRECIATION METHODS

W B

page 327

/N*ULY "ABYLANDPURCHASEDSHOPEQUIPMENTFORINCLUDING'344HE OWNERARGUESTHATTHEBESTWAYTOUPHOLDTHEACCOUNTINGPRINCIPLEOF#ONSISTENCYISTO DEPRECIATETHESHOPEQUIPMENTATPERANNUMUSINGTHESTRAIGHT LINEMETHOD4HE ACCOUNTANTHASARGUEDTHATTHESHOPEQUIPMENTSHOULDBEDEPRECIATEDATUSING THEREDUCINGBALANCEMETHOD Required a SuggestONEREASONWHYTHEOWNERMIGHTINCORRECTLY ARGUETHATTHESTRAIGHT LINE METHODPROVIDES#ONSISTENCY b 2EFERRINGTOYOURANSWERTOPART@A stateONEREASONWHYTHEOWNERISINCORRECT c IdentifyONEEXTRAPIECEOFINFORMATIONYOUWOULDREQUIREBEFOREAGREEINGWITHTHE ACCOUNTANTJustifyYOURANSWER d CalculateDEPRECIATIONOFSHOPEQUIPMENTFORTHEYEARENDED*UNEUSING THESTRAIGHT LINEMETHOD e CalculateDEPRECIATIONOFSHOPEQUIPMENTFORTHEYEARENDED*UNEUSING THEREDUCINGBALANCEMETHOD f ExplainHOWTHECHOICEOFDEPRECIATIONMETHODWILLAFFECT.ET0ROlTFORTHEYEAR ENDED*UNE g Calculate THEYEARINWHICHTHEDEPRECIATIONEXPENSEUNDERTHEREDUCINGBALANCE METHODWILLBELOWERTHANDEPRECIATIONEXPENSEUNDERTHESTRAIGHT LINEMETHOD

EXERCISE 15.8 GRAPHING DEPRECIATION

W B

page 329

*USTINIAN0RINTINGHASPROVIDEDTHEFOLLOWINGGRAPHSRELATINGTODEPRECIATIONOFITSNON CURRENTASSETS $8 000

$12 000

$7 000

$10 000

$6 000 $8 000 $5 000 $6 000 $4 000 $4 000 $3 000 $2 000 $2 000 $0 $1 000 2015

2016

2017

2018

2019 $0

Photocopiers

2015

2016

2017

2018

2019

Office Equipment Depreciation expense

Depreciation expense

Line A

Line B

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

361

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CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

Required a IdentifyTHEDEPRECIATIONMETHODUSEDFORTHE s 0HOTOCOPIERS s /FlCE%QUIPMENT b IdentifyTHELINESLABELLED@,INE!AND@,INE" c Discuss WHETHER THE OWNER SHOULD CHANGE THE METHOD USED TO CALCULATE THE DEPRECIATIONOFTHEPHOTOCOPIERS d ExplainTHEEFFECTONTHECARRYINGVALUEOFTHEOFlCEEQUIPMENTATTHEENDOFITS USEFULLIFEIFTHEOWNERHADUSEDTHEOTHERDEPRECIATIONMETHOD

EXERCISE 15.9 CASH SALE OF A NON-CURRENT ASSET

W B

page 330

/N!UGUST 0ARTY0OTSSOLDAVANFORCASH2EC 4HEVANHADBEEN PURCHASEDFORANDALREADYDEPRECIATEDBYATTHETIMEOFSALE Required a Record2ECEIPTINTHE#ASH2ECEIPTS*OURNALOF0ARTY0OTS b ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDTHEDISPOSALOFTHEVANAND TRANSFERTHEPROlTORLOSSONDISPOSAL c ShowHOWTHE6AN !CCUMULATED$EPRECIATIONOF6AN $ISPOSALOF6ANAND0ROlTOR ,OSSON$ISPOSALOF6ANACCOUNTSWOULDAPPEARAFTERTHEJOURNALSWEREPOSTEDTOTHE 'ENERAL,EDGEROF0ARTY0OTS d ShowHOWTHEPROCEEDSFROMTHESALEWOULDBEREPORTEDINTHE#ASH&LOW3TATEMENT OF0ARTY0OTSFOR!UGUST

EXERCISE 15.10 CASH SALE OF A NON-CURRENT ASSET

W B

page 332

!SAT$ECEMBER THE"ALANCE3HEETOF4RIFlC4OYSSHOWEDTHEFOLLOWING TRIFFIC TOYS Balance Sheet as at 31 December 2014 Non-Current Assets

$

Fittings

36 000

Less Accumulated Depreciation

32 800

$ 3 200

4HElTTINGSAREDEPRECIATEDUSINGTHESTRAIGHT LINEMETHODATPERANNUM/N -ARCHTHElTTINGSWERESOLDFORCASH2EC  Required a CalculateCARRYINGVALUEOFTHElTTINGSASAT-ARCH b RecordTHEPROCEEDSFROMTHEDISPOSALOFTHElTTINGSINTHE#ASH2ECEIPTS*OURNAL OF4RIFlC4OYS c ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDTHEDISPOSALOFTHElTTINGS d ShowHOWTHE&ITTINGS !CCUMULATED$EPRECIATIONOF&ITTINGS $ISPOSALOF&ITTINGS AND0ROlTOR,OSSON$ISPOSALOF&ITTINGSACCOUNTSWOULDAPPEARAFTERTHESALEWAS POSTEDTOTHE'ENERAL,EDGEROF4RIFlC4OYS e SuggestTWOREASONSFORTHEPROlTORLOSSONTHEDISPOSALOFTHElTTINGS f ShowHOWTHEPROlTORLOSSONTHEDISPOSALOFTHElTTINGSWOULDBEREPORTEDINTHE )NCOME3TATEMENTOF4RIFlC4OYSFOR-ARCH

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CHAPTER 15

ACCOUNTING FOR NON-CURRENT ASSETS

EXERCISE 15.11 CASH SALE OF A NON-CURRENT ASSET

W B

page 334

!NEXTRACTFROMTHE'ENERAL,EDGEROF6ICKIS6INYLSASAT/CTOBERSHOWEDTHE FOLLOWING Disposal of Furniture Date Oct. 31

Cross-reference Furniture

Amount $

Date

8 000

Oct. 31

Cross-reference

Amount $

Acc. Dep. – Furniture

5 000

Bank

1 900

4HESALEOFFURNITUREOCCURREDON/CTOBER ANDWASVERIlEDBY2EC Required a ExplainHOWTHEPROCEEDSFROMTHEDISPOSALOFFURNITUREWOULDBEREPORTEDINTHE #ASH&LOW3TATEMENTOF6ICKIS6INYLSFOR/CTOBER b CalculateTHEPROlTORLOSSMADEONTHEDISPOSALOFFURNITURE c ExplainONEREASONFORTHEPROlTORLOSSONTHEDISPOSALOFFURNITURE d ShowHOWTHEPROlTORLOSSONTHEDISPOSALOFFURNITUREWOULDBEREPORTEDINTHE )NCOME3TATEMENTOF6ICKIS6INYLSFOR/CTOBER e Show HOW THE DISPOSAL OF FURNITURE WOULD HAVE BEEN RECORDED IN THE JOURNALS OF 6ICKIS6INYLS

EXERCISE 15.12 TRADE-IN OF A NON-CURRENT ASSET

W B

page 336

/N-AY AVANPURCHASEDFORBY3WING3EATSANDALREADYDEPRECIATED BYWASTRADEDINFORONANEWVAN BOUGHTONCREDITFORPLUS '34 FROM$ODGE-OTORS)NV  Required a DefineTHETERM@TRADE IN b ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDTHEDISPOSALOFTHEOLDVAN ANDTHEPURCHASEOFTHENEWVAN c ShowHOWTHE6AN !CCUMULATED$EPRECIATIONOF6AN $ISPOSALOF6AN 0ROlTOR,OSS ON$ISPOSALOF6ANAND3UNDRY#REDITORn$ODGE-OTORSACCOUNTSWOULDAPPEAR AFTERTHEDISPOSALWASPOSTEDTOTHE'ENERAL,EDGEROF3WING3EATS d DefineTHETERM@UNDER DEPRECIATION e StateTWOCAUSESOFUNDER DEPRECIATION

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363

364

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

EXERCISE 15.13 TRADE-IN OF A NON-CURRENT ASSET

W B

page 338

1UILTS)NCRECENTLYTRADEDINITSCASHREGISTERANDPURCHASEDAMUCHNEWERVERSION4HE OLDCASHREGISTERWASPURCHASEDFORINCLUDING'34 BUTHADBEENDEPRECIATEDBY ATTHETIMEOFTRADE IN4HEINVOICEFORTHETRANSACTIONISSHOWNBELOW

Cash Controllers

Invoice: A330

ABN: 45 765 300 118 Moore St, Moe VIC 3825

Charge to: Date 1 June 15

Terms: 10/7, n/60 Tax invoice

Quilts Inc. (ABN: 52 590 436 466) Keilor Rd, Essendon VIC 3040 Details Electronic cash register

Qty 1

Unit price

6 000

6 000

GST

600

Invoice price less

6 600

Trade in Balance owing

Total

500

$

6 100

/N*UNE 1UILTS)NCPAID#ASH#ONTROLLERSTHEBALANCEOWING Required a ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDTHEDISPOSALOFTHEOLDCASH REGISTERANDTHEPURCHASEOFTHENEWCASHREGISTER b ShowHOWTHE#ASH2EGISTER $ISPOSALOF#ASH2EGISTERAND3UNDRY#REDITORn#ASH #ONTROLLERS ACCOUNTS WOULD APPEAR AFTER THE DISPOSAL WAS POSTED TO THE 'ENERAL ,EDGEROF1UILTS)NC c ExplainHOWTHEVALUEOFTHETRADE INSHOULDBEREPORTEDINTHE)NCOME3TATEMENT FOR1UILTS)NCFOR*UNE d ShowHOWTHEPAYMENTTO#ASH#ONTROLLERSON*UNEWOULDBEREPORTEDIN THE#ASH&LOW3TATEMENTOF1UILTS)NCFOR*UNE

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CHAPTER 15

ACCOUNTING FOR NON-CURRENT ASSETS

EXERCISE 15.14 DISPOSAL OF A NON-CURRENT ASSET AND FINANCIAL REPORTS

W B

page 340

+YABRAM+ITESHASPROVIDEDTHEFOLLOWING0RE ADJUSTMENT4RIAL"ALANCEASAT*UNE  KYABRAM KITES Pre-adjustment Trial Balance as at 30 June 2015 Account

Debit

Accumulated Depreciation – Fittings Advertising

24 000 1 000

Bank

390

Capital – Darling Cost of Sales

34 720 14 820

Creditors Control Debtors Control Discount Expense

8 600 12 750 280

Discount Revenue Drawings Fittings

130 3 200 60 000

GST Clearing

1 060

Loan – Northern Bank (repayable $500 per month) Prepaid Rent

24 000 1 800

Sales Stock Control Stock Write-down Wages Totals

Credit

33 100 26 670 230 5 250 $126 000

$126 000

Additional information: s 4HElTTINGSARETOBEDEPRECIATEDATPERANNUMUSINGTHEREDUCINGBALANCE METHOD s /N*UNE SOMESHOPlTTINGSWERETRADEDINFORONNEWSHOPlTTINGS WHICHCOSTPLUS'34 FROM&ITS7ELL4HEOLDSHOPlTTINGSHADBEEN PURCHASEDFOR BUTHADACARRYINGVALUEOF s !PHYSICALSTOCKTAKEON*UNESHOWEDA3TOCK,OSSOF s !S AT  *UNE   INTEREST EXPENSE WAS ACCRUED AND PREPAID RENT WAS  s 2EPORTSAREPREPAREDMONTHLY

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CAMBRIDGE VCE ACCOUNTING

366

UNITS 3&4

Required

* * *

a Show THE 'ENERAL *OURNALENTRIES NECESSARY TO RECORD THE ADDITIONALINFORMATION .ARRATIONSAREnotREQUIRED b Prepare A0OST ADJUSTMENT4RIAL"ALANCEFOR+YABRAM+ITESASAT*UNE c ShowTHE'ENERAL*OURNALENTRIESNECESSARYTOCLOSETHEEXPENSEACCOUNTS d PrepareAN)NCOME3TATEMENTFOR+YABRAM+ITESFORTHEYEARENDED*UNE e Suggest TWO ACTIONS +YABRAM +ITES COULD TAKE TO IMPROVE !DJUSTED 'ROSS 0ROlT WITHOUTCHANGINGITSMARK UP f PrepareACLASSIlED"ALANCE3HEETFOR+YABRAM+ITESASAT*UNE

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Where are we headed? After completing this chapter, you should be able to: s define@REVENUE @EXPENSES AND@PROlT s explainHOWTHE2EPORTING 0ERIODPRINCIPLEAND QUALITATIVECHARACTERISTIC OF2ELEVANCEAFFECTTHE CALCULATIONOFPROlT s explainTHEPURPOSEOFA BALANCEDAYADJUSTMENT s identifyANDrecordPREPAID REVENUEINTHE#ASH2ECEIPTS *OURNALAND'ENERAL,EDGER

s stateTHEEFFECTOFBALANCE DAYADJUSTMENTSONTHE ACCOUNTINGEQUATION

s recordBALANCEDAY ADJUSTMENTSINTHE'ENERAL *OURNALAND'ENERAL,EDGER FORPREPAIDANDACCRUED REVENUES

s identifyANDrecordTHE RECEIPTOFANACCRUEDREVENUE INASUBSEQUENTPERIOD s distinguishBETWEENACCRUED REVENUEANDASUNDRYDEBTOR s reportPREPAIDANDACCRUED REVENUESINTHE"ALANCE 3HEET

CHAPTER 16

BALANCE DAY ADJUSTMENTS: REVENUES KEY TERMS After completing this chapter, you should be familiar with the following terms: s PREPAIDREVENUE s ACCRUEDREVENUE

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UNITS 3&4

16.1 THE NEED FOR BALANCE DAY ADJUSTMENTS #HAPTER  POINTED OUT THAT WHEN WE SPEAK OF DETERMINING PROlT WE ARE ACTUALLY COMPARINGTHEREVENUEEARNEDAGAINSTTHEEXPENSESINCURREDINTHECURRENT2EPORTING 0ERIOD "ALANCE DAY ADJUSTMENTS ARE MADE TO ENSURE THAT REVENUE ACCOUNTS SHOW REVENUESEARNEDANDEXPENSEACCOUNTSSHOWEXPENSESINCURREDINAPARTICULAR2EPORTING 0ERIOD SOANACCURATEPROlTCANBECALCULATED

Types of balance day adjustments 3O FAR WE HAVE COVERED BALANCE DAY ADJUSTMENTS THAT ENSURE THAT EXPENSE accounts SHOWTHEAMOUNTSINCURREDCONSUMED: s STOCKLOSSES#HAPTER s PREPAIDEXPENSESANDACCRUEDEXPENSES#HAPTER s DEPRECIATION#HAPTER  4OTHISPOINT THEONLYREVENUEWEHAVECOVEREDISASTOCKGAIN)NTHISCHAPTER WEWILL COVER TWO OTHER BALANCE DAY ADJUSTMENTS TO ENSURE THAT REVENUE ACCOUNTS SHOW THE AMOUNTSEARNED: s PREPAIDREVENUES s ACCRUEDREVENUES 2EMEMBER REVENUE IS DElNED AS AN INmOW OF ECONOMIC BENElTS OR SAVING IN OUTmOWS INTHEFORMOFANINCREASEINASSETSORAREDUCTIONINLIABILITIESTHATLEADSTO AN INCREASE IN OWNERS EQUITY 4HE DElNITION DOES NOT REQUIRE THAT CASH BE RECEIVED FOR REVENUE TO BE RECOGNISED THE RECEIPT OF CASH MAY OR MAY NOT BE INVOLVED &OR EXAMPLE ACREDITSALEINCREASESDEBTORSRATHERTHANCASH)NDEED MANYTRANSACTIONSARE NOTREVENUESEVENWHENCASHISRECEIVED4HEKEYISTHATSOMETYPEOFeconomic benefit HASBEENRECEIVEDEITHERBYASSETSINCREASINGORLIABILITIESDECREASING ANDTHATOWNERS EQUITYHASINCREASEDASACONSEQUENCE

REVIEW QUESTIONS 16.1

1 ExplainTHEPURPOSEOFABALANCEDAYADJUSTMENT 2 DefineTHETERM@REVENUE 3 StateTHREENON CASHREVENUEITEMS

16.2 PREPAID REVENUES

prepaid revenue a revenue received but yet to be earned

!LTHOUGH PERHAPS LESS FREQUENT THAN A PREPAID EXPENSE IT IS POSSIBLE FOR A lRM TO RECEIVEREVENUEINADVANCEOFSUPPLYINGTHEGOODS4HISWOULDBETHECASEIFAlRM ACCEPTEDSUBSCRIPTIONS SUCHASTOAMAGAZINERENTEDOUTEXTRASPACEINITSWAREHOUSE OFFEREDLAY BYFACILITIESORACCEPTEDCASHASADEPOSITTOSECUREASALE3ECTION COVERSTHELASTPOSSIBILITY )NCASESSUCHASTHESE THElRMWOULDHAVERECEIVEDTHECASH BUTBECAUSEITHASNOT SUPPLIEDANYGOODSORSERVICES TOTHECUSTOMER ITHASNOTEARNEDANYREVENUE4HIS MEANSTHERECEIPTISprepaid revenue ORREVENUERECEIVEDINADVANCE 7HERE REVENUE IS PREPAID THE GOODSERVICE IS OWED TO THE CUSTOMER SO THE lRM HAS AN OBLIGATION TO PROVIDE THEM SOMETIME IN THE FUTURE 4HUS PREPAID REVENUE IS NOTREVENUEATALL BUTRATHERAcurrent liabilityAPRESENTOBLIGATIONTHATISEXPECTEDTO RESULTINANOUTmOWOFECONOMICBENElTSWHENTHEGOODSERVICEISSUPPLIEDSOMETIME INTHENEXTMONTHS

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CHAPTER 16

B A L A N C E D AY A D J U S T M E N T S : R E V E N U E S

369

Although perhaps less frequent than a prepaid expense, it is possible for a firm to receive revenue in advance of supplying the goods; for example, a newspaper subscription

Recording revenues received in advance 7HEN REVENUE IS RECEIVED IN ADVANCE OR PREPAID IT MUST BE RECORDED AS A CURRENT LIABILITYINTHEJOURNALSANDLEDGERACCOUNTS

EXAMPLE

The Bag Emporium owns a warehouse, and rents out some office space to a small courier business. On 1 August 2015, the Bag Emporium received $420 rent (plus $42 GST) for use of the office space for the next six months. Reports are prepared monthly.

/FTHECASHRECEIVEDFROMTHECOURIERCOMPANY IS'34THATISNOWOWEDTO THE!4/7HATOFTHEREMAINING? 4HEKEYHEREISTHATTHECASHRECEIPTCOVERSTHENEXTMONTHSITISRECEIVEDINADVANCE OFPROVIDINGTHEUSEOFTHEOFlCESPACE!SAT!UGUST NONEOFTHEOFlCESPACE HASBEENPROVIDEDTOTHECOURIERBUSINESS THEREFORENOREVENUEHASBEENEARNED)N FACT 4HE"AG%MPORIUMOWESTOTHECOURIERCOMPANYUSEOFTHEOFlCESPACEFORSIX MONTHS SOTHISCASHRECEIPTISINFACTALIABILITYn0REPAID2ENT2EVENUE

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UNITS 3&4

4HISRECEIPTWOULDBERECORDEDINTHE#ASH2ECEIPTS*OURNALASSHOWNIN&IGURE STUDY TIP

)F'34ISIDENTIlED IT CANBERECORDEDINTHE #ASH2ECEIPTS*OURNAL

Figure 16.1

Cash Receipts Journal: prepaid revenue CASH RECEIPTS JOURNAL

Date Aug.1

Rec. no.

Details Prepaid Totals

Debtors Cost of Control Sales

Sales

Sundries

462

18

Rent Rev.

Disc. Exp.

Bank

33 020

300

12 000

12 500

19 000

GST

420

42

420

1 942

!FTERPOSTING THE'ENERAL,EDGERWOULDAPPEARASSHOWNIN&IGURE Figure 16.2

General Ledger: prepaid revenue GENERAL LEDGER Bank (A)

Date Aug. 1 Dec. 31

Cross-reference

Amount $

Balance

Date

Cross-reference

Amount $

5 000

Cash Receipts

33 020 Prepaid Rent Revenue (L)

Date

Cross-reference

Amount $

Date Aug. 31

Cross-reference Bank

Amount $ 420

GST Clearing (A/L) Date

Cross-reference

Amount $

Date Aug. 1 31

Cross-reference Balance Bank

Amount $ 700 1 942

4HISENTRYINCREASESBank ANDINCREASESTWOLIABILITIES0REPAID2ENT2EVENUEAND'34 #LEARING!TTHISPOINT THEREISNOREVENUERECORDEDINTHE'ENERAL,EDGERNORENTHAS BEENPROVIDED SONORENTREVENUEHASBEENEARNED Effect on the accounting equation !SARESULTOFTHERECEIPTOFPREPAIDREVENUE Increase/Decrease/No effect

Amount $

Assets

Increase (Bank)

462

Liabilities

Increase (Prepaid Rent Revenue $420, GST Clearing $42)

462

Owner’s Equity

No effect

.OTETHATTHEREISNOEFFECTONOWNERSEQUITY SOTHECASHRECEIVEDCANNOTBEREVENUE

Adjusting for prepaid revenues earned 0REPAIDREVENUESARERECORDEDASCURRENTLIABILITIESBECAUSEWHENTHECASHISRECEIVED NONEOFTHEAMOUNTHASBEENEARNEDITISAPRESENTOBLIGATIONTOPROVIDETHEGOOD ORSERVICE)FBYBALANCEDAYTHEGOODSERVICEHASBEENPROVIDEDTOTHECUSTOMER THE lRMWILLHAVEFULlLLEDITSOBLIGATIONTHELIABILITYHASBEENEXTINGUISHED SOTHEREVENUE

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B A L A N C E D AY A D J U S T M E N T S : R E V E N U E S

HASBEENEARNED4HISISAGOODEXAMPLEOFAREVENUEINTHEFORMOFADECREASEINA LIABILITYPREPAIDREVENUE RATHERTHANTHEUSUALINCREASEINASSETSCREATEDBYACASHOR CREDITSALE )TISNECESSARYTOADJUSTTHELEDGERACCOUNTSSOTHAT s THE AMOUNT EARNED IN THE CURRENT 2EPORTING 0ERIOD IS TRANSFERRED TO A REVENUE ACCOUNT s THE0REPAID2EVENUEACCOUNTONLYSHOWSTHEAMOUNTREMAININGTHATIS UNEARNED ORTOBEEARNEDINAFUTURE2EPORTING0ERIOD )NTHEEXAMPLE THERECEIVEDON!UGUSTRELATEDTOTHENEXTSIXMONTHS SO 2ENT2EVENUEFORONEMONTHWOULDBECALCULATEDAS $420 Prepaid Rent Revenue

=

$70 Rent per month

6 months 4HISREVENUEISONLYEARNEDASTHERENTISPROVIDEDEACHMONTH"Y!UGUST RENT WOULDHAVEBEENPROVIDEDFORONEMONTH!UGUST MEANING4HE"AG%MPORIUMWOULD HAVEEARNEDONEMONTHSWORTH OR2ENT2EVENUEOF-EMO !SARESULT THIS AMOUNTISNOLONGEROWEDTOTHECOURIERCOMPANY 4HEBALANCEDAYADJUSTMENTTORECORDTHEPREPAIDRENTREVENUEEARNEDISSHOWNIN THE'ENERAL*OURNALENTRYIN&IGURE Figure 16.3

General Journal: BDA for prepaid revenue earned GENERAL JOURNAL

Date

Details

Aug. 31

Prepaid Rent Revenue

General Ledger

Subsidiary ledger

Debit

Debit

Credit

Credit

70

Rent Revenue

70

Adjusting entry to record one month’s rent revenue earned (Memo 12)

4HISENTRYCREDITSTHE2ENT2EVENUEACCOUNTTORECOGNISETHEREVENUEEARNEDINTHE CURRENT2EPORTING0ERIOD WHILETHE0REPAID2ENT2EVENUEACCOUNTISDEBITEDTOREDUCE THECURRENTLIABILITYBECAUSETHEOBLIGATIONHASBEENFULlLLED!FTERPOSTING THE'ENERAL ,EDGERWOULDAPPEARASISSHOWNIN&IGURE Figure 16.4

General Ledger: BDA for prepaid revenue earned GENERAL LEDGER Prepaid Rent Revenue (L)

Date

Cross-reference

Amount $

Date

Aug. 31

Rent Revenue

70

Aug. 31

Cross-reference Bank

Amount $ 420

350 Rent Revenue (R) Date

Cross-reference

Amount $

Date Aug. 31

Cross-reference Prepaid Rent Revenue

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Amount $ 70

Cambridge University Press

371

372

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

4HE BALANCE OF THE 2ENT 2EVENUE ACCOUNT  REPRESENTS THE REVENUE EARNED IN THECURRENT2EPORTING0ERIOD WHILETHEBALANCEREMAININGINTHE0REPAID2ENT2EVENUE ACCOUNT REPRESENTSTHEREVENUETHATHASNOTYETBEENEARNED ANDWILLBEEARNED INAFUTURE2EPORTING0ERIOD Effect on the accounting equation !SARESULTOFTHEADJUSTMENTFORPREPAIDREVENUEEARNED Increase/Decrease/No effect

Amount $

Assets

No effect

Liabilities

Decrease (Prepaid Rent Revenue)

70

Owner’s Equity

Increase (Rent Revenue increases Net Profit)

70

!S A CONSEQUENCE OF THE BALANCE DAY ADJUSTMENT A LIABILITY BECOMES A REVENUE DECREASINGLIABILITIESANDINCREASINGOWNERSEQUITY!SSETSDONOTCHANGE

Closing the ledger 4HEADJUSTEDlGUREINTHEREVENUEACCOUNTCANNOWBECLOSEDTOTHE0ROlTAND,OSS 3UMMARYACCOUNT2EMEMBER ALLREVENUEACCOUNTSARECLOSEDINONE'ENERAL*OURNAL ENTRY WITHEACHREVENUEACCOUNTDEBITEDTOREDUCEITSBALANCETOZERO ANDONECREDIT TOTHE0ROlTAND,OSS3UMMARYACCOUNT!FTERITHASBEENCLOSED THE2ENT2EVENUE ACCOUNTINOUREXAMPLEWOULDSHOW Rent Revenue (R) Date

Cross-reference

Amount $

Date

Aug. 31

P&L Summary

70

Aug. 31

Cross-reference Prepaid Rent Revenue

Amount $ 70

!SACURRENTLIABILITY THE0REPAID2ENT2EVENUEACCOUNTWOULDBEBALANCED ANDTHE AMOUNTSTILLOWINGCARRIEDFORWARDTOTHENEXTPERIOD Prepaid Rent Revenue (L) Date

Cross-reference

Aug. 31

Rent Revenue

Amount $

Balance

70

Date Aug. 31

Cross-reference Bank

Amount $ 420

350 420

420 Sept. 1

Balance

350

REVIEW QUESTIONS 16.2

1 2 3 4

DefineTHETERM@PREPAIDREVENUE ExplainHOWPREPAIDREVENUEISREPORTEDINTHE"ALANCE3HEET StateTHEEFFECTOFARECEIPTOFPREPAIDREVENUEONTHEACCOUNTINGEQUATION Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO RECORD THE BALANCE DAY ADJUSTMENTFORPREPAIDREVENUEEARNED 5 StateTHEEFFECTOFTHEBALANCEDAYADJUSTMENTFORPREPAIDREVENUEEARNEDON THEACCOUNTINGEQUATION

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373

16.3 PREPAID SALES REVENUE: SALES OF STOCK INVOLVING A DEPOSIT 3ECTION  DESCRIBED THE RECORDING OF PREPAID REVENUE WHERE CASH IS RECEIVED IN ADVANCEFORREVENUETHATISYETTOBEEARNED/NCETHEREVENUEISEARNED ENTRIESARE NECESSARYTORECORDTHEREVENUEEARNED ANDTHEREDUCTIONINTHELIABILITYOWEDTOTHE CUSTOMER 4HISAPPLIESTOALLPREPAIDREVENUES BUTPREPAIDSales2EVENUEISAPARTICULARTYPEOF PREPAIDREVENUE BECAUSEITINCLUDESTHEPROVISIONOFSTOCK0REPAID3ALESMIGHTOCCUR WHEN A NEW PRODUCT SUCH AS A $6$ OR ELECTRONIC GAME IS RELEASED AND CUSTOMERS PAYINADVANCETOENSURETHEYAREAMONGTHElRSTTOOWNTHEITEM)TMIGHTALSOOCCUR WHENACUSTOMERPAYSADEPOSITONANITEMOFSTOCKINORDERTOSECURETHESALE7HEN THISSTOCKISPROVIDED THEENTRIESAREREQUIREDTORECORDTHEREVENUEEARNEDANDTHE REDUCTIONOFTHELIABILITY BUTALSOTHESTOCKLEAVINGTHEBUSINESS

EXAMPLE

Wollard Prints sells a signed and framed poster of the Australian soccer team for $1 200 (plus $120 GST). On 14 September 2015, Wollard Prints received a deposit of $500 from B. Hogan for the sale of one poster (Rec. 35). On 23 September 2015, Hogan collected the poster, paying the balance in cash (Rec. 39). The poster has a cost price of $650.

Recording the deposit )NCOMMONWITHANYPREPAIDSALE THEDEPOSITRECEIVEDON3EPTEMBERINCREASES CASHINTHE"ANKACCOUNT ANDCREATESALIABILITYINTHISCASE 0REPAID3ALESREVENUE "UT BECAUSETHISISSIMPLYADEPOSITTOGUARANTEETHESALEnANDNOTARECEIPTOFTHEFULL AMOUNTOFCASHFORTHESALEnTHETRANSACTIONDOESNOTIDENTIFYANY'34RECEIVED!SA RESULT '34NEEDNOTBERECORDEDINTHE#ASH2ECEIPTS*OURNAL ASISSHOWNIN&IGURE  Figure 16.5

Cash Receipts Journal: deposit (no GST) Cash Receipts Journal

Date Sept. 14

Details Prepaid Sales

Rec. no.

Bank

35

500

Disc. Exp.

Debtors Control

Cost of Sales

Sales

Sundries 500

Recording a cash sale involving a deposit

STUDY TIP

/NCE THE CUSTOMER (OGAN COLLECTS THE POSTER ON  3EPTEMBER  THE 3ALES 2EVENUEHASBEENEARNED ANDTHELIABILITYMET&IGURESHOWSTHE'ENERAL*OURNAL ENTRYTORECORDTHISINFORMATION

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GST

$EPOSITSDONOT INCLUDE'34

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CAMBRIDGE VCE ACCOUNTING

374

Figure 16.6

UNITS 3&4

General Journal: deposit earned GENERAL JOURNAL General Ledger

Date Sept. 23

Details

Debit

Prepaid Sales

Credit

Subsidiary ledger Debit

Credit

500

Sales

500

Prepaid sales revenue earned (Rec. 39)

STUDY TIP

7HEREADEPOSIT ISINVOLVED '34IS RECOGNISEDATTHE POINTOFSALE

4HISISTHESAMEASANYENTRYTORECORDPREPAIDREVENUEEARNED ANDTHEREFORETHE SAMEASTHEENTRIESSHOWNIN&IGURE4HEENTRYDEBITS0REPAID3ALESREVENUETO REDUCE THE AMOUNT OWED TO THE CUSTOMER AND CREDITS 3ALES REVENUE BOTH BY  TORECORDTHEREVENUEEARNEDWHENTHEGOODTHEPOSTER ISPROVIDEDTOTHECUSTOMER (OGAN  (OWEVER THESELLINGPRICEOFTHEPOSTERSISNOTJUSTTHISTHESELLINGPRICEWAS ACTUALLY  4HUS WHEN THE POSTER IS SOLD ON  3EPTEMBER  WE MUST ALSO RECORDANextraOF3ALESREVENUE4HISAMOUNT ALONGWITHTHEFULLAMOUNTOF'34 ONTHESALE nATOTALOFnWILLBERECEIVEDINCASHON3EPTEMBER ANDSOMUSTBERECORDEDINTHE#ASH2ECEIPTS*OURNAL 7EMUSTALSORECORDTHATASTHEPOSTERWASCOLLECTED $650WORTHCost of SalesHAS BEENINCURRED ANDStock ControlHASDECREASEDBYTHESAMEAMOUNT  4HE#ASH2ECEIPTS*OURNALENTRYTORECORDTHISEXTRASALESINFORMATIONISSHOWNIN &IGURE Figure 16.7

Cash Receipts Journal: cash sale (involving a deposit) CASH RECEIPTS JOURNAL

STUDY TIP

!SADOUBLE CHECK ADDTOGETHERANY AMOUNTSLABELLED @3ALESTHEYSHOULD EQUALTHESELLINGPRICE OFTHESTOCKEXCLUDING '34 

Date

Details

Sept. 23

Sales

Rec. No.

Bank

39

820

Disc. Exp.

Debtors Control

Cost of Sales 650

Sales Sundries 700

GST

120

4HIS#ASH2ECEIPTS*OURNALENTRYLOOKSLIKEASTANDARD ORDINARYCASHSALEWHICH FORTHE MOSTPART ITIS (OWEVER THE'34AMOUNT ISnotOFTHEAMOUNTRECORDED INTHE3ALESCOLUMN )NSTEAD THE'34ISOFTHEtotal3ALESlGUREOF WHERE • HASBEENRECORDEDINTHE'ENERAL*OURNALASSHOWNIN&IGURE AND • HASBEENRECORDEDINTHE#ASH2ECEIPTS*OURNAL&IGURE  4HESEtwoENTRIESnTHE'ENERAL*OURNALENTRYIN&IGURE ANDTHE#ASH2ECEIPTS *OURNALIN&IGURE nARENECESSARYTORECORDTHESALEON3EPTEMBER Effect on the accounting equation !SARESULTOFRECORDINGTHECASHSALEINVOLVINGADEPOSIT Increase/Decrease/No effect

Amount $

Assets

Increase (increase Bank $820, decrease Stock Control $650)

170

Liabilities

Decrease (decrease Prepaid Sales Revenue $500; increase GST Clearing $120)

380

Owner’s Equity

Increase (Sales Revenue $1 200* less Cost of Sales $650 = Net Profit)

550

3ALES2EVENUEPREPAID'* #ASH3ALES#2* ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

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CHAPTER 16

B A L A N C E D AY A D J U S T M E N T S : R E V E N U E S

375

Recording a credit sale involving a deposit )N THE PREVIOUS EXAMPLE THE CUSTOMER (OGAN PAID CASH FOR THE BALANCE REMAINING WHENCOLLECTINGTHEGOODSON3EPTEMBER4HISWASVERIlEDBY2ECEIPT!S ACONSEQUENCE THE CASHRECEIVEDWASRECORDEDINTHE#ASH2ECEIPTS*OURNALAS WASTHEOF@EXTRA3ALES2EVENUE THE'34ANDTHECost of Sales of $650 )NTHEEVENTTHATTHESALEISMADEon credit THESAMEINFORMATIONMUSTBERECORDED THEONLYDIFFERENCESBEINGTHATITWOULDBEVERIlEDBYANinvoiceRATHERTHANBYACASH RECEIPT ANDRECORDEDINTHE3ALES*OURNALRATHERTHANTHE#ASH2ECEIPTS*OURNAL&IGURE SHOWSHOWTHISWOULDBERECORDEDINTHE'ENERAL*OURNALAND3ALES*OURNAL Figure 16.8

Journals: credit sale (involving a deposit) GENERAL JOURNAL General Ledger

Date Sept. 23

Details

Debit

Prepaid Sales

Subsidiary ledger

Credit

Debit

Credit

500

Sales

500

Prepaid Sales Revenue earned (Inv. 12) SALES JOURNAL Date Sept. 23

Debtor B. Hogan

Invoice number 12

Cost of Sales 650

Sales

GST

700

120

Debtors Control 820

4HIS'ENERAL*OURNALENTRYISIDENTICALTOTHATUSEDIFTHEREMAINDERISPAIDINCASH IN&IGURE !NDTHEINFORMATIONRECORDEDINTHIS3ALES*OURNALISTHESAMEASTHAT RECORDEDINTHE#ASH2ECEIPTS*OURNALIN&IGURE THEONLYDIFFERENCEBEINGTHAT FORACREDITSALEITIS$EBTORS#ONTROLANDINTHESUBSIDIARYLEDGER $EBTORn(OGAN NOT "ANK THATINCREASESBY)NBOTHCASES THETOTAL3ALESREVENUEEARNEDAMOUNTS TOTHESELLINGPRICEOFTHEPOSTER THECost of SalesIS$650 THE0REPAID3ALES REVENUELIABILITYDECREASESAND'34OFISRECOGNISED!SACONSEQUENCE THEEFFECT ONTHEACCOUNTINGEQUATIONISIDENTICALTOTHATOFACASHSALE

STUDY TIP

2EMEMBER ADD TOGETHERANYAMOUNTS LABELLED@3ALESTOCHECK THATTHEYEQUALTHE SELLINGPRICEOFTHESTOCK EXCLUDING'34 

Posting to the General Ledger "ECAUSEPARTOFASALEINVOLVINGADEPOSITISRECORDEDINTHE'ENERAL*OURNALTHEEARNING OFTHEDEPOSIT THISMUSTBEPOSTEDTOTHE'ENERAL,EDGERSEPARATELY3EE&IGURE FORAREMINDER 4HE@EXTRASALEINFORMATIONISRECORDEDINTHE#ASH2ECEIPTS*OURNALFOR ACASHSALE OR3ALES*OURNALFORACREDITSALE ASWITHANYOTHERSALE SOTHISINFORMATION ISSIMPLYPOSTEDTOTHE'ENERAL,EDGERATTHEENDOFTHEMONTHASPARTOFTHECOLUMN TOTALSFROMTHE#ASH2ECEIPTS*OURNAL3ALES*OURNAL REVIEW QUESTIONS 16.3

1 Identify TWOSITUATIONSTHATMAYLEADTOTHERECEIPTOFADEPOSIT 2 StateTHEEFFECTONTHEACCOUNTINGEQUATIONOFTHERECEIPTOFADEPOSIT 3 ShowTHEDEBITANDCREDITENTRIESREQUIREDTORECORDACASHSALEINVOLVINGA DEPOSIT 4 StateTHEEFFECTONTHEACCOUNTINGEQUATIONOFASALEINVOLVINGADEPOSIT 5 IdentifyTHREEDIFFERENCESBETWEENRECORDINGACASHSALEINVOLVINGADEPOSIT ANDRECORDINGACREDITSALEINVOLVINGADEPOSIT ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

376

UNITS 3&4

16.4 ACCRUED REVENUE

accrued revenue a revenue that has been earned but not yet received

0REPAID REVENUES ARE RECEIVED BEFORE THEY ARE EARNED BUT IN SOME CASES REVENUES WILL BE RECEIVED after THEY ARE EARNED &OR EXAMPLE INTEREST ON A TERM DEPOSIT MAY HAVEBEENearned BUTISNOTDUETOBERECEIVEDUNTILNEXTMONTH/THERITEMSSUCHAS ROYALTIESANDCOMMISSIONSMAYONLYBERECEIVEDAFTERTHEYHAVEBEENEARNED"ECAUSE THISAMOUNTHASBEENEARNEDINTHECURRENT2EPORTING0ERIOD ITMUSTBERECOGNISEDAS REVENUE4HEAMOUNTOWINGSHOULDALSOBERECORDEDASAcurrent asset ASSOMETIME INTHEFUTURE THECASHWILLBERECEIVED4HEAMOUNTOWEDTOUSFORREVENUEWEHAVE ALREADYEARNEDISCALLEDaccrued revenue

Accrued revenue versus debtors !CCRUEDREVENUEANDDEBTORSARESIMILARINTHATTHEYARECURRENTassets)NBOTHCASESTHE REVENUEISEARNEDBEFORETHECASHISRECEIVED SOTHEYREPRESENTARESOURCECONTROLLED BYTHEENTITYTHEDEBTOWEDTOTHEBUSINESS WHICHWILLBRINGAFUTUREECONOMICBENElT INTHENEXTMONTHSWHENTHECASHISRECEIVED (OWEVER THEYAREDIFFERENTINASUBTLE BUTIMPORTANTWAY)FTHECUSTOMERHASTHEgoods and the invoice THENACREDITSALE HASOCCURRED ANDADEBTORSHOULDBERECOGNISED(OWEVER IFTHEREVENUERELATESTO ATRANSACTIONOTHERTHAN3ALES ANDTHECUSTOMERHAS not been sent the invoice THEN ACCRUEDREVENUEHASBEENEARNED!SSUCH ACCRUEDREVENUEWILLBEVERIlEDBYAMEMO RATHERTHANANINVOICE

Adjusting for accrued revenues 0RIORTOMAKINGANYBALANCEDAYADJUSTMENTS THEREVENUEACCOUNTSWILLONLYSHOWTHE AMOUNTSRECEIVED

EXAMPLE

On 1 August 2014, Kilvington Kites invested $10 000 in a term deposit, earning interest at 9% per annum. Interest is received on 31 January and 31 July each year. The firm prepares its reports on 30 June each year.

/N*ANUARY THElRMWOULDRECEIVEINTERESTREVENUEFORTHElRSTSIX MONTHSOFTHETERMDEPOSIT Interest revenue for first 6 months

= =

$10 000 $450

x

9%

x

6 12

!SARESULT ASAT*UNETHE)NTEREST2EVENUEACCOUNTWOULDSHOW GENERAL LEDGER Interest Revenue (R) Date

Cross-reference

Amount $

Date June 30

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Cross-reference Bank

Amount $ 450

Cambridge University Press

CHAPTER 16

B A L A N C E D AY A D J U S T M E N T S : R E V E N U E S

4HENEXTINTERESTRECEIPTISNOTDUEUNTIL*ULYnSOMETIMEINTHEnext2EPORTING 0ERIODnSOTHECURRENTLYSHOWNINTHE)NTEREST2EVENUEACCOUNTREPRESENTSTHE AMOUNTACTUALLYRECEIVEDBY*UNE"UTISTHISTHETOTALREVENUEEARNEDINTHE PERIOD "EFORETHEREPORTSCANBEPREPARED THEACCOUNTANTMUSTCALCULATEHOWMUCHEXTRA REVENUEHASBEENEARNED BUTNOTYETRECEIVED ANDADDTHISTOTHEREVENUEACCOUNT BEFORE THE CLOSING ENTRIES ARE MADE )T IS THEREFORE NECESSARY TO ADJUST THE LEDGER ACCOUNTSSOTHAT • THEEXTRAAMOUNTEARNEDINTHEcurrent2EPORTING0ERIODISADDEDTOTHEREVENUE ACCOUNT • ACURRENTASSETACCOUNTn!CCRUED2EVENUEnISCREATEDTOSHOWTHEAMOUNTOWING TOUSWHICHWILLBERECEIVEDINTHEnext2EPORTING0ERIOD  "ETWEENTHELASTRECEIPTOFINTEREST*ANUARY ANDBALANCEDAY*UNE ARElVEMONTHSINWHICHTHEBUSINESSWILLSTILLBEEARNINGINTERESTREVENUE Interest revenue for 5 months

= =

$10 000 $375

x

9%

x

5 12

4HISEXTRAINTERESTOFHASBEENEARNED BUTISNOTYETRECEIVED-EMO ANDTHISMUSTBERECORDEDINTHE'ENERAL*OURNALASABALANCEDAYADJUSTMENT ASIS SHOWNIN&IGURE Figure 16.9

General Journal: BDA for accrued revenue GENERAL JOURNAL

Date

Details

June 30

Accrued Interest Revenue

General Ledger

Subsidiary ledger

Debit

Debit

Credit

Credit

375

Interest Revenue

375

Adjusting entry to record interest earned but not received (Memo 8)

4HIS ENTRY CREDITS THE )NTEREST 2EVENUE ACCOUNT TO RECOGNISE THE EXTRA AMOUNT EARNEDINTHECURRENT2EPORTING0ERIOD!TTHESAMETIME THE!CCRUED)NTEREST2EVENUE ACCOUNTISDEBITEDTORECOGNISETHECURRENTASSETTHEINTERESTOWEDTOUS!FTERPOSTING THE'ENERAL,EDGERWOULDAPPEARASSHOWNIN&IGURE Figure 16.10

General Ledger: BDA for accrued revenue General Ledger Interest Revenue (R)

Date

Cross-reference

Amount $

Date June 30

Cross-reference

Amount $

Bank

450

Accrued Interest Rev.

375

825 Accrued Interest Revenue (A) Date

Cross-reference

Amount $

June 30

Interest Revenue

375

Date

Cross-reference

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Amount $

Cambridge University Press

377

378

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

.OTETHATTHEAMOUNTUSEDINTHEADJUSTMENT ISNOTTHETOTALREVENUEFORTHE PERIODITISSIMPLYTHEAMOUNTOWING)TISaddedTOTHEAMOUNTRECEIVEDTOCALCULATE THETOTALREVENUEEARNEDOF Effect on the accounting equation !SARESULTOFTHEADJUSTMENTFOR!CCRUED)NTEREST2EVENUE Increase/Decrease/No effect

Amount $

Assets

Increase (Accrued Interest Revenue)

Liabilities

No effect

Owner’s Equity

Increase (increase Interest Revenue increases Net Profit)

375

375

Closing the ledger !S A CURRENT ASSET THE !CCRUED )NTEREST 2EVENUE ACCOUNT WILL BE BALANCED BUT THE )NTEREST2EVENUEACCOUNTWILLBECLOSEDTOTHE0ROlTAND,OSS3UMMARYACCOUNT!FTER ITHASBEENCLOSED THE)NTEREST2EVENUEACCOUNTWOULDSHOW Interest Revenue (R) Date June 30

Cross-reference P&L Summary

Amount $

Date

825

June 30

Cross-reference

Amount $

Bank

450

Accrued Interest Rev.

375

825

825

4HEAMOUNTCLOSED ISGREATERTHANTHEAMOUNTOFTHEADJUSTMENT THE TOTALREVENUEINCLUDESBOTHTHERECEIVED ANDTHESTILLOWINGTOUSATTHEEND OFTHEPERIOD&ORANITEMTOBERECOGNISEDASREVENUE THEDElNITIONREQUIRESANITEM TOBEEARNEDTHERECEIPTOFCASHISnotNECESSARY

Receipt of accrued revenues in subsequent periods 3OMETIMEINTHENEXT2EPORTING0ERIOD THEAMOUNTOWINGTOUSASACCRUEDREVENUEWILL BERECEIVED4HEREFORE WHENTHECASHISRECEIVED SOMEMAYREPRESENTAREVENUEOF THEcurrent2EPORTING0ERIOD BUTATLEASTSOMEOFTHERECEIPTWILLRELATETOTHEprevious 2EPORTING 0ERIOD )N OTHER WORDS SOME OF THE AMOUNT RECEIVED REDUCES THE ASSET !CCRUED2EVENUEnREVENUEEARNEDANDACCRUEDLASTPERIOD )NOUREXAMPLE WECREATEDTHECURRENTASSET!CCRUED)NTEREST2EVENUEON*UNE TOREPRESENTTHEWORTHOFINTERESTWEHADEARNED BUTNOTYETRECEIVED4HUS WEHAVEALREADYCOUNTEDITASREVENUE3O WHENTHESECONDINSTALMENTOFINTERESTOF $450ISRECEIVEDON*ULY2EC WECANNOTCOUNTITASALLREVENUE 7EMUSTRECOGNISETHATOFTHE$450RECEIVED WASEARNEDINAprevious2EPORTING 0ERIOD4HISAMOUNTISNOTREVENUEINTHECURRENTPERIOD BUTRATHERAREDUCTIONINTHE CURRENTASSET!CCRUED)NTEREST2EVENUE/NLYTHEREMAINING$450RECEIVEDn ACCRUEDREVENUE REPRESENTSREVENUEEARNEDINTHEcurrent2EPORTING0ERIOD 4HE RECEIPT OF INTEREST ON  *ULY  WOULD BE RECORDED IN THE #ASH 2ECEIPTS *OURNALASSHOWNIN&IGURE

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 16

Figure 16.11

B A L A N C E D AY A D J U S T M E N T S : R E V E N U E S

379

Cash Receipts Journal: accrued revenue received Cash Receipts Journal

Date

Rec. no.

Details

July 31 Accrued Interest Rev./

Bank

78

Disc. exp.

Debtors Control

Cost of Sales

Sales

Sundries

GST

375

450

Interest Revenue

75

Totals

41 000

900

21 650

12 000

18 000

450

1 800

4HEFULLAMOUNTRECEIVED$450 ISRECORDEDINTHE"ANKCOLUMN ASTHISISTHETOTAL CASHRECEIVED(OWEVER RELATESTOINTERESTTHATWASEARNEDINANDADJUSTEDATTHE ENDOF *UNE4HISPARTOFTHERECEIPTDECREASES!CCRUED)NTEREST2EVENUE4HE REMAININGIS)NTEREST2EVENUEEARNEDINTHECURRENTPERIODnTHENEWlNANCIALYEAR WHICHINCLUDES*ULY /NCE THE #ASH 2ECEIPTS *OURNAL HAS BEEN POSTED TO THE 'ENERAL ,EDGER THE ACCOUNTSWOULDAPPEARASSHOWNIN&IGURE Figure 16.12

General Ledger: accrued revenue received GENERAL LEDGER Bank (A)

Date July 1 31

Cross-reference

Amount $

Balance

Date

Cross-reference

Amount $

3 000

Cash Receipts

41 000 Accrued Interest Revenue (A)

Date

Cross-reference

July 1

Balance

Amount $ Date 375

July 31

Cross-reference Bank

Amount $ 375

Interest Revenue (R) Date

Cross-reference

Amount $

Date July 31

Cross-reference Bank

Amount $ 75

.OT ALL OF THE $450 RECEIPT WILL BE RECORDED AS REVENUE  WAS EARNED IN THE previous 2EPORTING0ERIODANDONLYWASEARNEDINTHEcurrent2EPORTING0ERIOD Effect on the accounting equation !SARESULTOFTHERECEIPTOFINTERESTREVENUEAND!CCRUED)NTEREST2EVENUE Increase/Decrease/No effect Assets

Increase (increase Bank $450, decrease Accrued Interest Revenue $375)

Liabilities

No effect

Owner’s Equity

Increase (Interest Revenue increases Net Profit)

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Amount $ 75

75

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

380

STUDY TIP

)F'34APPLIESTOTHE CASHRECEIVED ITWILL BEIDENTIlEDINTHE INFORMATIONPROVIDED

Date

UNITS 3&4

GST on receipt of accrued revenues )NTHEEVENTTHAT'34APPLIESTOTHERECEIPTOFACCRUEDREVENUE ITISONLYTHENON '34 AMOUNTTHATWOULDBEALLOCATEDBETWEENTHE2EVENUEAND!CCRUED2EVENUEACCOUNTS )NOUREXAMPLE ITWOULDBERECORDEDINTHE#ASH2ECEIPTS*OURNALASSHOWN Cash Receipts Journal Rec. no.

Details

July 31 Accrued Revenue

Bank

Disc. exp.

Debtors Control

495

Revenue

Cost of Sales

Sales

Sundries

GST

375

45

75

REVIEW QUESTIONS 16.4

1 2 3 4

DefineTHETERM@ACCRUEDREVENUE ExplainHOWACCRUEDREVENUEISREPORTEDINTHE"ALANCE3HEET DistinguishBETWEENACCRUEDREVENUEANDDEBTORS Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO RECORD THE BALANCE DAY ADJUSTMENTFORACCRUEDREVENUE 5 State THE EFFECT OF THE BALANCE DAY ADJUSTMENT FOR ACCRUED REVENUE ON THE ACCOUNTINGEQUATION 6 ExplainWHYTHERECEIPTOFACCRUEDREVENUEINASUBSEQUENTPERIODREQUIRES THERECEIPTTOBESPLITINTHE#ASH2ECEIPTS*OURNAL 7 StateTHEEFFECTOFTHERECEIPTOFACCRUEDREVENUEINASUBSEQUENTPERIODON THEACCOUNTINGEQUATION

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 16

B A L A N C E D AY A D J U S T M E N T S : R E V E N U E S

381

WHERE HAVE WE BEEN? s "ALANCEDAYADJUSTMENTSARENECESSARYSOTHATANACCURATEPROlTISCALCULATEDBY COMPARINGREVENUEEARNEDANDEXPENSESINCURREDINTHECURRENT2EPORTING0ERIOD s "ALANCEDAYADJUSTMENTSMAYBENECESSARYFOR n STOCKLOSSESANDGAINS n PREPAIDEXPENSES n ACCRUEDEXPENSES n DEPRECIATION n PREPAIDREVENUES n ACCRUEDREVENUES s %ACHBALANCEDAYADJUSTMENTFORREVENUEINCREASESREVENUE THUSINCREASINGPROlT ANDOWNERSEQUITY s !DJUSTMENTS FOR PREPAID REVENUES DECREASE LIABILITIES ADJUSTMENTS FOR ACCRUED REVENUESINCREASEASSETS s "ALANCEDAYADJUSTMENTSHAVENOEFFECTONCASH BUTWILLCHANGE.ET0ROlTANDTHE ITEMSINTHE"ALANCE3HEET

EXERCISE 16.1 PREPAID REVENUE

W B

page 346

EXERCISES

/N-ARCH 3OLS3MALL'OODSRECEIVEDRENTPLUS'34 FROMTHE SOLICITORWHORENTSOUTTHETOPmOOROFTHEBUILDING2EC 4HESOLICITORPAYSRENTIN ADVANCEFORTHENEXTSIXMONTHS-EMO AND3OLS3MALL'OODSPREPARESITSlNANCIAL REPORTSON*UNE Required a RecordTHECASHRECEIVEDINTHE#ASH2ECEIPTS*OURNALOF3OLS3MALL'OODS b 2EFERRINGTOONEACCOUNTINGPRINCIPLE explainWHYONLYPARTOFTHERENTRECEIVED SHOULDBERECOGNISEDASREVENUEFORTHEYEARENDED*UNE c CalculateTHERENTREVENUEEARNEDFORTHEYEARENDING*UNE d ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDRENTREVENUEEARNEDFORTHE YEARENDING*UNE e StateTHEEFFECTOFTHEADJUSTMENTFORRENTREVENUEONTHEACCOUNTINGEQUATIONOF 3OLS3MALL'OODS f ShowHOWTHE2ENT2EVENUEAND0REPAID2ENT2EVENUEACCOUNTSWOULDAPPEARIN THE'ENERAL,EDGEROF3OLS3MALL'OODSASAT*UNEAFTERALLCLOSINGAND BALANCINGENTRIESHAVEBEENMADE

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Cambridge University Press

382

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

EXERCISE 16.2 CASH SALE INVOLVING A DEPOSIT

W B

page 348

/N*ANUARY #LINK'LASSWARERECEIVEDADEPOSITOFONABULKORDERFROM ONEOFITSCUSTOMERS2EC 4HEGOODS WHICHHADASELLINGPRICEOFPLUS '34 ANDACOSTPRICEOF WEREDELIVEREDON&EBRUARY WITHTHECUSTOMER PAYINGTHEBALANCEINCASH2EC  Required a RecordTHEDEPOSITRECEIVEDON*ANUARYINTHE#ASH2ECEIPTS*OURNALOF #LINK'LASSWARE b ExplainHOWTHEDEPOSITWOULDBEREPORTEDINTHE"ALANCE3HEETOF#LINK'LASSWARE ON*ANUARY c RecordTHESALEON&EBRUARYINTHEJOURNALSOF#LINK'LASSWARE d 2EFERRINGTOTHE#ASH2ECEIPTS*OURNALINPART@C explainWHYTHEAMOUNTRECORDED INTHE'34COLUMNDOESNOTEQUALOFTHEAMOUNTRECORDEDINTHE3ALESCOLUMN e ShowHOWTHE'ENERAL,EDGERACCOUNTSWOULDAPPEARAFTERPOSTINGTHEJOURNALSIN PARTS@AAND@C

EXERCISE 16.3 CREDIT SALE INVOLVING A DEPOSIT

W B

page 350

$URING$ECEMBER 4ERRYS!PPLIANCESRECEIVEDADEPOSITOFFROM(ARTWELL (OSPITALSFORAWASHINGMACHINETHATSELLSFORPLUS'342EC 4HEWASHING MACHINE WHICHHADACOSTPRICEOF WASDELIVEREDON*ANUARY WITHTHE BALANCEONCREDIT)NV  Required a StateTHEEFFECTOFTHEDEPOSITONTHEACCOUNTINGEQUATIONOF4ERRYS!PPLIANCES b 2EFERRINGTOONEACCOUNTINGPRINCIPLE explainWHYTHEDEPOSITISnotRECOGNISEDAS REVENUEFOR$ECEMBER c RecordTHESALEON*ANUARYINTHEJOURNALSOF4ERRYS!PPLIANCES d StateTHEEFFECTOFTHESALEON*ANUARYONTHEACCOUNTINGEQUATIONOF4ERRYS !PPLIANCES e ShowHOWTHE'ENERAL,EDGERACCOUNTSWOULDAPPEARAFTERPOSTINGTHEJOURNALSIN PART@C

EXERCISE 16.4 CREDIT SALE INVOLVING A DEPOSIT

W B

page 352

)NSENSITELRECENTLYADVERTISEDFORSALEANEWVERSIONOFITSAWARD WINNING'AME3TATION CONSOLE4HECONSOLEISPURCHASEDFORPLUS'34 ANDISSOLDFORINCLUDING'34 /N.OVEMBER 3POT/NDEPARTMENTSTORESORDEREDGAMECONSOLES PAYING ADEPOSITONTHETOTALINVOICEPRICE2EC /N.OVEMBER )NSENSITEL DELIVEREDALLGAMECONSOLESTO3POT/N)NV 

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Cambridge University Press

CHAPTER 16

B A L A N C E D AY A D J U S T M E N T S : R E V E N U E S

Required a CalculateTHECASHRECEIVEDBY)NSENSITELON.OVEMBER b ExplainWHYNO'34ISRECOGNISEDON.OVEMBER c RecordTHECASHRECEIVEDON.OVEMBERINTHE#ASH2ECEIPTS*OURNALOF )NSENSITEL d 2EFERRINGTOTHEDElNITIONSOFTHEELEMENTSOFTHEREPORTS explainWHYTHETRANSACTION ON.OVEMBERMUSTnotBEREPORTEDASREVENUE e RecordTHESALEON.OVEMBERINTHEJOURNALSOF)NSENSITEL f ShowHOWTHE'ENERAL,EDGERACCOUNTSWOULDAPPEARAFTERPOSTINGTHEJOURNALSIN PART@E g StateTHEEFFECTONTHEACCOUNTINGEQUATIONOF)NSENSITELIFTHESALEON.OVEMBER HADnotBEENRECORDED

EXERCISE 16.5 ACCRUED REVENUE

W B

page 355

$URING !UGUST  'AVIN *EWELLERY RECEIVED  INTEREST REVENUE BUT AS AT  !UGUSTITWASSTILLOWEDINTERESTFROMONEOFITSINVESTMENTS-EMO  Required a 2EFERRING TO ONE ACCOUNTING PRINCIPLE justify WHY THE INTEREST OWING SHOULD BE INCLUDEDINTHE)NTEREST2EVENUEACCOUNTFOR!UGUST b ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDACCRUEDINTERESTREVENUEASAT !UGUST c StateTHEEFFECTOFTHEADJUSTMENTFORACCRUEDINTERESTREVENUEONTHEACCOUNTING EQUATIONOF'AVIN*EWELLERY d ShowHOWTHEINTERESTREVENUEANDACCRUEDINTERESTREVENUEACCOUNTSWOULDAPPEAR INTHE'ENERAL,EDGEROF'AVIN*EWELLERYASAT!UGUSTAFTERALLCLOSINGAND BALANCINGENTRIESHAVEBEENMADE e ExplainHOWTHEACCRUEDINTERESTREVENUEWOULDBEREPORTEDINTHE"ALANCE3HEET OF'AVIN*EWELLERYASAT!UGUST

EXERCISE 16.6 ACCRUED REVENUE

W B

page 357

/N-ARCH $IANAS$ELICACIESINVESTEDINA YEARTERMDEPOSITATA lXED RATE OF  PER ANNUM )NTEREST REVENUE IS DIRECTLY CREDITED TO THE lRMS BANK ACCOUNTINEQUALINSTALMENTSONTHELASTDAYOF-AY !UGUST .OVEMBERAND&EBRUARY 4HISISVERIlEDBYTHEBANKSTATEMENT"ALANCEDAYIS*UNE Required a CalculateINTERESTREVENUERECEIVEDON-AY b CalculateACCRUEDINTERESTREVENUEASAT*UNE c ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDACCRUEDINTERESTREVENUEFOR THEYEARENDED*UNE.ARRATIONIS notREQUIRED d ShowHOWTHEINTERESTREVENUEANDACCRUEDINTERESTREVENUEACCOUNTSWOULDAPPEAR INTHE'ENERAL,EDGEROF$IANAS$ELICACIESASAT*UNEAFTERALLCLOSINGAND BALANCINGENTRIESHAVEBEENMADE e RecordTHERECEIPTOFINTERESTON!UGUSTINTHE#ASH2ECEIPTS*OURNAL f Explain WHY ONLY SOME OF THE INTEREST RECEIVED ON  !UGUST  SHOULD BE REPORTEDASREVENUEFORTHEYEARENDED*UNE

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

Cambridge University Press

383

384

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

EXERCISE 16.7 ACCRUED REVENUE

W B

page 359

$URING!PRIL 7EIGHTS7ORLDRECEIVEDCOMMISSIONREVENUEOFPLUS'34FOR WEIGHTSITHADSOLDONBEHALFOFSPECIALISTGYMS!SAT!PRIL AFURTHER WAS STILL OWING -EMO   /N  -AY   INCLUDING '34 WAS RECEIVED FOR COMMISSIONREVENUE2EC  Required a CalculateCOMMISSIONREVENUEEARNEDFOR!PRIL b ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDACCRUEDCOMMISSIONREVENUE ASAT!PRIL c StateTHEEFFECTON.ET0ROlTFOR!PRILIFTHEADJUSTMENTFORACCRUEDCOMMISSION REVENUEWASnotMADE d RecordTHERECEIPTOFTHECOMMISSIONON-AYINTHE#ASH2ECEIPTS*OURNAL e StateTHEEFFECTOFTHERECEIPTOFTHECOMMISSIONON-AYONTHEACCOUNTING EQUATIONOF7EIGHTS7ORLD f ShowHOWTHE#OMMISSION2EVENUEAND!CCRUED#OMMISSION2EVENUEACCOUNTS WOULDAPPEARINTHE'ENERAL,EDGEROF7EIGHTS7ORLDAFTERALLTHEINFORMATIONWAS RECORDED

EXERCISE 16.8 ACCRUED REVENUE

W B

page 361

/N3EPTEMBER 3OUND7AVESINVESTEDINTOASIX MONTHTERMDEPOSIT WITHINTERESTEARNEDATPERANNUM PAYABLEATTHEENDOFTHESIX MONTHTERM/N MATURITYAT&EBRUARY ACHEQUEFORWASRECEIVEDFROMTHEBANK2EC  Required a ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDTHEINTERESTREVENUEEARNED FORTHEYEARENDED$ECEMBER.ARRATIONISnotREQUIRED b RecordTHECASHRECEIVEDON&EBRUARYINTHE#ASH2ECEIPTS*OURNAL c ShowHOWTHECASHRECEIVEDON&EBRUARYWOULDBEREPORTEDINTHE#ASH &LOW3TATEMENTOF3OUND7AVESFORTHEYEARENDED$ECEMBER d DiscussHOWTHECASHRECEIVEDFROMTHE4ERM$EPOSITSHOULDBEREPORTEDIN THE#ASH&LOW3TATEMENT

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CHAPTER 16

B A L A N C E D AY A D J U S T M E N T S : R E V E N U E S

EXERCISE 16.9 REPORTING FOR PREPAID AND ACCRUED REVENUES

W B

page 362

2AWSON2UGSHASPROVIDEDTHEFOLLOWING4RIAL"ALANCEASAT$ECEMBER RAWSON RUGS Trial Balance as at 31 December 2015 Account Advertising Bank

Debit 2 100

Capital – Parker Cartage In Cost of Sales

51 540 990 20 620

Creditors Control Debtors Control Depreciation – Premises Discount Expense Drawings

31 070 29 600 3 900 690 8 610

GST Clearing Interest Expense

390 400

Accumulated Depreciation – Premises

19 500

Mortgage – Bank of Erica (repayable $12 000 p.a.) Premises Prepaid Advertising

100 000 130 000 1 360

Prepaid Sales Revenue

1 680

Profit on Disposal of Vehicle

650

Sales

43 000

Sales Returns

860

Stock Control

38 750

Stock Gain Stock Write-down Term Deposit (matures 15 April 2020) Wages Totals

Credit

340

130 240 3 600 5 900 $247 960

$247 960

Additional information: s 2EPORTS ARE PREPARED ON  $ECEMBER EACH YEAR "ALANCE DAY ADJUSTMENTS FOR EXPENSEITEMSHAVEALREADYBEENRECORDED s $URINGTHElNANCIALYEARACUSTOMERRETURNEDARUGTHATHADBEENSOILEDDURINGTHE DELIVERYTOHERHOUSE4HISRUGWASTHROWNAWAY s 4HE4ERM$EPOSITWASTAKENOUTON$ECEMBER)NTERESTISEARNEDATPER ANNUM WITHINTERESTFOR$ECEMBERDUETOBERECEIVEDON*ANUARY s 0REPAID3ALES2EVENUERELATESTOANORDERFROM&+HARITHERUGSHADASELLINGPRICE OFINCLUDING'34ANDACOSTPRICEOF4HERUGS AND)NVOICE WERE DELIVEREDON$ECEMBERAFTERTHEJOURNALSHADBEENPOSTEDTOTHE'ENERAL ,EDGER Required a 2EFERRINGTOONEACCOUNTINGPRINCIPLE explainTHEPURPOSEOFMAKINGBALANCEDAY ADJUSTMENTS b ShowTHE'ENERAL*OURNALENTRIESNECESSARYTORECORDTHEADDITIONALINFORMATIONON $ECEMBER.ARRATIONSARE notREQUIRED ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restriced under law and must not be transferred to another party.

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* *

*

UNITS 3&4

c PrepareA0OST ADJUSTMENT4RIAL"ALANCEFOR2AWSON2UGSASAT$ECEMBER d PrepareAN)NCOME3TATEMENTFOR2AWSON2UGSFORTHEYEARENDED$ECEMBER  e 2EFERINGTOYOURANSWERTOPARTDidentifyTWOITEMSTHATRESULTEDFROMTHERUGTHAT WASRETURNEDANDTHROWNAWAY f PrepareACLASSIlED"ALANCE3HEETFOR2AWSON2UGSASAT$ECEMBER

EXERCISE 16.10 REVENUES, RECORDS AND REPORTS

W B

page 366

--S-USICHASPROVIDEDTHEFOLLOWINGEXTRACTFROMITS4RIAL"ALANCEASAT*UNE MM’s MUSIC Trial Balance (extract) as at 30 June 2015 Account

Debit

Credit

$

$

Accrued Wages

1 900

Bank Cost of Sales

1 800 120 000

Creditors Control Debtors Control Discount Expense

44 900 12 300 860

Discount Revenue

410

GST Clearing

630

Loan – QuickFin (repayable $600 per month) Prepaid Advertising

25 000 10 400

Prepaid Sales Revenue

16 000

Sales Stock Control Stock Write-down

160 000 83 460 1 500

Additional information: s /N*UNE AVEHICLEWASTRADEDINFORONANEWVEHICLEWITHACOST PRICEOFPLUS'34 WHICHWASPURCHASEDONCREDITFROM1-OTORS4HEOLD VEHICLEHADBEENPURCHASEDFOR ANDHADACARRYINGVALUEOFATTHE TIMEOFTHETRADE IN s $URING*UNE ASALEFORPLUS'34WASMADETO!'ERLING)NV 4HE STOCKHADACOSTPRICEOF BUT'ERLINGHADPAIDADEPOSITEARLIERINTHE MONTH s )NTERESTREVENUEOFHADBEENEARNEDBUTNOTYETRECEIVED Required

*

a SuggestTWOPOSSIBLEREASONSOTHERTHANDAMAGE FORTHESTOCKWRITE DOWN b Show THE 'ENERAL *OURNAL ENTRIES NECESSARY TO RECORD THE ADDITIONAL INFORMATION .ARRATIONSAREnotREQUIRED c SuggestTWOREASONSFORTHEPROlTORLOSSONTHEDISPOSALOFTHEVEHICLE d 2EFERRINGTOONEQUALITATIVECHARACTERISTIC explainTHEPURPOSEOFCLOSINGTHELEDGER e ShowTHE'ENERAL*OURNALENTRIESNECESSARYTOCLOSETHEREVENUEACCOUNTS f Prepare A "ALANCE 3HEET FOR --S -USIC AS AT  *UNE  SHOWING THE lRMS #URRENT!SSETSAND#URRENT,IABILITIES!FULL"ALANCE3HEETISnotREQUIRED g 2EFERRINGTOYOURANSWERTOPART@F explainYOURCLASSIlCATIONOF'34#LEARING

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Where are we headed? After completing this chapter, you should be able to: s define@BUDGETING s distinguishBETWEEN BUDGETEDANDACTUALREPORTS s explainTHEPURPOSESOF BUDGETING s describeTHEBUDGETING PROCESS s prepareBUDGETEDREPORTS FORCASH PROlTANDlNANCIAL POSITION s explainTHEUSESOFBUDGETED REPORTS s suggestSTRATEGIESTOADDRESS PROBLEMSIDENTIlEDBY BUDGETEDREPORTS s distinguishBETWEENCASH ANDPROlTITEMSINBUDGETED REPORTS

s prepareA3CHEDULEOF 2ECEIPTSFROM$EBTORS s reconstructLEDGERACCOUNTS TODETERMINEBUDGETED lGURES s prepareVARIANCEREPORTSFOR CASHANDPROlT s distinguishBETWEEN FAVOURABLEANDUNFAVOURABLE VARIANCES

CHAPTER 17

BUDGETS KEY TERMS After completing this chapter, you should be familiar with the following terms: s BUDGETING s BUDGET s "UDGETED#ASH&LOW3TATEMENT s "UDGETED)NCOME3TATEMENT s "UDGETED"ALANCE3HEET s 3CHEDULEOF2ECEIPTSFROM$EBTORS s 3CHEDULEOF0AYMENTSTO#REDITORS s VARIANCEREPORT s #ASH"UDGET6ARIANCE2EPORT s VARIANCE s )NCOME3TATEMENT6ARIANCE2EPORT ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

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388

UNITS 3&4

17.1 BUDGETING

budgeting the process of predicting/ estimating the financial consequences of future events budget an accounting report that predicts/estimates the financial consequences of future events

3OFARTHISTEXTHASDEALTONLYWITHHISTORICALTRANSACTIONS CONCENTRATINGONHOWTOIDENTIFY RECORDANDREPORTEVENTSTHATHAVEALREADYOCCURRED4HISISALOGICALSTARTINGPOINTTO ANALYSEBUSINESSPERFORMANCE ASWITHOUTINFORMATIONONWHATHASALREADYHAPPENED WE AREUNABLETOIDENTIFYAREASTHATMAYNEEDTOBEIMPROVED(OWEVER ITISALSOIMPORTANT TOKEEPANEYEONTHEFUTURE"USINESSOWNERSMUSTATTEMPTTOPREDICTWHATWILLHAPPEN INTHEFUTURE SOTHATTHEYCANPLANAHEADANDBEPREPAREDFORWHATISLIKELYTOOCCUR 4HISISTHEFOCUSOFbudgetingTHEPROCESSOFPREPARINGREPORTSTHATestimateORPREDICT THElNANCIALCONSEQUENCESOFLIKELYfutureTRANSACTIONS

Budgeted reports ! SMALL BUSINESS OWNER COULD PREPARE A budget ON JUST ABOUT ANY AREA OF BUSINESS PERFORMANCE RANGING FROM HOW MANY SALES ARE MADE IN A MONTH TO HOW MUCH WILL BE SPENT ON ADVERTISING AND HOW MANY RETURNS WILL BE MADE )N THIS COURSE WE WILL CONCENTRATEONTHREEGENERAL PURPOSEBUDGETS s THEBudgeted Cash Flow Statement WHICHSHOWSALLEXPECTEDFUTURECASHINmOWS AND CASH OUTmOWS THE ACTUAL BANK BALANCE AT THE START OF THE PERIOD AND THE EXPECTEDBANKBALANCEATTHEENDOFTHEPERIOD s THE Budgeted Income Statement WHICH SHOWS ALL EXPECTED FUTURE REVENUES AND EXPENSES ANDTHEEXPECTED'ROSS0ROlT !DJUSTED'ROSS0ROlTAND.ET0ROlT s THEBudgeted Balance Sheet WHICHSHOWSALLEXPECTEDASSETS LIABILITIESANDOWNERS EQUITYATSOMEPOINTINTHEFUTURE

Budgeted versus actual reports

STUDY TIP

)FYOUCANPREPARE REPORTS YOUCAN PREPAREBUDGETED REPORTS BECAUSETHEY CONTAINTHESAME TYPESOFITEMS

"UDGETS OR BUDGETED REPORTS DIFFER FROM THE ACTUAL OR HISTORICAL REPORTS WE HAVE PREPAREDSOFARINTWOKEYWAYS s "UDGETSREPORTfutureEVENTSRATHERTHANHISTORICALEVENTS4HEYFOCUSONWHATWILL HAPPENRATHERTHANWHATHASALREADYHAPPENED s !SACONSEQUENCE BUDGETSUSEestimatesORpredictionsRATHERTHANACTUAL VERIlABLE DATA )NALLOTHERWAYS BUDGETEDREPORTSARETHESAMEASACTUALREPORTSTHEYUSETHESAME HEADINGS ANDINCLUDETHESAMEITEMS

The importance of budgeted Sales !SWEHAVESEENINEARLIERCHAPTERS THEACCOUNTINGREPORTS ARE INTERCONNECTED WITH TRANSACTIONSREPORTEDINONEAFFECTINGITEMSREPORTEDINANOTHER ANDTHISISNODIFFERENT FORBUDGETS4HISMEANSITISESSENTIALTHATTHEPREPARATIONOFBUDGETEDREPORTSBEGIN WITHANACCURATEESTIMATEOFBUDGETEDSALES &IRST SALES IS THE MAIN REVENUE ITEM IN THE "UDGETED )NCOME 3TATEMENT AND GENERATESSIGNIlCANTCASHINmOWSEITHERAS#ASH3ALESOR IFCREDITSALESAREINVOLVED AS 2ECEIPTS FROM $EBTORS 3ECOND THE LEVEL OF SALES WILL BE CRUCIAL IN ESTIMATING THE EXPENSESTHATVARYWITHTHENUMBEROFUNITSSOLDSUCHAS#OSTOF3ALESAND7AGES AND THEIRCORRESPONDINGCASHOUTmOWS4HIRD THELEVELOFSALESWILLAFFECTHOWMUCHSTOCKIS PURCHASED WHICHWILL INTURN AFFECTCASHPAIDTOCREDITORS 4HE"ALANCE3HEETDOESNOTREPORTSALESDIRECTLY BUTBECAUSEITUSESlGURESDERIVED FROMTHEOTHERTWOREPORTS ITSACCURACYISALSODEPENDANTONANACCURATEESTIMATEOF SALES!TTHEVERYLEAST THEEXPECTEDBANKlGUREWILLCOMESTRAIGHTFROMTHE"UDGETED

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CHAPTER 17

BUDGETS

389

#ASH&LOW3TATEMENT ANDTHEEXPECTED.ET0ROlTOR,OSSWILLBEDETERMINEDINTHE "UDGETED)NCOME3TATEMENT

The purpose of budgeting )N COMMON WITH ALL ACCOUNTING REPORTS BUDGETS HAVE A ROLE IN BOTH PLANNING AND DECISION MAKING3PECIlCALLY s "UDGETINGassistsplanningBYPREDICTINGWHATISLIKELYTOOCCURINTHEFUTURE4HIS ALLOWS THE OWNER TO PREPARE SO THAT POSSIBLE PROBLEMS MAY BE MANAGED AND POSSIBLEOPPORTUNITIESMAYBETAKEN s "UDGETING aids decision-making BY PROVIDING A STANDARD AGAINST WHICH ACTUAL PERFORMANCE CAN BE MEASURED 4HIS ALLOWS THE OWNER TO IDENTIFY AREAS IN WHICH PERFORMANCEISUNSATISFACTORY SOTHATREMEDIALACTIONCANBETAKEN4HISCANINCLUDE THECALCULATIONOFBUDGETEDRATIOSANDOTHERINDICATORSOFPERFORMANCE

In common with all accounting reports, budgets have a role in both planning and decision-making

REVIEW QUESTIONS 17.1

1 DefineTHETERM@BUDGETING 2 Identify THEINFORMATIONTHATISREPORTEDINA s "UDGETED#ASH&LOW3TATEMENT s "UDGETED)NCOME3TATEMENT s "UDGETED"ALANCE3HEET 3 StateTWODIFFERENCESBETWEENTHEINFORMATIONPRESENTEDINBUDGETEDREPORTS ANDACTUALREPORTS 4 ExplainWHYITISIMPORTANTTOHAVEANACCURATEESTIMATEOFBUDGETEDSALES 5 ExplainHOWBUDGETSASSISTPLANNING 6 ExplainHOWBUDGETSASSISTDECISION MAKING

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STUDY TIP

)F'34ISIDENTIlED IT CANBERECORDEDINTHE #ASH2ECEIPTS*OURNAL

UNITS 3&4

17.2 THE BUDGETING PROCESS )THASBEENSAIDTHATFAILINGTOPLANISPLANNINGTOFAIL SOTHEPREPARATIONOFBUDGETED REPORTSSHOULDBEONEOFTHElRSTSTEPSINSTARTINGANEWBUSINESS(OWEVER BUDGETING SHOULDBEAcontinuous processBUDGETSSHOULDBECOMPAREDAGAINSTACTUALREPORTSTO ALLOWPROBLEMSTOBEIDENTIlED DECISIONSSHOULDBEMADEBASEDONTHATASSESSMENT ANDTHENNEWBUDGETSSHOULDBEPREPAREDFORTHEnextPERIOD4HISBUDGETINGPROCESS ISSHOWNIN&IGURE Figure 17.1

The budgeting process

Budgeted reports are prepared, predicting what is likely to occur

Decisions are made to improve business performance for the next period

Actual reports are prepared to detail what has happened in the current period

Variance reports are prepared to highlight differences/problem areas

!BUDGETHASLIMITEDVALUEIFITISNOTUSEDTOMAKEDECISIONSTOIMPROVEBUSINESS PERFORMANCE IN THE FUTURE )N ADDITION IT MAKES LITTLE SENSE TO DEVELOP A BUDGET FOR ONE PERIOD WITHOUT PREPARING ANOTHER BUDGET FOR THE NEXT PERIOD 5NDER THE 'OING #ONCERNPRINCIPLE BUSINESSESAREASSUMEDTOBECONTINUOUS SOTHEBUDGETINGPROCESS SHOULDBECONTINUOUSTOO 4HEINFORMATIONPRESENTEDINTHEBUDGETEDREPORTSSHOULDBEBASEDONTHEHISTORICAL DATA BUTALLOWANCESMUSTBEMADEFORCHANGESANDTHEEFFECTOFNEWBUSINESSDECISIONS /BVIOUSLY ABRANDNEWBUSINESSWILLNOTHAVEANYHISTORICALDATAONWHICHTORELYTHIS MAKESBUDGETINGHARDERFORNEWBUSINESSES BUTNOLESSIMPORTANT

REVIEW QUESTIONS 17.2

1 ExplainWHYBUDGETINGISDESCRIBEDASAPROCESS 2 OutlineTHEVARIOUSSTAGESINTHEBUDGETINGPROCESS 3 ExplainTHEROLEOFHISTORICALDATAINTHEPREPARATIONOFBUDGETEDREPORTS

17.3 THE BUDGETED CASH FLOW STATEMENT Budgeted Cash Flow Statement an accounting report that attempts to predict all future cash inflows and cash outflows, and thus the estimated bank balance at the end of the budget period

)NORDERTOSURVIVE ASMALLBUSINESSMUSTHAVESUFlCIENTCASHTOMEETITSOBLIGATIONS 4HESEOBLIGATIONSWILLINCLUDEMAKING0AYMENTSTO#REDITORS PAYINGEXPENSESSUCHAS WAGES RENTANDADVERTISING MEETINGLOANREPAYMENTSANDPROVIDINGDRAWINGSFORTHE OWNER)NORDERTODOTHIS THEBUSINESSMUSTGENERATESUFlCIENTCASHINmOWS CHIEmY THROUGHITS#ASH3ALESAND2ECEIPTSFROM$EBTORS4HE Budgeted Cash Flow Statement ATTEMPTSTOPREDICTALLFUTURECASHINmOWSANDCASHOUTmOWS ANDTHUSTHEESTIMATED BANKBALANCEATTHEENDOFTHEBUDGETEDPERIOD TOASSISTTHEOWNERINASSESSINGTHE lRMSABILITYTOMEETITSOBLIGATIONSOVERTHEBUDGETPERIOD

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BUDGETS

391

2EMEMBER THAT THE #ASH &LOW 3TATEMENT CLASSIlED THE INmOWS AND OUTmOWS AS /PERATING )NVESTING AND &INANCING ACTIVITIES AND THESE CLASSIlCATIONS MUST ALSO BE PRESENTINTHE"UDGETED#ASH&LOW3TATEMENT

Operating activities /PERATINGACTIVITIESAREALLCASHmOWSRELATEDTOTHElRMSDAY TO DAYTRADINGACTIVITIES /PERATINGCASHmOWSTHATWEWOULDEXPECTTOSEEINATYPICAL"UDGETED#ASH&LOW 3TATEMENTMIGHTINCLUDE Operating cash inflows #ASH3ALES 2ECEIPTSFROM$EBTORS /THERREVENUEreceived MAYALSOBETITLED@ACCRUEDANDOR@PREPAID '34RECEIVED '34REFUND

Operating cash outflows #ASHPURCHASESOFSTOCK 0AYMENTSTO#REDITORS /THER%XPENSESpaid MAYALSOBETITLED@ACCRUEDANDOR@PREPAID '34PAID '34SETTLEMENT

)DEALLY THEBUDGETED.ET#ASH&LOWSFROM/PERATIONSWILLBEPOSITIVE4HISMEANS THATTHEBUSINESSWILLGENERATESUFlCIENTCASHFROMITS/PERATIONSTOMEETITSONGOING OBLIGATIONS "Y PREPARING THE "UDGETED #ASH &LOW 3TATEMENT THE OWNER WILL BE FOREWARNEDIFTHE/PERATINGCASHmOWSAREEXPECTEDTOBENEGATIVE4HEOWNERCANTHEN TAKESTEPSTOADDRESSTHECASHSHORTAGEBEFOREITOCCURSBYIMPLEMENTINGSTRATEGIESTO s INCREASEEXPECTEDINmOWS SUCHAS n INCREASE3ALESFOREXAMPLE VIAPROMOTIONS GREATERADVERTISINGORDISCOUNTING PRICES n INCREASE2ECEIPTSFROM$EBTORSFOREXAMPLE VIAOFFERINGDISCOUNTS CONTACTING SLOWPAYERSORSENDINGREMINDERNOTICES s DECREASEEXPECTEDOUTmOWS SUCHAS n DEFER0AYMENTSTO#REDITORS n CUTBACKONCASHPAIDFOREXPENSES 4HEOWNERMUSTBEPARTICULARLYMINDFULOFREDUCINGCASHPAIDFOREXPENSES ASTHE BENElTSTHATEXPENSESPROVIDEAREVITALINTHEEARNINGOFSALES ANDHENCETHEGENERATION OFCASHINmOWSCUTTINGEXPENSESMAYMAKETHECASHSITUATIONWORSERATHERTHANBETTER

Investing activities )NVESTINGACTIVITIESAREALLCASHmOWSRELATINGTOTHEPURCHASEORSALEOFNON CURRENTASSETS )NVESTINGCASHmOWSTHATWEWOULDEXPECTTOSEEINATYPICAL"UDGETED#ASH&LOW 3TATEMENTMIGHTINCLUDE Investing cash inflows

Investing cash outflows

#ASHSALEOFANON CURRENTASSET

#ASHPURCHASEOFANON CURRENTASSET

#ASHPAIDTOASUNDRYCREDITOR

STUDY TIP

'IVEN THAT NON CURRENT ASSETS ARE FREQUENTLY EXPENSIVE AND SALES OF NON CURRENT ASSETSARERARE ITWILLBECOMMONFORBUDGETED.ET#ASH&LOWSFROM)NVESTING!CTIVITIES TOBENEGATIVE

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4HESETHREE)NVESTING CASHmOWSARETHEONLY ONESINTHISCOURSEBUT THEREMAYBEMORETHAN ONEOFEACHTYPE 

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STUDY TIP

4HESEFOUR&INANCING CASHmOWSARETHEONLY ONESINTHISCOURSE

UNITS 3&4

Financing activities &INANCINGACTIVITIESAREALLCASHmOWSTHATARETHERESULTOFCHANGESINTHElRMSlNANCIAL STRUCTURE &INANCINGCASHmOWSTHATWEWOULDEXPECTTOSEEINATYPICAL"UDGETED#ASH&LOW 3TATEMENTMIGHTINCLUDE Financing cash inflows

Financing cash outflows

,OANRECEIPTOF

,OANREPAYMENTPRINCIPALONLY

#APITALCONTRIBUTIONCASHONLY

#ASHDRAWINGS

7HETHER.ET#ASH&LOWSFROM&INANCING!CTIVITIESISPOSITIVEORNEGATIVEWILLDEPEND VERYMUCHONWHETHERTHEBUSINESSISEXPANDING ORSIMPLYCONTINUINGITSOPERATIONSAS THEYARE4HEREMAYINFACTBEARELATIONSHIPBETWEEN&INANCINGAND)NVESTING!CTIVITIES NEGATIVE )NVESTING CASH mOWS DUE TO THE PURCHASE OF NON CURRENT ASSETS COULD BE lNANCEDBYPOSITIVE&INANCINGCASHmOWSINTHEFORMOFALOANORCAPITALCONTRIBUTION 

EXAMPLE Denzel Washing Machines will begin trading Operations on 1 March 2016, and has provided the following estimates for its first month of Operations: s 4HEOWNERWILLMAKEACAPITALCONTRIBUTIONOF$30 000 to commence Operations. s #ASH3ALESAREESTIMATEDTOBE$24 000PLUS'34 s #REDIT3ALESAREESTIMATEDTOBEINCLUDING'34/FTHIS amount, $11 000 is expected to be received in March 2016. s !LLSTOCKWILLBEPURCHASEDONCREDIT0URCHASESFOR-ARCHARE EXPECTEDTOBEPLUS'34!TTHEENDOF-ARCH it is anticipated that $6 500 will be owed to creditors. s #OSTOF3ALESISEXPECTEDTOBEAND BASEDONTHE experience of similar firms, Stock Loss is expected to be $300. s 4HEFOLLOWINGEXPENSESWILLBEINCURREDDURING-ARCH – wages $ 8 000 – advertising 1 300 (plus $130 '34 – depreciation of office equipment 100 s 2ENTFORTHENEXTSIXMONTHSWILLBEPAIDON-ARCH$9 000 plus $900'34 s .EWOFFICEEQUIPMENTWORTH$5 000 (plus $500'34 WILLBE purchased on 1 March 2016 using cash. s #ASHDRAWINGSWILLBE$1 000. Drawings of stock is expected to be $600. s /N-ARCH $10 000 will be borrowed from AXC Bank to purchase a new vehicle. Beginning in April 2016, $500 will be paid OFFTHEPRINCIPALEACHMONTH4HEVEHICLEWILLNOTBEPURCHASEDUNTIL April 2016.

4HE"UDGETED#ASH&LOW3TATEMENTFOR$ENZEL7ASHING-ACHINESISSHOWNIN&IGURE 

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CHAPTER 17

Figure 17.2

BUDGETS

Budgeted Cash Flow Statement

STUDY

DENZEL WASHING MACHINES Budgeted Cash Flow Statement for March 2016 $

$

CASH FLOW FROM OPERATING ACTIVITIES Cash inflows Cash Sales

24 000

2ECEIPTSFROM$EBTORS

11 0001

'342ECEIVED

2 4002



Less Cash Outflows 0AYMENTSTO#REDITORS

32 0003

Wages

8 000

Advertising

1 300

0REPAID2ENT

9 0004

'340AID

1 5305

Net Cash Flows from Operations

51 830 (14 430)

CASH FLOW FROM INVESTING ACTIVITIES Cash Inflows .IL Less Cash Outflows Office Equipment

5 000

Net Cash Flows from Investing Activities

(5 000)

CASH FLOW FROM FINANCING ACTIVITIES Cash Inflows Capital Contribution

30 000

Loan – AXC Bank

10 000

40 000

Less Cash Outflows Drawings

1 000

Net Cash Flows from Financing Activities

39 000

Net Increase (Decrease) in Cash Position

19 570

Add Bank Balance at start (1 March 2016) Bank Balance at end (31 March 2016)

Nil 19 570

.OTETHEFOLLOWINGIN&IGURE  #REDIT3ALESISAREVENUEBUTNOTACASHmOWONLYTHECASHRECEIVEDFROMDEBTORS  ISREPORTEDHERE  '34RECEIVEDISCALCULATEDASOFTHE#ASH3ALESlGURETHATIS

#ASH3ALESX'34'342ECEIVED

 #REDITPURCHASESOFSTOCKPLUS'34 WILLCREATEADEBT TOCREDITORS BUTATTHEENDOF-ARCHONLYWILLREMAINOWING MEANING THEDIFFERENCEWILLBEPAIDTOCREDITORSTHATIS

393

n0AYMENTSTO#REDITORS

 2EGARDLESSOFHOWMUCHHASBEENincurred THETOTALCASHpaidFORRENT IS REPORTEDHERE"ECAUSEITISPAIDin advance ITISTITLED@0REPAID2ENT

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STUDY TIP

 4OTAL'34PAIDISCALCULATEDBYADDINGTHE'34PAIDONADVERTISING PREPAIDRENT ANDOFlCEEQUIPMENTTHATIS

2EADINGSKILLSARE ESSENTIALINBUDGETING QUESTIONSYOUWILLlND MOSTOFTHEANSWERSIN THEQUESTIONITSELFIFYOU LOOKHARDENOUGH

UNITS 3&4

'34PAID

)N ADDITION NOTE THAT NOT ALL THE TRANSACTIONS ARE REPORTED IN THE "UDGETED #ASH &LOW3TATEMENT BECAUSENOTALLINVOLVECASH)NTHISEXAMPLE #REDIT3ALESANDCREDIT PURCHASES AND THE '34 RELATED TO EACH #OST OF 3ALES 3TOCK ,OSS DEPRECIATION OF OFlCE EQUIPMENT AND DRAWINGS OF STOCK HAVE BEEN EXCLUDED AS THEY ARE NON CASH TRANSACTIONS4HEYMAYAFFECTOTHERBUDGETEDREPORTS BUTNOTTHE"UDGETED#ASH&LOW 3TATEMENT

Consecutive budgets 4HEPRECEDINGBUDGETRELATESONLYTOONEMONTHTAKENINISOLATION BUTITWOULDBEWISE FORABUSINESSTOPREPAREBUDGETSFORCONSECUTIVEMONTHSTOSHOWTHEEFFECTOFMONTHLY VARIATIONSTHATIS SEPARATEBUDGETSFOR-ARCH !PRIL -AY ETCCOULDBEPREPAREDAND PRESENTEDSIDEBYSIDETOSHOWTRENDSININmOWSANDOUTmOWSFROMMONTHTOMONTH 3UCHABUDGETMAYAPPEARASISSHOWNIN&IGURE .OTEHOWTHEBALANCEATTHEENDOF-ARCH ISTHENTRANSFERREDTOBECOME THEBALANCEATTHESTARTOF!PRIL!PRILSCLOSINGBALANCE BECOMESTHEOPENING BALANCEFOR-AYANDSOON 4HISTYPEOFBUDGETALLOWSTHEOWNERTOIDENTIFYMONTHLYANDEVENSEASONALTRENDS ANDCANBEVERYUSEFULFORIDENTIFYINGwhenTOUNDERTAKEAPARTICULARCASHACTIVITY SUCH ASTHEPURCHASEOFANON CURRENTASSETORREPAYMENTOFALOAN )NGENERAL MOREFREQUENTBUDGETSWILLBEMOREACCURATE ANDTHEREFOREMOREUSEFUL ASBENCHMARKSFORCOMPARISON)NADDITION THEYWILLALLOWFORTHEEARLIERDETECTIONOF PROBLEMS SO THAT CORRECTIVE ACTION CAN BE TAKEN IN A MORE TIMELY FASHION AND CAN PERHAPSSTOPASMALLPROBLEMFROMBECOMINGLARGE

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CHAPTER 17

Figure 17.3

BUDGETS

Budgeted Cash Flow Statement: consecutive periods DENZEL WASHING MACHINES Budgeted Cash Flow Statement for March–May 2016 March

April

May

Cash Sales

24 000

28 000



2ECEIPTSFROM$EBTORS

11 000

15 000

13 000

2 400

2 800



CASH FLOW FROM OPERATING ACTIVITIES Cash Inflows

'342ECEIVED

–

1 100



45 800

43 800

32 000

36 000

33 000

Wages

8 000

9 000

8 500

Advertising

1 300

1 300

1 300

0REPAID2ENT

9 000

'342EFUND 4OTAL/PERATING)NmOWS

–

Less Cash Outflows 0AYMENTSTO#REDITORS

'340AID 4OTAL/PERATING/UTmOWS Net Cash Flows from Operations

–

–

1 530

130

830

51 830

46 430

43 630

(14 430)

(630)

170

CASH FLOW FROM INVESTING ACTIVITIES Cash Inflows 0ROCEEDSON3ALEOF%QUIPMENT

–

–

1 600

Less Cash Outflows Office Equipment

5 000

–



(5 000)

Nil

(5 400)

Capital Contribution

30 000

–

–

Loan – AXC Bank

10 000

–

–

4OTAL&INANCING)NmOWS

40 000

.IL

.IL

1 000

1 000

Net Cash Flows from Investing Activities CASH FLOW FROM FINANCING ACTIVITIES Cash Inflows

Less Cash Outflows Drawings

1 000

Net Cash Flows from Financing Activities

39 000

(1 000)

(1 000)

Net Increase (Decrease) in Cash Position

19 570

(1 630)

(6 230)

Add Bank Balance at start Bank Balance at end

Nil

19 570

17 310

19 570

17 310

11 080

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REVIEW QUESTIONS 17.3

1 DefineTHEFOLLOWINGTERMSASTHEYRELATETOTHE"UDGETED#ASH&LOW3TATEMENT ANDPROVIDEONEEXAMPLEOFANINmOW ANDONEEXAMPLEOFANOUTmOWTHAT WOULDFALLUNDEREACHOFTHESEHEADINGS s /PERATING!CTIVITIES s )NVESTING!CTIVITIES s &INANCING!CTIVITIES 2 ExplainWHYITISIMPORTANTTHATBUDGETED.ET#ASH&LOWSFROM/PERATIONSIS POSITIVE 3 StateTWOACTIONSTHEOWNERCOULDTAKETO s IMPROVEESTIMATED/PERATINGINmOWS s REDUCEESTIMATED/PERATINGOUTmOWS 4 StateTWOEXPECTEDEXPENSESTHATWILLnotBEREPORTEDINTHE"UDGETED#ASH &LOW3TATEMENT 5 Explain WHY IT IS USUAL FOR .ET #ASH &LOWS FROM )NVESTING !CTIVITIES TO BE NEGATIVE 6 ExplainTHEPOSSIBLERELATIONSHIPBETWEENTHECASHmOWSFROM)NVESTINGAND &INANCINGACTIVITIES 7 ExplainTWOBENElTSOFPREPARINGBUDGETSMOREFREQUENTLYTHANONCEAYEAR

17.4 USES OF THE BUDGETED CASH FLOW STATEMENT Planning 4HE "UDGETED #ASH &LOW 3TATEMENT aids planning BY ALLOWING THE OWNER TO PREPARE INADVANCEFORANEXPECTEDCASHSURPLUSORCASHDElCIT3HOULDTHEBUDGETPREDICTAN OVERALL.ET$ECREASEIN#ASH0OSITION THEOWNERMIGHT s DEFER THE PURCHASE OF NON CURRENT ASSETS OR USE CREDIT FACILITIES OR A LOAN FOR A PURCHASE s DEFERLOANREPAYMENTS s TAKELESSCASHASDRAWINGS s MAKEACASHCAPITALCONTRIBUTION s ORGANISEOREXTEND ANOVERDRAFTFACILITY 3HOULDTHEBUDGETPREDICTANOVERALL.ET)NCREASEIN#ASH0OSITION THEOWNERMIGHT USETHEEXTRACASHTO s PURCHASEMORENEWERNON CURRENTASSETS s INCREASELOANREPAYMENTS s INCREASECASHDRAWINGS s EXPAND TRADING ACTIVITIES BY INCREASING ADVERTISING OR EMPLOYING MORE STAFF FOR EXAMPLE !LTERNATIVELY ABUSINESSSTARTINGAPERIODWITHABANKOVERDRAFTMAYCHOOSETODO NOTHING ANDLETTHEEXPECTEDCASHSURPLUSBRINGITSBANKBALANCEBACKINTOTHEBLACK

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Decision-making )NADDITION THE"UDGETED#ASH&LOW3TATEMENTaids decision-makingBECAUSEITSETS A STANDARD BENCHMARK FOR THE ASSESSMENT OF THE lRMS ACTUAL CASH PERFORMANCE "Y COMPARINGBUDGETEDANDACTUALCASHmOWS THEOWNERCANIDENTIFYPROBLEMSAREAS AND THENACTTOCORRECTTHESITUATION 3PECIlCALLY THEOWNERCOULDASSESS s THEEFFECTIVENESSOFADVERTISINGINGENERATING#ASH3ALES s DEBTORCOLLECTIONPROCEDURES s CREDITORPAYMENTPOLICIES s THELEVELOFCASHPAYMENTSFOREXPENSES s THELEVELOFCASHDRAWINGS s THEADEQUACYOFlNANCEFORTHEPURCHASEOFNON CURRENTASSETS

REVIEW QUESTIONS 17.4

1 2 3 4

ExplainHOWTHE"UDGETED#ASH&LOW3TATEMENTCANASSISTPLANNING StateTHREEACTIONSTHEOWNERCOULDTAKETOADDRESSABUDGETEDCASHDECREASE StateTHREEACTIONSTHEOWNERCOULDTAKETOUTILISEABUDGETEDCASHINCREASE ExplainHOWTHE"UDGETED#ASH&LOW3TATEMENTCANASSISTDECISION MAKING

17.5 CALCULATING CASH FLOWS Schedule of Receipts from Debtors )NTHEEXAMPLEIN WEREPORTED2ECEIPTSFROM$EBTORSINTHE"UDGETED#ASH&LOW 3TATEMENTRATHERTHAN#REDIT3ALES ASWEWEREINTERESTEDONLYINREPORTINGCASHmOWS 4HISDISTINCTIONISVERYIMPORTANTTHECREDITSALEANDRECEIPTOFTHECASHMAYEVENTAKE PLACEINDIFFERENTREPORTINGPERIODS)NSOMECASES ITMAYBENECESSARYTOCALCULATEHOW MUCHWILLBERECEIVEDFROMDEBTORSDURINGTHEbudgetPERIODFROM#REDIT3ALESMADE INpreviousPERIODSAND INSOMECASES THEcurrentPERIOD )NTEGRAL TO THIS TYPE OF CALCULATION IS KNOWLEDGE OF THE HISTORICAL BEHAVIOUR OF DEBTORSINMAKINGTHEIRREPAYMENTS4HEBUSINESSOWNERNEEDSTOBEABLETOESTIMATE APPROXIMATELYHOWLONGDEBTORSTAKETOPAY"ASEDONTHEINFORMATIONINTHE$EBTORS ,EDGER OWNERSCANESTIMATEWHATPERCENTAGEOFDEBTORSPAYWITHINAMONTHOFTHESALE WITHINTWOMONTHS ANDSOON THEREBYALLOWINGTHEMTOCALCULATETHEEXPECTED2ECEIPTS FROM$EBTORSFORTHEBUDGETPERIOD4HISCALCULATIONISFACILITATEDBYTHEPREPARATIONOF A 3CHEDULEOF2ECEIPTSFROM$EBTORS

Facial Attractions sells make-up and other cosmetics, and wants to prepare A"UDGETED#ASH&LOW3TATEMENTFOR/CTOBER .OVEMBERAND$ECEMBER 2016. On 30 September 2016, its owner provided the following Sales data: Actual Sales

Budgeted Sales

July August September October .OVEMBER December

Schedule of Receipts from Debtors a table used to calculate how much cash will be received from debtors in the budget period as a consequence of Credit Sales in the current and previous periods

EXAMPLE

$21 000 20 000 22 000 19 000  25 000

s3ALESFIGURESDONOTINCLUDE'34 sOF3ALESAREMADEONCREDITAREMADEONCASHTERMS ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

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UNITS 3&4

)FWEWEREPREPARINGA"UDGETED)NCOME3TATEMENT WEWOULDNOTHAVETOMAKE ANYCALCULATIONS ASWEALREADYHAVEINFORMATIONRELATINGTOEXPECTED3ALES2EVENUEFOR EACHMONTH(OWEVER INORDERTOPREPAREA"UDGETED#ASH&LOW3TATEMENT WENEED TOCALCULATEEXPECTED2ECEIPTSFROM$EBTORS &IRST WEMUSTCALCULATEHOWMUCHOFTHETOTAL3ALESlGUREIS#ASH3ALES ANDHOW MUCHISMADEONCREDIT4HISISSHOWNIN&IGURE Figure 17.4

Schedule of cash and credit sales Total Sales

Cash Sales 20%

July

21 000

4 200

16 800

August

20 000

4 000

16 000

September

22 000

4 400



October

19 000

3 800

15 200

.OVEMBER

23 000

4 600

18 400

December

25 000

5 000

20 000

Month

Credit Sales 80%

4HE#ASH3ALESlGURESFOR/CTOBERTO$ECEMBERCANGOSTRAIGHTINTOTHE"UDGETED #ASH&LOW3TATEMENTAS/PERATINGINmOWS ASTHEYREPRESENTCASHmOWSINTHEMONTHS WHENTHESALEISMADE#ASH3ALESFOR*ULYTO3EPTEMBERAREOUTSIDETHEBUDGETPERIOD ANDSOAREEXCLUDED !STHESEARE3ALES '34WILLALSOBERECEIVEDATTHERATEOFOFTHE#ASH3ALES lGURE4HECASHRECEIPTSARISINGFROM#ASH3ALESFOR/CTOBERTO$ECEMBERWOULD THUSBE October

November

December

CASH FLOW FROM OPERATING ACTIVITIES Cash Inflows Cash Sales '342ECEIVED

3 800

4 600

5 000

380

460

500

(OWEVER WE NEED TO CALCULATE HOW MUCH CASH WILL BE RECEIVED IN /CTOBER TO $ECEMBER AS A RESULT OF CREDIT SALES IN EARLIER MONTHS )N ORDER TO DO THIS WE MUST lRSTADDTOOURCREDITSALESTHE'34WEWILLCHARGEDEBTORS ASBOTHAMOUNTSMUSTBE COLLECTEDFROMDEBTORS Figure 17.5 Month

Credit Sales and GST Credit Sales (excluding GST)

GST charged (10%)

Credit Sales (including GST)

July

16 800

1 680

18 480

August

16 000

1 600

17 600

September





19 360

October

15 200

1 520

16 720

.OVEMBER

18 400

1 840

20 240

December

20 000

2 000

22 000

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BUDGETS

399

'IVENTHETOTALAMOUNTOWEDTOUSBYDEBTORSCredit Sales including GST WECAN NOWMOVETOCALCULATING2ECEIPTSFROM$EBTORSFROMTHOSECREDITSALES4HISREQUIRES MOREINFORMATIONABOUTTHEREPAYMENTPATTERNSOFTHElRMSDEBTORS

EXAMPLE

Additional information "ASEDONANANALYSISOFTHEFIRMSDEBTORS THEOWNEREXPECTSOF DEBTORSTOPAYINTHEMONTHAFTERTHESALE4HESEDEBTORSRECEIVEA DISCOUNT/FTHEREMAINDER OFDEBTORSPAYTWOMONTHSAFTERTHE SALE ANDPAYINTHETHIRDMONTHAFTERSALE

"ASEDONTHISINFORMATION WECANPREPAREA3CHEDULEOF2ECEIPTSFROM$EBTORSLIKE THEONESHOWNIN&IGURE Figure 17.6

STUDY TIP

Schedule of Receipts from Debtors

Month

Credit Sales (including GST)

October

November

December

July

18 480



August

17 600

10 560

2 640

September

19 360

4 598

11 616

2 904

October

16 720



10 032

.OVEMBER

20 240

December

22 000

Budgeted Receipts from Debtors



17 930

18 227

17 743

4HEMONTHSACROSSTHETOPOFTHETABLE/CTOBER .OVEMBER $ECEMBER ARETHOSEFOR WHICHWEAREPREPARINGTHEBUDGET4HEMONTHSDOWNTHELEFTSIDE*ULYTO$ECEMBER ARETHOSEFORWHICHWEHAVE3ALESDATA )FWEEXAMINETHEAMOUNTOWINGFORCREDITSALESMADEIN3EPTEMBER WECANSEE HOWTHECALCULATIONSWEREMADE"ASEDONTHEANALYSISOFWHENDEBTORSPAY OF THE3EPTEMBERCREDITSALESlGURE$19 360INCLUDING'34 LESSTHEDISCOUNTWILLBE COLLECTEDINTHEMONTHAFTERTHESALETHATIS IN/CTOBER !MOUNTOWINGFORCREDITSALESINCLUDING'34 XRECEIVEDONEMONTHAFTERSALE LESSDISCOUNTX

$19 360  242

#ASHRECEIVEDFROMDEBTORSIN/CTOBER

$ 4 598

4HE3CHEDULEOF 2ECEIPTSFROM$EBTORS ISNOTABUDGETED REPORTITISSIMPLYA TECHNIQUEUSEDTO CALCULATE2ECEIPTSFROM $EBTORS WHICHCAN THENBESHOWNINTHE "UDGETED#ASH&LOW 3TATEMENT

STUDY TIP

7ITHTHEDISCOUNT DONT JUSTMULTIPLYBY THATIS LESS  THISWOULDGIVETHE DISCOUNTTOALLDEBTORS RATHERTHANJUSTTHOSE WHOPAYWITHINONE MONTH

!FURTHEROF $19 360 WILLBECOLLECTEDTWOMONTHSLATERIN.OVEMBER  ANDTHElNALOF$19 360 WILLBECOLLECTEDTHREEMONTHSAFTERTHE SALEIN$ECEMBER 4HESAMEPROCESSAPPLIESTOTHEOTHERMONTHSTOSHOWTHATALTHOUGHACREDITSALEIS MADEINONEMONTH THECASHMAYBERECEIVEDOVERANUMBEROFMONTHS )FWEADDUPALLTHElGURESINTHECOLUMNSFOR/CTOBER .OVEMBERAND$ECEMBER WE CAN CALCULATE ESTIMATED 2ECEIPTS FROM $EBTORS FOR EACH MONTH 4HIS INFORMATION CANNOWBEREPORTEDINTHE"UDGETED#ASH&LOW3TATEMENT ALONGWITHTHE#ASH3ALES lGURESWEHADALREADYCALCULATED ASISSHOWNOVERTHEPAGE ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

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UNITS 3&4

FACIAL ATTRACTIONS Budgeted Cash Flow Statement (extract) for October–December 2016 CASH FLOW FROM OPERATING ACTIVITIES Cash Inflows Cash Sales '342ECEIVED 2ECEIPTSFROM$EBTORS

October

November

December

3 800 380 

4 600 460 

5 000 500 

2EMEMBERTHATALTHOUGHTHECASHRECEIVEDFROMDEBTORSINCLUDESSOME'34 ITISNOT NECESSARYTOIDENTIFYTHISAMOUNTSEPARATELYASTHE'34ISONLYIDENTIlEDATTHEPOINTOF SALEONLY'34RECEIVEDON#ASH3ALES MUSTBEREPORTEDSEPARATELY

Schedule of Payments to Creditors Schedule of Payments to Creditors a table used to calculate how much cash will be paid to creditors in the budget period as a consequence of credit purchases in the current and previous periods

4HIS TECHNIQUE CAN ALSO BE APPLIED TO CALCULATE 0AYMENTS TO #REDITORS WITH CREDIT PURCHASESSUBSTITUTINGFORCREDITSALES)NORDERTODRAWUPA3CHEDULEOF0AYMENTSTO Creditors WEREQUIREINFORMATIONONHOWFREQUENTLYCREDITORSAREPAIDSOTHATWECAN CALCULATEwhen ANDhow much CREDITORSWILLBEPAIDDURINGTHEBUDGETPERIOD

REVIEW QUESTIONS 17.5

1 2EFERRING TO ONE ACCOUNTING PRINCIPLE explain WHY IT MAY BE NECESSARY TO PREPARE A 3CHEDULE OF 2ECEIPTS FROM $EBTORS WHEN PREPARING A "UDGETED #ASH&LOW3TATEMENT 2 ExplainTHEROLEOFHISTORICALDATAINTHEPREPARATIONOFA3CHEDULEOF2ECEIPTS FROM$EBTORS 3 Explain WHY 2ECEIPTS FROM $EBTORS MUST BE CALCULATED USING CREDIT SALES INCLUDING'34 4 Explain WHYTHE'34MUSTBEIDENTIlEDWHEN#ASH3ALESARESHOWNINTHE "UDGETED#ASH&LOW3TATEMENT 5 StateONEREASONWHYTHE'34ISnotIDENTIlEDWHENCASHISRECEIVEDFROMA DEBTOR

17.6 THE BUDGETED INCOME STATEMENT

Budgeted Income Statement an accounting report that shows expected future revenues and expenses

'IVENTHATTHEMAINOBJECTIVEOFATRADINGBUSINESSISTOEARNAPROlT THEOWNERSHOULD PLANAHEADFORHOWTOACHIEVETHISGOAL)NADDITION THElRMMUSTHAVESOMETYPEOF BENCHMARKAGAINSTWHICHITCANASSESSITSTRADINGPROlT PERFORMANCE"OTHOFTHESE AIMSAREMETBYTHEPREPARATIONOFA"UDGETED)NCOME3TATEMENT WHICHATTEMPTSTO PREDICTREVENUESANDEXPENSESFORTHEBUDGETPERIOD

Cash versus profit !TTHISPOINTITISPROBABLYWORTHREMEMBERINGTHATCASHANDPROlTAREDIFFERENTMEASURES OFPERFORMANCE ANDTHEREFORETHEITEMSREPORTEDINTHE"UDGETED)NCOME3TATEMENT WILLNOTNECESSARILYBETHESAMEASTHOSEREPORTEDINTHE"UDGETED#ASH&LOW3TATEMENT 7HEREASTHE"UDGETED#ASH&LOW3TATEMENTREPORTSEXPECTEDcash inflowsANDcash outflowsOVERTHEBUDGETPERIOD THE"UDGETED)NCOME3TATEMENTREPORTSexpected revenues earnedANDexpected expensesincurredOVERTHEBUDGETPERIOD

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!S SOME CASH ITEMS ARE NOT REVENUES OR EXPENSES THEY WILL BE OMITTED FROM THE "UDGETED)NCOME3TATEMENT Cash inflows that are not revenues

Cash outflows that are not expenses

'34RECEIVED

'34PAID

'34REFUND

'34SETTLEMENT

#ASHSALEOF.#!

#ASHPAYMENTFOR.#!TOSUNDRYCREDITOR

Cash capital contribution

Cash drawings

2ECEIPTOFLOAN

2EPAYMENTOFLOANPRINCIPAL

3TRICTLYSPEAKING CASHSALEFROMAN.#!REPRESENTSREVENUE(OWEVER ITISONLYTHEOVERALL PROlTORLOSS ONTHEDISPOSALTHATISREPORTEDINTHE"UDGETED)NCOME3TATEMENT

(OWEVER THE"UDGETED)NCOME3TATEMENTWILLINCLUDESOMEREVENUESANDEXPENSES THATARENOTREPORTEDASCASHmOWS Revenues that are not cash inflows

Expenses that are not cash outflows

Stock gain

Stock Loss Stock write-down

0ROlTONDISPOSALOF.#!

,OSSONDISPOSALOF.#! Bad debts Depreciation

&INALLY SOMEOFTHEITEMSWILLAFFECTBOTHBUDGETS BUTTHEAMOUNTSMAYDIFFER Revenue/expense

Cash inflow/cash outflow

Credit Sales

2ECEIPTSFROM$EBTORS

Cost of Sales

0AYMENTSFORSTOCK

Other revenue earned

Other revenue received (may also be TITLEDACCRUEDANDORPREPAID

Other Expense incurred

Other Expense paid (may also be titled ACCRUEDANDORPREPAID

,ETS USE THE INFORMATION THAT WAS USED TO GENERATE THE "UDGETED #ASH &LOW 3TATEMENTIN&IGURETOILLUSTRATEHOWTHE"UDGETED)NCOME3TATEMENTWILLAPPEAR BUTTHISTIMEWITHTHEREVENUESANDEXPENSESHIGHLIGHTED

Denzel Washing Machines will begin trading Operations on 1 March 2016, and has provided the following estimates for its first month of Operations: s 4HEOWNERWILLMAKEACAPITALCONTRIBUTIONOFTOCOMMENCE Operations. s #ASH3ALESAREESTIMATEDTOBE$24 000PLUS'34 s #REDIT3ALESAREESTIMATEDTOBE$17 600 including GST. Of this amount, $11 000 is expected to be received in March 2016. s !LLSTOCKWILLBEPURCHASEDONCREDIT0URCHASESFOR-ARCHARE EXPECTEDTOBEPLUS'34!TTHEENDOF-ARCHIT is anticipated that $6 500 will be owed to creditors.

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EXAMPLE

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s #OSTOF3ALESISEXPECTEDTOBE$20 000 and, based on the experience of similar firms, Stock Loss is expected to be $300. s 4HEFOLLOWINGEXPENSESWILLBEINCURREDDURING-ARCH – wages $ 8 000 – advertising 1 300 PLUS'34 100 – depreciation of office equipment s 2ENTFORTHENEXTsix months will be paid on 1 March 2016: $9 000 plus '34 s .EWOFFICEEQUIPMENTWORTHPLUS'34WILLBEPURCHASEDON 1 March 2016 using cash. s #ASHDRAWINGSWILLBE$RAWINGSOFSTOCKISEXPECTEDTOBE s /N-ARCH WILLBEBORROWEDFROM!8#"ANKTO purchase a new vehicle. Beginning in April 2016, $500 will be paid off THEPRINCIPALEACHMONTH4HEVEHICLEITSELFWILLNOTBEPURCHASEDUNTIL April 2016.

4HE"UDGETED)NCOME3TATEMENTFOR-ARCHISSHOWNIN&IGURE Figure 17.7

Budgeted Income Statement DENZEL WASHING MACHINES Budgeted Income Statement for March 2016

Revenue

$

Cash Sales

24 000

Credit Sales

16 0001

$

40 000

Less Cost of Goods Sold Cost of Sales

20 000

Gross Profit

20 000

Less Stock Loss

300

Adjusted Gross Profit

19 700

Less Other Expenses Wages

8 000

Advertising

1 300

Depreciation of Office Equipment

100 1 5002

2ENT Net Profit

10 900 8 800

.OTETHEFOLLOWINGIN&IGURE  #REDIT3ALESOF$17 600includes GST4HUS THEAMOUNTOF#REDIT3ALESREVENUEIS ONLYTHATIS

$17 600



X





#REDIT3ALES

 0REPAID RENT IS NOT SHOWN IN THIS REPORT AS IT IS THE PURCHASE OF A CURRENT ASSET )NTERMSOFEXPENSES ONLYONEMONTHHASBEENINCURREDTHATIS



X



MONTHS



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403

Uses of the Budgeted Income Statement 4HE "UDGETED )NCOME 3TATEMENT aids planning BECAUSE IT INDICATES THE FUTURE REQUIREMENTSOFTHElRMRELATINGTOISSUESSUCHASSTAFlNG WHICHMAYREQUIREHIRINGOR lRINGSTOCKLEVELSORADVERTISINGCAMPAIGNS !S A decision-making TOOL THE "UDGETED )NCOME 3TATEMENT PROVIDES A STANDARD AGAINSTWHICHTRADINGPERFORMANCECANBEMEASURED ALLOWINGPROBLEMSTOBEIDENTIlED ANDCORRECTIVEACTIONTAKEN4HISBENCHMARKCANALSOACTASAtargetORgoalTOMOTIVATE STAFFANDMANAGEMENT 3PECIlCALLY THEOWNERCOULDASSESS s THELEVELOFSALESANDTHEEFFECTIVENESSOFADVERTISING s THEMARK UPACHIEVED s THELEVELOFSTOCKLOSSTOASSESSSTOCKMANAGEMENTPROCEDURES s EXPENSECONTROL s STAFFPERFORMANCE

REVIEW QUESTIONS 17.6

1 Explain THE DIFFERENCE BETWEEN A "UDGETED #ASH &LOW 3TATEMENT AND A "UDGETED)NCOME3TATEMENT 2 StateTWOEXAMPLESOF s CASHINmOWSTHATARENOTREVENUES s CASHOUTmOWSTHATARENOTEXPENSES 3 StateTWOEXAMPLESOF s REVENUESTHATARENOTCASHINmOWS s EXPENSESTHATARENOTCASHOUTmOWS 4 ExplainHOWA"UDGETED)NCOME3TATEMENTCANBEUSEDTOASSISTPLANNING 5 Explain HOW A "UDGETED )NCOME 3TATEMENT CAN BE USED TO ASSIST DECISION MAKING 6 StateTHREEAREASOFBUSINESSPERFORMANCETHEOWNERMIGHTASSESSBYUSING THE"UDGETED)NCOME3TATEMENTASABENCHMARK

17.7 THE BUDGETED BALANCE SHEET 4HEBudgeted Balance SheetATTEMPTSTOPREDICTTHElRMSASSETS LIABILITIESANDOWNERS EQUITYATSOMEPOINTINTHEFUTURE2EMEMBERTHEEXAMPLEFROMEARLIERINTHISCHAPTER

Denzel Washing Machines will begin trading Operations on 1 March 2016, and has provided the following estimates for its first month of Operations: s 4HEOWNERWILLMAKEACAPITALCONTRIBUTIONOFTOCOMMENCE Operations. s #ASH3ALESAREESTIMATEDTOBEPLUS'34. s #REDIT3ALESAREESTIMATEDTOBEINCLUDING'34. Of this amount, $11 000 is expected to be received in March 2016. s !LLSTOCKWILLBEPURCHASEDONCREDIT0URCHASESFOR-ARCHARE expected to be $35 000 PLUS'34. At the end of March 2016 it is anticipated that $6 500 will be owed to creditors. s #OSTOF3ALESISEXPECTEDTOBE$20 000 and, based on the experience of similar firms, Stock Loss is expected to be $300.

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Budgeted Balance Sheet an accounting report that predicts assets, liabilities and owner’s equity at some point in the future

EXAMPLE

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s 4HEFOLLOWINGEXPENSESWILLBEINCURREDDURING-ARCH – wages $8 000 – advertising 1 300 (PLUS'34 100 – depreciation of office equipment s 2ENTFORTHENEXTSIXMONTHSWILLBEPAIDON-ARCHplus '34 s .EWOFFICEEQUIPMENTWORTHPLUS'34 WILLBEPURCHASED on 1 March 2016 using cash. s #ASHDRAWINGSWILLBE$RAWINGSOFSTOCKISEXPECTEDTOBE$600. s /N-ARCH WILLBEBORROWEDFROM!8#"ANKTO purchase a new vehicle. Beginning in April 2016, $500 will be paid off THEPRINCIPALEACHMONTH4HEVEHICLEITSELFWILLNOTBEPURCHASEDUNTIL April 2016.

4HEBUDGETED"ALANCE3HEETASAT-ARCHISSHOWNIN&IGURE Figure 17.8

Budgeted Balance Sheet DENZEL WASHING MACHINES Budgeted Balance Sheet as at 31 March 2016

Current Assets Bank1 Stock Control

2

$

$

Current Liabilities

$



Creditors Control

6 500

14 100

Loan – AXC Bank

6 000

Debtors Control3

6 600

0REPAID2ENT4



'34#LEARING5

1 030

6

$

12 500

Non-Current Liabilities 48 800

Non-Current Assets

Loan – AXC Bank 6

4 000

Owner’s Equity

Office Equipment

5 000

Less Accumulated Depreciation

100

Capital – Denzel 4 900

.ET0ROlT

30 000 8 800 38 800

Less Drawings8 Total Assets

53 700

1 600

Total Equities

 53 700

.OTETHEFOLLOWINGIN&IGURE 

"ANK

#ASHBALANCEATENDSEE"UDGETED#ASH&LOW3TATEMENT n&IGUREnBank Balance at end

 3TOCK#ONTROL

3EETHEFOLLOWINGPAGE

 $EBTORS#ONTROL

#REDIT3ALESINCLUDING LESS2ECEIPTSFROM $EBTORS

 0REPAIDRENT

0REPAIDRENT LESSRENTEXPENSE

 '34#LEARING

3EETHEFOLLOWINGPAGE

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BUDGETS

 ,OANn!8#"ANK

2EPAYABLEPERMONTHX#, REMAINDER.#,



3EE"UDGETED)NCOME3TATEMENTn&IGURE

.ET0ROlT

 $RAWINGS

#ASHDRAWINGS PLUSDRAWINGSOFSTOCK

)T IS WORTH CONSIDERING IN DETAIL HOW TWO OF THESE ITEMS IN THE BUDGETED "ALANCE 3HEET n 3TOCK #ONTROL AND '34 #LEARING n WERE CALCULATED 'IVEN OUR KNOWLEDGE OF DOUBLE ENTRYACCOUNTING WEWILLEXPRESSTHECALCULATIONINTHEFORMOFALEDGERACCOUNT Figure 17.9

Reconstructed ledger accounts Stock Control (A)

Date March 1 31

Cross-reference Balance Creditors Control

Amount .IL

Date March 31

35 000

Cross-reference Cost of Sales

600

Stock Loss

300

35 000 Balance

20 000

Drawings

Balance

April 1

Amount

14 100 35 000

14 100 GST Clearing (A/L)

Date

Cross-reference

March 31 Bank Creditors Control

Amount

DCate

Cross-reference

1 530

March 1

Balance

3 500

31

.IL

Bank

2 400

Debtors Control

1 600

Balance

1 030

5 030 April 1 Balance

Amount

5 030

1 030

4HE DEBIT BALANCE IN THIS ACCOUNT MEANS '34 #LEARING IS AN ASSET A RESOURCE CONTROLLED BY THE BUSINESS FROM WHICH FUTURE ECONOMIC BENElTS WILL mOW THE REFUND OWED TO THE BUSINESS BY THE !4/  4HIS HAS OCCURRED BECAUSE THE BUSINESS HAS JUST STARTED SOITHASPURCHASEDMORESTOCKTHANITHASSOLD ANDPURCHASEDANUMBEROF ASSETS SUCH AS OFlCE EQUIPMENT AND PREPAID RENT 4HUS THE '34 ON ITS PURCHASES  ISgreaterTHANTHE'34ONITSSALES 

Uses of the Budgeted Balance Sheet 4HE "UDGETED "ALANCE 3HEET CAN BE USED AS A planning DOCUMENT "Y DETAILING THE EXPECTEDCARRYINGVALUEOFNON CURRENTASSETSATSOMETIMEINTHEFUTURE ITHELPSTHE OWNER PREPARE FOR THEIR REPLACEMENT 7HEN USED IN CONJUNCTION WITH THE "UDGETED #ASH&LOW3TATEMENT ITCANALSOBEUSEDTOPLANFORTHEREPAYMENTOFLOANS ANDTOSET THELEVELFORDRAWINGSFORTHECOMINGPERIOD )NADDITION ITCAN assist decision-making BYSETTINGABENCHMARKFORINDICATORSTHAT ASSESSLIQUIDITYANDSTABILITY3PECIlCALLY ITWILLALLOWTHEOWNERTOCALCULATETHE"UDGETED 7ORKING#APITAL2ATIO WHICHCANBEUSEDTOASSESSLIQUIDITYANDTHE$EBT2ATIO WHICH CANBEUSEDTOASSESSSTABILITY4HESERATIOSARECOVEREDINDETAILIN#HAPTER

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UNITS 3&4

REVIEW QUESTIONS 17.7

1 StateTHREEITEMSREPORTEDINTHE"UDGETED"ALANCE3HEETTHATAREAFFECTED BYTHETRANSACTIONSREPORTEDINTHE s "UDGETED#ASH&LOW3TATEMENT s "UDGETED)NCOME3TATEMENT 2 ExplainHOWTHE"UDGETED"ALANCE3HEETCANBEUSEDTOASSISTPLANNING 3 Explain HOW THE "UDGETED "ALANCE 3HEET CAN BE USED TO ASSIST DECISION MAKING STUDY TIP

4OSELECTWHICH ACCOUNTTORECONSTRUCT THINKOFTHETRANSACTION THATISMISSINGIT WILLAPPEARINTWO LEDGERACCOUNTS4HEN CHOOSETHEACCOUNT FORWHICHYOUHAVETHE BESTINFORMATION

EXAMPLE

17.8 ACCOUNT RECONSTRUCTION 4HEPRECEDINGEXAMPLEILLUSTRATEDHOWLEDGERACCOUNTSCANBEUSEDTOCALCULATECLOSING BALANCESFORTHE"UDGETED"ALANCE3HEET4HISISNOTTHEONLYUSEOFLEDGERACCOUNTSIN THEBUDGETINGPROCESS)FWEALREADYKNOWTHECLOSINGBALANCE WECANWORKBACKWARDS TOCALCULATEOTHERlGURESTHATMAYBENECESSARYTOCOMPLETETHE"UDGETED#ASH&LOW 3TATEMENT ORTHE"UDGETED)NCOME3TATEMENT 7HEREONLYSOMEINFORMATIONISKNOWN WECANUSEOURKNOWLEDGEOFLEDGERACCOUNTS ANDDOUBLE ENTRYACCOUNTINGTOCALCULATEMISSINGORUNKNOWNlGURESBYRECONSTRUCTING THERELEVANTLEDGERACCOUNT2ECONSTRUCTINGALEDGERACCOUNTINVOLVESTHREESTEPS  IdentifyTHEENTRIESWEWOULDEXPECTTOSEEINAPARTICULARLEDGERACCOUNT  MatchTHESEENTRIESWITHlGURESTHATAREKNOWN  CompleteTHELEDGERACCOUNTTOCALCULATETHElGURESTHATARENOTKNOWN

On 1 July 2015, Kings Sportswear had debtors of $12 000. During THEMONTHOF*ULY #REDIT3ALESWEREINCLUDING'34 AND 3ALES2ETURNSWEREPLUS'34$ISCOUNT%XPENSEAMOUNTEDTO $400. On 16 July 2016, a Bad Debt for $900 was written off. At 31 July 2016, debtors owed $15 000.

4HEDATAABOVEISSUFlCIENTTOPREPARETHE"UDGETED)NCOME3TATEMENTAS#REDIT 3ALESISKNOWN ANDTHE"UDGETED"ALANCE3HEETCANBEPREPAREDAS$EBTORS ATTHEENDISKNOWN (OWEVER THE"UDGETED#ASH&LOW3TATEMENTcannotBE PREPARED AS2ECEIPTSFROM$EBTORSISunknown7EDONOTHAVESUFlCIENTINFORMATION TOPREPAREA3CHEDULEOF2ECEIPTSFROM$EBTORS BUTWECANRECONSTRUCTTHE$EBTORS #ONTROLACCOUNT

Step 1: identify the entries we would expect to see )NCLUDINGEVERYTRANSACTIONTHISCOURSEHASCOVEREDSOFAR ACOMPLETE$EBTORS#ONTROL ACCOUNT EXCLUDINGAMOUNTS WOULDSHOW

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 17

Figure 17.10

BUDGETS

407

Debtors Control template Debtors Control (A)

Date

Cross-reference

July 1 31

Balance 3ALES'34#LEARING

Aug. 1

Amount

Date

Cross-reference

July 31

Bank/ Discount Expense 3ALES2ETURNS'34#LEARING Bad Debts Balance

Amount

STUDY TIP

Balance

+EEP IN MIND THAT ALTHOUGH WE ARE CALCULATING 2ECEIPTS FROM $EBTORS IT WILL BE IDENTIlEDINTHE$EBTORS#ONTROLACCOUNTBYTHECROSS REFERENCE@"ANK!LSONOTETHAT THELINE@"ANK$ISCOUNT%XPENSEHASBEENSPLITACROSSTWOLINES4HISISUSUALLYWRITTEN ONONELINE BECAUSEITISPOSTEDFROMTHETOTALOFTHE$EBTORS#ONTROLCOLUMNINTHE #ASH2ECEIPTS*OURNAL(OWEVER THISONEAMOUNTREPRESENTSTHETOTALBYWHICHDEBTORS WILL DECREASE THAT IS CASH RECEIVED PLUS ANY DISCOUNT EXPENSE &OR THE PURPOSE OF THE"UDGETED#ASH&LOW3TATEMENT WEAREONLYINTERESTEDINTHECASHRECEIVEDFROM DEBTORS"ANK NOTTHEDISCOUNTEXPENSE SOTHETWOAMOUNTSHAVEBEENIDENTIlEDON SEPARATELINESINTHELEDGERACCOUNT

$EVISEACODETO REMEMBERTHENUMBER OFENTRIESINEACH ACCOUNT$EBTORS #ONTROLHASTWOONTHE DEBITSIDE ANDFOUR ONTHECREDITSIDE&OR EXAMPLE YOUCOULDCALL IT@THEBYACCOUNT

Step 2: match these entries with figures that are known !FTERENTERINGTHEINFORMATIONTHATISKNOWN THE$EBTORS#ONTROLACCOUNTWOULDSHOW Debtors Control (A) Date

Cross-reference

July 1 31

Amount

Date

Balance

12 000

July 31

3ALES'34#LEARING

88 000

Cross-reference

Amount

Bank/ Discount Expense

400 1 320

3ALES2ETURNS'34#LEARING Bad Debts Balance Aug. 1

Balance

900 15 000

15 000

4HE3ALESRETURNSlGUREWASPROVIDEDASplus'34 MEANINGTHETOTALlGURE TOBERECORDEDHEREISPLUS'34 

Step 3: complete the ledger account to calculate the missing figure "YCOMPLETINGTHEACCOUNT WECANDETERMINETHEMISSINGlGURE WHICHINTHISCASEIS 2ECEIPTSFROM$EBTORS Debtors Control (A) Date

Cross-reference

Amount

Date

July 1

Balance

12 000

July 31

3ALES'34#LEARING

88 000

31

Cross-reference Bank/ Discount Expense 3ALES2ETURNS'34#LEARING Bad Debts Balance

100 000 Aug. 1

Balance

Amount 82 380 400 1 320 900 15 000 100 000

15 000

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408

STUDY TIP

4HISACCOUNTISALMOST THEOPPOSITEOFDEBTORS CONTROL BUTITHASNO BADDEBTSENTRY

UNITS 3&4

4HETOTALONTHEDEBITSIDEEQUALS SOTHISMUSTALSOBETHETOTALONTHE CREDITSIDE)NORDERTOMAKETHECREDITENTRIESTOTAL 2ECEIPTSFROM$EBTORS MUSTBE WHICHCANNOWBEREPORTEDINTHE"UDGETED#ASH&LOW3TATEMENT 4HESAMEAPPROACHCOULDBEUSEDTORECONSTRUCTOTHERLEDGERACCOUNTS Figure 17.11

Creditors Control template Creditors Control (L)

Date

Cross-reference

Amount

Bank/

Date

Cross-reference

Start

Balance

Amount

$ISCOUNT2EVENUE 3TOCK#ONTROL'34 Clearing End

3TOCK#ONTROL'34 Clearing

Balance Balance

)NTHE#REDITORS#ONTROLACCOUNT THE3TOCK#ONTROL'34#LEARINGENTRYONTHECREDIT SIDEISCREDITPURCHASESTHESAMEENTRYONTHEDEBITSIDEISPURCHASERETURNS Figure 17.12

Stock Control template Stock Control (A)

Date

Cross-reference

Start

Balance Creditors Control

Amount $

Date

Cross reference Cost of Sales

Amount $

4

Cost of Sales5

1

Bank2

Cost of Sales6

Cost of Sales3

Creditors Control Advertising Drawings Stock Write-down

3TOCK'AIN

End

3TOCK,OSS

Balance

Balance

'IVENTHENUMBEROFENTRIESINTHE3TOCK#ONTROLACCOUNT ITISWORTHCLARIFYINGAFEW Debit side 1 2 3

Credit purchases Cash purchases 3ALESRETURNSCOSTPRICE

Credit side 4 5 6 

#ASH3ALESCOSTPRICE #REDIT3ALESCOSTPRICE 0REPAID3ALESCOSTPRICE 0URCHASERETURNS

3TOCKLOSSor stock gain will be recorded, but not both

.OTE THAT ALTHOUGH #OST OF 3ALES MAY INVOLVE THREE ENTRIES IN THE 3TOCK #ONTROL ACCOUNT ITWOULDONLYBEreportedASASINGLElGUREINTHE"UDGETED)NCOME3TATEMENT AND HENCE MAY IN SOME CASES BE PROVIDED AS ONLY ONE lGURE .OTE ALSO THE LINKS BETWEENTHE#REDITORS#ONTROLAND3TOCK#ONTROLACCOUNTSRELATINGTOCREDITPURCHASES ANDPURCHASERETURNS

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 17

Figure 17.13

BUDGETS

GST Clearing template GST Clearing (A/L)

Date

Cross-reference Bank

Amount

1

Date

Cross-reference

Start

Balance

Bank

Bank6

Creditors Control3

Debtors Control

Debtors Control4

Creditors Control8

2

Amount

Sundry Creditor5 End

Balance Balance

4HEENTRIESINTHE'34#LEARINGACCOUNTARE Debit side 1 2 3 4 5

Credit side 6  8

'34SETTLEMENT '34ONCASHPURCHASES '34ON#REDIT0URCHASES '34ON3ALES2ETURNS '34ONCREDITPURCHASEOF.#!

'34ON#ASH3ALES '34ON#REDIT3ALES '34ONPURCHASERETURNS

4HIS EXAMPLE ASSUMES A CREDIT BALANCE '34 LIABILITY TO BEGIN WITH SO A '34 SETTLEMENTISALSOLIKELYINTHECASEOFADEBITBALANCE'34ASSET A'34REFUNDWOULD BEEXPECTED)NTERMSOFTHE"UDGETED#ASH&LOW3TATEMENT ONLYTHETHREEBANKENTRIES '34SETTLEMENT '34ONCASHPURCHASESAND'34ON#ASH3ALES WOULDBEREPORTED Figure 17.14

Capital template Capital (OE)

Date

Cross-reference

Amount $

Drawings End

Date

Cross-reference

Start

Balance

0,3UMMARY

Bank

Balance

.#!

Amount $

0,3UMMARY Balance

4HECROSS REFERENCE@0,3UMMARYREFERSTOTHE.ET0ROlTOR.ET,OSSFORTHEPERIOD SOOBVIOUSLYONLYONEOFTHESEENTRIESWILLAPPEARATANYONETIME)FAPROlTISGENERATED ITWILLAPPEARONTHECREDITSIDEIFALOSSISINCURRED ITWILLAPPEARONTHEDEBITSIDE Figure 17.15

Disposal of NCA template Disposal of NCA

Date

Cross-reference

Amount $

Date

Cross-reference

.#!

!CC$EPOF.#!

0ROlTON$ISPOF.#!

Bank or Sundry Creditor

Amount $

,OSSON$ISPOF.#!

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

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CAMBRIDGE VCE ACCOUNTING

410

STUDY TIP

)FYOUONLYKNOW TWOOFTHEBIGFOUR lGURES SEEIFTHEREIS ENOUGHINFORMATIONTO RECONSTRUCTARELATED ACCOUNTFOREXAMPLE 3TOCK#ONTROLAND #REDITORS#ONTROLARE LINKED ITMAYALLOW YOUTOCALCULATETHE THIRDlGURESOYOU CANRECONSTRUCTTHE ORIGINALACCOUNT

UNITS 3&4

4HISLISTISBYNOMEANSEXHAUSTIVEANYLEDGERACCOUNTCOULDBERECONSTRUCTEDTO CALCULATEAMISSINGlGURE FORANYOFTHETHREEGENERAL PURPOSEBUDGETS 4HEONLYRESTRICTIONISWENEEDTOKNOWTHREEOFTHE@BIGFOURPIECESOFINFORMATION &ORDEBTORSANDCREDITORS THISMEANSATLEASTTHREEOF s OPENINGBALANCE s CLOSINGBALANCE s #REDIT3ALES#REDIT0URCHASES s 2ECEIPTSFROM$EBTORS0AYMENTSTO#REDITORS s s s s

&ORSTOCK ITMEANSTHREEOF OPENINGBALANCE CLOSINGBALANCE #OSTOF3ALES PURCHASESCASHORCREDIT 

)F WE KNOW ONLY ONE OR TWO OF THE BIG FOUR WE HAVE INSUFlCIENT INFORMATION TO RECONSTRUCTTHEACCOUNT

REVIEW QUESTIONS 17.8

1 StateTHEPURPOSEOFRECONSTRUCTINGALEDGERACCOUNT 2 ListTHETHREESTEPSINVOLVEDINRECONSTRUCTINGALEDGERACCOUNT 3 ExplainWHENITWOULDBEMOREAPPROPRIATETORECONSTRUCTTHE$EBTORS#ONTROL ACCOUNTRATHERTHANPREPAREA3CHEDULEOF2ECEIPTSFROM$EBTORS 4 ShowTHETEMPLATESFORTHEFOLLOWINGLEDGERACCOUNTS s $EBTORS#ONTROL s '34#LEARING s #REDITORS#ONTROL s #APITAL s 3TOCK#ONTROL s $ISPOSALOF.#!

17.9 VARIANCE REPORTS: CASH AND PROFIT

variance report an accounting report that compares actual and budgeted figures, highlighting variances, so that problems can be identified and corrective action taken

! NUMBER OF TIMES IN THIS CHAPTER WE HAVE NOTED THE BENElT OF BUDGETS IN TERMS OF PROVIDING A BENCHMARK FOR THE ASSESSMENT OF ACTUAL PERFORMANCE "Y COMPARING ACTUAL AND BUDGETED lGURES SIGNIlCANT DIFFERENCES AND PROBLEMS IN PARTICULAR CAN BEIDENTIlED ALLOWINGTHEOWNERTOMAKEDECISIONSTOIMPROVETHElRMSPERFORMANCE 4HISCOMPARISONISFACILITATEDBYTHEPREPARATIONOFAvariance report !VARIANCEREPORTCOMPARESACTUALANDBUDGETEDlGURES HIGHLIGHTINGANYSIGNIlCANT DIFFERENCES WHICH ARE KNOWN AS VARIANCES SO THAT PROBLEMS CAN BE IDENTIlED AND CORRECTED)TISPREPAREDONCETHElGURESAREAVAILABLE BUTBEFORETHENEXTBUDGET )NTHISCOURSE WEWILLPREPARETWOVARIANCEREPORTS s #ASH"UDGET6ARIANCE2EPORT s )NCOME3TATEMENT6ARIANCE2EPORT

Cash Budget Variance Report Cash Budget Variance Report an accounting report that compares actual and budgeted cash flows, highlighting variances

! #ASH "UDGET 6ARIANCE 2EPORT COMPARES ACTUAL AND BUDGETED CASH mOWS )N APPEARANCE ITISVERYSIMILARTOA"UDGETED#ASH&LOW3TATEMENT BUTISHASADDITIONAL COLUMNSFORACTUALlGURES ANDTHECALCULATIONOFTHEVARIANCE &IGURESHOWSTHE#ASH"UDGET6ARIANCE2EPORTFOR$ENZEL7ASHING-ACHINES FOR-ARCH

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 17

Figure 17.16

BUDGETS

411

Cash Budget Variance Report DENZEL WASHING MACHINES

STUDY TIP

Cash Budget Variance Report for March 2016 Budget

Actual

Variance

F/U

Cash Sales

24 000

29 000

5 000

F

2ECEIPTSFROM$EBTORS

11 000

8 000

3 000

U

2 400

2 900

500

F



39 900

2 500

F

32 000

30 000

2 000

F

Wages

8 000

8 600

600

U

Advertising

1 300

1 100

200

F

0REPAID2ENT

9 000

9 000

–

'340AID

1 530

1 610

80

U

51 830

50 310

1 520

F

(14 430)

(10 410)

4 020

F

CASH FLOW FROM OPERATING ACTIVITIES Cash Inflows

'342ECEIVED 4OTAL/PERATING)NmOWS

6ARIANCEREPORTSAREALSO KNOWNASPERFORMANCE REPORTS ASTHEYASSESS THElRMSPERFORMANCE INMEETINGITSBUDGET

Less Cash Outflows 0AYMENTSTO#REDITORS

4OTAL/PERATING/UTmOWS Net Cash Flows from Operations

–

CASH FLOW FROM INVESTING ACTIVITIES Cash Inflows .IL Less Cash Outflows Office Equipment Net Cash Flows from Investing Activities

5 000

5 000

–

–

(5 000)

(5 000)

–

–

CASH FLOW FROM FINANCING ACTIVITIES Cash Inflows Capital Contribution

30 000

30 000

–

–

Loan – AXC Bank

10 000

11 000

1 000

F

4OTAL&INANCING)NmOWS

40 000

41 000

1 000

F

1 000

1 200

200

U

Net Cash Flows from Financing Activities

39 000

39 800

800

F

Net Increase (Decrease) in Cash Position

19 570

24 390

4 820

F

Nil

Nil

–

–

19 570

24 390

4 820

F

STUDY TIP

Less Cash Outflows Drawings

add Bank Balance at start Bank Balance at end

! variance IS SIMPLY THE DIFFERENCE BETWEEN THE BUDGETED lGURE AND THE ACTUAL lGURE7HETHERITISFAVOURABLEORUNFAVOURABLEDEPENDS INTHE#ASH"UDGET6ARIANCE 2EPORT ONITSEFFECTONCASH!VARIANCEISFAVOURABLE& IFITMEANSCASHWILLBEHIGHER THANEXPECTEDINTHEBUDGETAVARIANCEISUNFAVOURABLE5 IFITMEANSCASHWILLBELOWER THANEXPECTEDINTHEBUDGET .OTE THAT IN OUR EXAMPLE THE VARIANCE IN THE ,OAN n !8# "ANK IS REPORTED AS FAVOURABLEBECAUSECASHWILLINCREASEMORETHANEXPECTED4HEFACTTHATTHELIABILITIES WILLALSOINCREASEDOESNOTAFFECTITSCLASSIlCATIONINTHE#ASH"UDGET6ARIANCE2EPORT 3IMILARLY 0AYMENTSTO#REDITORSISCLASSIlEDASFAVOURABLE EVENTHOUGHITCOULDMEAN THEBALANCEOWEDTOCREDITORSISHIGHERTHANEXPECTED

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

)FTHEREISNOVARIANCE ATALL THENITIS NEITHERFAVOURABLENOR UNFAVOURABLE

variance the difference between an actual figure and a budgeted figure, expressed as ‘favourable’ or ‘unfavourable’

Cambridge University Press

CAMBRIDGE VCE ACCOUNTING

412

UNITS 3&4

Uses of the Cash Budget Variance Report

STUDY TIP

)TDOESNTREALLYMATTER WHETHERYOUSUBTRACT BUDGETEDlGURES FROMACTUAL ORTHE OTHERWAYAROUND4HE IMPORTANTTHINGISTO IDENTIFYTHEVARIANCE CORRECTLYASfavourable ORunfavourable

)TISPOSSIBLETHATTHEVARIANCESREVEALEDINTHE#ASH"UDGET6ARIANCE2EPORTARECAUSED SIMPLYBYPOORBUDGETING(OWEVER THISDOESNOTMEANTHEREPORTISUSELESSITSHOULD BEUSEDINplanningTHENEXTBUDGET SOTHATITISMOREACCURATE !SSUMING THE VARIANCES ARE NOT CAUSED BY POOR ESTIMATES THEN THE #ASH "UDGET 6ARIANCE 2EPORT IS A VALUABLE aid to decision-making 4HE UNFAVOURABLE VARIANCES SHOULD BE INVESTIGATED AND THEIR CAUSE IDENTIlED 4HIS WILL ALLOW THE OWNER TO TAKE CORRECTIVEACTION)NOUREXAMPLE $ENZEL7ASHING-ACHINESMAYBECONCERNEDATTHE UNFAVOURABLE VARIANCE IN 2ECEIPTS FROM $EBTORS DOES IT INDICATE A DECLINE IN #REDIT 3ALES POORCOLLECTIONPOLICIESORSOMETHINGELSE 7HENUSINGTHEREPORTINTHISWAY ITISALSOIMPORTANTTOCONSIDERTHELINKSBETWEEN ITEMS &OR INSTANCE AN UNFAVOURABLE VARIANCE IN !DVERTISING MAY ACTUALLY GENERATE A FAVOURABLEVARIANCEIN#ASH3ALES BUTACORRESPONDINGUNFAVOURABLEVARIANCEIN7AGES

Income Statement Variance Report Income Statement Variance Report an accounting report that compares actual and budged revenues and expenses, and highlights variations

)NTHESAMEWAYTHATA#ASH"UDGET6ARIANCE2EPORTCOMPARESACTUALANDBUDGETED CASHmOWS AN)NCOME3TATEMENT6ARIANCE2EPORTCANBEPREPAREDTOCOMPAREACTUAL ANDBUDGETEDREVENUESANDEXPENSES 6ARIANCESINTHISREPORTARECLASSIlEDASFAVOURABLEORUNFAVOURABLEDEPENDINGON THEIREFFECTONPROlT)NTHE)NCOME3TATEMENT6ARIANCE2EPORT AVARIANCEISFAVOURABLE & IFITMEANSPROlTWILLBEHIGHERTHANEXPECTEDINTHEBUDGETAVARIANCEISUNFAVOURABLE 5 IFITMEANSPROlTWILLBELOWERTHANEXPECTEDINTHEBUDGET Figure 17.17

Income Statement Variance Report DENZEL WASHING MACHINES Income Statement Variance Report for March 2016 Budget

Actual

Variance

F/U

Revenue Cash Sales

24 000

29 000

5 000

F

Credit Sales

16 000

14 000

2 000

U

4OTAL2EVENUE

40 000

43 000

3 000

F

Cost of Sales

20 000

19 000

1 000

F

Gross Profit

20 000

24 000

4 000

F

300

900

600

U

19 700

23 100

3 400

F

Wages

8 000

8 600

600

U

Advertising

1 300

1 100

200

F

100

100

–

–

1 500

1 500

–

–

10 900

11 300

400

U

8 800

11 800

3 000

F

Less Cost of Goods Sold

Less Stock Loss Adjusted Gross Profit Less Other Expenses

Depreciation of Office Equipment 2ENT 4OTAL%XPENSES Net Profit

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

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CHAPTER 17

BUDGETS

Uses of the Income Statement Variance Report 4HE)NCOME3TATEMENT6ARIANCE2EPORTCANBEUSEDFOREXACTLYTHESAMEPURPOSESAS THE#ASH"UDGET6ARIANCE2EPORTASAplanningDOCUMENTANDTOaid decision-making 4HEPRECEDINGREPORTIDENTIlESTHAT3ALESOVERALLHASINCREASED SOTHISMAYEXPLAINTHE UNFAVOURABLEVARIANCESIN#OSTOF3ALESAND7AGES 4HE UNFAVOURABLE VARIANCE IN 3TOCK ,OSS IS PERHAPS MORE PROBLEMATIC IT MAY BE CAUSED BY POOR STOCK MANAGEMENT PROCEDURES WHICH MAY NEED TO BE IMPROVED 7ITHOUT THE BUDGET PROVIDING THE BENCHMARK AND THE VARIANCE REPORT MAKING THE COMPARISON THISPROBLEMMAYNOTHAVEBEENIDENTIlED

REVIEW QUESTIONS 17.9

1 State WHATINFORMATIONISSHOWNINA s #ASH"UDGET6ARIANCE2EPORT s )NCOME3TATEMENT6ARIANCE2EPORT 2 DefineTHETERM@VARIANCE 3 ExplainWHENAVARIANCEWOULDBECONSIDEREDTOBEFAVOURABLEIFREPORTEDIN THE s #ASH"UDGET6ARIANCE2EPORT s )NCOME3TATEMENT6ARIANCE2EPORT 4 ExplainHOWAVARIANCEREPORTCANBEUSEDTOASSISTPLANNING 5 Explain HOWAVARIANCEREPORTCANBEUSEDTOASSISTDECISION MAKING

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Cambridge University Press

413

CAMBRIDGE VCE ACCOUNTING

414

UNITS 3&4

WHERE HAVE WE BEEN? s "UDGETINGISTHEPROCESSOFPREPARINGREPORTSTHATESTIMATEORPREDICTTHElNANCIAL CONSEQUENCESOFLIKELYFUTURETRANSACTIONS s "UDGETSASSISTPLANNINGBYPREDICTINGWHATISLIKELYTOOCCURINTHEFUTUREANDAID DECISION MAKINGBYPROVIDINGABENCHMARKORYARDSTICKASTANDARD AGAINSTWHICH ACTUALPERFORMANCECANBEMEASURED s "UDGETEDCASHANDBUDGETEDPROlTARENOTNECESSARILYTHESAME s &IGURES CAN BE CALCULATED BY PREPARING 3CHEDULES OF 2ECEIPTS FROM $EBTORS 0AYMENTSTO#REDITORS ORBYRECONSTRUCTINGLEDGERACCOUNTS s 6ARIANCE REPORTS COMPARE ACTUAL AND BUDGETED lGURES HIGHLIGHTING VARIANCES SO THATPROBLEMSCANBEIDENTIlEDANDCORRECTED s !VARIANCEISTHEDIFFERENCEBETWEENTHEBUDGETEDlGUREANDTHEACTUALlGURE AND CLASSIlEDASFAVOURABLEORUNFAVOURABLEDEPENDINGONITSEFFECTONBANKORPROlT

EXERCISE 17.1 CASH BUDGET

EXERCISES

W B

page 370

/N*ULY 4OP(ATSHADINITSBANKACCOUNT)THASPROVIDEDTHEFOLLOWING LISTOFEXPECTEDTRANSACTIONSFOR*ULY s #ASH3ALESAREEXPECTEDTOBEPLUS'34#REDIT3ALESAREEXPECTEDTOBE PLUS'34 BUTONLYISEXPECTEDTOBECOLLECTEDIN*ULY s !LLSTOCKISSOLDATAMARK UP s #ASHPURCHASESOFSTOCKWILLBEPLUS'34  s $RAWINGSWILLCONSISTOFCASHANDWORTHOFSTOCK s 4HEFOLLOWINGEXPENSESWILLBEPAID n ADVERTISING  PLUS'34 n WAGES  n INTEREST  s WAGESWILLBEOWINGATTHEENDOF*ULY s 9EARLYRENTWILLBEPAIDON*ULY COSTINGPLUS'34 s 4HEMONTHLYLOANREPAYMENTOFWILLBEMADEON*ULY s .EWSHOPlTTINGSWORTHINCLUDING'34 WILLBEPURCHASEDFORCASHFROM&ITTS "EST Required



a CalculateBUDGETED'34PAIDFOR*ULY b PrepareA"UDGETED#ASH&LOW3TATEMENTFOR4OP(ATSFOR*ULY c SuggestTWOACTIONSTHEOWNERMAYTAKETOPLANFORTHEOUTCOMEPREDICTEDINTHE "UDGETED#ASH&LOW3TATEMENT

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

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CHAPTER 17

EXERCISE 17.2 CASH BUDGET: CONSECUTIVE PERIODS

W B

BUDGETS

page 372

,OCKHARDT,OCKSHASPROVIDEDTHEFOLLOWINGINFORMATIONREGARDINGITSEXPECTEDACTIVITIES FOR*ANUARYTO-ARCH s !SAT*ANUARY THEBUSINESSHADINTHEBANK s 3ALES ARE MADE ON CASH ONLY TERMS AND ARE BUDGETED TO BE  IN *ANUARY  IN &EBRUARY AND  IN -ARCH '34 WILL ALSO BE RECEIVED ON THESE AMOUNTS s 3TOCK IS PURCHASED ON CREDIT WITH CREDITORS PAID THE MONTH FOLLOWING PURCHASE #REDIT PURCHASES FOR $ECEMBER  WERE   BUT ARE EXPECTED TO RISE TO IN*ANUARY ANDIN&EBRUARYAND-ARCH'34WILLALSOBEOWINGON THESEAMOUNTS s 4HEFOLLOWINGEXPENSESWILLBEPAIDEACHMONTH n WAGES  n ADVERTISING  PLUS'34 n INTEREST  s 2ENTFORTHENEXTSIXMONTHSWILLBEPAIDDURING*ANUARYnINCLUSIVEOF'34 s )N*ANUARY THEBUSINESSWILLSELLANOLDVEHICLEFORCASH ANDIN&EBRUARY WILLPAYCASHFORANEWVEHICLE WHICHWILLCOSTPLUS'34 s !'34SETTLEMENTISDUEIN*ANUARYn s -ONTHLYCASHDRAWINGSWILLBE s !REPAYMENTONTHEPRINCIPALOFALOANISDUEON*ANUARYn s 4HE OWNER PLANS TO CONTRIBUTE   CASH AND SOME OFlCE EQUIPMENT WORTH IN-ARCH Required



a CalculateBUDGETED'34PAIDFOR*ANUARY &EBRUARYAND-ARCH b PrepareA"UDGETED#ASH&LOW3TATEMENTFOR,OCKHARDT,OCKSFOR*ANUARY &EBRUARY AND-ARCH c Suggest TWO ACTIONS THE OWNER MIGHT TAKE TO ADDRESS ANY PROBLEMS REVEALED BY YOURANSWERTOPART@B d Explain ONEBENElTOFPREPARINGA"UDGETED#ASH&LOW3TATEMENTFORCONSECUTIVE PERIODS

EXERCISE 17.3 SCHEDULE OF RECEIPTS FROM DEBTORS

W B

page 375

"ATS @N "ALLS HAS PROVIDED THE FOLLOWING BUDGETED INFORMATION RELATING TO ITS CREDIT SALESDURING Month

Credit Sales

!UGUSTACTUAL

8 000

3EPTEMBERACTUAL

9 000

/CTOBERBUDGETED

10 000

.OVEMBERBUDGETED

11 000

$ECEMBERBUDGETED

12 000

'34WILLALSOBECHARGEDONTHESEAMOUNTS)TISEXPECTEDTHATOFDEBTORSWILL PAYINTHEMONTHFOLLOWINGTHESALE WHILETHEREMAININGWILLPAYINTHESECOND MONTH

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415

416

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

Required a SuggestONEREASONFORTHETRENDIN3ALESFROM!UGUSTTO$ECEMBER b PrepareA3CHEDULEOF2ECEIPTSFROM$EBTORSFOR/CTOBER .OVEMBERAND$ECEMBER  c 2EFERRINGTOTHEINFORMATIONPROVIDED explainONEREASONWHYBUDGETED.ET0ROlT AND"UDGETED.ET)NCREASE$ECREASE IN#ASH0OSITIONARELIKELYTOBEDIFFERENTFOR $ECEMBER

EXERCISE 17.4 SCHEDULE OF RECEIPTS FROM DEBTORS

W B

page 376

*AZZY *ACKETS HAS PROVIDED THE FOLLOWING INFORMATION TO AID IN THE PREPARATION OF ITS "UDGETED#ASH&LOW3TATEMENTFOR!PRIL -AYAND*UNE Month

Credit Sales

Cash Sales

January

50 000

43 000

February

40 000

32 000

March

45 000

35 000

April

35 000



May

30 000

32 000

June

20 000

26 000

4HESEAMOUNTSDONOTINCLUDE'34

)T IS EXPECTED THAT  OF DEBTORS WILL PAY IN THE MONTH OF SALE  OF DEBTORS WILLPAYINTHEMONTHFOLLOWINGTHESALE ANDTHEREMAININGWILLPAYINTHESECOND MONTHFOLLOWINGTHESALE Required a CalculateBUDGETED2ECEIPTSFROM$EBTORSFOR!PRIL -AYAND*UNE b Prepare AN EXTRACT OF THE "UDGETED #ASH &LOW 3TATEMENT FOR *AZZY *ACKETS THAT SHOWS/PERATINGCASHINmOWSFOR!PRIL -AYAND*UNE c ExplainHOWTHEPREPARATIONOFA"UDGETED#ASH&LOW3TATEMENTCANASSISTPLANNING

EXERCISE 17.5 SCHEDULES AND THE BUDGETED CASH FLOW STATEMENT

W B

page 377

/N  *ANUARY  "ETTYS "AGS COMMENCED /PERATIONS 0ROJECTED PURCHASES AND 3ALESFORTHElRSTFOURMONTHSARE Month

Credit purchases

Credit Sales

Cash Sales

January

12 000

20 000

30 000

February

13 000

25 000

34 000

March

14 000

28 000

36 000

Additional information: s 4HEAMOUNTSABOVEDOnotINCLUDE'34 s "ETTYS "AGS ALLOWS A  DISCOUNT IF DEBTORS PAY WITHIN THE MONTH THAT THE SALE OCCURRED)TISEXPECTEDTHATOFTHE3ALESWILLBECOLLECTEDWITHINTHEDISCOUNT PERIOD BYTHEENDOFTHEMONTHAFTERPURCHASE INTHEFOLLOWINGMONTH ANDTHATWILLBEUNCOLLECTABLE ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 17

BUDGETS

s /F CREDIT PURCHASES  ARE PAID IN THE MONTH OF PURCHASE WITH THE REMAINDER PAIDINTHEFOLLOWINGMONTH s -ONTHLYEXPENSESINCLUDEADVERTISINGOFPLUS'34 WAGESOFAND DEPRECIATIONONEQUIPMENTOF4HEREARENOPREPAIDORACCRUEDEXPENSES s #ASHDRAWINGSWILLBEPERMONTH Required



a CalculateBUDGETED2ECEIPTSFROM$EBTORSFOR*ANUARY &EBRUARYAND-ARCH b CalculateBUDGETED0AYMENTSTO#REDITORSFOR*ANUARY &EBRUARYAND-ARCH c Prepare AN EXTRACT OF THE "UDGETED #ASH &LOW 3TATEMENT FOR "ETTYS "AGS THAT SHOWSTHE/PERATINGACTIVITIESFOR*ANUARY &EBRUARYAND-ARCH d 2EFERRING TO YOUR ANSWER TO PART @C explain YOUR TREATMENT OF DEPRECIATION OF EQUIPMENT e ExplainHOWCASHDRAWINGSWOULDBEREPORTEDINTHE"UDGETED#ASH&LOW3TATEMENT f ExplainHOWTHEPREPARATIONOFA"UDGETED#ASH&LOW3TATEMENTCANASSISTDECISION MAKING

EXERCISE 17.6 BUDGETED REPORTS

W B

page 379

$ANAS$ETERGENTSWILLBEGINTRADING/PERATIONSON-AY ANDHASPROVIDEDTHE FOLLOWINGESTIMATESFORITSlRSTMONTHOF/PERATIONS s 4HEOWNERWILLMAKEACAPITALCONTRIBUTIONOFTOCOMMENCE/PERATIONS s 3HELVINGWORTHPLUS'34 WILLBEPURCHASEDONCREDITFROM*ANCKE&ITTINGS ON-AY"EFORETHEENDOF-AY WILLBEPAIDTOTHECREDITOR s #ASH3ALESAREESTIMATEDTOBEPLUS'34 s #REDIT3ALESAREESTIMATEDTOBEINCLUDING'34$EBTORSOWINGATTHEEND OF-AYISEXPECTEDTOBE s !LLSTOCKWILLBEPURCHASEDONCREDIT0URCHASESFOR-AYAREEXPECTEDTOBE PLUS'34!TTHEENDOF-AY ITISANTICIPATEDTHATWILLBE OWEDTOCREDITORS s #OSTOF3ALESISEXPECTEDTOBEAND BASEDONINDUSTRYAVERAGES 3TOCK,OSS ISEXPECTEDTOBE s 3IXMONTHSADVERTISINGWILLBEPAIDINADVANCEON-AY ATACOSTOF PLUS'344HEREWILLBENOOTHERPREPAYMENTSORACCRUALS s 4HEFOLLOWINGEXPENSESWILLBEINCURREDDURING-AY n WAGES  n DEPRECIATIONOFSHELVING  n RENT  PLUS'34 s /N-AY ALOANFORWILLBERECEIVEDFROM:.!"ANK4HELOANWILL BE USED TO PURCHASE A VAN IN *UNE  %ACH MONTH  WILL BE PAID OFF THE PRINCIPAL STARTINGON*UNE s #ASHDRAWINGSWILLBE$RAWINGSOFSTOCKISEXPECTEDTOBE Required







a Prepare A"UDGETED#ASH&LOW3TATEMENTFOR$ANAS$ETERGENTSFOR-AY b Prepare A"UDGETED)NCOME3TATEMENTFOR$ANAS$ETERGENTSFOR-AY c ExplainTWOREASONSWHYTHEBUDGETED.ET)NCREASEIN#ASH0OSITIONISMUCHLARGER THANTHEBUDGETED.ET0ROlTFOR-AY d Show HOW THE 3TOCK #ONTROL AND '34 #LEARING ACCOUNTS WOULD APPEAR IN THE 'ENERAL,EDGERASAT-AY e Prepare A"UDGETED"ALANCE3HEETFOR$ANAS$ETERGENTSASAT-AY f ExplainHOWA"UDGETED"ALANCE3HEETCANASSISTPLANNING ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

417

CAMBRIDGE VCE ACCOUNTING

418

UNITS 3&4

EXERCISE 17.7 BUDGETED REPORTS

W B

page 382

/N*UNE THE"ALANCE3HEETOF*ACUZZI*OINTSHOWEDTHEFOLLOWING JACUZZI JOINT Balance Sheet as at 30 June 2016 Current Assets

$

Bank

$

4 000

Stock Control

28 000

Debtors Control



0REPAID2ENT

6 000

Current Liabilities

$

Creditors Control

9 900 200

'34#LEARING 45 480

Non-Current Assets

$

!CCRUED)NTEREST%XPENSE

300

Sundry Creditor – Wilks



11 150

Non-Current Liabilities

Office Equipment

24 000

Less Accumulated Depreciation



30 000

,OANn!03&INANCE 16 800

Owner’s Equity Capital – Jacqui

Total Assets

$62 280

Total Equities

21 130 $62 280

4HE OWNER HAS PROVIDED THE FOLLOWING INFORMATION TO ASSIST IN THE PREPARATION OF BUDGETEDREPORTSFOR*ULY Month

Credit purchases

Credit Sales

Cash Sales

June

9 000



19 000

July

11 000

18 000

22 000

4HESEAMOUNTSDOnotINCLUDE'34 s !LLSTOCKISMARKEDUP s 4HEOWNEREXPECTSA3TOCK,OSSOFFOR*ULY s #REDIT3ALESARERECEIVEDINTHEMONTHOFTHESALEANDINTHEMONTHAFTER THESALE s !LLPURCHASESAREMADEONCREDIT!MOUNTSOWINGTOCREDITORSAREPAIDINTHEMONTH FOLLOWINGPURCHASETOEARNADISCOUNT s 3IXMONTHSRENTWASPREPAIDON-AY s 7AGES PAID DURING *ULY  WILL BE  BUT  WAGES IS EXPECTED TO BE OWINGATTHEENDOF*ULY s $EPRECIATIONOFOFlCEEQUIPMENTFOR*ULYWILLBE s %LECTRICITYEXPENSEWILLBEPLUS'344HISAMOUNTWILLBEPAIDINFULLDURING*ULY  s )N*ULY WILLBEPAIDTOCOVERTHEINTERESTEXPENSEFOR-AY *UNEAND*ULY  s $URING *ULY  NEW OFlCE EQUIPMENT COSTING   INCLUDING '34 WILL BE PURCHASEDONCREDITFROM0HELPS#O!PAYMENTOFWILLBEMADETO0HELPS #OBEFORETHEENDOF*ULY s /N*ULY THEOWNERPLANSTOCONTRIBUTECASHANDHEROWNVEHICLE WORTH$RAWINGSOFCASHBYTHEOWNERWILLBE s 4HEAMOUNTOWINGTO3UNDRY#REDITORn7ILKSWILLBEPAIDINFULL s 4HE,OANn!03&INANCEISANINTERESTONLYLOANDUEINFULLIN/CTOBER

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 17

BUDGETS

Required







a b c d e

CalculateBUDGETED2ECEIPTSFROM$EBTORSFOR*ULY CalculateBUDGETED0AYMENTSTO#REDITORSFOR*ULY Prepare A"UDGETED#ASH&LOW3TATEMENTFOR*ACUZZI*OINTFOR*ULY Prepare A"UDGETED)NCOME3TATEMENTFOR*ACUZZI*OINTFOR*ULY ExplainTWOREASONSWHYTHE.ET#ASH&LOWSFROM/PERATIONSISBUDGETEDTOBE GREATERTHANTHE.ET0ROlTFOR*ULY f Show HOW THE 3TOCK #ONTROL AND '34 #LEARING ACCOUNTS WOULD APPEAR IN THE 'ENERAL,EDGERASAT*ULY g Prepare A"UDGETED"ALANCE3HEETFOR*ACUZZI*OINTASAT*ULY

EXERCISE 17.8 ACCOUNT RECONSTRUCTION

W B

page 386

-OVING "OXES SELLS CARDBOARD BOXES FOR PEOPLE WHO ARE MOVING HOUSE AND HAS PROVIDEDTHEFOLLOWINGINFORMATIONRELATINGTOTHEIR$EBTORS#ONTROLACCOUNT s "ALANCEASAT*ULY  s "UDGETEDBALANCEASAT*UNE  s "UDGETED#REDIT3ALESFORTHEYEARENDED*UNE  INCLUDING'34 s "UDGETED$ISCOUNT%XPENSE  Required a &OREACHITEMABOVE identifyTHEBUDGETEDREPORTINWHICHTHEITEMWILLAPPEAR b Reconstruct THE $EBTORS #ONTROL ACCOUNT TO DETERMINE BUDGETED 2ECEIPTS FROM $EBTORSFORTHEYEARENDED*UNE c ExplainTHEIMPORTANCEOFBUDGETED3ALESINTHEBUDGETINGPROCESS

EXERCISE 17.9 ACCOUNT RECONSTRUCTION

W B

page 387

"ULLY(IDESSELLSLEATHERPRODUCTSANDHASPROVIDEDTHEFOLLOWINGINFORMATIONRELATINGTO ITSEXPECTEDTRANSACTIONSFOR s ACTUALBALANCESASAT*ANUARY n $EBTORS#ONTROL  n #REDITORS#ONTROL  s BUDGETEDBALANCESASAT$ECEMBER n $EBTORS#ONTROL  n #REDITORS#ONTROL  s FROMTHE"UDGETED)NCOME3TATEMENT n #ASH3ALES

 n #REDIT3ALES

 n 3ALES2ETURNS

 n $ISCOUNT2EVENUE  n "AD$EBTS  n $ISCOUNT%XPENSE  s OTHERINFORMATION n CASHPURCHASES

 n CREDITPURCHASES



&IGURESDONOTINCLUDE'34

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

419

420

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

Required a Reconstruct THE $EBTORS #ONTROL ACCOUNT TO DETERMINE BUDGETED 2ECEIPTS FROM $EBTORSFOR b PrepareANEXTRACTFROMTHE"UDGETED#ASH&LOW3TATEMENTFOR"ULLY(IDESFOR THATSHOWS/PERATINGCASHINmOWS c Reconstruct THE #REDITORS #ONTROL ACCOUNT TO DETERMINE BUDGETED 0AYMENTS TO #REDITORSFOR

EXERCISE 17.10 ACCOUNT RECONSTRUCTION

W B

page 388

4ONYS4YRE%MPORIUMHASPROVIDEDTHEFOLLOWINGINFORMATIONRELATINGTOITSEXPECTED TRANSACTIONSFORTHEYEARENDED*UNE s BALANCESASAT*ULY n 3TOCK#ONTROL n #REDITORS#ONTROL s FROMTHE"UDGETED)NCOME3TATEMENT n 3ALES

n 3ALES2ETURNS

n 3TOCK'AIN n $ISCOUNT2EVENUE s EXPECTEDBALANCESASAT*UNE n 3TOCK#ONTROL n #REDITORS#ONTROL s OTHERINFORMATION n CASHPURCHASES

n DRAWINGSOFSTOCK

&IGURESDONOTINCLUDE'34

         

INCLUDESCASH ANDSTOCK

!LLSTOCKISSOLDATAMARK UP Required a ReconstructTHE3TOCK#ONTROLACCOUNTTODETERMINEBUDGETEDCREDITPURCHASESFOR THEYEARENDED*UNE b Reconstruct THE #REDITORS #ONTROL ACCOUNT TO DETERMINE BUDGETED 0AYMENTS TO #REDITORSFORTHEYEARENDED*UNE

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 17

EXERCISE 17.11 CASH BUDGET VARIANCE REPORT

W B

BUDGETS

page 389

3IMPLY3TUNNINGSELLSHAIRCAREPRODUCTSTOHAIRDRESSERSIN-ELBOURNEANDHASPROVIDED THEFOLLOWING#ASH"UDGET6ARIANCE2EPORTFORTHEYEARENDED*UNE SIMPLY STUNNING Cash Budget Variance Report for the year ended 30 June 2016 Budgeted

Actual

Variance

Fav./ Unfav.

–

–

CASH FLOW FROM OPERATING ACTIVITIES 2ECEIPTSFROM$EBTORS

99 200

89 200

Cash Sales

85 000

94 000

8 500

9 400

'342ECEIVED 0AYMENTSTO#REDITORS

















Advertising





)NTEREST%XPENSE





'343ETTLEMENT





0REPAID2ENT '340AID Wages

Net Cash Flows from Operations

25 460

5 410

0ROCEEDSON3ALEOF%QUIPMENT

5 000

3 000

Shelving

–

Net Cash Flows from Investing Activities

5 000

(9 000)

Capital Contribution

–

20 000

Loan



CASH FLOW FROM INVESTING ACTIVITIES 

CASH FLOW FROM FINANCING ACTIVITIES –

Drawings





Net Cash Flows from Financing Activities

(41 000)

(20 000)

Net Increase (Decrease) in Cash Position

(10 540)

(23 590)

Add Bank Balance at start

8 500

8 500

Bank Balance at end

(2 040)

(15 090)

3OPHIEHADORGANISEDANOVERDRAFTLIMITWITHTHEBANKOF Required a ExplainONEBENElTOFPREPARINGA#ASH"UDGET6ARIANCE2EPORT b CompleteTHE#ASH"UDGET6ARIANCE2EPORTFOR3IMPLY3TUNNINGFORTHEYEARENDED *UNE c StateWHETHERTHEVARIANCEIN0AYMENTSTO#REDITORSISFAVOURABLEORUNFAVOURABLE JustifyYOURANSWER d SuggestONEPOSSIBLEREASONFORTHE#APITAL#ONTRIBUTION

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

421

422

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

e ExplainTHEEFFECTONTHEACTUALCLOSINGBANKBALANCEOFTHEVARIANCESIN)NVESTING ACTIVITIES f Identify TWO ASSETS THAT WILL DIFFER AS AT  *UNE  AS A CONSEQUENCE OF THE VARIANCESINTHE#ASH"UDGET6ARIANCE2EPORTJustifyYOURANSWER

EXERCISE 17.12 CASH VARIANCE REPORT

W B

page 391

"RIGHT ,IGHTS HAS PROVIDED THE FOLLOWING PARTIALLY COMPLETED #ASH "UDGET 6ARIANCE 2EPORTFORTHEYEARENDED*UNE BRIGHT LIGHTS Cash Budget Variance Report (extract) for the year ended 30 June 2016 Budgeted

Actual

Variance

Fav./ Unfav.

5 000

F

300

U

1 000

U

2 500

F

CASH FLOW FROM OPERATING ACTIVITIES 2ECEIPTSFROM$EBTORS

100 000

0AYMENTSTO#REDITORS



105 000

)NTEREST%XPENSE '340AID 0REPAID2ENT

 





CASH FLOW FROM INVESTING ACTIVITIES Sale of Shelving Van

5 000 



CASH FLOW FROM FINANCING ACTIVITIES Loan Drawings

 



Additional information: s 4HEBUDGETEDFOR0REPAID2ENTFAILEDTOTAKEINTOACCOUNTINPREPAID RENTAT*ULYANDPREPAIDRENTOFAT*UNE s 4HEOWNERHASARGUEDTHATTHE,OANVARIANCEISUNFAVOURABLEBECAUSEITINCREASES THElRMSLIABILITIES Required a Calculate ACTUAL 0REPAID2ENTFORTHEYEARENDING*UNE b Complete THE#ASH"UDGET6ARIANCE2EPORTEXTRACT FOR"RIGHT,IGHTSFORTHEYEAR ENDED*UNE c ExplainWHETHERTHE,OANVARIANCEISFAVOURABLEORUNFAVOURABLE d 'IVENTHAT#REDIT3ALESDECREASED suggestONEPOSSIBLEREASONFORTHEVARIANCEIN 2ECEIPTSFROM$EBTORS e ExplainONEPOSSIBLEEFFECTOF&INANCINGACTIVITIESONTHElRMSACTUAL.ET0ROlTFOR THEYEARENDED*UNE

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 17

EXERCISE 17.13 INCOME STATEMENT VARIANCE REPORT

W B

BUDGETS

page 393

4OOTAND4WANGSELLSMUSICALINSTRUMENTSFROMASHOPIN-ELTON ANDHASPROVIDEDTHE FOLLOWING)NCOME3TATEMENT6ARIANCE2EPORTFORTHEYEARENDED*ULY TOOT AND TWANG Income Statement Variance Report for the year ended 30 June 2016 Budgeted

Actual

120 000

110 000

Cost of Sales



55 000

Gross Profit

50 000

55 000

!DD3TOCK'AIN,OSS

1 500



Adjusted Gross Profit

51 500

50 800

Variance

Fav./ Unfav.

Revenue Sales Less Cost of Goods Sold

Add Other Revenue 1 500

6 500

53 000

57 300

Wages

18 000

19 000

2ENT

12 000

14 000

Depreciation of Vehicles

2 300

1 600

)NTEREST%XPENSE

1 400

1 800

Net Profit/(Loss)

19 300

20 900

0ROlTON$ISPOSALOF6EHICLE Less Other Expenses

Required a Explain THEIMPORTANCEOFVARIANCEANALYSISINTHEBUDGETINGPROCESS b Complete THE)NCOME3TATEMENT6ARIANCE2EPORTFOR4OOTAND4WANGFORTHEYEAR ENDED*ULY c Explain WHETHERTHEVARIANCEIN#OSTOF3ALESISFAVOURABLEORUNFAVOURABLE d Suggest ONEPOSSIBLEREASONFORTHEVARIANCEIN$EPRECIATIONOF6EHICLES e Explain WHY THE OWNER SHOULD BE CONCERNED ABOUT THE lRMS PROlT PERFORMANCE WHENCOMPAREDTOTHEBUDGET

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

423

424

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

EXERCISE 17.14 INCOME STATEMENT VARIANCE REPORT

W B

page 395

"LADES WHICH SELLS KITCHEN KNIVES AND CUTTING UTENSILS HAS PROVIDED THE FOLLOWING )NCOME3TATEMENT6ARIANCE2EPORTFORTHEYEARENDED*UNE BLADES Income Statement Variance Report for the year ended 30 June 2016 Budgeted

Actual

Variance

Fav./.Unfav.

Revenue Sales 3ALES2ETURNS

105 000

90 000

8 500

4 500

F

5000

U

300

F

96 500 Less Cost of Goods Sold Cost of Sales #ARTAGE)NWARDS Gross Profit Less Stock Loss Adjusted Gross Profit

48 000

54 000

3 000

1 000

45 500 1 800

2 300

43 700

Less Other Expenses Wages

28 000

2ENT

15 000

18 000

1 400

2 200

Depreciation – Equipment )NTEREST

800

Net Profit/(Loss)

4HEBUSINESSHADANOVERDRAFTOFASAT*ULY Required a Complete THE)NCOME3TATEMENT6ARIANCE2EPORTFOR"LADESFORTHEYEARENDED *UNE b SuggestTWOPOSSIBLEREASONSFORTHEVARIANCEIN3ALES2ETURNS c SuggestONEPOSSIBLEREASONFORTHEVARIANCEIN)NTEREST%XPENSE d Explain THEIMPLICATIONSOFTHEVARIANCEIN'ROSS0ROlT

EXERCISE 17.15 ACCOUNT RECONSTRUCTION AND BUDGETED REPORTS

W B

page 396

3ETH"AYESISTHEPROPRIETOROF"AYES3URFBOARDS WHICHSELLSSURFGEARONTHE6ICTORIAN WESTCOAST(EHASPROVIDEDTHEFOLLOWINGINFORMATIONTOASSISTINTHEPREPARATIONOF BUDGETSFOR

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

CHAPTER 17

BUDGETS

BAYES SURFBOARDS Assets and equities as at 31 December 2015 Assets

$

Equities

$

Debtors Control



Bank

5 000

'34#LEARING

3 000

Stock Control

62 400

Creditors Control

41 800

Shop Fittings

52 000

Capital – Bayes

69 500

Less Accumulated Depreciation

18 000

Total Assets

$117 000

Accrued Wages

Total Equities



$117 000

%XPECTEDTRANSACTIONSFOR s #REDIT3ALESAREEXPECTEDTOBEANDWILLINCLUDEFOR$ECEMBER '34WILLALSOBECHARGEDONTHESEAMOUNTS$EBTORSUSUALLYPAYINTHEMONTH FOLLOWINGSALETOTAKEADVANTAGEOFASETTLEMENTDISCOUNT s #REDITPURCHASESAREBUDGETEDTOBEPLUS'34 AND ASAT$ECEMBER  ISEXPECTEDTOBEOWINGTOCREDITORS s !LLSTOCKISSOLDATAMARK UP s /THERESTIMATESFORINCLUDE n OCCUPANCYEXPENSES  PLUS'34 n OFlCEEXPENSES  PLUS'34 n WAGESEXPENSE  n DEPRECIATIONEXPENSE  n CASHDRAWINGS  n STOCKLOSS  s !'34REFUNDOFISDUEFROMTHE!4/IN s !NEWADVERTISINGCONTRACTWILLBESIGNEDANDPAIDON3EPTEMBER WITHTHE PAYMENTOFINCLUDING'34 COVERINGMONTHSSTARTINGON/CTOBER !SIDE FROM THE ADVERTISING THERE WILL BE NO OTHER PREPAYMENTS OR ACCRUALS AS AT $ECEMBER s %ARLYIN$ECEMBER 3ETHWANTSTOBORROWFROM!8"ANKTOlNANCE THE PURCHASE OF NEW SHOP lTTINGS EARLY IN  4HE LOAN WILL BE REPAID IN FULL IN $ECEMBER BUTINTERESTOFDUEON $ECEMBERWILLNOTBEPAID UNTILTHENEXTWORKINGDAYON*ANUARY s )N.OVEMBER SOMEOLDSHOPlTTINGSWILLBESOLDTOALOCALSUPERMARKETATA PROlTOF4HESHOPlTTINGSWEREORIGINALLYWORTH BUTBYTHESALEDATE WILLHAVEACCUMULATEDDEPRECIATIONOF Required





a b c d e f g

Calculate THECASHPROCEEDSFROMTHEDISPOSALOFTHESHOPlTTINGS CalculateBUDGETED2ECEIPTSFROM$EBTORSFOR CalculateBUDGETED0AYMENTSTO#REDITORSFOR Calculate BUDGETED'34PAIDFOR Prepare A"UDGETED#ASH&LOW3TATEMENTFOR"AYES3URFBOARDSFOR Explain ONEADVANTAGEOFPREPARINGBUDGETSMORETHANONCEAYEAR Show HOW THE 3TOCK #ONTROL AND '34 #LEARING ACCOUNTS WOULD APPEAR IN THE 'ENERAL,EDGERASAT$ECEMBER h Prepare AN EXTRACT OF THE "UDGETED "ALANCE 3HEET OF "AYES 3URFBOARDS AS AT $ECEMBERTHATSHOWS#URRENT!SSETSAND#URRENT,IABILITIES!FULL"ALANCE 3HEETISnotREQUIRED i ExplainHOWA"UDGETED"ALANCE3HEETCANBEUSEDTOASSISTPLANNING

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

425

CAMBRIDGE VCE ACCOUNTING

426

UNITS 3&4

EXERCISE 17.16 ACCOUNT RECONSTRUCTION AND BUDGETED REPORTS

W B

page 399

0OPPY -ARCEL IS THE PROPRIETOR OF $IGITAL -ASTERS WHICH SELLS DIGITAL CAMERAS FROM A SHOPIN4ORQUAY3HEHASREQUESTEDSOMEASSISTANCEINPREPARINGTHEBUDGETSANDHAS PROVIDEDTHEFOLLOWINGINFORMATION DIGITAL MASTERS Account balances as at 30 June 2015 Debit

$

Credit

$

0REPAID0HOTOCOPIER2ENT

1 000

'34#LEARING

3 400

Debtors Control Bank

16 000 1 200

Creditors Control



Acc. Depreciation – Shop Fittings

21 600

Stock Control

35 000

Accrued Wages

1 300

Shop Fittings

48 000

Capital – Marcel

61 200

$101 200

$101 200

!NTICIPATEDTRANSACTIONSFORTHEYEARENDED*UNE s #ASH3ALESAREEXPECTEDTOBEPLUS'34AND#REDIT3ALESOFPLUS '34$EBTORSASAT*UNEAREEXPECTEDTOBE s !LLSTOCKISPURCHASEDONCREDITANDSOLDATAMARK UP s /THERESTIMATESFORTHEYEARINCLUDE n PURCHASESOFSTOCK  PLUS'34 n SALESRETURNS  PLUS'34 n DISCOUNTEXPENSE  n WAGEEXPENSEINCURRED  n DEPRECIATIONnSHOPlTTINGS  n CASHDRAWINGS  n STOCKLOSS  s 0OPPYISCURRENTLYRENTINGAPHOTOCOPIERATINCLUDING'34 PERMONTH PAYABLE  MONTHS IN ADVANCE 0OPPY HAS RECEIVED NOTIlCATION THAT THE RENT WILL INCREASE TO  INCLUDING '34 PER MONTH COMMENCING WITH THE NEXT PAYMENT DUE ON 3EPTEMBER s /N!PRIL THEBUSINESSWILLINVESTINATHREE YEARTERMDEPOSIT)NTEREST ISEARNEDATPERANNUM PAYABLEON-ARCHEACHYEAR s %STIMATEDBALANCESASAT*UNEINCLUDE – 3TOCK#ONTROL  n "ANK/VERDRAFT  n '34#LEARING  #2 Required





a CalculateBUDGETEDRENTEXPENSEFORTHEYEARENDED*UNE b CalculateBUDGETEDINTERESTREVENUEFORTHEYEARENDED*UNE c PrepareA"UDGETED)NCOME3TATEMENTFOR$IGITAL-ASTERSFORTHEYEARENDED *UNE d Explain HOW THE PREPARATION OF A "UDGETED )NCOME 3TATEMENT COULD ASSIST WITH PLANNINGTOACHIEVEANIMPROVED'ROSS0ROlT e Prepare AN EXTRACT OF THE "UDGETED "ALANCE 3HEET OF $IGITAL -ASTERS AS AT *UNETHATSHOWS#URRENTAND.ON CURRENT!SSETS!FULL"ALANCE3HEETIS notREQUIRED f ExplainONEBENElTOFPREPARINGA"UDGETED"ALANCE3HEET

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and must not be transferred to another party.

Cambridge University Press

Where are we headed? After completing this chapter, you should be able to: s define@PROlTABILITY AND distinguishBETWEENPROlT ANDPROlTABILITY s analysePROlTABILITYUSING TRENDS VARIANCES BENCHMARKS ANDPROlTABILITYINDICATORS s calculateANDexplainVARIOUS PROlTABILITYINDICATORS s explainTHERELATIONSHIPS BETWEENVARIOUSPROlTABILITY INDICATORS s analyseANDevaluate PROlTABILITYUSINGNON lNANCIALINDICATORS s suggestSTRATEGIESTO IMPROVEPROlTABILITY

Course advice: advice: 4HE 6#% !CCOUNTING 3TUDY 4HE6#%!CCOUNTING3TUDY $ESIGNSTATESTHATSTUDENTS $ESIGN STATES THAT STUDENTS WILL WILLNOTBEREQUIREDTO NOT BE REQUIRED TO CALCULATElNANCIALINDICATORS CALCULATE lNANCIAL INDICATORS INTHEEXAMINATION(OWEVER IN THE EXAMINATION (OWEVER CALCULATIONSAREINCLUDED CALCULATIONS ARE INCLUDED INTHISTEXTASANESSENTIAL IN THIS TEXT AS AN ESSENTIAL MECHANISMFORUNDERSTANDING MECHANISM FOR UNDERSTANDING THEINFORMATIONTHESEINDICATORS THE INFORMATION THESE INDICATORS PRESENT

CHAPTER 18

EVALUATING PROFITABILITY KEY TERMS After completing this chapter, you should be familiar with the following terms: s ANALYSING

s PROlTABILITYINDICATORS

s INTERPRETING s PROlTABILITY

s 2ETURNON/WNERS )NVESTMENT2/)

s LIQUIDITY

s 2ETURNON!SSETS2/!

s EFlCIENCY

s !SSET4URNOVER!4/

s STABILITY

s EXPENSECONTROL

s TREND

s .ET0ROlT-ARGIN.0-

s HORIZONTALANALYSIS

s 'ROSS0ROlT-ARGIN'0-

s VARIANCE

s VERTICALANALYSIS

s BENCHMARK

s NON lNANCIALINFORMATION

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18.1 ANALYSIS AND INTERPRETATION OF PROFITABILITY

analysing examining the financial reports in detail to identify changes or differences in performance interpreting examining the relationships between the items in the financial reports in order to explain the cause and effect of changes or differences in performance profitability the ability of the business to earn profit, as compared against a base, such as Sales, assets or owner’s equity liquidity the ability of the business to meet its short-term debts as they fall due efficiency the ability of the business to manage its assets and liabilities stability the ability of the business to meet its debts and continue its operations in the long term

4O THIS POINT WE HAVE DEVOTED MOST OF OUR TIME TO THE lRST THREE PHASES OF THE ACCOUNTINGPROCESSGATHERINGSOURCEDOCUMENTS RECORDINGTHEDATASOITISCLASSIlED AND SUMMARISED AND REPORTING THE INFORMATION THAT IS THEN GENERATED 4HIS CHAPTER CONCENTRATESONanalysingANDinterpretingTHEINFORMATIONCONTAINEDINTHEREPORTSIN ORDERTOPROVIDEADVICETOHELPTHEOWNERMAKEMOREINFORMEDDECISIONS )N ACCOUNTING TERMS ANALYSING INVOLVES EXAMINING THE REPORTS IN GREAT DETAIL TO identify changes or differences in performance WHILEINTERPRETINGINVOLVESEXAMINING THE RELATIONSHIPS BETWEEN THE ITEMS IN THE REPORTS IN ORDER TO EXPLAIN THE cause and effect of those changes or differences /NCE THE CAUSES AND EFFECTS OF CHANGES OR DIFFERENCESINPERFORMANCEAREUNDERSTOOD ACOURSEOFACTIONCANBERECOMMENDEDTO THEOWNERTOASSISTDECISION MAKING !NYANALYSISOFBUSINESSPERFORMANCEMUSTINCLUDEANASSESSMENTOF s profitabilitynTHEABILITYOFTHEBUSINESSTOEARNPROlT MEASUREDBYCOMPARINGITS PROlTAGAINSTABASE SUCHAS3ALES ASSETSOROWNERSEQUITY s liquiditynTHEABILITYOFTHEBUSINESSTOMEETITSSHORT TERMDEBTSASTHEYFALLDUE s efficiencynTHEABILITYOFTHEBUSINESSTOMANAGEITSASSETSANDLIABILITIES s stabilitynTHEABILITYOFTHEBUSINESSTOMEETITSDEBTSANDCONTINUEITS/PERATIONS INTHELONGTERM #LEARLY BUSINESS SURVIVAL DEPENDS ON HAVING BOTH SATISFACTORY PROlTABILITY AND SATISFACTORYLIQUIDITYAPROlTABLEBUSINESSWILLSTILLFAILIFITCANNOTPAYITSDEBTS 4HISCHAPTERCONCENTRATESONANASSESSMENTOFPROlTABILITY WHILELIQUIDITYISADDRESSED IN#HAPTER)NTHEPROCESS THElRMSEFlCIENCYANDSTABILITYWILLALSOBEASSESSED

Assessing profitability !TITSMOSTELEMENTAL AlRMSABILITYTOEARNPROlTISDEPENDENTONITSABILITYTO s EARNREVENUEAND s CONTROLEXPENSES #ONSEQUENTLY ANYASSESSMENTOFPROlTABILITYMUSTEXAMINETHElRMSPERFORMANCE INTHESETWOAREAS WITHANANALYSISOFTHE)NCOME3TATEMENTALOGICALSTARTINGPOINT (OWEVER ANASSESSMENTOFPROlTABILITYMUSTNOTCONCENTRATEONPROlTINDOLLARTERMS ALONE-ANYFACTORSMAYAFFECTAlRMSABILITYTOEARNREVENUEANDCONTROLITSEXPENSES ANDTHESIGNIlCANCEOFTHESEFACTORSMUSTBECONSIDEREDWHENASSESSINGPROlTABILITY 4HESIZEOFTHEBUSINESSINTERMSOFTHEASSETSITCONTROLS THESIZEOFTHEINVESTMENTBY THEOWNER ANDTHELEVELOF3ALESAREALLSIGNIlCANTINDETERMININGHOWMUCHPROlTA BUSINESSISableTOEARN &OREXAMPLE AlRMWITHASSETSOFUNDERITSCONTROLISLIKELYTOGENERATEA MUCHLARGERPROlTINDOLLARTERMS THANAlRMWITHONLYWORTHOFASSETSUNDER ITSCONTROL#OMPARINGTHESElRMSONTHEBASISOFPROlTALONEWILLNOTTELLUSWHICHONE ISMOREableTOUSEITSASSETSTOEARNPROlT ITWILLSIMPLYTELLUSTHATONElRMHADMORE ASSETSTOUSE(OWEVER IFTHEPROlTWASEXPRESSEDper dollar of assets ACOMPARISON OFTHEABILITYOFEACHlRMTOEARNPROlTIFITHADTHEsame asset baseWOULDBEPOSSIBLE SHOWINGWHICHWASMOREPROlTABLE 0ROlTABILITYISMORETHANASSESSINGTHElRMSPROlTITISABOUTASSESSINGTHElRMS capacityORabilityTOEARNPROlT ASSUMINGALLTHESEOTHERFACTORSWEREEQUAL%XPRESSING PROlTrelative to another measureALLOWSFORCOMPARISONSBETWEENDIFFERENTlRMS AND DIFFERENTPERIODS

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/BVIOUSLY THE level OF PROlT IS AN IMPORTANT MEASURE OF PERFORMANCE AND AN ASSESSMENTOFPROlTABILITYMAYBEGINWITHANEXAMINATIONOFPROlT ANDTHEREVENUES ANDEXPENSESBYWHICHITWASDERIVED"UTITMUSTTHENGOFURTHERBYCOMPARINGTHAT PROlTAGAINSTABASEOFSOMESORTTOEXAMINETHElRMSABILITYTOUSEITS3ALES ITSASSETS ORTHEOWNERSCONTRIBUTIONTOEARNPROlT)NTHISSENSEPROlTABILITYISArelativemeasure

REVIEW QUESTIONS 18.1

1 Explain THE RELATIONSHIP BETWEEN ANALYSING AND INTERPRETING ACCOUNTING REPORTS 2 DefineTHEFOLLOWINGTERMS s PROlTABILITY s LIQUIDITY s EFlCIENCY s STABILITY 3 StateTHETWOBASICFACTORSONWHICHTHEABILITYTOEARNAPROlTISDEPENDENT 4 ExplainHOWPROlTABILITYCANBEASSESSEDBETWEENDIFFERENTlRMS

18.2 TOOLS FOR ASSESSING PROFITABILITY 4HEREAREVARIOUSTOOLSAVAILABLETOASSESSPROlTABILITY INCLUDING s TRENDS s VARIANCES s BENCHMARKS s PROlTABILITYINDICATORS

Trends 7EWILLBEGINANANALYSISOFPROlTABILITYBYANALYSINGCONSECUTIVE)NCOME3TATEMENTSTO IDENTIFYCHANGESINREVENUESANDEXPENSESFROMONEPERIODTOTHENEXT7HERECHANGES OVERANUMBEROFPERIODSFORMAPATTERN THISISKNOWNASAtrend

Clear View Windows has provided the following (summarised) Income Statements for the year ended 31 December:

trend the pattern formed by changes in an item over a number of periods

EXAMPLE

CLEAR VIEW WINDOWS Income Statement for the year ended 31 December 2014

2015

2016

100 000

112 000

115 000

Less Cost of Goods Sold

62 000

72 800

78 200

Gross Profit

38 000

39 200

36 800

700

600

500

Adjusted Gross Profit

37 300

38 600

36 300

Less Other Expenses

25 000

25 600

26 000

Net Profit

12 300

13 000

10 300

Sales

Less Stock Loss

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4HEREPORTSSHOWTHAT3ALESINCREASEDEVERYYEARlRSTBYFROMTO THENBYAFURTHERIN4HETRENDIN3ALESISFAVOURABLEITISHIGHEREVERYYEAR 4HETRENDIN3TOCK,OSSISALSOFAVOURABLEASITDECREASEDEVERYYEARANDTHEFACTTHAT THISHASHAPPENEDDESPITEHIGHERSALESISPARTICULARLYPLEASINGPERHAPSSTOCKCONTROL PROCEDURES WERE MORE EFFECTIVE (OWEVER THERE IS AN UNFAVOURABLE UPWARD TREND IN #OSTOF'OODS3OLDAND/THER%XPENSES!SACONSEQUENCE AINCREASEIN3ALES INRESULTEDINANINCREASEIN.ET0ROlTOFONLY AND.ET0ROlTISACTUALLYLOWER INDESPITE3ALESBEINGHIGHERTHANITWASIN )NORDERTOAIDTHEUnderstandabilityOFTHEACCOUNTINGINFORMATION TRENDSMAYBE PRESENTEDASLINEORBARGRAPHS4HISMAKESTHEMEASIERTOUNDERSTANDFORUSERSWHO HAVELITTLEORNOACCOUNTINGKNOWLEDGE&IGURESHOWSALINEGRAPHSHOWING3ALES 2EVENUE 'ROSS0ROlTAND.ET0ROlTFORTO Figure 18.1

Sales Revenue, Gross Profit and Net Profit

$120 000

Sales Revenue

$90 000 $60 000

Gross Profit

$30 000

Net Profit

$0 2014

2015

2016

Year

horizontal analysis comparing reports from one period to the next, and identifying the increase or decrease in specific items in the report

4HERISINGTRENDIN3ALESISCLEAR BUTTHEINCREASINGGAPBETWEEN3ALESAND.ET0ROlT ISCAUSEFORCONCERN )N THE PREVIOUS EXAMPLE BOTH 3ALES AND #OST OF 'OODS 3OLD INCREASED BUT THE FACTTHAT'ROSS0ROlTDECREASEDININDICATESTHAT#OSTOF'OODS3OLDINCREASED by more7ECANREACHTHISCONCLUSIONINTUITIVELY BUTPREPARINGAhorizontal analysis WILLSHOWTHENUMERICALPROOF!HORIZONTALANALYSISCALCULATESTHECHANGEINITEMSFROM ONEPERIODTOTHENEXT EXPRESSINGTHECHANGEINBOTHDOLLARANDPERCENTAGETERMSSO THATTHERELATIVESIZEOFTHECHANGESCANBEASSESSED5SINGTHEINFORMATIONABOVE THE HORIZONTALANALYSISOFTHE)NCOME3TATEMENTWOULDAPPEARASISSHOWNIN&IGURE Figure 18.2

Horizontal analysis of the Income Statement Increase/ Decrease

Difference Difference $ %

2014

2015

100 000

112 000

Increase

12 000

12.0

Less Cost of Goods Sold

62 000

72 800

Increase

10 800

17.4

Gross Profit

38 000

39 200

Increase

1 200

3.2

700

600

Decrease

100

14.3

Adjusted Gross Profit

37 300

38 600

Increase

1300

3.5

Less Other Expenses

25 000

25 600

Increase

600

2.4

Net Profit

12 300

13 000

Increase

700

5.7

Sales

Less Stock Loss

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4HEPERCENTAGEDIFFERENCEISCALCULATEDBYDIVIDINGTHEdifferenceINDOLLARTERMS BY THEPREVIOUSYEARSlGUREFOREXAMPLE 3ALESX 4HEHORIZONTALANALYSISSHOWSTHATALTHOUGH3ALESHASINCREASEDBYIN #OST OF'OODS3OLDHASACTUALLYINCREASEDBYAlargerINCREASE ANDTHISHASLEDTO 'ROSS0ROlTONLYINCREASINGBY AND.ET0ROlTBYONLY!LTHOUGHREVENUE CAPACITYHASIMPROVED EXPENSECONTROLHASWORSENED

Variances 4RENDSHIGHLIGHTCHANGESINREVENUESANDEXPENSESFROMONEPERIODTOTHENEXT BUT THEYDONTALLOWTHEOWNERTOASSESSWHETHERTHEYHAVEMETTHElRMSGOALSFORTHAT PERIOD 4HIS ASSESSMENT IS PERFORMED USING A variance REPORT WHICH HIGHLIGHTS THE DIFFERENCEBETWEENACTUALANDBUDGETEDlGURES SOTHATPROBLEMAREASCANBEIDENTIlED AND ADDRESSED SEE #HAPTER   )N THIS SENSE THESE REPORTS ARE INVALUABLE TOOLS FOR ASSESSINGPROlTABILITYBECAUSETHEYDRAWATTENTIONTOAREASINWHICHPERFORMANCEHAS BEENBELOWEXPECTATION

variance the difference between an actual figure and a budgeted figure, expressed as ‘favourable’ or ‘unfavourable’

Benchmarks )NTERMSOFPROlTANDPROlTABILITY ITISIMPOSSIBLETOSAYWHETHERARESULTISSATISFACTORY WITHOUTREFERENCETOAbenchmarkOFSOMESORT!BENCHMARKISANACCEPTABLESTANDARD AGAINSTWHICHTHElRMSACTUALPERFORMANCECANBEASSESSED4HEREISNOSETLEVELOF PROlTABILITYTHATISCONSIDEREDTOBESATISFACTORY BUTAlRMMAYCOMPAREITSACTUALPROlT PERFORMANCEAGAINST s Performance IN previous periods 4HIS ALLOWS FOR THE PREPARATION OF A HORIZONTAL ANALYSISANDIDENTIlCATIONOFTRENDS5SINGTHISBENCHMARKENABLESANASSESSMENTOF WHETHERPROlTABILITYHASimprovedORworsenedFROMONEPERIODTOTHENEXT s "UDGETED performance for the current year 4HIS ALLOWS FOR THE PREPARATION OF A VARIANCEREPORT ANDENABLESANASSESSMENTOFWHETHERPROlTABILITYWASsatisfactory ORunsatisfactoryINTERMSOFMEETINGTHElRMSGOALSEXPECTATIONS s Performance of other similar firms4HISISSOMETIMESEXPRESSEDASAN@INDUSTRYAVERAGE )TALLOWSTHElRMSPERFORMANCETOBECOMPAREDAGAINSTOTHERlRMSOPERATINGUNDER SIMILARCONDITIONS4HISISSOMETIMESKNOWNASAN@INTER lRMCOMPARISON

benchmark an acceptable standard against which the firm’s actual performance can be assessed

Profitability indicators )NADDITIONTOTHETOOLSOUTLINEDABOVE THEOWNERMAYASKTHEACCOUNTANTTOCALCULATE ANY NUMBER OF profitability indicators 4HESE ARE SOMETIMES KNOWN AS @PROlTABILITY RATIOS EVEN THOUGH MOST ARE ACTUALLY PRESENTED AS PERCENTAGES 4HESE INDICATORS EXPRESSANELEMENTOFPROlTin relation to some other aspect of business performance !SARESULT DIFFERENCESINPROlTABILITYBETWEENYEARSANDALSOBETWEENBUSINESSESCAN BEASSESSED ASTHEINDICATOREXPRESSESPROlTABILITYACCORDINGTOACOMMONBASE 4HISCOURSECONSIDERSTHEFOLLOWINGINDICATORS s 2ETURNON/WNERS)NVESTMENT2/) s 2ETURNON!SSETS2/! s !SSET4URNOVER!4/ s .ET0ROlT-ARGIN.0- s 'ROSS0ROlT-ARGIN'0- 

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profitability indicators measures that express an element of profit in relation to some other aspect of business performance

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REVIEW QUESTIONS 18.2

1 DefineTHEFOLLOWINGTERMS s TREND s BENCHMARK s VARIANCE s PROlTABILITYINDICATOR 2 ExplainHOWTRENDSCANBEUSEDTOASSESSPROlTABILITY 3 ExplainHOWVARIANCESCANBEUSEDTOASSESSPROlTABILITY 4 DescribeTHREEBENCHMARKSTHATCANBEUSEDTOASSESSPROlTABILITY 5 ListlVEINDICATORSTHATCANBEUSEDTOASSESSPROlTABILITY

18.3 RETURN ON OWNER’S INVESTMENT (ROI) Return on Owner’s Investment (ROI) a profitability indicator that measures how effectively a business has used the owner’s capital to earn profit

&ROMANINVESTORSPOINTOFVIEW THEMAINMEASUREOFPROlTABILITYISReturn on Owner’s Investment (ROI) WHICHMEASURESTHEPROlTRETURN EARNEDPERDOLLAROFCAPITALINVESTED BYTHEOWNER!SARESULT ITINDICATESHOWEFFECTIVELYTHEBUSINESSHASUSEDTHEOWNERS FUNDSTOEARNPROlT WHICHISUSEFULINHELPINGTHEOWNERTODECIDEBETWEENALTERNATIVE INVESTMENTS Return on Owner’s Investment: formula Return on Owner’s Investment (ROI)

=

Net Profit

x

Average Capital

100

'IVENTHATTHE.ET0ROlTlGUREISEARNEDOVERAPERIOD BUTCAPITALISMEASUREDATA PARTICULARPOINTINTIME !VERAGE#APITALISUSEDINTHECALCULATIONOF2ETURNON/WNERS )NVESTMENTSOTHATANYINCREASESORDECREASESINCAPITALOVERTHEYEARAREACCOUNTEDFOR ANDISCALCULATEDAS

Average Capital

=

Capital at start + Capital at end 2

EXAMPLE

The following data was provided by two clothing stores. Carl’s Clothing

Anna’s Attire

$14 000

$10 000

Capital – 1 July 2014

72 000

41 000

Capital – 30 June 2015

68 000

39 000

Net Profit

#LEARLY#ARLS#LOTHINGHASEARNEDMOREPROlTTHAN!NNAS!TTIRE BUTHISINVESTMENT ISALSOHIGHER&ROMANINVESTORSPOINTOFVIEW WHICHISMOREPROlTABLE 4HE2ETURNON/WNERS)NVESTMENTFOREACHBUSINESSWOULDBECALCULATEDASISSHOWN IN&IGURE

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Figure 18.3

E VA L U AT I N G P R O F I TA B I L I T Y

Calculating Return on Owner’s Investment (ROI) Carl’s Clothing

ROI

=

433

14 000 (72 000 + 68 000)/2

= =

14 000 70 000

Anna’s Attire x 100

ROI

x 100

=

10 000 (41 000 + 39 000)/2

=

20%

10 000 40 000

=

x 100

x 100 STUDY TIP

25%

4HE lGURES SHOW THAT DESPITE EARNING LESS PROlT !NNAS !TTIRE IS ACTUALLY MORE PROlTABLE FOR ITS OWNER FOR EVERY DOLLAR SHE HAS INVESTED !NNA OWNER EARNS  PROlT WHEREAS FOR EVERY DOLLAR HE HAS INVESTED #ARL ONLY EARNS  %VEN THOUGH #ARLHASEARNEDMOREPROlTTHAN!NNA HEHASHADTOMAKEASUBSTANTIALLYLARGER INVESTMENTOFHISOWNFUNDSTODOSO

7HENENTERINGTHESE lGURESINYOURCALCULATOR PRESS@BEFORE DIVIDING ORYOULLONLY DIVIDETHELASTlGURE NOTTHETOTAL BY

Benchmarks !SWITHMOSTPROlTABILITYINDICATORS THEREISNOSETLEVELATWHICH2ETURNON/WNERS )NVESTMENTWOULDBECONSIDEREDSATISFACTORY BUTITCOULDBECOMPAREDAGAINST s THE2ETURNON/WNERS)NVESTMENTFROMprevious periods s THEbudgeted2ETURNON/WNERS)NVESTMENT s THE2ETURNON/WNERS)NVESTMENTOFsimilar businesses/alternative investments 4HISLASTBENCHMARKISPARTICULARLYIMPORTANT BECAUSE2ETURNON/WNERS)NVESTMENT ASSESSESPROlTABILITYFROMANinvestor’sPOINTOFVIEW!LTHOUGHWEHAVEAPPROACHEDTHIS COURSEFROMTHEPERSPECTIVETHATTHEOWNERISALSOTHEOPERATOR WEMUSTNOTLOSESIGHT OFTHEFACTTHATTHEOWNERHASINVESTEDHISORHEROWNMONEYINTHEBUSINESS"YDOING SO THEOWNERHASGIVENUPTHEOPPORTUNITYTOINVESTELSEWHERE ANDTHEREFOREFORGONE THE RETURN THAT MIGHT BE EARNED BY INVESTING IN PROPERTY SHARES lNANCIAL PRODUCTS OROTHERVALUABLES SUCHASART WINE ANTIQUESOREVENSPORTINGMEMORABILIA&ORTHIS REASON THE2ETURNON/WNERS)NVESTMENTMUSTBECOMPARABLEWITHTHEINTERESTRATEON ATERMDEPOSIT THERENTEARNEDONPROPERTY THEDIVIDENDEARNEDONSHARES ORSIMPLY THERETURNEARNEDBYSIMILARBUSINESSES )NFACT GIVENTHERISKTHEOWNERTAKESBYINVESTING ANDTHELONGHOURSMANYOWNERS WORK HEORSHEMAYREQUIREA2ETURNON/WNERS)NVESTMENTTHATISHIGHERTHANTHESE ALTERNATIVEINVESTMENTS/NTHEOTHERHAND ASMALLBUSINESSOWNERMAYBEWILLINGTO ACCEPTASLIGHTLYLOWERRETURNASATRADE OFFFORTHESATISFACTIONTHATCOMESFROMRUNNING HISORHEROWNBUSINESS

Changes in Return on Owner’s Investment 2ETURNON/WNERS)NVESTMENTCANALSOBEUSEDTOASSESSCHANGESINPROlTABILITYFROM ONEPERIODTOTHENEXT

Filmore Doors has provided the following information relating to its trading activities for the year ended 31 December: 2015 Net Profit

$

6 400

EXAMPLE

2016 $

5 400

Average Capital

40 000

30 000

Return on Owner’s Investment

16%

18%

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STUDY TIP

0ROlTABILITYINDICATORS ARETHEFUNCTIONOF WHATEVERISINTHEIRTOP LINEANDBOTTOMLINEIF THEINDICATORCHANGES ITISBECAUSEONE OR BOTH OFTHESELINES HASCHANGED

UNITS 3&4

)N PROlTDECREASEDBYFROMTO ANDYETTHE2ETURNON /WNERS)NVESTMENTINCREASEDFROMTOHOWISTHISPOSSIBLE4HEANSWERLIES INTHEFACTTHATTHEAVERAGE CAPITALDECREASEDTHEOWNERISEARNINGPROlTONASMALLER BASE4HISMAYMEANTHEBUSINESSISMORERELIANTONDEBTORHASAHIGHER$EBT2ATIO SEE3ECTION ANDTHUSTHERISKTOTHEBUSINESSISINCREASED BUTFROMTHEPOINTOF VIEWOFTHEOWNERASANINVESTOR ITRESULTSINIMPROVEDPROlTABILITY

REVIEW QUESTIONS 18.3

1 StateWHATISMEASUREDBY@2ETURNON/WNERS)NVESTMENT2/)  2 ShowTHEFORMULATOCALCULATE2ETURNON/WNERS)NVESTMENT 3 Explain WHY THE FORMULA TO CALCULATE 2ETURN ON /WNERS )NVESTMENT USES !VERAGE#APITAL 4 List THREE BENCHMARKS THAT COULD BE USED TO ASSESS THE ADEQUACY OF THE 2ETURNON/WNERS)NVESTMENT 5 ExplainTHESIGNIlCANCEOFTHE@RETURNONSIMILARINVESTMENTSASABENCHMARK FORASSESSINGTHE2ETURNON/WNERS)NVESTMENT 6 Explain HOW THE 2ETURN ON /WNERS )NVESTMENT CAN INCREASE EVEN THOUGH PROlTHASDECREASED

18.4 DEBT RATIO

Debt Ratio a stability indicator that measures the percentage of a firm’s assets that are financed by liabilities

STUDY TIP

4HE$EBT2ATIOIS SOMETIMESREFERREDTO AS@GEARING

3ECTIONREFERREDTOTHEFACTTHATTHE2ETURNON/WNERS)NVESTMENTCANINCREASE WITHOUT AN INCREASE IN PROlT IF THE OWNERS CAPITAL REDUCES 4HIS POINT ILLUSTRATES THAT THE2ETURNON/WNERS)NVESTMENTISNOTJUSTRELIANTONPROlT BUTALSODEPENDSONTHE lNANCIALSTRUCTUREOFTHEBUSINESSWHETHERITHASRELIEDONOWNERSCAPITALTOPURCHASE THEASSETSTHATEARNITSPROlT ORHASINSTEADRELIEDONBORROWEDFUNDS4HUS ANANALYSIS OFTHE2ETURNON/WNERS)NVESTMENTMUSTALSOINCLUDEANANALYSISOFTHE$EBT2ATIO 4HE Debt Ratio MEASURES THE PERCENTAGE OF A lRMS ASSETS THAT ARE lNANCED BY LIABILITIES AND THUS INDICATES THE EXTENT TO WHICH THE BUSINESS IS RELIANT ON LIABILITIES DEBTRATHERTHANOWNERSCAPITAL TOPURCHASEITSASSETS

Debt Ratio: formula Debt Ratio

=

Total liabilities Total assets

x

100

!HIGH$EBT2ATIOMEANSAGREATERRELIANCEONBORROWEDFUNDSLIABILITIES TOPURCHASE ASSETS AND CONSEQUENTLY A LOWER RELIANCE ON FUNDS CONTRIBUTED BY THE OWNER 4HIS WILLHAVEIMPLICATIONSFORTHElRMSPROlTABILITY ANDITS2ETURNON/WNERS)NVESTMENT (OWEVER THE$EBT2ATIOISALSOAMEASUREOFTHElRMSLONG TERMSTABILITY ANDCANBE USEDTOEVALUATETHELEVELOFRISKASSOCIATEDWITHTHEBUSINESS

EXAMPLE

High Fashions Net Profit $ 8 000 Capital 32 000 Return on Owner’s Investment 24% Total liabilities 68 000 Total assets 100 000

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Low RIders $

8 000 80 000 10% 20 000 100 000

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E VA L U AT I N G P R O F I TA B I L I T Y

!LTHOUGHBOTHlRMSHAVEEARNEDTHESAME.ET0ROlT THE2ETURNON/WNERS )NVESTMENTISHIGHERFOR(IGH&ASHIONS THANITISFOR,OW2IDERS 4HEREASON FORTHISDIFFERENCEISREVEALEDBYTHE$EBT2ATIOOFEACHBUSINESS Figure 18.4

Calculating Debt Ratio High Fashions

Debt Ratio

=

68 000

x 100

Low Riders Debt Ratio

=

68%

x 100

100 000

100 000 =

20 000

=

20%

!LTHOUGHBOTHlRMSARETHESAMESIZEWITHASSETSOFUNDERTHEIRCONTROL OFTHEASSETSOF(IGH&ASHIONSAREFUNDEDFROMLIABILITIES WITHTHEREMAINING lNANCED USING FUNDS FROM THE OWNERS CAPITAL 4HIS RELATIVELY HIGH $EBT 2ATIO AND THEREFORE LOW RELIANCE ON CAPITAL EXPLAINS WHY THE 2ETURN ON /WNERS )NVESTMENT OF (IGH &ASHIONS IS  )T COULD HOWEVER MEAN THAT (IGH &ASHIONS IS EXPOSED TO A GREATERRISKOFlNANCIALCOLLAPSESEEBELOW  &OR,OW2IDERS ONLYOFTHEASSETSAREFUNDEDFROMLIABILITIESWITHTHEMAJORITY  lNANCEDBYTHEOWNER4HISLOWRELIANCEONDEBTMEANSLESSRISK BUTITALSOMEANS A HIGHER RELIANCE ON OWNERS CAPITAL AND THUS A LOWER 2ETURN ON /WNERS )NVESTMENT  

Benchmarks )NASSESSINGTHE$EBT2ATIO ITSHOULDBECOMPAREDAGAINSTprevious reporting periods ANDTHEbudgeted$EBT2ATIO BUTTHECOMPARISONAGAINSTsimilar firmsISPARTICULARLY USEFUL AS BY DElNITION THEY OPERATE IN THE SAME INDUSTRY USING SIMILAR ASSETS AND SELLING SIMILAR PRODUCTS (OWEVER THE $EBT 2ATIO CANNOT BE ASSESSED IN ISOLATION IT SHOULDBEASSESSEDINCONJUNCTIONWITHTHE2ETURNON/WNERS)NVESTMENT

The Debt Ratio: risk and return ! HIGHER $EBT 2ATIO MEANS THE lRM IS MORE HEAVILY RELIANT ON BORROWED FUNDS THAN IT IS ON THE OWNERS CAPITAL AND THIS IS ONE WAY OF INCREASING THE 2ETURN ON /WNERS )NVESTMENTWITHOUTACTUALLYINCREASINGPROlT7ITHAHIGHER$EBT2ATIO THEBUSINESSIS USINGSOMEONEELSESFUNDSTOBUYTHEASSETSTOEARNPROlT BUTTHEOWNERSTILLRECEIVES ALLTHATPROlT(OWEVER AHIGHER$EBT2ATIOMEANSTHEREISAHIGHERRISKTHATTHEBUSINESS WILLBEUNABLETOREPAYITSDEBTSANDMEETTHEINTERESTPAYMENTS&URTHER INTERESTRATE RISESCOULDHAVEASIGNIlCANTIMPACTONPROlTANDCASHASTHEBUSINESSISCARRYINGSO MUCHDEBT /NTHEOTHERHAND ALOW$EBT2ATIOMEANSTHElRMISNOTVERYRELIANTONBORROWED FUNDS ANDISTHEREFOREATRELATIVELYLOWRISKOFBEINGUNABLETOREPAYITSDEBTS(OWEVER ITALSOMEANSTHATMOSTOFTHElNANCEUSEDTOPURCHASEASSETSHASCOMEFROMTHEFUNDS OF THE OWNER AND AS THE OWNER HAS HAD TO CONTRIBUTE MORE PERSONAL FUNDS A LOWER 2ETURNON/WNERS)NVESTMENTWILLENSUE 4HEOWNERMUSTJUDGECAREFULLYSOTHATTHE$EBT2ATIOISHIGHENOUGHTOMAXIMISE THE2ETURNON/WNERS)NVESTMENT BUTNOTTOOHIGHTHATITWILLCREATEDIFlCULTIESFORTHE BUSINESSINRELATIONTOITSDEBTBURDEN

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CAMBRIDGE VCE ACCOUNTING

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UNITS 3&4

REVIEW QUESTIONS 18.4

1 2 3 4 5

ExplainWHATISMEASUREDBYTHE$EBT2ATIO ShowTHEFORMULATOCALCULATETHE$EBT2ATIO ExplainTHESIGNIlCANCEOF@SIMILARlRMSINASSESSINGTHE$EBT2ATIO ExplainWHYAHIGH$EBT2ATIOMEANSHIGHRISKOFlNANCIALCOLLAPSE ExplainWHYAHIGH$EBT2ATIOISLIKELYTORESULTINAHIGH2ETURNON/WNERS )NVESTMENT

18.5 RETURN ON ASSETS (ROA) Return on Assets (ROA) a profitability indicator that measures how effectively a business has used its assets to earn profit

7HEREAS 2ETURN ON /WNERS )NVESTMENT ASSESSES PROlTABILITY FROM AN investor’s POINT OFVIEW Return on Assets (ROA)ASSESSESPROlTABILITYFROMAmanager’sPOINTOFVIEW 3PECIlCALLY ITMEASURES.ET0ROlTPERDOLLAROFASSETSCONTROLLEDBYTHEBUSINESS!SA RESULT ITINDICATESHOWEFFECTIVELYTHElRMHASUSEDITSASSETSTOEARNPROlT

Return on Assets: formula Return on Assets (ROA)

=

Net Profit Average total assets

x

100

*USTASTHEFORMULAFOR2ETURNON/WNERS)NVESTMENTUSEDAVERAGECAPITAL 2ETURN ON!SSETSUSESAVERAGETOTALASSETS)FTOTALASSETSHASNOTCHANGEDSIGNIlCANTLYOVER THEPERIOD ORANAVERAGECANNOTBECALCULATED TOTALASSETSATTHEENDOFTHEPERIOD MAYBEUSED

EXAMPLE

The following data was provided by two similar book stores. Barry’s Books Net Profit Total assets – 1 January 2015 Total assets – 31 January 2015

$

15 000 73 000 77 000

Tina’s Texts $

18 700 105 000 115 000

4HElRSTPOINTTONOTEFROMTHElGURESISTHAT4INAS4EXTSHASEARNEDMOREPROlT BUTTHISMAYBESIMPLYBECAUSEITHASMOREASSETSTHATIS ITISALARGERBUSINESS ANDIS THEREFORECAPABLEOFGENERATINGLARGER3ALESANDPROlT"UTWHICHISMOREPROlTABLE 4HE 2ETURN ON !SSETS FOR EACH BUSINESS WOULD BE CALCULATED AS IS SHOWN IN &IGURE

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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CHAPTER 18

Figure 18.5

E VA L U AT I N G P R O F I TA B I L I T Y

Calculating Return on Assets (ROA) Barry’s Books

ROA

=

437

15 000 (73 000 + 77 000)/2

= =

15 000 75 000 20%

Tina’s Texts x 100

x 100

ROA

=

18 700 (105 000 + 115 000)/2

= =

18 700 110 000

x 100

x 100

17%

4HElGURESSHOWTHATITISACTUALLY"ARRYS"OOKSTHATISMOREPROlTABLE ASITEARNS PROlTFROMEVERYDOLLAROFASSETSITCONTROLS WHEREAS4INAS4EXTSONLYEARNS PROlTPERDOLLAROFASSETS"ARRYISUSINGHISlRMSASSETSMOREEFFECTIVELYTOEARNPROlT ANDTHISCOULDBEFORANUMBEROFREASONSPERHAPSHISSTOCKISINHIGHERDEMAND ORHIS STOREISINABETTERLOCATION ORHISEXPENSECONTROLISBETTER!STHEMANAGER 4INAMAY WISHTOADOPTSOMEOF"ARRYSSTRATEGIESIFHEISWILLINGTOTELL


Benchmarks 4HEPRECEDINGEXAMPLEUSEDTHE2ETURNON!SSETSOFAsimilar businessASABENCHMARK BUTITCOULDALSOBEASSESSEDAGAINSTTHE2ETURNON!SSETSFROMprevious periods ORTHE budgeted2ETURNON!SSETS

Return on Owner’s Investment and Return on Assets

STUDY TIP

!SMANYSMALLBUSINESSOWNERSAREBOTHINVESTORSANDMANAGERS THEYWILLNEEDTOLOOK AT BOTH THE 2ETURN ON /WNERS )NVESTMENT AND THE 2ETURN ON !SSETS WHEN ASSESSING PROlTABILITY /NE THING THEY WILL NOTICE IS THAT THE 2ETURN ON /WNERS )NVESTMENT WILL ALWAYSBEhigherTHANTHE2ETURNON!SSETS4HISISBECAUSEOWNERSEQUITYWILLALWAYS BELOWERTHANTOTALASSETS WHICHINTURNISDUETOITSBORROWINGSnITSLIABILITIES/NLY INAlRMTHATHASNOLIABILITIES WHICHISEXTREMELYUNLIKELY WILLTHE2ETURNON/WNERS )NVESTMENTBETHESAMEASTHE2ETURNON!SSETS

4HEEXACTSIZEOFTHE GAPBETWEEN2/)AND 2/!WILLDEPENDONTHE lRMS$EBT2ATIO

Changes in Return on Assets 7HENASSESSINGCHANGESINTHE2ETURNON!SSETS ITISIMPORTANTTOKEEPINMINDTHE lGURESTHATAREUSEDINITSFORMULAONTHETOPLINE THEPROlTTHEBUSINESSHASEARNED ANDONTHEBOTTOM THEASSETSITCONTROLS)FASSETSINCREASE AND.ET0ROlTINCREASES BY A SMALLER PROPORTION THEN THE 2ETURN ON !SSETS WILL FALL INDICATING DETERIORATING PROlTABILITY/NTHEOTHERHAND IF.ET0ROlTINCREASESBYMORETHANASSETS THE2ETURN ON!SSETSWILLRISE INDICATINGIMPROVEDPROlTABILITY 4HE .ET 0ROlT lGURE ITSELF IS RELIANT ON THE TWO BASIC FACTORS WE IDENTIlED EARLIER EARNINGREVENUEANDCONTROLLINGEXPENSES4HEREFORE ASSUMINGASSETSDONOTCHANGE ANIMPROVEMENTINTHE2ETURNON!SSETSMAYBETHERESULTOFANIMPROVEDABILITYTO EARNREVENUEORBETTEREXPENSECONTROL ORBOTH!DETERIORATIONINTHE2ETURNON!SSETS WOULD OF COURSE BE CAUSED BY THE OPPOSITE %ITHER WAY THE 2ETURN ON !SSETS WILL DEPENDHEAVILYONTHElRMSABILITYTOEARNREVENUEANDCONTROLITSEXPENSES SOTHISIS THENEXTPHASEINOURANALYSISOFPROlTABILITY

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UNITS 3&4

REVIEW QUESTIONS 18.5

1 StateWHATISMEASUREDBY2ETURNON!SSETS2/!  2 ShowTHEFORMULATOCALCULATE2ETURNON!SSETS 3 List THREE BENCHMARKS THAT COULD BE USED TO ASSESS THE ADEQUACY OF THE 2ETURNON!SSETS 4 ExplainWHY2ETURNON/WNERS)NVESTMENTWILLALWAYSBEHIGHERTHAN2ETURN ON!SSETS 5 IdentifyTWOFACTORSTHATCOULDCAUSEANINCREASEINTHE2ETURNON!SSETS

18.6 EARNING REVENUE: ASSET TURNOVER (ATO) Asset Turnover (ATO) an efficiency indicator that measures how productively a business has used its assets to earn revenue

4ECHNICALLY Asset Turnover (ATO)ISANefficiencyINDICATORITINDICATESHOWEFlCIENTLY THElRMHASUSEDITASSETSTOGENERATEREVENUE"UTASEARNINGREVENUEISONEOFTHEKEYS TOEARNINGPROlT !SSET4URNOVERWILLHAVEADIRECTANDSIGNIlCANTEFFECTONPROlTABILITY Asset Turnover: formula Asset Turnover (ATO)

=

Sales Average total assets

3PECIlCALLY THIS INDICATOR MEASURES THE NUMBER OF TIMES IN A PERIOD THE VALUE OF ASSETSISEARNEDAS3ALESREVENUETHEHIGHERTHE!SSET4URNOVER THEMORECAPABLETHE lRMISOFUSINGITSASSETSTOEARNREVENUE

EXAMPLE

Pino’s Plant Nursery has provided the following information relating to its trading activities for the year ended 30 June: 2015 Sales revenue Average total assets

$

96 000 80 000

2016 $

121 500 90 000

!VERAGEASSETSINCREASEDBY IN SOANINCREASEIN3ALESREVENUEIS EXPECTED(OWEVER HASTHElRMUSEDTHESEEXTRAASSETSMOREORLESSPRODUCTIVELYTHAN ITDIDIN 4HE!SSET4URNOVERFOREACHBUSINESSWOULDBECALCULATEDASISSHOWNIN&IGURE Figure 18.6

Calculating Asset Turnover (ATO) 2015

ATO ATO

=

ATO

=

96 000

2016 =

80 000

ATO ATO

1.2 times

ATO

=

121 500 90 000 1.35 times

)N THEBUSINESSEARNEDTIMESTHEVALUEOFITSASSETSASREVENUE ANDTHIS HASRISENTOTIMESIN4HISCONlRMSTHAT0INOS0LANT.URSERYHASEARNEDMORE REVENUEINNOTONLYBECAUSEITHASMOREASSETS BUTBECAUSEITHASUSEDTHOSE ASSETSMOREPRODUCTIVELY ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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439

Benchmarks 4HE PRECEDING EXAMPLE COMPARED !SSET 4URNOVER AGAINST A previous period BUT IT COULDEQUALLYBEASSESSEDAGAINSTTHEbudgeted!SSET4URNOVER ORTHE!SSET4URNOVER OFsimilar businesses)NCASESWHEREANEXPANSIONISPLANNED ANDAVERAGEASSETSARE EXPECTEDTOINCREASE BUDGETED!SSET4URNOVERMAYBETHEBESTBENCHMARKTOUSEFOR ASSESSMENT ASITREmECTSTHElRMSGOALFORINCREASED3ALESREVENUEONAGREATERASSET BASE

Asset Turnover and Return on Assets 4HESIMILARITYBETWEEN!SSET4URNOVERANDTHE2ETURNON!SSETSREmECTSTHEFACTTHATTHEY BOTHASSESSTHElRMSABILITYTOUSEITSASSETSTHEONLYDIFFERENCEBEINGTHAT2ETURNON !SSETSRELATESTOprofit WHEREAS!SSET4URNOVERRELATESONLYTOrevenue4HEORETICALLY AN INCREASEIN!SSET4URNOVERMEANINGANINCREASEDABILITYTOEARN3ALESREVENUE SHOULD MEANANINCREASEINTHE2ETURNON!SSETS ANDINCREASED.ET0ROlT(OWEVER THISISNOT ALWAYSTHECASE ,ETUSRETURNTOTHEPREVIOUSEXAMPLE0INOS0LANT.URSERY WITHADDITIONALINFORMATION PROVIDED

2015 Sales revenue Net Profit Average total assets Asset Turnover Return on Assets

$ 96 400 12 000 80 000 1.2 times 15%

EXAMPLE

2016 $ 121 500 12 600 90 000 1.35 times 14%

STUDY TIP

!SNOTEDPREVIOUSLY THE!SSET4URNOVERSHOWSTHEBUSINESSISMOREPRODUCTIVE IN TERMSOFUSINGITSASSETSTOEARNREVENUE IN(OWEVER THElGURESSHOWTHATINSPITE OFTHISINCREASEIN!SSET4URNOVER PROlTABILITYASMEASUREDBYTHE2ETURNON!SSETS HAS ACTUALLYFALLENBYPERCENTAGEPOINT 4HEONLYDIFFERENCEBETWEENTHE!SSET4URNOVER ANDTHE2ETURNON!SSETSISTHEDIFFERENCEBETWEEN3ALES2EVENUEAND.ET0ROlT IE EXPENSES 4HEREFORE WHERE THE !SSET 4URNOVER AND THE 2ETURN ON !SSETS MOVE IN DIFFERENT DIRECTIONS OR TO DIFFERING DEGREES IT INDICATES A change in expense control )N THIS EXAMPLE THE !SSET 4URNOVER INCREASED AND THE 2ETURN ON !SSETS DECREASED INDICATINGWORSEEXPENSECONTROL

7HENINDICATORSARE ALREADYEXPRESSED ASPERCENTAGES THE CHANGESHOULDBE DESCRIBEDINTERMSOF PERCENTAGEPOINTS

REVIEW QUESTIONS 18.6

1 StateWHATISMEASUREDBY!SSET4URNOVER!4/  2 ShowTHEFORMULATOCALCULATE!SSET4URNOVER 3 ListTHREEBENCHMARKSTHATCOULDBEUSEDTOASSESSTHEADEQUACYOFAlRMS !SSET4URNOVER 4 ExplainHOWTHERELATIONSHIPBETWEENAlRMS!SSET4URNOVERANDITS2ETURN ON!SSETSCANBEUSEDTOASSESSITSEXPENSECONTROL

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440

UNITS 3&4

18.7 CONTROLLING EXPENSES

expense control the firm’s ability to manage its expenses so that they either decrease or, in the case of variable expenses, increase no faster than Sales revenue

7ENOTEDIN#HAPTERTHATEXPENSESSHOULDNOTNECESSARILYBELOOKEDONAS@BAD BECAUSETHEYASSISTINTHEEARNINGOFREVENUE4HISDOESNOTMEANTHATTHElRMSHOULD BE HAPPY TO SEE MORE AND MORE OF ITS 3ALES REVENUE BEING CONSUMED BY EXPENSES !FTERALL EVERYDOLLARTHATISCONSUMEDBYEXPENSESMEANSONEDOLLARLESS.ET0ROlT 4HISMEANSTHElRMSABILITYTOCONTROLITSEXPENSESISAKEYFACTORINITSABILITYTOEARN PROlT Expense controlREFERSTOTHElRMSABILITYTOMANAGEITSEXPENSESSOTHATTHEYEITHER DECREASE ORINCREASENOFASTERTHAN3ALESREVENUE4HISLASTPOINTMAYSEEMALITTLEODD WHYSHOULDTHEOWNERSETTLEFORANYTHINGLESSTHANAREDUCTIONINEXPENSES2EMEMBER THATINTHEPURSUITOFGREATER3ALES ITISUNAVOIDABLETHATSOMEEXPENSESWILLINCREASE %XPENSESSUCHAS#OSTOF3ALESAND7AGESVARYDIRECTLYWITHTHELEVELOF3ALES SOITIS LOGICALTHATAS3ALESVOLUMEINCREASES THESEEXPENSESWILLINCREASETOO0ROVIDEDTHEY DONOTINCREASEmoreTHAN3ALES WECANCONSIDERTHISTOBEEVIDENCEOFSATISFACTORY EXPENSECONTROL3HOULDTHEYACTUALLYINCREASEBYlessTHAN3ALES WEWOULDCONSIDER THISTOBEEVIDENCEOFIMPROVEDEXPENSECONTROL )FEXPENSECONTROLIMPROVES THENPROlTABILITYSHOULDALSOIMPROVE7EWILLEVALUATE EXPENSECONTROLBYANALYSINGTWOINDICATORSTHATCALCULATETHEPERCENTAGEOFEACHDOLLAR OF3ALESTHATISRETAINEDASPROlT s .ET0ROlT-ARGIN.0- s 'ROSS0ROlT-ARGIN'0-  )NASSESSINGTHESEINDICATORS WEWILLUSETHEBENCHMARKSESTABLISHEDEARLIERINTHIS CHAPTER NAMELY s PERFORMANCEIN previous periods s budgetedPERFORMANCE s PERFORMANCEOFsimilar firms

REVIEW QUESTIONS 18.7

1 DefineTHETERM@EXPENSECONTROL 2 StateTWOREASONSWHYTHEOWNEROFASMALLBUSINESSWILLTOLERATEINCREASESIN SOMEEXPENSES 3 StateTWOPROlTABILITYINDICATORSTHATASSESSEXPENSECONTROL

18.8 NET PROFIT MARGIN (NPM)

Net Profit Margin (NPM) a profitability indicator that measures expense control by calculating the percentage of Sales revenue that is retained as Net Profit

#OMPETITIONINMANYMARKETSMEANSTHATEARNINGREVENUEISACHALLENGINGEXERCISEFOR MOSTSMALLBUSINESSES7ITHTHISINMIND ITISVITALTHATONCEASALEISMADE THEBUSINESS RETAINSASMUCHOFTHATREVENUEASPROlTASISPOSSIBLE4HE Net Profit Margin (NPM) MEASURESTHEPERCENTAGEOF3ALESREVENUETHATISRETAINEDAS.ET0ROlT0UTANOTHER WAY ITMEASURESHOWMUCHOFEACHDOLLAROF3ALESREVENUEREMAINSAS.ET0ROlTAFTER EXPENSESAREDEDUCTED!SARESULT ITISAGOODINDICATOROFEXPENSECONTROL

Net Profit Margin: formula Net Profit Margin (NPM)

=

Net Profit Sales revenue

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

x

100

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E VA L U AT I N G P R O F I TA B I L I T Y

441

$UETODIFFERENCESIN3ALESREVENUE COMPARING.ET0ROlTBETWEENBUSINESSESAND BETWEEN PERIODS CAN BE DIFlCULT IT IS DIFlCULT TO ISOLATE HOW MUCH OF THE DIFFERENCE IS DUE TO EXPENSE CONTROL AND HOW MUCH IS SIMPLY DUE TO DIFFERENT 3ALES REVENUE "ECAUSETHISINDICATOREXPRESSES.ET0ROlTper dollar of Sales ITCANIDENTIFYCHANGESIN PROlTINDEPENDENTOFCHANGESIN3ALESREVENUE

EXAMPLE

Misha’s Shoe Barn has provided the following information from its Income Statement for the year ended 30 June: 2015 Sales revenue Net Profit

$ 72 000 14 400

2016 $ 80 000 15 200

!SWEWOULDEXPECT HIGHER3ALESREVENUEINHASGENERATEDEXTRAPROlT BUT HASITGENERATEDenoughEXTRAPROlT(ASEXPENSECONTROLCHANGED 4HE.ET0ROlT-ARGINFOREACHYEARWOULDBECALCULATEDASISSHOWNIN&IGURE Figure 18.7

Calculating Net Profit Margin (NPM) 2015

NPM

=

14 400

2016 NPM

x 100

=

x 100

80 000

72 000 =

15 200

=

20%

19%

STUDY TIP

4HElGURESTELLUSTHATIN COFEVERYDOLLAROF3ALESREVENUEWASRETAINEDAS .ET0ROlT BUTINTHISFELLTOCPERDOLLAR!LTERNATIVELY CWASCONSUMEDBY EXPENSESIN ANDTHISINCREASEDTOCIN4HISMEANSTHATEXPENSECONTROL WASWORSEIN

$EDUCTINGTHE.0- FROMWILLREVEALTHE PERCENTAGEOFEACH 3ALESDOLLARTHATIS CONSUMEDBYEXPENSES

Net Profit Margin, Asset Turnover and Return on Assets 4HEEARLIERDISCUSSIONOF2ETURNON!SSETSHIGHLIGHTEDTHATTHEABILITYOFAlRMTOUSE ITSASSETSTOEARNPROlTDEPENDSONITSABILITYBOTHTOEARNREVENUEANDTOCONTROLITS EXPENSES7ENOWHAVEANINDICATORTHATMEASURESEACHOFTHESEFACTORS s Asset TurnoverMEASURESTHEABILITYOFTHElRMTOUSEITSASSETSTOEARNREVENUE s Net Profit MarginMEASURESTHEABILITYOFTHElRMTOCONTROLITSEXPENSESANDRETAIN 3ALESREVENUEAS.ET0ROlT 4HUS 2ETURNON!SSETSDEPENDSONBOTHTHE!SSET4URNOVERANDTHE.ET0ROlT-ARGIN 4HISRELATIONSHIPISBORNEOUTMATHEMATICALLYTOO)FWEMULTIPLYTHE!SSET4URNOVER ANDTHE.ET0ROlT-ARGIN WEGET

= =

ATO

x

NPM

Sales revenue Average total assets

x

Net Profit Sales revenue

Net Profit Average total assets

WHICH OFCOURSE ISTHEFORMULAFOR2ETURNON!SSETS ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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UNITS 3&4

@#ANCELLING DOWN PROVES THAT THE 2ETURN ON !SSETS AND THEREFORE PROlTABILITY DEPENDSONTHEABILITYOFTHElRMTOUSEITSASSETSTOEARNREVENUEASMEASUREDBY !SSET4URNOVER ANDTOCONTROLITSEXPENSESASMEASUREDBYTHE.ET0ROlT-ARGIN 

REVIEW QUESTIONS 18.8

1 StateWHATISMEASUREDBYTHE.ET0ROlT-ARGIN.0-  2 ShowTHEFORMULATOCALCULATETHE.ET0ROlT-ARGIN 3 ExplainTHERELATIONSHIPBETWEEN!SSET4URNOVER .ET0ROlT-ARGINAND2ETURN ON!SSETS

18.9 GROSS PROFIT MARGIN (GPM)

Gross Profit Margin (GPM) a profitability indicator that measures the average mark-up by calculating the percentage of Sales revenue that is retained as Gross Profit

"ECAUSETHE.ET0ROlT-ARGINUSESNet0ROlTINITSCALCULATION ITCANBEUSEDTOASSESS OVERALLEXPENSECONTROL)FGross0ROlTISUSEDINSTEAD WEAREABLETOASSESSEXPENSE CONTROLSPECIlCALLYASITRELATESTOSTOCKAND#OSTOF'OODS3OLD4HUS THEGross Profit Margin (GPM)MEASURESTHEPERCENTAGEOF3ALESREVENUETHATISRETAINEDASGross0ROlT

Gross Profit Margin: formula Gross Profit Margin (GPM)

=

Gross Profit

x

Sales revenue

100

'ROSS0ROlTISTHEDIFFERENCEBETWEEN3ALESREVENUEAND#OSTOF'OODS3OLD ANDIS USEDTOASSESSTHEADEQUACYOFTHElRMSMARK UPTHEDIFFERENCEBETWEENTHESELLING PRICEANDTHECOSTPRICEOFITSSTOCK4HEREFORE THE'ROSS0ROlT-ARGINCANBEUSEDTO ASSESSTHEAVERAGEMARK UPONALLGOODSSOLDDURINGAPARTICULARPERIOD ,ETS REFER BACK TO OUR EARLIER EXAMPLE n -ISHAS 3HOE "ARN n WITH SOME EXTRA INFORMATIONNOWAVAILABLE

EXAMPLE Sales revenue Gross Profit Net Profit Net Profit Margin

2015

2016

$ 72 000 38 160 14 400 20%

$ 80 000 44 800 15 200 19%

"Y CALCULATING THE .ET 0ROlT -ARGIN WE ESTABLISHED THAT ALTHOUGH .ET 0ROlT INCREASED THISWASONLYDUETOHIGHER3ALES)NFACT THE.ET0ROlT-ARGINFELLIN INDICATINGWORSEEXPENSECONTROL3OWHICHEXPENSES ISARE THECAUSE 4HE'ROSS0ROlT-ARGINFOREACHYEARWOULDBECALCULATEDASISSHOWNIN&IGURE Figure 18.8

Calculating Gross Profit Margin 2015

GPM

=

38 160

2016 x 100

GPM

=

53%

x 100

80 000

72 000 =

44 800

=

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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443

)N COFEACHDOLLAROF3ALESWASRETAINEDAS'ROSS0ROlT)N THISROSETO CPERDOLLAR REmECTINGAHIGHERAVERAGEMARK UP0UTANOTHERWAY COFEVERY3ALES DOLLARWASCONSUMEDBY#OSTOF'OODS3OLDINLESSC#OSTOF'OODS3OLD C'ROSS0ROlT BUTTHISFELLTOCPERDOLLARIN7HY!LTHOUGH3ALESREVENUE AND'ROSS0ROlTBOTHINCREASED 'ROSS0ROlTINCREASEDPROPORTIONALLY MORE DUETOA PROPORTIONALLY SMALLERINCREASEIN#OSTOF'OODS3OLD 'IVENTHATTHE'ROSS0ROlT-ARGININCREASED POORCONTROLOF#OSTOF'OODS3OLDIS notRESPONSIBLEFORTHEDECREASEINTHE.ET0ROlTRATEWEWILLHAVETOINVESTIGATETHE /THER%XPENSES

Changes in mark-up !HIGHER'ROSS0ROlT-ARGINMEANSAHIGHERAVERAGEMARK UPONAVERAGE ABIGGER GAPBETWEENSELLINGANDCOSTPRICES4HISCOULDOCCURIF s SELLINGPRICESINCREASEDANDCOSTPRICESREMAINEDCONSTANT s COSTPRICESDECREASED ANDSELLINGPRICESREMAINEDCONSTANT s BOTHINCREASED BUTSELLINGPRICESINCREASEDBYMORE s BOTHDECREASED BUTCOSTPRICESDECREASEDBYMORE )NCREASINGSELLINGPRICESWILLINCREASETHEAVERAGEMARK UP BUTITCARRIESTHERISKOF LOWERINGDEMAND ANDTHUSREDUCINGTHEVOLUMEOF3ALES4HISCOULDMEANTHATWHILE THE'ROSS0ROlTMarginINCREASES 'ROSSProfitINDOLLARS MAYACTUALLYDECREASE4HATIS THEBUSINESSMAYMAKEMORE'ROSS0ROlTper item BUTMAKEFEWERACTUAL3ALES)FTHE DROPINTHENUMBEROF3ALESOUTWEIGHSTHEINCREASEINPROlTPERITEM 'ROSS0ROlTWILL ACTUALLYFALL &INDINGACHEAPERSUPPLIERWILLAVOIDTHISRISK BUTITCARRIESARISKOFITSOWN)FTHE QUALITY OF THE STOCK IS REDUCED THIS COULD CAUSE A DECREASE IN 3ALES OR AN INCREASE IN3ALESRETURNSOR3TOCK,OSSESTHROUGHDAMAGE !LLTHESEFACTORSCOULDPOTENTIALLY UNDERMINETHEBENElTSOFAHIGHERAVERAGEMARK UP4HISDOESNOTMEANTHEBUSINESS SHOULDNOTLOOKFORACHEAPERSUPPLIER BUTITDOESMEANTHEBUSINESSMUSTBEVIGILANT ABOUTTHEQUALITYOFITSSTOCK !SSUMINGTHEBUSINESSCANMAINTAINITS3ALESVOLUMETHENUMBEROF3ALESITMAKES AND CUSTOMER SATISFACTION A HIGHER MARK UP WILL MEAN NOT ONLY A HIGHER 'ROSS 0ROlT -ARGIN BUTALSOAHIGHER'ROSS0ROlT

REVIEW QUESTIONS 18.9

1 2 3 4

StateWHATISMEASUREDBYTHE'ROSS0ROlT-ARGIN'0-  ShowTHEFORMULATOCALCULATETHE'ROSS0ROlT-ARGIN ExplainTWOWAYSABUSINESSCOULDINCREASEITSAVERAGEMARK UP ExplainHOWANINCREASEINMARK UPCOULDLEADTOADECREASEIN'ROSS0ROlT

18.10

VERTICAL ANALYSIS OF THE INCOME STATEMENT

7HEN WE CALCULATED THE .ET 0ROlT -ARGIN AND 'ROSS 0ROlT -ARGIN WE DIVIDED THE vertical analysis APPROPRIATEPROlTlGUREBY3ALESREVENUE4HISALLOWEDUSTOEVALUATEEXPENSECONTROL a report that expresses BYASSESSINGWHATHADHAPPENEDTOEACHDOLLAROF3ALESREVENUE4HISAPPROACHCANBE every item as a percentage APPLIEDTOEVERYITEMINTHE)NCOME3TATEMENTINWHATISKNOWNASAvertical analysis of a base figure; in this 4HEVERTICALANALYSISFOR-ISHAS3HOE"ARNISSHOWNIN&IGURE case, Sales revenue

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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CAMBRIDGE VCE ACCOUNTING

Figure 18.9

UNITS 3&4

Vertical analysis of the Income Statement MISHA’S SHOE BARN Income Statement for the year ended 30 June 2015

2016

$

%

$

%

Sales Revenue

72 000

100

80 000

100

Less Cost of Goods Sold

33 840

47

35 200

44

Gross Profit

38 160

53

44 800

56

720

1

800

1

37 440

52

44 000

55

12 240

17

16 800

21

Rent

7 200

10

7 200

9

Advertising

3 600

5

4 800

6

14 400

20

15 200

19

Less Stock Loss Adjusted Gross Profit Less Other Expenses Wages

Net Profit

"YCOMPARINGTHEVERTICALANALYSISFROMONEYEARTOTHENEXT WECANSEECHANGES NOTJUSTINEXPENSEamountsASWOULDBESHOWNINAHORIZONTALANALYSIS BUTCHANGES INEXPENSESASApercentage of Sales4HATIS ITSHOWSWHATEACHREVENUEANDEXPENSE WOULDBEif Sales had been constant 4HISVERTICALANALYSISCONlRMSWHATWEIDENTIlEDBYCALCULATINGTHE.ET0ROlT-ARGIN AND'ROSS0ROlT-ARGIN s 3ALESREVENUEINCREASEDBY ANDTHISLEDTOANINCREASEIN.ET0ROlTOF (OWEVER THE .ET 0ROlT -ARGIN DECREASED FROM  TO  INDICATING A SLIGHT DETERIORATIONINEXPENSECONTROL s 4HE'ROSS0ROlT-ARGININCREASEDFROMTO INDICATINGAHIGHERAVERAGE MARK UP s !LTHOUGH 3TOCK ,OSS INCREASED THIS WAS IN PROPORTION TO THE INCREASE IN 3ALES REVENUE SO AS A PERCENTAGE OF REVENUE IT WAS CONSTANT AT   %XPENSE CONTROL HEREWASSATISFACTORY s (IGHER3ALESLEDTOHIGHERWAGES BUTTHEEXPENSEINCREASEDPROPORTIONATELYMORE THAN3ALESREVENUE INCREASINGFROMTOOF3ALESREVENUE4HESAMEAPPLIES TOADVERTISING WHICHINCREASEDFROMTOOF3ALESREVENUE s !SAlXEDEXPENSE RENTWASCONSTANTINDOLLARTERMS BUTAS3ALESREVENUEINCREASED ITABSORBEDLESSOFEACHDOLLAROF3ALES DECREASINGFROMTO

Using graphs 'IVENTHATNOTALLBUSINESSOWNERSAREACCOUNTANTS PRESENTINGAVERTICALANALYSISINAPIE CHARTISONEWAYOFENSURINGUnderstandabilityINTHEACCOUNTINGREPORTS&IGURE SHOWSTHEPIECHARTFOR

ISBN 978-1-107-64070-2 © Anthony Simmons, Richard Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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CHAPTER 18

Figure 18.10

E VA L U AT I N G P R O F I TA B I L I T Y

445

Graphical representation of vertical analysis Cost of Goods Sold Wages Net Profit Rent Advertising Stock Loss

4HISPIECHARTSHOWSTHAT#OSTOF'OODS3OLDISCLEARLYTHEMOSTSIGNIlCANTEXPENSE CONSUMING ALMOST HALF OF EVERY 3ALES DOLLAR SO ACTION HERE MAY PROVE VERY EFFECTIVE INTERMSOFIMPROVINGPROlTABILITY/NTHEOTHERHAND 3TOCK,OSSSHOWNINYELLOW IS RELATIVELYSMALL SOEVENIFSTOCKMANAGEMENTWASIMPROVEDSIGNIlCANTLY ONLYASMALL IMPROVEMENTINPROlTABILITYISLIKELY

REVIEW QUESTIONS 18.10

1 ExplainWHATISSHOWNINAVERTICALANALYSISOFTHE)NCOME3TATEMENT 2 ExplainONEBENElTOFPREPARINGAVERTICALANALYSISASAPIECHART

18.11

NON-FINANCIAL INFORMATION

4HE ASSESSMENT OF PROlTABILITY IN THIS CHAPTER HAS RELIED PRIMARILY ON THE )NCOME 3TATEMENT ANDPROlTABILITYINDICATORS WHICHARETHEMSELVESDERIVEDINLARGEPARTFROM THE )NCOME 3TATEMENT 4HESE ARE OBVIOUSLY VERY IMPORTANT IN EVALUATING PROlTABILITY BUTWENEEDTOBEMINDFULTHATTHEREARELIMITSONTHEABILITYOFTHISINFORMATIONTOASSIST THEOWNERINMAKINGlNANCIALDECISIONS4HESEINCLUDETHEFACTTHAT s THEREPORTSUSEhistorical datanTHEYDONOTGUARANTEEWHATWILLHAPPENINTHEFUTURE s MANY INDICATORS RELY ON averages AND THIS MAY CONCEAL DETAILS ABOUT INDIVIDUAL ITEMS s lRMSUSEdifferent accounting methods WHICHCANUNDERMINETHEComparabilityOF THEREPORTS ANDPROlTABILITYINDICATORSAND • THEreports contain limited informationTHEREAREMANYITEMSOFINFORMATIONSIMPLY NOTREPORTEDINAN)NCOME3TATEMENT !S A CONSEQUENCE OF THESE LIMITATIONS THE OWNER SHOULD NOT RELY ON PROlTABILITY INDICATORSANDTHE)NCOME3TATEMENTALONE)NFACT non-financial information CANBE JUSTASIMPORTANTINAIDINGDECISION MAKING Non-financial informationISAFAIRLYBROADTERMCOVERINGBASICALLYANYINFORMATION THATISNOTEXPRESSEDINDOLLARSANDCENTS ORRELIANTONDOLLARSANDCENTSFORITSCALCULATION )TREFERSTOINFORMATIONTHATCANNOTBEFOUNDINTHElNANCIALSTATEMENTS4HETYPESOF NON lNANCIAL INFORMATION THAT COULD BE USEFUL TO THE OWNER OF A SMALL BUSINESS ARE IMPOSSIBLE TO QUANTIFY BUT IN ASSESSING THE lRMS PERFORMANCE THE OWNER MAY WANT INFORMATIONABOUTTHEFOLLOWING

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non-financial information any information that cannot be found in the financial statements, and is not expressed in dollars and cents, or reliant on dollars and cents for its calculation

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The firm’s relationship with its customers 'IVENTHEDIFlCULTIESTHEYFACEINATTRACTINGCUSTOMERS ITISVITALTHATSMALLBUSINESSES RETAIN THOSE CUSTOMERS THEY ALREADY HAVE )T IS THEREFORE ESSENTIAL TO HAVE FEEDBACK FROMCURRENTCUSTOMERSONTHEIRDEGREEOFSATISFACTIONORDISSATISFACTION WITHCURRENT PRODUCTSANDSERVICESOFFEREDBYTHElRM#USTOMERSATISFACTIONSURVEYSAREDESIGNED FORTHISPURPOSE BUTOTHERMEASURESCOULDBEUSED SUCHAS s NUMBEROFREPEATSALES s NUMBEROFSALESRETURNS s NUMBEROFCUSTOMERCOMPLAINTS s NUMBEROFSALESENQUIRIESCATALOGUEREQUESTS s DEGREEOFBRANDRECOGNITION BASEDONMARKETRESEARCH

The suitability of stock "USINESSES MUST ASSESS THE SUITABILITY OF THEIR STOCK ON A CONTINUOUS BASIS TO ENSURE THATTHEYAREMEETINGTHEDEMANDSOFCONSUMERS4HELEVELOF3ALESREPORTSHOWMUCH WAS SOLD BUT IT GIVES LITTLE FEEDBACK ON WHETHER CUSTOMERS WERE SATISlED WITH THEIR PURCHASE .OT EVERY CUSTOMER CAN BE SURVEYED BUT THE NUMBER OF SALES RETURNS WILL PROVIDEAUSEFULGUIDETOTHESUITABILITYOFSTOCK WITHTHElRMKEEPINGDETAILEDRECORDS ONTHEREASONSFORTHOSERETURNS4HENUMBEROFPURCHASERETURNSWILLPROVIDEAGOOD GUIDEASTOTHEQUALITYOFSTOCK ASWILLTHENUMBEROFCUSTOMERCOMPLAINTS

The firm’s relationship with its employees !LTHOUGHNOTREPORTEDDIRECTLYINTHE)NCOME3TATEMENT THEPERFORMANCEOFEMPLOYEES HASADIRECTANDSIGNIlCANTBEARINGONWHETHERAPROlTORLOSSISGENERATED3TAFFMAY BE RESPONSIBLE FOR IMPORTANT TASKS SUCH AS GENERATING 3ALES OR MANAGING STOCK SO APPRAISINGTHEIRPERFORMANCEISANIMPORTANTPARTOFASSESSINGTHElRMSPERFORMANCE 4HISCOULDBEDONEBYSTRUCTUREDPERFORMANCEAPPRAISALS 4HE DEGREE OF EMPLOYEE SATISFACTION AND WORKPLACE HARMONY ON THE OTHER HAND COULDBEASSESSEDBYTHENUMBEROFDAYSLOSTDUETOSICKLEAVEINDUSTRIALACTION ORTHE STAFFTURNOVERAVERAGELENGTHOFEMPLOYMENT

The state of the economy %VENTHEMOSTPROlTABLEBUSINESSWILLSTRUGGLETOSURVIVEINASHRINKINGECONOMY SOTHE STATEOFTHEECONOMYMUSTBEFACTOREDINTOANYEVALUATIONOFPROlTABILITY3PECIlCALLY THEOWNERMAYWISHTOCONSIDERINTERESTRATES THEUNEMPLOYMENTRATE ANDTHENUMBER OFCOMPETITORSITFACES ALLOFWHICHWILLAFFECTTHElRMSABILITYTOGENERATE3ALES4HELEVEL OFINmATIONWILLALSOBERELEVANTWHENASSESSINGTHElRMSABILITYTOCONTROLITSEXPENSES

REVIEW QUESTIONS 18.11

1 Explain FOUR LIMITATIONS OF RELYING SOLELY ON THE )NCOME 3TATEMENT AND PROlTABILITYINDICATORSTOEVALUATEPROlTABILITY 2 DefineTHETERM@NON lNANCIALINFORMATION 3 StateTWOMEASURESTHATCOULDBEUSEDTOASSESS s THElRMSRELATIONSHIPWITHITSCUSTOMERS s THESUITABILITYOFSTOCK s THElRMSRELATIONSHIPWITHITSEMPLOYEES s THESTATEOFTHEECONOMY

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CHAPTER 18

18.12

E VA L U AT I N G P R O F I TA B I L I T Y

STRATEGIES TO IMPROVE PROFITABILITY

4HEWHOLEPOINTOFGATHERINGANDRECORDINGlNANCIALDATA REPORTINGlNANCIALINFORMATION ANDANALYSINGANDINTERPRETINGTHElNANCIALREPORTSISTOENABLETHEACCOUNTANTTOASSIST THEOWNERINMAKINGDECISIONS)NMANYCASESTHEACCOUNTANTWILLDOTHISBYPROVIDING ADVICESUGGESTINGSTRATEGIESTOIMPROVETHElRMSPERFORMANCE )FPROlTABILITYISAFUNCTIONOFTHElRMSABILITYTOEARNREVENUEANDCONTROLITSEXPENSES THENSTRATEGIESTOIMPROVEPROlTABILITYSHOULDCONCENTRATEONTHESETWOAREAS

Earning revenue )NORDERTOIMPROVEITSABILITYTOEARNREVENUE ABUSINESSCOULDCHANGEITS s Selling price. 3ELLINGPRICESCOULDBEDECREASEDTOGENERATEMORE3ALESVOLUME OR INCREASEDTOGENERATEGREATERREVENUEPERSALE s Advertising. !DVERTISING COULD BE INCREASED OR TARGETED MORE ACCURATELY AT PROSPECTIVECUSTOMERS s Stock mix. 3TOCKHELDFORSALECOULDBECHANGEDSOTHATONLYTHOSEPRODUCTSTHATARE INDEMANDAREKEPTONHANDSLOW MOVINGLINESSHOULDBEREMOVED ANDREPLACED WITHTHOSETHATSELL s Non-current assets. .ON CURRENT ASSETS COULD BE INCREASED OR REPLACED BY MORE EFlCIENT VERSIONS TO ENABLE THE lRM TO INCREASE 3ALES OR LOWER OPERATING AND MAINTENANCE EXPENSES  4HIS MAY BE BETTER EQUIPMENT DISPLAY lTTINGS DELIVERY VEHICLESOR INEXTREMECASES ANEWLOCATION s Customer service. )NTERNAL PROCEDURES SUCH AS PAPERWORK COULD BE MADE MORE CUSTOMER FRIENDLY STAFF TRAINING COULD IMPROVE EMPLOYEES SERVICEPRODUCT KNOW LEDGE EXTRA SERVICES SUCH AS DELIVERIES WRAPPING INTERNETPHONE ACCESS AND PRODUCTADVICE COULDBEOFFERED

Controlling expenses )NORDERTOIMPROVEITSABILITYTOCONTROLEXPENSES ABUSINESSCOULDCHANGEITS s Management of stock. !NALTERNATIVESUPPLIERMAYBEABLETOPROVIDECHEAPERAND OR BETTER QUALITY STOCK WHILE DIFFERENT ORDERING PROCEDURES COULD REDUCE STORAGE COSTSAND3TOCK,OSSES ORGENERATEPRICEDISCOUNTS3EE#HAPTERFORADETAILED DISCUSSIONOFSTOCKMANAGEMENTPRINCIPLES s Management of staff. $IFFERENTROSTERINGSYSTEMS APPROPRIATEINCENTIVESANDEXTRA TRAININGMAYIMPROVESTAFFPRODUCTIVITYANDPERFORMANCE s Management of NCAs. !SSETSTHATAREINEFlCIENT UNDER UTILISEDORUN2ELIABLEARE ULTIMATELYEXPENSIVE ANDSHOULDBEREPLACEDORREMOVED 4HESPECIlCNATUREOFTHEADVICEGIVENTOTHEOWNERWILLDEPENDINLARGEPARTONTHE CIRCUMSTANCESOFTHEINDIVIDUALBUSINESSINQUESTIONWHATISRIGHTFORONEMAYNOTBE APPROPRIATEFORANOTHER4HEACCOUNTANTSROLEISTOPROVIDEGUIDANCEANDASSISTANCESO THATDECISIONSAREMADEINANINFORMEDMANNER BUTULTIMATELYITISUPTOTHEOWNERTO DECIDEWHATCOURSEOFACTIONTOTAKE

REVIEW QUESTIONS 18.12

1 StateTHREESTRATEGIESTHATCOULDBEUSEDTOIMPROVEAlRMSABILITYTOEARN REVENUE 2 StateTHREESTRATEGIESTHATCOULDBEUSEDTOIMPROVEAlRMSABILITYTOCONTROL ITSEXPENSES

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UNITS 3&4

WHERE HAVE WE BEEN? s !NALYSINGINVOLVESEXAMININGTHEREPORTSINDETAILTOIDENTIFYCHANGESORDIFFERENCES INPERFORMANCE s )NTERPRETING INVOLVES EXAMINING THE RELATIONSHIPS BETWEEN ITEMS IN THE REPORTS IN ORDERTOEXPLAINTHECAUSEANDEFFECTOFTHOSECHANGESORDIFFERENCES s 0ROlTABILITYISABOUTASSESSINGTHElRMSCAPACITYORABILITYTOEARNPROlT ASSUMING ALLOTHERFACTORSWEREEQUAL s 4HEREAREVARIOUSTOOLSAVAILABLETOASSESSPROlTABILITY INCLUDINGTRENDS VARIANCES BENCHMARKSANDPROlTABILITYINDICATORS s "ENCHMARKS FOR ASSESSING PROlTABILITY INCLUDE PERFORMANCE IN PREVIOUS PERIODS BUDGETEDPERFORMANCEANDTHEPERFORMANCEOFOTHERSIMILARlRMS s 0ROlTABILITYINDICATORSEXPRESSANELEMENTOFPROlTINRELATIONTOSOMEOTHERASPECT OFBUSINESSPERFORMANCE s 2ETURNON/WNERS)NVESTMENTASSESSESPROlTABILITYFROMANINVESTORSPOINTOFVIEW s 4HE $EBT 2ATIO HAS IMPLICATIONS FOR BOTH THE RISK LONG TERM STABILITY AND RETURN 2ETURNON/WNERS)NVESTMENT  s 2ETURNON!SSETSASSESSESPROlTABILITYFROMAMANAGERSPOINTOFVIEW s 4HE.ET0ROlT-ARGINAND'ROSS0ROlT-ARGINASSESSEXPENSECONTROL s 4HE2ETURNON!SSETSDEPENDSONTHE!SSET4URNOVERANDTHE.ET0ROlT-ARGIN s %VALUATINGPROlTABILITYISLIMITEDBYTHEUSEOFHISTORICALDATA THEUSEOFAVERAGES DIFFERENTACCOUNTINGMETHODSANDLIMITEDINFORMATION s ! BUSINESS MAY REQUIRE NON lNANCIAL INFORMATION ABOUT ITS RELATIONSHIP WITH ITS CUSTOMERS ITSSTOCK ITSRELATIONSHIPWITHITSEMPLOYEES ANDTHESTATEOFTHEECONOMY

EXERCISES

EXERCISE 18.1 PROFITABILITY

W B

page 402

6INCE)ACONISISTHEOWNEROF#HELTENHAM(I&I WHICHLASTYEAREARNEDPROlT (ISFRIEND-ARINDA2ENDLEISTHEOWNEROF-ENTONE3TEREO3TORE WHICHEARNED PROlTFORTHESAMEPERIOD6INCEHASSTATEDTHATBECAUSEHISlRMSPROlTISHIGHER HIS lRMMUSTBEMOREPROlTABLE Required a ExplainWHY6INCESSTATEMENTISINCORRECT b StateTWOBASESTHATPROlTCOULDBECOMPAREDAGAINSTINANASSESSMENTOF PROlTABILITY

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CHAPTER 18

E VA L U AT I N G P R O F I TA B I L I T Y

EXERCISE 18.2 RETURN ON OWNER’S INVESTMENT

W B

page 403

+ARLS +ITES IS A KITE SHOP OWNED AND RUN BY +ARL ,ARGERmAG +ARL HAS PROVIDED THE FOLLOWINGINFORMATIONRELATINGTOITSPERFORMANCEOVERTHELASTTWOYEARS

Net Profit Average Capital

2015

2016

15 000

14 400

150 000

120 000

+ARLISCONSIDERINGWHETHERTOCONTINUEASTHEOWNER ORSELLTHEBUSINESSANDINVEST INAPROPERTYTRUSTTHATISCURRENTLYEARNINGPERYEAR Required a CalculateTHE2ETURNON/WNERS)NVESTMENTFOR+ARLS+ITESFORAND b ExplainTHECAUSES OFTHECHANGEINTHE2ETURNON/WNERS)NVESTMENTFROM TO c StateTWOREASONSWHY+ARLSHOULDBEHAPPYWITHTHElRMSPROlTABILITYIN d State ONE REASON WHY +ARL SHOULD BE CONCERNED ABOUT THE lRMS PROlTABILITY IN 

EXERCISE 18.3 RETURN ON OWNER’S INVESTMENT AND DEBT RATIO

W B

page 404

"ABBLING "ROOKE SELLS PONDS AND OTHER GARDEN ORNAMENTS AND HAS PROVIDED THE FOLLOWINGINFORMATIONRELATINGTOITSPERFORMANCEOVERTHELASTTWOYEARS 2015 Net Profit

2016

22 000

10 000

10%

12.5%

Total Liabilities

180 000

320 000

Total Assets

400 000

400 000

Return on Owner’s Investment

Required a StateWHETHERPROlTABILITYIMPROVEDORWORSENEDINJustifyYOURANSWER b CalculateTHE$EBT2ATIOFOR"ABBLING"ROOKEFORAND c Explain THE EFFECT OF THE CHANGE IN THE $EBT 2ATIO ON THE LONG TERM STABILITY OF "ABBLING"ROOKE d ExplainTHEEFFECTOFTHECHANGEINTHE$EBT2ATIOONTHEPROlTABILITYOF"ABBLING "ROOKE e Discuss WHETHER THE OWNER SHOULD BE PLEASED ABOUT THE CHANGE IN THE lRMS PERFORMANCEIN

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UNITS 3&4

EXERCISE 18.4 RETURN ON OWNER’S INVESTMENT AND RETURN ON ASSETS

W B

page 405

,EGEND'UITARSAND!XEMANS(EAVENARECOMPETITORSINSELLINGMUSICALINSTRUMENTS 4HEFOLLOWINGINFORMATIONRELATESTOTHEIRTRADINGPERFORMANCEFOR Legend Guitars

Axeman’s Heaven

Net Profit

12 000

12 000

Average Owner’s Equity

80 000

40 000

120 000

150 000

Return on Owner’s Investment

15%

30%

Debt Ratio

22 000

10 000

Average Total Assets

Required a StateWHATISMEASUREDBY2ETURNON!SSETS b CalculateTHE2ETURNON!SSETSFOREACHlRMFOR c ExplainWHYTHE2ETURNON/WNERS)NVESTMENTISHIGHERFOR!XEMANS(EAVENTHAN ,EGEND'UITARS d &ROM A MANAGERS POINT OF VIEW state WHICH lRM IS MORE PROlTABLE Justify YOUR ANSWER e ExplainWHYAlRMS2ETURNON/WNERS)NVESTMENTWILLALWAYSBEGREATERTHANITS 2ETURNON!SSETS f State ONE OTHER INDICATOR THE ACCOUNTANT WOULD NEED TO CONSIDER BEFORE GIVING ADVICETOIMPROVEPROlTABILITYExplainTHEROLEOFTHISINDICATOR

EXERCISE 18.5 RETURN ON ASSETS AND ASSET TURNOVER

W B

page 407

/NLY"IKESHASPRESENTEDTHEFOLLOWINGINFORMATIONRELATINGTOITSPERFORMANCEFOR AND 2014 Sales Revenue Net Profit Average Total Assets Return on Assets

2015

300 000

448 000

15 000

16 800

200 000

280 000

7.5%

6%

4HEOWNEROF/NLY"IKESARGUESTHATEXPENSECONTROLMUSTHAVEIMPROVEDIN BECAUSE.ET0ROlTINCREASED Required a b c d

StateWHATISMEASUREDBY@!SSET4URNOVER Calculate!SSET4URNOVERFOR/NLY"IKESFORAND ExplainWHY!SSET4URNOVERHASCHANGEDFROMTO 2EFERRINGTO!SSET4URNOVERAND2ETURNON!SSETS explainWHYTHEOWNERSASSERTION ISINCORRECT e SuggestTWOSTRATEGIESTHEOWNERCOULDADOPTTOIMPROVE.ET0ROlTINWITHOUT CHANGING!SSET4URNOVER

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CHAPTER 18

E VA L U AT I N G P R O F I TA B I L I T Y

EXERCISE 18.6 ASSET TURNOVER AND NET PROFIT MARGIN

W B

page 408

&ILMORE &ITTINGS SELLS HARDWARE AND HOMEWARES AND HAS PROVIDED THE FOLLOWING INFORMATIONRELATINGTOISPERFORMANCEFOR Filmore Fittings Return on Owner’s Investment Return on Assets Asset Turnover Net Profit Margin

Industry average

20%

12.5%

6%

8%

0.60 times

0.64 times

10%

12.5%

Required a StateTWOREASONSWHYTHE2ETURNON!SSETSOF&ILMORE&ITTINGSISLOWERTHANTHE INDUSTRYAVERAGE b StateTWOBENCHMARKSOTHERTHANTHEINDUSTRYAVERAGETHATCOULDBEUSEDTOASSESS THE2ETURNON!SSETSOF&ILMORE&ITTINGS c SuggestTWOSTRATEGIES&ILMORE&ITTINGSCOULDADOPTTOIMPROVEITS!SSET4URNOVER d Explain WHY AN IMPROVEMENT IN EXPENSE CONTROL COULD STILL SEE TOTAL EXPENSES INCREASE e !SSUMING IT HAD THE SAME TOTAL ASSETS AS THE INDUSTRY AVERAGE   state WHETHERTHE$EBT2ATIOOF&ILMORE&ITTINGSWOULDBE s HIGHERTHANTHEINDUSTRYAVERAGE s LOWERTHANTHEINDUSTRYAVERAGE s THESAMEASTHEINDUSTRYAVERAGE s UNABLETOBEDETERMINED Justify YOURANSWER

EXERCISE 18.7 NET PROFIT MARGIN

W B

page 409

!LL4HE7EIGHTSSELLSGYMEQUIPMENT ANDHASPROVIDEDTHEFOLLOWINGINFORMATIONABOUT ITSPROlTPERFORMANCEFORAND

Sales Net Profit Asset Turnover Return on Assets

2015

2016

153 000

175 000

8 500

11 000

1.8 times

1.75 times

10%

11%

Required a 2EFERRINGTOTHEINFORMATIONABOVE identifyONEINDICATORTHATSUPPORTSTHECLAIM THATTHElRMSABILITYTOEARNREVENUEHASWORSENED b StateTHEREASONFORTHEDECREASEINTHElRMS!SSET4URNOVER c StateWHATISMEASUREDBYTHE.ET0ROlT-ARGIN d CalculateTHE.ET0ROlT-ARGINFORAND e ExplainWHYTHElRMS2ETURNON!SSETSHASINCREASEDIN

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EXERCISE 18.8 GROSS PROFIT MARGIN

W B

page 410

(OLLYS'OLF'EARHASPROVIDEDTHEFOLLOWINGINFORMATIONFOR $ Sales Revenue

120 000

Gross Profit

75 000

Adjusted Gross Profit

72 000

Net Profit

45 000

Gross Profit Margin – 2009

60%

Required a b c d

ExplainWHATISMEASUREDBYTHE'ROSS0ROlT-ARGIN Calculate'ROSS0ROlT-ARGINFOR StateTWOSTRATEGIESTHEOWNERCOULDADOPTTOIMPROVETHE'ROSS0ROlT-ARGIN ExplainHOWINCREASINGSELLINGPRICESCOULDLEADTOANINCREASEINTHE'ROSS0ROlT -ARGINBUTADECREASEIN'ROSS0ROlT e SuggestTWOSTRATEGIESTHATTHEOWNERCOULDADOPTTOIMPROVETHEADJUSTED'ROSS 0ROlTWITHOUTCHANGINGTHE'ROSS0ROlT-ARGIN

EXERCISE 18.9 GROSS PROFIT MARGIN

W B

page 411

4HE'ROSS0ROlT-ARGINOF#AMPBELL0AINTSFELLFROMINTOIN)N RESPONSE THEOWNERHASDECIDEDTOINCREASESPENDINGONADVERTISING Required a SuggestTWOPOSSIBLEREASONSFORTHECHANGEINTHE'ROSS0ROlT-ARGINFROM TO b ExplainWHYTHEOWNERSPLANOFACTIONWILLNOTLEADTOANIMPROVEMENTINTHE'ROSS 0ROlT-ARGIN c StateONEWAYOFIMPROVINGTHE'ROSS0ROlT-ARGINWITHOUTAFFECTING!SSET4URNOVER d ExplainHOWTHEOWNERSPLANOFACTIONCOULDLEADTO s ANIMPROVEMENTINTHE.ET0ROlT-ARGIN s AWORSENINGINTHE.ET0ROlT-ARGIN e StateTWOPIECESOFNON lNANCIALINFORMATIONTHEOWNERMAYWANTTOSEETOASSESS THEQUALITYOFHISSTOCK f State ONE LIMITATION OF RELYING ON THE 'ROSS 0ROlT -ARGIN TO ASSESS THE lRMS PROlTABILITY

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CHAPTER 18

E VA L U AT I N G P R O F I TA B I L I T Y

EXERCISE 18.10 VERTICAL ANALYSIS OF THE INCOME STATEMENT

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page 412

7OOLLY'OODISACLOTHINGSHOP ANDITHASPROVIDEDAVERTICALANALYSISOFITS)NCOME 3TATEMENTSFORTHEYEARENDING$ECEMBERAND WOOLLY GOOD Income Statement for the year ended 31 December 2015

2016

$

%

$

%

Sales Revenue

90 000

100

120 000

100

Less Cost of Goods Sold

37 800

42

54 000

45

Gross Profit

52 200

58

66 000

55

Less Stock Loss Adjusted Gross Profit

1 800

3

2 400

2

50 400

55

63 600

53

15 300

17

21 600

18

9 000

10

12 000

10

Advertising

11 700

13

13 200

11

Net Profit

13 500

15

16 800

14

Less Other Expenses Wages Rent

Required a ListTHREEPOSSIBLEREASONSFORTHEINCREASEIN3ALESREVENUE b StateWHETHEROVERALLEXPENSECONTROLHASIMPROVEDORWORSENEDINJustify YOURANSWER c ExplainHOWAREDUCTIONINTHE'ROSS0ROlT-ARGINHASBEENBENElCIALFORTHElRM IN d StateTWOREASONSWHYTHEOWNERSHOULDnotBECONCERNEDABOUTTHEDECREASEIN THE!DJUSTED'ROSS0ROlT-ARGIN e SuggestTWOSTRATEGIESTHElRMCOULDADOPTTOIMPROVEITSCONTROLOFWAGES f SuggestONEPOSSIBLEREASONWHYRENTHASINCREASED g DiscussWHETHERTHECHANGEINADVERTISINGHASBEENBENElCIALTOTHElRMSOVERALL PROlTABILITY h State TWO PIECES OF NON lNANCIAL INFORMATION THE OWNER COULD USE TO ASSESS THE lRMSRELATIONSHIPWITHITSSTAFF

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EXERCISE 18.11 GRAPHICAL REPRESENTATION OF VERTICAL ANALYSIS

W B

page 414

0ETER#OLE%NTERPRISESHASPRESENTEDTHEFOLLOWINGGRAPHSRELATINGTOITSPROlTABILITYFOR AND Cost of Goods Sold Wages

2015

Rent Stock loss Advertising Net Profit

Cost of Goods Sold Wages

2016

Rent Stock Loss Advertising Net Profit

Additional information: s 3ALESREVENUEWASINANDIN s 2ENTEXPENSEWASINEACHYEAR s 4OTALASSETSREMAINEDTHESAMEBUTTHE$EBT2ATIODECREASEDIN Required a 2EFERRING TO INFORMATION PROVIDED identify ONE REASON FOR THE INCREASE IN 3ALES REVENUEIN b 2EFERRINGTOTHEGRAPHS explainWHYTHERENTEXPENSESEGMENTTHEGREENSEGMENT ISSMALLERIN c SuggestTWOSTRATEGIES0ETERMAYHAVEUSEDTOCAUSETHECHANGEIN3TOCK,OSS d StateWHETHERWAGESEXPENSEINDOLLARTERMS WOULDBEHIGHER LOWERORTHESAME INJustifyYOURANSWER e ExplainWHYTHE'ROSS0ROlT-ARGINWOULDBELOWERIN f DiscussWHETHERPROlTABILITYIMPROVED WORSENEDORREMAINEDTHESAMEIN

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Cambridge University Press

Where are we headed? After completing this chapter, you should be able to: s define@LIQUIDITY s analyseLIQUIDITYAND EFlCIENCYUSINGTRENDS VARIANCES BENCHMARKSAND LIQUIDITYINDICATORS s calculateANDexplainVARIOUS LIQUIDITYANDEFlCIENCY INDICATORS s explainTHERELATIONSHIP BETWEENTURNOVERINDICATORS s suggestSTRATEGIESTO IMPROVELIQUIDITYANDMANAGE STOCKANDDEBTORS

Course advice: advice: 4HE6#%!CCOUNTING3TUDY 4HE 6#% !CCOUNTING 3TUDY $ESIGNSTATESTHATSTUDENTS $ESIGN STATES THAT STUDENTS WILLNOTBEREQUIREDTO WILL NOT BE REQUIRED TO CALCULATElNANCIALINDICATORS CALCULATE lNANCIAL INDICATORS INTHEEXAMINATION(OWEVER IN THE EXAMINATION (OWEVER CALCULATIONSAREINCLUDED CALCULATIONS ARE INCLUDED INTHISTEXTASANESSENTIAL IN THIS TEXT AS AN ESSENTIAL MECHANISMFORUNDERSTANDING MECHANISM FOR UNDERSTANDING THEINFORMATIONTHESEINDICATORS THE INFORMATION THESE INDICATORS PRESENT

CHAPTER 19

EVALUATING LIQUIDITY KEY TERMS After completing this chapter, you should be familiar with the following terms: s s s s s s s s

LIQUIDITY 7ORKING#APITAL2ATIO7#2 1UICK!SSET2ATIO1!2 #ASH&LOW#OVER#&# 3TOCK4URNOVER34/ $EBTORS4URNOVER$4/ $EBTORS!GEING!NALYSIS #REDITORS4URNOVER#4/ 

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456

UNITS 3&4

19.1 ASSESSING LIQUIDITY #HAPTER  DISCUSSED THE TOOLS AND TECHNIQUES THAT CAN BE EMPLOYED TO EVALUATE PROlTABILITY WITH THE AIM OF PROVIDING BUSINESS OWNERS WITH ADVICE TO AID THEIR DECISION MAKING4HISCHAPTERTAKESASIMILARAPPROACH BUTCONCENTRATESINSTEADONAN ASSESSMENTOFLIQUIDITY

Liquidity refers to the ability of a business to meet its short-term debts as they fall due

liquidity the ability of a business to meet its short-term debts as they fall due

Liquidity REFERSTOTHEABILITYOFABUSINESSTOMEETITSSHORT TERMDEBTSASTHEYFALL DUE !NY ASSESSMENT OF LIQUIDITY SHOULD BEGIN BY ANALYSING THE level OF LIQUID FUNDS THAT IS AVAILABLE TO MEET SHORT TERM OBLIGATIONS 4HIS WILL OBVIOUSLY INCLUDE CASH THAT ISALREADYONHAND BUTITWILLALSOINCLUDECASHTHATCANBEGENERATEDFROMSTOCKAND DEBTORS (OWEVER IT SHOULD ALSO ANALYSE THE speed AT WHICH THOSE LIQUID RESOURCES BECOMEAVAILABLE SOTHATWECANASSESSWHETHERTHECASHWILLBEAVAILABLEINTIMETO MEETTHElRMSSHORT TERMOBLIGATIONS

Tools for assessing liquidity 4HE SAME TYPES OF TOOLS THAT WERE USED TO ASSESS PROlTABILITY CAN BE APPLIED TO AN ASSESSMENTOFLIQUIDITY s TRENDS s BENCHMARKS s VARIANCES s LIQUIDITYINDICATORS )NTERMSOFIDENTIFYINGtrendsANDvariances THEPRIMARYSOURCESOFINFORMATIONWILL BE THE #ASH &LOW 3TATEMENT AND "UDGETED #ASH &LOW 3TATEMENT WHICH DETAIL THE ACTUALANDEXPECTEDINmOWSANDOUTmOWSOFCASH4HISWASCOVEREDINDETAILIN#HAPTER  )NFACT THE"UDGETED#ASH&LOW3TATEMENTISESSENTIALTOANANALYSISOFLIQUIDITY AS ITDETAILSALLEXPECTEDCASHINmOWSANDCASHOUTmOWS ANDSTATESCATEGORICALLYWHETHER THEBUSINESSWILLBEABLETOMEETITSCASHOBLIGATIONSFORTHECOMINGYEAR )N#HAPTER WEASSESSEDPROlTABILITYAGAINSTTHREEKEYBENCHMARKS ANDTHESECAN BEAPPLIEDTOASSESSLIQUIDITY s LIQUIDITYIN previous periods s budgetedLIQUIDITY s LIQUIDITYOFsimilar businesses ISBN 978-1-107-64070-2 © Anthony SImmons, Richardy Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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)N ADDITION SOME OF THE LIQUIDITY INDICATORS HAVE THEIR OWN SPECIlC BENCHMARK AGAINSTWHICHLIQUIDITYCANBEMEASURED 7EWILLUSETHEFOLLOWINGINDICATORSTOASSESSTHElevelOFLIQUIDITY s 7ORKING#APITAL2ATIO7#2 s 1UICK!SSET2ATIO1!2 s #ASH&LOW#OVER#&#  7EWILLUSETHREEEFlCIENCYINDICATORSTOASSESSTHEspeedOFLIQUIDITY s 3TOCK4URNOVER34/ s $EBTORS4URNOVER$4/ s #REDITORS4URNOVER#4/ 

REVIEW QUESTIONS 19.1

1 2 3 4

DefineTHETERM@LIQUIDITY ExplainTHEROLEOFTHE"UDGETED#ASH&LOW3TATEMENTINEVALUATINGLIQUIDITY StateTHREEINDICATORSTHATAREUSEDTOASSESSTHELEVELOFLIQUIDITY State THREEINDICATORSTHATAREUSEDTOASSESSTHESPEEDOFLIQUIDITY

19.2 WORKING CAPITAL RATIO (WCR) 4HEWorking Capital Ratio (WCR)ASSESSESLIQUIDITYBYCOMPARINGCURRENTASSETSAND CURRENTLIABILITIES Working Capital Ratio: formula Working Capital Ratio (WCR)

Current assets

=

Current liabilities

Working Capital Ratio (WCR) a liquidity indicator that measures the ratio of current assets to current liabilities, to assess the firm’s ability to meet its short-term debts

3PECIlCALLY THE7ORKING#APITAL2ATIOMEASURESHOWMANYDOLLARSOFCURRENTASSETS AREAVAILABLETOMEETEACHDOLLAROFCURRENTLIABILITIES!SARESULT ITINDICATESWHETHER THEBUSINESSWILLBEABLETOMEETITSSHORT TERMDEBTSITSCURRENTLIABILITIES USINGCASH GENERATEDFROMITSCURRENTASSETS

Grant’s Glasses has presented the following extract from its Balance Sheet as at 31 January 2015: Current Assets Bank Debtors Control Stock Control Prepaid Rent Expense Total Current Assets

EXAMPLE

Current Liabilities 3 500 12 500 34 000 1 000 $51 000

Creditors Control Loan – GV Bank Accrued Wages GST Clearing Total Current Liabilities

20 000 12 000 500 1 500 $34 000

4HE7ORKING#APITAL2ATIOWOULDBECALCULATEDASISSHOWNIN&IGURE Figure 19.1

Calculating Working Capital Ratio (WCR)

WCR

= =

51 000 34 000 1.5:1

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4HE7ORKING#APITAL2ATIOSHOWSTHAT'RANTS'LASSESHASOFCURRENTASSETSFOR EVERYOFCURRENTLIABILITIES

Assessing the Working Capital Ratio !SWASSTATEDEARLIER THE7ORKING#APITAL2ATIOFORTHECURRENTPERIODCANBECOMPARED AGAINST previous periods OR THE budgeted lGURE TO ASSESS WHETHER IT HAS INCREASED OR DECREASED BUT THIS WILL NOT ALLOW US TO DETERMINE WHETHER IT IS SATISFACTORY OR UNSATISFACTORY 4HE7ORKING#APITAL2ATIOISBASEDONTHEIDEATHATTHECASHTHATCANBEGENERATED FROMCURRENTASSETSINTHENEXTMONTHS SHOULDBEENOUGHTOMEETTHESHORT TERM DEBTSTHATFALLDUEINTHATTIME!SARESULT satisfactoryLIQUIDITYEXISTSIFTHE7ORKING #APITAL2ATIOISat least 1:1 ASTHISWOULDINDICATETHATTHEREISATLEASTOFCURRENT ASSETSAVAILABLETOMEETEVERYOFCURRENTLIABILITIES ANDTHElRMWOULDBEABLETO MEETALLITSSHORT TERMDEBTSASTHEYFALLDUE'RANTS'LASSESACTUALLYHASWORTHOF CURRENTASSETSFOREVERYDOLLAROFCURRENTLIABILITIES SOITSLEVELOFLIQUIDITYISSATISFACTORY !7ORKING#APITAL2ATIOOFless than 1:1 INDICATES unsatisfactory LIQUIDITYTHEBUSINESS MAYNOTBEABLETOMEETITSDEBTSASTHEYFALLDUEASITHASINSUFlCIENTCURRENTASSETSTO MEETITSCURRENTLIABILITIES)FTHESITUATIONISNOTADDRESSED ANDCREDITORSANDOTHERSARE UNABLETOBEPAID THEBUSINESSMAYBEFORCEDINTOLIQUIDATION WITHITSASSETSSOLDTO RAISEFUNDSTOPAYOFFITSDEBT !7ORKING#APITAL2ATIOOFexactly1:1WOULDLEAVENOMARGINFORERRORIFANYOFTHE CURRENT ASSETS COULD NOT BE CONVERTED INTO CASH THE BUSINESS WOULD HAVE INSUFlCIENT CASHTOMEETITSDEBTS ANDCOULDFACELIQUIDITYPROBLEMS Working Capital Ratio less than 1:1 )FTHE7ORKING#APITAL2ATIOISless than 1:1 THElRMMAYEXPERIENCEDIFlCULTIESINMEETING ITSDEBTSASTHEYFALLDUE)NORDERTOAVOIDSUCHDIFlCULTIES THEOWNERMAYBEREQUIREDTO s MAKEACASH CAPITALCONTRIBUTION s SEEKADDITIONALlNANCEBYENTERINGINTO OREXTENDING ANOVERDRAFTFACILITY s TAKEOUTALOANTOPURCHASENON CURRENTASSETS )NTHELONGTERM BORROWINGMAYWORSENTHECASHSITUATION ASTHESERVICINGOFTHE DEBTWOULDREQUIRECASHTOREPAYBOTHTHEPRINCIPALANDINTEREST(OWEVER INTHESHORT TERM THESURVIVALOFTHEBUSINESSMAYDEPENDONTHEEXTRAlNANCEPROVIDEDBYALOAN Working Capital Ratio much greater than 1:1 !LTHOUGH IT IS BENElCIAL FOR THE 7ORKING #APITAL 2ATIO TO BE ABOVE  A BUSINESS OWNERSHOULDALSOBEWARYOFHAVINGA7ORKING#APITAL2ATIOTHATIStoo high ASTHIS MAYINDICATETHATTHEBUSINESSHASEXCESSCURRENTASSETSTHATAREIDLE ANDNOTBEING EMPLOYEDEFFECTIVELY 4HISCANBEAPPARENTINANUMBEROFDIFFERENTCURRENTASSETS s Bank"USINESSBANKACCOUNTSPAYVERYSMALLAMOUNTSOFINTEREST THUSTHEREISLITTLE TOGAINFROMKEEPINGMORECASHINTHEBANKTHANISNECESSARYTOMEETOBLIGATIONS EXPECTEDANDUNEXPECTED !BUSINESSWOULDBEBETTEROFFUSINGEXCESSCASHTO RETIRE DEBT EXPAND /PERATIONS OR EVEN TO MAKE OTHER INVESTMENTS EG A TERM DEPOSIT WHEREITWILLBEABLETOEARNAGREATERRETURNONITSFUNDS s Stock Control. ! LARGE AMOUNT OF STOCK COULD INCUR ADDITIONAL STORAGE COSTS AND INCREASE THE POSSIBILITY OF STOCK LOSS DAMAGE AND TECHNICAL OBSOLESCENCE WHICH COULDREQUIREASTOCKWRITE DOWN s Debtors Control. ! LARGE DEBTORS lGURE MIGHT INDICATE AN INCREASING GROUP OF @AGEINGDEBTORS4HEOLDERADEBTBECOMESTHELESSLIKELYITISTOBERECEIVEDAND THEGREATERTHEPROBABILITYTHATTHEDEBTWILLGO@BADTHATIS BECOMEUNCOLLECTIBLE

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7HERETHE7ORKING#APITAL2ATIOISTOOHIGHTHEOWNERMAY s USEEXCESSCASHBYREPAYINGDEBTS PURCHASINGNON CURRENTASSETSORTAKINGEXTRA DRAWINGS s ALLOWSTOCKLEVELSTORUNDOWNBEFOREREORDERING s CONTACTDEBTORSTOCOLLECTAMOUNTSOUTSTANDING

REVIEW QUESTIONS 19.2

1 2 3 4 5

State WHATISMEASUREDBYTHE7ORKING#APITAL2ATIO7#2  ShowTHEFORMULATOCALCULATETHE7ORKING#APITAL2ATIO Explain WHYTHE7ORKING#APITAL2ATIOSHOULDBEATLEAST ExplainONEPROBLEMASSOCIATEDWITHANEXCESSIVE7ORKING#APITAL2ATIO State TWOACTIONSTHEOWNERMAYBEREQUIREDTOTAKEIF7ORKING#APITAL2ATIOIS s TOOLOW s TOOHIGH

19.3 QUICK ASSET RATIO (QAR) 5NDERLYINGTHEUSEOFTHE7ORKING#APITAL2ATIOTOASSESSTHELEVELOFLIQUIDITYISTHE ASSUMPTIONTHATALLCURRENTASSETSCANBELIQUIDATEDIMMEDIATELYIFCASHISNEEDEDTOMEET SHORT TERMDEBTS(OWEVER THEREARESOMEPRACTICALDIFlCULTIESWITHTHISASSUMPTION #ONSIDERstock-OSTTRADINGBUSINESSESWOULDALREADYBETRYINGTOSELLTHEIRSTOCK ASFASTASTHEYCAN SOTHEREISNOGUARANTEETHATALLTHEIRSTOCKWILLSUDDENLYBESOLD JUSTBECAUSETHElRMISFACINGLIQUIDITYPROBLEMS!NDTHEREISVIRTUALLYNOCHANCEOF THIS HAPPENING IMMEDIATELY !S A RESULT IT IS QUESTIONABLE WHETHER THESE ASSETS CAN BE RELIED ON AS SOURCES OF LIQUID FUNDS !LSO prepaid expenses CANNOT NORMALLY BE CONVERTED BACK INTO CASH )F THE BUSINESS HAS ENTERED INTO A CONTRACT AND PAID FOR A  MONTHLEASE ITISNOTLIKELYTOBEABLETOASKFORAREFUND !TTHESAMETIME ALTHOUGHAbank overdraftISACURRENTLIABILITY ITISUNLIKELYTHATIT WILLBECALLEDINFORREPAYMENT ASLONGASITREMAINSUNDERTHELIMIT4HISISANARGUMENT FOREXCLUDINGITASADEBTTHATWILLREQUIREPAYMENTINTHESHORTTERM)FTHEOVERDRAFTIS WELLBELOWTHELIMIT ITMAYREPRESENTASOURCEOFFUNDS Quick Asset Ratio (QAR) )NORDERTOOVERCOMETHESEDElCIENCIES THEQuick Asset Ratio (QAR)CANBEUSED a liquidity indicator that ASANALTERNATIVEINDICATOROFTHELEVELOFLIQUIDITY)TASSESSESTHElRMSABILITYTOMEETITS measures the ratio of quick immediateDEBTSUSINGITSimmediateASSETS

assets to quick liabilities, to assess the firm’s ability to meet its immediate debts

Quick Asset Ratio: formula Quick Asset Ratio = (QAR)

Current assets (excluding Stock and Prepaid Expenses) Current liabilities (excluding Bank Overdraft)

4HE 1UICK !SSET 2ATIO IS A MODIlCATION OF THE 7ORKING #APITAL 2ATIO IT EXCLUDES STOCKANDPREPAIDEXPENSESFROMCURRENTASSETSASTHEYMAYNOTBEEASILYCONVERTEDTO CASHINATIMEOFCRISIS ANDEXCLUDESANYBANKOVERDRAFTFROMCURRENTLIABILITIESASTHISIS UNLIKELYTOREQUIREREPAYMENT

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UNITS 3&4

Assessing the Quick Asset Ratio !LTHOUGHTHE1UICK!SSET2ATIOISASLIGHTLYDIFFERENTMEASUREOFLIQUIDITY THEBENCHMARKS FORASSESSINGITSADEQUACYREMAINTHESAMEASTHOSEUSEDTOASSESSTHE7ORKING#APITAL 2ATIO4HATIS THE1UICK!SSET2ATIOSHOULDBEATLEAST BUTCANALSOBECOMPARED TOTHE1UICK!SSET2ATIOFROMprevious periodsORTHEbudgetTOIDENTIFYINCREASESOR DECREASES

EXAMPLE

WILSON’S WHITE GOODS Balance Sheet (extract) as at 31 December 2015 Current Assets Debtors Control Stock Control Prepaid rent Total Current Assets

Current Liabilities 15 000 51 000 9 000 $75 000

Bank overdraft Creditors Control Accrued electricity GST Clearing

5 000 15 000 3 000 2 000

Total Current Liabilities

$25 000

!COMPARISONOFTHE7ORKING#APITAL2ATIOAND1UICK!SSET2ATIOISSHOWNIN&IGURE  STUDY TIP

Figure 19.2 !LTHOUGHPREPAID EXPENSESARE EXCLUDEDFROMQUICK ASSETS ACCRUED EXPENSESAREINCLUDED ASQUICKLIABILITIESAS THEYWILLSTILLHAVETO BEREPAID

Comparing Working Capital Ratio and Quick Asset Ratio

Working Capital Ratio WCR

= =

75 000 25 000 3:1

Quick Asset Ratio QAR

= =

15 000 20 000 0.75:1

4HE 7ORKING #APITAL 2ATIO INDICATES THAT THE BUSINESS HAS $3 OF CURRENT ASSETS FOR EVERYOFCURRENTLIABILITIESAND ASARESULT ITSLIQUIDITYISSATISFACTORYTHERESHOULD BESUFlCIENTCURRENTASSETSTOMEETITSCURRENTLIABILITIESASTHEYFALLDUE(OWEVER THE 1UICK !SSET 2ATIO SUGGESTS THAT LIQUIDITY IS UNSATISFACTORY BECAUSE THE lRM WILL HAVE ONLYCOFQUICKASSETSTOPAYQUICKLIABILITIES7HATDOESTHISMEANFORLIQUIDITY7ILL THEBUSINESSBEABLETOMEETITSSHORT TERMDEBTSORNOT 4HEFACTTHATTHE7ORKING#APITAL2ATIOISSATISFACTORYBUTTHE1UICK!SSET2ATIOIS UNSATISFACTORYISADIRECTRESULTOFTHEFACTTHATTHEBUSINESSHASALARGEINVESTMENTINITS STOCKANDPREPAIDEXPENSES'IVENTHEDIFlCULTIESINLIQUIDATINGPREPAIDEXPENSES THE lRMSABILITYTOMEETITSDEBTSWILLDEPENDHEAVILYONITSABILITYTOSELLITSSTOCKONTIME IFTHESTOCKCANBESOLD THElRMWILLBEABLETOMEETITSDEBTSASTHEYFALLDUEIFNOT LIQUIDITYPROBLEMSMAYRESULT )NORDERTOADDRESSTHESITUATION THEBUSINESSWILLNEEDTOIMPROVETHELEVELOFQUICK ASSETSBYIMPROVINGDEBTORSORBYTRYINGTOMAINTAINAPOSITIVEBANKBALANCE)TCANALSO ATTEMPT TO REDUCE THE LEVEL OF QUICK LIABILITIES BY REDUCING THE LEVEL OF CREDITORS AND ACCRUEDEXPENSES

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REVIEW QUESTIONS 19.3

1 StateWHATISMEASUREDBYTHE1UICK!SSET2ATIO1!2  2 ShowTHEFORMULATOCALCULATETHE1UICK!SSET2ATIO 3 Explain WHY THE FOLLOWING ITEMS ARE EXCLUDED FROM THE CALCULATION OF THE 1UICK!SSET2ATIO s STOCK s PREPAIDEXPENSES s BANKOVERDRAFT 4 ExplainWHATISINDICATEDIFTHE7ORKING#APITAL2ATIOISSATISFACTORY BUTTHE 1UICK!SSET2ATIOISUNSATISFACTORY

19.4 CASH FLOW COVER (CFC) /NE OF THE KEY PROBLEMS WITH USING BOTH THE 7ORKING #APITAL 2ATIO AND THE 1UICK !SSET2ATIOISTHATTHEYRELYONstatic itemsTOMEASUREFUTURECASHmOWS4HATIS THE INFORMATIONUSEDINBOTHRATIOSCOMESFROMTHE"ALANCE3HEET SOITPROVIDESNOREAL INDICATIONOFTHECASHmOWSOFTHEBUSINESS )NCONTRAST THECash Flow Cover (CFC) ASSESSESLIQUIDITYBYIDENTIFYINGTHEACTUAL CASH THAT THE BUSINESS GENERATES FROM ITS /PERATING ACTIVITIES TO MEET ITS lNANCIAL OBLIGATIONS3PECIlCALLY ITMEASURESTHENUMBEROFTIMESAVERAGECURRENTLIABILITIESCAN BEMETUSINGTHE.ET#ASH&LOWSFROM/PERATIONS

Cash Flow Cover (CFC) a liquidity indicator that measures the number of times Net Cash Flows from Operations is able to cover average Current Liabilities

Cash Flow Cover: formula Cash Flow Cover (CFC)

=

Net Cash Flows from Operations Average Current Liabilities

)FABUSINESSCANNOTGENERATESUFlCIENTCASHFROMITSDAY TO DAYOPERATINGACTIVITIES IT WILL REQUIRE REGULAR CONTRIBUTIONS FROM THE OWNER OR EXTERNAL lNANCIERS IN ORDER TO MEETITSLOANREPAYMENTSANDPROVIDECASHFORTHEOWNERSDRAWINGS

EXAMPLE

Jenny’s Jumpers has provided the following information about its liquidity position as at 30 June: Net Cash Flows from Operations

2015

2016

$ 40 000

$ 36 000

Current liabilities at start

18 000

14 000

Current liabilities at end

14 000

10 000

#LEARLY THEREISLESSCASHAVAILABLEFROMOPERATINGACTIVITIESIN BUTHASLIQUIDITY IMPROVED OR WORSENED AS A RESULT 4HE #ASH &LOW #OVER FOR EACH YEAR WOULD BE CALCULATEDASISSHOWNIN&IGURE

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Figure 19.3

UNITS 3&4

Calculating Cash Flow Cover 2015

STUDY TIP

CFC

=

40 000

2016 CFC

=

(14 000 + 10 000)/2

(18 000 + 14 000)/2

!LTHOUGHITISCALLEDA @RATIO THECALCULATION ISACTUALLYEXPRESSEDIN TERMSOF@TIMES

=

40 000

36 000

=

12 000

16 000 =

2.5 times

36 000

=

3 times

)N .ET#ASH&LOWSFROM/PERATIONSWASABLETOPAYAVERAGECURRENTLIABILITIES TIMES4HISHASINCREASEDTOTIMESIN INDICATINGIMPROVEDLIQUIDITY7HYDID THISHAPPEN%VENTHOUGH.ET#ASH&LOWSFROM/PERATIONSDECREASEDFROM TO   IN  AVERAGE CURRENT LIABILITIES DECREASED BY PROPORTIONATELY MORE LEADINGTOANIMPROVEMENTINTHEABILITYOFTHElRMTOPAYITSSHORT TERMDEBTSUSINGITS OPERATINGCASHmOWS

Assessing the Cash Flow Cover 5NLIKE THE 7ORKING #APITAL 2ATIO AND 1UICK !SSET 2ATIO THERE IS NO SET BENCHMARK AT WHICH THE #ASH &LOW #OVER WOULD BE CONSIDERED SATISFACTORY (OWEVER IT CAN BE COMPAREDAGAINSTTHE#ASH&LOW#OVERFROMprevious periods ORTHEbudgeted#ASH &LOW#OVERTOASSESSWHETHERITHASIMPROVEDORWORSENED ORAGAINSTTHE#ASH&LOW #OVEROFsimilar businesses)NGENERAL THELONGERTHEPERIODBEINGEXAMINEDINTHE RATIO THE MORE TIMES THE BUSINESS WOULD EXPECT THE AVERAGE CURRENT LIABILITIES TO BE COVERED

REVIEW QUESTIONS 19.4

1 State WHATISMEASUREDBYTHE#ASH&LOW#OVER#&#  2 Show THEFORMULATOCALCULATETHE#ASH&LOW#OVER 3 State THREE BENCHMARKS THAT COULD BE USED TO ASSESS THE ADEQUACY OF THE #ASH&LOW#OVER

19.5 THE SPEED OF LIQUIDITY /URANALYSISOFLIQUIDITYSOFARHASBEENPREDICATEDONTHENOTIONTHATABUSINESSWILL STRUGGLE TO MEET ITS DEBTS AS THEY FALL DUE IF ITS CURRENTQUICK ASSETS ARE LESS THAN ITS CURRENTQUICK LIABILITIES 4HIS ASSESSMENT OF THE level OF LIQUIDITY USED THE 7ORKING #APITAL2ATIOANDTHE1UICK!SSET2ATIOTOASSESSHOWMUCHCASHTHEBUSINESSCOULD GENERATETOMEETITSSHORT TERMOBLIGATIONS (OWEVER BUSINESSESARENOTSTATICENTITIESTHEYARECONSTANTLYGENERATINGSALES WHICH WILLTHENTURNINTOCASH WHICHWILLTHENBEUSEDTOPURCHASEMORESTOCK TOGENERATE MORESALES ETC4HUS THELEVELOFLIQUIDITYIS ONITSOWN ANINADEQUATEMEASUREOFA lRMSABILITYTOMEETITSDEBTS)NFACT ABUSINESSCANSURVIVEINSPITEOFANUNSATISFACTORY LEVELOFLIQUIDITY IFTHEspeedOFITSTRADINGCYCLEISFASTENOUGH4HATIS IFABUSINESSCAN SELLITSSTOCKANDCOLLECTTHECASHFROMITSCUSTOMERS BEFORETHATCASHISNEEDED ITWILL BEABLETOSURVIVEEVENWITHAVERYLOW7ORKING#APITAL2ATIO "USINESSESSUCHASTHISMAYNEVERHAVEAHIGHLEVELOFCASHONHAND BUTCANSURVIVE BECAUSE THEIR turnover IS SO FAST 4HEREFORE OUR ASSESSMENT OF LIQUIDITY MUST ALSO CONSIDERTHESPEEDOFTHElRMS

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s 3TOCK4URNOVER34/ s $EBTORS4URNOVER$4/ s #REDITORS4URNOVER#4/  )NCOMMONWITH!SSET4URNOVERFROM#HAPTER THESEINDICATORSACTUALLYASSESS efficiencyTHEABILITYOFTHElRMTOMANAGEITSSTOCK DEBTORSANDCREDITORS(OWEVER BECAUSE THEY HAVE A DIRECT AND SIGNIlCANT EFFECT ON CASH mOWS NAMELY #ASH 3ALES 2ECEIPTSFROM$EBTORSAND0AYMENTSTO#REDITORS THEYALSOHAVEASIGNIlCANTEFFECT ONLIQUIDITY

REVIEW QUESTIONS 19.5

1 Explain HOW A lRM WITH A HIGH TURNOVER CAN REMAIN SOLVENT DESPITE AN UNSATISFACTORYLEVELOFLIQUIDITY 2 Define THE TERM @EFlCIENCY AS IT RELATES TO THE ASSESSMENT OF BUSINESS PERFORMANCE

19.6 STOCK TURNOVER (STO) !STHEMAINSOURCEOFREVENUE STOCKISALSOTHEMAINSOURCEOFCASHINmOWS"UTBEFORE CASHCANBECOLLECTEDFROMCASHSALESORDEBTORS THESTOCKMUSTlRSTBESOLDStock Turnover (STO) ASSESSES HOW EFFECTIVELY THE lRM HAS MANAGED ITS STOCK HOLDINGS BY CALCULATINGTHEAVERAGENUMBEROFDAYSTAKENTOCONVERTSTOCKINTOSALES Stock Turnover: formula Stock Turnover (STO)

=

Stock Turnover (STO) the average number of days it takes for a business to convert its stock into sales

Average stock x 365 Cost of Goods Sold

!VERAGESTOCKISUSEDINANATTEMPTTOREmECTTHESTOCKONHANDCARRIEDTHROUGHOUT THEPERIOD WHILEMULTIPLYINGBYCONVERTSTHETURNOVERINTODAYS &AST3TOCK4URNOVER ASMEASUREDBYLOWDAYS MEANSTHAT ONAVERAGE STOCKISSOLD QUICKLY4HISWILLENHANCETHElRMSABILITYTOGENERATECASHFROMTHESALEOFSTOCK AND ASSISTITSLIQUIDITY

Markwell Mirrors has provided the following information relating to its trading Operations for the year ended 30 June: 2015 Cost of Goods Sold Average stock

$ 90 000 25 000

EXAMPLE

2016 $ 100 000 20 000

4HE3TOCK4URNOVERWOULDBECALCULATEDASISSHOWNIN&IGURE Figure 19.4

Calculating Stock Turnover 2015

STO

2016

=

25 000 x 365

=

20 000 x 365

=

90 000

=

100 000

=

101 days*

=

73 days

2OUNDEDTONEARESTDAY

STO

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UNITS 3&4

4HElGURESINDICATETHATIN ITTOOKANAVERAGEOFDAYSTOSELLSTOCK4HE FOLLOWINGYEAR 3TOCK4URNOVERDECREASEDFAVOURABLYBYDAYSITONLYTOOKDAYSON AVERAGE TOTURNSTOCKINTOSALESIN )N -ARKWELL-IRRORSNOTONLYsold more stockASISSHOWNBYTHEINCREASEIN #OSTOF'OODS3OLD BUTITheld less stock on handIN DOWNTO IN "OTHFACTORSARERESPONSIBLEFORTHEIMPROVEMENTIN3TOCK4URNOVER

Assessing Stock Turnover )NTHEPRECEDINGEXAMPLE WEUSEDTHE3TOCK4URNOVERFROMA previous periodTOIDENTIFY ANIMPROVEMENT)NTERMSOFASSESSINGWHETHER3TOCK4URNOVERISSATISFACTORY ITCANBE COMPAREDAGAINSTTHEbudgetedlGURE ORTHE3TOCK4URNOVEROFsimilar firms !NASSESSMENTOF3TOCK4URNOVERMUSTALSOCONSIDERTHENATUREOFTHEGOODSSOLD 'OODS THAT ARE PERISHABLE SUCH AS FRESH PRODUCE OR SUSCEPTIBLE TO TECHNOLOGICAL OBSOLESCENCESHOULDHAVEAFAST3TOCK4URNOVERSOTHEYARENOTSUBJECTTOSTOCKLOSSOR STOCKWRITE DOWNISSUES2ELATIVELYCHEAPITEMSSHOULDALSOBESOLDMUCHFASTERTHAN MOREEXPENSIVEITEMS SUCHASLUXURYCARS Stock Turnover too slow )F3TOCK4URNOVERISTOOSLOWTHATIS AHIGHNUMBEROFDAYS THElRMWILLBELESSABLETO GENERATESALESAND THEREFORE LESSABLETOGENERATECASHINmOWSFROM#ASH3ALESAND 2ECEIPTSFROM$EBTORS INTIMETOMEETDEBTSASTHEYFALLDUE4HISCOULDBECAUSEDBY ADECREASEINTHELEVELOFSALESDUETOGENERALECONOMICCONDITIONS SEASONALFACTORS STOCKQUALITYORCOMPETITION ORANINCREASEINTHELEVELOFSTOCKONHANDDUETOORDERING MORESTOCKTHANISREQUIRED  )NTHISCASE THEBUSINESSMAYNEEDTO s EMPLOYSTRATEGIESTOincrease sales SUCHASADVERTISING CHANGINGSELLINGPRICESOR CHANGINGTHESTOCKMIXSEE#HAPTERFORSTRATEGIESTOINCREASESALES s decrease the level of stock on hand BY ORDERING LESS ORDERING SMALLER AMOUNTS MOREFREQUENTLYJUST IN TIMEORDERING ORREPLACINGSLOW MOVINGSTOCKLINES Stock Turnover too fast )TISALSOPOSSIBLETHAT3TOCK4URNOVERCOULDBETOOFAST!LTHOUGHTHEBUSINESSWOULD BEGENERATINGHIGHSALES ITMAYBEBECAUSETHESELLINGPRICEISTOOLOW ANDTHISWOULD BEALOSSOFPOTENTIALREVENUE ANDPROlT!LTERNATIVELY ITMAYBEBECAUSETHElRMIS HOLDINGTOOLITTLESTOCK)FTHISISTHECASE COSTSSUCHASDELIVERYMAYBEHIGHERBECAUSE DELIVERIES ARE MORE FREQUENT AND THE BUSINESS COULD LOSE THE POSSIBILITY OF EARNING DISCOUNTSFORBUYINGINBULK "ECAUSE IT ONLY MEASURES THE average TIME TAKEN TO SELL STOCK DECISIONS SUCH AS THESESHOULDNOTBEMADEONANASSESSMENTOF3TOCK4URNOVERALONE)TISIMPORTANT THATTHEOWNERALSOANALYSESTHESTOCKCARDS SOTHATHEORSHEHASDETAILEDINFORMATION ABOUTTHESPEEDATWHICHspecific lines of stockARESELLING SOTHATAPPROPRIATEDECISIONS CANBEMADE

Stock management 4HEREARECERTAINSTRATEGIESABUSINESSOWNERCANEMPLOYTOENSURETHATSTOCKISMANAGED WISELYTOMAXIMISETHEPOTENTIALFORSALES

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Review sales to maintain an appropriate stock mix 7HATIS@APPROPRIATEMAYCHANGEFROMSEASONTOSEASON ORASTASTESANDPREFERENCES CHANGE SOTHEOWNERMUSTPAYCLOSEATTENTIONTOWHICHSTOCKISSELLING3TOCKLINESTHAT ARE SELLING WELL SHOULD BE EXPANDED WHILE THOSE THAT ARE NOT SHOULD BE REDUCED OR EVENDISCONTINUED Promote the sale of complementary goods #OMPLEMENTARY GOODS ARE ADD ON SALES THAT ARE GENERATED TO SUPPORT THE ORIGINAL ITEMSOLD!SPARTOFITSASSESSMENTOFITSSTOCKMIX THEBUSINESSSHOULDCONSIDERWHAT @EXTRA SALES IT CAN GENERATE FROM STOCK THAT IS RELATED IN SOME WAY &OR EXAMPLE A BUSINESSSELLINGTENTSMAYALSOSELLSLEEPINGBAGS INmATABLEMATTRESSESANDGASLIGHTS TOENCOURAGEMORESALES Ensure stock is up to date 3ALESOFSOMESTOCKLINESWILLBEHEAVILYAFFECTEDBYCHANGESINFASHIONORTECHNOLOGY)N ORDERTOMAINTAINSALES STOCKOFTHESEITEMSMUSTBETHEMOSTCURRENTVERSIONAVAILABLE OLDERANDOUT OF DATEVERSIONSSHOULDBEDISCOUNTEDFORQUICKSALE Rotate stock 4HEPOSITIONINGOFSTOCKINTHESTORECANHAVEASIGNIlCANTIMPACTONWHETHERITSELLS ORSIMPLYSITSONTHESHELF0ARTICULARLYFORPERISHABLEITEMS OLDERPRODUCTSSHOULDBE MOVEDTOTHEFRONTSOTHEYARETAKENlRSTTHISWILLMINIMISESTOCKLOSSORWRITE DOWN ISSUES!TOTHERTIMES MOVINGANENTIRESTOCKLINETOANOTHERLOCATIONWITHINTHESTORE MAYBOOSTITSSALES Determine an appropriate level of stock on hand 3TOCK LEVELS SHOULD BE SUFlCIENT TO MEET DEMAND BUT NOT SO HIGH THAT ADDITIONAL STORAGECOSTSORSTOCKWRITE DOWNISSUESSUCHASDAMAGEORTECHNICALOBSOLESCENCE ENSUE3ETTINGATARGETLEVELFORSTOCKALSOASSISTSINIDENTIFYINGWHENTOREORDER Strong marketing 3TRATEGIESLIKEADVERTISINGWILLHOPEFULLYLEADTOINCREASEDSALESANDFASTER3TOCK4URNOVER FORALLLINESOFSTOCK ORFORAPARTICULARLINEWHICHMAYTHENATTRACTCUSTOMERSANDENTICE THEMTOBUYOTHERITEMSTOO 

REVIEW QUESTIONS 19.6

1 2 3 4 5 6 7

State WHATISMEASUREDBY3TOCK4URNOVER34/  Show THEFORMULATOCALCULATE3TOCK4URNOVER ExplainWHYFAST3TOCK4URNOVERISBENElCIALFORLIQUIDITY StateTWOACTIONSTHATANOWNERCOULDTAKETOIMPROVE3TOCK4URNOVER ExplainONEADVANTAGEANDONEDISADVANTAGEOFFAST3TOCK4URNOVER ExplainTHEROLEOFSTOCKCARDSINANANALYSISOF3TOCK4URNOVER ExplainFOURSTRATEGIESTHATBUSINESSESSHOULDUSETOMANAGETHEIRSTOCK

19.7 DEBTORS TURNOVER (DTO) )NBUSINESSESTHATSELLPREDOMINANTLYONACASHBASIS THETIMETAKENTOTURNSTOCKINTO SALES3TOCK4URNOVER ALSOMEASURESTHETIMETAKENTOGENERATECASHASSOONASTHE STOCKISSOLD THECASHISCOLLECTED"USINESSESTHATMAKECREDITSALESMUSTWAITALITTLE LONGERlRSTUNTILTHESTOCKISSOLD THENAGAINUNTILTHECASHISRECEIVEDFROMDEBTORS 4HUS Debtors Turnover (DTO) IS AN IMPORTANT FACTOR INmUENCING A lRMS ABILITY TO GENERATECASHTOMEETITSSHORT TERMDEBTSASTHEYFALLDUE ISBN 978-1-107-64070-2 © Anthony SImmons, Richardy Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

Debtors Turnover (DTO) the average number of days it takes for a business to collect cash from its debtors

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UNITS 3&4

Debtors Turnover: formula Debtors Turnover (DTO)

=

Average debtors x 365 Credit Sales

$EBTORS 4URNOVER ASSESSES HOW EFFECTIVELY THE lRM HAS MANAGED ITS DEBTORS BY CALCULATINGTHEAVERAGENUMBEROFDAYSITTAKESAlRMTOCOLLECTCASHFROMITSDEBTORS &AST$EBTORS4URNOVERMEANSITTAKESONAVERAGE AFEWDAYSTOCOLLECTCASHIFCASHIS COLLECTEDQUICKLY ITCANTHENBEUSEDTOMEETOTHERDEBTSASTHEYFALLDUE ,ETSRETURNTO-ARKWELL-IRRORS WITHSOMEINFORMATIONADDED

EXAMPLE

2015 Credit Sales Cash Sales Average debtors Stock Turnover Credit terms offered to customers

2016

$180 000 16 000 30 000 101 days 30 days

$200 000 17 000 35 000 73 days 30 days

4HE$EBTORS4URNOVERWOULDBECALCULATEDASISSHOWNIN&IGURE Figure 19.5

Calculating Debtors Turnover 2015

DTO

2016 =

35 000 x 365

180 000

=

200 000

61 days*

=

64 days*

=

30 000 x 365

= =

DTO

2OUNDEDTONEARESTDAY

STUDY TIP

"ECAREFULWHEN EXPLAININGCHANGES IN34/AND$4/A DECREASEINDAYSISAN IMPROVEMENTINLIQUIDITY

4HElGURESINDICATETHATIN ITTOOKANAVERAGEOFDAYSTOCOLLECTCASHFROM DEBTORS BUT IN  THIS INCREASED UNFAVOURABLY TO  DAYS 4HIS MEANS THAT ON AVERAGE IT TOOK THREE DAYS LONGER TO GENERATE CASH FROM DEBTORS IN  BECAUSE ALTHOUGH#REDIT3ALESINCREASED AVERAGEDEBTORSINCREASEDBYPROPORTIONATELYMORE

Turning stock into cash 'IVEN THAT -ARKWELL -IRRORS SELLS MOST OF IT STOCK ON CREDIT ITS ABILITY TO MEET ITS COMMITMENTSWILLDEPENDONTHETIMETAKENTOTURNTHESTOCKINTO3ALES34/ ANDTHEN THETIMETAKENTOTURNDEBTORSINTOCASH$4/ 4HUS IN ITWILLTAKETHEBUSINESS DAYSTOTURNSTOCKINTOCASH3TOCK4URNOVERDAYS$EBTORS4URNOVERDAYS

Assessing Debtors Turnover 4HETHREE DAYINCREASEINTHEPRECEDINGEXAMPLEMAYNOTBEASIGNIlCANTINCREASE BUT THEFACTTHATDEBTORSCONTINUETOTAKEMORETHANDAYSISOFGRAVECONCERN BECAUSE THElRMOFFERSONLYDAYSCREDITTOITSCUSTOMERS$EBTORS4URNOVERCANBEASSESSED AGAINSTAprevious periodTOIDENTIFYINCREASESORDECREASES BUTITISTHEcredit terms offered to customers AND PERHAPS THE budgeted $EBTORS 4URNOVER THAT SHOULD BE USEDTODETERMINEWHETHER$EBTORS4URNOVERISSATISFACTORY ISBN 978-1-107-64070-2 © Anthony SImmons, Richardy Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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CHAPTER 19

E VA L U AT I N G L I Q U I D I T Y

%VENIF$EBTORS4URNOVERISWITHINTHECREDITTERMS ITSHOULDBENOTEDTHATITISAN average lGURE SOME DEBTORS MAY BE REPAYING WITHIN THE CREDIT TERMS WHILE OTHERS MAYBEPAYINGTHEIRSLATE)NCONJUNCTIONWITH$EBTORS4URNOVER THEOWNERWILLNEEDTO ANALYSETHEDEBTORSLEDGERSOTHATEACHINDIVIDUALDEBTORCANBEMANAGEDAPPROPRIATELY 4OTHISEND THEBUSINESSMAYPREPAREADebtors Ageing Analysis WHICHCALCULATESHOW MUCHISOWINGFROMDEBTORSBASEDONTHE@AGEOFTHEDEBT

Debtor management

467

Debtors Ageing Analysis a listing of the amount and proportion of debtors according to the length of time they are owing

)F$EBTORS4URNOVERISTOOSLOWTHATIS GREATERTHANTHECREDITTERMSOFFEREDTOCUSTOMERS THElRMWILLHAVETOWAITTOOLONGFORCASHFROMDEBTORSANDTHUSWILLBELESSABLETO MEETITSSHORT TERMDEBTSASTHEYFALLDUE)NORDERTOAVOID ORADDRESS THISSITUATION THEOWNERMAYCONSIDERIMPLEMENTINGTHEFOLLOWINGSTRATEGIES Discounts for quick settlement /FFERINGSETTLEMENTDISCOUNTSCANENCOURAGEDEBTORSTOPAYWELLWITHINTHECREDITTERMS $ISCOUNTSSHOULDNOTBEOFFEREDONOVERDUEDEBTS
Prompt invoicing )NVOICESSHOULDBESENTWITHTHEGOODSSOTHATTHECUSTOMERISIMMEDIATELYAWAREOFTHE AMOUNTOWINGANDTHEREPAYMENTDATE5NTILTHEINVOICEISRECEIVED THEDEBTORWILLNOT BEGINTOEVENTHINKABOUTPAYING Extensive credit checks /NLYOFFERINGCREDITTOCUSTOMERSWHOHAVEAPROVENRECORDWILLINCREASETHECHANCES THATCASHWILLBERECEIVEDONTIME Reminder notices .OTICESSHOULDBESENTIMMEDIATELYTOREMINDDEBTORSTHATTHEIRPAYMENTISOVERDUE PROGRESSING FROM FRIENDLY REMINDERS TO THREATENING LEGAL ACTION 2EMINDERS MAY TAKE THEFORMOFACOPYOFTHEINVOICE ORASTATEMENTOFACCOUNTTHATHASTHEOUTSTANDING AMOUNTCLEARLYSHOWNASOVERDUE Threats of legal action 4HETHREATOFCOURTACTIONCANSOMETIMESPROMPTPAYMENT BUTLEGALACTIONCANBEA LONGANDCOSTLYPROCESS)TALSOSIGNALSTHEENDOFTHERELATIONSHIPWITHTHEDEBTOR BUT PERHAPSDEBTORSWHOPAYTHISLATEAREUNDESERVINGOFFURTHER#REDIT3ALES
Debt collection agency $EBTCOLLECTIONAGENCIESCANEMPLOYPRACTICESRANGINGFROMANNOYINGALATEPAYERBY PERSISTENTTELEPHONECONTACTTOEMBARRASSMENTATTHEIRPLACEOFWORK Threats of not providing credit in the future $EBTORSWHOHAVENOTPAIDTHEIRCURRENTDEBTSSHOULDBEREFUSEDFURTHERCREDITUNTILTHE AMOUNTOUTSTANDINGISRECEIVED REVIEW QUESTIONS 19.7

1 2 3 4

StateWHATISMEASUREDBY$EBTORS4URNOVER$4/  ShowTHEFORMULATOCALCULATE$EBTORS4URNOVER ExplainWHY$EBTORS4URNOVERISCRUCIALTOANASSESSMENTOFLIQUIDITY Explain THE IMPORTANCE OF CREDIT TERMS OFFERED TO CUSTOMERS IN ASSESSING $EBTORS4URNOVER 5 ListTHESTRATEGIESABUSINESSCOULDUSETOIMPROVEITS$EBTORS4URNOVER INTHE ORDERINWHICHTHEYSHOULDBEIMPLEMENTED ISBN 978-1-107-64070-2 © Anthony SImmons, Richardy Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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UNITS 3&4

19.8 CREDITORS TURNOVER (CTO) /FALLTHEOBLIGATIONSATRADINGlRMMUSTMEET THEMOSTPERSISTENTISPAYINGFORSTOCK )FSTOCKISPURCHASEDFORCASH THEBUSINESSWILLLEAVEITSELFNOTIMETOSELLTHESTOCKAND COLLECTTHECASHBEFORETHEPAYMENTMUSTBEMADE/NTHEOTHERHAND CREDITPURCHASES ALLOWTHElRMSOMETIMETOSELLTHESTOCKANDCOLLECTTHECASHBEFORETHECREDITORMUST BEPAID(OWEVER ITISSTILLIMPORTANTTHATCREDITORSAREPAIDONTIME Creditors Turnover: formula Creditors Turnover (CTO)

Creditors Turnover (CTO) the average number of days it takes for a business to pay its creditors

=

Average creditors x 365 Credit purchases

Creditors Turnover (CTO)MEASURESTHEAVERAGENUMBEROFDAYSTAKENTOPAY CREDITORS INDICATINGTHEEFFECTIVENESSOFTHElRMINMANAGINGITSCREDITORS 2ETURNINGTO-ARKWELL-IRRORS

EXAMPLE Credit purchases Average creditors Stock Turnover Debtors turnover Credit terms offered to customers

2015

2016

$ 70 000 10 000 101 days 61 days 60 days

$ 90 000 12 000 73 days 64 days 60 days

4HE#REDITORS4URNOVERWOULDBECALCULATEDASISSHOWNIN&IGURE Figure 19.6

Calculating Creditors Turnover 2015

CTO

=

10 000 x 365

2016 CTO

=

12 000 x 365

=

70 000

=

90 000

=

52 days*

=

49 days*

2OUNDEDTONEARESTDAY 4HElGURESINDICATETHATIN CREDITORSWEREPAIDEVERYDAYSTHATIS EIGHT DAYSBEFORETHECREDITTERMSEXPIRED)N THISDECREASEDBYTHREEDAYSTODAYS THATIS DAYSSHORTERTHANTHECREDITTERMSALLOWED4HISWASBECAUSE ALTHOUGHCREDIT PURCHASES AND AVERAGE CREDITORS INCREASED AVERAGE CREDITORS INCREASED BY A SMALLER PROPORTION

Stock Turnover, Debtors Turnover and Creditors Turnover 4HElRMSABILITYTOPAYITSCREDITORSWILLRELYHEAVILYONITSABILITYTOGENERATECASHFROM ITSSTOCK4HISMEANS#REDITORS4URNOVERISRELIANTON3TOCK4URNOVERAND IFTHEBUSINESS DEALSMAINLYONCREDIT $EBTORS4URNOVER &IGURESHOWSTHISRELATIONSHIPBETWEEN3TOCK4URNOVER $EBTORS4URNOVERAND #REDITORS4URNOVER

ISBN 978-1-107-64070-2 © Anthony SImmons, Richardy Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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CHAPTER 19

Figure 19.7

E VA L U AT I N G L I Q U I D I T Y

Cash cycle

Sale of stock

Purchase of stock

Receipt from debtor

Payment to creditor

4HE DAYS BETWEEN THE PURCHASE OF STOCK AND SALE OF STOCK ARE MEASURED BY THE 3TOCK4URNOVERTHEDAYSBETWEENTHESALEOFSTOCKANDTHERECEIPTFROMTHEDEBTORARE MEASUREDBYTHE$EBTORS4URNOVERANDTHEDAYSBETWEENTHEPURCHASEOFTHESTOCK ANDTHEPAYMENTTOTHECREDITORAREMEASUREDBYTHE#REDITORS4URNOVER )NTHISEXAMPLE SLOWER$EBTORS4URNOVERWASMORETHANOFFSETBYMUCHFASTER3TOCK 4URNOVER LEADING TO A DECREASE IN THE NUMBER OF DAYS TAKEN TO TURN STOCK INTO CASH 7ITHADECREASEINTHENUMBERSOFDAYSTOTURNSTOCKINTOCASH CASHWASAVAILABLEMORE QUICKLY SO THE BUSINESS WAS ABLE TO PAY ITS CREDITORS MORE QUICKLY LEADING TO FASTER #REDITORS4URNOVERS

Assessing Creditors Turnover #REDITORS 4URNOVER CAN BE ASSESSED AGAINST A previous period TO IDENTIFY INCREASES OR DECREASES BUT IN COMMON WITH $EBTORS 4URNOVER IT IS THE credit terms offered by suppliers AND PERHAPS THE budgeted #REDITORS 4URNOVER THAT SHOULD BE USED TO DETERMINEWHETHER#REDITORS4URNOVERISSATISFACTORY )FDISCOUNTSAREOFFERED ANDTHECASHISAVAILABLE THENPAYINGEARLYMAYBEBENElCIAL (OWEVER IF DISCOUNTS ARE not AVAILABLE THERE IS NO INCENTIVE TO PAY EARLY #REDITORS 4URNOVERSHOULDBEASCLOSEASPOSSIBLETOTHECREDITTERMS4HISWILLMEANTHEBUSINESS RETAINSCASHLONGER ANDCANUSEITTOMEETOTHERPAYMENTSASTHEYFALLDUE !TTHESAMETIME #REDITORS4URNOVERSHOULDNOTEXCEEDTHECREDITTERMSOFFEREDBY THESUPPLIER ORPENALTIESMAYBEINCURRED SUCHASTHOSEOUTLINEDBELOW Interest charges on late accounts )NTERESTCHARGESWOULDDECREASEPROlTANDREQUIREANEVENGREATERCASHOUTmOW4HIS WOULDHAVETOBESTIPULATEDINTHECREDITCONTRACT Removal of credit facilities 7ITHCREDITFACILITIESWITHDRAWN THEBUSINESSWOULDHAVETOPAYCASHFORITSSTOCK ORMAY NOTBEABLETOPURCHASESTOCKATALL Reduction in credit rating 4HISMAYMAKEITDIFlCULTTOESTABLISHLINESOFCREDITINTHEFUTUREIFTHEBUSINESSHASA POORHISTORYOFREPAYINGITSDEBTS )NMOSTCASES AlRMWILLWANTITSCASHINmOWFROM34/AND$4/ TOBEASFASTAS POSSIBLETHATIS THELOWESTNUMBEROFDAYSPOSSIBLE WHEREASITWILLWANTTOPAYITS CREDITORS AS SLOWLY AS POSSIBLE THAT IS THE HIGHEST NUMBER OF DAYS POSSIBLE WITHOUT EXCEEDINGCREDITTERMS 4HEBESTCIRCUMSTANCEFORATRADINGBUSINESSISTOSELLSTOCKFOR CASHANDTOBUYSTOCKONCREDIT4HISAPPROACHPROVIDESTIMEFORTHEBUSINESSTOSELLITS STOCK COLLECTTHECASHANDREPAYITSCREDITORS ISBN 978-1-107-64070-2 © Anthony SImmons, Richardy Hardy 2012 Photocopying is restricted under law and this material must not be transferred to another party.

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469

CAMBRIDGE VCE ACCOUNTING

470

UNITS 3&4

REVIEW QUESTIONS 19.8

1 StateWHATISMEASUREDBY#REDITORS4URNOVER#4/  2 ShowTHEFORMULATOCALCULATE#REDITORS4URNOVER 3 ExplainTHERELATIONSHIPBETWEEN3TOCKAND$EBTORS4URNOVER AND#REDITORS 4URNOVER 4 StateTHREENEGATIVECONSEQUENCESOFEXCEEDINGTHECREDITTERMSOFFEREDBY SUPPLIERS

WHERE HAVE WE BEEN? s ,IQUIDITYREFERSTOTHEABILITYOFABUSINESSTOMEETITSSHORT TERMDEBTSASTHEYFALL DUE s 4HE "UDGETED #ASH &LOW 3TATEMENT IS ESSENTIAL TO AN ANALYSIS OF LIQUIDITY AS IT DETAILSALLEXPECTEDCASHINmOWSANDCASHOUTmOWS ANDSTATESCATEGORICALLYWHETHER THEBUSINESSWILLBEABLETOMEETITSCASHOBLIGATIONSFORTHECOMINGYEAR s 4HE7ORKING#APITAL2ATIOAND1UICK!SSET2ATIOASSESSTHELEVELOFLIQUIDITY AND SHOULDBEATLEAST s 3TOCK 4URNOVER $EBTORS 4URNOVER AND #REDITORS 4URNOVER ASSESS EFlCIENCY THE ABILITYOFTHElRMTOMANAGEITSSTOCK DEBTORSANDCREDITORS s 3TOCK MANAGEMENT STRATEGIES ARE DETERMINING AN APPROPRIATE LEVEL OF STOCK ON HANDMAINTAININGANAPPROPRIATESTOCKMIXROTATINGSTOCKENSURINGSTOCKISUP TO DATEANDPROMOTINGTHESALEOFCOMPLEMENTARYGOODS s $EBTOR MANAGEMENT STRATEGIES ARE THE USE OF DISCOUNTS FOR QUICK SETTLEMENT PROMPTINVOICINGEXTENSIVECREDITCHECKSREMINDERNOTICESTHREATSOFLEGALACTION DEBTCOLLECTIONAGENCYANDTHREATSOFNOTPROVIDINGCREDITINTHEFUTURE s $EBTORS 4URNOVER AND #REDITORS 4URNOVER SHOULD BE ASSESSED AGAINST THE CREDIT TERMS s 0ENALTIES FOR EXCEEDING CREDIT TERMS ARE INTEREST REMOVAL OF CREDIT FACILITIES AND REDUCTIONINCREDITRATING

EXERCISES

EXERCISE 19.1 LIQUIDITY

W B

page 416

!TTHEENDOF (ILLTOP3PORTING'OODSHADCASHINTHEBANK BUTBYTHE ENDOF THATHADFALLENTO PROMPTINGITSOWNERTOSAYTHATITSLIQUIDITYHAD FALLEN Required a State TWO REASONS WHY THE OWNERS ASSERTION ABOUT THE lRMS LIQUIDITY MAY BE INCORRECT b StateTWOINDICATORSTHATCANBEUSEDTOASSESSTHELEVELOFLIQUIDITY c StateTWOINDICATORSTHATCANBEUSEDTOASSESSTHESPEEDOFLIQUIDITY

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CHAPTER 19

E VA L U AT I N G L I Q U I D I T Y

EXERCISE 19.2 WORKING CAPITAL RATIO

W B

page 417

7ELLINGTON"OOTSHASPROVIDEDTHEFOLLOWINGINFORMATIONFROMITS"ALANCE3HEETASAT $ECEMBER Current assets

34 000

Current liabilities

42 500

Required a StateWHATISMEASUREDBYTHE7ORKING#APITAL2ATIO b CalculateTHE7ORKING#APITAL2ATIOFOR7ELLINGTON"OOTSASAT$ECEMBER c 2EFERRING TO YOUR ANSWER TO PART @B state WHETHER THE 7ORKING #APITAL 2ATIO IS SATISFACTORYORUNSATISFACTORYJustifyYOURANSWER d SuggestTWOACTIONSTHEOWNEROF7ELLINGTON"OOTSMAYNEEDTOTAKETOENSURETHE BUSINESSISABLETOMEETITSSHORT TERMDEBTSASTHEYFALLDUE

EXERCISE 19.3 WORKING CAPITAL RATIO

W B

page 418

,IGHTSOF9OUR,IFEHASPROVIDEDTHEFOLLOWINGINFORMATION

Working Capital Ratio

2015

2016

1.65:1

1.21:1

Required a Explain ONE REASON WHY THE OWNER SHOULD BE CONCERNED ABOUT THE TREND IN THIS INDICATOR b ExplainONELIMITATIONOFRELYINGONTHE7ORKING#APITAL2ATIOTOASSESSLIQUIDITY c ExplainHOWTHEBUDGETED#ASH&LOW3TATEMENTCOULDBEUSEDTOASSESSLIQUIDITY

EXERCISE 19.4 WORKING CAPITAL RATIO AND QUICK ASSET RATIO

W B

page 419

-ADDEN(OMEWARESHASPROVIDEDTHEFOLLOWINGEXTRACTFROMITS"ALANCE3HEET MADDEN HOMEWARES Balance Sheet (extract) as at 30 June 2015 Current Assets

$

Current Liabilities

$

Accrued Interest Revenue

300

Bank Overdraft

12 000 20 100

Stock Control

47 200

Creditors Control

Debtors Control

34 100

Accrued Electricity

500

GST Clearing

900

Prepaid Rent Total Current Assets

2 150 $83 750

Total Current Liabilities

$33 500

4HE7ORKING#APITAL2ATIOOF-ADDEN(OMEWARESASAT*UNEWAS

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Cambridge University Press

471

472

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

Required a b c d

StateWHATISMEASUREDBYTHE1UICK!SSET2ATIO ExplainWHYSTOCKISEXCLUDEDFROMTHECALCULATIONOFQUICKASSETS CalculateTHE1UICK!SSET2ATIOOF-ADDEN(OMEWARESASAT*UNE 2EFERRINGTOYOURANSWERTOPART@C stateWHETHERTHE1UICK!SSET2ATIOISSATISFACTORY ORUNSATISFACTORYJustifyYOURANSWER e ExplainHOWTHEEFlCIENCYOFTHISBUSINESSINMANAGINGITSCURRENTASSETSWILLAFFECT ITSLIQUIDITY

EXERCISE 19.5 WORKING CAPITAL RATIO AND QUICK ASSET RATIO

W B

page 420

*ORDANS2UGSHASPROVIDEDTHEFOLLOWINGINFORMATION 2015

2016

7ORKING#APITAL2ATIO





1UICK!SSET2ATIO





Required a ExplainONEPOSSIBLEREASONFORTHECHANGEINTHE7ORKING#APITAL2ATIOAND1UICK !SSET2ATIOFROMTO b ExplainONENEGATIVECONSEQUENCEIFTHE7ORKING#APITAL2ATIOISTOOHIGH c ExplainTHECIRCUMSTANCESINWHICHTHISlRMISLIKELYTO s HAVENODIFlCULTIESMEETINGITSSHORT TERMDEBTS s HAVEDIFlCULTIESMEETINGITSSHORT TERMDEBTS

EXERCISE 19.6 CASH FLOW COVER (CFC)

W B

page 421

(AIR4ODAYHASPROVIDEDTHEFOLLOWINGINFORMATION 2015

2016

Net Cash Flows from Operations

39 000

35 000

Average current liabilities

13 000

10 000

Required a CalculateTHE#ASH&LOW#OVERFOR(AIR4ODAYFORAND b 2EFERRING TO YOUR ANSWER TO PART @A explain WHETHER LIQUIDITY HAS IMPROVED OR WORSENEDFROMTO c ExplainTHECAUSES OFTHECHANGEINTHE#ASH&LOW#OVERFROMTO d State TWO OTHER PIECES OF INFORMATION FROM THE #ASH &LOW 3TATEMENT THAT WOULD ASSISTINTHEASSESSMENTOFLIQUIDITY e Explain WHY IT IS IMPORTANT FOR LIQUIDITY THAT .ET #ASH &LOWS FROM /PERATIONS IS POSITIVE

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CHAPTER 19

E VA L U AT I N G L I Q U I D I T Y

EXERCISE 19.7 LEVEL OF LIQUIDITY

W B

page 422

E #OMMS AND 6IRTUAL 7ORLD BOTH SELL COMPUTER SYSTEMS AND HAVE PROVIDED THE FOLLOWINGINFORMATIONFOR e-Comms

Virtual World

Working Capital Ratio

1.2:1

5.3:1

Quick Asset Ratio

0.75:1

3.4:1

Cash Flow Cover

4.6 times

1.25 times

Required a Explain WHYTHE7ORKING#APITAL2ATIOOFEACHlRMISHIGHERTHANITS1UICK!SSET 2ATIO b Explain ONE REASON WHY 6IRTUAL 7ORLD SHOULD BE CONCERNED ABOUT ITS 7ORKING #APITAL2ATIO c Explain HOW THE "ALANCE 3HEET OF 6IRTUAL 7ORLD AS AT  $ECEMBER  COULD ASSISTINASSESSINGITSLIQUIDITY d DiscussWHETHERE #OMMSWILLBEABLETOMEETITSSHORT TERMDEBTSASTHEYFALLDUE e IdentifyONEOTHERPIECEOFINFORMATIONTHATWOULDASSISTINASSESSINGTHELIQUIDITYOF E #OMMSJustifyYOURANSWER

EXERCISE 19.8 STOCK TURNOVER

W B

page 423

/RLANDOS"LOOMSISAmOWERSHOPOPERATINGIN(ORSHAM)THASPROVIDEDTHEFOLLOWING INFORMATIONRELATINGTOITSSTOCKFOR Cost of Goods Sold

195 000

Average stock

8 000

Budgeted Stock Turnover

4 days

Required a StateWHATISMEASUREDBY3TOCK4URNOVER b Calculate3TOCK4URNOVERFOR/RLANDOS"LOOMSFOR c 2EFERRINGTOYOURANSWERTOPART@B stateTWOREASONSWHYTHEOWNERWOULDCONSIDER THIS3TOCK4URNOVERTOBEUNSATISFACTORY d ExplainHOWSLOW3TOCK4URNOVERCANHAVENEGATIVECONSEQUENCESFOR s Profitability s liqUIDITY e StateONEACTIONTHEOWNERCOULDTAKETOIMPROVE3TOCK4URNOVERWITHOUTAFFECTING 'ROSS0ROlT

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Cambridge University Press

473

474

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

EXERCISE 19.9 STOCK TURNOVER

W B

page 424

4HE,IGHT(OUSESELLSAHUGEVARIETYOFLIGHTSANDLAMPSASWELLASCANDLES CANDLESTICKS ANDOTHERDECORATIVEITEMS4HEOWNERHASPROVIDEDTHEFOLLOWINGINFORMATIONRELATING TOITSSTOCKFORAND 2015

2016

Stock Turnover

42 days

33 days

Average stock

34 000

30 000

Required a b c d

ExplainWHYTHEOWNERWOULDBEPLEASEDWITHTHISTRENDIN3TOCK4URNOVER ExplainONENEGATIVECONSEQUENCEIF3TOCK4URNOVERISTOOFAST ExplainTHERELATIONSHIPBETWEENSELLINGPRICESAND3TOCK4URNOVER State ONE LIMITATION OF USING 3TOCK 4URNOVER TO ASSESS THE EFFECTIVENESS OF STOCK MANAGEMENT e Explain HOW STOCK CARDS CAN ASSIST AN ASSESSMENT OF THE EFFECTIVENESS OF STOCK MANAGEMENT

EXERCISE 19.10 DEBTORS TURNOVER

W B

page 425

&ERRANTE3UITSHASPROVIDEDTHEFOLLOWINGINFORMATIONRELATINGTOITSACTIVITIESFOR Cash Sales Credit Sales Average debtors

200 000 45 000 6 000

Credit terms offered to customers

40 days

Stock Turnover

21 days

Required a StateWHATISMEASUREDBY$EBTORS4URNOVER b Calculate$EBTORS4URNOVERFOR&ERRANTE3UITSFOR c 2EFERRINGTOYOURANSWERFORPART@B stateWHETHER$EBTORS4URNOVERISSATISFACTORY ORUNSATISFACTORYJustifyYOURANSWER d SuggestTWOSTRATEGIESTHEOWNERCOULDIMPLEMENTTOIMPROVE$EBTORS4URNOVER e ExplainWHYTHISlRMS$EBTORS4URNOVERISUNLIKELYTOHAVEASIGNIlCANTIMPACTON ITSABILITYTOMEETITSSHORT TERMDEBTS

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CHAPTER 19

E VA L U AT I N G L I Q U I D I T Y

EXERCISE 19.11 DEBTORS TURNOVER AND STOCK TURNOVER

W B

page 426

,OWEN,IFEVESTSHASPROVIDEDTHEFOLLOWINGINFORMATIONFOR Stock Turnover

46 days

Debtors Turnover

25 days

Credit terms offered to customers

30 days

Credit terms offered by suppliers

60 days

Stock Turnover (2014)

31 days

Required a ExplainWHYTHISlRMMAYHAVELIQUIDITYPROBLEMSIN b IdentifyTWOFACTSTHATSUPPORTTHECLAIMTHATSTOCKMANAGEMENTHASBEENWORSE THANDEBTORMANAGEMENTIN c ExplainTHEIMPORTANCEOFSTOCKMANAGEMENTINTERMSOFMEETINGSHORT TERMDEBTS ASTHEYFALLDUE d List THREE STOCK MANAGEMENT STRATEGIES THIS lRM COULD IMPLEMENT TO IMPROVE ITS 3TOCK4URNOVER e StateONEBENElTANDONECOSTOFOFFERINGDISCOUNTSTODEBTORS f ExplainHOWCREDITCHECKSCANLEADTOFASTER$EBTORS4URNOVER

EXERCISE 19.12 CREDITORS TURNOVER

W B

page 427

0RINGLE0UMPSHASPROVIDEDTHEFOLLOWINGINFORMATIONFOR Credit purchases

91 250

Average creditors

10 000

Credit terms offered by suppliers

30 days

Budgeted Sales revenue

140 000

Sales revenue

100 000

)N #REDITORS4URNOVERWASDAYS Required a StateWHATISMEASUREDBY#REDITORS4URNOVER b Calculate#REDITORS4URNOVERFOR0RINGLE0UMPSFOR c StateTWOREASONSWHYTHEOWNERSHOULDBECONCERNEDABOUT#REDITORS4URNOVER IN d StateTWONEGATIVECONSEQUENCESOFEXCEEDINGTHECREDITTERMSOFFEREDBYSUPPLIERS

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475

476

CAMBRIDGE VCE ACCOUNTING

UNITS 3&4

EXERCISE 19.13 STOCK TURNOVER, DEBTORS TURNOVER AND CREDITORS TURNOVER

W B

page 428

#LAIRES#LOCKSHASPROVIDEDTHEFOLLOWINGINFORMATIONRELATINGTOITSACTIVITIESFOR AND 2015

2016

Stock Turnover

36 days

33 days

Debtors Turnover

31 days

49 days

Creditors Turnover

51 days

64 days

Credit terms offered to customers

30 days

Credit terms offered by suppliers

45 days

Stock Turnover – industry average

11 days

Required a SuggestTWOREASONSTHATCOULDEXPLAINTHEIMPROVEMENTIN3TOCK4URNOVERIN b SuggestTWOSTRATEGIESTHEOWNERCOULDADOPTTOENCOURAGELATEDEBTORSTOPAY c Explain HOW THE CHANGE IN $EBTORS 4URNOVER HAS AFFECTED #REDITORS 4URNOVER IN d 2EFERRING TO ONE OTHER LIQUIDITY INDICATOR explain HOW THIS BUSINESS COULD AVOID LIQUIDITYPROBLEMSWITHOUTRAISINGFURTHEREXTERNALlNANCEIN

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477

GLOSSARY

accounting equation [p. 23] the rule that states that assets must always equal liabilities plus owner’s equity

bad debt [p. 152] an expense incurred when a debt is written off because it is deemed to be irrecoverable

accounting principles [p. 8] the generally accepted rules that govern the way accounting information is generated

balance day adjustment (BDA) [p. 218] a change made to a revenue or expense account on balance day so that revenue accounts show revenues earned and expense accounts show expenses incurred in a particular Reporting Period

accrual accounting [p. 10] calculating profit by comparing revenues earned against expenses incurred in a particular Reporting Period accrued expense [p. 223] an expense that has been incurred but not yet paid accrued revenue [p. 376] a revenue that has been earned but not yet received accumulated depreciation [p. 246] the value of a non-current asset that has been consumed/incurred over its life thus far advice [p. 7] the provision to the owners of a range of options appropriate to their aims/objectives, together with recommendations as to the suitability of those aims/objectives agreed value [p. 9] the accepted value of a non-cash asset at the time of its contribution by the owner analysing [p. 428] examining the financial reports in detail to identify changes or differences in performance Analysing Chart [p. 42] a tool used to identify the steps for recording transactions in the General Ledger asset [p. 13] a resource controlled by an entity, as a result of past events, from which future economic benefits are expected to flow to the entity Asset Turnover (ATO) [p. 438] an efficiency indicator that measures how productively a business has used its assets to earn revenue

Balance Sheet [p. 24] an accounting report that details the business’s assets, liabilities and owner’s equity at a particular point in time balancing [p. 51] ruling off an asset, liability or owner’s equity account to determine its balance at the end of the reporting period and transferring that balance to the next reporting period benchmark [p. 431] an acceptable standard against which the firm’s actual performance can be assessed budget [p. 388] an accounting report that predicts/estimates the financial consequences of future events Budgeted Balance Sheet [p. 403] an accounting report that predicts assets, liabilities and owner’s equity at some point in the future Budgeted Cash Flow Statement [p. 390] an accounting report that attempts to predict all future cash inflows and cash outflows, and thus the estimated cash balance at the end of the budget period Budgeted Income Statement [p. 400] an accounting report that shows expected future revenues and expenses budgeting [p. 388] the process of predicting/estimating the financial consequences of future events carrying value [p. 249] the value of a non-current asset that is yet to be consumed/allocated as an expense, plus any residual value

Cash Budget Variance Report [p. 410] an accounting report that compares actual and budgeted cash flows, highlighting variances cash deficit [p. 265] an excess of cash payments over Cash Receipts, leading to a decrease in the bank balance Cash Flow Cover (CFC) [p. 461] a liquidity indicator that measures the number of times Net Cash Flows from Operations is able to cover average Current Liabilities Cash Flow Statement [p. 266] an accounting report that details all cash inflows and outflows from Operating, Investing and Financing activities, and the overall change in the firm’s cash balance Cash Payments Journal [p. 109] an accounting record summarising all cash paid during a month cash receipt [p. 62] a source document used to verify cash received Cash Receipts Journal [p. 114] an accounting record that summarises all cash received during a month cash surplus [p. 265] an excess of cash receipts over cash payments, leading to an increase in the bank balance cheque butt [p. 67] a source document used to verify cash payments classification [p. 25] grouping together items that have some common characteristic closing the ledger [p. 197] transferring balances from revenue and expense ledger accounts to the Profit and Loss Summary account so that profit can be calculated

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478

GLOSSARY

commencing entry [p. 145] a General Journal entry to establish doubleentry records by entering existing asset, liability and owner’s equity balances in the ledger accounts Comparability [p. 12] accounting reports should be able to be compared over time Conservatism [p. 10] losses should be recorded when probable but gains should only be recorded when certain, so that liabilities and expenses are not understated and assets and revenues are not overstated Consistency [p. 10] accounting methods should be applied in a consistent manner to ensure that reports are comparable between periods control account [p. 90] an account in the General Ledger summarising the transactions recorded in the subsidiary ledger accounts cost of a non-current asset [p. 251] all costs incurred in order to bring the asset into a location and condition ready for use, which will provide a benefit for the life of the asset. Cost of Goods Sold (COGS) [p. 182] all costs incurred in getting stock into a condition and location ready for sale cost of stock [p. 308] all costs incurred in order to bring stock into a condition and location ready for sale cost price [p. 167] the original purchase price of stock credit note [p. 293] a source document that verifies the return of stock either to a trade creditor or by a trade debtor Creditors Schedule [p. 91] a list of the name and balance of each individual account in the Creditors Ledger, added together to enable checking against the balance of the Creditors Control account Creditors Turnover (CTO) [p. 468] the average number of days it takes for a business to pay its creditors cross-reference [p. 39] the name of the other account affected by a transaction, so that both accounts affected by a particular transaction can be identified current asset [p. 25] a resource controlled by the entity as a result of past events, from which a future economic benefit is expected to flow to the entity in the next 12 months

current liability [p. 26] a present obligation of the Entity arising from past events, the settlement of which is expected to result in an outflow of resources embodying economic benefits in the next 12 months

expense [p. 15] an outflow or consumption of economic benefits (or reduction in inflows) in the form of a decrease in assets (or increase in liabilities) that reduces owner’s equity, except for drawings by the owner

Debt Ratio [p. 434] a stability indicator that measures the percentage of a firm’s assets that are financed by liabilities Debtors Ageing Analysis [p. 467] a listing of the amount and proportion of debtors according to the length of time they are owing

expense control [p. 440] the firm’s ability to manage its expenses so that they either decrease or, in the case of variable expenses, increase no faster than Sales revenue

Debtors Turnover (DTO) [p. 465] the average number of days it takes for a business to collect cash from its debtors

financial information [p. 5] financial data that has been sorted, classified and summarised into a more useable and understandable form

depreciable asset [p. 241] a non-current asset that has a finite life, and must be depreciated over its life depreciable value [p. 244] the total value of the asset that will be consumed by the current entity, and so must be allocated over its useful life depreciation [p. 242] the allocation of the cost of a non-current asset over its useful life depreciation expense [p. 242] that part of the cost of a non-current asset that has been consumed in the current Reporting Period

financial data [p. 5] raw facts and figures upon which financial information is based

Financing activities [p. 266] cash flows related to changes in the financial structure of the firm finite life [p. 241] the limited period of time (usually measured in years) for which a non-current asset will exist First In, First Out (FIFO) [p. 170] the assumption that the stock that is purchased first will be sold first footing [p. 49] an informal process used to determine the balance of a ledger account

discount expense [p. 126] an expense, in the form of a decrease in debtors, incurred when cash is received early from debtors

General Journal [p. 144] an accounting record used to record infrequent, non-cash transactions, which cannot be recorded in the special journals

discount revenue [p. 123] a revenue (in the form of a decrease in creditors) earned when creditors are paid early

General Ledger [p. 36] the collective name for the main group of ledger accounts

double-entry accounting [p. 28] a system that records two effects on the accounting equation as a result of each transaction

Going Concern [p. 9] the life of the business is assumed to be continuous, and its records are kept on that basis

efficiency [p. 428] the ability of the business to manage its assets and liabilities

Goods and Services Tax (GST) [p. 60] a 10% tax levied by the federal government on most purchases of goods (excluding fresh food) and services

Entity [p. 8] the business is assumed to be separate from the owner and other businesses, and its records should be kept on this basis

Gross Profit Margin (GPM) [p. 442] a profitability indicator that measures the average mark-up by calculating the percentage of Sales revenue that is retained as Gross Profit

equities [p. 23] claims on the assets of the business, consisting of both liabilities and owner’s equity

GST refund [p. 96] a cash receipt from the ATO to refund the excess that occurs when GST on sales is less than GST on purchases

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Cambridge University Press

GLOSSARY

GST settlement [p. 96] a cash payment made to the ATO to settle the liability that occurs when GST on sales is greater than GST on purchases

narration [p. 145] a brief description of a transaction recorded in the General Journal, including a reference to the relevant source document

Historical Cost [p. 10] the recording of a transaction at its original cost or value, as this value is verifiable by reference to the source document

Net Profit Margin (NPM) [p. 440] a profitability indicator that measures expense control by calculating the percentage of Sales revenue that is retained as Net Profit

horizontal analysis [p. 430] comparing reports from one period to the next, and identifying the increase or decrease in specific items in the report Income Statement [p. 203] an accounting report that details the revenues earned and expenses incurred during the current Reporting Period

Net Realisable Value (NRV) [p. 219] the estimated selling price of stock less any costs involved in its selling, marketing or distribution Net Sales [p. 301] sales revenue after the deduction of Sales Returns; that is, sales less Sales Returns

Income Statement Variance Report [p. 412] an accounting report that compares actual and budgeted revenues and expenses, and highlights variations

non-current asset [p. 25] a resource controlled by the Entity as a result of past events, from which a future economic benefit is expected to flow to the entity for more than the next 12 months

interpreting [p. 428] examining the relationships between the items in the financial reports in order to explain the cause and effect of changes or differences in performance

non-current liability [p. 26] a present obligation of the Entity arising from past events, the settlement of which is expected to result in an outflow of resources embodying economic benefits in more than 12 months

Investing activities [p. 266] cash flows related to the purchase and sale of non-current assets ledger accounts [p. 36] accounting records showing all the transactions that affect a particular item

non-financial information [p. 445] any information that cannot be found in the financial statements, and is not expressed in dollars and cents, or reliant on dollars and cents for its calculation

479

Post-adjustment Trial Balance [p. 228] a list of all General Ledger accounts and their balances after balance day adjustments have been made Pre-adjustment Trial Balance [p. 228] a list of all General Ledger accounts and their balances before balance day adjustments have been made prepaid expense [p. 220] an expense paid in advance but yet to be consumed prepaid revenue [p. 368] a revenue received but yet to be earned product cost [p. 307] a cost incurred in order to bring stock into a condition and location ready for sale, which can be allocated to individual units of stock on a logical basis profit on disposal of asset [p. 350] where the proceeds from the disposal of an asset are greater than its carrying value profitability [p. 428] the ability of the business to earn profit, as compared against a base, such as Sales, assets or owner’s equity profitability indicators [p. 431] measures that express an element of profit in relation to some other aspect of business performance purchase invoice [p. 72] a source document used to verify a credit purchase of stock or other items

liability [p. 14] a present obligation of the entity as a result of past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits

Operating activities [p. 266] cash flows related to day-to-day trading activities

purchase return [p. 292] the return of stock by our firm to a trade creditor

order form [p. 76] a document requesting the supply of stock or other goods

liquidity [p. 428] the ability of a business to meet its shortterm debts as they fall due

over-depreciation [p. 346] occurs when excess depreciation has been allocated over the life of the asset, so that the carrying value of the asset is understated

Purchases Journal [p. 88] an accounting record that summarises all transactions involving the purchase of stock on credit during a month purpose of accounting [p. 4] to provide financial information to assist decision-making

owner’s equity [p. 14] the residual interest in the assets of the entity after the deduction of its liabilities

qualitative characteristics [p. 11] the qualities of the information in accounting reports

period cost [p. 313] a cost incurred in order to bring stock into a condition and location ready for sale that is not allocated to individual units of stock because there is no logical basis to do so

Quick Asset Ratio (QAR) [p. 459] a liquidity indicator that measures the ratio of quick assets to quick liabilities, to assess the firm’s ability to meet its immediate debts

loss on disposal of asset [p. 348] where the proceeds from the disposal of an asset is less than its carrying value materiality [p. 12] size or significance memo [p. 74] a source document used to verify an internal transaction Monetary Unit [p. 10] all items must be recorded and reported in a common unit of measurement; that is, Australian dollars

perpetual system of stock recording [p. 183] recording stock transactions in stock cards, then conducting a physical stocktake at the end of the Reporting Period to verify the balances of those stock cards

recording [p. 6] sorting, classifying and summarising the data contained in the source documents so that it is more useable

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480

GLOSSARY

Relevance [p. 12] accounting reports should include all information that is useful for decisionmaking Reliability [p. 12] accounting reports should contain information that is accurate, and free from bias or error reporting [p. 7] the preparation of financial statements that communicate financial information to the owner Reporting Period [p. 9] the life of the business must be divided into periods of time to allow reports to be prepared; these accounting reports should reflect the Reporting Period in which a transaction occurs Return on Assets (ROA) [p. 436] a profitability indicator that measures how effectively a business has used its assets to earn profit Return on Owner’s Investment (ROI) [p. 432] a profitability indicator that measures how effectively a business has used the owner’s capital to earn profit revenue [p. 15] an inflow of economic benefits (or saving in outflows) in the form of an increase in assets (or decrease in liabilities) that increases owner’s equity, except for capital contributions by the owner

settlement discount [p. 121] a reduction in the amount repayable by a credit customer in return for early repayment source documents [p. 6] paper or electronic documents that provide both the evidence that a transaction has occurred and the details of the transaction itself

trading firm [p. 164] a firm that purchases goods in order to resell them at a profit

special journal [p. 87] an accounting record that summarises similar transactions

transaction [p. 6] an exchange of goods or services with another party

stability [p. 428] the ability of the business to meet its debts and continue its operations in the long term

trend [p. 429] the pattern formed by changes in an item over a number of periods

statement of account [p. 75] a summary of the transactions a firm has had with a particular debtor/creditor over a certain period of time (usually a month)

Trial Balance [p. 49] a list of all the accounts in the General Ledger, and their balances, to determine if total debits equal total credits

Statement of Receipts and Payments [p. 264] an accounting report that details cash received and paid during a Reporting Period, and the change in the firm’s bank balance over that period

under-depreciation [p. 356] occurs when insufficient depreciation has been allocated over the life of the asset, so that the carrying value of the asset is overstated

stock [p. 164] goods purchased by a trading firm for the purpose of resale at a profit stock card [p. 166] a subsidiary accounting record that records each individual transaction involving the movement in and out of the business of a particular line of stock

sales invoice [p. 70] a source document used to verify a credit sale of stock

stock gain [p. 176] a revenue earned when the stocktake shows a figure for stock on hand that is more than the balance shown in the stock card

Sales Journal [p. 92] an accounting record summarising all transactions involving the sale of stock on credit during a month

stock loss [p. 174] an expense incurred when the stocktake shows a figure for stock on hand that is less than the balance shown in the stock card

sales return [p. 292] the return of stock to our firm by a trade debtor

Stock Turnover (STO) [p. 463] the average number of days it takes for a business to convert its stock into sales

Schedule of Payments to Creditors [p. 400] a table used to calculate how much cash will be paid to creditors in the budget period as a consequence of credit purchases in the current and previous periods

Stock Write-down [p. 320] the expense incurred when the NRV of an item of stock falls below its original purchase price

Schedule of Receipts from Debtors [p. 397] a table used to calculate how much cash will be received from debtors in the budget period as a consequence of Credit Sales in the current and previous periods

trade-in [p. 351] when a firm uses the proceeds from the sale of a non-current asset to reduce the amount payable for the purchase of a new noncurrent asset

stocktake [p. 173] a physical count of the number of units of each line of stock on hand

Understandability [p. 12] accounting reports should be presented in a manner that makes it easy for them to be understood by the user unit cost [p. 309] the cost price of each individual item/unit of stock variance [p. 411] the difference between an actual figure and a budgeted figure, expressed as ‘favourable’ or ‘unfavourable’ variance report [p. 410] an accounting report that compares actual and budgeted figures, highlighting variances, so that problems can be identified and corrective action taken vertical analysis [p. 443] a report that expresses every item as a percentage of a base figure; in this case, Sales revenue Working Capital Ratio (WCR) [p. 457] a liquidity indicator that measures the ratio of current assets to current liabilities, to assess the firm’s ability to meet its shortterm debts

subsidiary ledger [p. 90] an additional set of ledger accounts kept outside the General Ledger, recording individual transactions for each individual debtor or creditor

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481

SELECTED ANSWERS

CHAPTER 7

Chapter 2 2.2 2.3 2.4 2.6 2.7

c b a d b

Total Assets = $92 600 Total Assets = $83 190 Total Assets = $165 500 Total Assets = $103 100 Total Assets = $91 700

Chapter 3 3.4 3.5 3.6 3.7 3.8

c e d c d g h

b

5.3 5.5 5.6 5.8

e/f b e/f a c/d

5.9

c/d

Purchases Journal: Total Creditors Control = $54 120 Creditors Control (balance) = $15 950 Sales Journal: Total Debtors Control = $6 402 Debtors Control (balance) = $9 130 Purchases Journal: Creditors Control = $2 970 Sales Journal: Debtors Control= $3 850 Creditors Control (balance) = $4 720 Debtors Control (balance) = $8 140 Creditors Control (balance) = $7 260 Debtors Control (balance) = $8 525

Chapter 6 6.1 6.2 6.3 6.4 6.5 6.6 6.7

6.10 6.11

b d/e b d/e c e a d/e c/d a d/e c/d b

6.12

c d/f

6.8 6.9

8.8

8.12

b f a d d e

Total assets = $51 250 Stock Control (Balance) = $8 855

Net profit = $15 500 Total assets = $174 500 Net profit = $300 Total assets = $64 600 Stock Control (balance) = $10 530 Debtors Control (balance) = $22 000 Net profit = $20 520

CHAPTER 9 9.3 9.4 9.5 9.6 9.7 9.8

e b d g c f c g d f

Total equities = $68 700 Net profit = $24 000 Net loss = ($880) Total assets = $44 570 Net profit = $2 600 Total assets = $165 300 Net profit = $920 Total assets = $40 320 Net profit = $24 910 Total assets = $238 300

CHAPTER 10 10.11

10.12 Cash Payments Journal: Bank = $8 660 Creditors Control (balance) = $9 590 Cash Payments Journal: Bank = $10 085 Debtors Control (balance) = $6 910 GST Clearing (balance) = $550 CCR GST Clearing (balance) = $600 CCR Cash Payments Journal: Bank = $50 162 Creditors Control (balance) = $18 150 Creditors Control (balance) = $13 940 Cash Payments Journal: Bank = $10 427 Debtors Control (balance) = $1 815 Debtors Control (balance) = $5 720 Bank (balance) = $4 580 CR GST Clearing (balance) = $560 CR Trial Balance = $242 050 Creditors Control (balance) = $6 380 Debtors Control (balance) = $11 440

d e

CHAPTER 8

8.9 Trial Balance = $183 900 Trial Balance = $37 470 Trial Balance = $245 130 Trial Balance = $14 000 Trial Balance = $272 380 Net profit = $5 240 Total assets = $263 240

Chapter 5 5.2

7.2 7.12

10.13

c e f c e g c f g

Trial Balance = $194 970 Net profit = $2180 Total assets = $96 650 Trial Balance = $480 530 Net profit = $52 550 Total assets = $311 500 Trial Balance = $172 120 Net profit = $26 260 Total assets = $113 670

CHAPTER 11 11.10

11.11

c e h b e g

Trial Balance = $288 150 Net loss = ($8250) Total assets = $84 450 Trial Balance = $204 220 Net profit = $19 880 Total assets = $79 100

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SELECTED ANSWERS

482

CHAPTER 16

CHAPTER 12 12.1 12.10 12.11 12.12 12.13 12.14

a/b b b b c a/b c d

Bank Balance at End = $2900 DR. Bank Balance at End= ($530) Bank Balance at End= ($7950) Bank Balance at End= $57 800 Net loss = ($1350) Bank Balance at End= ($560) Debtors Control (balance) = $56 000 Bank Balance at End= $10 860

16.9

16.10

c d f f

CHAPTER 17 17.1 17.2

b b

17.5

c

17.6

a b d

CHAPTER 13 13.2 13.4 13.5

e d e d

13.6

c

13.8

d b

Freezing Fridges (balance) = $5434 Mega World (balance) = $1355 Gross profit = $480 Stock Control (balance at Nov 1) = $46 000 Creditors Control (balance at Nov 1) = $28 500 GST Clearing (balance at Nov 1) = $2 400 Debtors Control (balance at Dec 1) = $30 120 Stock Control (balance at Dec 1) = $16 600 GST Clearing (balance at Dec 1) = $970 Gross profit = $18 800 Debtors Control (balance at Jul 1) = $4 290 Creditors Control (balance at Jul 1) = $4 268 Stock Control (balance at Jul 1) = $7 820 GST Clearing (balance at Jul 1) = $363 City of Hume (balance) = $924 Net loss = ($3 379)

d e

17.7

17.15

f c d f g e g

CHAPTER 14 14.5 14.8 14.12

c e f

Adjusted Gross Profit = $1 100 Adjusted Gross Profit = $1 900 Adjusted Gross Profit = $19 500

Trial Balance = $247 975 Net profit = $10 415 Total assets = $185 925 Current Assets = $109 180 Current Liabilities = $93 500

h 17.16

c e

Bank Balance at End = ($7330) Bank Balance at End: Jan. = $120 Feb. = ($15 160) Mar. = $4 910 Net Cash Flows from Operations: Jan. = $120 Feb. = ($15 160) Mar. = $4 910 Bank Balance at End= $42 480 Net profit = $5 250 Stock Control (balance) = $21 200 GST Clearing (balance) = $2 120 Total assets = $76 250 Bank Balance at End= $28 135 Net profit = $9 745 Stock Control (balance) = $18 700 GST Clearing (balance) = $1 880 Total assets = $110 755 Bank Balance at End = $25 108 Stock Control (balance) = $49 900 GST Clearing (balance) = $7 220 Current Assets = $98 358 Current Liabilities = $55 220 Net profit = $25 220 Total assets = $69 320

CHAPTER 15 15.14

b d f

Trial Balance = $131 440 Net profit = $9 440 Total assets = $72 950

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