AA015 Chapter 5

ACCOUNTING 1 (AA015) ADJUSTMENT AT THE END
OF ACCOUNTING PERIOD

CHAPTER 5

ADJUSTMENT AT THE END OF

ACCOUNTING PERIOD

LEARNING OUTCOMES:

5.1 Describe basis of accounting: cash basis and accrual basis.
5.2 Define revenues and expenses and explain their effects on owner’s equity.

5.3 Record revenues and expenses items.

5.4 Describe the differences between revenue expenditures and capital

expenditures.

5.5 Describe the form of reporting of revenues and expenses in statement of

comprehensive income / profit or loss account.

5.6 Describe the purposes for adjustments at the end of accounting period under

accrual basis.

5.7 Describe, calculate and record adjustments at the end of accounting period as

follows:

5.7.1 Unearned Revenues

5.7.2 Accrued Revenues

5.7.3 Prepaid Expenses

5.7.4 Accrued Expenses / Expenses payable

5.7.5 Depreciation Expenses

5.7.6 Bad Debt Expenses

5.8 Describe two types of errors, i.e errors affecting trial balance and errors not

affecting trial balance.

5.9 Prepare the adjusted trial balance

5.10 Prepare statement of comprehensive income / profit or loss statement,
statement of owner’s equity and statement of financial position based on the

adjusted trial balance.

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ACCOUNTING 1 (AA015) ADJUSTMENT AT THE END
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5.1 BASIS OF ACCOUNTING : CASH BASIS AND ACCRUAL BASIS

5.2 DEFINITION OF REVENUES AND EXPENSES
Revenue recognition principle
Recognize revenue in the accounting period in which the performance obligation is satisfied.
Revenues
1. Revenue of Operations:

• The revenue obtained from core business activities.
• Example: Sales Revenue / Service Revenue.

2. Other Revenues:
• Revenues that are not related to the main activity.
• Example: Interest Revenue, Dividend Revenue

Expense recognition principle
Match expenses with revenues in the period when the company makes efforts that generate
those revenues.

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Expenses

1. Operating Expenses:
• Expenses incurred in the process of earning sales revenue.
• Example: Salaries expense, advertising expense, and insurance expense.

2. Non Operating expense:
• Expenses that are not directly related to the main activity.
• Example: Interest expense, Loss on Disposal of Vehicles

5.3 REVENUES AND EXPENSES EXPENSES

REVENUES Definition Cost of services /
goods used to generate revenue
Earnings that result from delivering
goods or services to customers. GAAP Expense Recognition Principle

Revenue Recognition Principle Effect on Decreases Owner’s
Increases Owner’s Owner’s Equity
Equity
Equity

5.4 DIFFERENCES BETWEEN REVENUE EXPENDITURES AND CAPITAL EXPENDITURES

Revenue Expenditure

A revenue expenditure is an amount that is expensed immediately—thereby being matched with
revenues of the current accounting period. Routine repairs are revenue expenditures because
they are charged directly to an account such as Repairs and Maintenance Expense. Even
significant repairs that do not extend the life of the asset or do not improve the asset (the repairs
merely return the asset back to its previous condition) are revenue expenditures.

Capital Expenditure

A capital expenditure is an amount spent to acquire or improve a long term asset such as
equipment or buildings. Usually the cost is recorded in an account classified as Property, Plant
and Equipment. The cost (except for the cost of land) will then be charged to depreciation
expense over the useful life of the asset.

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ACCOUNTING 1 (AA015) ADJUSTMENT AT THE END
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Revenue Expenditures
VS Capital Expenditures
Any expenditure incurred to
maintain the assets in working Any expenditure incurred to acquire
condition and for the operation of an asset or /and bring it into
the business. working condition

Decrease the business profit Improve the efficiency or substantial
working life of the asset
The benefit is received for the
current period and sometimes The benefit of which is received over
recurring a period of more than one year.

Report in the Statement of Report in the Statement
Profit or Loss of Financial Position

Eg: Repairs of furniture, Eg:Purchase of machinery,
Cleaning of machinery, Repainting Installation cost of machinery, Custom
of building duty on machinery

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ACCOUNTING 1 (AA015) ADJUSTMENT AT THE END
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5.5 REVENUES AND EXPENSES REPORTING

Example Of Reporting Revenues And Expenses (Trading Company) RM RM
20,000
Seia Sekata Company (8,000)
Statement of Profit or Loss
For The Year Ended December 31, 2019. 12,000

Sales
(-) Cost of goods sold
Gross profit

(-) Operation expenses: 3,100
Advertising expense 4,900
Depreciation expense
Rent expense 500
Total expenses
(8,500)
Net Profit 3500

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ACCOUNTING 1 (AA015) ADJUSTMENT AT THE END
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Example Of Reporting Revenues And Expenses (Services)

Fastway Ent.
Statement of Profit or Loss
For The Year Ended October 31, 2019.

Services revenue RM RM
Expenses: RM2,700
RM500
Advertising expense 400 ( 1,700 )
Rent expense 800 RM1,000
Salaries expense
Total expenses
Net Income

5.6 PURPOSE OF ADJUSTMENT

Adjusting Entries
◆ To ensure that the revenue recognition and expense recognition principles are
followed.
◆ It is necessary because the trial balance may not contain up-to-date and
complete data.
◆ Required every time financial statements are prepared.

5.7 TYPES OF ADJUSTMENTS

Prepayment Accruals

Prepaid Expenses. Accrued Revenues.
- Expenses paid in cash before they - Revenues for services performed but
are used or consumed. not yet received in cash or recorded.

Unearned Revenues. Accrued Expenses.
- Cash received before services are - Expenses incurred but not yet paid in
performed. cash or recorded.

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5.7.1 Unearned Revenues

Receipt of cash that is recorded as a liability because the service has not been performed/
goods has not been sold.

Adjusting entry is made to record the revenue for services performed during the period and to
show the liability that remains at the end of the period.

Results in a decrease (debit) to a liability account and an increase (credit) to a revenue
account.

Illustration 1: Pioneer Advertising received RM1,200 on October 2 from R. Knox for advertising
services expected to be completed by December 31. Unearned Service Revenue shows a
balance of RM1,200 in the October 31 unadjusted trial balance. Analysis reveals that the company
performed RM400 of services in October.

Date Account Titles and Explanation RM RM

------OR------

Illustration 2: Pioneer Advertising received RM1,200 on October 2 from R. Knox for advertising
services expected to be completed by December 31. Service Revenue shows a balance of
RM1,200 in the October 31 unadjusted trial balance. Analysis reveals that the company
performed RM400 of services in October.

Date Account Titles and Explanation RM RM

5.7.2 Accrued Revenues

Revenues for services performed / goods sold but not yet received in cash or recorded.
Adjusting entry shows the receivable that exists and records the revenues for services
performed / goods sold.
Adjusting entry:

► Increases (debits) an asset account and
► Increases (credits) a revenue account

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Illustration: In October Pioneer Advertising performed services worth RM200 that were not
billed to clients on or before October 31.

Date Account Titles and Explanation RM RM

5.7.3 Prepaid Expenses

Payment of cash, that is recorded as an asset to show the service or benefit the company will
receive in the future.

Prepayments often occur in regard to:
◆ insurance
◆ supplies
◆ advertising
◆ rent

Expire either with the passage of time or through use.
Adjusting entry:

► Increase (debit) to an expense account and
► Decrease (credit) to an asset account.

Insurance

Illustration: On October 4, Pioneer Advertising paid RM600 for a one-year fire insurance
policy. Coverage began on October 1. Pioneer recorded the payment by increasing (debiting)
Prepaid Insurance. This account shows a balance of prepaid insurance RM600 in the October
31 unadjusted trial balance. Insurance of RM50 (RM600 ÷ 12) expires each month.

Date Account Titles and Explanation RM RM

------OR------

Company may choose to debit (increase) an expense account rather than an asset account.
This is an alternative treatment.

Date Account Titles and Explanation RM RM

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Supplies

Illustration: Pioneer Advertising purchased supplies costing RM2,500 on October 5. Pioneer
recorded the payment by increasing (debiting) Supplies. This account shows a balance of
RM2,500 in the October 31 trial balance. An inventory count at the close of business on October
31 reveals that RM1,000 of supplies are still on hand.

Date Account Titles and Explanation RM RM

------OR------

Company may choose to debit (increase) an expense account rather than an asset account.
This is an alternative treatment.

Date Account Titles and Explanation RM RM

Summary of the accounting for prepaid expenses.
ACCOUNTING FOR PREPAID EXPENSES

Examples Reason For Accounts Adjusting Entry
Adjustment Before Dr. Asset
Insurance, Adjustment
supplies, Not all the Cr.Expenses
advertising, rent, expenses Expenses
depreciation paid have overstated,
been used asset
understated

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ACCOUNTING 1 (AA015) ADJUSTMENT AT THE END
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5.7.4 Accrued Expenses / Expenses Payable

Expenses incurred but not yet paid in cash or recorded.
Accrued expenses often occur in regard to:
• Rent
• Interest
• Taxes
• Salaries

Expense Recorded BEFORE Cash Payment

Adjusting entry records the obligation and recognizes the expense.
Adjusting entry:
► Increase (debit) an expense account and
► Increase (credit) a liability account.

Illustration: Pioneer Advertising paid salaries and wages on October 26; the next
payment of salaries will not occur until November 9. At October 31, the salaries for the last
three days of the month represent an accrued expense and a related liability. The
employees receive total salaries of RM2,000 for a five-day work week, or RM400 per day.

Date Account Titles and Explanation RM RM

Summary of the accounting for accrued expenses

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Exercises: Adjusting Entries for Accruals

Prepare the adjusting entries needed at August 31, 2016.

1. At August 31, the company owed its employees RM800 in salaries and wages that will
be paid on September 1.

Date Account Titles and Explanation RM RM

2. On August 1, the company borrowed RM30,000 from a local bank on a 15-year
mortgage. The annual interest rate is 10%.

Date Account Titles and Explanation RM RM

3. Revenue for services performed but unrecorded for August totaled RM1,100.

Date Account Titles and Explanation RM RM

5.7.5 Depreciation Expenses

Buildings, equipment, and motor vehicles (assets that provide service for many years) are
recorded as assets, rather than an expense, on the date acquired.

Depreciation is the process of allocating the cost of an asset to expense over its useful life.

Depreciation does not attempt to report the actual change in the value of the asset.

► Allocation concept, not a valuation concept.

➢ Straight -Line Method Formula :
Depreciation Expense = Cost – Salvage Value
Useful Life
OR
Depreciation Expense = (Cost – Salvage Value) x %

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Statement Presentation:

• Accumulated Depreciation is a contra asset account (credit).
• Offset the related asset account in the statement of financial position
• Book value is the difference between the cost of any depreciable asset and its

accumulated depreciation.

Illustration 1: For Pioneer Advertising, assume that depreciation on the equipment is RM480 a
year, or RM40 per month.

Date Account Titles and Explanation RM RM

Illustration 2: On January 1, 2010 the business bought a lorry at a price of RM100,000. The
estimated useful life is 10 years and is expected to have a salvage value of RM5,000. The
accounting period ends 31 December each year.

Date Account Titles and Explanation RM RM

5.7.6 Bad Debts Expenses

A bad debt is a debt by a customer (an asset to the business) that is almost certain cannot be
collected. Whenever a bad debt occurs, the debtors account should be closed.
There are many reasons why a bad debt can occur. Among them are:
– The debtor may have passed away.
– The debtor may have become bankrupt.
– The debtor may have disappeared and cannot be contacted.
– The debtor cannot afford to pay anymore.

The bad debt account must be charged as expenses in the Statement of Profit or Loss

The double entry are as follows:-

Debit the Bad Debts account
Credit the respective Debtors accounts

(when the bad debts are written-off during the year)
On 25 November 2010 the business identified that a debtor named Badrul has gone bankrupt
and unable to pay its debts RM 1,000.

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ACCOUNTING 1 (AA015) ADJUSTMENT AT THE END
Date Account Titles and Explanation OF ACCOUNTING PERIOD

RM RM

5.8 CORRECTING ENTRIES

Errors Affecting Trial Balance

Types of errors you will see:
• An error in the journal (the entry has not yet been posted)
• Journal entry is correct; a mistake is made while posting to the ledger
• Error in a journal entry that has already been posted (both journal and ledger are incorrect)

Errors Not Affecting The Trial Balance

Types of errors you will not see:
• Unrecorded transaction
• Incorrect amount recorded for debit and credit
• Accounts reciprocity
• Error of principle

5.9 ADJUSTED TRIAL BALANCE

• Prepared after all adjusting entries are journalized and posted.
• Purpose is to prove the equality of debit balances and credit balances in the ledger.
• Is the primary basis for the preparation of financial statements.
• Adjusted trial balance prepared after adjustments are made.
• Financial statements prepared using the adjusted trial balance information.

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5.10 PREPARATION OF FINANCIAL STATEMENTS AFTER ADJUSTMENT

SmartShop Enterprise
Trial balance As At June 30, 2019

Accounts Debit Credit
(RM) (RM)
Cash
Inventory 7,430 26,500
Accounts receivable 8,900 4,000
Supplies 4,300 1,100
Vehicles (cost) 2,250
Accumulated Depreciation - Vehicles 70,000 60,000
Furniture (cost) 2,500
Accumulated Depreciation - Furniture 10,000
Accounts Payable 74,400
Capital 6,500
Unearned Rental Revenue 4,200
Drawings 3,300 2,100
Sales 1,400
Sales return and allowances 40,900 174,800
Sales discounts
Purchases 9,000
Purchase returns and allowances 600
Purchase discounts
Rental expense 1,600
Insurance Expenses 4,000
Vehicle Maintenance Expenses
Advertising expense 400
Freight in 300
Freight out 2,800
Utilities Expenses 1,120
Miscellaneous expenses 174,800
Jumlah

Additional information :

1. The ending inventory as at 30 June 2019 is RM8,700.
2. Part of the unearned rental revenue of RM2,000 has been recognized in the current year.
3. On 28 June 2019, merchandise was sent to customers valued at RM3,500 but cash has not

been received yet.
4. Insurance expense is for a half-year period beginning 1 March 2019.
5. Supplies on hand at June 30 are RM1,500.
6. Advertising expense of RM300 has not been recorded and will not be paid until next month.

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7. Furniture is depreciated 20% per annum on straight line basis.
8. Annual depreciation is RM8,750 on vehicles .
9. Debtors ( Hamid Company) were found bankrupt and their debts of RM390 were written off.
10. A withdrawal of RM500 has been recorded as a miscellaneous expense.

Required:
a) Prepare the adjusting entries for the above transactions.
b) Prepare an Adjusted Trial Balance on June 30, 2019.
c) Prepare a Statement of Comprehensive Income for the year ended 30 June 2019.
d) Prepare a Statement of Owners' Equity on June 30, 2019.
e) Prepare a Statement of Financial Position as at 30 June 2019.

Answers:

a) Adjusted Journal Entries

Date Accounts Debit Credit
RM RM

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Account Title Perniagaan SmartShop Kredit
Adjusted Trial Balance As At June 30, 2019 (RM)

Debit
(RM)

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Perniagaan SmartShop RM
Statement of Comprehensive Income

For The Year Ended June 30, 2019
RM RM

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Perniagaan Smartshop
Statement of Owner’s Equity

As at June 30, 2019

Beginning capital Perniagaan SmartShop RM RM
(+) Net Profit Statement of Financial Position
(-) Drawings
Ending capital As at June 30, 2019
RM
ASSETS
Non Current Assets

Total Non Current Assets
Current Assets

Total Current Assets
TOTAL ASSETS
OWNER’S EQUITY

LIABILITIES

Total Liabilities
TOTAL LIABILITIES AND OWNER’S EQUITY

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Exercise 1:

The ledger of Hammond Company, on March 31, 2017, includes these selected accounts

before adjusting entries are prepared.

Debit Credit

Prepaid Insurance RM 3,600

Supplies 2,800

Equipment 25,000
Accumulated Depreciation—Equipment
RM5,000

Unearned Service Revenue 9,200

An analysis of the accounts shows the following.
1. Insurance expires at the rate of RM100 per month.
2. Supplies on hand total RM800.
3. The equipment depreciates RM200 a month.
4. During March, services were performed for one-half of the unearned service revenue

Prepare adjusting entries for the month of march.

Answer:

Date Account Titles and Explanation RM RM

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Exercise 2:

SINGGAH SELALU ENTERPRISE
UNADJUSTED TRIAL BALANCE AS AT DECEMBER 31, 2018

Accounts Debit Credit
RM RM
Cash
Accounts receivable 12,000 18,000
Office supplies 8,000 7,000
Inventory 1,200
Building 5,000 13,000
Accumulated depreciation- Building 25,000
Van 60,000 29,600
Accumulated depreciation- Van 65,000
Accounts Payable 35,000
Bank loan 2,000
Capital 3,000 1,500
Drawings
Sales 30,000 400
Purchases 1,500
Sales return and allowances 800
Sales discounts
Purchase returns and allowances 1,300
Purchase discounts 1,100
Freight in
Freight out 800
Utilities Expenses 300
Interest expenses
Interest revenue 1,500
Miscellaneous expenses

Total 161,500 161,500

Additional information:

• Inventory as at 31 December 2018 amounts RM6,300
• Depreciation on the non-current assets is to be provided 10% per year
• Office supplies on hand total RM 600
Required:
a. Adjusted Trial Balance
b. Statement of Comprehensive Income for the year ended 31 December 2018.
c. Statement of Financial Position as at 31 December 2018

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Answer:

PERNIAGAAN SINGGAH SELALU
ADJUSTED TRIAL BALANCE AS AT DECEMBER 31, 2018

Accounts Debit Credit
RM RM

Total 171,000 171,000

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PERNIAGAAN SINGGAH SELALU RM
STATEMENT OF PROFIT OR LOSS
FOR THE YEAR ENDED DECEMBER 31, 2018

RM RM

Gross profit 36,200

Net income 22,800

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PERNIAGAAN SINGGAH SELALU RM RM
STATEMENT OF FINANCIAL POSITION

AS AT DECEMBER 31, 2018
RM

Non Current Assets

Total Non current assets
Current assets

Total Current assets 87,400
Total Assets 87,400

Owner’s Equity

Ending capital
Non Current liabilities
Current Liabilities
Total liabilities
Total Liabilities And Owner’s Equity

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