MODULE 3

ACCRUAL ACCOUNTING（10%)

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 Module 3

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 THE ACCRUALS BASIS OF ACCOUNTING(P.93)

 Accruals basis: Revenue should be recognised when earned. Costs should be

recognized when incurred. Revenues and related costs should be matched in the
same time period.

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 THE ACCRUALS BASIS OF ACCOUNTING(P.93)

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 ACCRUALS AND PREPAYMENTS(P.94)

 Accrued expenses (accruals) are expenses which relate to an accounting period

but have not been paid in that accounting period. They are shown in the statement
of financial position at the end of the accounting period as a current liability.

 Prepaid expenses (prepayments) are expenses which are paid in an accounting

period but which relate to a future accounting period. They are shown in the
statement of financial position at the end of the accounting period as a current
asset.

 For example, in preparing the statement of profit or loss of a business for a period
of, say, six months, it is appropriate to charge six months' expenses for rent and
local taxes, insurance costs and telephone costs, and so on

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 Worked Example: Accrual(P.96)

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 Worked Example: Accrual(P.96)

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 Worked Example: Prepayment (P.96)

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 Worked Example: Prepayment (P.96)

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 PRACTICE 1

 Electricity paid during the year is $14 000. There was an opening accrual of $500.
A bill for the quarter ended 31 January 20X7 was $900. What is the electricity
charge in the statement of profit or loss for the year ended 31 December 20X6?

• A $13 900
• B $14 000
• C $14 100
• D $14 400

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 PRACTICE 1 ANSWER

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 PRACTICE 2

 A business compiling its accounts for the year to 31 January each year pays rent
quarterly in advance on 1 January, 1 April, 1 July and 1 October each year. After
remaining unchanged for some years, the rent was increased from $24 000 per
year to $30 000 per year as from 1 July 20X0. Which of the following figures is the
rent expense which should appear in the statement of profit or loss for year ended
31 January 20X1?

• A $27 500
• B $28 000
• C $29 000
• D $29 500

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 PRACTICE 2 ANSWER

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 REVENUE RECOGNITION (P.106)

 IFRS 15 governs the recognition of revenue and the key principle is to recognise
revenue when there is transfer of control from the entity supplying the goods or
services to the customer.

 The standard uses a five-step model that should be applied to ensure revenue is
correctly recognised.

 The model is as follows:

• 1. Identify the contract with a customer

• 2. Identify the separate performance obligations in the contract
• 3. Determine the transaction price
• 4. Allocate the transaction price to the performance obligations
• 5. Recognise revenue when (or as) the entity satisfies a performance obligation

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 Worked Example: Performance obligations(P.106)

 Thomas manufactures bikes and on 1 May 20X4 he receives an order for 10 bikes
for $10 000. Thomas agrees to supply the bikes on the 1 June 20X4. The bikes are
delivered to the customer on 1 June 20X4 and the customer pays on the 30 June
20X4.

 Applying the five-step model to this scenario, when should Thomas recognise
revenue?

 The contract with the customer was entered into on 1 May 20X4 and Thomas has
agreed to deliver 10 bikes so this is the performance obligation. The transaction
price is the amount agreed in the contract of $10 000 and as there is only one
performance obligation in the contract the whole amount is allocated to it.

 The performance obligation is satisfied when the bikes are delivered to the
customer on 1 June 20X4, as at this point Thomas has transferred control of the
bikes to the customer. Thomas will recognise revenue of $10 000 on that date.

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 DISCOUNTS(P.107)

 Discounts can be defined as follows:

 A trade discount is a reduction in the list price of goods or services, given by a

wholesaler or manufacturer to a retailer. It is often given in return for bulk purchase
orders.

 A settlement discount (sometimes called cash discount) is a reduction in the

amount payable for goods or services in return for payment immediately in cash, or
within an agreed period.

 A discount allowed is one of the above discounts given to a customer on a sale.

 A discount received is one of the above discounts received from a supplier on a

purchase.

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 ACCOUNTING FOR DISCOUNTS(P.108)

 Trade discounts received are deducted from the cost of purchases.

 Settlement discounts received are deducted from the cost of purchases. A

finance cost will be shown if the business does not pay within the agreed period.

 Trade discounts allowed are deducted from the full sales price, and this amount is
invoiced to the customer.

 Settlement discounts allowed are deducted from revenue if the business expects
the customer to pay within the agreed period.

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 TRADE DISCOUNTS JOURNALS(P.108)

 For example, Company A purchases inventory on credit from Supplier B at a gross

cost of $100, and receives a trade discount of 5 per cent from the supplier.
Company A will record the purchase as follows:

• Dr. Purchases $95

• Cr. Trade payables control account $95

 For example, Company B sells inventory on credit to Customer A at a gross sale

price of $100 and offers a trade discount of 10 per cent to the customer. The double
entry for the sale is as follows:

• Dr. Trade receivables control account $90

• Cr. Income $90

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 SETTLEMENT DISCOUNTS EXAMPLE(P.111)

 On 1 May 20X7 Freddie sells some football merchandise to a customer on credit for
$6000, he offers the customer a settlement discount of 10 per cent if they pay
within 10 days. In the past the customer has always taken up the settlement
discount and Freddie expects this to continue. The customer pays the full amount
on the 16 May 20X7.

 (a) Prepare the initial entry to record the sale on 1 May 20X7.
 (b) Prepare the entry to record the cash receipt on 16 May 20X7.

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 SETTLEMENT DISCOUNTS EXAMPLE(P.111)

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 IRRECOVERABLE DEBTS(P.112)

 Irrecoverable debts are specific debts owed to a business which it decides are
never going to be paid. They are written off as an expense in the statement of profit
or loss.

 When a business decides that a specific debt is unlikely to be paid, the amount of
the debt is 'written off' as an expense in the statement of profit or loss:

• Dr. Irrecoverable debts

• Cr. Trade receivables control account

 The debit entry is to trade receivables control, and to the personal account in the
subsidiary ledger. irrecoverable debts are debited as an expense in the
statement of profit or loss.

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 Worked Example: Irrecoverable debts written off(P.113)

 At 1 October 20X5 a business had total outstanding debts of $8600. During the
year to 30 September 20X6 the following transactions took place:

• credit sales amounted to $44 000

• payments from various credit customers amounted to $49 000
• two debts, for $180 and $420, were declared irrecoverable. These are to be written
off.

 Required

 Prepare the trade receivables control account and the irrecoverable debts
account for the year.

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 Worked Example: Irrecoverable debts written off(P.114)

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 ALLOWANCE FOR RECEIVABLES(P.114)

 In addition to irrecoverable debts, a business may make an allowance for

receivables as a precaution to account for the fact that some trade receivables
balances might not be collectable.

 Trade receivables in the statement of financial position are shown net of any
allowance for receivables.

 An increase (or decrease) in the allowance for receivables is debited (or Credited)
to irrecoverable debts in the statement of profit or loss.

 A doubtful debt is a debt which is possibly irrecoverable.

 Allowance for receivables. An amount that reduces trade receivables to the

recoverable amount in the statement of financial position. It is offset against trade
receivables, which are shown at the net amount.

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 PRACTICE 3

 At 31 December 20X2 a company's trade receivables totalled $400 000 and an

allowance for receivables of $50 000 had been brought forward from the year
ended 31 December 20X1. It was decided to write off debts totalling $38 000 and to
adjust the allowance for receivables to an amount equivalent to 10 per cent of
receivables. What charge for irrecoverable debts should appear in the company's
statement of profit or loss for the year ended 31 December 20X2?

• A $24 200
• B $28 000
• C $51 800
• D $74 200

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 PRACTICE 3 ANSWER

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 PRACTICE 4

 At 30 June 20X4 a company's allowance for receivables was $39 000. At 30 June
20X5 trade receivables totalled $517 000. It was decided to write off debts totalling
$37 000 and to adjust the allowance to 5 per cent of trade receivables. What figure
should appear in the statement of profit or loss for these items?

• A $22 000
• B $23 850
• C $24 000
• D $61 000

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 PRACTICE 4 ANSWER

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 CONTRA ENTRIES(P.120)

 A contra entry is an adjustment between the trade receivables control and trade
payables control accounts when someone is both a customer and a supplier so
appears in both the trade receivables ledger and the trade payables ledger.

 For example, C Cloning buys hardware from you and you buy stationery from C
Cloning. In the trade receivables ledger, C Cloning owes you $130. However, in
the trade payables ledger you owe C Cloning $250. You agree with C Cloning to
offset the trade receivable and trade payable, so cash does not need to change
hands in respect of the amount mutually owed. This is known as a 'contra'.

 The double entry for this kind of contra is as follows:

• Dr. Trade payables control account $130

• Cr. Trade receivables control account $130
• You will also need to make the appropriate entries in the memorandum trade
receivables and trade payables ledgers. After this, C Cloning will owe you nothing
and you will owe C Cloning $120 ($250 – $130).

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 MODULE 4

ACCOUNTING FOR INVENTORIES（5%)

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 Module 4

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 WHAT IS INVENTORY?(P.132)

 IAS 2 Inventories defines inventories as follows:

 Inventories are assets:

• (a) held for sale in the ordinary course of business;

• (b) in the process of production for such sale; or

• (c) in the form of materials or supplies to be consumed in the production process or

in the rendering of services

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 COST OF GOODS SOLD(P.132)

 Sales – Cost of sales = Gross profit.

 On 1 January 20X6, the Grand Union Food Stores had goods in inventory valued
at $6000. During 20X6 its proprietor purchased supplies costing $50 000. Sales for
the year to 31 December 20X6 amounted to $80 000. The cost of goods in
inventory at 31 December 20X6 was $12 500. Calculate the gross profit for the
year.

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 THE COST OF CARRIAGE INWARDS AND OUTWARDS(P.134)

 'Carriage' refers to the cost of transporting purchased goods from the supplier
to the premises of the business which has bought them.

 The cost of carriage inwards is usually added to the cost of purchases in the
statement of profit or loss.

 When the purchaser pays, the cost to the purchaser is carriage inwards (into the
business). When the supplier pays, the cost to the supplier is known as carriage
outwards (out of the business)

 The cost of carriage outwards is a selling and distribution expense in the

statement of profit or loss.

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 Worked Example: Carriage inwards and carriage outwards(P.134)

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 OPENING AND CLOSING INVENTORIES(P.135)

 When an inventory count is made, the business will record a value for its closing
inventory, and the double entry is:

• Dr. Inventory account (closing inventory value) $X

• Cr. Profit or loss account $X

 Closing inventory at the end of one period becomes opening inventory at the start
of the next period. The inventory account remains unchanged until the end of the
next period, when the value of opening inventory is taken to the profit or loss
account:

• Dr. Profit or loss account $X

• Cr. Inventory account (value of opening inventory) $X

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 COUNTING & VALUING INVENTORIES(P.136)

 The quantity of inventories held at the year end is established by a physical

count of inventory in an annual counting exercise, or by a 'continuous' inventory
count.

 The value of inventories is calculated at the lower of cost and net realisable value
for each separate item or group of items. Cost can be arrived at by using FIFO
(first in, first out) or AVCO (weighted average costing).

 The accounting treatment of inventory is governed by an accounting standard, IAS

2 Inventories. IAS 2 states that 'inventory shall be measured at the lower of
cost and net realisable value' (IAS 2: para 9)

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 APPLYING THE BASIC VALUATION RULE(P.137)

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 APPLYING THE BASIC VALUATION RULE(P.137)

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 DETERMINING THE PURCHASE COST(P.138)

 FIFO (first in, first out). Using this technique, we assume that components are
used in the order in which they are received from suppliers. The components
issued are deemed to have formed part of the oldest consignment still unused and
are costed accordingly.

 AVCO (average cost). As purchase prices change with each new consignment,
the average price of components in the bin is constantly changed. Each
component in the bin at any moment is assumed to have been purchased at the
average price of all components in the bin at that moment.

 There is a further method known as LIFO (last in first out). IAS 2 Inventories does
not permit the use of LIFO (IAS 2: para IN13)

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 INVENTORY VALUATIONS AND PROFIT(P.140)

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 INVENTORY VALUATIONS AND PROFIT(P.140)

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 INVENTORY VALUATIONS AND PROFIT(P.140)

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 INVENTORY VALUATIONS AND PROFIT(P.140)

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 PRACTICE 5

 The closing inventory at cost of a company at 31 January 20X3 amounted to $284

700.The following items were included at cost in the total:

• 800 skirts, which had cost $20 each. These too were found to be defective.
Remedial work in February 20X3 cost $5 per skirt, and selling expenses for the
batch totalled $800. They were sold for $28 each.

• 400 coats, which had cost $80 each and normally sold for $150 each. Owing to a
defect in manufacture, they were all sold after the reporting date at 50 per cent of
their normal price. Selling expenses amounted to 5 per cent of the proceeds.

 What should the inventory value be after considering the above items?

• A $281 200
• B $282 800
• C $284 700
• D $329 200
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 PRACTICE 5 ANSWER

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 PRACTICE 6

 A company values its inventory using the first in, first out (FIFO) method. At 1 May
20X2 the company had 700 engines in inventory, valued at $190 each. During the
year ended 30 April 20X3 the following transactions took place:

 20X2
• 1 July Purchased 500 engines at $220 each
• 1 November Sold 400 engines for $160 000
 20X3
• 1 February Purchased 300 engines at $230 each
• 15 April Sold 250 engines for $125 000

What is the value of the company's closing inventory of engines at 30 April 20X3?
• A $133 000
• B $166 000
• C $188 500
• D $195 500

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 PRACTICE 6 ANSWER

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 PRACTICE 7

 At 30 September 20X3 the closing inventory of a company amounted to $386 400.

The following items were included in this total at cost:

• 1000 items which had cost $18 each. These items were all sold in October 20X3
for $15 each, with selling expenses of $800.
• Five items which had been in inventory for a number of years, when they were
purchased for $100 each, sold in October 20X3 for $1000 each, net of selling
expenses.

 What figure should appear in the company's statement of financial position at 30

September 20X3 for inventory?

 A $382 600
 B $384 200
 C $387 100
 D $400 600

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 PRACTICE 7 ANSWER

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 PRACTICE 8

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 PRACTICE 8 ANSWER

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