14/5/08
chp 14 p 439 of text
BALANCE DAY CLOSING ENTRIES
Recapitulation;
Balance Day Adjustments
Definition;
GAAP, Accounting Standards and Legislation require that Revenue earned in a period be Matched with the Expenses incurred in earning it. Balance day adjustment is the term used to describe the process we adopt to achieve this.
It is commonly referred to as Accrual Accounting.
Balance day adjustments are done after the initial trial balance is completed.
Accounts affected by adjusting entries
This gives rise to the following generic asset (dr) and liability (cr) provision accounts. We make ‘provision’ for the portion pertaining to the accounting period.
Accrued Expense (cr) – Cost incurred in period not yet paid
Prepaid Expense (dr) – Cost paid in period that relates to a future period
Accrued Income (dr) – Income earned in period not yet received
Income in Advance (cr) – Income received in period for goods or services to be provided in a future period.
Adjustments made to these accounts at period end (balance day) are reversed at first day of next accounting period.
Other Accounts affected by adjusting entries
It also gives rise to other specific provision accounts that need to be adjusted. Such as;
Provision for depreciation or accumulated depreciation
Bad debts & Provision for doubtful debts
Inventory variance – perpetual inventory compared to physical
Provision for leave
Standing Journals
It may also give rise to the use of specific journals known as ‘standing journals’ to be used for entering the amounts when they are known in advance for;
Prepaid expenses,
Income received in advance and
Depreciation
Note! No adjustments are made for GST as it is not an Expense or Revenue item.
CLOSING ENTRIES
Information flow in the accounting cycle
As mentioned in balance day adjustments we produce 3 major financial reports as the end product of the accounting system;
1. Income Statement – revenue less expenses,
2. Balance Sheet – assets, liabilities and owners equity and
3. Cash Flow Statement – reconciles cash movements over period.
The journal entries we make to close the accounts for the period facilitate the generation of these reports. This is the final stage in the financial recording process.
The closing general journal entries are done after you have done all the balance day adjusting entries.
Normal flow in the closing process
Hint
You will not always have complete records or a trial balance given to you. So first go through the information given and identify wether it’s a revenue (cr), expense (dr), asset (dr), liability (cr) or equity (cr) account and wether it would normally be a debit or credit balance
Step 1
Close trading revenue (sales) account/s by debiting it for the balance as at end of period and crediting the Trading Account. Then close the trading (expense) accounts by debiting the Trading Account and crediting the appropriate expense accounts with their period end balances.
Step 2
Close Trading account balance to the Profit and Loss account. If you made a profit i.e. Sales – Expenses = Positive value or Credit balance. You debit the Trading account and credit the Profit & Loss account, and reverse this if it’s a loss i.e. negative value or Debit balance.
Step 3
Close all other revenue accounts to the Profit & Loss account (debit revenue a/c and credit P & L a/c). Then close all other expense accounts to the Profit & Loss account (debit P & L a/c and credit the expense a/c)
Step 4
Close the balance in the Profit and Loss account to the Balance sheet Owners equity (Capital a/c). If it’s a profit you debit P & L and credit Capital a/c and the reverse if it’s a loss.
Step 5
Close the balance in the owners Drawing Account/s to the Capital a/c in the owner’s equity section of the balance sheet (If they have taken cash or inventory or services from the business in the period these a/c’s will have a debit balance and this reduces the amount of funds owed to them by the business or reduces the owners equity section of the balance sheet). So normally you would debit Capital and credit Drawings for the balance.
Step 6
Prepare the classified Income Statement and Balance Sheet.
Inventory
How you treat the inventory in the closing process depends on wether you have adopted the Periodic or Perpetual method of inventory accounting.
Periodic inventory
Strictly speaking the entry to transfer the balance in the inventory account, the opening inventory, to the Trading Account is a closing entry and the entry to take up Closing Inventory balance at the end of the period is an adjusting entry. Both are usually shown with the closing entries
Example
Trading Sales for period were $520,000
Opening inventory balance given is $140,000 as at 1/7/07
Closing inventory balance (verified by physical count) is $160,000 as at 30/6/08.
Purchases for period were $220,000 (i.e. closing bal as at 30/6/08) and
Customs duty paid on purchases was $10,000 (i.e. closing bal as at 30/6/08)
30/6/08 Trading Sales
Trading Account
(trading revenue transferred) 520,000
520,000
Trading Account
Inventory(opening)
Purchases
Customs Duty
(trading expenses transferred) 370,000
160,000
220,000
10,000
Closing Inventory(balance sheet a/c)
Trading Account
(unsold inventory as at this date) 160,000
160,000
Note! If it’s a Periodic system you will have opening and closing inventory balances given to you and no Cost of Goods Sold Account.
Perpetual inventory
This is a simpler system at balance time as you always treat the inventory a/c as a Balance sheet current asset account. The cost value for the goods sold is recorded as an expense in the Cost of Goods Sold account every time a sale is made during the period.(if we used the example above the COGS would be the $200,000 inventory plus the $10,000 customs duty. The end effect on P & L is the same just a different way of getting there)
Consequently you only need to close this Cost of Goods Sold account by transferring the balance as at period end to the Trading Account
Work through example p442 Periodic
Work through example p444 Perpetual
Have students do self testing exercise 1(a) periodic and 1 (b) perpetual
Have students do Question 1 (a) p464
Have students do Question 3 (b) p469
Classified Income Statement and Balance Sheet
The aim of classifying the income statement and balance sheet is to make it easier for end users to read and understand.
We are guided by the accounting standards in doing this in that it sets out a series of Classification we must adhere to.
At this stage you don’t need to know the standard but just follow the layout given in the text.
Work through examples on p448, periodic
Work through example p451, Perpetual
Have students do self testing exercise 2(a) periodic and 2 (b) perpetual
Now to test yourselves do the following questions, these require both the balance day adjustment entries, then the closing entries and finally the classified Income statement and Balance Sheet.
Have students do Question 6 (a) p474
Have students do Question 6 (b) p475
