LaiACCT1200/fall20 (lecture 5)

ADA University, School of Business

ACCT1200 Principles of Financial Accounting, Fall 2020
Lecture 5 – Accounting Cycle 3

 Trial Balance:
o Before using the account balances to prepare the financial statements, it is
desirable to prove that the total of the accounts with debit balances is equal to
the total of the accounts with credit balances. This proof of the equality of debit
and credit balances is achieved through a trial balance.
o A trial balance is a statement prepared at the end of an accounting period. In its
simplest form, a trial balance is a two-column schedule listing the names and
balances of all the accounts in the order in which they appear in the ledger. The
debit balances are listed in the left-hand column and the credit balances are
listed in the right hand column. The totals of the two columns should agree. The
trial balance does not form part of the double-entry system.

 Exercise: Prepare a trial balance of the accounts of Brian’s business as at 01 February

2018 (Issue 1 of Tutorial 4).

Debit ($) Credit ($)

Bank 23,000
Capital 30,000
Rent 4,000
Linda 4,300
Purchases 18,000
Motorcar 4,000
Sydney 900
Sales 14,000
Ann 1,000
Return outwards 2,000
Return inwards 1,000
Petty cash 250
Discounts allowed 500
Office expenses 250
Discounts received 800
Total 52,000 52,000

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 LaiACCT1200/fall20 (lecture 5)

 Uses of the trial balance:

o It provides proof that the ledger is in balance.
o It helps in the preparation of the financial statements.
o The agreement of the debit and credit totals of the trial balance provides you
with the confidence that:
 equal debits and credits have been recorded for all transactions.
 the debit or credit balance of each account has been correctly calculated.
 the addition of the account balances in the trial balance has been
correctly done.
The trial balance, however, does not guarantee that no error has been committed.

 What should you do if the trial balance does not “balance”?

 Errors that are not identified by the trial balance:

(i) error of omission - no debit or credit entries were made for a particular transaction;
completely missed the transaction.
(ii) complete reversal of entries – entries were made in the wrong side of the accounts; a
transaction requires a debit entry in account A and a credit entry in account B but
account A was credited and account B was debited instead.
(iii) error of accounting principle – a transaction may have been entered in the wrong
type of account, e.g. the purchase of a new delivery van may have been debited to the
purchases account instead of the delivery vans account.
(iv) error of original entry – the original figure was incorrectly entered in both accounts,
e.g. $100 instead of $1,000.
(v) compensating errors – an error on one side of the ledger account is compensated or
“cancelled” by an error of equal amount on the other side of the account, e.g. both
the Bank and the Trade Creditor accounts were each incorrectly reduced by an
equal amount of $100.
(vi) error of commission – entries were made on the correct sides of the accounts but to
the wrong personal account, e.g. credit sales to Kasimov were incorrectly recorded
in the accounts of Karimov.

 Making end-of-period adjustments: the main adjustments are for (a) stock; (b)
depreciation; (c) accruals and prepayments; and (d) bad and doubtful debts.
(a) Stock:
o Cost of goods sold is calculated from the following formula:
Cost of goods sold = (opening stock + purchases) – closing stock.
o Carriage inwards added to cost of purchases; Return outwards deducted.
o In the first year of operation, opening stock is zero; in subsequent years, the
closing stock of the previous year becomes the opening stock of the following
year.
o Opening Stock + Purchases = Goods available for sale.

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 o The amount or value of closing stock (for discrete products) is often obtained
through physical counting.
LaiACCT1200/fall20 (lecture 5)

o Why is physical counting necessary to obtain the value of closing stock, why is it
not possible to obtain this value from the ledger accounts?

(b) Depreciation:
o As discussed earlier, this is the “adjustment” made on fixed assets.
o Common methods of calculating depreciation:
(i) straight-line method
= (original cost – estimated residual value) / estimated useful life.
(ii) Reducing balance method – a fixed percentage is deducted as depreciation
from the reduced balance (net book value) of the asset existing at the beginning
of each year.

o Example: A motor vehicle costs $6,400. It will be kept for 5 years, then sold for
scrap for $400. Calculate the depreciation for each year using (a) the straight-
line method; and (b) the reducing balance method using a depreciation rate of
50%.
(a) Annual depreciation = (6,400-400)/5 = 6,000/5 = $1,200 per year.

Accounting entries for depreciation:

(i) Debit depreciation (Motor Vehicle) expense account $1,200;
(ii) Credit provision for accumulated depreciation (Motor Vehicle) account
$1,200.

Provision for accumulated depreciation account is used to offset respective fixed

asset account and will increase by $1,200 every year.

(b) Reducing balance method:

Year Beginning Depreciation Ending Balance /
Balance ($) (50%) Net Book Value
($)
1 6,400 3,200 3,200
2 3,200 1,600 1,600
3 1,600 800 800
4 800 400 400 (residual
value)

o In the balance sheet, it is normal to show the following details for each group of
fixed assets:
(i) historical cost (or revalued amount);
(ii) accumulated depreciation;
(iii) net book value (NBV).

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 Note: historical cost – accumulated depreciation = net book value.

LaiACCT1200/fall20 (lecture 5)

Example of motor vehicle in example above (using straight-line depreciation):

Year Fixed Asset At Cost ($) Accumulated Net Book
Depreciation Value ($)
($)
1 Motor vehicle 6,400 1,200 5,200
2 Motor vehicle 6,400 2,400 4,000
3 Motor vehicle 6,400 3,600 2,800
4 Motor vehicle 6,400 4,800 1,600
5 Motor vehicle 6,400 6,000 400

(c) Accruals and prepayments:

o Accruals – an accrual is an amount owing for a service provided during a
particular accounting period and still unpaid for at the end of it. The amount
due will normally be settled in a subsequent accounting period.
o Example: At 31 December 2017 your company still have not received the
electricity bill for the month of December 2017. The normal electricity
expense per month is $500, thus your company owed the electricity
company $500 (an estimated amount) as at 31 December 2017. Thus an
adjustment would be made to debit the Electricity Expense Account by
$500 and credit the Accrual (Electricity Company) Account by $500.
o Prepayments – a prepayment is an amount paid in cash for a service that will be
provided in a subsequent period. A prepayment is essentially an advance
payment and therefore accounted as a current asset. For example, if the year-
end of a company is 31 December and it buys a van on 1 July 2017 and pays the
full year road tax license up to 30 June 2018, then half the road tax fee paid will
relate to 2017 and the other half to 2018. An adjustment for this effect is
therefore needed at the end of 2017.
o Example: During the year to 31 December 2017, Hillary Company paid
its insurance company $10,000, out of which $2,000 is for insurance cover
for the next year. On 31 December 2017, an adjustment would be made to
credit the Insurance Expense Account by $2,000 and debit the
Prepayment (Insurance) Account by $2,000.

(d) Bad and doubtful debts:

o Bad debts – highly unlikely it will be paid/recovered; long-time owing and
proven to be bad; an expense account.
o Doubtful debts – debts that are likely to be bad but have not yet been proven to
be so.
o In line with the prudence principle, business entities make an allowance or a
provision for bad and doubtful debts. The estimate of this provision is commonly
based on the experience of the entity [for example, the estimate may be the

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 average of the amount of previous years and expressed as a percentage figure
(5% of debtors)]; or entities may use an ageing schedule technique.
LaiACCT1200/fall20 (lecture 5)

o 2 separate accounts are kept:

(a) Bad debts account – Homework: find out the recording for this.
(b) Provision or Allowance for bad and doubtful debts account.
o The allowance or provision for bad and doubtful debts account is
considered as a contra-account (liability) to the debtors account, thus the
rules of debit and credit for this account should be the opposite to the
debtors account. If there is an increase in the provision, a credit entry
should be made; a decrease in the provision will require a debit entry.
o Once original (first) entries have been made, subsequent entries in the
provision (allowance) for bad and doubtful debts account will only be
made for the additional or the reduced amounts of the provision /
allowance.
Example: On 31 December 2012 (year in which provision is first made),
debtors amounted to $10,000 and provision / allowance for bad and
doubtful debts is 2% or $200. The accounting entries would be as follows:
(a) debit Profit and Loss Account $200;
(b) credit Provision / Allowance for Bad and Doubtful Debts $200.

Increasing the provision: suppose that at the end of the following

year, 31 December 2013, debtors had risen to $12,000 but the provision is
still kept at 2%, or $240. Since a provision of $200 had been brought
forward from 2012, in 2013 a provision for the additional $40 only will be
made. The accounting entries on 31 December 2013 would be as follows:
(a) debit Profit and Loss Account $40;
(b) credit Provision / Allowance for Bad and Doubtful Debts $40.

Reducing the provision: suppose that at the end of the following

year, 31 December 2014, debtors fell to $10,500 but the provision
remained at 2%, or $210. Since a provision of $240 had been brought
forward from 2013, the provision in 2014 needs to be reduced by $30.
The accounting entries on 31 December 2014 would be as follows:
(a) debit Provision / Allowance for Bad and Doubtful Debts $30;
(a) credit Profit and Loss Account $30.

o The bad debts and provision (allowance) for bad & doubtful debts accounts
will appear in the profit and loss account as follows:
Profit & Loss Account (extract) for the year ended 31 December 20xx____
$
Gross profit xxx
Less Expenses:
Bad debts (xxx)
(Increase) /decrease in provision / allowance

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 for bad and doubtful debts (xxx)
LaiACCT1200/fall20 (lecture 5)

Balance Sheet (extract) as on 31 December 20xx

$ $
Current assets:
Debtors xxx
Less Allowance for bad & doubtful debts (xxx) xxx

Note: In each of the adjustments made above, the accountant is exercising a great deal of
personal judgement which can have a significant effect on the profit or loss reported for the
year. Examples of instances when the accountant is using his or her personal judgement
are:
● valuation of closing stock.
● estimates have to be made of accruals and prepayments.
● the cost of fixed assets is allocated / apportioned between different accounting periods
using different depreciation methods that are simplistic and may not be representative;
estimate of residual value.
● arbitrary reductions / increase in profit are made to allow for bad and doubtful debts.

Readings:
 F Wood & A Sangster, Business Accounting 1, 13th edition, 2015, Pearson, chapters 6,
25 – 28, 32.
 Leiwy, D and Perks, R; “Accounting: Understanding and Practice”, 4th edition, 2013,
McGraw-Hill Education, chapter 10, pages 234 – 249 only.

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 LaiACCT1200/fall20 (tutorial 5)

ADA University, School of Business

ACCT1200 Principles of Financial Accounting, Fall 2020
Tutorial 5 – Accounting Cycle 3

● Issue 1:
What action can you take if the trial balance does not balance?

 Issue 2:
Calculate the cost of sales / cost of goods sold from the following information extracted
from the trial balance of an entity:
$
Purchases 45,000
Stock (at 1 May 2014) 3,000
Stock (at 30 April 2015) 4,000
Purchases returns 5,000

 Issue 3:
(i) A motor vehicle costs $12,000. It will be kept for five years, and then sold for
scrap for $400. Calculate the depreciation for each year using (a) the reducing
balance method, using a depreciation rate of 50 per cent; and (b) the straight line
method.
(ii) List one advantage of using the reducing balance method as compared with the
straight-line method in calculating the depreciation of fixed assets.

 Issue 4:
An entity keeps a provision for bad and doubtful debts account. It is maintained at a
level of 3% of its total outstanding trade debtors as at the end of the year. The balance
on the provision account at 1 January 2014 was $9,000. Its trade debtors at
31 December 2014 amounted to $250,000.
What balance on its provision for bad and doubtful debts does the entity need to carry
forward as at 31 December 2014?What amount does it need to write off to the profit
and loss account for that year? And will it increase or decrease the entity’s profit?

 Issue 5:
A company maintains a provision for bad and doubtful debts at a level of 4
per cent of its total outstanding trade debtors as at the end of the year. The balance on
the provision account at 1 January 2014 was $10,000. Its trade debtors at 31 December
2014 amounted to $200,000. What amount of provision for bad and doubtful debts will
the company charge to its profit and loss account for 2014? And state the effect of this
on the company’s profit for 2014.

 Issue 6:

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 From the accounts which have been balanced in Issue 1 of Tutorial 4 (Brian’s business),
prepare a trial balance as of 01 February 2018.
LaiACCT1200/fall20 (tutorial 5)

 Issue 7:
From the following information extracted from the accounts of Z Zidane, calculate the
cost of goods sold for the year ended 30 September 2016.
$
Stock 1 October 2015 2,368
Carriage inwards 310
Returns outwards 205
Purchases 11,874
Stock at 30 September 2016 was $2,946.

 Issue 8:
In an entity with financial years ended 31 December, a delivery van is bought for $2,000
on 1 January 2015. It is to be depreciated at the rate of 20 per cent using the straight
line method. Calculate the balance in the accumulated depreciation of the delivery van
account for each of the years of its estimated useful life.

 Issue 9:
A business had always made a provision for bad and doubtful debts at the rate of 5% of
debtors. On 1 January 2015 the provision for this, brought forward from the previous
year, was $260. During the year to 31 December 2015 the bad debts written off
amounted to $540. On 31 December 2015 the remaining debtors totaled $6,200 and the
usual provision for bad and doubtful debts is to be made.
(a) what is the bad debts expense for the year ended 31 December 2015?
(b) what amount of provision for bad and doubtful debts will be “charged” to the profit
and loss account for the year ended 31 December 2015?
(c) show the relevant extract from the profit and loss account for the year.
(d) show the relevant extract from the balance sheet as at 31 December 2015.

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 LaiACCT1200/fall20 (tutorial 5)

 Issue 10:
A Baki, a sole trader, extracted the following trial balance from his books at the close of
business on 31 May 2016
Dr ($) Cr ($)
Purchases and sales 82,350 138,078
Carriage inwards 2,211
Carriage outwards 2,933
Drawings 7,800
Rent, rates and insurance 6,622
Postage and stationery 3,001
Advertising 1,330
Wages and salaries 26,420
Bad debts 877
Provision / Allowance for bad and doubtful debts 130
Debtors and creditors 12,000 6,071
Returns inwards 120
Returns outwards 400
Cash in hand 177
Cash at bank 1,002
Stock 1 June 2015 11,927
Equipment
at cost 58,000
accumulated depreciation 19,000
Capital 53,091
216,770 216,770
Notes:
(a) Rent is accrued by $210
(b) Rates have been prepaid by $880.
(c) Equipment is to be depreciated at 15 % per annum using the straight line method.
(d) Increase the provision for bad and doubtful debts by $40.
(e) Stock 31 May 2016 $13,551.

Required:
(i) Calculate the cost of goods sold for the year ending 31 May 2016.
(ii) Calculate the depreciation expense on equipment for the year and the balance in the
accumulated depreciation for equipment account as at 31 May 2016.
(iii) Calculate the relevant expense for rent, rates and insurance to be charged to the profit
and loss account for the year ending 31 May 2016.
(iv) What is the provision for bad and doubtful debts to be charged to the profit and loss
account for the year ending 31 May 2016? and show the relevant extracts in the profit and
loss account and the balance sheet.