Chapter 4 - Income Statement & Asset valuation and profit measurement 1
In December of 2019, ABC buys materials worth £100,000. How much expense is recognised in this 2019's financial statements?
0 This uses the matching principle as no revenue was generated so we don't include any of the expenses
How do you record a fall in the value of inventory?
1) If it is very large and not expected it is shown as a separate expense (e.g flooding ruins stock) 2) If it is a common fall in inventory value e.g something to do with the fact that it's summer so no one wants jumpers then you can just incorporate it into the COGS expense - debit cost of goods sold - credit inventory
What are the three ways of adjusting entry?
1) Prepaid expense 2) Accruable expense (payable) 3) Depreciation
State the two important conventions when creating the income statement
1. Matching principle - Expenses are matched to the revenue they help generate 2. Conservatism or prudence principle - Recognise anticipated losses immediately (e.g depreciation), recognise anticipate gains only when realised
The cost of inventory on 30 September 2011 was £1,100. Included in this total is men's sportswear costing £150 whose colour has faded. It has been decided to sell these clothes at 30% of their cost. • Beginning inventory = £1,050 • Purchases = £6,520 Write out the change in COGS
COGS = (OPENING INVENTORY+ PURCHASES - RETURNED PURCHASES) − CLOSING INVENTORY Original COGS: 1050 + 6520 - 1100 = 6470 New COGS: 1050 + 6520 - [(150 x 3) + 950] = £6575 1050 + 6520 - 995 = £6575 This is because closing inventory was 1100 But then 150 is sold at 30% so 150 x 0.3 And then 1100 - 150 = £950 is sold at full price So we see COGS has increased so debited and closing inventory has been credited and decreased.
ABC had a beginning inventory of £1000. They purchased £250 worth of goods during the year. The closing inventory was £500 of which they had to sell goods worth £75 for £25. The COS is:
COGS = (OPENING INVENTORY+ PURCHASES) − CLOSING INVENTORY 1000 + 250 - (425 + 25) = £800
What are expenses?
Expenses are decreases in owner's equity that arisewhen generating revenue They include: -cost of buying or making the goods sold during the period concerned; known as cost of sales or cost of goods sold (COGS) -salaries and wages -rent -motor vehicle running expenses -Insurance -printing and stationary -heat/lighting -telephone -postage
How do we layout the income statement?
First write out gross profits: 1) Sales revenue 2) cost of goods sold GROSS PROFIT Now write out operating expenses - costs of running business (salaries, rent...) 3) rent 4) wage .... Gross profit - operating expenses = OPERATING PROFITS Now write out any non-operating income - includes taxes and interest received and paid 5) tax 6 ) interest on borrowings .... operating profits - non-operating income = PROFIT FOR THE PERIOD
What happens when the doubtful debt actually decreases into the next year?
For the journal entry: 1) Doubtful debt expense which is decreases so is now credited 2) Provision for doubtful debts (this is a contra asset) which is also decreases so is now debited For income statement: you under the doubtful debt expense (also known as provision release when adding) you add it instead of subtracting it For the SOFP: Under current assets you will need to add the provision for doubtful debts (total doubtful debts) Then add a NET receivables under assets and subtract the doubtful debts from the receivables
When is revenue recognised?
From the sale of goods ( sales revenues): When goods are delivered and accepted by the customer Services : When services are complete (service revenues) e.g how much revenue generated at each accounting period even if I provide the service for 3years Long-term contracts As each distinct stage is completed (if it is a building contract is when the foundations go down or when the walls are put up etc)
How do you calculate COGS?
GOODS AVAILABLE TO SELL − CLOSING INVENTORY= COST OF GOODS SOLD To calculate goods available to sell: OPENING INVENTORY+ PURCHASES
ABC corp has fiscal year from Jan 1 - 31 Dec. On Dec 1, ABC pays £4000 for 4 month's rent. What will be the entries on 1 Dec and 31 Dec?
Here we have paid 3 months extra rent for the year So on the 1st Dec -Dr Rent Expense (+E) 4000 (remember expenses act in the same way as assets) -Cr cash(-A) 4000 On the 31st Dec -Dr prepaid rent (+A) 3000 -Cr Rent expense (-E) 3000
ABC corp has fiscal year from Jan 1 - 31 Dec. For the month of December employees need to be paid salary of £25000. The salary is paid only on Jan 5th next year. What is the entry on 31st December?
Here we need to pay £25000 worth of salary On 31st Dec Dr Salary expense (+E) 25000 Cr Accrual expense (liability) (+L) 25000 On 5th Jan Dr Accrual expense (+L) 25000 Cr cash (-A) 25000
What is the purpose of the income statement?
Measures and reports the amount of wealth (profit or loss) Also known as profit or loss account Remember: Assets = Equity (capital) + (sales revenue - expenses) + liabilities and this is put in SOFP but it can get messy trying to work out profits so we use the income statement to calculate the net profits part Profit (or loss) for the period = total revenue - total expenses incurred in generating that revenue
Answer to SOFP
Note for the PPE it was 60,000 but we have to take into consideration the deprecation of PPE so we minus 5000
Give the two types of expenses
Product costs: Directly related to products they help generate. Eg: direct labour, materials used Period costs: Indirect costs not directly associated with a product, also related to time period costs Eg: Rent, advertising expense
What is revenue?
Revenue is an increase in owner's equity from providing goods and services. -It is earned (goods and services are delivered) - It is realised or realisable (payment is received in cash or something that can be converted to cash i.e payables on credit) Includes: Sales of goods Fees for service Subscription Interest received (by investment funds)
What is a bad debt?
The customer definitely will not pay the amount owed due to bankruptcy for example
What is a doubtful debt?
The customer might not pay back the debt
What is the carrying amount fo inventory?
The initial cost (value) of inventory
How do you record bad debt in the t-table?
The two accounts are the: 1) Bad debt expense which is debited 2) Trade receivables which is credited
How do you record doubtful debt in the t-table?
The two accounts are the: 1) Doubtful debt expense which is debited 2) Provision for doubtful debts (this is a contra asset) which is credited
What must you remember about how doubtful debts follow through the next year?
They are on going - you do not refresh them after each year.
How do we adjust for prepaid expenses?
This is when the amount paid during the period is more than the full expense for the period You just add to the journal entry an asset called prepaid expense e.g prepaid rent and debit it by the amount overpaid You then go to the expense which you overpaid and credit it by the amount overpaid Note - prepaid expenses or prepayable appears in the assets side of SOFP
How do we adjust for accruable expense (payables)?
This is when the expense for the period is more than the cash paid during the period Add to the journal entry an expense and debit by the amount you need to pay Also add accruable expense (which is a liability) and credit by the amount you need to pay Note: accruable expense is appears under the liabilities in the SOFP
Now we have the net profit from the income statement what can we do?
Transfer this value to the balance sheet (SOFP) under retained earnings
How do you record doubtful debt in the SOFP?
Under current assets you will need to add the provision for doubtful debts Then add a NET receivables under assets and subtract the doubtful debts from the receivables
How do you transfer this bad debt to the SOFP?
Under current assets you will need to reduce your trade receivables Under the retained earnings this figure will have changed from the income statement
How do you transfer this bad debt to the income statement?
Under the operating expenses add: Bad debt expense This will change the net profit (retained earnings)
How do you record doubtful debt in the income statement?
Under the operating expenses add: Doubtful debt expense This will change the net profit (retained earnings)
How do we calculate the value of inventory?
We calculate the COGS
How do we adjust for depreciation?
We just minus depreciation from the asset
What is the Net Realisable Value, NRV?
When there is a fall in the value of inventory, the NRV is the recoverable amount.
Winsor Ltd also considered that some of the remaining debts were doubtful and decided to establish a 5% provision against doubtful debts. Record this in the trial balance, journal entry, income statement and SOFP leading on from the previous bad debt.
we calculate the doubtful debt by commuting 0.05 x 30,000 (remaining receivables) = 1500
ABC pays a consultant £40,000 for services for 2019 and 2020. How much expense is recognised for consulting services by ABC in the 2019 financial statements?
£20,000 We only include what we used for that year so £20,000
