Profit Determination

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Profit Determination
Prepared by John Hoggett and Clare Innes

Measurement of Profit
• Cash basis
• Cash income received - Cash expenses paid
– Revenues recorded when received – Expenses recorded when paid

• Accrual basis
• Profit = Income (incl. Revenues) - Expenses
– Revenue is recognised when the anticipated inflow of economic benefit can be reliably measured – Expenses when the consumption of benefits can be reliably measured 2

Adjusting Entries
• The need for adjusting entries- needed because the cash receipt or payment does not coincide with the recognition criteria for income and expenses. • Classification – Deferrals
• prepaid expenses • pre-collected or unearned revenue

– Accruals
• accrued expenses • accrued revenue
3

1

The Accounting Cycle – The place for adjusting entries
1. Recognise & record transactions Source documents

2. Journalise transactions

General journal

3. Post to ledger accounts

General ledger

4. Prepare unadjusted trial balance of GL

Trial balance (unadjusted)
4

Continued next slide

The Accounting Cycle (cont’d)
5. Determine adjusting entries and/or journalise General journal

6. Post adjusting entries to general ledger

General ledger (accounts adjusted)

7. Prepare adjusted trial balance of GL (adjusted)

Trial balance (adjusted)

8. Prepare financial statements

work sheet

Financial statements
5

Prepaid Expenses
• Amounts paid before the benefit is consumed

ASSET ACCOUNT Prepaid Expenses Initial cost Debit Adjusting entry Credit

EXPENSE ACCOUNT Adjusting entry Debit

cost used up, incurred or expired
6

2

Example: Prepaid Insurance
• On 3 June a 24 month insurance policy purchased for $960. (Ignore GST). Initially recorded as: June 3 Prepaid Insurance 960 Cash at Bank 960 to record purchase of 24 month policy

• Initially recorded as an asset • Will need to be converted to an expense as consumed 7

By 30 June, the period end, we need to adjust prepaid insurance a/c to reflect the consumption June 30 Insurance Expense Prepaid Insurance adjusting entry to record expiration of 1 month’s insurance Prepaid Insurance Initial cost 960 Adjusting entry 40 Insurance Expense Adjusting entry 40

40 40

cost used up, incurred or expired

8

Prepaid Expenses - Depreciation
ASSET ACCOUNT Initial cost Debit

CONTRA ASSET ACCOUNT Accumulated Depreciation Adjusting entry Credit

EXPENSE ACCOUNT Adjusting entry Debit

cost used up & allocated to current period

9

3

Depreciation
• Nature of depreciation
– Refer: AASB 116 Property, Plant and Equipment

Depreciation: “the systematic allocation of the depreciable amount of an asset over its useful life.”

10

Depreciation
• Determining the amount of depreciation
– Useful life – Residual value

• Depreciation methods
– Straight-line – Diminishing-balance – Sum-of-years’-digits – Units of production 11

Accounting for Depreciation
• Straight Line:
– Simple & widely used – Total cost of asset divided equally over expected useful life – Uniform charge

Dep’n charge/year =

cost - residual value useful life

12

4

Depreciation Schedule - Straight Line Assume - cost $105 000 - residual $ 5 000 - estimated useful life of 5 years Depn Base $100 000 100 000 100 000 100 000 100 000 Depn Charge $20 000 20 000 20 000 20 000 20 000 Accum. Depn. $20 000 40 000 60 000 80 000 100 000 Carrying Amount $105 000 85 000 65 000 45 000 25 000 5 000

Date 1/7/X0 30/6/X1 30/6/X2 30/6/X3 30/6/X4 30/6/X5

Asset Cost $105 000

13

Accounting for Depreciation
• Diminishing balance:
– Accelerated depreciation method – Greater portion written off in early years – Asset more productive in its earlier years & earns more revenue

Rate = 1 − n

r c

n = estimated useful life r = estimated residual c = original cost 14

Depreciation Schedule – Diminishing Balance
Assume - cost $105 000 - residual $ 5 000 - estimated useful life of 5 years...
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