1. TOPIC 7 PRINCIPLES OF INTERNAL CHECKS

4. Underlying Concepts Accounting Period Matching Principle Accrual Concept The need to prepare periodic financial reports. Expense & revenue have to be assigned and matched to periods of time. Revenue reported when earned Expense reported when incurred (used) Cash receipts/payment irrelevant

5. The Accounting Period 1 2 3 4 Annual 1 2 Monthly Quarterly Semiannual 1 2 3 4 5 6 7 8 9 10 11 12 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

7. 2007 2008 5 months 7 months According Matching Principle: Expenses incurred must match with the accounting period. Since the accounting year ended for Sunny Company was on 31 December, it should record the insurance expenses for only 5 months : RM 24,000 x 5/12 = RM 10,000 1 2 3 4 5 6 7 8 9 10 11 12 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 1 2 3 4 5 6 7 8 9 10 11 12 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

8. Accrual Basis vs. Cash Basis Accrual Basis Revenues are recognized when earned and expenses are recognized when incurred. Cash Basis Revenues are recognized when cash is received and expenses recorded when cash is paid. Not GAAP

9. Accrual Basis vs. Cash Basis On the cash basis the entire RM2,400 would be recognized as insurance expense in 2006. No insurance expense from this policy would be recognized in 2007 or 2008, periods covered by the policy. RM 2,400 Jan Feb Mar Apr May Jun Jul Sep Oct Nov Dec Aug

10. RM 100 RM 100 RM 100 RM 100 RM 100 RM 100 RM 100 RM 100 RM 100 RM 100 RM 100 Jan Feb Mar Apr May Jun Jul Sep Oct Nov Dec Aug RM 100 2007 RM 100 RM 100 RM 100 RM 100 RM 100 RM 100 RM 100 RM 100 RM 100 RM 100 RM 100 Jan Feb Mar Apr May Jun Jul Sep Oct Nov Dec Aug RM 100 2006 Jan Feb Mar Apr May Jun Jul Sep Oct Nov Dec Aug 2008

12. Adjusting Accounts Adjustments An adjusting entry is recorded to bring an asset or liability account balance to its proper amount. Framework for Adjustments Paid (or received) cash before expense (or revenue) recognized Paid (or received) cash after expense (or revenue) recognized Prepaid (Deferred) expenses* Unearned (Deferred) revenues Accrued expense Accrued revenues

13. Adjusting Prepaid (Deferred) Expenses This is the check for my first 6 months’ insurance . Resources paid for prior to receiving the actual benefits. A current asset item .

14. Suria Sdn. Bhd. TRIAL BALANCE as at 31 DECEMBER 2006 $ $

16. Adjusting for Prepaid Insurance Expense 31/12 2,000 Prepaid Insurance 31/12 2,000 1/12 12,000 12,000 12,000 31/12 Bal 10,000 31/12 P&L 2,000 Insurance expired for 1 month = Recognized insurance expense for 1 month 1 month = RM12,000 / 6 = RM 2,000

17. Adjusting Unearned (Deferred) Revenues - Cash received in advance of providing products or services. - A current liability item. On 1 October 200 6 , Suria Sdn. Bhd. received cheque RM 20,000 for services to be provide in next five months. Example

18. Adjusting Unearned (Deferred) Revenues 1/1 0 /0 6 31/12/0 6 Year end 28 /0 2 / 07 5 months Services already performed for 3 months Service performed for 3 months = Recognized service revenue for 3 months 3 month = RM20,000 x 3/ 5 = RM 12,000

19. Service revenue 31/12 1 2 ,000 Unearned revenue 1/10 20,000 31/10 1 2 ,000 20,000 20,000 31/12 Bal 8 ,000 31/10 P&L 1 2 ,000

20. Adjusting for Accrued Expenses - Costs incurred in a period that are both unpaid and unrecorded. - A current liability item. T he telephone bill for December 2006 haven’t pay. When should I record it?

21. Adjusting for Accrued Expenses On 3 January 200 7 , Suria Sdn. Bhd. paid RM 300 for its December telephone bill. Example 1/12/0 6 31/12/0 6 Year end 3/01/0 7 December Bill : RM300 Paid RM300

22. Adjusting for Accrued Expenses Telephone Expense 31/12 300 Telephone payable 31/12 300

23. Adjusting Accrued Revenues - Revenues earned in a period that are both unrecorded and not yet received. - A current asset item. Suria Sdn. Bhd. had RM31,200 of services c ompleted but not yet billed to clients. Let’s make the adjusting entry necessary on 31 December 2006 . Example

24. Adjusting for Accrued Revenues Accounts receivable 31/12 31,200 Service revenue 31/12 31,200

27. Adjusting for Depreciation Depreciation Expense 31/12 11,600 Accumulated Depreciation 31/12 11,600

28. Adjusting for Depreciation Equipment is shown net of accumulated depreciation .

29. Source Documents Journal Ledger Trial Balance Adjustments Adjusted Trial Balance Financial Statements Closing Entries The Accounting Cycle

30. Suria Sdn. Bhd. TRIAL BALANCE as at 31 DECEMBER 2006 First, the initial unadjusted amounts are added to the worksheet. $ $

31. Next, Suria’s adjustments are added. Suria Sdn. Bhd. TRIAL BALANCE 31 DECEMBER 2006 Suria Sdn. Bhd. TRIAL BALANCE as at 31 DECEMBER 2006

32. SYKT MAJU TRIAL BALANCE 31 DECEMBER 2006 Finally, the totals are determined. Suria Sdn. Bhd. TRIAL BALANCE as at 31 DECEMBER 2006

34. Receivables Bad & Doubtful Debts

36. Collectability of Debts Experience shows that not all amounts owing from debtors are collected. This uncollected portion is knows as bad debts.

38. Writing Off Bad Debts On May 10, D. Ross’ account was determined to be uncollectible. The RM420 balance is written off the books. May 10 Bad Debts Expense 420 00 Accounts Receivable — D. Ross 420 00 To write off an uncollectible account.

39. Writing-off Bad Debts Effect on Profit & Loss Dr Profit & Loss A/C for the year ended 31 Dec 05 Cr Bad debts RM420

41. Recovery of Bad Debts Later, on 1 August 2005, D. Ross unexpectedly turns up to settle his debt. Aug 1 Cash 420 00 Recovery of Bad Debts 420 00 To recover bad debts that were written-off earlier .

42. Recovery of Bad Debts Effect on Profit & Loss Dr Profit & Loss a/c for the year ended 31 Dec 2005 Cr Bad debts $500 Recovery of bad debts $500

44. Creating Provision for Doubtful Debts Dec. 31 Doubtful Debts Expense 4 000 00 Provision for Doubtful Debts 4 000 00 On December 31, Cynthia estimates that a total of RM4,000 of the RM105,000 balance in her company’s Accounts Receivable will eventually be uncollectible. Adjusting Entry

45. Creating Provision for Doubtful Debts Dr Profit & Loss a/c for the year ended 31 Dec 2004 Cr $ Doubtful debts 4,000 Balance Sheet as at 31 December 2004 Current Assets : $ $ Accounts Receivable 105,000 Less Provision for Doubtful Debts 4,000 101,000

46. Adjustment to Provision for Doubtful Debts On 31 December 2004, Cynthia’s Trial Balance appears as follows: Sundry debtors 135,000 (dr) Provision for Doubtful Debts 4,000 (cr) Cynthia still maintains 4% of sundry debtors as the Provision for Doubtful Debts.

48. Only the NET increase amount is being recorded in the entries. Dec. 31 Doubtful Debts Expense 1 400 00 Provision for Doubtful Debts 1 400 00 To increase amount of provision for doubtful debts. Adjustment to Provision for Doubtful Debts

49. Adjustment to Provision for Doubtful Debts Dr Profit & Loss a/c for the year ended 31 Dec 2005 Cr Doubtful debts $1,400 Balance Sheet as at 31 December 2005 Current Assets : $ $ Sundry debtors 135,000 Less Provision for Doubtful Debts 5,400 129,600

50. Adjustment to Provision for Doubtful Debts On 31 December 2005, Cynthia’s Trial Balance appears as follows: Sundry debtors 102,000 (dr) Provision for Doubtful Debts 5,400 (cr) The trader still maintains her policy of allowing 4% of sundry debtors as doubtful debts.

52. Only the NET decrease amount is being recorded in the entries. Dec. 31 Provision for Doubtful Debts 1 320 00 Doubtful Debts Expense 1 320 00 To decrease amount of provision for doubtful debts. Adjustment to Provision for Doubtful Debts

53. Adjustment to Provision for Doubtful Debts Dr Profit & Loss a/c for the year ended 31 Dec 2006 Cr Doubtful debts $1,320 Balance Sheet as at 31 December 2006 Current Assets : $ $ Sundry debtors 102,000 Less Provision for Doubtful Debts 4,080 97,920

56. Example - Calculations Calculation: Net debtors = $10,000 - $300 = $9,700 Provision for Doubtful Debts on 31.12.2006 (2% @ $9,700) $ 194 Less Provision for Doubtful Debts on 1.1.2006 150 Increase in Provision for Doubtful Debts 44

57. The additional bad debts, and the net increase in doubtful debts have to be recorded. Dec. 31 Bad Debts Expense 300 00 Debtors 300 00 Adjustment to Provision for Doubtful Debts Dec. 31 Doubtful Debts Expense 44 00 Provision for Doubtful Debts 44 00

58. Effect on P&L and Balance Sheet Dr Profit & Loss a/c for the year ended 31 Dec 2006 Cr $ Bad debts 500 Doubtful debts 44 Balance Sheet as at 31 December 2006 Current Assets : $ $ Sundry debtors 9,700 Less Provision for Doubtful Debts 194 9,506

59. End of Topic 7