Paper 2 Answering Technique
Paper 2 Answering Technique: Balance-Date Adjustments and Preparation of a Sole Proprietor's Financial Statements
This guide shows how to read structured questions, plan the sequence of adjustments, and present the accounts and Financial Statements neatly so that every method mark can be earned.
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Read and interpret the question carefully
- Identify the balance date because all accrual-basis adjustments are made as at this date, not the transaction date.
- Underline the keyword in every note: accrued expense, accrued revenue, prepaid, unearned, bad debts, provision for doubtful debts, depreciation and disposal.
- Determine the format asked for: General Journal, ledger, Adjusted Trial Balance, Profit and Loss Account or Statement of Financial Position, since each demands a different presentation.
- Distinguish whether the Provision for Doubtful Debts is created for the first time or adjusted from an existing balance, since only the difference is recorded in the Profit and Loss Account.
Plan the order of work before writing
- Settle the nominal account adjustments (expenses and revenues) first to obtain the correct net figures for the Profit and Loss Account.
- Compute the current year depreciation and add it to Accumulated Depreciation before determining the asset's net book value.
- Work out Bad Debts and Bad Debts Recovered first, then use the net Accounts Receivable to compute the Provision for Doubtful Debts.
- For disposal, prepare the Disposal of Non-Current Asset Account: transfer the asset cost, that asset's accumulated depreciation and the cash proceeds to find the gain or loss on disposal.
- Arrange the Adjusted Trial Balance as a bridge before preparing the Financial Statements to check that the debit and credit totals agree.
Present T-form accounts and statements neatly
- Write the full title of each account and statement, including the business name and the phrase 'for the year ended' or 'as at' the balance date.
- In the General Journal, record the debit first, indent the credit to the right, and add a brief narration for each adjusting entry.
- In the Profit and Loss Account, adjust expenses (add accrued, less prepaid) and revenues (add accrued, less unearned) before transferring the figures.
- In the Statement of Financial Position, show accrued revenue and prepaid as current assets, accrued expense and unearned as current liabilities, and deduct Accumulated Depreciation and the Provision for Doubtful Debts from the gross amounts.
Show your working for method marks
- Write out the depreciation formula used: straight-line (cost multiplied by rate) or reducing balance (net book value multiplied by rate).
- Show the Provision for Doubtful Debts computed from the net Accounts Receivable (after deducting bad debts) and state only the increase or decrease taken to the Profit and Loss Account.
- For disposal, show the gain or loss step: cash proceeds less the net book value at the date of disposal.
- Keep figures consistent across the General Journal, ledger, Adjusted Trial Balance and Financial Statements so the examiner can trace the flow of marks.
Manage time and check your answer
- Allocate time by the number of steps, not the length of the question; T-form accounts and full statements usually need more time than short journal entries.
- Check that total assets equal owner's equity plus liabilities in the Statement of Financial Position before leaving the question.
- Ensure each adjustment appears twice: once in the revenue/expense account and once in the Statement of Financial Position, in line with the double-entry principle.
- If time is short, prioritise the figures carried to the final accounts because errors here affect net profit and closing balances.
Avoid common mistakes
- Do not confuse the direction: accrued expense increases the expense, prepaid reduces it; accrued revenue increases income, unearned reduces it.
- Do not charge the whole Provision for Doubtful Debts to the Profit and Loss Account when a provision already exists; take only the change.
- Do not forget to remove the disposed asset's cost and accumulated depreciation from the asset account and the accumulated depreciation account.
- Do not omit Accumulated Depreciation as a deduction under non-current assets in the Statement of Financial Position to arrive at net book value.
| Adjustment item | Profit and Loss Account | Statement of Financial Position |
|---|---|---|
| Accrued expense | Add to the related expense | Current liability |
| Prepaid expense | Deduct from the related expense | Current asset |
| Accrued revenue | Add to the related revenue | Current asset |
| Unearned revenue | Deduct from the related revenue | Current liability |
| Current year depreciation | Expense (debit) | Added to Accumulated Depreciation, deducted from asset cost |
| Provision for Doubtful Debts | Increase as expense; decrease as income | Deducted from Accounts Receivable |
| Item | Straight-line | Reducing balance |
|---|---|---|
| Year 1 depreciation | 1,000 | 1,000 |
| Net book value end of Year 1 | 9,000 | 9,000 |
| Year 2 depreciation | 1,000 | 900 |
| Net book value end of Year 2 | 8,000 | 8,100 |
Figures show annual depreciation and net book value at year-end; use as a working model, not actual exam figures.
How do I know whether the provision for doubtful debts should be increased or decreased?
Compute the new provision from the net Accounts Receivable at the balance date, then compare it with the existing provision balance. If the new provision is higher, the increase is an expense in the Profit and Loss Account; if lower, the decrease is income. Only the difference is recorded, not the full amount.
What are the steps to prepare the Disposal of Non-Current Asset Account?
Debit the Disposal Account with the cost of the asset disposed, credit it with that asset's accumulated depreciation and with the cash proceeds. The remaining balance is a gain (if credits exceed debits) or a loss (if debits exceed credits) on disposal, which is then transferred to the Profit and Loss Account.
Why should I prepare the Adjusted Trial Balance before the Financial Statements?
The Adjusted Trial Balance combines the original balances with the effect of all adjustments so debit and credit totals can be checked to agree. This reduces the risk of error and ensures the figures carried into the Profit and Loss Account and Statement of Financial Position are already correct.
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