BSC BUSINESS STUDIES

BUSINESS ACCOUNTING 1

COURSE STRUCTURE
AIM
The aim of the module is to provide non-accounting students with an academically
challenging and intellectually stimulating study of foundation accounting.

ASSESSMENT
Assessment in this module is entirely via coursework.
Course work will consist of three 1 hour class tests, to be completed on days 6, 9 and 12
and one two hour class test which will take place on day 15.
The first class test will have an assessment weighting of 10%.
The second class test will have an assessment weighting of 20%.
The third class test will have an assessment weighting of 20% and the #
Final two hour class test a weighting of 50%.

READING LIST

Required Reading:
Atrill P., and McLaney, E., Accounting and finance for Non-Specialists, (6th ed), FT
Prentice Hall, 2008.

Recommended Reading:
Ryan B., Finance and Accounting for Business, (2nd ed), South Western Cengage
Learning, 2008.
Berry., A and Jarvis, R., Accounting in a business context, Thompson (2006)
Wood, F., and Sangster, A., Business Accounting 1, (11th Ed) Prentice Hall, 2008.

Websites:
Chartered Institute of Management Accountants (CIMA)
Association of Chartered Certified Accountants (ACCA)

www.cimaglobal.com
www.accaglobal.com

Journals:
The following journals are all of particular relevance to this module:
Accounting & Business Magazine
Management Accounting (UK)

SESSION

TOPIC

SESSION 1

INTRODUCTION & ACCOUNTING EQUATION

SESSION 2

DOUBLE ENTRY

SESSION 3

PRACTICE QUESTIONS

SESSION 4

TRIAL BALANCE & INVENTORY

SESSION 5

ESSAY WRITING

SESSION 6

CAPITAL & REVENUE

SESSION 7

FINANCIAL STATEMENTS

SESSION 8

ACCOUNTING ADJUSTMENTS & ANALYSIS

SESSION 9

MOCK TEST 1

SESSION 10

EXAM 1

SESSION 11

MANAGEMENT ACCOUNTING INTRODUCTION

SESSION 12

JOB COSTING

SESSION 13

PRACTICE QUESTIONS

SESSION 14

MOCK TEST 2

SESSION 15

EXAM 2

SESSION 16

MATERIAL PRICING

SESSION 17

REMUNERATION

SESSION 18

PRACTICE QUESTIONS

SESSION 19

MOCK TEST 3

SESSION 20

EXAM 3

SESSION 21

MANUFACTURING ACCOUNTS

SESSION 22

MANUFACTURING ACCOUNTS QUESTIONS

SESSION 23

REVISION

SESSION 24

MOCK TEST 4

SESSION 25

EXAM 4

BSC BUSINESS STUDIES

BUSINESS ACCOUNTING
SESSION ONE

Introduction
The first question many people ask is what is accounting?
Basically accounting is broadly made up of two elements:
1. Recording business transactions - Book keeping
2. Presenting the information

WHAT IS A BUSINESS?
A business is a commercial organisation which exists with a view to making a profit.
An organisation is an arrangement of people, pursuing common goals achieving results
and standards of performance.

Businesses will fall into 3 main categories.

Sole Trader
This is a business that is owned and operated by one person

The main advantage of being a

sole trader is that you can make
your own decisions. You will also
keep all of the profit that you
hopefully will make. However,
there are also disadvantages.
These include having unlimited
liability and also raising finance
could be a problem.

Partnership
This type of business is owned by more than one individual, some of which will actively
be involved in the business and others may not.

As with sole traders there will be

advantages and disadvantages in
entering into a partnership.
Advantages would include a wider
knowledge base and also more
people to share the workload.
Disadvantages would include losing
some control and maybe having to
compromise your opinions for the
good of the partnership.

Companies
A company is owned by shareholders and is operated on their behalf by a nominated
board of directors.

Responsibility for Financial Statements

The management of an enterprise has the primary responsibility for preparing and
presenting the enterprise's financial statements.

The Framework:

Defines the objective of financial statements;

Identifies the qualitative characteristics that make information in financial
statements useful; and
Defines the basic elements of financial statements and the concepts for
recognising and measuring them in financial statements.

Users and their Information Needs

The principal classes of users of financial statements are present and potential investors,
employees, lenders, suppliers and other trade creditors, customers, governments and
their agencies and the general public. All of these categories of users rely on financial
statements to help them in decision making.
The framework also concludes that because investors are providers of risk capital to the
enterprise, financial statements that meet their needs will also meet most of the general
financial information needs of other users. Common to all of these user groups is their
interest in the ability of an enterprise to generate cash and cash equivalents and of the
timing and certainty of those future cash flows.
The framework notes that financial statements cannot provide all the information that
users may need to make economic decisions. For one thing, financial statements show
the financial effects of past events and transactions, whereas the decisions that most
users of financial statements have to make relate to the future. Further, financial
statements provide only a limited amount of the non-financial information needed by
users of financial statements.
While all of the information needs of these user groups cannot be met by financial
statements, there are information needs that are common to all users, and general
purpose financial statements focus on meeting these needs.

Management accounts
Management accounts are produced as often as a business wants them (usually
monthly). They are produced for internal use and will not, usually be seen by people
outside of the organisation. Management accounts can be prepared using the
companys own internal policies.

Financial accounts
Financial accounts are usually produced annually. They are based on historical
information and are rarely used internally. Financial accounts are useful to many
different types of people who are not part of the organisation.

Qualitative characteristics of financial statements

The four main characteristics are:

Understandability
Information should be presented in a way that is readily understandable by users who
have a reasonable knowledge of business and economic activities and accounting
and who are willing to study the information diligently.

Relevance
Information in financial statements is relevant when it influences the economic
decisions of users. It can do that both by
(a) helping them evaluate past, present, or future events relating to an enterprise and
(b) confirming or correcting past evaluations they have made.
Materiality is a component of relevance. Information is material if its omission or
misstatement could influence the economic decisions of users.
Timeliness is another component of relevance. To be useful, information must be
provided to users within the time period in which it is most likely to bear on their
decisions.

Reliability
Information in financial statements is reliable if it is free from material error and bias and
can be depended upon by users to represent events and transactions faithfully.
Information is not reliable when it is purposely designed to influence users' decisions in a
particular direction.
There is sometimes a tradeoff between relevance and reliability - and judgment is
required to provide the appropriate balance.
Reliability is affected by the use of estimates and by uncertainties associated with items
recognised and measured in financial statements. These uncertainties are dealt with, in
part, by disclosure and, in part, by exercising prudence in preparing financial
statements. Prudence is the inclusion of a degree of caution in the exercise of the
judgments needed in making the estimates required under conditions of uncertainty,
such that assets or income are not overstated and liabilities or expenses are not
understated. However, prudence can only be exercised within the context of the other
qualitative characteristics in the Framework, particularly relevance and the faithful
representation of transactions in financial statements. Prudence does not justify
deliberate overstatement of liabilities or expenses or deliberate understatement of

10

assets or income, because the financial statements would not be neutral and,
therefore, not have the quality of reliability.

Comparability
Users must be able to compare the financial statements of an enterprise over time so
that they can identify trends in its financial position and performance. Users must also
be able to compare the financial statements of different enterprises. Disclosure of
accounting policies is essential for comparability.

11

The elements of financial statements

Asset is a resource controlled by the enterprise as a result of past events and from
which future economic benefits are expected to flow to the enterprise.
Liabilities are an entitys obligations to transfer economic benefits as a result of past
transactions or events.
Equity is the residual amount found by deducting all liabilities of the entity from all of the
entitys assets.
Income is increases in economic benefits during the accounting period in the form of
inflows or enhancements of assets or decreases in liabilities that result in increases in
equity, other than those relating to contributions from equity participants.
Expenses are decreases in economic benefits during the accounting period in the form
of outflows or depletions of assets or incurrences of liabilities that result in decreases in
equity, other than those relating to distributions to equity participants.
Recognition of the elements of financial statements

In order to recognise anything in the Balance Sheet and income statement it must meet
all three of the following criteria:

12

Meet the definition of the element (as above)

Probable future economic benefit will flow to or from the entity

The item can be measured reliably

The Fundamental Assumptions

When about to prepare a set of Financial Statements, it is

very important that the professional accountant follows
certain key assumptions.

Prudence
Due to the fact that lots of items within sets of accounts are subjective or uncertain then
a prudent approach must be adopted at all times. This basically means that the
professional accountant will exercise a degree of caution in any judgements that have
to be made to be sure that any assets have not be overstated and liabilities
understated.
Some key examples of this include any time a loss is foreseen then it MUST
MUS be
recognised and accounted for immediately, and that profits can only be recognised
when they are realised.

13

Going Concern

The concept of Going Concern means that the entity will be considered to be a
going concern unless there is evidence to suggest otherwise. This means that it will
continue to operate in business for the foreseeable future. This is assuming that the
entity has no plans to go into liquidation or to significantly curtail (reduce) the scale of
its operations.

Accruals
This principal is often referred to as the Matching Principal. It means that income and
expenses must be accounted for in the period to which they relate.
So in other words if you have earned some income then any expenses you incurred to
get it in the first place must be matched against it.

Consistency
To enable the performance of the entity to be compared year on year, items included
must be included consistently from one period to the next in other words included on
the same basis.
This should remain the situation unless there are any changes required by the issue of
new accounting standards or where there has been a major change in the business
itself such that a different presentation would give a fairer picture.

14

Fair Presentation
The Financial Statements must be presented fairly, in other words free from bias. IAS 1
includes detail on what specifically must be included to ensure that a fair presentation
is given;

The entity has chosen and applied suitable accounting policies, which are
relevant to it, reliable and are understandable and comparable.

The information is presented in such a way so that the user can understand,
compare and be able to draw relevant and reliable conclusions from it

Where necessary additional disclosures have been included.

15

The Accounting Equation

Assets consists of property of all kinds, such as building, machinery, inventory (stock held
for resale), and motor vehicles. Other assets include debts owed by customers to the
business and the amount of money held by the business in cash or in the bank.
Liabilities are amounts owed by the business to a third party, that is other than the
owner.
Capital is often called the owners equity, net worth or net assets. It represents the
amount of money owed by the business to the owner. It is equal to the funds invested in
the business initially by the owner plus any profits earned by the business, less any profits
taken out of the business by the owner (drawings).
Drawings are cash/goods or services taken from the business for the proprietors own
use. They reduce capital but are recorded separately.

16

Three Basic Principles

1

Separate entity

A proprietor and the business are distinct. We look at the business from its point of view.
Eg Fred puts 1,000 into his business. From the point of view of the business the dual
effect is

it has 1,000 cash

it owes Fred 1,000

ASSET
CAPITAL.

The liability of a business to its proprietor is known as capital.

2 Dual effect

Every transaction has two effects.

Fred borrows 250 from Sid. The two effects are

Fred has 250 in cash. The having is an ASSET

Fred owes 250 to Sid. The owing is a LIABILITY

The two effects are equal and opposite, hence they balance.

17

Accounting equation

The first two principles lead to the third, the accounting equation. The Balance Sheet
(SFP) is based on the accounting equation.

Net as sets

Asse ts liab ilities

Pr opr ietor's fun ds

C ap ital + pr ofits (or loss es)

d ra win gs

A BUSINESS
1

Introduce capital

You inherit 100,000 and use it to create a retail business selling books and stationary
called Fox Books. What is the dual effect?

Dual effect

The business has cash of

100,000

(asset)

The business owes you

100,000

(capital)

Foxs position is
Assets

18

Capital

Buy inventory with cash

Fox buys 500 books. The cost of each book is 5. What is the dual effect?

Dual effect

Foxs position is

Assets

19

Capital

Buy inventory on credit

In reality a business will not always pay for its purchases with cash but is more likely to
buy things on credit.
Fox buys inventory of 200 diaries. Each diary costs 10. What is the dual effect?

Dual effect

Foxs position is

Net assets

20

Capital

Buy a delivery van

The delivery van will be a fixed asset because it is available for continuing use in the
business.

Fox buys a delivery van for 1,000 cash. What is the dual effect?

Dual effect

Foxs position is

Net assets

21

Capital

Sell inventory for profit

Fox sells 200 books for 15 each. What is the dual effect?

Dual effect

Foxs position is

Net assets

22

Capital

Sell inventory (on credit) for profit

It is equally likely that a business will sell goods on credit. When goods are sold on credit
an asset of the business called a receivable (debtor) is generated.
Fox sells 100 diaries to Badger . Badger will pay 12.50 per diary at the end of the
month. What is the dual effect?

Dual effect

Foxs position is

Net assets

23

Capital

Pay expenses

In reality Fox will have been incurring expenses from its commencement. Fox
received and paid a gas bill for 500. What is the dual effect?

Dual effect

Foxs position is

Net assets

24

Capital

Take out a loan

In order to fund your future expansion plans for Fox 20,000 is borrowed from Lendit
Bank.
The loan is to be repaid in two years time. What is the dual effect?

Dual effect

Foxs position is
Net assets

25

Capital

Payment to trade payables

Fox pays cash of 1,500 towards the 2,000 owed to the supplier. What is the dual
effect?

Dual effect

Foxs position is
Net assets

26

Capital

10

Receive cash from receivables

Foxs receivable sends a cheque for 1,000. What is the dual effect?

Dual effect

Foxs position is

Net assets

27

Capital

11

Drawings

You withdraw 1000 from the business. Such a withdrawal is merely a repayment of
the capital you introduced. Your withdrawal is called drawings. What is the dual
effect?

Dual effect

Foxs position is

Net assets

28

Capital

Practice question
Edward started a business as a sports equipment retailer on 1 July 2011
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)

Started the business by paying 5,000 into a business bank account.

Bought a 10 tennis rackets for 50 each in cash.
Bought 5 table tennis tables on credit from P Pong, for 100 each.
Sold all the tennis racquets to for 750 cash.
Sold 4 of the table tennis tables on credit to B Bjorg for 300 each.
Paid rent of 250 cash.
Drew 100 in cash out of the business for living expenses.
Paid P Pong 250 on account.
Received 1,200 from B Bjorg in full settlement of the amount due.
Bought a van for use in the business for 4,000 cash.
Paid a telephone bill for 150 in cash

Requirements
Show the accounting equation which results from the above transactions made
during Edwards first two weeks of trading.

29

Alternative presentation
The accounting equation is often expressed in a financial position statement called the
balance sheet. It shows the financial position at a point in time (snapshot).
Balance Sheet as at 31 December 2010
Non current assets

138,000
33,750
12,740

Buildings
Fixtures and fittings
Motor vehicles

184,490
Current assets
Inventory
Trade receivables
Cash

13,777
12,775
6,200

32,752
Current liabilities
Trade payables
Loan interest
Accruals

12,445
1,000
15,445
(28,890)

Net current assets

3,862
188,352

Non current liabilities

Loan

(20,000)

Net assets

168,352

Opening capital
Profit
Drawings

152,465
51,787
(35,900)
168,352

30

Balance sheet classifications:

Non-current assets are assets purchased not with the primary intention to re-sell them,
but rather to assist in the generation of future income.
Eg

Current assets are assets which are cash or will be converted into cash within one
year, that is inventory, receivables or cash

Current Liabilities are those liabilities which have the date of the balance sheet.

31

Edward Balance Sheet as at................

Non current assets

Motor vehicles

Current assets
Inventory
Trade receivables
Cash

Current liabilities
Trade payables
________
Net current assets

NET ASSETS

Opening capital
Profit
Drawings

32

BSC BUSINESS STUDIES

BUSINESS ACCOUNTING
SESSION TWO

33

Double Entry Bookkeeping

Introduction
Bookkeeping is the recording of monetary transactions of a business. Each company
will employ a bookkeeper to ensure all the accounting records are kept up to date.

Double entry bookkeeping

Double entry bookkeeping is the fundamental concept underlying accountancy. All
accounting transactions should be recorded using the double entry system.
Every transaction is recorded individually in ledger accounts, and these accounts are
kept in the Nominal Ledger.

Ledger Accounts
A ledger account is sometimes called a T Account. It is called this because it looks like
the letter T.
It has two sides the left side will be classed as the Debit side and the Right will be the
Credit side.
DR

T Account

CR

Every transaction in the ledger accounts will have a debit transaction and a credit
transaction in another account.

34

It is important to learn which entries are DEBITS and which are CREDITS
DR

CR

T Account

Asset

Increase

Asset

Decrease

Liability

Decrease

Liability

Increase

Profit

Decrease

Profit

Increase

We can put the balance sheet into this format plus trading transactions:

Dr

Non current assets

Cr

Non current liabilities

Inventory
Receivables

Payables

Bank

Bank overdraft

Cash
Drawings

Capital

Losses

Profits

Purchases

Sales

Expenses

Income

Purchases - buying goods for which the business has the prime intention of re-selling.
Sales the of those goods which the business normally buys with the intention of selling
to make a profit called GROSS PROFIT

35

Example 1 Edward again

Edward started a business as a sports equipment retailer on 1 July 2011
1st
2nd
3rd
4th
5th
6th
7th
8th
9th
10th
11th

Started the business by paying 5,000 into a business bank account.

Bought a 10 tennis rackets for 50 each in cash.
Bought 5 table tennis tables on credit from P Pong, for 100 each.
Sold all the tennis racquets for 750 cash.
Sold 4 of the table tennis tables on credit to B Bjorg for 300 each.
Paid rent of 250 cash.
Drew 100 in cash out of the business for living expenses.
Paid P Pong 250 on account.
Received 1,200 from B Bjorg in full settlement of the amount due.
Bought a van for use in the business for 4,000 cash.
Paid a telephone bill for 150 in cash

Requirements
Show the accounting equation which results from the above transactions made
during Edwards first two weeks of trading.

Bank/Cash

36

Capital

Purchases

P Pong (Payables)

37

Sales

B Bjorg (Receivables)

Rent

38

Drawings

Van

Telephone

39

Once the ledger accounts have been completed they will need to be balance. In
order to do this you must:
I.
II.
III.
IV.
V.

Rule off the ledger account

Add up the largest side
Put the largest side total on both sides
Insert the required amount to ensure the smallest side balances (carried down
figure).
Bring the carried down figure forward on the opposite side (bought down figure).

NOW GO BACK AND BALANCE THE LEDGER ACCOUNTS OF EDWARD

40

BSC BUSINESS STUDIES

BUSINESS ACCOUNTING
SESSION THREE

41

1.

F. Earls has the following assets and liabilities as of 30 November 2010: Accounts
payable 2,950, Equipment 10,500, Inventory 7,150, Motor Vehicle 5,290, Cash at
bank, 6280, Cash in hand 20 and Accounts receivable 5,790.
During the first week of December, Earls:

Bought extra equipment on credit from P. Green for 1,500

Bought extra inventory by cheque 670
Accounts receivable paid to Erals 940 by cheque and 100 by cash
Earls paid an account payable by cheque 950
Earls puts an extra 500 cash into the business as capital.

Draw up a balance sheet after each of the above transactions have been
completed.

2.

Write up the accounts for Charles to record the following transactions.

Dec

42

Started business with 1,000 in the bank

2
8
9
10
11
15
16
20
31

Bought a Motor Van for 1,000 paying by cheque

A loan from R. Kirk to the business of 2,000 cash is received
Paid 2,000 cash into the bank
Took 400 out of the bank for the cash till
Bought Motor Van on credit for 600, from P. Keenan
Paid P. Keenan 600 by cheque
Bought Fixtures by cheque for 500
Bought more fixtures on credit from A. Brown for 880
Bought more fixtures by cash 250.

3.

4.

43

Enter the following transactions in double entry.

Nov1

Credit sales, C. Flanagan 465, S. Morgan 300, F. Hutchinson 645,

A. Adair 987.

Nov2

Credit purchases, N. Ward 123, F. Wood, 465, S. Duffy 786, N.

Hynd 56.

Nov5

Credit sales, C. Flanagan 560, S. Ruddle 560.

Nov6

Credit purchases, F. Wood 79, N. Hynd 560.

Nov7

Goods returned to us by F. Hutchinson 45, S. Ruddle 60

Nov9

Cash paid to us (the business) by A. Adair 900, S. Ruddle 500.

Nov10

We (the business) returned goods to N. Ward 19, N. Hynd 60.

Nov12

We (the business) received cheques from F. Hutchinson 600, C.

Flanagan 456.

Nov 25

We (the business) sold goods on credit to C. Flanagan 50, S.

Morgan 45.

Nov26

We (the business) paid by cheque the following, N. Ward 100, F.

Wood 465, N. Hynd 56.

Nov28

We (the business) returned goods to N. Ward 4.

Balance off the personal accounts above and identify which are accounts
receivable and which are accounts payable.

5.

Enter up the necessary acounts and balance off the accounts at the end of the
month.

20X7

44

Sept 1

Sales on credit as follows: C Latham 250, R Patch 455

Sept 4

Purchases made on credit for 190 from D Moynihan

Sept 11

Goods returned form R Patch worth 170

Sept 20

Credit sales of 680 made to E Bright

Sept 24

Purchases made on credit for 370 from C Peck

Sept 25

Cheque received from C Latham for 250

Sept 30

We return goods to Moynihan worth 150

6.

You are required to enter up the necessary accounts based on the following
information. All accounts should be balanced off and a trial balance should be
extracted as at 31 October 20X8.

20X8

45

Oct 1

Started business with 5,000 deposited in bank

Oct 4

Purchased delivery van for 1,800 paying by cheque

Oct 5

Bought office equipment on credit from Eves Ltd for 800

Oct 8

Paid for advertising 54 cheque

Oct 11

Withdrew 300 cash from bank

Oct 14

Bought stock on credit from: S Gabriel 56 and S Phipps 76

Oct 16

Returned stock to Gabriel worth 10

Oct 19

Sold goods on credit to: S Suckling 113 and C Dimmock 89

Oct 21

Paid for stationery 23 cash

Oct 22

Withdrew 275 from bank for personal use

Oct 26

Goods retuned by Suckling worth 27

Oct 29

Sales made on credit to J Rudling for 96

Oct 30

Commission received by firm: 29 cash

46

BSC BUSINESS STUDIES

BUSINESS ACCOUNTING
SESSION FOUR

47

The Trial Balance

All the debit and credit balances extracted from the ledger accounts can then be
grouped together in a trial balance. This will check the accuracy of the entries made in
the ledger accounts.

EXAMPLE
The following are the balances on the accounts of Christine at 31 December 2010

Sales

47,140

Purchases

26,500

Trade receivables

7,640

Trade payables

4,320

General expenses

9,430

Loan

5,000

Fixtures & fittings

7,300

Motor vehicles

2,650

Drawings

7,500

Rent and rates

6,450

Electricity

1,560

Bank overdraft

2,570

Capital

10,000

Required
Prepare Christines trial balance as at 31st December 2010

48

49

DEBIT

CREDIT

Some errors will be identified by extracting a trial balance:

Transposition error
Unequal entries
Extraction error

Some errors will not be identified by a trial balance:

Compensating error
Error of omission

NOW COMPLETE THE TRIAL BALANCE FOR EDWARD

50

51

DEBIT

CREDIT

Other movements in Inventories:

Dr

Non current assets

Cr

Non current liabilities

Inventory
Receivables

Payables

Bank

Bank overdraft

Cash
Drawings

Capital

Losses

Profits

Purchases

Sales

Expenses

Income

Returns inwards

Returns outwards

52

Example 2
Arathusa had the following transactions during July 2011.
1st
2nd
3rd
4th
5th
6th
7th
8th
9th
10th

Started a business with 10,000 cash.

Purchased a display units for cash, 200.
Paid rent for the premises for one month, 100.
Purchased goods on credit from Lion worth 1,000.
Returned goods to Lion to the value of 200.
Paid insurance for one month of 40.
Sold half of the goods on credit to Leopard for 400.
Took 60 cash for his own expenses.
Leopard returned half of the goods purchased.
Sold the remainder for the goods for cash of 420.

Required
Write up the relevant ledger accounts to record the above transactions then balance
the accounts.

53

Bank/Cash
DR

CR

Capital
DR

CR

Display Units
DR

54

CR

Rent
DR

CR

Purchases

55

DR

CR

Lion (Payables)
DR

CR

Purchase Returns
DR

CR

Insurance
DR

CR

Sales
DR

56

CR

Leopard (Receivables)
DR

CR

Drawings
DR

CR

Sales Returns
DR

57

CR

Different Types of Profit

Profit & Loss Account

GROSS PROFIT

X
(X)
__
X

Other Income

Sales
Cost of goods sold

Expenses
NET PROFIT

(X)
__
X
__

incurred during the day to day operations

Other income eg bank interest received, rent received, commission received

Expenses eg telephone, motor expenses, electricity, rent, wages & salaries

58

BSC BUSINESS STUDIES

BUSINESS ACCOUNTING
SESSION SIX

59

Practice Question
Clooney commences business on 1 April 2011. The following transactions take place in
his first two weeks of trading.
1 April

Invests 50,000 in to a business bank account

1 April

Purchases 5,000 worth of goods on credit from Pitt

2 April Clooney returned 1,000 worth of goods to Pitt

2 April

Sells half of the remaining inventory for 6,000 to Downey on credit

4 April

He writes a cheque to pay for the goods he received from Pitt

5 April

Pays his rent for April of 450 by cheque

6 April

Downey returns half the goods he purchased to Clooney

7 April

He sells the balance of his inventory for 6,000 on credit to Diggs

10 April

Purchased goods on credit for 7,000 from Pitt

11 April

Withdraws 500 for his personal expenses

14 April

He purchases a delivery van for 7,000 cash

Required
Prepare the ledger accounts of Clooney for the first two weeks of trading and the trial
balance at 14th April.
What is Clooneys gross profit & net profit for the first two weeks of trading?

60

Bank/Cash
DR

CR

Capital
DR

61

CR

Purchases
DR

CR

Pitt (Payables)
DR

62

CR

Purchase returns
DR

CR

Sales
DR

63

CR

Downey (Receivables)
DR

CR

Rent
DR

CR

Sales returns
DR

64

CR

Diggs (Receivables)
DR

CR

Drawings
DR

CR

Van
DR

65

CR

Clooney Trial Balance

Dr

66

Cr

Profit & Loss Account

Sales
Less sales returns
______
Less cost of goods sold
Purchases
Less purchase returns
_____
Less closing inventory
_____
______
GROSS PROFIT
Expenses Rent
______
NET PROFIT

W1 Closing inventory

Purchases
Returns

Sold
Sales Returns

Sold
Sales Returns

Sold

Purchases

67

Effect upon the Capital Account

The net profit generated will increase the amount the business owes to the owner
Looking at Clooney

Opening capital of the business was

Now complete the balance sheet of Clooney from your trial balance. The net profit you
have calculated will be added to the capital section as below:

68

Clooney Balance Sheet

Non-current assets
Motor van
Current assets
Inventory (same as in Gross Profit calc)
Receivables
Bank

Current liabilities
Payables

Net current assets

NET ASSETS

Capital
Profit for the period

Less Drawings

69

The owner/s will be very interested in the capital figure as it represents the amount of
money the business owes them. For this reason, the full details of movements in the
capital account are provided.
A business will have many credit suppliers and customers so the accounts will need to
be kept separately so balances due with and from each can be identified. These will
be called personal accounts.
Example - Nedge
Enter the following transactions in double entry, balance off the personal accounts,
and identify which are accounts receivable and accounts payable.
1 Jan

Credit sales, K.Tyler 900, H Ford 600, L Aitchison 1,200, D Bird 1900.

2 Jan

Credit purchases, B Ward 500, A Curtis 930, L Durnall 1,500, G Powell 110.

5 Jan

Credit sales, K.Tyler 1,000, L Larkin 1,100.

6 Jan

Credit purchases, A Curtis 150, G Powell 1,200.

7 Jan

Goods returned to the business by L Aitchison 100, L Larkin 100

9 Jan

Cash paid to the business by D Bird 1,500, L Larkin 900.

10 Jan

The business returned goods to B Ward 50, G Powell 60.

12 Jan

The business received cheques from L Aitchison 1,100, K.Tyler 900.

25 Jan

The business sold goods on credit to K.Tyler 80, H Ford 70.

26 Jan

The business paid by cheque the following, B Ward 200, A Curtis 900, G
Powell 110.

28 Jan

The business returned goods to B Ward 10.

70

Bank
DR

CR

Cash
DR

71

CR

Sales

72

DR

CR

Returns Inwards
DR

CR

Purchases

73

DR

CR

Returns outwards
DR

CR

74

DR

CR

DR

CR

75

DR

CR

DR

CR

76

DR

CR

DR

CR

77

DR

CR

DR

CR

DR

78

CR

Payables

79

Receivables

Other considerations
Carriage when goods are delivered from suppliers or sent to customers, the cost of
delivering the goods is often an additional cost to goods purchased, or an additional
cost to the business for delivering the goods to the customer free of charge.

Carriage inwards the cost incurred when goods are delivered by suppliers. This is
added to the cost of purchases in the calculation of gross profit.

Carriage outwards the cost to the business to deliver goods to the customer. This
becomes a cost to the business if it is not recharged to the customer. It is deducted
from gross profit, like other costs, to calculate net profit.

80

Inventory and the second year of a business

Continuing with Edward from our first day. Here is his trial balance at the end of his first
two weeks of trading.
Edward Trial Balance
Dr
Bank/cash

Cr

1,700

Capital

5,000

Purchases

1,000

P Pong (Payables)

250

Sales

1,950

B Bjorg (Receivables)

Rent

250

Drawings

100

Van

4,000

Telephone

150

7,200

7,200

The accounting equation at the end of the two weeks was as follows:

Assets Van 4,000

Inventory
Receivables
Cash (1850 150)

Liabilities

81

Payables

100
1,700

5,800
(250)

5,550

Capital
Profit (800 - 150)

Drawings

5,000
650

5,650
(100)

5,550

The equation could also be expressed as follows:

Edward Balance Sheet

Non-current assets
Motor van
Current assets
Inventory
Receivables
Cash

Current liabilities
Payables

Capital
Profit for the period

Less Drawings

82

4,000

100
1,700

1,800

250

1,550

5,550

5,000
650

5,650
100

5,550

Lets now use these details as if it was the end of the accounting period. The closing
inventory of 100 is now the opening inventory for the next accounting period. This will
be adjusted in the calculation of cost of goods sold within the profit and loss account
as follows:

X
(X)
______
X

Sales
Less sales returns

Less cost of goods sold

Opening inventory
Purchases
Less purchase returns

Less closing inventory

GROSS PROFIT

83

100
X
(X)
_____
X
(X)
_____
(X)
______
X

Capital & Revenue Expenditure

Capital expenditure is incurred when a business spends money either to buy noncurrent assets or add to the value of non-current assets
Revenue is spent on running the business on a day-to-day basis

Consider a delivery van:

Capital/Revenue Asset/Expense

Purchase price of the van

Motor insurance

Car tax

Adding a lift to the back of the van

Other examples:
1,500 spent on machinery, of which;
1000 relates to improvements
500 relates to repairs

Rendering & painting the outside of a

new building
Three years later, painting the same
Building

84

Revenue expenditure is shown as a cost in the Trading, profit and loss account
Capital expenditure will result in an increase in non-current assets in the Balance Sheet
The difference is important as it affects the profit of the business and the assets of the
business which in turn impacts upon owners capital.

In the same way that purchasing a non-current asset is capital expenditure the
proceeds from the disposal of a non-current asset is a capital receipt and not sales
revenue.

85

86

BSC BUSINESS STUDIES

BUSINESS ACCOUNTING
SESSION SEVEN

87

Financial Statements
Profit & Loss Account for the year ended........

Sales
Less sales returns

Less cost of goods sold

Purchases
Less purchase returns

Less closing inventory

GROSS PROFIT

Other income

Expenses

Rent
Electricity
Telephone
Wages
Stationary
Cleaning

88

Balance Sheet

Non-current assets
Buildings
Equipment
Motor vehicles

Current assets
Inventory (same as in Gross Profit calc)
Receivables
Bank
-
Current liabilities
Overdraft
Payables
Net current assets
-
NET ASSETS

-
Capital
Profit for the period
-

Less Drawings
-

89

Practice Question
From the following trial balance of Bonnie, you are asked to draw up a profit and loss
account (income statement) for the year ended 31 March 2011 and a balance sheet
as at that date.

Dr

Advertising
Bank
Capital as at 1 April 2010
Carriage inwards
Carriage outwards
Cash in hand
Drawings
Equipment
Insurance
Inventory as at 1 April 2010
Motor repairs
Premises
Purchases
Rates
Rent
Returns inwards
Returns outwards
Sales
Sundry expenses
Trade receivables
Trade payables
Vehicles
Wages

410
11,990
153,700
460
390
1,754
23,080
37,000
1,500
8,660
1,180
150,000
199,990
8,700
6,520
750
1,120
336,000
656
17,900
23,120
24,000
19,000
513,940

Inventory as at 31 March 2011 was valued at 23,710

90

Cr

513,940

Bonnie
Income statement for year ended 31 March 2011

Sales
Less Returns inwards

Net turnover
Less Cost of goods sold

Opening inventory

Add Purchases

Less Returns outwards

Add Carriage inwards

Less Closing inventory

Gross profit

Less Expenses

Wages
Insurance
Advertising
Motor repairs

91

Carriage outwards
Sundries
Rent
Rates

Net profit

92

Bonnie
Balance Sheet as at 31 March 2011

Non-current Assets

Premises
Equipment
Vehicles

Current Assets

Inventory
Trade receivables
Bank
Cash

Current Liabilities

Trade payables

Financed by:
Capital
Add Net profit

Less Drawings

93

Depreciation

Expenditure
Capital

Revenue

Balance Sheet

Profit & Loss

Assets

Costs

Buildings

One off expenses

Machinery

Electricity
Repairs

Including
Improvement to an asset

94

BSC BUSINESS STUDIES

BUSINESS ACCOUNTING
SESSION EIGHT

95

Materiality Concept
The Framework that we looked at in chapter 1 says;
Information is material if its omission or misstatement could influence the economic
decisions of users.

This means that a company will normally have a capital expenditure limit based on
materiality. Above this monetary limit the asset is recorded in the balance sheet as it is
considered to meet the above definition.
Below the limit the asset will be written off as a cost in the profit and loss account.

Non-current assets
Generally non-current assets will be owned by the business for more than one year.
They are carried in the balance sheet as capital expenditure but are used within the
business on a day to day basis to help generate income rather than resold. They are
initially recorded at their HISTORICAL COST.
As a result of their continued use, most non-current assets will wear out over time or use.
In accordance with the accruals or matching concept the cost of consuming these
assets need to be matched with the income they generate but based on the
accounting:
Asset is in the
Balance Sheet

Income is in the
Profit & Loss Account

This does not follow matching. To solve this problem we will use DEPRECIATION.

96

Depreciation
Depreciation is the systematic allocation of the depreciable amount of an asset over it
useful life.
Depreciable amount - The cost of an asset less its residual value.

Residual value - The estimated amount that an entity would currently obtain from
disposal of the asset, after deducting the estimated costs of disposal.

Useful life is;

-

The period over which an asset is expected to be available for use by an entity;
or
The number of production or similar units expected to be obtained from the
asset by the entity

Useful life is a matter of judgement.

Methods of depreciation
There are two main methods of calculating depreciation:

Straight line (based on time)

(Cost residual value)

______________________
useful life of the asset

= constant depreciation charge

Eg If a delivery van was bought by a business for 22,000. The van has an expected life
within the business of four years, after which it could sell it for 2,000.

The cost of depreciation would be:

97

If the van was expected to be scrapped after the four years and had no residual value,
the cost of depreciation would be:

Remember we considered the difference between capital and revenue. Consider the
delivery van as it gets older would you expect revenue expenditure to increase or
decrease?

Why?

Practice Question
Violet purchased a pressing machine for 23,000. Violet estimated that the machine
will last 5 years and will have a residual value of 3,000. How much depreciation will be
charged each year?

98

Example Choice of policy

Pete purchased a non-current asset on 1st July for 50,000. The asset has an expected
useful life of 5 years and a residual value of 5,000. Pete has a year end of 31
December.

If the business is attempting to match costs with the revenues (sales) from the use of
the non-current asset then it may be more appropriate to use a different method of
calculating depreciation.

99

Reducing balance

NBV x selected % = falling depreciation charge

(NBV is cost less accumulated depreciation)

Using the same delivery van costing 22,000 but applying a reducing balance rate of
20%. The depreciation cost for the first three years would be;

Over time the depreciation charge reduces but as the asset ages the repairs and
maintenance increases.

100

It could be argued that the reducing balance method is better at matching the total
costs (capital and revenue) of a non-current asset with the revenues (sales) generated
from its use.

Accounting Entries:
Once you have calculated the depreciation charge it will be entered into the
accounts via a journal.
The journal for depreciation is:
Dr

Depreciation expense

(Profit and loss account)

Cr

Accumulated Depreciation

(Balance Sheet)

Choice of method
The purpose of depreciation is to spread or allocate the total cost of a non-current
asset over the periods in which it is to be used.
The method chosen should be that which allocates cost to each period in accordance
with the proportion of the overall economic benefit from using the asset over its useful
life (the total period over which it is going to be used).

The choice is subjective but is supported by accounting policies and concepts:

Accruals/Matching
Going concern
Both of which we considered earlier

101

Increases in value of non-current assets

All non-current assets are initially recorded at their HISTORICAL COST ie what you paid
for them.
According to IAS 16 it is possible to carry your asset at its market value rather than
historical cost. This adjustment is referred to as a REVALUATION.
Dr Non-current asset
Cr Revaluation reserve
The new increased value of the asset is then depreciated over its remaining useful
economic life
Example
Willow buys a machine on 1 January 2002 for 500,000. The machine has an estimated
useful economic life of ten years with a residual value of 20,000. A straight line method
of depreciation was adopted.
On 1 January 2007 willow decides to revalue its machine to 750,000 in line with IAS 16.
The useful economic life remains unchanged.
Required:
Show how the revaluation would be accounted for and the subsequent depreciation
charge following the revaluation.

102

Land and Buildings

Due to its nature land does not normally require depreciation. Only land subject to
extraction eg coal mines or oil fields would be depreciated.
Buildings however must be depreciated as although the value of property generally
increases over time a building suffers wear and tear also.

IT IS IMPORTANT TO REMEMBER THAT DEPRECIATION IS A METHOD OF ALLOCATING THE

COST OF A NON-CURRENT ASSET TO THE PROFIT AND LOSS ACCOUNT IT IS NOT A
VALUATION METHOD.

Net book value is merely the difference between the cost or valuation of the asset and
the accumulated depreciation to date. It does not represent the market value of the
asset.

103

Investment Properties
These types of properties have an accounting standard of their own SSAP 19.
There are defined as
Investment property
An interest in land and/ or buildings:

In respect of which construction work and development have been completed

and

Which is held for its investment potential, any rental income being negotiated at
arms length

Investment properties should NOT be depreciated instead they are included in the
balance sheet at market value and a revaluation reserve created.
Note: IAS 40 the international standard for investment properties states that the gains
and losses arising on the property are included in the profit and loss account.

104

IAS 8 Accounting policies, Changes in accounting estimates and errors

Accounting policies
The specific principles, bases, conventions, rules and practices applied by an entity in
preparing and presenting the financial statements.

SELECTING ACCOUNTING POLICIES

In selecting accounting policies an entity must firstly consider the requirements of the
applicable accounting standards.
In all other situations policies should be selected so as to result in information that is
relevant and reliable in line with the framework.
Relevant to the economic decision making needs of users; and
Reliable

Faithful representation
Reflect the substance
Neutral, free from bias
Prudent
Complete

Consistency when a business chooses to treat certain transactions in a particular way

it should continue to treat similar transactions in the same way.

Disclosure
As each business will adopt its own set of accounting policies its is important for
comparability that each business discloses its chosen policies. That way any differences
in policies can be taken into account when comparing different businesses.
This will include the chosen policy for depreciation the useful life for the straight line or
the percentage used for reducing balance method.

105

Changing accounting policies

An accounting policy may be changed if and only if the new policy will give a more fair
representation of the transactions and balances of the entity. We discussed the idea of
FAIR PRESENTATION (TRUE & FAIR VIEW) in chapter 1. A change in accounting policy
should be to meet this concept and not to improve the figures reported.
Remember accounting information should be free from bias.

106

QUESTIONS TO BE ATTEMPTED IN CLASS

1. Which of the following is not a reason for providing for depreciation of non-current
assets?
A

Wear and tear of assets

Technical obsolescence

Assets may increase in value

Depletion

2. An asset was purchased on 1.1.20X3 for 5,500 and is to be depreciated at 20%

reducing balance. What would be the net book value of the asset as at 31.12.20X5?
A

3,300

2,200

3,520

2,816

3. Keeping the same depreciation policy even if it may not give a realistic asset value
at the year end is an example of:
A

Prudence

Accruals

Going concern

Consistency

4. Equipment was purchased on 1.1.20X6 for 25,000 and is to be depreciated at 30%

reducing balance. What would be the net book value of the asset as at 31.12.20X7?
A

12,250.

10,000.

5,250.

17,500.

107

5. The accruals concept states that:

a) Transactions should be recorded at historical cost
b) A company can not change its accounting policy
c) A business should be consistent in how it treats accounting transactions both within
an accounting period, and from one period to the next
d) Revenues and costs for an accounting period should be matched in order to
calculate the profit for the period.

6. The buildings from which the business trades, should not be depreciated because:
a) They increase in value with the passage of time
b) IAS 40 (Investment property) states they may not be depreciated
c) The accruals concept indicates that they are not subject to depreciation
d) None of the above.

7. Depreciation is:
a) Transferred to the Depreciation Account
b) The salvage value of a non-current asset
c) The part of the cost of anon-current asset consumed during its period of use by the
business
d) The amount of money spent in replacing assets.

108

R Grey is in business as a wholesale supplier of motor equipment. The following is his trial
balance as at 31 March 2011.

Capital (at 1 April 2010)

Accounts payable
Bank
Accounts receivable
Drawings
Insurance
Wages
Opening inventory
Purchases
Rent
Sales
Motor vehicle

DR

CR

9,000
10,000

400
16,000
11,000
500
12,600
5,000
62,000
1,500
100,000
10,000
119,000

119,000

You are provided with the following additional information.

1.

The value of closing inventory at 31 March 2011 was 6,000.

2.

Depreciation of 6,000 is to be charged this year for the motor vehicle.

3.

Goods taken for personal use during the year was estimated to be worth 1,000.

Required:
Prepare R Greys income statement for the year to 31 March 2011 and a Balance Sheet
as at that date.

109

Income statement for the year ended 31 March 2011

110

Balance Sheet as at 31 March 2011

111

Accounting Ratios and Analysing Accounts

Introduction
Accounting ratios are used to enable us to analyse and interpret financial statements
(accounts). They can also be of use when preparing financial statements from
incomplete records.

Margin

Sales
Cost of sales
Gross Profit

Mark up

%
100

Sales

(X)

80

Cost of sales

20

%
120

(X)

100

20

If we look at the following trading account:

Sales

5,000

Cost of sales

4,000

Gross profit

1,000

Gross profit mark-up is

Gross profit margin

112

is

Example
Margin

25%

Sales

1,000

Required:
What is the gross profit and cost of sales?

Sales

Cost of sales

Gross profit

Example
Mark-up

25%

Cost of sales 600

Required:
What is gross profit and sales?

Sales

113

Cost of sales

Gross profit

Example
Mark-up

10%

Sales

6,600

Opening inventory

300

Closing inventory

500

Required:
Complete a trading account from the above information.

Sales

Cost of sales

Opening inventory
Purchases (Balancing Figure)
Closing inventory

Gross profit

114

Example
Margin

5%

Purchases

2,840

Opening inventory 800

Closing inventory

600

Required:
Complete a trading account from the above information.

Sales

Cost of sales
Opening inventory
Purchases
Closing inventory

Gross profit

115

Calculating missing figures

Using the information that you have and the cost structure it is possible to calculate
missing figures in the trading account eg if inventory is lost or damaged or if
sale/purchase invoices go missing.

Example lost inventory

Margin

20%

Sales

100,000

Opening inventory

1,000

Closing inventory (after fire)

3,000

Purchases

82,000

Required:
Complete a trading account from the above information.

Sales

Cost of sales
Opening inventory
Purchases
Closing inventory
Inventory lost in fire (balancing figure)

Gross profit

116

Example purchases
Margin

25%

Sales

150,000

Opening inventory

10,000

Closing inventory

20,000

Purchases

Required:
Complete a trading account from the above information.

Sales
Cost of sales
Opening inventory
Purchases - (balancing figure)

Closing inventory

Gross profit

117

Example sales
Mark-up
Sales

20%
?

Opening inventory

15,000

Closing inventory

30,000

Purchases

120,000

Required:
Complete a trading account from the above information.

Sales (balancing figure)

Cost of sales
Opening inventory
Purchases
Closing inventory

Gross profit

118

Gross Profit Margin

Gross Profit
_______________

x 100

Sales Revenue

The gross profit margin represents the amount of gross profit generated for every 100 of
sales revenue.
It is referred as an accounting ratio and is used as a test of profitability and the pricing
policy of a business.

Consider the following:

Trading, profit and loss account for the year ended 31 December....

Sales
Cost of sales
Gross profit

2009

7,000

2010

8,000

(5,600)

(7,000)

1,400

1,000

Calculate the gross profit margin for each year

2009

119

2010

Now consider the information you have:

Increased/Fallen
What has happened to sales?

What has happened to cost of sales?

Gross profit margin has therefore

Can you think of any reasons for this?

Cost of goods sold have increased without an increase in selling price

Why would you not increase selling price?

Perhaps goods have been wasted or stolen resulting in higher cost but not
increased income

There may have been a change in the types of goods sold what we call the
SALES MIX

Perhaps the sales price has been reduced without a drop in cost of the goods

Why would this be done?

120