IGCSE

ACCOUNTING

Notes

By Samungweme L
Introduction to Accounts
IGCSE ACCOUNTING

KEY (COMMAND) WORDS IN ACCOUNTING EXAMINATIONS

ADVISE

Write down a suggested course of action in a given situation. Often linked with

Suggest” – see below.

CALCULATE

Self-explanatory – “work out”. Often no format specified. Often accompanied by –

“show workings”/”show calculations”

COMMENT

Make relevant statements, usually on given figures, or results of calculations

COMPARE

Write down the differences between two accounting statements/two

businesses/methods of recording something etc

COMPLETE

Self-explanatory – “Fill in”. Often use in relation to tables/ sentences/ “boxes”.

DEFINE

Write down an explanation of the meaning of an accounting term. e.g. “Define

depreciation”/“Define current assets”.

DISCUSS

Often linked with “Comment” see above. Write down a reasoned explanation of the
causes/effects of a course of action/the difference between two sets of figures/two
accounting statements etc.

DRAW UP

Sometimes used in place of “Prepare” Present something in statement or account format

etc. Often used in relation to bank reconciliation, statement of corrected net profit etc.
ENTER

Sometimes used in place of “Make entries”. Record given information in specified

accounts/ books/ledgers

EXPLAIN

Give a written account of what something means/why it is done/ the outcome of it etc.
Examples include – “Explain the entries in an account”/“Explain why a trader ……………..”

GIVE

Sometimes used in place of “State”. Write down. Sometimes used as “Give 2 examples
………………”.

LIST

Self-explanatory – write down information in a number of points – usually no further

explanation is necessary.

MAKE ENTRIES

See “Enter” above. Record information in specified accounts etc. NAME

NAME

Self-explanatory – write down the title of etc. Often used for short one-word answers e.g.
“Name a fixed asset”/“Name an example of ………….”.

OUTLINE

Write down. Often linked to “State” – see below. Give a brief written account of
something, e.g. “Outline the ways to reduce bad debts”/“Outline the imprest system of
petty cash”.

PREPARE

See “Draw up” above. Present some accounting information in a suitable format e.g.
“Prepare final accounts”/“Prepare journal entries”/“Prepare a bank reconciliation
statement”.
RECORD

Self-explanatory: Used in place of “Enter” or “Write up”. Make the necessary entries in a
set of accounting records e.g. “Record a series of transactions in the cash
book/ledger/books of prime entry”

SELECT

Self-explanatory – choose relevant information from that given. Often linked to a further
instruction e.g. “Select the relevant information and prepare a Manufacturing
Account/Trial Balance”.

SHOW

Self-explanatory - write down your workings/calculations or write down how an item will
appear in some accounting statement. Often used when requiring preparation of Balance
Sheet extracts/Profit and Loss Account extracts etc.

STATE

Self-explanatory – “write down”. Often used instead of “Give” – see above. Used when
requiring written explanation of something e.g. “State 2 ways in which
…………….”/“State how the trader can…………….”

STATE AND Explain

Usually requires a little more detail than just “State” and often an
EXPLAIN Explanation of why/how.

SUGGEST

Requiring knowledge to be related to a given situation. Offer explanation why something

occurred/how a situation can be improved/methods available to deal with a situation
etc.

USING

Refer back to some previous information e.g. using your answer to Part (a), and
calculate some figure or make suitable comments.
WRITE UP

May be used in place of “Prepare” see above. Often used in connection with ledger
accounts, cash books, books of prime entry etc

The purpose of accounting

The purpose of accounting is to accumulate and report on financial information about the
performance, financial position, and cash flows of a business. This information is then
used to reach decisions about how to manage the business, or invest in it, or lend money
to it.

Book-keeping

Bookkeeping is responsible for the recording of financial transactions in a syste matic

manner.

Accounting

It is responsible for interpreting, classifying, analyzing, reporting, and summarizing

the financial data from bookkeeping.
The difference between book-keeping and accounting

Bookkeeping is mainly related to Accounting is the process of

identifying, measuring, and recording, summarizing, interpreting, and
financial transactions communicating financial transactions
which were classified in the ledger
account

The process of bookkeeping does not Accounting uses bookkeeping information

require any analysis to analyze and interpret the data and then
compiles it into reports

Management can't take a decision based on Depending on the data provided by the
the data provided by bookkeeping accountants, the management can take
critical business decisions

The objective of bookkeeping is to keep The objective of accounting is to gauge

the records of all financial transactions the financial situation and further
proper and systematic communicate the information to the
relevant authorities

The purposes of measuring business profit and loss

 They provide a measure of success of a business which is important for

new businesses.
 They are the best source of finance/capital to invest in expanding the business.

 Measure of Growth and Efficiency

 Compensation for Owners and Employees

The role of accounting in providing information for monitoring progress and decision-
making

Accounting information may be used to monitor progress of a business by

comparing its past performance and its current performance using accounting
ratios.

Decisions may be made on all aspect of the business using accounting

information including when to borrow, selling excess assets and when to
increase the selling price.

Accountancy can support the decision making process and management activity. The
objective of an accounting system is to provide financial information concerning the
studied company. The information concerns the financial situation and the performance of
a company and there is intended to the users to taking decisions.

The following decisions can be made using accounting information

 Out of the existing products which should be discontinued and

 The production of which commodities should be increased?

 Whether to buy a component from the market or to manufacture it?

 Whether the cost of production is reasonable or excessive?

 What has been the impact of existing policies on the profitability of business?

Monitoring progress using accounting

 The key financial statements may be used to monitor the progress of the
business that is whether the business is improving or deteriorating.

 The accounting ratios may also be used to monitor the progress of a

business.

The double entry system of book-keeping

Assets

An asset is a resource controlled by the entity as a result of past events and from
which future economic benefits are expected to flow to the entity.

It is a resource acquired, generated and owned by an entity of which future economic

benefits are expected to contribute, directly or indirectly, to the flow of cash or other
benefits.
An entity usually employs its assets to produce goods or services capable of satisfying the
wants or needs of customers; because these goods or services can satisfy these wants or
needs, customers are prepared to pay for them and hence contribute to the cash flow of
the entity.

Assets are classified in to current assets and non-current assets

Non-current assets

These are assets which have a long life bought with the intention to use them in the
business and not with the intention to simply resell them, e.g. buildings, machinery,
fixtures, motor vehicles.

Current assets

These are assets consisting of cash, goods for resale or items having a short life. For
example, the value of stock in hand goes up and down as it is bought and sold.
Similarly, the amount of money owing to us by debtors will change quickly, as we sell
more to them on credit and they pay their debts. The amount of money in the bank will
also change as we receive and pay out money.

The future economic benefits embodied in an asset may flow to the entity in a number of
ways. For example, an asset may be:

(a) used singly or in combination with other assets in the production of goods or
services to be sold by the entity;
(b) exchanged for other assets;
(c) used to settle a liability; or

(d) distributed to the owners of the entity

Liability

It is a present obligation as a result of past events, which will lead to outflow of economic
benefits in the future. An obligation is a duty or responsibility to act or perform in a
certain way.

A liability is a present obligation of the entity arising from past events, the
settlement of which is expected to result in an outflow from the entity of resources
embodying economic benefits.

The settlement of a present obligation usually involves the entity giving up resources
embodying economic benefits in order to satisfy the claim of the other party.
Settlement of a present obligation may occur in a number of ways, for example, by:

(a) payment of cash;

(b) transfer of other assets;

(c) provision of services;

(d) replacement of that obligation with another obligation; or

(e) conversion of the obligation to equity.

Non-current liabilities

These are obligations which are to be repaid in a period which is more than a year e.g.
loans.

Current liabilities

These are those liabilities which have to be repaid within no more than a year from the
end of a trading period, e.g. trade payables for goods bought.
Incomes

Income is increases in economic benefits during the accounting period in the form of
inflows or enhancements of assets or decreases of liabilities that result in increases in
equity, other than those relating to contributions from equity participants.

The definition of income encompasses both revenue and gains. Revenue arises in the
course of the ordinary activities of an entity and is referred to by a variety of different
names including sales, fees, interest, dividends, royalties and rent.

Expense

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.

The definition of expenses encompasses losses as well as those expenses that arise in
the course of the ordinary activities of the entity. Expenses that arise in the course of
the ordinary activities of the entity include, for example, cost of sales, wages and
depreciation.

Capital

These are resources used by a proprietor to start a business. These includes all forms of
assets which can be used including cash, motor vehicles and buildings.

Owner's equity

 Equity is the residual interest in the assets of the entity after deducting all its
liabilities.

 Owner's equity or stockholders' equity is the amount left over after liabilities are
deducted from assets
 It reports the amounts invested into the company by the owners plus the
cumulative net income of the company that has not been withdrawn or distributed
to the owners.
The accounting equation

The equation that is the foundation of double entry accounting. It is how double-entry
bookkeeping is established.
The accounting equation displays that all assets are either financed by borrowing money
or paying with the money of the owner's.

The equation represents the relationship between the assets, liabilities, and owner's
equity of a small business

The financial position of a company is measured by the following items:

1. Assets (what it owns)

2. Liabilities (what it owes to others)

3. Owner's Equity (the difference between assets and liabilities)

The accounting equation (or basic accounting equation) offers us a simple way to
understand how these three amounts relate to each other.

Thus, the accounting equation is:

Assets = Liabilities + Owner’s Equity

If amounts of any two of the three elements are known, we can solve the equation to find
the third one.

For example, if L Sauz has total assets amounting to $200,000 and total liabilities
amounting to $60,000, the owners equity as computed below:

Assets – Liabilities = Owner’s Equity

$200,000 – $60,000 = $140,000

Example 1:

Using the concept of accounting equation, compute missing figures from the following:

1. Assets = $50,000, Liabilities = $20,000, Owner’s equity = ?

2. Assets = ?, Liabilities = $10,000, Owner’s equity = $15,000
3. Assets = $60,000, Liabilities = ?, Owner’s equity = $40,000
4. Assets = ?, Liabilities + Owner’s equity = $150,000
Solution

1. Owner’s equity = Assets – Liabilities

= $50,000 – $20,000
= $30,000
2. Assets = Liabilities + Owner’s equity
= $10,000 + $15,000
= $$25,000
3. Liabilities = Assets – Owner’s equity
= $60,000 – $40,000
= $20,000
4. The basic accounting equation is: Assets = Liabilities + Owner’s equity. If liabilities
plus owner’s equity is equal to $150,000, the assets must also be equal to
$150,000.

Question 1

Define the following terms:

I. Assets
II. Liabilities
III. Equity

State the accounting equation

LEDGER BOOKS

The double entry system of accounting or bookkeeping means that every

business transaction will involve two aspects that is the giving and receiving.
For example, when a company borrows money from its bank, the company's
Cash account will be receiving and its liability (loan) account will be giving.

The double entry system requires two entries for each transaction: a debit and
a credit

Ledger books are the books of final entry which contains the various accounts
to which the entries made in the Books of Original entry are transferred.

DIVISION OF LEDGER BOOK

Purchases Ledger Book: This book contains all the accounts of Suppliers.

Sales Ledger Book: This book contains all the accounts of Customers.
General Ledger Book: This book contains all the rest of the accounts like, Assets
Accounts, expenses account, losses account, etc., and also the Total purchases account,
Total sales account, Total Sales returns account, Purchases Returns account. It is also
called as Nominal ledger.

Structure for a ledger account

Date Details Folio $ Date Details Folio $

Advantages Of Dividing The Ledger

 It facilitates division of labour in the maintenance of ledger.

 It becomes easy to locate errors in ledger accounts.
 It helps the ledger clerks to complete their respective work in time with
perfection.
 It becomes easy to refer to any particular account.

Rules for recording assets, liabilities, equity, revenue and expenses

 Whether to debit or credit an account depends on what balance it usually has and
this depends whether the account is one that records an asset, a liability, equity, a
revenue or an asset.
 Usually, an increase is recorded on the same side as the balance and a decrease is
recorded on the opposite side.

The table below shows what balance accounts under each category have and how to
record increase and decrease:

CATEGORY BALANCE INCREASE DECREASE

Assets Dr Dr Cr
Liabilities Cr Cr Dr
Equity Cr Cr Dr
Revenue Cr Cr Dr
Expenses Dr Dr Cr
Question1
Liliosa Sauz is a trader. Her ledger is divided into a sales ledger, a purchases ledger and a
nominal (general) ledger.
REQUIRED
(a) State two advantages of dividing the ledger into these three sections. [2]
(b) Name one account which would appear in the nominal (general) ledger.[1]

On 1 October 2014 Liliosa Sauz’s trade payables included the following.

$
Waheed Khan 390
Iqbal Wholesalers 650

Liliosa Sauz transactions for October 2014 included the following.

October
1. Purchased goods on credit from Iqbal Wholesalers, $280
2. Purchased goods on credit from Waheed Khan, list price $420, less 20% trade
discount
3. Returned goods, list price $210, to Waheed Khan
4. Sent a cheque for $380 to Waheed Khan in full settlement of the amount owing on
1 October
5. Iqbal Wholesalers charged $6 on the overdue

REQUIRED
Write up the following accounts in the ledger of Sahira Ali for the month of October 2014.
Balance the accounts and bring down the balances on 1 November 2014.
BUSINESS DOCUMENTS
Why Documents are needed?

 For better internal control of the business.

 To record business transactions.
 For future references.
 Legal Requirements.
 To minimize misunderstandings between buyer and seller.

Common Features in Documents

1. Made on official paper (which include Brand name, Brand mark and contact
details (e.t.c.)
2. Date of issuance is written.
3. Reference number of the document in response of which document is issued.
4. Contact details.
5. Title of document.
a All documents must be signed by a competent authority from the issuer side.

Invoice

Whenever there is a credit sale, the selling business will send a document to buyer
showing full details of the goods sold. This document is called as Invoice. It is known to
the buyer as a “Purchases invoice” and to the seller as a “Sales invoice”.

Note: Entries in the sales book and the purchases Book are made with the help of an
invoice.
Debit Note

This document is prepared by the purchaser and it is sent to the supplier to

report him if any faulty goods are been sent or shortages or overcharges are
been made.
Credit Note

When goods are returned, or there has been an over-charge, a supplier may issue a
credit note to the buyer. This reduces the amount owed by the customer.

Note: This document is used to make the entries in both the purchases returns Book and
the sales returns Book.

Statement of Account

This document is prepared and sent to the customer by the supplier. It is issued to remind
the customer about his due amount. It is basically a summary of the transaction of a
customer during the month like sales made, Returns received and Cash received
Purpose: To inform buyer of outstanding recoverable balance from him at the end of
every month. It informs the transactions between the buyer and seller.

Question 1

Insert the missing figures in the following document.

CREDIT NOTE
Jai Kapur
44 West Street
Hightown

Vijay Singh
11 North Road 25 April
2015
Lowtown

Quantity Description Unit price Amount

$ $
4 External doors 55 220
Less (i)...............% trade 33
discount (ii)............

....30...
20 metres 1.50
(iii)...........
Floorboards

a. Name the person who issued the credit note.

b. Suggest one reason for the issue of the credit note.
c. Name the document which would have been issued to request a credit note.
Question 2
Andy sells furniture on credit. Fred is a credit customer.
Complete the following invoice.

Andy

Factory Street

Toptown

Invoice no 1001

Fred

Shop Road

Toptown 22 May 2017

Quantity Details Unit price

Amount

20 Standard chair $50 ……….

10 Luxury chair

………. ……….

1750

10% trade discount ……….

……….

Required

a. State which value from the invoice is recorded in Fred’s account.

b. Name the document Andy issues if Fred returns any chairs.
c. State the difference between Andy’s business and a service business.
BOOKS OF ORIGINAL ENTRIES
These are the books of first entry. The transactions are first recorded in these books
before being entered in the ledger books. These books are also called as books of Prime
entry or Subsidiary books or journals.

The structure of a journal

Date Details Folio Debit Credit

Advantages of using various books of prime entry

1. To avoid multiple entries in the ledger.

2. Different books of prime entry can be maintained by different people.
3. Acts as an aid for posting to the ledger by analysing a transaction into debit and
credit entry.
4. Helps to reduce the amount of detail in the ledger as only totals are posted to the
ledger.
5. Provides evidence of transactions since they are recorded from source documents.
6. Helps in the auditing/tracking process/facilitates cross-referencing.
7. Easy reference to source of a transaction.
8. Helps in gathering and summarising of accounting information.
9. Groups together similar types of transactions in one book in date order.
10. Reduces number of entries in ledger.

Purchases Journal (or Purchases Book) used to record all credit purchases of goods. It
is written up from invoice.

Sales Journal (or Sales Book) is used to record all the credit sales of goods. It is
written up from the invoice.

Sales Returns Journal (or Return Inwards Book): It is used to record all returns
inwards. It is written up from the copies of the credit notes send to customers.

Purchases Return Journal (or Returns Outwards Book): It is used to record all
purchases returns. It is written up from the credit notes received from the suppliers.

Cash Book: It is used to record all receipts and payments of cash and cheques. It is been
given the ruling in such a way that it acts both as a book of original entry and ledger
account.

General Journal (or Journal): This book is used to record all those items or transactions
that cannot be recorded in any other book of original entry like

 Correction of errors
 Opening entries
 Purchase or Sale of Assets on Credit and correction of errors.

A journal entry shows

  The date of transactions.
 The name of account to be debited and amount.
 The name of account to be credited and amount.
 A narrative.

When writing journal entries

 It is usual to show debit entries first.

 It usual to slightly indent the credit entries
 Draw a line to separate the journal entry.

A narrative: is a brief explanation of why the entry is being made.

A narrative is necessary because of the great variety of transactions which are recorded in
the journal, so the reason for each entry can be understood in the future

Question 1
State five advantage of using a book of prime entry.
[5]
A sales journal for July shows the following.
July $
2 Amber Retail 100
10 Business Supplies 65
18 Custom Print 22
31 Total 187
REQUIRED
Identify the account to be debited and the account to be credited for the above
transactions. [4]

Question 2

Kuda Maposa had the following transactions on 31 March 2015.

a Took goods costing $300 for personal use.
b Purchased a motor vehicle, $12 000, for business use, using a cheque drawn
on her personal bank account.
c Received an invoice from Valley Machines for $990. This included $865 for a
new machine. The balance was for repairs to existing machine.
REQUIRED
Prepare journal entries to record the above transactions. Narratives are required.

CASH BOOK Cash book is the only book of original entry which is given ruling in such a way
that it could act at the same time as a book of original entry and as a ledger account. This
is so because
The cash book is a book of prime (original) entry because it is written up from business
documents.
The cash book is part of the double entry system as it acts as ledger accounts for cash
and bank

Trade Discount: It is an allowance or deduction given by the supplier to the retailer on

the catalogue price or list price.
  It is given to encourage him to buy in bulk.
 It is given so that retailer could make some profit.
 Customer is in same type of trade
 To enable customer to make profit.

Note: It is not recorded in the books either by the seller or the buyer. 2. Cash Discount: It
is an allowance or deduction given by the receiver of cash to the payer of cash for prompt
payment. It is of two types discount allowed and discount received.
It is given to encourage the payer to pay on or before the due date.

Note: This discount is recorded in the Cash Book. Discount allowed is recorded at the
debit side and discount received on the credit side. Note: Discount columns are never
balanced. It is just totalled. Note: Every month the Totals of discount allowed column is
transferred to debit side of Discount allowed account in General ledger and the total of
discount received is transferred to the credit of the discount received account.

Petty cash book

Imprest System: It is a system where a reimbursement is made of the total amount paid in
a period or it can also be called as a system where petty cashier begin each new
accounting period with the same amount of petty cash.

An imprest system of petty cash means that the general ledger account Petty Cash will
remain dormant at a set amount. For example, if the petty cashier is entrusted with a
locking bag containing $100 of currency and coins, then the Petty Cash account will
always begin each period with a debit balance of $100.

The Petty cash imprest system allows only the re-imbursement of the amount spent. So, if
you start the month with €100 in your petty cash float and spend €90 of that cash in the
month, an amount of €90 will be then placed in your petty cash float to bring the balance
of your petty cash float back to €100.

Advantages Of Petty Cash Book:

1. The number of entries in the main cashbook is reduced.
2. The main cashier’s burden is reduced.
3. The chances of mistakes in recording is minimised.
4. Posting become easier with the Totals Analysis Columns. Advantages of using Analysis
columns: It let us know the money spent on each different nature of small expense. The
double entry for each analysis column by transferring the totals of the analysis columns to
their respective accounts which are available in the General ledger.
Question 1
Tendai Chikata maintains a petty cash book using the imprest system.
REQUIRED
(a) State one advantage of the imprest system of petty cash.

On 1 March 2015 the balance of Tendai Chikata petty cash book was $100 which was equal
to the amount of the imprest.
His transactions for the month of March 2015 were as follows.
$
March 6 Paid for postage costs 13
11 Bought tea and coffee 5
14 Purchased stationery 27
18 Paid T Masuka, a credit supplier 15
21 Received refund for damaged stationery 10
26 Paid window cleaner 12
29 Paid P Zhonga, a credit supplier 16
REQUIRED
b Enter these transactions in Tendai Chikata petty cash book on the page
opposite.
c Balance the petty cash book and bring down the balance on 1 April 2015.
d State the amount required to restore the imprest on 1April 2015.
e Name the account which would be credited with this amount.
f Name the ledger account in which the transaction of 21 March would be
recorded.

Verification of accounting records

TRIAL BALANCE

Trial balance may be defined as a statement or a list of all ledger account balances taken
from various ledger books on a particular date to check the arithmetical accuracy

Objectives or Advantages of Trial Balance

1. It checks the arithmetical accuracy of ledger accounts.

2. It gives material for preparing Final accounts.
3. To have a proof that the double entry of each transaction is made.

Important Points to remember when preparing the Trial Balance:

1. It should be remembered that all the Assets, Drawings and expenses accounts are
always debited.
2. All liabilities, capital and incomes are always credited.
3. All provisions are always credited.
4. Closing stock is never taken in trial balance. (it is to be shown out of the trial
balance).
Limitations of a trial balance
if a trial balance balances it does not guarantee that the ledgers are free of errors.

It only shows that ledgers accounts are mathematically accurate. If a trial balance fails
to agree a suspense account is opened before checking for errors to enable the
preparation of financial statements.
 If errors are not found the balance in the suspense account is entered in the
financial statements.
  A debit balance will be treated as an expense in the income statement and an
asset in the statement of financial position.
 A credit balance is treated as income in the income statement and a liability in
the statement of financial position.

Errors

Errors not affecting a trial balance

Error of commission

 This occurs when a transaction is entered using the correct amount and on the
correct side, but in the wrong account of the same class.
 Eg cash received from Mpopa was entered in Mapopa’s a/c

Error of complete reversal of entry

 This occurs when the correct amounts are entered in the correct a/cs but on
the wrong sides.
 Eg cash drawings were debited in cash a/c and credited in drawings a/c

Omission
 This is when a transaction is totally omitted from the books. Neither a credit entry
nor a debit entry has made.
 Eg payment of rent not entered in the books.

Principle
 This is when a transaction is posted to an account of wrong class.
 Eg motor expenses debited to motor vehicles a/c

Original entry
 This is when a transaction is incorrectly recorded in book of prime entry.
 Goods 200 bought were entered as 2000 in the purchases journal.

Compensating
 This is when errors cancel one another out.
 Eg purchases overcast by 200 and sales returns undercast by 200.

Errors affecting a trial balance

1. An error of addition in the trial balance.

2. An error of addition within one of the ledger accounts.

3. Completion of double entry using an incorrect amount.
4. Making single entry for a transaction rather than double entry.
5. Entering a transaction twice on the same side.
Correction for errors

When errors are discovered they should be corrected by means of a journal entry
before they are entered in the ledger accounts. Errors affecting a trial balance are
corrected via a suspense account. And errors not affecting a trial balance are not
corrected via a suspense a/c.

Effect of Errors on Profit or Loss

Some errors affect the profit while others do not. This distinction does not always coincide
with whether or not the trial balance balances.

Errors affecting Profit or Loss

These errors affect those accounts which are included in the Trading and Profit and Loss
Account e.g. purchases, sales, expenses etc. We must ask the following questions:

1)Does the error affect the gross profit, the net profit or both?

(a) Errors which affect items that go into the trading account affect gross profit and net
profit to the same extent and in the same direction. Such items are sales, purchases,
returns, stock, carriage inwards etc.

(b) Errors which affect items that are entered in the profit and loss section of the
account, i.e. operating expenses, affect only net profit. Purchases of fixed assets affect
profit only indirectly through provisions for depreciation.

2) In what direction is profit affected?

(a) If sales are overstated or purchases understated, both gross profit and net profit are
too high and must be reduced by the relevant amount. The same applies if sales returns
are understated or purchases returns overstated.

(b) If sales are understated or purchases overstated, both gross profit and net profit are
too low and must be increased by the relevant amount. The same applies if sales returns
are overstated or purchases returns understated.

(c) If miscellaneous receipts are overstated or if expenses are understated, gross

profit is not affected but net profit will be high and must be reduced.
(d) If miscellaneous receipts are understated or if expenses are overstated, again

gross profit is not affected but net profit is too low and must be increased.

(e) If capital expenditure is wrongly treated as revenue expenditure, eg if the purchase

of a fixed asset is treated as an expense, then net profit will be too low and must be
increased. The opposite applies if revenue expenditure is treated as capital
expenditure.

3) Does the errors that affect items in the balance sheet affect profit as well? The
answer is only those that were adjusted after the trial balance was prepared. Errors
affecting fixed assets, current assets and liabilities do not normally affect profit but if
one of these items has changed as a result of an adjustment, then profit is affected. For
example:

(a) If the closing stock has been overvalued, the stock figure in the balance sheet is
too high and so are the gross profit and the net profit. The opposite is true of a
closing stock which is undervalued. Remember that closing stock adds on to gross
profit and opening stock takes away from it.

(b) If an accrued or prepaid expense is the wrong amount, both profit and the item in
the balance sheet are wrong. If an amount owing is overstated or

a prepayment is understated, profit is too low and must be increased, and vice
versa.

(c) The opposite to (b) applies in the case of accrued or prepaid receipts. Estimating
the effects of errors can be confusing and you must keep a clear mind.
Think how the original figure has affected profit and then try to see in which direction
the error is affecting the profit.

Question 1
H Sauz, a sole trader, extracted the following balances from his books of account on 31
December 2014.
$
Motor vehicles 38 000
Provision for depreciation of motor vehicles 10 000
Sales 190 000
Purchases 103 000
Rent 4 000
Wages and salaries 41 000
Sundry expenses 6 800
Drawings 23 000
Trade payables 5 000
Trade receivables 7 000
Bank overdraft 1 500
Cash 100
Purchase returns 600
Inventory 12 000
Capital ?
REQUIRED
a. Prepare H Sauz’s trial balance at 31 December 2014.
b. Give the date to which the inventory in the trial balance relates.
c. Explain the contra entry to the purchases ledger.
d. Suggest why Vijay Singh charged a credit customer interest.
e. State one reason why Vijay Singh prepares a monthly sales ledger control
account.
f. State two reasons why Vijay Singh does not use the information contained in
the sales ledger to prepare the sales ledger control account.

Correction of errors
Suspense
A suspense account could be opened because there is a difference in a trial balance and a
suspense account is opened with the amount of the difference so that the trial balance
agrees (pending the discovery and correction of the errors causing the difference).
Only errors which affect a trial balance are corrected via the suspense account.
NB only compensating errors may be corrected via a suspense account.
Correction of errors

The first step is to journalise the errors by analysing the following

 What should have happened?
 What did happen?
 How can i correct the error?
Question 1

A book-keeper drew up a trial balance and found that it did not balance. He opened a
suspense
account with a debit balance of $60. The following errors were then discovered.
a) 1 Sales returns, $80, have been credited to the purchases returns account,
although correctly recorded in the debtor’s account.
b) 2 Vehicle repairs, $150, have been debited to the motor vehicles account.
c) 3 The purchases journal has been overcast by $100.
d) 4 Goods taken by the owner for his own use, $55, have not been recorded in the
books.
REQUIRED
a) Prepare journal entries to correct these errors. Narratives are not required.
b) Prepare the suspense account, showing the necessary corrections.

Question 2
The following errors were discovered after the trial balance failed to agree.

1. Goods returned, $310, to Ali, a credit supplier, had been entered into the account
of Alam.
2. Wages paid in cash, $1200, had been correctly entered in the cash book but posted
to the wages account as $2100.
3. The total of the general expenses column in the petty cash book, $48, had not
been posted to the general expenses account.
4. The total of the discount received column in the cash book, $114, had been
debited to the discount allowed account.
Required
Prepare the journal entries to correct the above errors.
 Prepare the suspense account.

Errors affecting profits

Once the errors have been corrected, the firm will need to reconsider if the net profit
needs calculating again. There are no general rules we can infer from the type of error
and whether profit is or is not affected.

BANK RECONCILIATION STATEMENT

The purpose of bank reconciliation statement is to explain any difference between the
bank balances appearing on the bank statement provided by the bank.

The bank statement: is a copy of the account of the business as it appears in the
books of the bank. This is from the viewpoint of the bank – the business depositing
money is a creditor of the bank hence its opposite of the cash book.

Importance

 Identify lost checks, deposits and unauthorized wire transactions.

 Detect and prevent excess/unjustified bank charges and ensure transactions are posted
correctly by your bank.
 Detect and prevent embezzlement of funds from within your company.
 Protect yourself. Timely reconciling and prompt objection to your bank regarding
unauthorized, fraudulent or forged checks presented to your bank and paid by that bank,
may allow you to relieve your business of responsibility for the shortfall and transfer the
risk to the bank.

The bank account in the cash book: is prepared from the viewpoint of the business – the
bank is a debtor of the business which has deposited the money

Dishonoured cheque – a cheque which the bank refuses to pay.

Cheque not presented – cheque paid by the business but which has not yet been
presented to the bank for payment/not yet paid by the bank.

Standing order – an instruction by a customer to the bank to pay fixed amounts

at stated dates to a named person or firm.

Direct debit – authority given to the bank to make payments (at irregular dates and
amounts) on request by a named person or firm.

Reasons For Difference:

Sometimes it so happen that some entries are made in cash book but they are not
recorded in the bank. Like.

 Cheques deposited but not credited in the Bank. They are found on the debit side
of the cash book.
 Cheques issued but are not presented in the bank. They are found on the credit
side of the cash book.
Sometimes it so happens that some entries are made in bank statement but they
are not recorded in cashbook. Like.

 Direct deposits in the bank by our customers

 Direct collections made by the bank on our behalf
 Interest allowed by the bank and charged by the bank
 Dishonoured cheques.
 Standing orders
 Direct debits
 Credit transfers
 Bank errors

Therefore a statement is prepared to reconcile this difference. This statement is called

as “Bank Reconciliation statement”.

Methods Of Preparing Bank Reconciliation Statement:

Step I: Compare the bank column of the cashbook with the bank statement. Tick all
those receipts and payments which can be found in both the cash book and the bank
statement, when this has been done, there remains some unticked items in cash book
and the bank statement.

Step II: Make Adjusted cash book by taking into account all the existing cash book
entries plus the unticked bank statement items into the cash book and calculate the
new balance. This balance is considered as the true bank balance of the business and
this figure will be shown in the balance sheet as bank balance.

Step III: Prepare Bank Reconciliation Statement.

Note: When we prepare B.R.S. we do not look at the entries of bank statement.

We just take into account the entries which are in Cash Book but not in Bank
Statement.

1. Start with the balance shown in the Adjusted cash book..

2. Add the entries that are credited in the cash book but not debited on the bank
statement. (unpresented cheques)
3. Deduct any items that are debited in the cash book but are not
credited in the bank statement.
The resulting figure should be equal to Bank Statement balance.

Reasons For Preparing bank Reconciliation Statement:

 To ensure that the cash book entries are complete.

 To discover bank errors.
 To discover errors in cash book.
 To check Fraud and embezzlement.
 To discover dishonoured cheques.
 Ascertain the true bank balance at a certain date.
 Demonstrate that any differences between the cash book balance and that on
the statement.
Structure of a bank reconciliation statement

Question 1
Amjad is a furniture wholesaler. He maintains a three column cash book.
On 1 March the bank column of his cash book showed a debit balance brought down of
$2750. On the same day the bank statement showed a credit balance of $2750.
REQUIRED
(a) State why the bank statement balance is on the opposite side to that shown in the cash
book.

The following transactions took place in March 2017.

March 6 Paid $950 by cheque. This included $790 for a new computer system, and the
balance was for repairs to existing office equipment

March

1. 13 Received a cheque from XY Limited for $196 to settle its account after
deducting 2% cash discount
2. 21 Paid Furniture Store a cheque for $351 in full settlement of the balance owing
of $360
3. 29 Made cash sales, $2148
4. 30 Paid cash into bank, $2000

Amjad received his bank statement for March 2017.

The following items appeared on the bank statement but had not been recorded in his
accounting records.
$
Bank charges 29
Insurance paid directly by the bank 50
A credit customer, Idris, had paid his account by credit transfer 474

The bank had not yet recorded the transactions which took place on 21 March and 30
March.
REQUIRED
Complete Amjad’s cash book on the page opposite.
Balance the cash book and bring down the balances on 1 April 2017.

Prepare a bank reconciliation statement for Amjad at 31 March 2017 to determine the
balance on the bank statement.

CONTROL ACCOUNTS
Control accounts are sometimes known as total accounts. A control account act as a
summary of the ledger which it controls. There are two control accounts.

1. Sales ledger control account / Total trade receivables account

2. Purchases ledger control account / Total trade payables account.

Sales Ledger Control Account

It resembles the account of an individual debtor. It is an account recording in total the

transactions affecting all the debtors.

Sources Of Information For Sales Ledger Control Account:

 Sales- sales day Book

 Cash and Cheques received- Cash Book
 Dishonoured Cheques- Cash Book
 Discount allowed- Cash Book
 Bad debts- Journal
 Sales returns- sales returns journal

Note: Sometimes sales ledger control account too also has small opening credit
balance b/d on a sales ledger control account, in addition to the usual opening debit
balance.

Causes of the credit balance in the sales ledger control account

 A customer returning goods which were already paid for.

 A customer paying for goods in advance.
 Over payment by a customer
 Payment by a customer before discount is deducted
The structure of a sales ledger control account

Balance b/d xxx Balance b/d xx

Credit sales xxx Bank/cash xxx

Interest on overdue accounts xxx Bad debts written off xxx

Dishonoured cheques xxx Set off xxx

Refunds to credit customers xxx Sales returns xxx

Discount allowed xxx

Balance c/d xxx Balance c/d xxx

xxx xxx

Balance b/d xxx Balance b/d xxx

NB Cash sales transactions are not entered in the sales ledger control a/c.
Provisions for bad debts are not entered in the control account because provisions are
kept in the general ledger.
Purchases Ledger Control Account

It resembles the account of an individual creditor. It records the transactions affecting all
the creditors.

Sources of Information for This Account

 Purchases- Purchase Book

 Purchases Returns- Purchase Returns Book
 Cash and cheque paid- Cash Book
 Discount received- Cash Book
 Cash refunds from creditors- Cash Book
  Note: Sometimes it can happen that there is a small opening Debit balance on a
purchases ledger control account in addition to the usual credit balance.

Cause of a debit balances in the purchases ledger control account

 Returning goods which were already paid for.

 Paying for goods in advance.
 Over payment to a supplier.
 Paying for goods before the discount is deducted.
Purchases ledger control account

Balance b/d xx Balance b/d xxx

Set off xxx Credit purchases xxx

Discount received xxx Interest on overdue a/c xxx

Bank/cash xxx Refunds xxx

Purchases returns xxx Balance c/d xxx

Balance c/d xxx

xxx xxx
xxx Balance b/d xxx
Balance b/d

Advantages Of Control Account:

 It helps in locating errors.

 It helps in checking the arithmetical accuracy of the ledger it controls.
 It gives us readymade figures for Total debtors and Total creditors on a certain
date.
 Enable the Balance Sheet to be prepared quickly
 Provide an internal check on sales/purchases ledgers – may reduce fraud

Question 1
 Sauz provided the following information.
$
At 1 July 2013
Total trade receivables 4 100
Total trade payables 3 161
For the year ended 30 June 2014
Cash sales 14 803
Credit sales 48 610
Returns of credit sales 1 001
Credit purchases 39 101
Returns of credit purchases 910
Receipts from credit customers 45 702
Payments to credit suppliers 37 691
Discount allowed 890
Discount received 663
Bad debts written off 274
Interest charged by Sauz on overdue accounts 77

REQUIRED

(a) Prepare the sales ledger control account and the purchases ledger control account
for the year ended 30 June 2014. Balance the accounts and bring down the balances on
1 July 2014.[14]

Complete the table below, naming the book of prime entry which provided the
following

Information.[5]
Book of prime entry

Credit sales

Returns of credit purchases

Receipts from credit customers

Bad debts written off

Interest charged on overdue accounts

Sauz provides for doubtful debts at the rate of 5%.

REQUIRED
Prepare his provision for doubtful debts account for the year ended 30 June 2014. Balance
the account and bring down the balance on 1 July 2014.[4]

Question 2
Vijay Singh maintains a full set of accounting records and prepares control accounts at the
end of each month.
He provided the following information.
 2015 $
April 1 Debit balance on sales ledger control account 475
30 Totals for the month
Sales journal 590
Sales returns journal 46
Cash sales 614
Cheques received from credit customers 387
Cheque received from credit customer
(included in the above figure) later dishonoured 26
Cheques paid to credit suppliers 469
Discounts allowed 13
Discounts received 34
Bad debts written off 32
Interest charged to credit customer 8
Contra entry to purchases ledger 150
May 1 Debit balance on sales ledger control account ?
Credit balance on sales ledger control account 21

REQUIRED
Select the relevant figures and prepare Vijay Singh’s sales ledger control account for the
month ended 30 April 2015.

Accounting procedures
Accounting concepts

After studying this topic, you will be able to:

 explain the term accounting concept;

 explain the meaning and significance of various accounting concepts : Business
Entity, Money Measurement, Going Concern, Accounting Period, Duality Aspect
concept, prudence, Realisation Concept, Accrual Concept and Matching Concept.

These are accounting rules which govern the preparation of financial statements.

Accounting concept refers to the basic assumptions and rules and principles which work as
the basis of recording of business transactions and preparing accounts.

Accruals (matching)
 costs must be matched against related income.
 It means that all incomes and expenses relating to the financial period to which
the accounts relate should be taken in to account without regard to the date of
receipts or payment.
 accrual concept requires that revenue is recognised when realised and expenses
are recognised when they become due and payable without regard to the time of
cash receipt or cash payment.
Significance
 It helps in knowing actual expenses and actual income during a particular time
period.
 It helps in calculating the net profit of the business.
Business entity and ownership
 A distinction should made between the financial transactions of a business and
those of its owner(s)
 This concept assumes that, for accounting purposes, the business enterprise and its
owners are two separate independent entities. Thus, the business and personal
transactions of its owner are separate.
 For example, when the owner invests money in the business, it is recorded as
liability of the business to the owner. Similarly, when the owner takes away from
the business cash/goods for his/her personal use, it is not treated as business
expense.
Significance
 The following points highlight the significance of business entity concept
 This concept helps in ascertaining the profit of the business as only the business
expenses and revenues are recorded and all the private and personal expenses are
ignored.
 This concept restraints accountants from recording of owner’s private/ personal
transactions.
 It also facilitates the recording and reporting of business transactions from the
business point of view l It is the very basis of accounting concepts, conventions and
principles.
Consistency
Understand that the same accounting treatment should be applied to similar items at all
times.

Duality
 It is the two-fold aspect of every transaction
 It provides the very basis of recording business transactions in the books of
accounts. This concept assumes that every transaction has a dual effect, i.e. it
affects two accounts in their respective opposite sides.
 Therefore, the transaction should be recorded at two places. It means, both the
aspects of the transaction must be recorded in the books of accounts.
 For example, goods purchased for cash has two aspects which are (i) Giving of
cash (ii) Receiving of goods. These two aspects are to be recorded.
Going concern
understand that accounting assumes that a business will continue to operate indefinitely

Money measurement
transactions must be expressed in monetary terms
According to this concept only those transactions which are expressed in money
terms are to be recorded in accounting books.

Prudence
Profit and assets should not be overstated by ignoring foreseeable losses or that revenue
should not be recorded before it is earned.
According to this concept all the losses incurred or expected to be incurred are to be
taken in to account but not all anticipated profits to be taken into consideration while
finding the profit. Similarly while finding the value of closing stock, least of the two
values i.e. Market price or Cost price is to be taken into account.
“Lower of the cost or net realisable value”.

Realisation
Revenue is recognised as being earned when legal liability to pay is incurred by the
customer (i.e. when ownership of goods passes to the customer).
This concept states that revenue from any business transaction should be included in the
accounting records only when it is realised. The term realisation means creation of legal
right to receive money. Selling goods is realisation, receiving order is not.

Significance
 It helps in making the accounting information more objective.
 It provides that the transactions should be recorded only when goods are accepted
by the buyer.
Accounting policies

Qualitative characteristics are the attributes that make the information provided in
financial statements useful to users. The four principal qualitative characteristics are
understandability, relevance, reliability and comparability.

Understandability

An essential quality of the information provided in financial statements is that it is

readily understandable by users.

For this purpose, users are assumed to have a reasonable knowledge of business and
economic activities and accounting and a willingness to study the information with
reasonable diligence.

However, information about complex matters that should be included in the financial
statements because of its relevance to the economic decision-making needs of users
should not be excluded merely on the grounds that it may be too difficult for certain
users to understand.

Relevance

To be useful, information must be relevant to the decision-making needs of users.

Information has the quality of relevance when it influences the economic decisions of
users by helping them evaluate past, present or future events or confirming, or
correcting, their past evaluations.

Financial information is only relevant if it can be used

1.
To correct or confirm prior expectations about past events
2.
To assist in forming, revising or confirming expectations about the future
3.
As a basis for financial decisions
4.
In time to be able to influence decisions
Reliability

To be useful, information must also be reliable. Information has the quality of reliability
when it is free from material error and bias and can be depended upon by users to
represent faithfully that which it either purports to represent or could reasonably be
expected to represent.

Information may be relevant but so unreliable in nature or representation that its

recognition may be potentially misleading.

For example, if the validity and amount of a claim for damages under a legal action are
disputed, it may be inappropriate for the entity to recognise the full amount of the claim
in the balance sheet, although it may be appropriate to disclose the amount and
circumstances of the claim.

Comparability

Users must be able to compare the financial statements of an entity through time in order
to identify trends in its financial position and performance. Users must also be able to
compare the financial statements of different entities in order to evaluate their relative
financial position, performance and changes in financial position.

Hence, the measurement and display of the financial effect of like transactions and other
events must be carried out in a consistent way throughout an entity and over time for that
entity and in a consistent way for different entities.

An important implication of the qualitative characteristic of comparability is that users

be informed of the accounting policies employed in the preparation of the financial
statements, any changes in those policies and the effects of such changes.

Users need to be able to identify differences between the accounting policies for like
transactions and other events used by the same entity from period to period and by
different entities. Compliance with International Accounting Standards, including the
disclosure of the accounting policies used by the entity, helps to achieve comparability.

Capital expenditure

Capital expenditure is money spent on acquiring, improving and installing fixed assets.
Examples include purchase of:

 Buildings (including subsequent costs that extend the useful life of a building)
 Computer equipment
 Office equipment
 Furniture and fixtures (including the cost of furniture that is aggregated and
treated as a single unit, such as a group of desks)
 Intangible assets (such as a purchased taxi license or patent)
 Land (including the cost of upgrading the land, such as the cost of an irrigation
system or a parking lot)
  Machinery (including the costs required to bring the equipment to its intended
location and for its intended use)
 Software
 Vehicles

Revenue expenditure

Revenue expenditure is money spent on running a business on a day-to-day basis.

Examples include:

 Wages paid to factory workers.

 Oil to lubricate machines.
 Power required to run machine or motor.
 Expenditure incurred in the ordinary conduct and administration of business, i.e.
rent, , carriage on saleable goods, salaries, wages manufacturing expenses,
commission, legal expenses, insurance, advertisement, free samples, postage,
printing charges etc.
 Repair and maintenance expenses incurred on fixed assets.
 Cost of saleable goods.
 Depreciation of fixed assets used in the business.
 Interest on borrowed money.
 Freight, cartage, transportation, insurance paid on saleable goods.
 Petrol consumed in motor vehicles.
 Service charges to motor vehicles.
 Bad debts.

Capital receipts

Capital receipts are amounts received which do not form part of the day-to-day
trading activities.

Examples include sale of:

Equipment

Machinery

Land and buildings

Motor vehicles

Machinery

NB these assets were Non-current assets for the business.

Revenue receipts

Revenue receipts are amounts received in the day-to-day trading activities from
revenue and other items of income.
Examples include:
  Rent received

 Commission received

 Dividends received

 Bad debts recovered

The effect on profit of incorrect treatment

Incorrect treatment of Capital and Revenue Expenditure occurs if:

1. Capital expenditure is mistakenly treated as Revenue Expenditure

Or

2. Revenue expenditure is mistakenly treated as Capital Expenditure

In both these cases, the incorrect treatment of expenditure effects the Profit for the year
in the Income Statement and Non-Current Assets in the Statement of Financial Position.

The following table explains the effect of incorrect treatment of expenditure on Profit for
the year and the value of Non-Current assets.

Incorrect treatment What happens? Effect on Profit Effect on asset

for the year valuation

Capital Expenditure Expenses will be shown more. Profit for the Non-current
incorrectly treated So, the profit for the year will year will be assets will be
as Revenue be incorrect in the Income understated understated
Expenditure statement.

The Non-current asset will be

shown less. So, the Non-current
asset value will be incorrect in
the Statement of Financial
Position.

Revenue Expenses will be shown less. So, Profit for the Non-current
Expenditure the Profit for the year will be year will be asset will be
incorrectly treated incorrect in the Income overstated overstated
as Capital statement.
Expenditure
The Non-current asset will be
shown more. So, the Non-
current asset value will be
incorrect in the Statement of
Financial Position.
incorrect treatment of Capital and Revenue Receipts.

Incorrect treatment of receipts occurs if:

1. Capital receipt is mistakenly treated as Revenue receipt

Or

2. Revenue receipt is mistakenly treated as Capital receipt

In both these cases, the incorrect treatment of receipts effects the Profit for the year in
the Income Statement and Non-Current Liability or Non-Current Asset in the Satement of
Financial Position.

Incorrect What happens? Effect on Profit Effect on Statement

treatment for the year of Financial Position

Capital Receipt Receipts will be shown more, so Profit for the Non-current asset
incorrectly the profit for the year will be year will be will be overstated
treated as incorrect in the Income overstated or Non-current
Revenue statement. liability will be
Receipt understated.
The Non-current asset will be
shown more or Non-current
liability will be shown less. So,
the value of Non-current assets or
the value of Non-current liability
will be incorrect in the Statement
of Financial Position.

Revenue Receipts will be shown less, so Profit for the Non-current asset
receipts the profit for the year will be year will be will be understated
incorrectly incorrect in the Income understated. or Non-current
treated as statement. liability will be
Capital receipts overstated.
The Non-current asset will be
shown less or The Non-current
liability will be shown more. So
the Non-current asset value or
Non-current liability value will be
incorrect in the Statement of
Financial Position.
FINAL ACCOUNTS

Trading Account: As the name itself implies this account deals with trading i.e.
buying and selling of goods. This account shows the Gross Profit earned or loss
incurred on the goods sold.

Profit and Loss Account: As the name implies this account deals with profits and
losses, gains and expenses. This shows the calculation of Final Profit or loss of a
business.

Statement of financial position: “This is not an account” but it is a statement

of financial position of a business on a certain date.

ADJUSTMENTS

Accruals: It is the due, which has to be paid for the benefit or service enjoyed during an
accounting period. It can also be called as due, an outstanding or an arrears. An amount
owing at the end of a trading period is added to amount paid during the year, to
calculate the amount to be debited in the income statement.

Prepayments: It is a payment for the benefit which has not yet been enjoyed. An
amount paid in advance at the end of the year is subtracted from the amount paid
because it does not relate to the current trading period.

Bad Debts: It is a debt which is deemed to be irrecoverable. It is treated as an expense

in the income statement.

Bad Debts Recovered: It is a debt which was previously written off and is now paid to
us. It is treated an income in the income statement.

Provision for Bad Debts: It is a saving from profit for a possible future loss that may or
may not occur. An increase in the provision for bad debts is treated as an expense. A
decrease in the provision for bad debts is treated as income.

Depreciation: It is the loss of the economic value of a non-currents due to a number of

factors including use passage of time and accident. It is treated as an expense.
Uses of financial statement

to know what assets and liabilities the business has,

to compare with previous years,

to compare with other businesses,

to calculate accounting ratios,

for use by other parties in decision making .g. bank

to calculate profit or loss,
Structure of an income statement

Sales xxx

Less sales returns (xx)

Turnover xxx

Less C.O.S

Opening inventory xxx

Add purchases xxx

Add carriage inwards xx

Freight on purchases xx

Less drawings of goods (xx)

Purchases returns (xx) xxx

xxx

Less closing inventory (xxx) xxx

xxx
Gross profit
Add other incomes

Discount received xx

Rent received xx

Commission received xx

Decrease in provision for bad debts xx

Bad debts recovered xx

Profit on disposal of a non-current asset xx

Total gross income xxx

Less operating expenses

Bad debts xxx

Carriage outwards xxx

Increase in provision for bad debts xxx

Depreciation xxx

Loss on disposal xxx

Rent xxx

Insurance xxx

Salaries xxx xxx

Net profit xxx

Structure of a statement of financial position

Non-current assets Cost Acc Dep NBV

Premises xxx - xxx

Fixtures and fittings xxx xxx xxx

Motor vehicles xxx xxx xxx

xxx xxx xxx

Current assets

Inventory xxx

Trade receivables xxx

Less provision for bad debts (xx) xxx

Other receivables (prepaid expense and accrued incomes) xxx

Bank xxx
Cash xxx

xxx
Current liabilities

Trade payables xxx

Other payables (accrued expenses and prepaid incomes) xxx

Bank overdraft xxx ( xxx)

Working capital xxx

Capital employed xxx

Financed by

Capital (opening) xxx

Add additional capital xxx

Net profit xxx

xxx

Less drawings (cash +drawings of goods) (xxx)

xxx

Add long term liabilities

Loans xxx

Capital employed xxx

 Other payables and other receivables
Accruals

It is the due, which has to be paid for the benefit or service enjoyed during an accounting
period. It can also be called as due, an outstanding or an arrears. An amount owing at the
end of a trading period is added to amount paid during the year, to calculate the amount
to be debited in the income statement.

Prepayments

It is a payment for the benefit which has not yet been enjoyed. An amount paid in
advance at the end of the year is subtracted from the amount paid because it does not
relate to the current trading period.

Question 1
Lewis is a trader with a financial year end of 31 August. He advertises in a monthly trade
magazine. He provided the following information.

1 November 2013 Paid a total of $450 for an advertisement in the January, February and
March 2014 editions.

1 May 2014 Paid a total of $620 for an advertisement in the June, July, August and
September 2014 editions.

REQUIRED
(a) Prepare Lewis’s advertising account for the year ended 31 August 2014. Balance the
account and bring down the balance on 1 September 2014.
Question 2
The following trial balance was extracted from the books of Syed Zilani at the end of his
first year
of trading on 31 January 2015.
$ $
Capital 90 000
Premises at cost 70 000
Equipment at cost 9 300
Revenue 77 100
Purchases 62 030
Wages 10 140
Insurance 2 800
Advertising 1 120
Bad debts 90
Rates 2 160
General expenses 151
Discount received 43
Trade receivables 6 500
Trade payables 5 950
Cash drawings 5 200
Bank 3 602
173 093 173 093
Additional information
1. At 31 January 2015 inventory was valued at $4100.
2. The insurance was paid for 14 months to 31 March 2015.
3. One third of the rates relates to Syed Zilani’s private flat.
4. During the year Syed Zilani took goods costing $580 for personal use. No entries
have been made in the accounting records.
5. A provision for doubtful debts of 2% of trade receivables is to be created.
6. Equipment is to be depreciated at 20% per annum on cost.

REQUIRED
a. Prepare the income statement for the year ended 31 January 2015.
b. Explain how the prudence principle has been applied in the preparation of the
income statement. Illustrate your answer by reference to one of the items in your
answer to (a).

Question 3
Leroy Smith is a trader. His financial year ends on 31 March.
He provided the following information about stationery for the year ended 31 March 2014.
2013 $

April 1 Inventory of stationery 144

June 30 Purchased stationery and paid by cheque 368
Aug 1 Took stationery for personal use 26

2014

Mar 31 Inventory of stationery 92

REQUIRED

Write up the stationery account as it would appear in Leroy Smith’s ledger for the year
ended 31 March 2014. Balance the account and bring down the balance on 1 April 2014.
Explain how the business entity principle has been applied in the preparation of the
Stationery account.

Depreciation and disposals of non-current

assets
“Depreciation is the gradual and permanent decrease in the value of an asset
from any cause.

Reasons for charging depreciation

 To spread the cost of fixed assets over their useful lives.

 To apply the accruals principle – recognising the time difference between payment
for the fixed asset and its loss in value.
 To provide a more realistic view of the fixed assets.
 To record the loss in value of fixed assets – the part of the cost of the fixed asset
consumed during the period of use.

The annual depreciation charge represents the cost of using the fixed asset to earn
revenue.

Causes Of Depreciation:

Wear and tear

 Some Assets get worn or torn out due to its constant use in production.
 When a motor vehicle or machinery or fixtures and fittings are used they eventually
wear out.
 This is also true of buildings, although some may last for a long time.

Erosion
Land may be eroded or wasted away by the action of wind, rain, sun and other elements
of nature.
Obsolescence

 Some Assets get decreased in their value with the passage of time.

This is the process of becoming out-of-date due to technological
advanced.

Inadequacy

 This arises when an asset is no longer used because of the growth and changes in
the size of the business.

Depletion

 It is the reduction in the level of minerals.

 Other assets are of wasting character, perhaps due to the extraction of raw
materials from them.
Accidents
Some Assets may meet an accident and therefore it may get depreciated in
its value.
Reasons For Providing Depreciation:

 To reveal the correct profit or loss of a business.

 To show correct financial position of a business.
 To make provision for replacement of an asset.

Methods Of Providing Depreciation:

There are three methods of providing depreciation

1. Straight Line Method: This is also termed as Fixed instalment method. Under
this method Fixed Percentage on original cost is written off the asset every
year.
The straight line method of depreciation uses the same amount of depreciation
each
This method is used where each year is expected to benefit equally from the use of
the asset.

The amount of depreciation is calculated as follows.

a. Rate of depreciation x cost

b. Cost – scrap value Estimated

number of years
Reducing Balance Method:
 This method is also known as Diminishing balance method or written down
value method. Under this method depreciation is charged at a fixed rate on
the reduced balance every year.
 The reducing balance method of depreciation uses the same percentage rate
of depreciation each year, but it is calculated on the book value at the end of
each year.
 This method is used where the greater benefits from the use of the asset will
be gained in the early years of its life.

Rate of depreciation x net book values (cost-accumulated depreciation)

3. Revaluation Method: Sometimes it is not possible to maintain detailed records of

certain types of fixed Assets, such as very small items of equipment packing cases and
hand tools. In such case the revaluation method is used. Under this method the assets are
revalued at the end of each year and this value is compared with the value at the
beginning of the period. The difference is treated as depreciation.
Formula = Value of Assets beginning + Purchases of Assets during the period – value of
assets sold during the year–value of Asset at the end.

Other methods include the following (sum of digits, machine hours and depletion
unit).

Provision For Depreciation: It means saving a part of profit for the

replacement of the Asset.
Prudence Concept: According to this concept all the losses incurred or expected to be
incurred are to be taken in to account but not all anticipated profits to be taken into
consideration while finding the profit. To apply this concept that we take depreciation in
the profit and loss account.
Asset account
Date details folio Date details folio amount
amount
Disposal xxx
balance b/d xxxxx
Bank(aditions)
xxxxx
Balance c/d xxx
xxx

xxx
Balance b/d xxx

Provision for depreciation account

Date details folio Date details folio amount
amount
Xxxx balance b/d xxxxx
Disposal
xxx Income statement xxx
Balance c/d Xxx
xxx
Balance b/d xxx
xxx

Bad debts and provision for bad debts

Bad debts

 It is an amount owing to a business which will not be paid by the debtor.

 It a situation whereby someone owes money and is unable to pay.
  If reasonable steps taken to obtain the payment failed the debt will be written off.
 As soon as debts are known to be bad they must be written off through the journal.
 When the debt is written off the debtor’s account is credited and the bad debts
account is debited.
 At the end of the year the bad debts account will be credited and the income
statement will be debited.
 Writing off bad debts is application of the prudence concept.

Bad debts recovered

 This is when a debtor who was previously not able to pay is now able to pay and
pays all or part of debt.
 When the debt is recovered the debt which was previously written off must be
reinstated by debiting the trade receivables account and crediting the bad debts
recovered account. Or
 At the end of the year debit bad debts recovered account and credit the income
statement.

Provision for bad debt

 It is an estimate of the amount of which a business will lose in the financial

year because of bad debts.
 It is an allowance which is created on the debts which are more likely to
become bad.
 At the end of a financial year many businesses try to anticipate the amount
which will be lost in bad debts.
 This ensures that profits are not overstated and it is application of the
prudence concept.
 Debit the cash book and credit the trade receivables and debit the trade
receivables and credit the bad debts recovered account.

Reason for providing a provision for doubtful debts

 Ensures that the profits are not overstated (prudence)

 Ensures that the debtors are shown in the Balance Sheet at a more realistic amount
(prudence)
 Application of the matching principle as the amount of sales unlikely to be paid for
are treated as an expense of that particular year

The amount of provision may be estimated by

 Looking at each debtor’s account and estimating which ones will not be paid.
 Estimating on the basis of past experience the percentage of amounts owing which
will not be made.
 Use of debtor’s age analysis and a provision will be made on older debts.

Creating the provision

The entries are summarised as follows

 Debit the income statement and credit the provision for doubtful debts account.
 In the statement of financial position on the provision for doubtful debts from the
trade receivables.

How to reduce bad debts

 Send statement of account

 Offer cash discount
 Refuse further business
 Refer to debt collectors
 Charge interest on overdue a/c
 Offer future incentives

Structures and journal entries

MANUFACTURING ACCOUNT

Manufacturing businesses prepare manufacturing account in addition to the usual final

Accounts. Manufacturing account shows how much it cost the business to manufacture
the goods in a financial year.

Uses of a manufacturing account

a.
To calculate the total cost of production.

b.
To make, make or buy decisions.

c.
To make pricing decisions.

Definition of terms

Direct material

It is material from which goods are made. The cost include the carriage inwards
of raw materials.
Direct labour

This consists of the wages of workers who actually make the goods.

Direct expenses

These are other direct cost which include royalties and licence fees which have to be paid
to other persons for the right to produce. The payment is fixed on the production of each
unit.

Indirect materials

All materials purchased for the factory but which do not form part of the goods being
produce e.g. cleaning materials lubricating oil for machinery.

Indirect wages

The wages for all factory workers who do not actually make the goods e.g.
supervisors, managers cleaners

Other indirect cost relating to production e.g. rent, heating and insurance for the
factory.

Cost of Raw Material Consumed

It is the value of Raw material used in production. It consist of net purchases of Raw
Material, carriage on raw material opening stock of raw material closing stock of Raw
material.

Other overheads

These are other indirect costs incurred in the process of producing goods.

Prime Cost

It is the basic cost of manufacturing the goods. It consists of direct raw

material direct labour and direct expenses.

Production Cost

It is the total cost of manufacturing the goods. It consist of prime cost plus factory
expenses, and it is after any adjustment for work-in progress.

Work-in-progress

These are the goods which are partly made, but which are not yet completed are known
as work-in-progress.

Goodwill

Goodwill means the good reputation of the business which enables it to enjoy regular
flow of customer. It is an intangible fixed Asset.
Types of inventory

Inventory of raw materials

Goods remaining at the year-end which were originally purchased for

converting into finished articles.

Example – wood, nails, screws, handles or other suitable example

Inventory of work in progress

Furniture which is partly made at the year end.

Example – partly made table/ wardrobe/chair/other suitable example.

Inventory of finished goods

Completed furniture which is awaiting sale.

Example – finished table/wardrobe/chair/other suitable example.

*
Structure of a manufacturing account

Manufacturing Account for the year ended 31 December 2020

$ $

Cost of raw material

Opening inventory xxx

Purchases xxx

Carriage inwards for raw materials xxx

Less returns for raw materials (xxx)

Less Closing stock of raw material (xxx) xxx

xxx

Direct factory wages xxx

Royalties xxx xxx

Prime Cost xxx

Factory indirect wages xxx

Factory general expenses xxx

Supervisor’s salary xxx

Loose tools xxx

Factory fuel and power xxx

Factory rent, rates and insurance xxx

Depreciation – Factory machinery xxx xxx

xxx

Add opening inventory for work in progress xxx

xxx

Less Closing stock of work in progress xxx

Cost of Production xxx

The Sauz Manufacturing Company was formed on 1 August 2013.
The following information is available.
$
At 1 August 2013
Cost of factory machinery 102 000
Cost of office fixtures and fittings 56 000
Cost of loose tools 4 400
For the year ended 31 July 2014
Revenue 400 400
Purchases: Raw materials 99 500
Finished goods 19 300
Purchases returns: Raw materials 1 100
Wages and salaries: Factory operatives 94 200
Factory supervisors 41 050
Office staff 33 100
Sales staff 18 900
General expenses: Factory 19 400
Office 17 530
Rates and insurance 5 000
At 31 July 2014
Inventory: Raw materials 8 600
Work in progress 8 200
Finished goods 21 100
Rates and insurance prepaid 400
General office expenses prepaid 280
Wages of factory operatives accrued 3 100
Value of loose tools 3 300

Additional information

1. 1 No additional non-current assets were purchased during the year.

2. 2 The factory machinery is to be depreciated at 15% per annum on cost.
3. 3 The office fixtures and fittings are to be depreciated at 12.5% per annum on cost.
4. 4 The loose tools are to be revalued at the end of each financial year.
5. 5 The rates and insurance are to be apportioned ¾ to the factory and ¼ to the
office.

REQUIRED
Prepare the manufacturing account of The Sauz Manufacturing Company for the year
ended 31 July 2014.

Prepare the income statement of The Sauz Manufacturing Company for the year ended
31 July 2014.

After the preparation of the manufacturing account and the income statement the
following errors and omissions were discovered.

1. 1 The trade receivables amounted to $32 600 on 31 July 2014. This included a
debt, $200,
2. which should have been written off.
 3. 2 A provision for doubtful debts of 2% of the remaining trade receivables should
have been created.
4. 3 No entry had been made for purchases returns of finished goods, $940.
5. 4 The inventory of finished goods on 31 July 2014 included goods, $3050, which
were damaged and which are expected to be sold for $2000.
REQUIRED
Complete the table below to show the effect of correcting errors 1 – 4 on the profit for
the
year ended 31 July 2014.

Question 2
The financial year of Msamati Manufacturing ends on 31 January.
The following is the summarised manufacturing account for the year ended 31 January
2017.
$
Prime cost 505 650
Factory overheads 176 390
682 040
Change in work in progress (12 090)
Cost of production 669 950
REQUIRED
(a) Explain the meaning of the term ‘prime cost’.
(b) (i) Explain the meaning of the term ‘factory overheads’.
(ii) Suggest two items which may be included in the factory overheads.
(ii) State whether the closing work in progress was greater or smaller than the opening
work
in progress.

Question 3
Msamati Manufacturing provided the following information for the year ended 31 January
2017.
$
Revenue 816 370
Purchases of finished goods 17 200
Commission received 2 700
Administration expenses 38 160
Selling expenses 28 270
Inventory of finished goods 1 February 2016 56 120
Office equipment at cost 32 000
Delivery vehicles at cost 68 000
Provision for depreciation
Office equipment 14 400
Delivery vehicles 17 000
Loan from A1 Loans received 1 April 2016 15 000
At 31 January 2017
Inventory of finished goods 61 340
Commission receivable outstanding 130
Loan interest at 5% per annum is outstanding
During the year ended 31 January 2017 the owner of the business took finished goods
costing $1620 for his own use.
Depreciation is charged as follows:
Office equipment at 15% per annum using the straight line (equal instalment) method

Delivery vehicles at 25% per annum using the reducing (diminishing) balance method.
Required

a. Prepare the income statement for the year ended 31 January 2017.
b. Explain how the accruals (matching) principle has been applied in the preparation
of the income statement. Illustrate your answer by reference to one of the items
in your answer for the previous question.
c. Suggest two ways in which the profit for the year could be increased.

Question 3

The financial year of Nasir Manufacturing Limited ends on 31 January.

The following information is available.
$
At 1 February 2013
Plant and machinery at cost 94 000
Office fixtures and equipment at cost 34 000
Loose tools at valuation 2 650
Provision for depreciation of plant and machinery 33 840
Provision for depreciation of office fixtures and equipment 12 240
Inventories: Raw materials 23 500
Work in progress 11 020
Finished goods 18 100

For the year ended 31 January 2014

Revenue 539 000

Purchases: Raw materials 124 600
Finished goods 16 900
Purchases returns: Finished goods 200
Wages and salaries: Factory workers 136 000
Factory supervisors 31 400
Administrative and sales staff 61 500
Expenses: Direct expenses 16 300
General factory expenses 19 208
General office expenses 8 900
Rates and insurance 6 360

Additional information

1 On 31 January 2014
Inventories: Raw materials 26 100
Work in progress 12 060
Finished goods 19 300
Direct wages accrued 2 200
Sales staff wages accrued 380
Rates prepaid 120

The rates and insurance are to be apportioned ¾ to the factory and ¼ to the office.

The plant and machinery and office fixtures and equipment are being depreciated at 20%
per annum using the reducing (diminishing) balance method.

During the year ended 31 January 2014 loose tools costing $310 were purchased.
On 31 January 2014 loose tools were valued at $2740.

Required

Prepare the manufacturing account of Nasir Manufacturing Limited for the year ended
31 January 2014.

Prepare the trading account section of the income statement of Nasir Manufacturing
Limited to show the gross profit for the year ended 31 January 2014.

INCOMPLETE RECORDS/SINGLE ENTRY SYSTEM

It is a system which is defined as any system which is not exactly the double entry
system. It is developed by certain small business people.

Calculation of profit by comparing capitals

The capital of a business is affected by three main items

I. Drawings-they reduce the profit of a business

II. Additional capital-it increases capita of a business
III. Profit or loss-profit increases capital where as a loss reduces capital

Statement of affairs

It is the list of assets and liabilities at a given date. It is a statement which is used
calculate capital using the accounting equation. This is done using assets and liabilities.

Ascertainment of Profit by comparing capitals at different dates:

Net Profit:

(Closing Capital + Drawings) – (Opening Capital + Additional Capital)= net profit

How to prepare the income statement and the statement of financial position

using incomplete records.

Step 1

Prepare an opening statement of affairs. This opening capital will be used in the
preparation of a statement of financial position.

Step 2

Prepare a receipts and payments account. This is similar to a cash or bank a/c for the
business. It may be used to calculate closing cash or bank balance for the preparation of
a statement of financial position.
Step 3

Prepare a sales ledger and purchases ledger control account. This is needed to calculate
credit sales and credit purchases, they are calculated as the balancing figure.

Step 4

Adjust the receipts for incomes and payments for expenses for opening and closing
accruals and prepayments, to calculate amounts to be entered in the income
statement.

Step 5

Calculate provision for bad debts, depreciation and profit or losses on disposal of non-
current assets.

Step 6

Prepare the income statement and the statement of financial position with the
information available. If the information which is available is still not enough there are
three ratios which can be used to calculate the missing information. Mark-up: gross profit
calculation as a percentage of cost price Profit

Mark-up = Gross profit 100

Cost price

This ratio is usually used to calculate gross profit if the information about the cost
of sales is available. Or

To calculate sales given the cost of sales and the ratio.

Margin: The calculation of Gross Profit as a percentage of selling price. Margin =

Gross profit x 100
Selling price

This ratio is usually used to calculate gross profit given the sales figure and the
ratio. Or

To calculate cost of sales given the sales figure and the ratio.

Average rate of inventory turnover

Average inventory turnover = cost of sales

Average inventory


This ratio is usually used to calculate both opening or closing inventory given the
cost of sales and either closing or opening inventory. or


The cost of sales given the opening and closing inventory and the rate of inventory
turnover.

Question 1
Chan Sauz is a trader. Her financial year ends on 31 May. She does not maintain many
accounting records, but was able to provide the following information at 31 May 2015.

$
Bank overdraft 4 080
Trade payables 8 100
Trade receivables 7 800
Other receivables 101
Inventory 6 750
Machinery at book value on 1 June 2014 (cost $28 600) 22 880
Motor vehicles at book value on 1 June 2014 (cost $24 000) 13 500
Loan (repayable 31 July 2016) 10 000

The following adjustments are required on 31 May 2015.

1 A provision for doubtful debts of 2% of the trade receivables should be created.

2 The machinery should be depreciated by 20% per annum using the straight line method.
3 The motor vehicles should be depreciated by 25% per annum using the reducing
(diminishing) balance method.

REQUIRED
Prepare a statement of affairs on 31 May 2015.
ACCOUNTS OF CLUBS AND SOCIETIES

Receipts and Payments Accounts: It is a summary of cashbook, i.e. all cash and bank
transactions during a given period of time. It starts with an opening balance and debited
with all items of receipts irrespective of whether they are of capital nature or revenue
nature and whether they are pertaining to the current period or not. It is credited with all
payments made during the year. Those payments may be of Capital or Revenue nature
whether pertaining to the current year or not.

Note: This account does not take into account outstandings and prepayments. Income and
Expenditure Account: Income and expenditure account is a nominal account. It is debited
with all expenses and losses and credited with all incomes and gains. This account serves
exactly the same purpose as the profit and loss account in a trading concern.

Accumulated Fund: It is the surplus accumulated within the organisation.

Difference Between The Terms Used In

Trading Business Non-Trading Business

1. Cash Book Receipts and payments account

2. Profit and Loss Account Income and expenditure account

3. Net Profit Surplus

4. Net Loss Deficit

5. Capital Accumulated fund

Sources Of Income To Club:

 Donations

 Subscriptions

 Entrance fees

 Sales of Old Assets

Structure of a subscriptions a/c

Owing b/d xxx prepaid b/d xxx

I&E (bal fig) xxx bank/cash xxx
Prepaid c/d xxx owing c/d xxx
 xxx xxx
owing b/d xxx prepaid b/d xxx
Question 1
The Leeford Athletics Club was formed some years ago.
The club has 100 members. The annual subscription is $120.
The club rents a clubhouse. The monthly rent is $300.
The following information was available on 1 November 2013.
$
Accumulated fund 9 510
Equipment at book value 8 300
4% Bank loan 2 000
Cash at bank 4 590
Insurance prepaid to 30 November 2013 120
Clubhouse rent accrued 300
Subscriptions prepaid 1 200
The amounts received and paid during the year ended 31 October 2014 were as follows.
$
Subscriptions for the year ended 31 October 2014 7 920
Purchase of new equipment 4 000
Proceeds of sale of old equipment (book value $2200) 1 500
General expenses 9 310
Loan interest paid 400
Rent of clubhouse 4 500
Net receipts from open day 770
Bank charges 30
All receipts were paid into the bank and all payments were made by cheque.

REQUIRED
a. Write up the subscriptions account for the year ended 31 October 2014. Balance
the account and bring down the balance on 1 November 2014.
b. State the section of the statement of financial position on 31 October 2014 in
which the balance of the subscriptions account would appear.
c. Prepare the receipts and payments account of the Leeford Athletics Club for the
year ended 31 October 2014.
Question 2
The Healthy Ways Sports Club provided the following information.
At 31 December 2013 At 31 December
2014
$ $
Subscriptions in advance 100 50
Subscriptions in arrears 350 500
Trade payables for café supplies 590 820
Inventory of café supplies 600 800
Sports equipment at valuation 18 700 20 100
Accrued wages for sports club staff - 300
Receipts and payments during the year ended 31 December 2014
$
Receipts
Subscriptions received 19 100
Café receipts 4 900

Payments
Café supplies 3 710
New sports equipment 4 600
Staff wages – café 1 800
– sports club 200
Rent and insurance – sports club 4 800
Sundry expenses – sports club 1 850
REQUIRED
a. Prepare the subscriptions account for the year ended 31 December 2014. Balance
the account and bring down the balances on 1 January 2015.
b. Prepare the total trade payables account for the year ended 31 December 2014 to
determine the café purchases.
c. Prepare the income and expenditure account for the year ended 31 December
2014.
d. Prepare the café income statement for the year ended 31 December 2014.
PARTNERSHIP BUSINESS

A partnership business is an Association of two or more persons formed with the object
of sharing profits arising out of business.

Advantages

I.
Huge Capital: More capital can be secured than in the case of a sole trading
II.
business.
Wise decision: It enjoys the benefit of combined ability.
III.
Introduction of Division of labour: Partnership enjoys all advantages of Division of
labour. Duties can be assigned to different partners according to their
qualifications and specialisation.
IV.
Greater borrowing capacity
V.
Diffusion of risk.
VI.
More contact with the customers.
Disadvantages
I.
Unlimited liability
II.
Delay in decision.
III.
Difference in opinions.
IV.
No perpetual existence.
V.
Secrets cannot be maintained.

Accounts of Partnership Firm

Partnership firms prepare the following final accounts:


Trading A/c

Profit & Loss A/c

Profit & Loss Appropriation A/c

Current Accounts

Partners’ Capital Accounts

Statement of financial position.

Trading and Profit & Loss A/c is prepared in the usual form.

Profit and Loss Appropriation Account

This account is a continuation of the profit and loss account and it is prepared to show
the appropriation of profits and losses among the partners.
Structure for profit and loss appropriation a/c

Net profit for the year xxx

Add interest on drawings A xxx

B xxx xxx

Less interest on capital A xxx

B xxx

Xxx

Less salary B xxx (xxx)

Profit to be shared xxx

Share of profit A½ xxx

B½ xxx (xxx)

Note: interest on partner’s loans is not entered in the appropriation account.

Reasons for charging interest on drawings


Interest on drawings discourages large or early cash withdrawals.

Thus could improve cash/working capital position.

Also produces additional residual income/profits for division between partners

Reasons for charging interest on capital


To reward the partner investing more capital

To encourage partners to invest in the business

Current Accounts

In a partnership business amount withdrawn by a partner is generally accounted for

separately by debiting the current accounts of the partner who withdraws the amount
from the business.
 Structure of a current account

A B A B

Balance b/d xxx balance b/d xxx

Drawings xxx xxx share of profit xxx xxx

Interest on drawings xx xx interest on capital xxx xxx

Interest on loan xxx

Salary xxx

Balance c/d xxx xxx

xxx xxx xxx xxx

Balance b/d xxx xxx

Capital Accounts

In a partnership business there are as many capital accounts as are partners. A partner’s
contribution to the business is called his capital. It always shows a credit balance which is
always fixed. It has changes only when extra capital is bought into the business are a new
partner enters into the business.
Question 1

Chanie and Charloe have been in partnership for some years. Charloe receives a
partnership salary of $15 000 per annum and both partners receive interest on capital of
10% per annum. They share profits and losses equally.
They provided the following information.
$
At 1 January 2013
Capital account balances - Chanie 100 000
- Charloe 60 000
Current account balances - Chanie 5 200 Dr
Charloe 4 800 Dr
During the year ended 31 December 2013
Drawings - Chanie 18 000
- Charloe 17 000
At 31 December 2013
Fixtures and fittings at cost 100 000
Provision for depreciation on fixtures and fittings 10 000
Delivery van at cost 40 000
Provision for depreciation on delivery van 12 000
Inventory 56 400
Trade receivables 19 000
Bank 6 600 C r
Trade payables 25 400

REQUIRED
a) Suggest one reason how the debit balances on the current accounts on 1 January
2013 could have arisen.
b) Calculate the value of the net assets of the partnership on 31 December 2013.
c) Calculate the profit for the year made by the partnership in the year ended 31
December 2013.
d) Prepare the appropriation account for the partnership for the year ended 31
December 2013.
e) Prepare the current accounts for Chanie and Charloe for the year ended 31
December 2013 in columnar format. Balance the accounts and bring down the
balances on 1 January 2014.

Question 2
Meena and Rafah are in partnership. Their financial year ends on 30 April.
When they started the business they drew up a partnership agreement which provided for:
Interest on capital at 3% per annum
Interest on drawings at 4% per annum
An annual salary of $6000 for Meena
Sharing of residual profits and losses in the ratio 2 : 1
On 1 May 2016 the balances on the partners’ capital accounts were as follows:
Meena Rafah
$ $
Capital account 40 000 20 000

On 1 November 2016 Rafah introduced a further $10 000 into the business as capital.
The partners agreed that Meena’s salary should be increased by $1000 per annum
starting on 1 November 2016.
 Drawings and interest on drawings during the year ended 30 April 2017 were as follows:
Meena Rafah
$ $
Drawings 7300 5100
Interest on drawings 292 204

The profit for the year ended 30 April 2017 was $7534.
REQUIRED
Prepare the profit and loss appropriation account for the year ended 30 April 2017.

Prepare the current account of Meena for the year ended 30 April 2017. Balance the
account
and bring down the balance on 1 May 2017.
Limited company accounts
A limited company is a legal entity which has a separate identity from its
shareholders whose liability for the company’s debts are limited.

Shareholder

Any person, company or other institution that owns at least one share in a company and
in whose name the share certificate is issued. A shareholder may also be referred to as a
"stockholder.

Limited liability

This means that the shareholders of a company are only liable to the debts of a company
up to the amount invested in the company.

Types of shares

The most common type of shares are preference and ordinary shares.

Preference shares


These are shares which receive a fixed rate of dividend in priority with ordinary
shares.

The dividend is the same year by year. This dividend is not entered in the
appropriation account of the company instead it is expensed in the income
statement.

If a company is wound up the residual money after paying the liabilities is paid to
preference shareholders.

Preference shares do not carry a voting right.

The dividend is paid before the ordinary share dividend.
Ordinary shares/equity shares


These are the true owners of the company. The dividend on these shares is not
payable until that of preference shares is accounted for.

The dividend of preference shares do vary with the trading results of a
company.

If a company is wound up the ordinary shares holders will receive their monies
after payment of liabilities and preference shareholders this may result in little
being paid to them.

Ordinary shareholders are entitled to voting rights.

They are also known as equity shares.

The dividend may vary according to profits.

Debentures

It is a long term loan which carries a fixed rate of interest.

The interest on debentures is paid whether the business makes a profit or a loss.

If a company is wound up the debenture holders are the first to receive their
monies before shareholders.

Debenture holders are not members of the company.

Features of debentures

Debentures are long-term loans

Debenture holders are not members of the company

Debentures do not carry voting rights

Debentures carry a fixed rate of interest

Debenture interest is not dependent on the company’s profit
 
Debentures are often secured on the assets of the company

Debenture holders are repaid before shareholders in the event of a
winding up

Debentures are repaid by a set date

A company may not immediately require all money due on shares it issues.

Called up capital is the amount of money requested from the shareholders by the
company. It may be less than issued share capital, it is just an amount needed at a
particular date.

Paid up capital: it is the part of called up capital the company has actually
received cash from shareholders.

The appropriation account

Net profit after interest tax and preference dividends xxx

Less transfer to general reserve xxx

Ordinary dividend xxx (xxx)

Retained earnings for the year xxx

Add retained profit brought forward xxx

Retained profit carried forward xxx

Statement of changes in equity

Ordinary general retained totals

Shares reserve profit

Bal b/d xxx xxx xxx xxxx

Issue of shares xxx xxx

Net profit for the year xxx xxx

Transfer to general reserve xxx (xxx) -

Less dividends . (xxx) (xxx)

xxx xxx xxx xxx

Statement of financial position extract

5% preference shares of $1 each xxxx

Ordinary shares of $0.5 each xxxx

General reserve xxxx

Retained profit xxxx

Shareholder’s funds xxxx

Question 1
At 1 February 2014, Green Meadow Limited had the following shares and debentures.
250 000 ordinary shares of $0.50 each
100 000 8% preference shares of $1 each
$50 000 6% debentures (2019)
The following balances were extracted from the books on 31 January 2015.
$
Retained earnings 65 000
Plant and equipment (at book value) 184 000
Motor vehicles (at book value) 87 000
Trade payables 43 000
Trade receivables 57 000
Inventory 63 000
Bank 2 000 debit
Long term bank loan (5%)
(taken out in 2013) 10 000
REQUIRED
Prepare the statement of financial position at 31 January 2015.

Calculate the profit from operations (profit before interest) for the year ended 31 January
2015.
Following additional information is available:
1 Retained earnings at 1 February 2014 were $51 500.
2 The interim ordinary dividend paid during the year was $0.04 per share.
3 The preference dividend was paid on time.

REQUIRED
Calculate the profit for the year ended 31 January 2015.
Question 2
JW Limited extracted the following balances from its books of account on 30 April 2017,
after the gross profit had been calculated.
$
Gross profit 63 000

Distribution costs 24 000

Administrative expenses 16 000

Interim dividend paid 6 000

Debenture interest 3 000

Ordinary shares of $1 each 100 000

General reserve 50 000

Retained earnings ?

Equipment at cost 260 000

Provision for depreciation of

Equipment 65 000

Inventory 33 000

Trade receivables 14 000

Bank 6 800credit

Trade payables 17 500

10% Debentures (repayable 2025) 30 000

Required

Prepare the trial balance at 30 April 2017. Insert a value for retained earnings.

Calculate the profit for the year. The depreciation charge for the year was $13 000.

Additional information

The directors of the company transferred $10 000 to general reserve on 30 April 2017.
REQUIRED
Prepare the statement of changes in equity for the year ended 30 April 2017.

Calculate to two decimal places the return on capital employed (ROCE) for the year ended
30 April 2017. (Use closing capital employed.)
Inventory Valuation
It is necessary for a business to value inventory at the end of each trading period. An
incorrect amount of inventory affects both the gross profit and net profit.

Inventory is valued at lower of cost and net realisable value.

This is an application of prudence concept because over-valuing inventory causes
both profit and assets to be over-valued.

Reasons for valuing inventory at lower of cost and net realisable value

 To avoid overstating the profit

 To avoid overstating the assets
 To apply the principle of prudence

The cost of inventory

The cost of inventory is the purchase price of plus any additional costs incurred in bringing
the inventory in present position and condition.

The net realisable value

It is the estimated receipts from the sale of inventory less any further costs of completing
the goods or costs of selling goods.

Reasons for valuing inventory at lower of cost and net realisable value

 To apply the principle of prudence

 To ensure that the current assets are not overstated
 To ensure that the profit is not overstated
 Inventory should be valued at the lower of cost and net realisable value

ANALYSIS AND INTERPRETATION


Analysis consist of a detailed examination of the information in a set of financial
records of a business.


Interpretation can include comparing the results of other similar business
and comparing within the business that is from different periods.

Ratios are divided into two main groups these are profitability and liquidity ratios.

Working capital

It is the difference between current assets and current liabilities of a business.

It is the amount available for the day to day running of a business.

It is also referred to as net current assets.

Capital owned by the business

It is the amount of money owed by the business to the owner at a certain date.

Capital employed

It is the total funds which are being used by the business. It is calculated as

follows

Non-current assets + net current assets= capital employed

Or

Owner’s capital + non-current liabilities = capital employed

Profitability ratios

These are ratios which are used to relate profits with other figures.

Return on capital employed

It is a measure of profitability of every dollar of capital employed. It is

calculated as follows

Net profit (profit for the year) x 100

Capital employed 1

Gross profit percentage

It is gross profit earned for every $100 of sales. It is also known as gross profit as a
percentage of sales. It is calculated as follows

Gross profit x 100

Sales/revenue 1

Ways of improving gross profit percentage


Increasing selling prices.

Obtaining cheaper supplies.
 
Increasing advertising and sales promotion.

Changing the proportions of different types of goods sold

Causes of a fall in gross profit percentage


Not buying goods as cheaply

Not taking advantage of bulk buying

Not passing increased costs on to customers

Buying more expensive goods

Selling goods at a lower margin

Allowing customers a higher rate of trade discount

Increasing the rate of trade discount.

Selling goods at cheaper prices.

Not passing on increased cost to customers.

Net profit percentage

It is net profit earned for every $100 of sales. It act as an indicator of how a business
manages its expenses. It is calculated as follows

Net profit x 100

Sales (revenue)

How to improve net profit percentage


Increase gross profit e.g. increase profit margin, increase selling prices etc.

Reduce expenses e.g. reduce staffing levels, reduce advertising etc.

Increase other income e.g. rent out part of premises, earn more discount

Liquidity ratios

Liquidity is how easily an asset is convertible into cash. Liquidity ratios measures how
ease and speed with which assets can be converted into cash.

Current ratio/working capital ratio


It measures the ability of a business to meet its short term obligations as the
fall due. It is calculated as follows
Current assets: current liabilities

Standard current Ratio

Somewhere between 1.5 – 2:1.

The effects of not having enough working capital


Problems in meeting debts as they fall due.

Inability to take advantage of cash discount.

Difficulty in obtaining further supplies.

Inability to take advantage of business opportunities as they arise.

Ways of improving working capital.


Introduction of further capital.

Obtaining long-term loan.

Reducing owner’s drawings.

Selling out useless fixed assets.

Charging interest on overdue accounts and avoid being charged interest.

Issue additional shares

Issue additional debentures

Reduced dividends paid

Importance of working capital


To be able to meet debts when they fall due

To be able to take advantage of cash discounts

To bed able to take advantage of business opportunities as they arise

To ensure that there is no difficulty in obtaining further supplies

Quick ratio/acid test ratio

The quick ratio shows whether the business would have any surplus liquid funds if all the
current liabilities were paid immediately from the liquid assets.

It is calculated as follows
Current assets-inventory: current liabilities

Reasons for deducting inventory


Stock is not regarded as a liquid asset – a buyer has to be found and then the
money collected. Some stock may prove to be unsaleable.

The standard quick ratio

1:1

Inventory turnover

This ratio calculate the number of time the business sells and replaces inventory in a
period of time. A business selling luxury expensive jewellery tends to have a low
inventory turnover whereas a business selling low value everyday requirements such as
fresh bread tends to have high inventory turnover.

To give number of times inventory is sold and replaced in a period

Cost of sales
Average inventory

To give number of days on average the inventory is held before being sold

Average inventory x 365

Cost of sales

Factors causing lower rate of inventory turnover

 Lower sales

Inventory over-purchased

Too high selling prices

Falling demand

Business activity slowing down

Business inefficiency

Collection period for trade receivables

It the average time of period a debtor takes to pay their accounts. The quicker the
debtors takes to pay their account the less the risk. The more time they take the more the
risk it is.

Trade receivables x 365 number of days

Credit sales 1
Trade receivables x 52 number of weeks

Credit sales 1

Trade receivables x 12 number of months

Credit sales 1

Ways of improving collection period for trade receivables

I.
Sending regular statement of account and chasing overdue accounts
II.
Offering cash discount for early settlement
III.
Charging interest on overdue accounts
IV.
Refusing offering further debts if overdue accounts are not settled
V.
Invoice discounting and debt factoring
VI.
Fix a credit limit for each customer

Cause of poor Collection period for debtors

I.
Less efficient credit control
II.
Allowing longer credit to maintain sales Not
allowing cash discounts to debtors

Payment period for trade payables

It is the average time taken to pay trade payables. Taking more time to pay means
that the business can use funds for other purposes but there may be adverse effects
such as
I.
The supplier refusing credit in future
II.
The supplier refusing further supplies
III.
The loss of cash discount for early settlement
IV.
Damage of the relationship with the supplier

It is calculated as follows

Trade payables x 365 give answer in days

Credit purchases 1
Trade payables x 52 give answer in weeks
1
Credit purchases
 Trade payables x 12 give answer in months
1
Credit purchases

Causes of a longer Payment period for creditors

I.
Shortage of liquid funds
II.
Knock-on effect of debtors taking longer to pay
III.
Suppliers not allowing cash discounts

Limitations of ratio analysis

I.
Should compare with a business of approximately the same size

II.
Should compare with a business of the same type (sole trader)

III.
Should compare with business selling same type of goods3

IV.
Should compare with a business with approximately the same amount of capital

V.
The accounts may be for one year only which will not show trends and may not
be a typical year
VI.
The financial year may end at a different point in the trading cycle

VII.
The businesses may operate different accounting policies

VIII.
There may be differences which affect profitability and the items on a balance
sheet
IX.
The financial statements do not show non-monetary items

X.
It is not always possible to obtain all the information about a business in order to make a
true comparison

Question 1
Lloyd provided the following information.
Revenue for the year ended 30 November 2014 $1000
Inventory at 1 December 2013 $60
Inventory at 30 November 2014 $40
Gross profit margin 40%
Net profit margin 15%
REQUIRED
Calculate the following for the year ended 30 November 2014.
Gross profit...............................................................................
Cost of sales.............................................................................
Purchases.................................................................................
Profit for the year......................................................................
Expenses..................................................................................

Lloyd’s brother, Louis, has a business selling similar type of goods.

His gross profit margin is 40% and his net profit margin is 20%.
REQUIRED

a. State one reason for the difference in the ratios.

b. Calculate Antoinette’s inventory turnover in days. Round up your answer to the
next whole day.
c. Suggest two reasons why Louis’ inventory turnover is faster than Antoinette’s.
d. State two advantages to Antoinette of going into partnership with Louis.

Question 2

The partners provided the following information.

At 30 April 2016 At 30 April 2017
Current ratio 1.85 : 1 1.68 : 1
Quick (acid test) ratio 1.01 : 1 0.78 : 1
$
Inventory 19 400
Trade receivables 16 900
Trade payables 17 450
Bank overdraft 4 100
REQUIRED
Explain why the partners calculated the quick (acid test) ratio as well as the current ratio.

Suggest two reasons for the change in the current ratio.

Additional information
The partners later discovered that no entry had been made for a cheque received from a
credit customer for $1800.

REQUIRED
Calculate the current ratio after this transaction had been recorded in the accounting
records. The calculation should be correct to two decimal places.

Suggest two possible problems the partners may encounter if the working capital is
inadequate.

Suggest two ways in which the partners could increase the working capital.
Inter-firm comparison

For accounting information to be useful

I.
Information must be
II.
capable of being independently verified
III.
free from bias
IV.
free from significant errors
V.
prepared with suitable caution being applied to any judgements and estimates
which are necessary
Problems of inter-firm comparison

Difference in accounting policies.


Non-monetary aspects such as goodwill are not included in financial
statements

It is not always possible to obtain information about another firm.

Information about another business maybe for one period hence making it difficult
to do trends analysis.

The financials years at different periods.

Accounts are prepared using historic cost and do show the effects of inflation.

All businesses are not same in all sense.

One business may not be of the same size like the other.

Location of the business may not be at the same place.

They might have started at different dates.

Factors considered when comparing performance of different business


Should compare with a business in the same trade

Should compare with a business of approximately the same size/same capital

Should compare with a business of the same type (sole trader)

The financial statements may be for one year which will not show trends

The financial statements may be for one year which is not a typical year

The financial year may end on different dates (when inventories are
high/low)

The businesses may operate different accounting policies

The statements do not show non-monetary fasctors

It may not be possible to obtain all the information needed to makeComparisons.
Limitations of financial statements
Time factor

Accounting statements are a record of the past not guide of the future.

There is a gap between the end of a trading period and the preparation of financial
statements. In that time significant events may occur such as changes in inventory.

Historic cost

The only way to record transactions is to use historic cost i.e. the actual cost price, hence
comparing transactions occurring at different times can be difficult because of the effect
of inflation.

Accounting policies

Difference in accounting policies being used by businesses makes it difficult to compare

firms. Similarly if a business changes its policy it becomes difficult to compare results with
previous years.

Different definitions

Comparison of results becomes easy if like is being compared with like difference in
some items being adjusted on the profit makes it difficult to compare the profit
figure.

Non-financial aspects

Accounts only record financial information all the other aspect which cannot be expressed in
financial term are shown in financial statements. This means that there are so many
important factors which influence the performance of a business which will not appear in
financial statements e.g. skills of management goodwill of the business government policies
and impact of new technology

Interested parties

The users of financial statements include present and potential investors, employees,
lenders, suppliers and other trade creditors, customers, governments and their agencies and
the public. They use financial statements in order to satisfy some of their different needs
for information. These needs include the following:

Investors


The providers of risk capital and their advisers are concerned with the risk
inherent in, and return provided by, their investments.

They need information to help them determine whether they should buy, hold or
sell.
 
Shareholders are also interested in information which enables them to assess the
ability of the entity to pay dividends.
Employees


Employees and their representative groups are interested in information about the
stability and profitability of their employers.

They are also interested in information which enables them to assess the ability of the
entity to provide remuneration, retirement benefits and employment opportunities.
Lenders


Lenders are interested in information that enables them to determine whether
their loans, and the interest attaching to them, will be paid when due.
Suppliers and other trade creditors


Suppliers and other creditors are interested in information that enables them to
determine whether amounts owing to them will be paid when due.

Trade creditors are likely to be interested in an entity over a shorter period than
lenders unless they are dependent upon the continuation of the entity as a major
customer.
Customers


Customers have an interest in information about the continuance of an entity,
especially when they have a long-term involvement with, or are dependent on, the
entity.
Governments and their agencies


Governments and their agencies are interested in the allocation of resources
and, therefore, the activities of entities.

They also require information in order to regulate the activities of entities, determine
taxation policies and as the basis for national income and similar statistics.
Public


Entities affect members of the public in a variety of ways. For example, entities may
make a substantial contribution to the local economy in many ways including the
number of people they employ and their patronage of local suppliers.

Financial statements may assist the public by providing information about the
trends and recent developments in the prosperity of the entity and the range of
its activities.
The Objective of Financial Statements


The objective of financial statements is to provide information about the financial
position, performance and changes in financial position of an entity that is useful to a
wide range of users in making economic decisions.
 Financial statements also show the results of the stewardship of management, or the
accountability of management for the resources entrusted to it. Those users who
wish to assess the stewardship or accountability of management do so in order that
they may make economic decisions; these decisions may include, for example,
whether to hold or sell their investment in the entity or whether to reappoint or
replace the management.
Question 1
Amjad wishes to compare his financial statements with those of another furniture wholesaler.

He has been told that financial statements have limitations and will not reveal everything
about the other business.

REQUIRED
Explain why Amjad should consider the following when he is looking at the financial
statements of the other business.

(i) Historical cost

(ii) Non-financial aspects