XII Textbook 2023

ACCOUNTANCY
Class XII
Department of School Education

Ministry of Education and Skills Development
Thimphu
Published by:
Department of School Education (DSE)
Ministry of Education and Skills Development (MoESD)
Thimphu
BHUTAN
Telephone: +975-2-332885/322880
Toll free: 1850
Website: www.education.gov.bt
Provisional Edition 2019

Copyright © 2023 DSE, MoESD, Thimphu.
All rights reserved. No part of this book may be reproduced in any form with-
out the permission from MoESD, Thimphu.
Reprint 2023
Copy Editor:
Kinley Wangchuk, Lecturer, GCBS, Gedu
Language Editing:
Gangaram Bhattarai, Lecturer, CLCS, Taktse
Layout Design:
Tashi Zangpo, CD, REC, Paro
Book Cover Design:

Surjey Lepcha, CD, REC
ISBN 978-99936-0-464-8
ii
ACKNOWLEDGEMENT
Advisors:
1. Kinga Dakpa, Director, REC, Paro
2. Wangpo Tenzin, Curriculum Specialist, REC, Paro
3. Dr. Sonam Choiden (Subject Committee Chair), President, GCBS, Gedu.
4. Kinley Namgyal, Unit Head, TVET and Commercial Division, REC
Research and Writing:

1. Kinley Wangchuk, Lecturer, Gadu College of Business Studies, Gedu
2. Karma Jamtsho, Deputy Collector, Department of Revenue & Customs,
Thimphu
3. Tashi Zangpo, Curriculum Developer, REC, Paro
4. Dawa Tshering, Teacher, Gongzim Ugyen Dorji Higher Secondary School,
Haa
5. Sonam Zangpo, Teacher, Phuntsholing Higher Secondary School, Chukha
6. Dhurba Kr.Giri, Teacher, Yangchenphug Higher Secondary School,
Thimphu
7. Pema Yoezor, Teacher, Gedu Higher Secondary School, Chukha
8. Jigme Nidup, Teacher, Damphu Central School, Tsirang
9. Tsheten Yangden, Teacher, Dechencholing Higher Secondary School,
Thimphu
Review and Refinement:
1. Sapna Subba, Subject Coordinator, BCSEA
2. Kench Dem, Subject Coordinator, BCSEA
3. Tashi Zangpo, CD, REC
4. Tshering Wangchuk, Teacher, Gelephu HSS, Gelephu
5. Jigme Tshering, Teacher, Monggar HSS, Monggar
6. Jigme Nidup, Teacher, Damphu HSS, Tsirang
7. Pema Yoezer, Teacher, Gedu HSS, Chukha
8. Kumar Pradhan, Teacher, Ugyen Academy, Punakha
9. Karna Bahadur Ghalley, Teacher, Punakha HSS, Punakha
10. Tashi Penjor, Teacher, Sarpang HSS, Sarpang
iii
FOREWORD
Accounting plays a vital role in organizational management. It accumulates

both monetary and non- monetary costs and its economic implication in the
process of proving a provision of physical goods and services to the customers,
and reports this information to the investors, managers and other wider
stakeholders group. In the modern economy, accounting information adds to
the organizational competitive edge through accounting analytics and supply
of financial information to the management and investors. Besides, accounting
provides an increasing opportunity of employment for our students in the fast
developing economy. At the individual level, accounting can help develop a sense
of accountability, ethics and organizational leadership skills.
It is critical that the Accountancy education taught in the school system aligns
with what is practised in the real work place. Following the international suit,
Bhutan adopted a set of international accounting standards called IFRS in 2013
(though these standards adopted in Bhutan are currently named as BASs), and
required our business entities to prepare financial statements following these
standards. Our school curriculum must therefore incorporate such changes to
ensure the provision of right knowledge and skills to the learners for their career
choice.
“Given the current scenario of globalization and liberalization, establishment
of businesses in various emerging economies, cross border movements of capital
and capital markets getting integrated, the use of financial statements of an entity
are no longer limited to single country and hence it is of paramount importance
that the accounting principles for reporting financial information to be consistent
with other countries”.
Accounting and Auditing Standards Board of Bhutan
The subject which was based on the curriculum materials designed by the foreign
authors and publishers was taught since its introduction into the Bhutanese
education system. Such a practice posed challenges to the Bhutanese learners
as most of the content were irrelevant, outdated and was contextualised to
foreign setting and needs. This hampered the learners in acquiring the required
knowledge and skills.
iv
With the rapid development and expansion of Bhutanese economy, and
its participation in the global financial transaction, the need to develop an
Accountancy curriculum that encompasses Bhutan’s ideologies, principles,
and philosophies in line with international standards was strongly felt. Of late,
Bhutan has witnessed several Foreign Direct Investment (FDI) projects and
establishment of joint venture undertakings with foreign companies, which also
requires the financial reporting standards in line with the International Financial
Reporting Standards. Thus, it is important that the Bhutanese education system
accommodates such changes to ensure that our learners learn accountancy in
keeping with the current realities.
The new textbook has been developed in close consultation with the relevant
stakeholders ensuring right content and learning activities that provide the
necessary knowledge and skills for our learners. Further, the revised content
of the textbook is aligned with BAS, which ensure the practical knowledge and
skills that are required to get employed in business industries.
The Royal Education Council anticipates that the revised accountancy curriculum
delivers cutting edge accountancy education and prepare accountancy learners
to join the world of works and contribute to achieving the Bhutan’s goal of Gross
National Happiness.
Kinga Dakpa
Director
v
Contents
Foreword---------------------------------------------------------------------------- vi
UNIT ONE: FINANCIAL ACCOUNTING
CHAPTER 1: Accounting for Taxation---------------------------------------- 1
CHAPTER 2: Accounting for Payroll ----------------------------------------47
CHAPTER 3: Accounting for Investment Property------------------------59
CHAPTER 4: Accounting for Intangible Assets and Government Grants --75
CHAPTER 5: Liability, Provisions and Contingencies--------------------99
CHAPTER 6: Accounting for Equity Shares and Debt Finance------- 115
CHAPTER 7: Accounting for Partnership Firm-------------------------- 149
CHAPTER 8: Financial Statements of a Limited Company----------- 169
CHAPTER 9: Analysis and Interpretations of Financial Statements-221
UNIT TWO: COST ACCOUNTING

CHAPTER 10: Stores Ledger------------------------------------------------- 243
UNIT THREE: MANAGEMENT ACCOUNTING

CHAPTER 11: Budgeting Process and Variance Analysis-------------- 277
CHAPTER 12: Application of Spreadsheet in Accounting ----------- 300
Assessment------------------------------------------------------------------------ 312
Chapter 1: Accounting for Taxation
Chapter 1
Accounting for Taxation
Learning Objectives:
• Explain the importance of taxation in business.
• Discuss the statutory responsibilities of managers for tax accounting in
business.
• Differentiate between accounting profit and taxable profit, and illustrate
how these differences arise.
• Explain the concept of current tax expense and tax liabilities including
under or over provision of taxes.
• Explain the concept of deferred tax and make related accounting entries.
• Report tax components in the financial statements of the reporting entity.
• Understand the meaning and scope of BIT in Bhutan.
• Identify the source documents for BIT.
• Classify and explain items under allowable deductions under the Income
Tax Act.
• Identify deductions not permissible under the Income Tax Act.
• Compute Business Income Tax (BIT).
Taxation is one of the important components of financial decisions of business.

The management of the
business entity has a statutory
responsibility to maintain proper
records of tax effects of business
transactions and deposit the tax
money on a timely basis to the
government account. Equally, the
management can do tax planning
for its financial transactions to
optimize tax benefits. Income tax
has a significant effect on the net
profit of the business. Earlier in
class XI you have studied the general principles and regulations of taxation. In this
chapter you will be studying the basics of accounting for taxation and reporting tax
components in the financial statements.
Page: 1 Reprint 2023

Accountancy for Class XII
1.1 Accounting for Sales Tax Collected from Customers

The sales tax amount collected from customers is a liability owed to the government.
Sales tax is levied on both cash sales as well as credit sales. For example, if a unit of
goods is sold at Nu. 70,000 and a sales tax of 10% is levied, this will have created a
tax liability of Nu. 7,000. Therefore, a total cash of Nu. 77,000 will be paid by the
customer.
Cash A/c Dr. 77,000
To Sales income 70,000
To Sales tax-RRCO 7,000
Credit sales are similarly subject to sales tax.

Trade receivables A/c Dr. 77,000
To Sales income 70,000
To Sales tax-RRCO 7,000
The fixation of sales tax rates, and the range of commodities and services under the
Sales Tax Schedule is updated and notified by the Government. Sales tax is collected
at the point of sale or at the time of import. Where the sales tax is levied at the point
of sale, tax liability is calculated on the sales price. The Sales Tax collected at the
point of sale of goods and services is deposited with the Department of Revenue
and Customs. In VAT taxation system, sales tax collected from customers is known
as output VAT.
1.2 Accounting for Sales Taxes on Purchases and Expenses

In the VAT taxation system, the tax paid by the business entity on purchases and
expenses is called input VAT. The registered business entity can recover his input
VAT as an offset from the output VAT. For example, if the business entity purchases
a unit of goods at Nu. 60,000, the supplier would have invoiced the business entity
for Nu. 66,000 (10% sales tax).
Purchases A/c Dr 60,000
Sales tax-RRCO A/c Dr 6,000
To Trade payables 66,000
Sales tax is an indirect tax, that is, the incidence of the tax is eventually borne
by the final consumer of goods and services. Countries like UK, Philippines, the
Netherlands and many EU countries have adopted VAT (value added tax), while
some countries like India, Singapore and Australia, have adopted GST (goods
and service tax). In countries where GST form of taxation is used, GST subsumes
various indirect taxes existed in the earlier regime such as exercise duty, sales tax
and VAT. With the adoption of GST in India in 2017, the largest trading partner

of Bhutan, it has become a priority for Bhutan to implement a similar goods and
service tax. It has been proposed that Bhutan will implement a broad based GST
by July 2020. GST and VAT taxation system require effective input tax credit,
refund management and administrative mechanisms as preconditions for effective
implementation of the GST taxation system. The proposed GST in Bhutan will take
the form of value added tax (VAT) system with input tax crediting and a mandatory
registration based on turnover of business entities.
If the output VAT is more than the input VAT, the difference is payable to the
government. If the input VAT is more than the output VAT, the difference is recovered
from the VAT office.
In the above example, the business entity collected output VAT of Nu. 7,000, and has
paid Nu. 6,000 input VAT. The difference of Nu. 1,000 is payable to the government
if remaining unpaid at the year end. This will be reported as current liability in the
statement of financial position.
1.3 Accounting for Current Tax

The business entity is required to pay tax on the profit made in the accounting period
unless the entity is exempted from tax payment. For example, the entity under
tax holiday may be exempted from paying tax to the government for certain time
period as stipulated by tax regulations. However, as discussed in the next section,
the accounting income and the taxable income are different. Accounting income is
calculated on the basis of accrual method of accounting while the taxable income is
calculated on the basis of tax regulations of the country. The tax regulations generally
provide a taxation rate to enable business entities to estimate their tax expense and
tax liabilities at the time of closing the books of accounts. This does not mean that
business entity will pay that amount as tax expense for the year. For example, if the
reported profit before tax is Nu. 100,000, and 30 percent of tax is charged, Nu. 30,000
is not the amount that business entity will pay to the government. This amount is
an estimate of the tax expense for the current year. The actual taxable income and
the amount of tax payable to the government will be assessed by tax authorities for
the year. The estimated tax on the current year’s profit is treated as an expense in the
income statement and current liability in the statement of financial position.
Tax expense A/c Dr 30,000
To current tax liability 30,000
It is possible that the tax estimated by the entity is different from what tax authorities
assess at the time of tax filing. If the tax estimate is lower than the assessed tax, it
results into under provision of tax. Consider the previous example of tax estimate
of Nu.30, 000 calculated on the reported profit of Nu. 100,000. What if the tax
authorities assess tax amount as Nu. 45,000. This will result into creation of additional

tax expense or a tax liabilities by Nu. 15,000 which must be recognized in the books
of accounts and present in the financial statements. The additional tax expense of
Nu. 15,000 is to make up the under provision.
Tax expense A/c Dr 15,000
Therefore, the current year’s income statement will not only recognize tax expense
on this year’s profit, but also any under-provision of tax of the previous year.
1.4 Difference between Accounting Income and Taxable Income

There is a concept called accounting income and taxable income. The accounting
income is the difference between total income earned and the total expenses
incurred during the accounting period of the entity. This is also called the net profit.
Accounting income is derived from the accrual method of accounting. The taxable
income, on the other hand, is the income calculated by tax authorities by adjusting
all tax admissible deductions of the income tax regulations on the accounting profit.
The tax regulations provide a lists of income and expense items which are recognized
as taxable income and tax deductions. Take an example of an accrued interest. From
the accounting perspective, accrued interest is an income that will increase the total
income of the entity. However, from the taxation point of view, accrued interest
will be accounted only in the next accounting year when the interest is actually
received. Therefore, there is a difference between accounting income and a taxable
income. Let’s consider an operating profit before tax of Nu. 600,000 which includes
accrued interest of Nu. 100,000. Tax authorities will not recognize accrued interest
of Nu. 100,000 as income for assessment of taxable income for the current year even
though the same amount has been treated as an income in the statement of income.
Thus, because of the difference in the treatment of the accrued income, the taxable
income is different from the accounting income.
Let’s take another example. Depreciation features quite well in the income statement
and for that reason tax authorities take interest in depreciation when they assess
the taxable income. Since deprecation is an estimate, different entities may adopt
a varying methods of deprecation that would affect the profit of the business and
the tax payments. Especially when the depreciation rate and the method used is
unreasonable, tax authorities insist on having the same depreciation rate for all
business entities in the country. This was the case in Bhutan prior to adoption of
new accounting standards in 2013.
Tax legislation allows depreciation on property, plant and equipment as deduction
subject to the maximum rates prescribed by the income tax act. The items of
property, plant and equipment as per the tax purpose are not depreciated in the year

of disposal that is in contradiction to the accounting approach.

Let’s consider few examples of income and expense items which are treated in
different ways in accounting and tax rules.
a. Bad debts
In accounting, bad debts are treated as expense and reduce profit for the year. However,
tax regulations generally allow only up to Nu. 25,000 per debtor for deduction.
b. Inventory obsolescence
In accounting, management must assess the obsolescence of inventory or slow
moving inventory and write it off to reduce profit for the year, whereas, tax
regulations do not allow such deduction unless the inventory obsolescence was
caused by unavoidable circumstances.
c. Penalties and fines
Penalties and fines are treated as administrative expenses in accounting that
will reduce net profit of the entity. However, tax regulations do not allow such
expenses as deductions for tax calculation.
d. Fully depreciated assets
Tax regulations require the fully depreciated items of property, plant and
equipment (say computer equipment) which is still in use to be recorded at Nu.
1 in asset register for asset identification. However, in accounting, management
of the entity may review the useful life of the asset and reinstate to the cost
and accumulated depreciation of the asset, if the cost and date of acquisition
of the asset is known. If it is impracticable to identify the cost and the date of
acquisition of the asset, an entity will revalue the asset and consider such value
as deemed value of the asset.
e. Research and development
Tax regulations allow 2 percent of the assessed turnover of research and
development cost for deductions. The treatment of research and development
cost is different in accounting. Generally, all research costs are expensed and
deducted from the income statement.
1.5 Accounting for Deferred Tax

The new accounting standards require business entities to recognize not only
current tax expense and under-provision of tax of the previous year, but also the
deferred tax. The deferred tax allows reporting entity to account the implication
of tax on its taxable temporary difference. In the following section, you will learn
the concept of deferred tax and method of accounting for such deferred tax in the
books of accounts. Also, note the way how deferred tax is presented in the financial
statements.

As the term denotes, deferred tax is the tax, the payment of which is deferred or
delayed until future accounting period for the income earned in the current year.
Let’s consider the same example of the accrued interest income. For accounting
purpose, we recognize the accrued income in the current year but for tax purpose
we recognise that as the income in future when the amount is received. Assuming
that an entity reports a profit of Nu. 600,000 which includes Nu. 100,000 accrued
interest income in 2019, the tax regulation will not charge tax for Nu. 100,000
accrued interest income in 2019. The tax on this income will be levied only in the
next accounting period when the amount is received. Therefore, this has created a
taxable temporary difference of income. The accounting standards require the entity
to recognize tax on this taxable temporary difference in the income statement of
the current year and as a deferred tax liability in the statement of financial position.
In this example the taxable temporary difference of income is Nu. 100,000. This
difference in taxable income is temporary because entity will pay tax on this income
in the next accounting period. Assuming 30 percent tax rate, we have the following
tax expenses recognized in the books of accounts in 2019.
Tax expense A/c Dr. 150,000
Tax expense A/c Dr. 30,000
To Deferred tax liability 30,000
Statement of comprehensive income for the year ended 2019

Particulars Amount
Operating profit 500,000
Interest income 100,000
Profit before tax 600,000
Current tax (150,000)
Deferred tax (30,000) (180,000)
Profit after tax 420,000

As presented above, income tax expense for the year consists of current tax expense
and deferred tax on the taxable income temporary difference. The entity will have
many such taxable temporary differences of income arising during the course
of its business. For all such taxable temporary difference, the entity will need to
recognize tax expense and deferred tax liability as discussed above. This syllabus
does not require student to know all sorts of transactions that give rise to deferred
tax consequences.

Current tax
Tax expense
Deferred tax
Statement of Comprehensive Income

for the year ended on 31st December2017 Amount in Nu.
Note
Particulars 2017 2016
No.
Income
Electricity revenue 11,953,372,682.94 12,602,988,785.09
Interest Earned 120,889,001.79 159,258,446.38
Other Incomes 202,983,418.74 120,695,148.21
12,277,245,103.47 12,882,942,379.68
Expenditure
Wheeling charges 742,351,161.01 617,472,078.88
Insurance 113,043,211.21 114,271,454.59
Running and maintenance expenses 18 443,656,365.04 309,814,013.87
Employees’ remuneration and benefits 19 847,624,681.20 812,915,270.97
Finance cost 20 345,415,270.69 477,493,972.42
Depreciation/amortization 2 2,267,598,498.36 2,307,281,458.81
Other expenses 21 293,101,904.60 292,084,940.18
5,052,791,092.11 4,931,333,189.72
Operating profit 7,224,454,011.36 7,951,609,189.96
Profit before tax 7,224,454,011.36 7,951,609,189.96
Tax expense 22
Current tax 2,137,363,491.72 2,360,252,582.32
Deferred tax (105,565,278.49) 37,383,238.27
Tax expense split into
Income Tax for earlier years 105,685,844.33
current and deferred tax
2,137,484,057.56 2,397,635,820.60
reported as separate line
Profit for the year 5,086,969,953.80 5,553,973,369.36
items in SoCI
DGPC Annual Report 2017

Statement of Financial Position

as at 31st December2017 Amount in Nu.
Note
No.
Assets
Non- current assets
Property, plant & equipment 1 42,312,400,734.10 43,425,707,386.04
Intangible assets 1 20,915,544.36 38,861,419.66
Investment property 2 32,000,000.00 32,000,000.00
Deferred tax asset 3 30,527,276.28 -
Investments in subsidiaries and joint 4 5,207,928,305.22 4,296,883,410.86
ventures
Current Liabilities
Trade and other payables 9d 510,221,940.06 446,932,070.72
Other financial liabilities 9e 2,521,260,976.05 2,413,112,292.10
Other current liabilities 12 43,925,248.83 44,118,103.23
Current tax liabilities 13 1,631,996,344.29 1,977,911,908.06
Employee benefit obligation 14 57,678,142.52 62,828,423.18
Total current liabilities 4,765,082,651.75 4,944,902,797.29
Total liabilities 8,776,271,520.43 10,889,086,685.20
Total shareholders’ equity & liabilities 54,943,374,255.60 55,300,320,684.35
Note referred to above form an integral part of the Accounts
This is the Statement of Financial Position referred to in our Current tax liability reported
report of even date in terms of our report of even date attached
as separate line item in SoFP

Statement of Cash Flows

for the year ended 31st December 2017 Amount in Nu.
Cash flows from operating activities
Profit before taxation 7,224,454,011.36 7,951,609,189.96
Adjustment for:
Depreciation / amortization 2,267,598,498.36 2,307,281,458.81
Foreign exchange loss (127,013,702.07) 40,281,973.83
Loss/(gain) on sale of property plant & equipment (1,851,728.90) 13,542,115.87
Investment income (120,889,001.79) (159,258,446.38)
Dividend income - (44,723,250.00)
Interest expenses 345,415,270.69 477,493,972.42
(Increase)/decrease in trade receivables and other 231,138,856.41 (532,283,029.54)
receivables
(Increase)/decrease in inventories 4,596,451.15 (10,570,333.02)

(Increase)/decrease in prepayments and advances 90,475,182.43 (31,726,769.49)
(Increase)/decrease in assets classified as held for (294,185.37) (299,312.25)
sale
Increase/(decrease) in trade and other payables 63,289,869.34 (55,578,384.30)
Increase/(decrease) in other current liabilities (192,854.40) 1,710,265.91
Increase/(decrease) in employee benefit obligation 62,419,143.87 66,016,851.65
(Increase)/Decrease in Other asset (152,941.14) (148,099.86)
Cash generated from Operation 10,038,992,869.94 10,023,348,203.61
Income tax paid (2,627,327,762.52) (2,000,335,456.99)
Net cash from operating activities 7,411,665,107.41 8,023,012,746.62
Cash flows from investing activities
Purchase of PPE & intangibles assets (1,134,494,242.22) (959,004,001.01)
Sale of PPE & intangible asset (84,730.01) 164,803,842.13
Payment for investments in subsidiaries and joint (911,044,894.36) (380,000,000.00)
ventures
Proceeds from held-to-maturity investments (12,771,974.07) 274,852,167.13
Interest received Tax paid reported as separate line 153,572,383.31 174,884,674.12
Dividend received item in statement of cash flows - 44,723,250.00
Net cash used in investing activities (1,904,823,457.36) (679,740,067.63)

Illustration 1
MKB Enterprise develops software for accounting and other business functions.
The software development process includes research, design, programming and
testing of software before implementation of the software. MKB Enterprise receives
overwhelming contracts from various customers. MKB Enterprise reports operating
profit of Nu. 1.5 million in 2019. A total cost of Nu. 150,000 was incurred on research
in 2019 which was treated as capital cost of the software design.
In 2020, MKB management adopted new accounting standards which require to
expense all market research costs. As a consequence, the accountant of MKB needs
to restate its profit figure. All business entities pay 30 percent tax on yearly profit.
Required:
a. Rewrite the statement of income of MKB Enterprise to report profit or loss as
per the requirement of the new accounting standards for 2020.
b. Ascertain the tax expense before and after the adoption of new accounting
standards.
c. Show tax components in the statement of financial statements.
Solution:
Statement of income for the year ended 2020 (before adoption of new accounting
standards)
Amount
Profit before tax 1,500,000
Tax (30%) (450,000)
Profit after tax 1,050,000
Statement of income for the year ended 2020 (after adoption of new accounting
standards)
Amount
Research expense (150,000)
Tax (30%) (405,000)
Statement of financial position as at 31 December 2020

Amount
Current liability
Tax liabilities 405,000

Illustration 2
A company presents the following ledger balance on 31 October 2019.
Amount
Sales tax payable to Department of Revenue and Customs 33,550
Bank overdraft 150,000
Trade receivables 845,500
Following transactions took place in November and December 2019
Sales of Nu. 100,000 were made on credit.
Office equipment of Nu. 45,000 was bought and paid by cheque.
Materials purchased on credit for Nu. 70,000.
Materials costing 10,000 were returned to the supplier and refund received by
cheque.
Nu. 3,500 administrative expense was paid by cheque.
Suppliers are paid Nu. 80,000 by cheque.
A refund of Nu. 25,000 was received by cheque from tax office.
Customers paid balance outstanding by cheque and were allowed Nu. 50,000
discount
Sales tax is 20% in all cases.
Required:
a. Prepare sales tax account for December 2019 showing the closing balance.
b. Calculate bank balance at 31 December 2019.
Solution
Sales tax account
Particulars Amount Particulars Amount
Purchases 14,000 Balance b/d 33,550
Expenses 700 Sales 20,000
Office equipment 9,000 Purchase returns 2,000
Balance c/d 56,850 Bank 25,000
80,550 80,550
Bank account
Purchase returns 12,000 Balance b/d 150,000
Tax refund 25,000 Office equipment 54,000
Trade receivables 795,500 Admin expense 4,200
Trade payables 80,000
Balance c/d 544,300
832,500 832,500


Practical Problem 1
You are given the following invoice. Study this invoice and answer the questions that
follow:
XXP Spare Shop Invoice No: 102856
Lambert Street Date: 15/10/2019
Phone:91
ZIP:
Kolkata Bills payable on or before 60 days from the date of invoice
Bill to:
Karma Tshongkhang
Phuntsholing
Jorden Lam
PB: 203
05234567
Particulars Quantity Price Total
Bumper 50 15,000 750,000

Bonnet 10 9,000 90,000
Cowl screen 15 3,000 45,000
Tax 8 % (GST)
a. Pass the entries in Karma Tshongkhang’s books showing the details of tax
component.
b. Prepare general ledger of Karma Tshongkhang.
Practical Problem 2
You are given the following trial balance of a business entity. Extract statement of
income from the given trial balance and assess tax expense of the entity for the
year 2019. The tax authorities in the month of March 2020 assessed the tax amount
of Nu. 267,880. Make the necessary adjustment for under or over provision of tax
expense for the year. All business entities are subject to 30% tax on profit. Make
entries in the books for tax expenses.


Trial Balance
Particulars Debit Credit
Sales 1,930,000
Inventory -31-12-2019 340,000
Purchases-inventory 600,000
Wages 378,000
Other direct costs 200,000
Admin cost 200,000
Interest on borrowing 130,000
Freight -inward 10,230
Advertisement 7,120
Property, plant and equipment 765,320
Accu. Depreciation-ppe 130,000
Investment 700,000
Cash 300,000
Bank 423,000
Capital 2,000,000
4,683,670 4,683,670

1.6 Business Income Tax (BIT)

1.1.1 Meaning and Scope of Business Income Tax
In class XI, we discussed about how taxation system in Bhutan evolved over the
period of time. The first major tax reform of 1989 replaced 2% turnover tax by
Business Income Tax (BIT) on the net profit.
BIT is a non-corporate business tax. It is levied @ 30% on net profit. BIT is payable by
all unincorporated business entities holding a trade license or registration certificate
issued by the Ministry of Economic Affairs (MoEA) or any other competent authority.
Development and competitive nature of business has provided better scope for
business as well as tax consultants. For business, it is important to claim expenses
under the correct alternative in order to maximize claims as well as to avoid any
penalties for non-compliance with law. For any claims, business should have an idea
of what deductions are allowed or not as per the Act. However, claims may remain
invalid if not supported by valid documents. This will be further discussed in detail.
1.1.2 Source Documents for BIT
All business units shall maintain proper accounting records. The specific book of
accounts to be maintained by a taxpayer depends on the category of unit to which
the taxpayer belongs. The categorisation of business is as follow:
a) Large and medium business units
All large and medium business units regardless of their size must maintain the
following books of accounts and associated records:
i) Trial Balance
ii) Manufacturing & Trading Accounts
iii) Income Statements
iv) Statement of Financial Position
v) General/Nominal Ledger
vi) Cash Book, Bank Statements and Bank Reconciliation Statements
vii) Sales Ledger, Registers and Supporting bills, Cash Memos and Receipts
viii) Purchase Ledger, Registers and Supporting Bills, Receipts and Vouchers
ix) Journal Book
x) Non-Current Asset Register
xi) Inventory Register

b) Small, Cottage/Micro Business Units

Small businesses must maintain basic accounting records to ensure that all
transactions are recorded. Therefore, for these businesses, records such as cash
book, a daily list of sales summarised monthly & annually, cash memos, and
purchase invoice may be maintained. However, where these records are not
available, annual tax assessment shall be done on an estimated basis as per the
General Provisions of the Income Tax Act.
c) Information from Third Parties
All public and private entities and individuals upon written request by a
Regional Director or the Head of the Department shall furnish any relevant
information on a taxpayer. The request for information shall be made when
a Regional Revenue and Customs Office (RRCO) requires the information to
determine tax liability of a taxpayer.
1.1.3 Allowable deductions as per Income Tax Act of Kingdom of
Bhutan, 2001 (4th Edition)
Deductions shall be allowed for tax purposes if proper books of accounts are
maintained as per the General Provisions of the Act. In order to qualify as an
allowable deduction, an expense must be incurred solely and exclusively for the
purpose of the business and transactions done on an arm’s length basis1. All expenses
must be supported by objective evidences such as purchase invoices, money receipts
or other legally valid documents. Where only part of an expense has been incurred
for the purpose of business or company, then only that part of the expenses shall be
allowed as a deduction in the calculation of taxable profit. Any expenses charged in
excess of the limits prescribed under these Rules shall be added back to Net Profit
and subject to tax.
Allowable deductions are grouped into the following broad categories:

a) Direct Costs
All direct costs incurred solely for the purpose of the business and associated with
its operation are allowable deductions. Direct costs are those costs, which can be
directly attributed to the generation of income. e.g. raw materials purchased by
manufacturing industries.
b) Employment expenses
Employment expenses means salary, wages, labour permit fees and allowances paid
in money or money’s worth to an employee in relation to his or her employment
and includes pay and any benefits provided free of cost or at a concessional rate by
1 Arms length’s basis mean transactions at the prevailing market conditions and where there is no
conflict of interest.
an employer. The treatment of employment expenses for tax purpose can be treated
as follows:
c) Salary
Salary means pay, allowances and includes benefits provided free of cost or at a
concessional rate to an employee who is employed full time in the business. Salary
shall be allowed as deductible expense only up to the maximum ceiling prescribed
in the Table 15.1and on fulfilment of the following conditions:
i) all information and documentary evidence are available regarding the
payment of salary.
ii) the employee is a regular employee of the business,
iii) the employee is actually working with the business, and
iv) the employee is actually located at the appropriate place of work.
Table 1.1 Employee Salary ceiling for BIT purposes

Category BIT (per month)
Large 50,000
Medium 40,000
Small 30,000
Cottage/Micro 20,000
Note:
• The above limits may be raised for technical experts and highly professional
employees with the prior approval of the Ministry.
• The categorisation of companies and businesses shall be as per categorisation
given in Annexure I.
Illustration 3
During the income year 2019, Gyemsap, a trading firm with an investment of Nu.
1.5 million made a turnover of Nu. 6.1 million. The proprietor claims a salary
expense of Nu. 45,000 per month. As per the Income Tax regulations, how much
salary expense is admissible?
Solution: According to Annexure I (ITA), the categorization of firm for tax purpose
is done under two categories i.e. Investment and Turnover Range.
Gyemsap’s firm falls under both categories. According to investment range, it falls
under small scale while according to turnover it falls under medium scale business.

However, salary expense allowable is higher in medium scale bracket (i.e. Nu.
40,000) compared to Nu. 30,000, in case of small scale business.
d) Wages
Wages means payments made to an individual who is not a regular employee of an
organization.
e) Benefits
Benefits means benefits provided by an employer to its employee such as education
facilities, accommodation, domestic services, holiday trips, tiffin allowances,
telephone facilities, medical benefits. Benefits shall be treated as tax-deductible
expenses provided that it is clubbed under salary and is within the prescribed limits.
Such benefits shall be valued at the actual cost incurred by the employer, or as agreed
in the Service Manual of the organisation or in accordance with the employment
contract. If actual costs incurred apply to more than one employee, the total cost
shall be allocated on a pro rata basis.
Benefits provided free of cost or at a concessional rate to an employee should be
valued as follows:
i) Accommodation
Accommodation provided free or at a concessional rate by an employer to its
employee is a deductible expense if it is within the salary limit prescribed in Rule
No.12.3.2.(a). Valuation of accommodation shall be;
• The actual cost incurred by the employer in providing the accommodation, or
30% of the employee’s basic salary if the cost cannot be determined.
• The actual concessional rate provided to the employee, or 30% of the
employee’s salary less the rent being charged by the employer if the cost cannot
be determined.
ii) Domestic Service
• Domestic services provided by an employer to its employee is a deductible
expense if it is within the prescribed salary limit. The valuation of domestic
services provided free of cost should be done on the actual cost incurred by
the employer in providing the service.
iii) Gas, Electricity and Water Supplies
• Gas, electricity and water supplies provided free or at a concessional rate to an
employee is a deductible expense. The valuation of such benefits shall be the
actual cost incurred by the employer in providing such benefits. Where the
cost cannot be determined, 2% of the employee’s basic salary shall be taken as
the cost of the benefits.

iv) Conveyance or Transport Facility

• Conveyance or transport facility provided free or at a concessional rate to
an employee is a deductible expense. Valuation of such benefits shall be the
actual cost incurred by the employer in providing such benefits. However, bus
services provided for daily transport of staff to work place shall not form part
of the salary
v) Telephone facilities
• Telephone facilities provided to an employee is a deductible expense. The

value of such benefit shall be the actual cost incurred by the employers in
providing the facilities to the employee.
• However, where such benefits cannot be segregated between private and
business use, 50% of the total expense shall be treated as benefits for PIT
purposes.
f) Bonus
The term ‘bonus’ include all incentives or productivity related payments made to an
employee. Bonuses paid shall be allowed as a deduction subject to fulfilment of the
following conditions:
i) the amount is reasonable with regard to the employee’s pay and conditions
of service,
ii) the amount is consistent with the practice in other similar enterprises, and
iii) the total bonus payable is limited to 10% of the assessed net profit or 3
months’ basic pay per employee, whichever is lower.
However, in the case of an unincorporated business, bonus paid to a business
proprietor, partner, or their immediate family (father, mother, spouse or children)
shall not be allowed as deduction for tax purposes.
Illustration 4
Zeko Enterprise earned an annual profit of Nu. 1 million during the income year
2018. The enterprise declared a bonus of Nu. 250,000 in the same year, out of
which Nu. 100,000 were paid to Dawa, the Manager, and the balance to the other
employees. Dawa is the son of Zeko, owner of the enterprise. How would you treat
this case as an Assessor?

Monthly salary schedule of Zeko Enterprise:

Sl. No. Name Designation Salary (Nu.)
1 Dawa Dorji Manager 15,000
2 Karma Jamtsho Finance Controller 15,000
3 Sonam T Dema Administrator 8,000
4 Bom Bdr. Rai Sales Executives 7,000
5 Chungku Front Desk Officer 5,000
Assuming the Self Assessed Net Profit is Nu.1 Million, Under ITA Rule 2.3.4 bonuses
paid shall be allowed as deduction subject to fulfilling following conditions :
a. The amount is reasonable with regard to the employee’s pay and conditions of
service,
b. The amount is consistent with the practice in other similar enterprises; and,
c. The total bonus payable is limited to 10% of the assessed net profit or 3 months
basic pay per employee, whichever is lower.
Solution
The Rule states that, in the case of an unincorporated business, bonus paid to a
business proprietor, partner, or their immediate family (father, mother, spouse or
children) shall not be allowed as deduction for tax purposes. Since Dawa is the son
of proprietor, bonus paid to him will not qualify for deduction
Bonus claimed: Nu.250, 000
(A) Bonus disallowed due to regulation (Dawa is the son of proprietor) = Nu. 100, 000
Bonus allowable as per booking = Nu.150, 000
Self declared Net Profit = Nu.1, 000, 000
Add: Bonus claimed = Nu. 250, 000
Assessed Net Profit = Nu. 1, 250, 000
10% of Assessed Net profit= Nu.125, 000
Now, calculate 3 months basic pay of other four employees:
45,000+24,000+21,000+15,000= Nu. 105,000
As per the above rule (c), the total bonus payable is limited to 10% of the assessed
net profit or 3 months basic pay per employee, whichever is lower. Therefore, bonus
allowable is 3 month’s basic pay (Nu.105,000) for remaining employees:
Bonus allowable as per booking Nu.150, 000
3 months basic pay of four employees = Nu.105, 000
(B) Bonus disallowed due to the difference = Nu.45, 000
Total bonuses to be disallowed:
(A) Bonus disallowed due to regulation Nu.100, 000
(B) Bonus disallowed due to the difference Nu.45, 000
Total Bonus disallowed Nu.145, 000

Therefore, Total amount of Nu.145, 000 will NOT be allowed as deduction and have
to be added back to Net Profit to compute Taxable Income.
Illustration 5
Lobneykha Construction Company has declared net loss of Nu. 50,000 during the
Income year 2018. The business declared one-month’s basic pay as the bonus to
all its employees, which amounted to Nu. 150,000. The above loss is derived after
deducting the bonus. Compute the taxable net profit and tax amount.
Solution:
Self Assessed Net Loss during the year Nu.(50,000)
Add: Bonus paid to employees Nu.150,000
Assessed Net Profit Nu. 100,000
Less: Bonus allowed @ 10% of Assessed Net Profit Nu. 10,000
Taxable Net Profit Nu. 90,000
BIT @ 30% (30%*90,000) Nu. 27,000
g) Contribution to Provident Fund and Gratuity Fund

Contributions made by an employer to the Provident Fund & Gratuity Fund for the
benefit of the employees are allowable deductions subject to the following conditions:
i) such contributions are invested with a financial institution in a separate
account as PF and GF Account, and
ii) the limits to be applied to this expenditure must be consistent with the
Service Manual of the company or business. If no such Service Manual
exists, then the Civil Service Rules shall apply.
In cases where the eventual pay out to the employee upon his or her retirement
is less than the guaranteed amount in the Service Manual, any additional amount
contributed thereof by the employer to make up the guaranteed amount shall be
allowed as deduction. Contributions not payable due to termination of services shall
be added back to the Net profit and subject to tax.
h) Staff Welfare Expenses
Staff welfare expenses means provision of canteen and recreational facilities to
employees within the business premises and shall be allowed on an actual basis.
i) Medical Expenses
Actual cost of treatment of an employee outside Bhutan shall be allowed as tax
deductible expense subject to the following conditions:
i) the expenses are in respect to an employee only, and
ii) medical treatment shall be as per the National Guideline for Patient
Referral issued by the Government from time to time.
j) Human Resource Development Expenses

Expenses incurred for Human Resource Development of employees shall be allowed
as deductible expense provided such expenses are incurred for the purpose of
upgrading and developing the employees’ craft, supervisory and technical skills or
increasing the productivity or quality of its products. If such expenses exceed 1% of
the assessed turnover, then the full expenditure must be spread equally over a period
of three years starting from the year the expense is incurred.
1.1.4 Overhead expenses
Overhead expenses include the following heads subject to fulfilment of certain
conditions:
a) Preliminary Expenses
Preliminary expenses mean all legitimate expenses incurred prior to the
commencement of a business or in connection with the extension of an existing
business. Such expenses incurred may be spread equally and allowed as deduction
over the first 3 years of operation. Examples of these expenses include feasibility
studies, market surveys, engineering services, project reports, and legal fees.
b) Research & Development
Research and development is defined as “use of scientific or technical know- how” to
produce new or substantially improved materials, mechanisms, products, processes,
systems or services. Research and development shall be allowed as deduction subject
to the following conditions:
i) Research and development cost not exceeding 2% of the assessed turnover will
be allowed as a deductible expense;
ii) Research and development cost exceeding 2% of the assessed turnover will be
treated as capital expenditure. The full amount of the cost will be capitalised
and depreciated in three subsequent years immediately following the income
year.
iii) Any cost of buying machinery, inventory, stock in trade and immovable
property acquired for the use of research and development shall be depreciated
in accordance with the ordinary rules of depreciation.
c) General Office Expenditure
The following items of general expenditure incurred for the purpose of the business
shall be treated as allowable deductions:
i. Printing & stationery. iv. Trunk call & telex charges.
ii. Postage & telegram expenses. v. User charges.
iii. Telephone. vi. Administrative fees and charges.
vii. Any other expenses of similar nature.

d) Insurance Premium
Insurance premium paid for any assets owned by an enterprise is an allowable
deduction, provided that the asset is owned / registered and used for the purpose of
the business. Insurance premium paid for employees to protect against occupational
risks and hazards at their work place shall be allowed as deduction.
e) Maintenance & Repair Costs
Maintenance & repair costs refer to current repairs of buildings and other assets owned
and used for the purpose of the business. The asset must be shown in the Statement
of Financial Position and included in the taxpayer’s Non-Current Asset register.
Current repair costs refer to any cost incurred to maintain the asset in a consistent
working condition, without changing the nature of the asset. Only current repair
costs shall be treated as revenue expenditure.
Major repair/enhancement work that modifies or significantly improves the asset,
such that the original nature of the asset is altered, must be treated as capital
expenditure and depreciated accordingly.
Where a taxpayer purchases an asset, but that asset requires additional
expenditure to bring it to a useable condition, such additional
expenditure must be capitalised as part of the cost of the asset.
Where a worn out asset is replaced with a new asset, the cost of the new asset must
be capitalised. Where an asset is upgraded, i.e. its nature is fundamentally altered,
then associated cost must be capitalised.
f) Hire of Plant, Machinery & Vehicles
The hire cost of plant, machinery and vehicles plus any associated costs referred to
in the lease agreement shall be treated as an allowable deduction, provided that the
expenditure is incurred for the purpose of business and the services are availed from
another tax entity.
g) Rent of Land & Buildings
Rental of property used for business purposes along with associated costs referred
to in the lease agreement shall be treated as an allowable deduction provided that
the expenditure is incurred for the purpose of business and the services are availed
from another tax entity.
h) Municipal and Motor Vehicle Tax
Municipal and motor vehicle tax shall be allowed as tax deductions provided that the asset is
owned and used for the purpose of business. However, motor vehicles tax paid by licensed/
registered transport companies/businesses shall be adjusted against their final tax liability.

i) License Registration & Renewal Fees

License registration and renewal fees are allowable deductions. However, this
provision only applies to fees related to licenses issued and renewed by authorised
agencies. All other fees that are sometimes referred to as ‘license fees’ including
auction rights such as liquor license fees, mining rights are not covered under this
provision and not allowed as deductions.
j) Legal & Professional Fees/Expenses
All fees and expenses related to legal and professional work carried out on behalf of
an enterprise for the purpose of business are allowed as deductions.
k) Annual Membership Fees & Subscriptions
Any membership fees paid or subscriptions made to any organisation or association
relevant to the business shall be allowed as deductions.
l) Interest on Loans
Interest on loans shall be allowed as deductions subject to the conditions and
procedures prescribed below:
i) Loans are taken from a recognised financial institution and within the
maximum limit of debt equity ratio of 3:1, i.e. the total borrowings for
tax purposes shall not exceed thrice the owner’s equity of the business.
Borrowings include all types of capital loans (e.g. bonds, term loans etc.),
plus any working capital borrowings (e.g. bank overdrafts). Capital includes
owners’ investment (BIT taxpayers), plus any retained profit reserves.
ii) For the purpose of debt equity ratio calculation, the average debt and equity
over a period of twelve months shall be considered.
iii) The loan must be taken in the name of the companies/business and for the
purpose of the said business.
iv) Interest paid prior to the commissioning of a project (or commencement of
a business) shall be capitalised, and depreciated as part of the asset.
Illustration 6
Pala, Kala and Bala formed a business under the name M/S Phuensumtshog. The
business borrowed loan from Bhutan Development Bank Limited in the name of
Drowa, wife of Mr. Pala amounting Nu. 300,000 @ 9% p.a. The Income Statement
of M/S Phuensumtshog disclosed a net profit of Nu. 120,000 after interest on such
loan. Does this interest expense qualify as deductible expenses for tax purpose?
Justify with reasons. What would be the actual taxable profit?

Solution:
Rule 2.4.12 of the Income Tax Act states about financial expenses, interest on loans
shall be allowed as deductions provided the loan must be taken in the name of the
companies/business and for the purpose of the said business.
Since M/S Phuensumtshog took loan not in the name of the business, but in the
name of spouse of one of the co-owners of the business irrespective of whether it
fulfills other condition i.e. loan from recognized financial institution and within the
limit of debt equity ratio of 3 : 1. Therefore, interest on loan borrowed will not be
allowed as expenses but added back to self-assessed net profit of Nu. 120,000.
Self Assessed Taxable Net Profit Nu.120,000
Add: Interest on loan (inadmissible) Nu. 27,000
(9%*300,000)
Taxable Net Profit Nu.147,000
Illustration 7
As of 31st December 2017, Tshering Enterprise has an average capital balance of Nu.
100,000, Reserves and Surplus Nu. 20,000. Proprietor withdrew Nu. 15,000 in the
same year. On the same date the average loan balance is Nu. 350,000. Interest paid
during the year is Nu. 10,000. Will the interest of Nu. 10,000 permissible for tax
deduction as per the Income Tax Rule? If not, compute the actual allowable interest
expenses.
Solution:
Application of Rule 2.4.12 of ITA condition (a)
Loans are taken from a recognised financial institution and within the maximum
limit of debt equity ratio of 3:1, i.e. the total borrowings for tax purposes shall not
exceed thrice the paid up capital of the company; borrowings include all types of
capital loans (e.g. bonds, term loans etc.), plus any working capital borrowings (e.g.
bank overdrafts). Capital includes paid up share capital (CIT taxpayers) or owners’
investment (BIT taxpayers), plus any retained profit reserves.
Loan amount Nu.350,000
Capital (Owner’s Equity)
Average Capital as on 31st December, 2017 Nu. 100,000
Reserves and Surplus Nu. 20,000
Drawings of proprietor Nu. (15,000)
Net Equity/Capital Nu. 105,000
105,000 * 3 = Nu. 315,000
Excess loan over Debt Equity ratio of 3:1 (350,000-315,000) = 35,000
Hence, interest on loan admissible under the rule will be calculated proportionately,
10, 000
350, 000 # 35, 000 = 1000

Therefore, allowable loan interest = Nu.9, 000 (Nu.10, 000 – Nu.1, 000)
1.1.5 Sales and marketing expenses
Sales and marketing expenses means expenses incurred for promotion of sales and
include expenses such as commission, entertainment, publicity, advertisement etc.
The following are some of the sales and marketing expenses:
a) Commission
Commission paid on purchase transactions is an allowable deduction as it forms
part of the purchase payment for goods or services. However, such commissions
must be clearly stated in the documentation relating to the purchase.
Commission paid to a sales agent is an allowable deduction provided that the
commission is clearly stated in all relevant bills, invoices and cash memos, or a
special agreement in writing must exist between the parties and is properly recorded
in the books of accounts.
b) Entertainment
Entertainment expenses refer to hospitality and gifts provided to existing or potential
clients or customers, agents or suppliers. Entertainment expenses directly related to
sales promotion of the business shall be allowed as deductions on actual expenses or
2% of the assessed Net Profit, whichever is lower.
Illustration 8
Lepta Enterprise has deducted Nu.5,000 as entertainment expenses in their income
statement of the year 2019. After this deduction, the self-assessed net profit of
Nu.10,000 in the same year were declared. Compute BIT of the year.
Solution:
According to Rule 2.5.2 of ITA states entertainment expenses directly related to
sales promotion of the business shall be allowed as deductions on actual expenses or
2% of the assessed Net Profit, whichever is lower.
2% * self-assessed net profit = 2%*15,000 = 300
Since 2% of assessed net profit is lower than actual expense incurred, only Nu.300
will be allowed as deduction for tax purpose.
Self Assessed Net Profit Nu. 10,000
Add: Actual Entertainment expenses Nu. 5,000
Adjusted Taxable net profit Nu. 15,000
Less: Admissible entertainment expenses Nu. 300
Final adjusted taxable net profit Nu.14,700
BIT @ 30% PAYABLE (30%*14,700) Nu.4,410

c) Publicity & Advertisement

Publicity expenses such as printing of brochures and advertisement through media
and magazines shall be allowed as deductions on an actual basis or 2% of the assessed
Gross Profit, whichever is lower.
Illustration 9
Seltob Poultry farm in Thimphu has income of Nu.200,000, gross profit of Nu.180,000
and net profit of Nu.160,000 during the income year 2018. The firm spent Nu.7,000
on publicity and advertisement. Do you think the self- assessed taxable income is
correctly computed? If no, re-compute the taxable net profit as per Income Tax Rules.
Solution:
Under Rule 2.5.3 of ITA, Publicity expenses such as printing of brochures and
advertisement through media and magazines shall be allowed as deductions on an
actual basis or 2% of the assessed Gross Profit, whichever is lower.
Allowable publicity expenses 2%*180,000 Nu. 3,600
Self Assessed Net Profit Nu. 160,000
Add: Publicity expenses in excess of 2% Nu. 3,400
Adjusted Final Taxable Net Profit Nu. 163,400
1.1.6 Irrecoverable Debts

Irrecoverable debts shall be allowed as deductions subject to the fulfillment of the
following conditions:
a) Irrecoverable debts up to Nu. 25,000 per Debt
A irrecoverable debt of Nu. 25,000 or less per debtor shall be allowed as deduction
on the fulfilment of the following conditions:
i) Tax has been paid on such debts in a previous year;
ii) The debt is not less than 5 years old; and
iii) Irrecoverable debt shall be incorporated as income if recovered in the
subsequent years; or
iv) Where the debtor is declared bankrupt under the Bankruptcy Act of the
Kingdom of Bhutan; or
v) Scheme of arrangement is made under the supervision of a judge.
In the case of financial institutions, irrecoverable debts below Nu.100,000 per debtor
may be written off if the conditions above are met.
b) Irrecoverable debts exceeding Nu. 25,000 per Accounts receivable
Irrecoverable debts exceeding Nu. 25,000 per debtor shall be allowed as deductions

on the fulfilment of the following conditions:

i) Tax has been paid on such debts in the relevant previous year;
ii) Judicial recourse has been exhausted in respect of the debt;
iii) Irrecoverable debt shall be incorporated as income if recovered in the
subsequent years; or
iv) Where the debtor is declared bankrupt under the Bankruptcy Act of the
Kingdom of Bhutan, or
v) Scheme of arrangement is made under the supervision of a Judge.
1.1.7 Miscellaneous/general expenses

The following items constitute miscellaneous/general expenses for tax purpose.
a) Accidental Loss
Accidental loss means loss due to events such as theft, fire, earthquake, flood and
road accidents. Documentary evidences such as police report and Court order must
support accidental losses, if applicable. Accidental losses for the purpose of taxation
shall be treated as follows:
i) Revenue losses shall be allowed as deductions and revenue receipts/
compensation as taxable income.
ii) Capital losses shall be treated as per Income Tax Act Rule.
b) Stock Obsolescence
Stock obsolescence shall not be allowed as deductions unless the obsolescence is
due to unforeseen circumstances and the taxpayer was not in a position to avoid it.
Conditions to be fulfilled for the above exceptions are:
i) Maintenance of a proper stock inventory register and
ii) Proper records showing disposal and sale of the obsolete stock.
c) Stock Shortages
Stock shortages due to unavoidable circumstances within an industry average
shall be allowed as deduction subject to maintenance of proper books of account.
Shortages due to negligence shall not be allowed as deductions for tax purposes.
d) Bhutan Sales Tax (BST)/Customs Duty
BST or Customs Duty paid on assets shall be capitalised and depreciated as per
depreciation rule for tax purpose.
However, BST collected on sale of domestic goods and services such as BST on hotels,
restaurant, beer, cement and entertainment services shall not be allowed as deductions.

e) Carriage & Freight Charges

Carriage and freight expenses incurred for business purposes shall be allowed as
deductions. However, such charges incurred for initial transportation of Non-
Current Assets to its place of use shall be capitalised and depreciated accordingly.
f) Donations
Donations made to organisations exempted by the Ministry shall be allowed as
deductions subject to the condition that such donation is supported by relevant
documents. Further donations for purposes such as;
i) A Relief Fund for natural calamities in Bhutan.
ii) For the preservation and promotion of Religion and Culture in Bhutan.
iii) For the promotion of Sports, Educational and Scientific activities in Bhutan.
Donations made in respect of the above shall be allowed as deductions, subject to
the condition that such purposes have the approval of the Government/Ministry
and is supported by the relevant documents.
Note: However, the total donation under point 1 and 2 of this section shall be allowed
as tax deductible expenditure up to a maximum
limit of 5% of the assessed Net Profit.
Illustration 10
Himalayan Enterprise in Tsirang recorded expenses on donation for following
purposes:
i) Donated a water dispenser to Damphu L.S.S. worth Nu. 12,000
ii) Paid Nu. 10,000 to Dzongkhag Sports Association.
iii) Paid for annual rimdro approved by the Dzongkhag in a community, Nu. 1,000
The self-assessed net profit of the firm during income year 2018 at the time of filing
income tax return was Nu.200,000 after claiming the above deductions. Explain
whether the deduction with respect to donations is justified. Compute the adjusted
taxable net profit.

Solution:
Rule 2.7.6 of the ITA states Donations made to organisations exempted by
the Ministry shall be allowed as deductions and donations for purposes such as
Relief Fund for natural calamities in Bhutan, for the preservation and promotion
of religion and Culture in Bhutan, for the promotion of Sports, Educational and
Scientific activities in Bhutan. However the total donation should not exceed 5% of
the assessed Net Profit.
Self Assessed Net Profit Nu.200, 000
Add: Donation claimed Nu.23, 000
Assessed Net Profit Nu.223, 000
5% of Assessed Net Profit Nu.11, 150
Total donation claimed Nu.23, 000

Disallow due to regulation (donation to rimdro) Nu.1, 000
Donation allowable as per booking Nu.22, 000
Working Note:
Donation allowable as per booking Nu. 22, 000
Maximum Limit allowable 5% of Assessed Net profit Nu.11, 150
Donation disallowed due to difference Nu. 10, 850
Total donations to be disallowed:

Donation disallowed due to regulation (donation to rimdro) Nu.1, 000
Donation disallowed due to the difference Nu.10, 850
Total donation disallowed Nu.11, 850
Therefore, Taxable Net profit shall be as shown below:
Self Assessed Net Profit Nu.200, 000
Add: Donation disallowed Nu.11, 850
Taxable Net Profit Nu.211, 850

Illustration 11
Dago Enterprise, registered with initial investment of Nu.5 million is a distributor
of soft drinks. The net turnover of the firm for the Income Year 2017 is 2 million.
The net profit as revealed by its Income Statement is Nu. 800,000. While Desk
Assessment was carried out, the assessing officer discovered following irregularities:
i) Stock shortages due to negligence of the store keeper worth Nu.5,000 was
booked.
ii) Entertainment expenses included refreshments served to its employees
worth Nu.10,000.
iii) Manager of the firm is provided accommodation near the business premises.
However, the cost of accommodation could not be determined. Manager’s
basic salary is Nu. 10,000 p.m. The firm has not claimed the deduction for
accommodation.
Compute the taxable net profit and the tax payable by Dago Enterprise according to
the Income Tax Act Rules.
Solution:
i) Stock shortage due to negligence is not be allowable
ii) Entertainment expenses for serving refreshment to employees is not
allowable
iii) Cost of accommodation to Manager is allowable under Rule 2.3.3 (a)
Self Assessed Net Profit Nu.800,000
Add: Inadmissible expenses:
Entertainment expenses Nu.10,000
Stock shortage Nu.5,000
Adjusted Taxable Net Profit Nu. 815,000
1.1.8 Non-Current Assets and depreciation
Non-Current Assets are assets that are intended for use within the enterprise on
a continuous basis for more than one accounting period. The Rules regarding
depreciation of Non-Current Assets are as follows:
i) Depreciation on assets purchased and owned by the taxpayer and used for
the purpose of the business except antiques, works of art and land, will be
allowed as deduction subject to the maximum depreciation rates prescribed
in Annexure II.
ii) For unincorporated businesses where an asset is owned by the taxpayer and

it is used in the business, depreciation expenses shall be allowed only for

the portion of the asset used in the business. e.g. Mr. Hodo owns a 5 storied
building (ground+ four floors) which he converts into a Hotel. The hotel
covers four floors and the ground floor is used to let out as shop space.
For the purpose of taxation, depreciation expense shall be allowed only for
the four floors of the building being used as a hotel. The income from the
ground floor from shop space will not form a part of his Business Income,
but would be his personal income accountable under PIT.
iii) Depreciation shall be calculated on the Straight Line Method (SLM) on an
asset at the end of the year.
iv) Assets purchased during the year shall be depreciated on a pro rata basis
from the date of purchase.
v) Assets disposed off during the year shall not be depreciated in the year
of disposal and the difference between the sale proceeds and the written
down value at the beginning of the year shall be declared in the statement
of income.
vi) Small assets costing up to Nu. 25,000 in total per taxpayer in each income
year may be written off. e.g. calculator, blow/rod heater, fans etc.
vii) Maintenance of an asset register for all types of assets is mandatory, and
must include details of each individual Non-Current Asset owned by the
business or company.
viii) Fully depreciated assets that are still in use must be recorded in the asset
register at a value of Nu.1 for identification purposes.
The depreciation rates given in Annexure II are the maximum limits allowed. Where
a taxpayer applies a lower depreciation rate than that prescribed in Annexure II, the
taxpayer will be permitted to make a clear adjustment on the tax return. However,
if this adjustment is not made, the tax officer will not be responsible for increasing
the depreciation claim on the taxpayer’s behalf, and should accept the lower amount
charged in the accounts.
Where business premises are closed for a considerable period or more than 180 days
in one income year, no depreciation of assets will be allowed during that time. In
order to claim depreciation, the following conditions must be fulfilled:
i) The asset must be purchased and registered in the name of the business or
company.

ii) The asset must be intended exclusively for use of the business or company.
iii) Proper books of account must be maintained, including a complete Non-
Current Asset register containing details of each individual asset for which
depreciation is claimed.
iv) Where the asset is only partially used by the business, then only an
appropriate portion of the depreciation can be charged for tax purposes.
Illustration 12
The accounting profit of Everest Tours & Travels owned by Mr. Kumar for the Income
Year 2019 disclosed Nu.5 million. The business owns three vehicles, the ownership
and cost of which are as follow:
i) Hiace bus registered in the name of above business – Nu.1 million.
ii) Car registered in the name of Kumar’s spouse – Nu.0.5 million.
iii) Van in the name of above business – Nu. 0.5 million.
The date of acquisition of bus and van was on 1 January, 2019 while car was purchased
on 1st July, 2019. Compute the amount of depreciation as per the income tax rule for
the Income Year 2019.
Solution:
According to Rule 4.1 of ITA depreciation on assets purchased and owned by the
taxpayer and used for business purpose will be allowed as deduction, subject to the
maximum depreciation rates prescribed in Depreciation Annexure calculated on
the Straight Line Method (SLM) on an asset at the end of the year. Assets purchased
during the year shall be depreciated on a pro rata basis from the date of purchase.
Depreciation on car registered in Kumar’s spouse will not qualify for deduction.
So depreciation on only bus and van will be allowed as deduction.
Hence, Total depreciation subject to calculation @15% on Straight Line method is:
Depreciation on Hiace Bus (15%* 10,00,000) Nu.150,000
Depreciation on Van (15%* 500,000) Nu. 75,000
Total Depreciation admissible Nu.225,000
1.1.9 Deductions not allowable under the Income Tax Act, 2001
The following expenses shall not be allowed as deductions:
a. Domestic and private expenses on food, clothing, marriage etc;
b. Personal administrative fees of employees. Example: fees paid for processing
employees’ identity card, citizenship card etc.
c. Payments of dividend or profit distributions to shareholders, partners and
proprietors before tax;

d. Creation of or adjustments to reserves.

e. Creation of allowances for irrecoverable debts/advances except for financial
institutions.
f. Life and/or health insurance premiums except for schemes that have been
approved by the Government.
g. Business, Corporate and Personal Income Tax.
h. Penalties, fines, penal interest, forfeiture, etc.
i. Donations other than those authorised by the Ministry.
j. Irrecoverable debts not fulfilling the conditions under the Act;
k. Any sum, by whatever name called, payable for the use of license or permit
through public auction or tender;
a. Any other expenses not related to the business.
1.1.10 Rates and Calculation of BIT
The rate and calculation of tax shall be as per the Rules prescribed below:
a) Full Tax Liability
Unincorporated business units shall pay Business Income Tax (BIT) at the rate of
30% of the Net profit. Net profit for the purpose of calculating the tax shall be the
Gross income minus the allowable deductions under these Rules.
b) Time Limit for Payments
All businesses shall pay their tax on a self-assessment basis to the RRCO before the
31st of March following the end of the income year (1st January to 31st December).
However, provisional taxes paid by way of tax deducted at source (TDS) and advance
tax shall be paid as per General Provisions Act.
c) Adjustment of Provisional Taxes
Advance tax, taxes paid on a quarterly basis and Taxes deducted at source shall be
adjusted in the following manner:
i) Advance Tax shall be adjusted at the time of filing of tax return against
provisional tax payable provided accounts are submitted.
ii) Taxes paid on a quarterly basis shall be adjusted at the time of filing of tax
return provided revenue receipts are produced.
d) Interest on Outstanding Tax
Any taxes not paid to the RGOB shall result in fines and penalties at the rate of 24%
per annum from the due date.

Annual BIT Return FORM BIT 2
In the format shown below, dd/mm/20yy represents the day/month/year of the end
of the current accounting period; 19yy represents the end of the previous accounting
period (of the same duration); XXXX are current year values; YYYY are prior year
values.
Profit and Loss Account for the year ended dd/mm/yy
Current Current Previous Previous
Particulars Schedule Schedule Year year year year
Nu.000 Nu.000 Nu.000 Nu.000
Total sales 1 xxxx yyyy
TOTAL INCOME xxxx yyyy
Less: Direct expenses 3 xxxx yyyy
GROSS PROFIT xxxx yyyy
Other income 2 xxxx yyyy
Less: Selling Expenses 4 xxxx yyyy
Less: Administrative Expenses 5 xxxx yyyy
Less: Depreciation for year 14 xxxx yyyy
Less: Other financial Expenses 6 xxxx yyyy
xxxx
Less: Interest Paid
yyyy
NET PROFIT FOR THE YEAR (#) xxxx
Add: Inadmissible expenses for tax purposes
Direct 7 xxxx yyyy
Selling 8 xxxx yyyy
Administration 9 xxxx yyyy
Financial Expenses 10 xxxx
yyyy
Appropriations 11 xxxx yyyy
INITIAL SELF ASSESSED PROFIT FOR YEAR(A) xxxx yyyy
Add: Bonus limit@10%=amount disallowed 12 xxxx
yyyy
Ent/Staff welfare limit@2%=amount disallowed 13 xxxx
yyyy
SELF ASSESSED TAXABLE PROFIT xxxx yyyy
Less: tax allowed losses carried forward (xxxx)
(yyyy)
FINAL SELF ASSESSED TAXABLE PROFIT(B) xxxx
SELF DECLARED BIT/BIT@30% of B (*) xxxx yyyy
yyyy
Less: amount already paid
Advance taxes (xxxx)
(yyyy)
BIT withheld at source (xxxx)
(yyyy)
BALANCE BIT PAYABLE XXXX
YYYY
Note : please note that a tax allowed loss could only be carried over for a maximum
of three years and then it becomes invalid. An account showing how much loss and
to which year the loss relates to, needs to be kept.

Practical Problem
Yegyal potato chips has three employees whose basic pay are as follow:
Mr. Tandi, the Manager, Nu. 25,000 p.m.
Mrs. Kencho, an Accountant, Nu. 15,000 p.m.
Miss Om, an Administrative Officer, Nu. 10,000 p.m.
The business has declared a bonus of three month’s basic pay to all employees. The
net profit is Nu. 1.3 million during the Income Year 2017.
• Calculate the allowable bonus expense. Explain your findings.
• Why do you think business provide bonus to its employees?
Illustration 13
Salary Schedule
Sl.No. Employees Designation Basic Pay (Nu) Months Amount (Nu.)
1 Nima Manager 15,000 12 180,000
2 Dawa Adm. Officer 10,000 12 120,000
3 Karma Accountant 7,000 12 84,000
Total Salary 384,000
Depreciation Schedule
Sl.No. Particulars Date of Initial Cost Dep % Dep. Acc. Dep
Acq. Amount
1 Vehicle 1.1.2015 1,500,000 15.00% 225,000
2 Computer 1.7.2015 25,000 15.00% 3,750
3 Furniture 1.1.2015 150,000 15.00% 22,500
4 Laserjet Printer 1.1.2015 8,000 15.00% 1,200
Total Dep 1,683,000 252,450
Bemchen and Sachen took over their parents business named Bright Future Exporter
where they focused mainly on the export of boulders to Bangladesh. They purchased
a ten wheeler dumper truck for Nu. 1.5 million. At the end of the year their business
reported net profit of Nu.361,550.

For the purpose of filing BIT returns, the business furnished the following
information.
Sl .No Particulars Amount
1. Purchases 1,500,000
2. Employment expenses 384,000
3. Repairs 5,000
4. Office expenses 25,000
5. Rent 60,000
6. Depreciation 252,450
7. Interest charges 45,000
8. Miscellaneous expense 30,000
9. Accounts payable 100,000
10. Cash and cash equivalents 270,000
11. Accounts receivable 350,000
12. Property, Plant and Equipment 183,000
13. Capital 1,475,000
14. Sales 2,500,000
Their books of account revealed opening inventories of Nu. 150,000. One of their
parties in Bangaledesh gave false promise and he didn’t clear an amount of Nu. 25,000
which they treated as irrecoverable debts. As part of the social responsibility of their
business they donated Nu. 12,000 for the renovation of a lakhang in their locality. At
the end of the year inventories amounted to Nu. 350,000. You as an account officer
of the business is required to compute the taxable net profit and BIT payable for the
Income Year 2019 for the Bright Future Exporter, considering the details furnished
to you.
Solution :
Particulars Amount
Sales 2,500,000
Direct Expenses:
Purchases 1,500,000
Opening stock 150,000
Closing Stock 350,000
GROSS PROFIT 1,200,000
Other income 0
Less :
Employment expenses 384,000
Irrecoverable debts 25,000

Repairs 5,000
Office expenses 25,000
Rent 60,000
Depreciation 252,450
Donations 12,000
Interest charges 45,000
Miscellaneous expenses 30,000
NET PROFIT FOR THE YEAR 361,550
Add : inadmissible expenses for tax purposes
Depreciation 1,875
Donations 12,000
TAXABLE NET PROFIT 422,425
Less : Donation allowed 12,000
FINAL SELF ASSESSED TAXABLE PROFIT 400,425
BIT PAYABLE@30% 120,127.5
Explanations:
1) Its assumed bad debt was incurred during the Income year 2015. It should
be at least 5 years old.
2) Depreciation of Nu. 1,875 is written back as it is not computed on pro-rata
on computer.
3) It is assumed donation was paid to organization authorized by the
Government. Further the amount does not exceed 5% of the Assessed
Taxable net profit.
Illustration 14
Sonam D choden and Sonam D Paldon are Commerce graduates from Gedu College
of Business Studies. Right after their graduation, they didn’t wait for the government
job, rather they decided to start a business.
They commenced Damcho Shoe Manufacturing Pvt. Ltd in Chukha. Initially they
have invested Nu.111,000 as their capital with property, plant and equipment worth
Nu. 20,000. To start manufacturing, they purchased raw materials for Nu.150,000.
They employed Mr. Daotu, an expert in shoe making who monitors other staff and
paid wages and salaries of Nu. 50,000 out of which Nu.2,000 was paid to one of the
staffs as an advance.

Their monthly rent has amounted to Nu.15,000. Office expense of Nu.12,000 need to
be paid along with outstanding office expenses of Nu. 8,000 which was incurred in
the previous year while they were planning to set up their business which they have
decided to carry forward.
They manufactured 100 pairs of shoes under the brand Abibas, and in order to
attract more customers, they spent Nu. 8,000 on publicity and advertisement.
There was an opening stock of Nu.50,000 which they carried forward from previous
year before they formally started their business. During its operation, they purchased
raw materials from TD enterprise on credit where accounts payable amounted to
Nu.120,000.
They insured their business and paid premium in advance Nu.2,000. There was a
religious program conducted in the locality where the business donated Nu. 10,000.
The owners of the business withdrew Nu. 15,000 each p.a for their personal use. The
sales amounted to Nu. 311,000. Their books of account s showed account receivable
of Nu.183,780. The depreciation on property, plant and equipment due to continuous
use amounted to be Nu.3,000. The business also received an interest of Nu. 4,000.
The unfortunate part for the business was, there appeared irrecoverable debts of
Nu.11,000 and at the end they determined that closing stock was Nu. 60,000. The
good news for the business was, though the owners struggled a lot but they were
rewarded with a net profit of Nu.62,000. There are some additional information
pertaining to the business as follow:
1. Tax has been paid on above mentioned debts in the previous income year.
2. Internal arrangement scheme was made with the debtors, however, debtor
failed to pay.
3. Out of the donations, Nu.5,000 was paid towards VAST Bhutan.
You are required to compute the taxable net profit according the rules laid down
under Income Tax Act, Kingdom of Bhutan. Also calculate the amount of income
tax payable under BIT after considering the above transactions.

Solution:
Particulars Amount (Nu.)
Sales 311,000
Direct Expenses:
Purchase 150,000
Opening Stock 50,000
Closing Stock 60,000
GROSS PROFIT 171,000
Indirect Income 4,000
Wages and Salaries 50,000
Rent 15,000
Publicity and Advertisement 8,000
Donations 10,000
Office expenses 20,000
Depreciation 3,000
Less: Advance to staff -2,000
Less: Prepaid insurance -2,000
NET PROFIT 62,000
Add: Inadmissible expenses for the purpose of tax
Bad debts (note 1) 11,000
Donations (note 2) 5,000
Publicity and Advertisement (note 3) 4,580
FINAL SELF ASSESSED TAXABLE PROFIT 82,580
BIT @30% 24,774
Less: BIT withheld at source (TDS) 6,220
BALANCE BIT PAYABLE 18,554
Explanation:
1. Irrecoverable debts is a disallowed loss as it does not fulfill all the conditions
listed under Rule 2.6.1 of ITA
2. Donation of Nu.5, 000 is allowable expense as it was paid to an organization
listed in the Exempted List of organizations issued by Ministry of Finance.
3. Only 2% of the Publicity expense is deductible, the balance is written back to
profit as it is taxable.

Exercises:
1. Explain the difference between current tax expense and deferred tax expense.
Assess the merit of deferred tax treatment in the books of accounts.
2. Identify one item or event that will give rise to taxable temporary difference.
Discuss how that taxable temporary difference will be treated in the accounts
and reported in the financial statements.
3. Pema wants to start a new business in vegetable oil extraction with the financial
aid of priority sector lending. He is planning to buy property, plant and
equipment including a delivery van. His friend Dorji who has some accounting
knowledge advises him to use straight line method of depreciation (SLM) for
tax benefits for all items of property, plant and equipment accounting. He
also insist Pema to use depreciation rate given in the income tax regulations.
Assess whether this makes sense in terms of accounting.
4. A business entity chose to use LIFO method of inventory valuation although

LIFO method is not allowed by the accounting rules. Discuss why the entity is
still using LIFO method instead of FIFO and Weighted Average Cost method
(student should have the knowledge of inventory valuation to complete this
exercise).
5. Following is the financial statements for the Income Year 2017 of Kalo
Enterprise, a small manufacturing unit.
Income Statement for the year ending 31st December, 2017
Particulars Notes Amount (Nu.)
Revenue 1 2,269,000
Total Revenue 2,309,000
Cost of goods Sold 2 -1,086,000
Gross Profit 1,223,000
Add: Other Income 9 5000
Administrative Costs 3 -705,000
Other Expenses 4 -23,000
Profit before Tax (PBIT) 500,000
Interest Cost -

Profit Before Tax (PBT) 500,000

-
Profit for the year (Net Income) 500,000
Statement of Changes in Financial Position

As at 31st December, 2017
Particulars Notes Amount (Nu.)
Assets
Non- Current Assets
Property, Plant and Equipment 5 1,343,000
Current Assets 6 412,000
Cash and Cash Equivalents 7 665,000
Total Assets 2,420,000
Equity and Liabilities
Owner’s Equity 1,500,000
Retained Earnings 500,000
Non- Current Liabilities
Current Liabilities 8 420,000
Total Liabilities 2,420,000
Note No. 1 Revenue 2,318,000

Less: Returns sales or inward (9,000) 2,309,000
Total 2,309,000
Note No. 2 Cost of Goods Sold
Opening Inventories 250,000
Purchases 800,000
Less: Closing Inventories (100,000)
Direct Expenses
Wages 126,000
Carriage and duties 10,000
COGS 1,086,000

Note No. 3 Administrative Costs

Salaries 408,000
Electricity 12,000
Telephone and fax 4,000
Advertisement and Publicity 18,000
Maintenance and Repairs 26,000
Depreciation 237,000
Adm. Cost 705,000
Note No. 4 Other Expenses
Insurance Premium 13,000
Total 23,000
Note No. 5 Property, Plant and Equipment
Computer 80,000
Machinery 1,500,000
Less accumulated depreciation -237,000
Total 1,343,000
Note No. 6 Current Assets
Prepaid Insurance 2,000
Advance Tax 10,000
Trade Receivables 300,000
Closing Inventories 100,000
Total 412,000
Note No. 7 Cash and Cash equivalents
Cash Balance 125,000
Bank Balance 540,000
Total 665,000
Note No. 8 Current Liabilities
Trade payable 400,000
Outstanding Wages 6,000
Outstanding Salaries 14,000
Total 420,000
Note No. 9 Other Income
Commission received 5,000

Statement of changes in Equity

Particulars Share capital Retained Owner’s Equity
Earning
Opening Balance
Owner’s Equity 1,500,000 1,500,000
Profit for the year 500,000 500,000
Dividends
Closing Balance 1,500,000 500,000 2,000,000
Salary Schedule of the unit

Sl.No. Employee Name Designation Monthly Pay Annual Salary
1 Menchu Bum Manager 15,000 180,000
2 Dhombo Executive 9,000 108,000
3 Sila Maya Accountant 7,000 84,000
4 Sakshe Peon 3,000 36,000
Total 408,000
Depreciation Schedule
Sl.No. Particulars of PPE Dep. Value (Op.) Dep. Rate Dep. Amount
1 Machinery 1,500,000 15% 225,000
2 Computer 80,000 15% 12,000
Additional information:
1. Depreciable value of PPE excludes an old machinery sold for Nu.25000 on
30.8.2017 whose WDV on the same date was Nu.20,000. Profit was not disclosed
in income statement.
2. Irrecoverable debts were of not older than two years.
Assess the financial statements of the firm for BIT purpose and then compute the
Taxable Net Income and the BIT payable by the business. Give explanation where
necessary to support your computation. Take into consideration all details furnished
to you.
[Ans: Taxable Net Income (Profit) Nu.580,500]

1.1.11 Annexure
ANNEXURE I CATEGORIZATION
SECTOR CATEGORY INVESTMENT RANGE TURNOVER RANGE
Large More than Nu. 5 million More than Nu.10 million
Medium Between Nu.3 - 5 million Between Nu.6 - 10 million
Trading
Small Between Nu.1 - 3 million Between Nu.2- 6 million
Micro Less than 1 million Less than 2 million
Large More than Nu.100 million
Medium Between Nu. 10 - 100 million
Manufacturing
Small Between Nu. 1 - 10 million
Cottage Less than Nu. 1 million
Large More than Nu.10 million More than Nu.20 million
Between Nu.10 - 20
Medium Between Nu. 5 - 10 million
Service million
Small Between Nu.1- 5 million Between Nu.2 - 10 million
Micro Less than 1 million Less than 2 million
Note:
i) All companies and businesses shall be categorized based on fulfillment of
either one of the criteria.
ii) Investment means owners contributions/ paid up share capital plus long
term loans.
iii) However, the construction sector will be categorized in accordance with the
classification made by the Construction Development Board.

ANNEXURE II DEPRECIATION SCHEDULE

Block Sl.No Asset type Maximum Rates
I INFRASTRUCTURAL FACILTIES
1 Building - Permanent - all types
2 Bridges – Permanent
3 Compound walls and Fencing 3%
4 Roads – Permanent
5 Tube Wells and Deep wells and Water Pipe lines
1 Semi Permanent 20%
2 Temporary 50-100%
II ELECTRICITY GENERATION AND TRANSMISSION
1 Devices for controlling transmission loss
2 Generator (Hydro)
3 Power House Equipments
4 Poles & Pillars 5%
5 Sub Station Equipment
6 Transmission Lines - HT & LT
7 Underground Cables
III EQUIPMENT
1 Audio/Visual Equipments
2 Computer/Data Processing System
3 Deep Freezers/Refrigerators (hotels &General Use)
4 Fire Fighting Equipments/System
5 Lighting Arresters
6 Laboratory Equipments
7 LPG Cylinders
8 Office Equipments - all types
9 Photographic/Reprographic Equipments 15%
10 Pollution Control Equipments
11 Telephone including PABX system
12 Tools and Implements
13 Trekking Equipments
14 Vacuum Cleaner
15 Water Cooler and Water Purifier
16 Weighing Machines
17 Washing Machines

IV FURNITURE, FIXTURES & UTENSILS
1 Ceramic and Glass Utensils
2 Carpets of all types
3 Curtains & Heavy Drapes
4 Domestic Electrical Appliances and Fixtures 15%
5 Furniture of all Kinds
6 Mattresses. Pillows and Blankets
7 Silver, Steel, and Metallic Cookeries
PLANT & MACHINERY (Including spare parts and
V accessories)
1 Boilers
2 Cinema Projectors and Screen
3 Cranes, Chain and Pulley
4 Deep Freezers & Refrigerators (Industrial Purposes)
5 Earth Moving Machinery including Bulldozers,
6 Scrapers, Excavators, Wheel Loaders, etc 15%
7 Fork Lifts
8 Industrial Gas Cylinders
9 Lifts
10 Mining Equipments and Machineries
11 Petrol Pump Installation and Tanks
12 Printing Machineries
13 Rope Way Installation
14 Road Rollers
15 Railing & Locomotives’ Storage Tanks
16 Wood Cutting / Processing Machines
VI VEHICLES, VESSELS & AIRCRAFTS
1 Aircraft including Helicopter
2 Buses & Vans
3 Cycles & Rickshaws
15%
4 Light Motor Vehicles including two or three Wheelers
5 Trucks & Trailers
6 Vessels - Ships, Boats, Rafts, etc
Small assets costing up to Nu. 25000 in total per taxpayer per
VII Write off
income year

Chapter 2: Accounting for Payroll
Chapter 2
Accounting for Payroll
• Explain the concept of payroll
• Explain the concept of gross pay, deductions (including TDS, Pension and
GIS) and take home pay
• Differentiate between salaries and wages
• Prepare pay-sheet
• Record payroll expenses including recoveries.
• Report employee costs on financial statements
Employee remuneration and benefits form another significant costs in the

organisation. A proper accounting of this cost is important not only for management
but also for external information users as it includes various components of
remunerations paid to the company senior executives. Lack of proper accounting

and reporting will not only mislead the information users but also can demotivate
employees as remunerations serve as the basic motivation factor for employees.
The corporate scandals of the past also indicate that employee remuneration and
payroll can be easily manipulated and forged by the staff and managers. A typical
case of Satyam Company in India (2008) highlights this issue in corporate world.
This chapter highlights the importance of accounting for payroll and deals with
some practical skills of recording and reporting employee costs in the financial
statements of an entity.
2.1 Employee Remunerations and Benefits

Employees are paid different packages of remunerations to attract and motivate them
to perform in the organisation. Employee remunerations are broadly classified into
two:
i) Nonperformance based (fixed) remuneration, and
ii) Performance based remuneration.
Nonperformance based remunerations are paid as the basic remunerations to
support employees irrespective of their performance. This includes basic salary,
pension, house rent allowance, health insurance etc. which do not change with the
change in the performance of the entity. On the other hand, performance based
remunerations such as bonus and share options paid to employees are tied up with
performance targets to be achieved by the individual employees or the entity as a
whole.
Employee remunerations also includes post-employment benefits such as gratuity,
pension and provident funds paid to employees after their retirement. Thus,
employee remunerations can be either short term remunerations such as salaries
and wages or long term benefits such as gratuity and pension
2.2 Accounting for Employee Remunerations and Benefits

Accounting and financial reporting for employee remunerations and benefits
depend on whether it is short term or long term benefits. Short term remunerations
are paid in consideration of the services rendered by the employees whose service
benefits are expected to be consumed within the accounting year.
Accounting for long term post-employment benefits such as gratuity, pension and
provident are complex and will not be covered in this syllabus. The remaining part
of this chapter will discuss and cover accounting for short term remunerations of
employee.

2.2.1 Salaries and wages

a) Salary
When the employee is recruited to work on a monthly or annual rate, the payment
is called a salary.
b) Wages
Payments made to an employee for work done, when calculated either on hourly
rate (e.g. Nu.20 per hour or at piece rate (e.g. Nu.100 per unit of goods produced),
or daily basis (e.g. Nu.130 per day). The wages may be accumulated for a period and
paid at the end of the period, say a month. Employees recruited under muster rolls
normally are paid wages. The recruitment of employees under muster roll might
differ from government and public sector organizations to corporate organizations.
c) Basic salary
Basic salary is the minimum amount of remuneration paid to employees based on
his experience and the position to be filled in. The fixation of basic salary may vary
from one to another organisation. Many organisations use 50:50 proportion i.e. the
basic salary constitute 50% of the total remuneration paid to the employees.
d) Allowances and other components of remunerations
Employees may be paid additional remunerations in the form of allowances such
as house rent, health and medical benefits, car allowance, fuel allowance, group
insurance, difficulty allowance, etc. These allowances are normally calculated as a
percentage on the basic salary.
e) Gross and net salaries and wages
The total of basic salary and other additional remunerations give the gross salary/
remuneration of the employee.
f) Deductions
Deductions are statutory or organizational recoveries from the employees including
personal income taxes adjusted with the salary or wage income payable to the
employees. Deductions include, house rent, salary tax, pension, insurance, personal
loans (if it is an employee loan), etc.
g) Net salaries and wages
This is the net take home salary or wage income of the employee after adjusting for
the recoveries/deductions.
h) Employee personal files
The HR section of the oragnisation maintains a file for each employee containing all
employment contract documents of the employee. The personal file is updated for
any development and changes in the employment contracts with the organisation.

The changes in the remunerations payable to the employee must be properly

authorized and validated.
2.3 Accounting Records for Salaries and Wages

The salary and wage payments to employees must be properly documented before
disbursement of the payment. The accounting documents include preparation of
payment/disbursement vouchers and writing of a payment cheque. The payroll staff
must ensure that the employee list is updated for the month before disbursement of
payment. Also, the entitlement of employees must be updated with the HR section
for each month. Particularly for the months of January and July where employee
promotions and salary increments are most common and require updates of the
personal files of employees.
All short term employee remunerations including leave encashment are recognized
as expense in the statement of income, and accrued remunerations recognized as
current liabilities if remunerations or benefits are payable. Similarly costs incurred
on trainings and development of employee are expensed when incurred.
PAY SLIP
Tshering Pem
Employee ID 122 TPN: TAP224887
Designation Sweeper Grade: GSP
Bank Details 101456220
Years of Service 12
Employee Type Contract
Over time allowance 0
Earnings Amount Gross Salary Deductions Amount Gross Salary
Basic Pay 7000 7000 TDS (10% of GP)# 1145 1145
HRA(20% of BP) 1400 1400 Provident Fund** 0 0
Contract Allowance (30% of BP) 2100 2100 GIS *** 0 0
Service Allowance * 1050 1050 Health Contribution 100 100
Over time allowance (300/Hr) 0 0 Staff Welfare Fund 100 100
0 BoB Loan 0 0
Total Earnings 11550 11550 Total Deducations 1345 1345
Net Amount 10205 10205
*(Less than 5 Years: NA, 5 -10 years: 10% of BP, 11-15 Years: 15%, Above 15 Years: 20%)
**15% of their basic pay for regular employees
***Grade I-III= 1000, IV-VIII=500, IX-XII=300, ESP&GSP=NA
#TDS=10%(GP-[PF,GIS,HC])

Dema Mining Pvt. Limited
Payroll for July, 2019
Employee Name Gender Designation Employee Grade Years of Basic Over EWF Bank TPN Loan
Code Type Service Pay Time Account Instalment
111 Karma Uthra F CEO Regular I 20 65,000 0 Yes 101456226 KAP442121 10,000
112 Sangay Jamtsho M General Manager Regular II 20 35,000 0 Yes 101456230 SAP664215 5,000
113 Ugyen Dorji M Engineer Regular II 20 40,000 10 Yes 101456218 UAP221239
114 Karma Loday M Asst Engineer Contract III 3 36,000 5 Yes 101456229 KAP442214
115 Sonam Jamtsho M Supervisor Regular IX 5 12,000 5 Yes 101456227 SAP331245
116 Shacha Singye M Technician Regular X 4 15,000 8 Yes 101456221 SAP114522
117 Ugyen Jamtsho M Driver Regular XII 10 8,000 5 Yes 101456224 UAP112233 3,500
118 Pema Rigzin M Finance Officer Regular VI 12 20,000 5 Yes 101456223 PAP143326
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119 Sangay Dorji M Driver Contract XII 13 12,000 6 Yes 101456222 SAP661142
120 Rinzin Lhamo F Office Assistant Regular X 5 10,000 8 Yes 101456225 RAP412145 1,500
121 Leki Dema F PA Regular X 3 8,000 1 Yes 101456216 LAP558941
122 Tshering Pem F Sweeper Contract GSP 12 7,000 0 Yes 101456220 TAP224887
123 Lekila M Night Guard Contract ESP 10 5,000 12 Yes 101456228 LAP443217
124 Dhan Maya Tamang F Accountant Regular IX 8 16,000 13 Yes 101456219 DAP145587 2,000
125 Bolanath Sharma M Site Supervisor Contract X 2 14,000 0 Yes 101456217 BAP884512
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2.4 Accounting Records

On disbursement of monthly salary and wages
On disbursement of monthly salary and wages
Salary and wages expense A/c Dr
To Salary tax
To House rent
To GIS
To Pension and provident (if entity has pension and provident fund scheme
for employees)
To Personal loan (if any)
To Bank (net pay credited to employee bank account)
For remittance of recoveries to agencies

RRCO A/c Dr (for income tax deduction)
Insurance A/c Dr (for GIS deduction)
Pension fund A/c Dr (for pension and provident deduction)
Loan A/c Dr (for recovery of loan)
To Bank (recoveries deposited to individual agency accounts)
2.5 Some Ratios Relevant to Payroll Staff

i) Staff turnover ratio
Staff turnover ratio measures the average number of employees leaving the
organisation per year. It is calculated as:
No of resignation during the year

Staff turnover = Average no of employees for the year
Average employees during the year:

Number of employees in the beginning of the year xxx ----------(A)
Add: New recruitments xxx
Less: Retirement and resignation during the year (xxx)
Total employees at the year-end xxx ------------(B)
(A + B)
Average employees during the year = 2

ii) Salary increment rate

2019 2018 2017
Average number of employees for the year x y z
Average salary per employee for the year o p q
Increments = o - p p-q -
These ratios are useful in accounting for employee benefits such as gratuity and
pensions as well as for employee cost analysis.
2.6 Reporting Employee Remuneration and Employee Benefits in

Financial Statements
Employee remunerations and benefits are reported as personnel cost or employee costs in
the financial statements.
The salaries, wages and all other short term employee costs are presented as expense in
the statement of income. Accrued salaries and remunerations are presented as accrued
expenses or payables under current liabilities.
Consolidated Statement of Comprehensive Income for the year
ended 31 December 2017 (In millions Ngultrums)
INCOME Notes 31st-Dec-2017 31st-Dec-2016
Revenue from customers 2 37,110.25 39,598.13
Other Income 3 1,724.86 1,761.08
Share of Profits of Associates 4a 60.45 0.84
Total Income 38,895.56 41,360.05
EXPENDITURE
Direct Costs of Sales 5 11,098.05 13,401.02
Personnel and Other Costs 6 8,461.76 7,843.60
Finance Cost 1,614.49 1,751.28
Depreciation and amortization 7& 11 5,667.89 5,710.27
Impairment losses 88.64 64.34
Share of Losses of Associates & Joint venture 4a&b 64.96 34.51
Total Expenditure 26,995.79 28,805.02
Profit on Operations before Tax 11,899.77 12,555.03
Income Tax Expenses 8 5,888.99 5,960.61
Profit on Operations after Tax 6,010.78 6,594.42
Personnel Costs Source: DHI Annual Report 2017

Consolidated Statement of Financial Position as at 31 December, 2017 Contd..,

(In millions Ngultrum)
Current Liabilities
Current Portion of Borrowings 22 3,654.86 3,716.21 3,994.19
Deferred Government Grants 23 76.44 100.34 -
Income Tax Payable 3,477.22 4,058.84 2,617.48
Trade and Other Payables 25 4,173.67 3,376.80 2,652.61
Other Current Liabilities 26 4,018.28 2,176.40 2,523.99
Total Current Liabilities 15,400.47 13,428.59 11,788.27
TOTAL EQUITY AND LIABILITIES 172,949.66 163,619.78 157,333.76
Accrued personnel cost
presented with other payables
25. EMPLOYEE BENEFITS EXPENSES
As on As on
December 31, 2017 December 31, 2016
Payroll and related expenses -
Salaries and Performance based variable pay 41,903,901 45,825,109
Leave travel allowance 2,470,506 2,710,621
Bonus 4,858,638 5,407,397
Overtime allowances 86,400 99,063
Medical expenses 555,945 789,253
Staff welfare 69,620 585,513
Uniforms 16,145 45,712
HRD expenses 13,733,157 11,237,725
63,694,312 66,700,393
Post employment benefits -
Provident fund contribution 2,099,558 2,233,828
Gratuity 942,555 674,830
3,042,113 2,908,658
Other employee benefits
Leave encashment (Annual benefit) 674,073 793,320
Leave encashment (Separation benefit) 275,628 461,021
Others 502,620 473,345
1,452,321 1,727,686
68,188,746 71,336,737
Source: DHI Annual Report 2017

Dema Mining Pvt. Ltd
Pay-sheet for July, 2019
Earnings Deductions
Employee Gross "Total
Name Basic Pay Net Pay
ID Salary
HRA CA SA OTA PF GIS HC TDS SWF Loan
111 Karma Uthra 65,000 13000 0 13000 0 91,000 9750 1000 100 8015 100 10000 28965 62,035
112 Sangay Jamtsho 35,000 7000 0 7000 0 49,000 5250 1000 100 4265 100 5000 15715 33,285
113 Ugyen Dorji 40,000 8000 0 8000 3,000 59,000 6000 1000 100 5190 100 0 12390 46,610
114 Karma Loday 36,000 7200 10800 0 1,500 55,500 0 1000 100 5440 100 0 6640 48,860
115 Sonam Jamtsho 12,000 2400 0 1200 1,500 17,100 1800 300 100 1490 100 0 3790 13,310
116 Shacha Singye 15,000 3000 0 0 2,400 20,400 2250 300 100 1775 100 0 4525 15,875
117 Ugyen Jamtsho 8,000 1600 0 0 1,500 11,100 1200 300 100 950 100 3500 6150 4,950
118 Pema Rigzin 20,000 4000 0 3000 1,500 28,500 3000 500 100 2490 100 0 6190 22,310
Page: 55
119 Sangay Dorji 12,000 2400 3600 1800 1,800 21,600 0 300 100 2120 100 0 2620 18,980
120 Rinzin Lhamo 10,000 2000 0 1000 2,400 15,400 1500 300 100 1350 100 1500 4850 10,550
121 Leki Dema 8,000 1600 0 0 300 9,900 1200 300 100 830 100 0 2530 7,370
122 Tshering Pem 7,000 1400 2100 1050 0 11,550 0 0 100 1145 100 0 1345 10,205
123 Lekila 5,000 1000 1500 0 3,600 11,100 0 0 100 1100 100 0 1300 9,800
124 Dhan Maya Tamang 16,000 3200 0 1600 3,900 24,700 2400 300 100 2190 100 2000 7090 17,610
125 Bolanath Sharma 14,000 2800 4200 0 0 21,000 0 300 100 2060 100 0 2560 18,440
Total 303,000 60,600 22,200 37,650 23,400 446,850 34,350 6,900 1,500 40,410 1,500 22,000 106,660 340,190
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Exercises:
1. The year-end trial balance of Karma Printings, as shown below includes the net
salary paid to the employees and the tax deducted at source. Tax deductions are
10% of gross pay and national pension fund contribution is 6% from employees
and another 9% from employer.
Amount
Particulars (Nu)
Salaries 166,740,000
Payments to Tax and Pension fund:
Tax 17,250,000
Pension fund 27,500,000
Required:
Determine the amount to be stated in the statement of income and the liabilities
to be reported, if unpaid on the statement of financial position. The net salary
paid after deducting 10% tax and 6% pension fund is 84% of gross salary.
2. Phuntsho and Banu are two employees of a Bhutan Shoes company. They receive
wages calculated at Nu. 420 per unit and Nu. 450 per unit produced respectively.
Minimum wage per week is Nu. 975. Any employees producing more than 80
units is paid at Nu. 500 per unit for the excess. In week 43, Phuntsho produced
105 units and Banu produced 64 units.
Required
Calculate the gross pay for the week of the company.
3. Gyeltshen Construction Company’s payroll shows that a pension fund

contribution is at 6%. Employer’s contribution is 9%. By the year-end net salary
paid to its employees amounts to Nu. 154,630,000 and the total amount remitted
as the pension contribution is Nu. 21,400,000.
Required
Calculate the amount of salary to be reported as expense and a liability for
pension fund.

4. The year-end trial balance of a Bluescope Limited Company as at 31 December

2019 reports a staff loan of Nu. 10,000 as an asset. Monthly recoveries of Nu. 500
made from pay-sheet, from August should be accounted for as:
Debit cash, credit staff loan with Nu. 2,500
Debit staff loan, credit cash with Nu. 2,500
Debit salaries account, credit staff loan account with Nu. 2,500
Debit staff loan account, credit salaries account with Nu. 2,500
5. The reporting entity accounts its employee costs and prepares payroll every
month and sends employee pay slips by the last day of the month. In its financial
reporting, what amount should be recognized as expense in its statement of
income for the year?
The gross salary payable to the employee.
The net salary paid after making all pay sheet recoveries.
The gross salary payable for the year plus employer’s contribution to pension
fund.
The net salary paid plus the amount of all pay sheet recoveries.
6. Create a Payroll in a spreadsheet for a business firm considering following

benefits and deductions given to the employees.
vii. Basic Pay
viii.House rent allowance 20% of basic pay for all the employees
ix. Contract allowance 30% for employment status with ‘Contract’
x. Service allowance of 10% for those who served 5 to 10 years, 15% for those
serving in 11 to 15 year and serving above 15 years are paid 20%
xi. Overtime allowance of Nu.300 per hour irrespective of the grade
xii. Provident fund is deducted at 15% of basic pay
xiii.Group Insurance Scheme of Nu.1,000 from grade IV and above, Nu.800 for
grade VII to V, Nu.500 for grade IX to XII and not deducted if employees
are in grade ESP and GSP.
xiv. Heath contribution of Nu.200 is compulsory for all
xv. Staff welfare contribution of Nu.200 for grade VIII and above and those
below grade IX contribute Nu.100 per month.
xvi. Salary tax deducted at source is 10% of gross pay after PF,GIS and Health
contributions
xvii. At least five staff have taken loan from different banks and must be shown
as deduction in the payroll.

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Chapter 3: Accounting for Investment Property
Chapter 3
Accounting for Investment
Property
• Explain the concept of investment property.
• Explain the recognition and measurement basis for investment property.
• Discuss issues in classification of investment properties.
• Record accounting transactions related to investment property.
• Present investment property in financial statements.
“Price is what you pay. Value is what you get.” (Warren Buffet). This quote aptly
underlines the reason why many business entities invest in properties. Business entities
usually invest in properties such as land, buildings, gold and other precious metals
apart from keeping their money in banks and investment in stocks of other entities.
The property market provides a platform for buyers and sellers to undertake such
transactions related to properties. However, the price of property may not be fully
determined by the market players especially when the government intends to
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intervene in the market in order to address the social disparities. The distribution
of residential houses by the National Housing Development Corporation in Thiphu
and Phunstholing is a typical example of such control of price of property. In more
competitive market, investment in properties yield good returns to the investors.
In this chapter, you will learn the concept of investment property, methods of
accounting and reporting of investment property in entity’s financial statements.
In fact, accounting for investment property addresses the issue of accounting for
real estate business (building, land or both) that are held for the purpose of capital
appreciation or rental income or both.
3.1 Concept and Definition of Investment Property

Investment property is property (land or a building or part of a building or both)
held (by the owner or by the lessee under a finance lease) to earn long-term rentals
or for capital appreciation or both. As such, investment property generates cash
flows or income independently of the other assets held by an entity. Other properties
such as land, and buildings generate cash flows with combination of other related
properties.
On the other hand, owner-occupied property is property held (by the owner or by
the lessee as a right-of-use asset) for use in the production or supply of goods or
services or for administrative purposes. The owner here refers to the business entity
and not the capital providers of the business. Property, plant and equipment is an
example of an owner-occupied property.
Examples of investment property:
• land held for long-term capital appreciation
• building leased out under an operating lease
• vacant building held to be leased out under an operating lease
• property that is being constructed or developed for future use as investment
property
The following are not investment property:
• property held for use in the production or supply of goods or services or
• for administrative purposes
• property held for sale in the ordinary course of business or in the process of
construction of development for such sale
• property being constructed or developed on behalf of third parties
• owner-occupied property
• property held for future development and subsequent use as owner-occupied
property,
• property occupied by employees and owner-occupied property awaiting
disposal
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• property leased to another entity under a finance lease

You will observe in the definition of investment property that it does not include
gold and other precious metals which otherwise is the most sought after property
for investment. Apart from gold and other precious metals, investment in properties
other than land and buildings do not make sense when they are held especially for
appreciation in its value over the years. Thus, investment property includes only
land and buildings or part of land and buildings and no other properties.
Other definitions used in investment property include:
Cost: The amount of cash or cash equivalents paid or the fair value of other
consideration given to acquire an asset at the time of its acquisition or construction.
Fair value: Fair value is the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction between market participants at the
measurement date.
Owner occupied property: Property that is held (by the owner or by the lessee
under a finance lease) for use in the production or supply of goods or services or for
administrative purposes.
Statement of Financial Position as at 30th June 2018
Particulars Note 30-June-18 30-June-17
Assets
Cash and cash equivalent 4 546,907,673 1,044,294,701
Trade receivables 5 7,056,259 3,910,885
Term deposits 6 11,379,618,764 10,306,537,704
Investments in bonds and commercial papers 7 4,406,821,100 4,958,624,209
Loans 8 12,190,581,280 8,570,206,110
Investment in equity shares 9 3,216,096,180 3,096,824,575
Inventories 10 642,396 541,892
Investment property 11 568,039,820 519,185,535
Property, plant and equipment 12 180,365,244 188,244,657
Intangible assets 13 4,821,569 7,349,525
Other receivables 5 835,977 827,377
Other assets 14 16,349,127 11,751,575
32,518,137,387 28,708,298,745
Source: NPPF Annual Report 2017-2018
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Note 11. Investment Property
Gross blocks Accumulated depreciation Net block
Particulars 01-Jul-17 Additions Adjustments 30-Jun-18 01-Jul-17 Depreciation Adjustments 30-Jun-18 30-Jun-18 30-Jun-17
during the during the
year Year
RE land 76,347,937 638,000 76,985,937 - - - 76,985,937 76,985,937
RE building 447,364,255 4,795,535 (4,424,414) 447,735,376 134,258,099 8,631,921 (4,191,396) 138,698,624 309,036,752 313,106,156
RE building (Semi-Permanent) 2,420,278 806,846 3,227,124 358,943 133,003 491,946 2,735,178 2,061,335
Road network 7,896,690 1,533,599 9,430,289 6,689,687 867,291 7,556,978 1,873,310 1,207,003
Retention wall 2,192,352 - 2,192,352 238,135 73,196 311,331 1,881,021 1,954,217

Capital work in progress 114,457,122 61,381,578 (7,135,980) 168,702,720 - - 168,702,720 114,457,122
Capital stores 10,051,766 820,963 (4,047,827) 6,824,902 - - 6,824,902 10,051,766
Total 660,730,399 69,976,522 (15,608,222) 715,098,699 141,544,864 9,705,411 (4,191,396) 147,058,879 568,039,820 519,185,535
Gross blocks Accumulated depreciation Net block
Page: 62
Particulars 01-Jul-16 Additions Adjustments 30-Jun-17 01-Jul-16 Depreciation Adjustments 30-Jun-17 30-Jun-17 30-Jun-16
during the during the
year Year
RE land 76,347,937 - - 76,985,937 - - - 76,985,937 76,985,937
RE building 413,584,867 35,077,300 (1,297,912) 447,364,255 126,897,311 8,365,356 (1,004,568) 134,258,099 313,106,156 286,687,556
RE building (Semi-Permanent) 2,420,278 - - 2,420,278 260,513 98,430 - 358,943 2,061,335 2,159,765
Road network 7,830,756 65,934 - 7,896,690 5,640,709 1,048,978 - 6,689,687 1,207,003 2,190,047
Retention wall 2,041,974 150,378 - 2,192,352 167,753 70,382 - 238,135 1,954,217 1,874,221
Capital work in progress 98,294,173 37,464,958 (21,302,010) 114,457,122 - - - - 114,457,122 98,294,173
Capital stores 3,805,159 6,246,607 - 10,051,766 - - - - 10,051,766 3,805,159
Total 604,325,144 79,005,177 (22,599,922) 660,730,399 132,966,286 9,583,146 (1,004,568) 141,544,864 519,185,535 471,358,858
Source: NPPF Annual Report 2017-2018
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g. Investment Property
Property that is held for long-term rental yields or for capital appreciation or both,
and that is no occupied by NPPF, is classified as investment property is measures
initially at its cost, including related transaction cost and where applicable
borrowing costs. Subsequent expenditure is capitalized to the asset’s carrying
amount only when it is probable that future economic benefits associated with the
expenditure will flow to NPPF and the cost of the item can be measured reliably.
All other repairs and maintenance cost are expensed when incurred. When part
of an investment property is replaced, the carrying amount of the replaced part is
derecognised.
Capital work in progress is stated at cost incurred including provision for
outstanding bills up to the date of the statement of financial position.
An item of investment property is depreciated using straight line method on their
depreciable amount over their estimated useful life as mentioned in note 3(f)
Disclosure of accounting policy adopted by NPPF for investment property (Source: NPPA Annual
report 2017-2018)
STATEMENT OF FINANCIAL POSITION FOR THE YEAR ENDED 31

DECEMBER 2018
(All figures in millions of Bhutanese Ngultrums, except share data and as otherwise stated)
Consolidated Parent
Notes
31-Dec-18 31-Dec-17 31-Dec-18 31-Dec-17
Non-current Assets
Property, Plant and Equipment 8 88,445.88 88,715.53 104.85 68.51
Capital work in progress 11 11,533.81 9,414.25 75.84 12.37
Investment Property 12 335.06 325.05 - -
Intangible Assets 13 1,438.12 1,354.27 0.34 0.64
Goodwill 14 11.95 11.95 - -
Investments 15 5,136.32 4,103.61 53,312.53 51,038.29
Long Term Financial assets 16 2,169.09 2,444.69 - -
Banking Loans and Advances 35,179.02 33,802.76 - -
Long Term Employee Benefits 75.39 6.52
Other Non Current Assets 17 128.51 252.02 367.59 86.09
Total Non-current Assets 144,453.15 140,430.65 53,861.15 51,205.90
Source: DHI Annual Report 2018
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Illustration 1
DNT Company operates a logistic and courier service business. In 2018 DNT
rented 10 refrigerated trailers to another similar logistic company ST Logistics on
1.1.2019. The contract was signed for a period of 5 years for which all costs related
to maintenance and repairs will be borne by ST Logistics. These trailers are acquired
at Nu. 2.1 million each in 2017 and are depreciated at straight-line method over 15
years.
Discuss whether the trailers can be accounted as investment property.
3.2 Recognition of Investment Property

Investment property should be recognised as an asset when it is probable that
the future economic benefits that are associated with the property will flow to the
entity, and the cost of the property can be reliably measured. These are the basic
requirements for recognition of asset in the financial statements.
Remember this recognition conditions will work only if the property meets
the definition of investment property. In the later part of the chapter you will be
introduced to some issues of classification of investment property which will also
pose some challenges in the recognition of investment property.
Illustration 2
Company A reported all items of land and buildings as fixed assets before adoption
of a new accounting standards. In order to improve its reporting and accounting
information, company A adopted BAS in which it is required to classify it’s assets.
The company management provides you the list of their assets as follows:
a. 15 acres of land is used for construction of office buildings and car parking of
their employees
b. 10 acres of land is held for future use
c. 20 units of buildings were used for administrative purpose of the company
d. 25 units of building were allotted to their staff for which they collect monthly
rent
e. 10 units of buildings are rented out to tenants
f. A vacant building owned by parent company and to be leased out under an
operating lease
g. Company A has a real estate department that develops land and constructs
buildings for sale. They have currently 50 units of buildings under this category
of asset.
Discuss each category of asset and classify them into:
i) Property, plant and equipment
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ii) Investment property

iii) Inventory
Solution
Properties described under items (a), (c), (d) and (f) would qualify as property, plant
and equipment as these items are used for company’s own office, and employees.
Properties described under items (b) and (e) will be classified as investment property
as these properties are held either for capital appreciation or held for rental. The land
held for future use indicate that the company would derive the benefits of increased
value of the land over the years.
Properties described under items (g) should be classified as inventory as these units
of buildings are held for sale in the ordinary course of business.
3.3 Initial Measurement of Investment Property

Investment property is measured at cost at initial recognition. Costs include all
directly attributable cost of the investment property such as legal fees, brokerage
fees, property transfer taxes and other transaction costs in addition to the cost of
acquiring investment property. However, in case of construction of investment
property, abnormal waste of materials and general costs which are not directly
attributable to the construction of investment property are excluded from the cost.
3.4 Subsequent Measurement

In the subsequent years, investment property can be measured either at:
i) fair value, or
ii) cost
One method must be adopted for all of an entity’s investment property. Change is
permitted only if this results in a more appropriate presentation. Generally, if the
entity has used fair value method, it would be highly unlikely that it would require to
change it to cost method as the carrying amount of investment property at fair value
will bring a better presentation of investment property in the financial statement.
In the next section, you will learn the basic difference between the two methods of
accounting for investment property.
3.4.1 Fair value model
Under this method, investment property is remeasured at fair value. Remember
that we measured the investment property initially at cost at the time when the
investment property was first time recognized in the books. Now in the following
year, we need to remeasure the investment property, this time at fair value. If
there is any difference in the value of the investment property when we measured
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at fair value, this represents a gain or a loss arising from changes in the fair value
of investment property. The gain or loss on remeasurement should be reported in
the income statement for the period in which it arises. Remember, the revaluation
surplus in case of property, plant and equipment is accounted as part of equity but
the difference in fair value and carrying amount of investment property is always
taken to income statement.
The concept and practice of fair value needs careful consideration of the market
conditions. Fair value means the price that is acceptable to both buyers as well as
sellers without any transaction cost. In the developing economies, fair value poses a
challenge in the absence of active market where the item of investment property or
a similar property is bought and sold. However, in the absence of such information,
the entity may consider current prices on less active markets. If an entity has
previously used fair value method, it should continue to use fair value measurement
until disposal of its investment property, even if the market is less active and market
prices is less readily available. Note that under fair value method, no depreciation is
charged on investment property.
Illustration 3
A company has rented a property where it collects a yearly rent of Nu. 120,000 from
the tenants. The property was constructed at a cost of Nu. 2 million before 5 years.
The company charged 10% depreciation on written down value method. In the
current year, management intends to change the method of measurement from cost
to fair value due to the volatility of property market in the country. The fair value of
the similar property in the market was reported as Nu. 1,345,800.
Compute the gain or loss on remeasurement of the investment property and pass
journal entries to record the effect.
Solution
Depreciation Carrying
Year Cost Depreciation
Rate Amount
1 2,000,000 10% 200,000 1,800,000
2 1,800,000 10% 180,000 1,620,000
3 1,620,000 10% 162,000 1,458,000
4 1,458,000 10% 145,800 1,312,200
5 1,312,200 10% 131,220 1,180,980
6 Carrying amount 1,180,980
Fair value 1,345,800
Gain in value of property 164,820
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Year 6:
Accumulated depreciation Dr 819, 020
To Investment property 819,020
Investment property Dr 164,820

To Income Statement 164,820
Cash/accrued income Dr 120,000

To rental income 120,000
3.4.2 Cost model

When the entity chooses cost model in the subsequent years, investment property
is accounted for in accordance with the cost model as set out in IAS 16 Property,
Plant and Equipment. The value of investment property then will be reduced by the
amount of yearly depreciation and impairment losses if there is any.
Illustration 4
A business entity invested in a property where it desired to have a regular source
of income from the property in the form of rents. The property was purchased at
Nu. 550,000 in 2017 and it incurred legal fees and other transaction costs of Nu.
50,000. The entity collects a monthly rent of Nu. 12,000 from the property. The
management of the entity decided to use cost model in the subsequent years with
8.5% depreciation on carrying amount.
Compute carrying amount of investment property for the year ended 31 December
2019. Also, record entries for the same effect.
Solution
Year Cost Depreciation Depreciation Carrying
Rate amount
2017 600,000 8.5% 51,000 549,000
2018 549,000 8.5% 46,665 502,335
2019 502,335 8.5% 42,698 459,637
Year 2019
Cash/Accrued income Dr 144,000 (12000x12months)
To rental income 144,000
Depreciation Dr 42,698
To Accumulated depreciation 42,698
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Summary of accounting for property, plant and equipment, and investment

property
Property, Plant and Equipment Investment Property
Revaluation model/
Cost Model Cost Model Fair Value Model
Fair Value
Depreciation Asset is depreciated Depreciation Asset is not

after revaluation depreciated after
revaluation
Impairment Impairment
Revaluation surplus
is recognised in equity while Revaluation surplus or
revaluation loss is recognised in loss is recognised income
income statement statement
3.5 Transfers to or from Investment Property Classification

It is possible that an entity having investment property may transfer the investment
property to its own use (owner-occupied) or the owner occupied property to
investment property. This transfer of property to and from owner occupied property
should only be made when there is a change in use, evidenced by one or more of the
following:
a. commencement of owner-occupation (transfer from investment property to
owner-occupied property)
b. commencement of development with a view to sale (transfer from investment
property to inventories)
c. end of owner-occupation (transfer from owner-occupied property to
investment property)
d. commencement of an operating lease to another party (transfer from
inventories to investment property)
e. end of construction or development (transfer from property in the course of
construction/development to investment property
In other words, an entity should transfer a property to, or from, investment property
only when the property first meets, or ceases to meet, the definition of investment
property.
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3.6 Some Issues of Classification
3.6.1 Partial own use.

Owner occupied
(PP&E)
On rental
(Investment Property)
Figure 3.1 Properties partially occupied by owner and rented
If the owner (business entity) uses part of the property for its own use, and part to
earn rentals or for capital appreciation, and the portions can be sold or leased out
separately, they are accounted for separately. The part that is rented out is investment
property. The other part that is used by the owner is accounted as property, plant
and equipment.
3.6.1 Ancillary services.
If the entity provides ancillary services to the occupants of a property held by the
entity, the appropriateness of classification as investment property is determined by
the significance of the services provided. If those services are a relatively insignificant
component of the arrangement as a whole (for example, the building owner supplies
security and maintenance services to the rented property), then the entity may
treat the property as investment property. However, if the services provided are
more significant (such as food, housekeeping and help-desk services in the rented
property), the property should be classified as owner-occupied. This means, the
property should be treated as property, plant and equipment.
Note that the classification of property will depend on the extent of ancillary services
provided as part of the contract as a whole. Therefore, a single thump rule may not
be sufficient to classify the property as investment or not.
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Figure 3.2 Significant ancillary services
3.7 Disposal of Investment Property

Like property, plant and equipment, an investment property should be derecognised
on disposal or when the investment property is permanently withdrawn from use
and no future economic benefits are expected from investment property. Any gain
or loss on disposal should be recognized in the income statement.
Illustration 5
Happy Homes Limited (HHL) supplies sofa sets and internal decoration items to local
market. The company accounts all its properties using revaluation model after its initial
recognition. HHL has a building which was revalued on 31 December 2019 to its fair value
Nu. 100,000. On 1 July 2020, the company management decided to transfer this building
which was occupied by the business to investment property. On 1 July 2020, the following
information were obtained related to this building:
i) fair value at the date of transfer Nu 90,000
ii) Revaluation surplus of the building Nu. 15,000
iii) Carrying amount of the building at the date of transfer Nu. 98,000
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At the end of 2020, fair value of investment property was Nu. 88,000. The property was
later disposed of at Nu. 100,000 in June 2021.
Required:
Explain how a change in use of property from owner-occupied to investment property
will be accounted. Pass all the required journal entries so that the full economic activities
related to the property are captured in the financial records.
Solution
The change in use of property from owner-occupied to investment property will result
into change in accounting for building. When the property was owner-occupied, it
was accounted as property, plant and equipment (BAS16). However, after management
decision to transfer to investment property, building will be accounted as investment
property (BAS40).
The carrying amount of the property at the date of transfer was Nu. 98,000. However, the
fair value of building was Nu. 90,000. This fair value represents the cost of investment
property when it is initially recognized.
Therefore, on 1 July 2020, carrying amount of the property should be brought down to Nu.
90,000 by passing the following entry.
Revaluation surplus A/c Dr 8, 000 [accounted as per BAS16]
To PPE-Building 8 000
Investment property- building Dr 90,000 [transfer and reclassification of property]
To PPE-building 90,000
31 December 2020
Revaluation loss (I/S) A/c Dr 2,000
To Investment property- building 2,000
June 2021
In June 2021, investment property was disposed of and derecognised. This require
reclassification of the remaining revaluation surplus in equity as follows.
Equity- Revaluation surplus A/c Dr 7, 000
To Equity- Retained earnings 7, 000
Cash A/c Dr 100,000

To Investment property (building) 88,000 [derecognised IP]
To Income statement 12,000 [gain on disposal]
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Read the following statement of changes in equity and the reclassification of

revaluation surplus from one component of equity to another component of equity.
Statement of changes in equity
Share capital Revaluation Retained Total Equity
surplus earnings
Opening balance 1.1.2020 1,000,000 15,000 450,000 1,465,000
Profit for the year 2020 600,000 600,000
Dividend paid -200,000 -200,000
Adjustment of FV -8,000 -8,000
Closing balance 31.12.2020 1,000,000 7,000 850,000 1,857,000
Opening balance 1.1.2021 1,000,000 7,000 850,000 1,857,000
Transfer of revaluation surplus -7,000 7000 0
Profit for the year2021 550,000 550,000
Dividend for the year -200,000 -200,000
Closing balance 31.12.2021 1,000,000 0 1,207,000 2,207,000
The decision tree
Property
Is the property held for sale in the YES It is treated as an inventory

ordinary course of business? (BAS2)
NO
YES It is treated as Property, Plant and

Is the property owner occupied?
Equipment (BAS16)
NO
The property is an investment

property Treated same as Property Plant
l
o de and Equipment (BAS 16)
st M
Co
Which model is used for all
Fair V Apply Investment Property
investment properties? alu
Mod e Standard (BAS40)
el
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Exercises:
1. City Builders Limited, a real estate business purchased a land in Thimphu

at Nu 1.2 million. The management of City Builders Limited not decided
whether to hold the land for a couple of years and then sell it or to develop it
into a high-rise rental property. The company incurred the following costs, in
addition to the purchase price:
i) Cost of demolishing an old building Nu 10,000
ii) Erecting a fence around the perimeter of the land Nu 40,000
iii) Paying overdue real estate tax Nu 80,000
Required:
1. Does this property qualify as investment property under BAS 40?
2. What is the total cost to be recorded for this land?
2. A year after purchasing the land, City Builders Limited decided not to sell the
land but rather to build its own office building since the location is excellent.
However, because of the decline in property price in Thimphu, the fair value
of this land now is Nu 1.1 million.
Required:
What action does City Builders Limited have to take in relation to this decision?
3. The central bank of a country A holds gold worth hundred millions of its
national currency. Generally the central banks hold gold and other precious
metals as reserves to ease out its liquidity problems.
Required:
Discuss in group whether gold holding of the central bank can be classified as
investment property.
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Chapter 4: Accounting for Intangible Assets and Government Grants
Chapter 4
Accounting for Intangible
Assets and Government Grants
• Explain the concept of intangible asset.
• Discuss the capitalization criteria for an item of intangible asset.
• Discuss the nature of internally generated goodwill and other intangible
assets.
• Record and report intangible asset in financial statements.
• Record and report for impairment and amortization of intangible assets.
• Explain the concept of government grants.
• Account government grants under accrual or deferral methods.
• Report government grants in financial statements.
This chapter is divided into two parts. First part will discuss on the concept of
intangible assets and its accounting methods while the second part will introduce
a topic on government grants and the approach to accounting and reporting of
government grants by business entities.
Companies like Pfizer, GlaxoSmithKilne and Johnson and Johnson continuously
Strengthening the develop different healthcare products
R&D Commercial to global consumers. A large part
interface of the revenue of these companies
comes from the manufacture and sale
of biopharmaceutical products such
as medicines and vaccines. Another
significant thing of these companies is
that they carry huge intangible assets on
their statement of financial position in
the form of intellectual property rights
(mostly as patents) and licensing rights.
Every year these companies spend millions of dollars in research and development
activities. Pfizer’s spent $ 7,657 million in research and development alone. They
reported $ 48,741 million intangible assets in 2017 year-end excluding goodwill.
This makes 28 percent of the total assets of the company. Together with goodwill,

61 percent of the Pfizer’s asset was made up by intangible assets.
Read the extracts of their financial statements given below.

Pfizer Inc. and Subsidiary Companies
As of December 31
(MILLIONS, EXCEPT PREFERRED STOCK ISSUED AND PER COMMON SHARE DATA) 2018 2017
Assets
Cash and cash equivalents $ 1,139 $ 1,342
Short term investments 17,694 18,650
Trade accounts receivable, less allowance for doubtful accounts: 2018-$541 2017-$584 8,025 8,221
Inventories 7,508 7,578
Current tax assets 3,374 3,050
Intangible
Other current assets 2,461 2,289
Assets
Assets held for sale 9725 12
Total current assets 49,926 41,141
Long-term investments 2,767 7,015
Property plant and equipment, less accumulated depreciation 13,385 13,865
Identifiable intangible assets, less accumulated amortization 35,211 48,741
Goodwill 53,411 55,952
Noncurrent deferred tax and other noncurrent tax assets 1,924 1,855
Other noncurrent assets 2,799 3,227
Total assets $ 159,422 171,797
Identifiable Intangible Assets and Goodwill

The following table provides the components of identifiable intangible assets:
Identifiable Identifiable
intangible intangible
Gross assets, less Gross assets, less
Carrying Accumulated accumulated Carrying Accumulated accumulated
(Millions Dollars) amount amortization amortization amount amortization amortization
Finite-lived intangible assets
Developed technology right $ 89,430 $ (58,895) 30,535 $ 89,550 $ (54,785) $ 34,765
Brands 923 (708) 215 2,134 (1,152) 982
Licensing agreement and other 1,436 (1,140) 296 1,911 (1,096) 815
91,788 (60,743) 31,045 93,595 (57,033) 36,562
infinite-lived intangible assets
Brands and others 1,994 1,994 6,929 6,929
IPR&D 2,171 2,171 5,249 5,249
4,165 4,165 12,179 12,179
Identifiable intangible assets $ 95,954 $ (60,743) $ 35,211 $ 105,774 $ (57,033) $ 48,741
Let’s look at another pharmaceutical company, GlaxoSmithKline, a British company.
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The company boldly declares its strategic resources as people’s talent, scientific and
technical know-how, external collaborations and effective supply chain management.
How does this impact financial accounting and reporting? These strategic resources
collectively generate a huge amount of intangible assets. GlaxoSmithKline reported
about 58 percent of intangible assets including goodwill of its total assets in 2017.
As a science-led global healthcare company our three businesses have the common
aim of improving health. On this page we describe the resources we rely on, how our
business activities span the life cycle of a product, and how we create long-term value
for shareholders and society.
Business entities whose success depends

on scientific research, development and
innovation of products and services must
spend huge amount on such scientific research
and innovation in order to meet the complex
demand of the consumers. As discussed
above, a major chunk of their assets is made
up by intangible assets.
There are many such companies in the world
including our own national companies that

engage in scientific research and development. Not only that these companies also
have very strong brand equity.
Consolidated balance sheet Financial statements

as at 31 December 2018 Investor information
Non-current assets Notes 2018 £m 2017 £m

Property, plant and equipment Goodwill and 17 11,058 10,860
Goodwill other identifiable 18 5,789 5,734
Other intangible assets intangible assets 19 17,202 17,562
Investments in associates and joint ventures 20 236 183
Other investments 21 1,322 918
Deferred tax assets 14 3,887 3,796
Derivative financial instruments 42 69 8
Other non-current assets 22 1,576 1,413
Total non-current assets 41,139 40,474
GlaxoSmithKline Annual Report 2018
Statement of Financial Position for the year ended 31st December, 2018
Amount in Nu
Particulars Notes As at 31st December, As at 31st December,
2018 2017
I. ASSETS :
(a) Non-current assets
Property, plant and equipment 2(a) 3,035,956,265 3,353,676,890
Intangible assets 2(b) 1,129,198,308 1,337,580,391
Capital work-in-progress 2(c) 83,416,952 15,077,015
Financial Assets
- Investment in associate 3 - 92,308,400
- Investments 4 190,682,583 124,734,293
Deferred tax assets (net) 5 27,892,024 9,659,869
Other non-current asset 6 1,282,729 -
Total non-current assets 4,468,428,861 4,933,036,858
Software application (21% of
Bhutan Telecom Limited Annual Report 2017
total assets)
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Notes As at As at
ASSETS
Non-current assets
Property, plant and equipment 5 23,038,202,033 21,992,373,551
Intangible assets 6 65,061,864 14,576,623
Investments 7 - 155,590,324
Long-term loans and advances 8 535,714 459,654
Other receivables 9 199,330 199,330
Other non-current assets 10 505,962,594 947,327,154
Total non-current assets 23,609,961,535 23,110,526,636
Note 6: Intangible assets

Computer Software As at As at
Opening gross carrying value (i) 219,106,646 217,176,585
Additions 66,033,794 1,930,061
Closing gross carrying value (ii) 285,140,440 219,106,646
Opening accumulated amortization (iii) (204,530,023) (194,905,716)
Additions (15,548,553) (9,624,307)
Closing accumulated amortization (iv) (220,078,576) (204,530,023)

Net carrying value (ii-iv) 65,061,864 14,576,623
Source: Bhutan Power Corporation limited Annual Report 2018
Statement of Financial Position: as at 31st December 2018 Amount in Nu.

Particulars Note No. 2018 2017
Assets
Non- current assets
Property, plant & equipment 1 41,062,098,514.24 42,312,400,734.10
Intangible assets 1 12,994,358.93 20,915,544.36
Investment property 2 32,000,000.00 32,000,000.00
Deferred tax asset 3 39,640,095.76 30,527,276.28
Investments in subsidiaries and joint
4 6,373,520,668.70 5,207,928,305.22
ventures
Long-Term Investments 5a 788,406,858.80 725,682,631.67
Other assets 5b 847,980.42 667,619.28
Total non - current assets 48,309,508,476.85 48,330,122,110.91
Source: Druk Green Power Corporation Limited Annual Report 2018

4.1 Concept of Intangible Assets

Before defining intangible asset, let’s recall the definition of an asset discussed in
chapter 2 of Class XI Accountancy. An asset is a resource controlled by an entity
as a result of past events, from which economic benefits are expected to flow to the
entity. BAS 38 expands this definition to intangible asset. It defines intangible assets
as “an identifiable non-monetary asset without physical substance”.
Monetary assets are money held in the form of cash and assets to be received in fixed
or determinable amounts of money.
In nutshell, intangible asset has three characteristics:
i. Intangible asset is controlled by the entity.
ii. Intangible asset does not have physical substance unlike property, plant
and equipment.
iii. Intangible asset is identifiable.
Examples of intangible assets include- software license, licensing rights such as to
operate TV/radio, patent and copy rights, brands, trademarks, franchise agreements,
video and audiovisual materials (e.g. motion pictures, television rights), royalty and
database.
Some examples of intangible assets

Before we discuss the accounting aspects of intangible assets, let’s consider
some examples of intangible assets so that we are able to understand the concept
thoroughly.
Let’s take the case of operating system of
computer such as Windows 2016. Does
it fulfill the definition of and recognition
criteria of an intangible asset? Yes, it does.
However, windows is an integral part of the
computer and without windows operating
system, computer cannot run. Therefore,
windows operating system as part of
computer is recognized as property, plant
and equipment.
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Now think about accounting software such as Tally ERP,

MYOB and QuickBooks. Can we recognise these softwares
as intangible assets? They do meet the definition as well
as recognition criteria of intangible assets. Therefore, we
recognize them as intangible assets. However, we must
know that we recognize license to use these software as
intangible asset and not the software itself, because the
computer can operate without these accounting software.
Intangible assets
Computer Software As at As at
Opening gross carrying value (i) 219,106,646 217,176,585
Additions 66,033,794 1,930,061
Closing gross carrying value (ii) 285,140,440 219,106,646
Opening accumulated amortization (iii) (204,530,023) (194,905,716)
Additions (15,548,553) (9,624,307)
Closing accumulated amortization (iv) (220,078,576) (204,530,023)

Net carrying value (ii-iv) 65,061,864 14,576,623
Think about an advertisement. Some

entities argue that advertisement
can create future economic benefits,
and therefore must be capitalized
or recognized as intangible asset.
However, from the definition we
know that intangible asset must be
identifiable from other assets or the
entity. Since advertisement and its
benefits cannot be separated from rest of the business (or sell it to others), cost
incurred on advertisement cannot be recognized as intangible asset. Therefore, it
must be recognized as expense in the statement of income.

Let us consider one more example.

Many people are fans of English
football clubs such as Manchester
United, Real Madrid and Chelsea.
Can the football clubs capitalize
expenditure incurred on buying
players for the club? Obviously, the
value of the player depends on the
fame and popularity of the player that will help the club generate economic benefits
or cash revenues. The fundamental question here is whether the club can control
the player leaving the club if he so desires to move to another club? Well, this can
be applied to contract with employees in the organization. As discussed earlier, an
organization cannot capitalize costs incurred to recruit or develop employees as the
organization cannot control them. However, in the football club, the case may be
different from employees in the organization. For example, a player in the football
club might be prohibited to play in other clubs by a regulation of the club. Moreover,
the contracts with individual players might legally bind the player to stay with the
same club for a number of years. That way, we would be able to demonstrate control
and recognize the player as an intangible asset. Again, remember that an intangible
asset is the ‘right to use’ the player and not the player itself.
4.2 Goodwill vs Intangible Assets

Goodwill is generally interpreted as an intangible asset by many entities as it lacks
physical substance like other intangible assets. However, unlike other intangible
assets such as copy rights and patents, goodwill cannot be separated from other
assets. Goodwill is recognised as of the acquisition date measured as the excess of
consideration paid over net of the identifiable assets acquired and the liabilities
assumed on the date of acquisition. Let’s consider a case where entity A purchases
entity B on 1 January 2019 at a fair value of Nu. 200,000. Entity B has assets worth
of Nu. 180,000 and a liability of Nu. 15,000. Assets and liabilities of entity B are
measured at fair value at the time of acquisition. In the books of entity A, the excess
payment of Nu. 35,000 is recognized as goodwill.
Goodwill is recognised only in a business combination as explained in the case. This
means goodwill does not fulfil the definition of intangible asset as goodwill cannot
be identified from other assets.
An asset is identifiable if it is capable of being separated from the entity and sold,
transferred, licensed, rented or exchanged either individually or together with a
related contract. Intangible assets also arise from legal or contractual rights regardless
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of whether these rights are transferrable or separable from the entity.

Goodwill recognised in a business combination is an asset representing the future
economic benefits arising from other assets acquired in a business combination that
are not individually identified and separately recognised. Therefore, intangible assets
do not include goodwill and goodwill, if recognized, must be reported separately
from other intangible assets. The calculation of goodwill in partnership accounting
is merely to facilitate adjustment of partners account at the time of admission of a
new partner or retirement of the partner. Accounting standards do not recognize
internally generated goodwill.
Goodwill is an intangible asset but not identifiable. Therefore, goodwill is not
accounted under BAS38 Intangible Assets. It is accounted under BFRS3 Business
Combination.
4.3 Acquisition of Intangible Assets

Intangible assets can be acquired through many of ways as listed below.
i. An entity may acquire intangible assets by a separate purchase from the
vendors, like any other assets.
ii. Intangible assets can also be acquired through acquiring another business.
iii. Government may transfer or allocate intangible assets to the entity as a
government grant. For example, government may allocate the right to operate
radio and television to some private operators.
iv. Intangible assets may be acquired by exchange of assets.
v. Many entities also generate its own intangible assets. These are self-created
or internally generated intangible assets. The introductory part of the chapter
discussed on how industries (e.g. pharmaceutical) spend millions of amount
in research and development activities to discover, develop and innovate
new products and designs. These are good examples of internally generated
intangible assets. You must carefully consider the recognition criteria for such
internally generated intangible assets in the later section.
4.4 Recognition criteria of an intangible asset

As you know that a mere fulfillment of a definition of an item does not permit us
to recognize the item in the books of accounts. In other words, in addition to the
definition, an item must meet the recognition criteria given by the standards. The
recognition of an item as an intangible asset requires an entity to demonstrate that
the item meets:
i. the definition of an intangible asset; and
ii. the recognition criteria.

An intangible asset is recognised if, and only if:

i. it is probable that the expected future economic benefits that are attributable
to the asset will flow to the entity; and
ii. the cost of the asset can be measured reliably.
Future economic benefits can be derived either in the form of increased revenue or
reduction in expenses.
4.5 Measurement of an Intangible Asset

An intangible asset is measured initially at cost. The cost of a separately acquired
intangible asset comprises:
i) its purchase price, including import duties and non-refundable purchase
taxes, after deducting trade discounts and rebates; and
ii) any directly attributable cost of preparing the asset for its intended use.
An intangible asset may be acquired in the business combination. In that case, the
acquisition cost of the intangible asset is at its fair value at the date of acquisition.
In the business combination, the acquiring entity may also recognize a group
of complementary intangible assets such as trademarks, formula, recipes and
technological know-how as single intangible asset, if these intangible assets have
same useful lives.
4.6 Acquisition of intangible asset by way of a government grant

Some intangible assets may be acquired by an entity free of cost or at nominal fees
through government grant. There are number of examples of government grants
allocated to business entities. These may include-import license, airport lending
rights, license to operate television or newspapers, import quotas and rights to
have access to certain restricted public resources such as mining. The intangible
asset acquired as a government grant may be initially measured at fair value or
at a nominal amount. If measured at a nominal amount, the entity must add any
directly attributable cost incurred to prepare the item of intangible asset ready for
its intended use.
4.7 Internally generated intangible assets

It is quite usual that some entities incur expenditures to generate future economic
benefits, for example, the expenditure incurred on training and development of
human resources, improvement in business processes and customer relationship
programmes. There is a tendency that an entity may recognize such expenditure
that generates future economic benefits as intangible assets. The issue with this
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approach of recognizing intangible asset is that it is difficult to establish clearly (i)

whether and when there is an identifiable asset that will generate future economic
benefits and (ii) determine the cost of the asset reliably. In many cases it will be
difficult to distinguish between costs incurred directly on the intangible asset and
those incurred for maintaining or enhancing internally generated goodwill or on day
to day operations. Because of this, the expenditure expected to generate intangible
asset in the entity is categorized into (i) a research phase and (ii) a development
phase.
4.7.1 Research phase
Research is original and planned investigation undertaken with the prospect of
gaining new scientific or technical knowledge and understanding.
All expenditure incurred in research phase of the project to develop an intangible
asset are treated as expense when incurred. This is because at a research phase of
the project, the entity cannot demonstrate that an intangible asset exists that will
generate future economic benefits.
4.7.2 Development phase

Development is the application of research findings or other knowledge to a plan
or design for the production of new or substantially improved materials, devices,
products, processes, systems or services before the start of commercial production
or use.
An entity can recognize intangible asset arising from development phase if, and only
if, an entity can demonstrate all of the following:
i. the technical feasibility of completing the intangible asset so that it will be
available for use or sale,
ii. its intention to complete the intangible asset,
iii. its ability to use or sell the intangible asset,
iv. how the intangible asset will generate probable future economic benefits. For
example, the entity can demonstrate the existence of a market for the output of
the intangible asset or the intangible asset itself or, if it is to be used internally,
the usefulness of the intangible asset,
v. the availability of adequate technical, financial and other resources to complete
the development, and
vi. its ability to measure reliably the expenditure attributable to the intangible
asset during its development.
If all of the above conditions are fulfilled, the expenditure incurred on development
phase of the project can be recognized as intangible asset. This is because, at this stage
of the project, the entity can identify the intangible asset that will generate future
economic benefits. Examples of development activities include design, construction

of model, prototype and pilot testing of system, process, product, and devices.
By the same token, internally generated brands, mastheads, publishing titles,
customer lists and items similar in nature are not recognised as intangible assets.
Costs incurred on these activities are treated as expense in the statement of income
and not capitalized.
Brand management cost

is not recognized as an
intangible asset
Source: Bhutan Telecom Limited Annual Report 2017
4.7.3 Costs of internally generated intangible asset

The cost of an internally generated intangible asset is the sum of expenditure
incurred from the date when the intangible asset first meets the recognition criteria.
Remember recognition criteria is at the development phase of the project when an
intangible asset can be identified.
The cost of an internally generated intangible asset comprises all directly attributable
costs necessary to create, produce, and prepare the asset to be capable of operating
in the manner intended by management. These costs include materials consumed,
employee costs and fees to register legal rights.
4.7.4 Measurement after initial recognition

An entity may choose either cost or revaluation model as in the case of property,
plant and equipment in the subsequent years.
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Revaluation Model
Cost Model
4.8 Accounting for Intangible Asset

Accounting for intangible assets remained quite elusive in the past as business
entities struggled to agree on a definition of intangible asset and the controversy of
capitalizing cost. These issues have been largely resolved with the issuance of IAS 38
(equivalence of BAS38 Intangible Assets) way back in 1998 and later revised in 2004.
The accounting of an intangible asset is based on its useful life. The useful life of an
intangible asset can be (i) finite or (ii) indefinite.
4.8.1 Finite useful life
Finite useful life indicates that the intangible asset has a limited period for which
the entity can expect to derive the economic benefits. Imagine about the computer
software and many other intangible assets that are heavily based on technology. Due
to rapid technological changes these software become susceptible to obsolescence
making the useful life of the intangible assets much shorter. Intangible assets such
as licensing rights, franchise agreements, and technological patent rights are subject
to legal contracts. Thus, the useful life of these intangible assets is determined by
the legal contracts. An intangible asset with a finite useful life is amortised over its
useful life. The carrying amount of the intangible asset is calculated as acquisition or
development cost less accumulated amortization and any accumulated impairment
loss of the asset.
Carrying amount of Intangible Asset =
Cost - (accum ulated amortization + accum ulated impairment loss)

The depreciable amount (cost) of an intangible asset with a finite useful life is allocated
in a systematic basis over its useful life. Amortization begins when the asset is
available for use. As in the case of a property, plant and equipment, the amortization
method should be based on the pattern of consumption of the economic benefits of
the asset. When that pattern cannot be determined reliably, the straight-line method
of amortization is used. The amortization is recognized as expense in the statement
of income. The other methods of amortization include diminishing balance method
and the units of production method.
The useful life and the amortization method of the asset must be reviewed at least at
each financial year-end.
4.8.2 Indefinite useful life

Indefinite is not same as infinite. The indefinite useful life of the intangible asset
means that there is no foreseeable limit to the period over which the asset is expected
to generate cash inflows for the entity. Examples include brands, trademarks and
perpetual franchise agreements. An intangible asset with indefinite useful life is not
amortised.
An entity is required to test an intangible asset with an indefinite useful life for
impairment by comparing its recoverable amount with its carrying amount annually
and whenever there is an indication that the intangible asset may be impaired. Also,
the useful life of an intangible asset must be reviewed each period to determine
whether events and circumstances continue to support an indefinite useful life
assessment for that asset.
4.8.3 Residual value of an intangible asset
The residual value of an intangible asset with a finite useful life is assumed to be zero,
unless:
i) there is a commitment by a
third party to purchase the asset at
the end of its useful life; or
ii) there is an active market for
the asset;
iii) residual value can be
determined by reference to that
market; and
iv) it is probable that such a market will exist at the end of the asset’s useful life.
4.9 Derecognition of an intangible asset

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An intangible asset must be derecognised when no future economic benefits are

expected from its use or when the asset is disposed off. The gain or loss on disposal
must be recognized in the statement of income.
Amortisation of an intangible asset with a finite useful life does not cease when the
intangible asset is no longer used, unless the asset has been fully depreciated or is
classified as held for sale which is then accounted in accordance with BFRS5.
Illustration 1
Phuensum City Restaurant (PCR) acquired a new catering business from Lhamo
Restaurant (LR). As part of the acquisition deal, Phuensum City Restaurant obtained
a customers’ list from Lhamo Restaurant. These customers have remained loyal to
LR for more than a decade which the valuers have estimated worth Nu. 1. Million.
The new manager of PCR intends to capitalize this as intangible asset.
Required:
Advise PCR whether they can recognize customers’ list as intangible asset in their
books of accounts.
Solution
Customers list is a list of customers who have remained loyal and repeatedly
subscribed to the goods or services of the entity for a long period of time. One
can argue that this is a potential source of revenue for the business and must be
capitalized. However, whether to capitalize this will depend on (i) whether the asset
is identifiable and (ii) whether it will meet the recognition criteria of intangible
asset. In this case, PCR can neither sell nor transfer the customers list without
selling the whole business as a going concern. In addition, PCR would not have
control over customers list to assure that these customers would continue to be loyal
and economic benefits will flow to the entity. Thus, PCR should not capitalize or
recognize customers list as an intangible asset.
Illustration 2
In the above illustration, Lhamo Restaurant which was given the contract for catering
service by the local schools amounting Nu. 1.2 million was transferred to PCR. It is
not certain whether PCR will be able to sell or transfer the contract to others. PCR
has also learnt that the contract will not be renewed after the expiry of the existing
contract by 30 June 2022.
Solution
The catering service contracts from the local schools are an intangible assets coming
by way of government grants. They are identifiable intangible assets although they
may not be separable or transferred due to a legal contract. The contracts also meet
the recognition criteria since the economic befits are assured and within PCR’s

control. The amount of the contract is also reliably measured as PCR is prepared to
pay them as a separate acquisition.
Illustration 3
ABC Company limited was researching for a medication to treat high level of
cholesterol in the bloodstream. On 1st March 2017, it paid Nu.3,600,000 to acquire
equipment for carrying out research. During 2017 it spent Nu.1,460,000 on research
and in 2018 Nu. 980,000 on developing the prototype of the medication. Nu. 210,000
of the development cost was incurred before 1st March 2018 when the project met
the recognition criteria. Further development cost of Nu. 1,210,000 were incurred
on this project in 2019. The product launched in 2020 with the expectation that its
market will continue for not less than five years. The research equipment is expected
to have a useful life of five years and is depreciated using the straight line method.
Required:
Show how the transactions will be accounted and reported in the company’s financial
statements for 2020.
Solution
Note Amount
Non-current assets
Research Equipment 1 840,000
Development cost 6 2,640,000
Statement of income for the year ending 31 December 2020

Note Amount
Depreciation and amortisation
Depreciation –PPE 720,000
Amortisation on intangible assets 5 660,000
Notes:
1. Equipment – 3,600,000 – 2,760,000 = 840,000 (600,000+720,000*3)
2. Research expense of Nu. 1,460,000 and Nu. 210,000 are expensed in 2017 and
2018.
3. Development cost is capitalized as follows:
2018: 980,000 – 210,000 = 770,000
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2019: = 1,210,000
1,980,000
4. Depreciation for equipment
2018: =600,000 (720,000*10/12)
2019: =720,000
Total Development cost = 3,300,000(1,980,000+600,000+720,000)
5. Amortization of intangible asset ( 2020-2024)
= 660,000 (3,300,000/5 years)
6. Carrying amount of intangible asset for 2020
= 2,640,000 (3,300,000-660,000)
7. Amortisation of intangible asset/development cost starts as soon as commercial
exploitation of it begins (in our case is from 2020) over its useful life where
economic benefits are expected to flow.
4.10 Accounting for Government Grants

The second part of this chapter will introduce learners to accounting for government
grants. Government grants are sometimes known by other names such as subsidies,
subventions, or premiums. There are many entities who receive government grants
either in the form of direct monetary or non-monetary assets and other government
assistance such as marketing services, entrepreneurship development and training
facilities, and other general support. The government subsidy of 50% printing cost of
private newspaper companies (Kuensel, 2018) is a typical example of the government
grants. A few other examples are listed below.
Examples of government grants :
i) Bhutan Trust Fund for Environmental Conservation (BTFEC) as part of
its small grants project awarded four project grants of Nu. 400,000 to four
entities involved in environmental conservation (May 4, 2018, http://www.
bhutantrustfund.bt).
ii) SUNGJAB, an electronic scarecrow to protect crops from wild animals
was given a government grant through Information and Communication
Ministry.
iii) The government approved annual subsidy amount of Nu. 2.725 million to
support 50 percent of the printing cost of private newspapers for a period
of two years. In addition to that, the government through MOIC has also
approved additional Nu 2M annually in the 12th Plan under the budget

head ‘Support to media enterprise’ to be used for capacity and content

development. (Kuensel, 2018).
iv) ADB $ 35 million for health sector development, out of which grant of $
15 million is specifically for a project called Skills Training and Education
Pathway Up gradation Projection. (Kuensel, 2018)
Read the financial statements presented in the following sections and identify
government grants reported in these financial statements of different companies.
II. EQUITY AND LIABILITIES :
(a) Shareholders Fund
Equity share capital 13 854,082,000 854,082,000
Retained earnings & reserves 2,903,751,554 2,938,916,121
Total shareholders fund 3,757,833,554 3,792,998,121
(b) Deferred government grants 14 87,633,714 110,957,565
(c) Non-current liabilities
Financial liabilities
- Long term borrowings 15 602,627,144 648,615,398
- Other non-current liabilities 16 155,400,000 194,250,000
Deferred tax liability (net) 5 - -
Long term provision 17 57,164,638 67,340,966
Total non-current liabilities 815,191,782 910,206,364
Note 28: Depreciation & amortization
Particulars As at 31st As at 31st
December, 2018 December, 2017
Depreciation* 605,754,716 460,260,722
Amortization* 347,081,358 259,405,538
952,836,074 719,666,260
* Depreciation expense has been netted off with amortisation of govt grant Nu. 23,323,850
4.10.1 Definitions
The following definitions are reproduced from the standards to help you to
understand the accounting methods of government grants.
Government refers to government, government agencies and similar bodies
whether local, national or international. In Bhutanese context, government means
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the central government, dzongkhags, gewogs and chiwogs. It also includes all
government funded agencies and international agencies operating in Bhutan. For
example, entities receive grants from ADB and World Bank. Such grants may qualify
as government grants.
Government grants are assistance by government in the form of transfers of
resources to an entity in return for past or future compliance with certain conditions
relating to the operating activities of the entity. All government grants come with
some conditions to be fulfilled by the recipient entity such as the one given in the
above examples. No government grants are awarded as gratuitous.
Government grants exclude those forms of government assistance which cannot
reasonably have a value placed upon them and transactions with government which
cannot be distinguished from the normal trading transactions of the entity.
Government assistance is action by government designed to provide an economic
benefit specific to an entity or range of entities qualifying under certain criteria.
Government assistance does not include benefits provided only indirectly through
action affecting general trading conditions, such as the provision of infrastructure in
development areas or the imposition of trading constraints on competitors.
Note that government grants do not include government assistance. The government
assistance can be seen in the form of technical and marketing support to the entity
whose value cannot be measured reliably. This form of benefits received from the
government is not recognized as income or asset. It is merely disclosed as notes in
the financial statements of the entity.
4.10.2 Recognition criteria of government grants

A government grant is not recognised until there is reasonable assurance that:
i) the entity will comply with the conditions attaching to it, and
ii) the grant will be received.
Receipt of a grant does not of itself provide conclusive evidence that the conditions
attaching to the grant have been or will be fulfilled.
4.10.3 Treatment of government grants

Accounting for government grants depend on the purpose of the grants received.
Government grants can be received either for:
i. Acquisition of assets. These types of grants are called grants related to assets.
These are government grants whose primary condition is that an entity
qualifying for them should purchase, construct or otherwise acquire long-
term assets. Subsidiary conditions may also be attached restricting the type
or location of the assets or the periods during which they are to be acquired

or held, Or
ii. Reimbursement of cost. These types of grants are called grants related to
income. They are government grants other than those related to assets.
4.10.4 Accounting for grants related to assets
Accounting standards specify two methods of accounting for government grants
when the grants are received for acquisition of assets.
i. Deferred income approach, or
ii. Asset approach
Illustration 4
An entity received a government grants to install drinking water from Mawongpa
Water Solution on its premise of Nu. 200,000. The cost of the project was Nu. 315,000
and its useful life is 10 years. An entity acquired the facilities on 1 April 2019 and
charged depreciation on a straight line basis.
Solution
You will understand that this grant is related to acquisition of property, plant
and equipment. We can account and report under two methods for this type of
government grants.
i. Government grants treated as deferred income
When we use this method, government grant received is credited to deferred income
(this means that an income has been received in advance) and amortise it over the
useful life of the asset in order to match grant income with the relevant cost. As in
the case of property, plant and equipment, the relevant cost here is the depreciation
charges).
Journal entries
Date Particulars L/F Debit Credit

1.1.2018 Cash/bank A/c 200,000
To Deferred Income 200,000
31.12.2018 Deferred income A/c ** 15,000

To Income from government grants 15,000
(adjustment entry)
** Deferred income recognized as income (depreciation charges) = (200,000/10)/12*9

months = 15,000
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Amount
Equity and liabilities
Non-current liabilities
Deferred Government grants 185,000
Statement of income for the year ended 31 December 2019

Amount
Other income
Government grants 15,000
ii. Deduction from an asset
In this method, we calculate carrying amount of the asset by deducting the grants
received from the cost of asset acquired. This means, the recognition of grants in
statement of income is automatically reflected in depreciation charges. This will
give us Nu. 115,000 as the carrying amount of the facilities (315,000-200,000) upon
initial recognition.
The annual depreciation charge is Nu. 8,625 [315,000-200,000]/10*9/12
Journal entries
Date Particulars L/F Debit Credit
1.1.2018 Cash/bank A/c 200,000

To PPE-water solution facilities 200,000
31.12.2018 Depreciation A/c 8,625

To PPE- water solution facilities 8,625
Illustration 5
Bhutan Trust Fund for Environmental Conservation (BTFEC) as part of its small
grants project awarded grants of Nu. 400,000 to an entity for environmental
conservation activities during 2018-2022. The entity spent Nu. 100,000 in 2018. A
total of Nu. 600,000 is estimated to incur in the project.
Solution
This grant is the case of grant received to reimburse the expenses for environmental
conservation activities in 2018-2022. What is important in this method is the entity
needs to recognize the income from grant in the periods when relevant expenses are
incurred.

Journal entries
Debit Credit
Cash/Bank A/c 400,000
To Deferred Grant Income 400,000
Deferred Income A/c 66,667***

To Grant income 66,667
*** (Total spent/Total cost of project/asset) x Government grants received.
Illustration 6
Let’s assume that the entity received a grant of Nu. 1 million on 1 January 2019 to
cover or compensate the expenses incurred on environmental conservation project
undertaken by the entity in 2016-2018.
Solution
In this case the grant is received to compensate the expenses already incurred by
the entity. Since the expenses have been already incurred in the previous accounting
year, the grants received will be immediately recognized as expense in the year when
the grant is received.
Journal entries
Debit Credit
Cash/Bank A/c 1 million
To Deferred income 1 million
Deferred income A/c 1 million

To Income statement 1 million
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Exercises:
1. In a group of 2-3 students, complete this learning activity and share your results
with the class.
Dragon Tours and Treks (DTT) was in the business for twenty years. It has seen
the changing landscape of the tourism industry in the country. Today DTT
has established almost 45 percent of market share. Recently, an international
firm from Switzerland proposed a deal to buy DTT. In the proposal, there was
not anything on the brand and logo of DTT which DTT management is very
concerned about. DTT management feels that its brand and logo should be
fairly priced and form part of the consideration.
Required:
Assess whether DTT management can value their brand and add to the
consideration of the acquisition.
2. A local firm was contracted by an international firm to research and develop a
hybrid plant that can adapt to a local climate. If successful, this will be launched
as commercial undertaking which is expected to last for at least 10 years. All
research and development costs will be fully reimbursed by the international
firm. During the year ended 31st December, 2019, a total expenditure of Nu.
670,000 were incurred to carry out the project. The project will continue
for another 2 years. If successful, the patent right of the hybrid plant will be
automatically owned and controlled by the international firm.
Required:
Explain how this cost will be treated in the books of the local firm when they
prepare the financial statements for the year ended 31 December 2019. Share
your workings with the class.
3. In a small group of 2-3 students discuss the following questions and present the
outcome of your discussion to the class.
i. Company A acquired a popular brand name as part of business acquisition
which is expected to have a useful life of 50 years. Discuss how this will be
accounted in the books of Company A.
ii. Company B regularly supplied free goods and gifts to its customers to
maintain customers’ loyalty. Discuss how this will be accounted as per
accounting for intangible asset rules.
iii. Company C conducted research to improve its product in the market and
incurred Nu. 1.5 million. Discuss how this cost will be treated in the books of
Company C and reported.

4. XYZ Limited produces school shoes and supplies to all central schools in
Bhutan. It received a grant of Nu. 800,400 in 2018 from the UNICEF Thimphu
office. This grant will be used to meet the operating expenses of the company
for 2018-2020 when they produce school shoes to central schools. 30% of the
grant will be used in 2018. The company estimates a total operating cost of Nu.
1.8 million over 2018-2020.
Required:
i. Identify the type of grant received by XYZ limited.
ii. Explain how the grant received will be accounted in the books of XYZ
limited. Write entries as well.
5. LNT limited is an export company. It received a government grant of Nu. 2.5

million to construct a warehouse on 30 June 2018. The warehouse will have an
estimated useful life of 50 years over which it will be depreciated using a straight
line method. The construction last for 6 months in 2018 and was put into use
from 1 January 2019. The company incurred Nu. 3 million as construction cost.
Required:
Account for grant correctly using the method of deferred income. Prepare the
extracts of financial statements showing the grants in the appropriate financial
statements.
6. LNT limited in learning activity 2 received a week-long training in marketing

sponsored by the agriculture marketing department. Thirty employees of the
company attended the training in ‘export marketing and how to be a good
marketer in international business’ from 15 October -21 October 2018.
Required:
Discuss the nature of government assistance in this case and explain how this
information will be presented in the financial statements of LNT Company for
2018 reporting.
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Chapter 5: Liability, Provisions and Contingencies
Chapter 5
Liability, Provisions and
Contingencies
• Explain the concept and recognition criteria of liability.

• Explain the concept of provisions and when a provision needs to be created.
• Calculate and record provision.
• Explain the concept of contingent liability and contingent asset.
• Differentiate between liability, provision and contingent liability.
• Identify disclosure requirement of contingencies in financial statements.
The disclosure of provisions, contingent liabilities and contingent assets has been an
area of much debate in the field of accounting. In particular, the accounting treatment
of provisions has been criticized for being used as an earnings management tools.
‘Earnings Management’ is a term used to describe manipulation of the recognition
of revenue and expenses items to smooth out fluctuations in profit or to achieve
predetermined profit results. When provision is used for income smoothing, the
financial statements will provide misleading information.
The introduction of BAS 37 has addressed these issues in the best interest of the
stakeholders. This chapter deals with the recognition criteria of liability, concept of
provisions, treatment of contingent liabilities and contingent assets, and will further
discuss on the disclosure requirement of contingencies in financial statements.
5.1 Liability
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. (BAS 37, para. 10).
An obligating event is an event that creates a legal or constructive obligation that
results in an entity having no realistic alternative to settling that obligation.

5.1.1 Recognition Criteria of Liability

Apart from satisfying the definition of liability, the following criteria have to be
fulfilled before a liability can be recorded in financial statement:
a. The outflow of resources embodying economic benefits (such as cash) from
the entity is probable.
b. The cost / value of the obligation can be measured reliably.
The first test requires liability to be recognized only if it is likely that the entity
will be required to settle it. The second test ensures that only liabilities that can be
objectively measured are recognized in the financial statements.
Trade Payable
There is a present obligation as a result

of past events. Goods were purchased Settlement requires an outflow of
on credit because of which at present economic benefits in future (Cash)
there is obligation to make a payment.
Figure 5.1 Represents the use of recognition criteria for liability:
Hence, Debit Inventory Account and Credit Trades Payable if the cash payment is
probable and the amount can be measured reliably.
5.2 Provision
A provision is a liability of uncertain timing or amount. How is provision different
from a liability? As we discussed in the previous section, the liability is a present
obligation and both the timing when to settle the liability and the amount of liability
to be settled are known to the entity at the date of reporting. Provision is also a
present obligation. However, in provision, there is an uncertainty about the timing
or amount of the future expenditure. Whilst uncertainty is clearly present in the case

of certain accruals such as trade receivables and loans receivables, the uncertainty
is generally much less than for provisions. In such situation, what the entity can do
is to make the best estimate of the amount that it may need to settle the obligation.
Provision = Liability + Uncertainty
Illustration 1
Dejung Graphics and Printing firm started a printing business on 1 January 2019 by
acquiring a printing machines at Nu. 480,000. The useful life of the printing machine
is estimated at 10 years and the total cost of repair and maintenance during the
whole life estimated at Nu. 120,000. Accordingly, in the financial statements from
the year ended 31 December 2019, they have depreciated the machine by Nu.48, 000
and have, in addition, set up a provision for machine repair and maintenance of Nu.
12,000. The actual cost of repair and maintenance for the year was Nu. 3,200 which
was adjusted with provision.
Explain whether the accounting for provision was made correctly.
Solution
The accounting for the provision is wrong because there is no present obligation on
the reporting date. The cost related to future repair and maintenance is not a present
obligation and is not permitted to set up a provision. The obligating event is the need
to repair and since it has not arisen at the date of reporting there is no past event
triggering the obligation. Moreover, there is no certainty in the amount of obligation
and the timing to settle the obligation. The repair and maintenance of the printing
machine in future may be quite obvious, however, the entity cannot be certain about
when such repair need to be carried out. It could also happen that the entity may
avoid repair by replacing the machine with a new one.
5.2.1 Recognition criteria of provisions

A provision should be recognized as a liability in the financial statements when:
a. An entity has a present obligation (legal or constructive) as a result of a past
event
b. It is probable that an outflow of resources embodying economic benefits will
be required to settle the obligation
c. A reliable estimate can be made of the amount of the obligation
5.2.2 Present obligation from a past event
This rule has two parts, first the type of obligation, and second, the requirement for
it to come from a past event (something must have already happened to create the

obligation).
a. Types of obligation
The obligation could be a legal or contractual one, arising from a court case or some
kind of contractual arrangement.
The second type of obligation is called a constructive obligation. A constructive
obligation is an obligation that derives from an entity's actions where:
a. by an established pattern of past practice, published policies or a sufficiently
specific current statement the entity has indicated to other parties that it will
accept certain responsibilities; and
b. as a result, the entity has created a valid expectation on the part of those other
parties that it will discharge those responsibilities.
Illustration 2
ABC Co. has published an environmental policy to replant trees in order to counter-
balance the environmental damage resulting from its operations. It has a consistent
history of honoring this policy. During 2018, it opened a new factory, leading to
some environmental damage estimated at Nu.400, 000 for restoration works.
Even if the country has no legal regulations forcing ABC Co. to replant trees, it will
have a constructive obligation because it created an expectation from its publications,
practice and history.
b. Past event
The obligation should be a result of a past event, rather than simply something which
may or may not arise in the future.
Illustration 3
ABC Co. would have to provide for a potential legal case arising from an employee
who was injured at work in 2018 due to faulty equipment. This is because the event
arose in 2018 which could lead to an obligation.
Suppose, if ABC Co. has to pay to install new safety equipment in the factory in
2019, there is no present obligation to do this in 2018, so no provision is required.
ABC Co. could delay the work until 2019.
5.2.3 Measurement of provisions

The amount recognised as a provision should be the best estimate of the expenditure
required to settle the present obligation at the end of the reporting period.

The estimate is made by the judgement of the entity’s management using the past
experience and the surrounding circumstances. Generally, the amount of provision
is measured by using the following methods:
i) Expected value method.

If the obligation involves large number of population of items or a number of
expected outcomes, the provision is estimated by weighting all possible outcomes
by their associated probabilities, i.e. expected value.
ii) The most likely outcome
If the obligation involves single outcome or item, such as the court case, the most
likely outcome method is used. Generally, if the chance of having the obligation is
more than 50%, we recognize the provision.
Illustration 4 - best estimate:
ABC Co. has received legal advice that the most likely outcome of the court case
from the employee is that, they will lose the case. The Company’s legal advisor
thinks that there is an 80% chance of paying Nu.10m, 12% chance of having to pay
Nu. 12m, and 8% chance of paying nothing.
In this case, ABC Co. would provide Nu. 10m, being the most likely outcome. It
will not be uncommon to take the Nu. 12m, thinking that the worst-case scenario
should be provided for.
Illustration 5 – expected value:

ABC Co. gives a year’s warranty with all goods sold during the year. Past experience
shows that ABC Co. needs to do no repairs on 85% of the goods. On average, 10%
need minor repairs, and 5% need major repairs. ABC Co’s manufacturing manager
has calculated that if minor repairs were needed on all goods, it would cost Nu.
100,000 and major repairs on all goods would cost Nu. 1m.
Here, the provision would be measured at Nu. 60,000. The expected cost of minor
repairs would be Nu. 10,000 (10% of Nu. 100,000) and the expected costs of major
repairs is Nu. 50,000 (5% of Nu.1m). This is because there will not be a one-off
payment, so ABC Co. should calculate the estimate of all of the likely repairs.
d. Probable outflow
There is no specific list of what percentage of likelihood is required for an outflow
to be probable. A probable outflow simply means that the probability an event will
occur is greater than the probability that it will not.

Illustration 6 – Likelihood:
ABC Co’s legal advisors continue to believe that ABC Co. will lose the court case
against the employee and have to pay out Nu. 10m. However, it has come to light
that ABC Co. may have a counter claim against the manufacturer of the machinery.
The legal advisors believe that there is an 80% chance that the counter claim against
the manufacturer is likely to succeed, and believe that ABC Co. would win Nu. 8m.
In this case, ABC Co. would include a provision for the Nu.10m loss in liabilities.
5.2.4 Effect of time value of money on provision

Where the effect of the time value of money is material, the amount of a provision
should be the present value of the expenditure required to settle the obligation. An
appropriate discount rate should be used.
Illustration 7
Suppose ABC company constructed a manufacturing plant on a 5 years period of
a leased land. The company has a practice of cleaning up all environment after it
ceases the operations in the place. The company lawyer estimated a cost of Nu.2.5
million. The provision to be made now will be the present value of Nu. 2.5 million in
5 years time. Assuming the relevant discount rate in this case as 10%.
The provision to be made for the current year will be:
2,500,000 x 0. 621 (10% discount rate) = Nu. 1,552,500
The following year provision will be:
2, 500,000 x 0. 683 = Nu. 1,707,500
The difference of Nu. 155,000 (i.e. 1,552,500 – 1,707,500) will be charged to income
statement.
This is called the unwinding of the discount. This is accounted for as a finance cost.
1st year
Income statement a/c Dr 1,552,500
To provision for environmental clean cup 1,552,500
2nd year
Finance cost a/c Dr 155,000 (IS)
To Provision for environmental cleanup a/c 155,000 (SOFP)
The unwinding of the discount effectively increases the provision each year to reflect
the passage of time. After one year has passed, Nu. 1,552,500 is no longer sufficient
to settle the Nu.2, 500,000 liability in four years’ time. The value of Nu.2, 500,000
after one year would now be Nu.1, 707,500. Therefore, the entity must increase the

provision by Nu. 155,000 in the second year (i.e. the difference between first year
and second year), and so on till the last year of the provision.
The provision must be reviewed at each reporting date and adjusted to reflect the
current best estimate. If it is no longer probable that an obligation will be required
to settle, the provision should be reversed.
Provision for environmental cleanup Dr

To Income statement
5.2.5 Use of provisions

A provision should be used only for expenditures for which the provision was
originally recognised. Meeting expenditures against a provision that was originally
recognised for another purpose would mislead the financial statements.
5.2.6 Future operating losses

Provisions should not be recognised for future operating losses. They do not
meet the definition of a liability and the general recognition criteria set out in the
standard. Therefore, it is inappropriate to set provision for future doubtful debts and
an expected decrease in the value of inventories.
5.2.7 Provisions should not be exaggerated

As discussed in the previous sections, the amount of provision should be the best
estimate at the reporting date of the amount necessary to settle the obligation.
When creating a provision, the entity must consider risks and uncertainties. The
entity must make sure that they do not create excessive provisions to deliberately
overstate the liability and understate the reported profits. This issue is discussed in
the beginning of the chapter.
5.2.8 Onerous contracts

An onerous contract is a contract in which the unavoidable costs of meeting the
obligations under the contract exceed the economic benefits expected to be received
under it.
If an entity has a contract that is onerous, the present obligation under the contract
should be recognised and measured as a provision. For example, if ABC company
has entered in to a lease contract for 5 years and required to pay a lease rent of Nu.
100,000 per year. The lease contract provides that the lease if terminated before the
lease period, the entity will pay the full lease payment for 5 years as if the contract has
been honoured. What if ABC company decide to terminate the lease after one year?
In that case, ABC company is said to have entered into an onerous contract. This
would require ABC company to pay a total lease rent of Nu. 400,000 for remaining 4
years as a penalty for terminating the lease contract. Therefore, ABC company must
create a provision to meet this expenditures.
5.3 Contingent Liabilities

Contingent liabilities are defined as:
a. a possible obligation that arises from past events and whose existence will be
confirmed only by the occurrence or non-occurrence of one or more uncertain
future events not wholly within the control of the entity; or
b. a present obligation that arises from past events but is not recognized because:
i) it is not probable that an outflow of resources embodying economic
benefits will be required to settle the obligation; or
ii) the amount of the obligation cannot be measured with sufficient
reliability.
Contingent liabilities should not be recognized in financial statements but should
be disclosed as notes unless the possibility of an outflow of resources is remote. The
disclosure must provide:
a. A brief description of the nature of the contingent liability,
b. An estimate of its financial effect,
c. An indication of the uncertainties that exist, and
d. The possibility of any reimbursement.
Generally, probable means more than 50% likely. If an obligation is probable, it is
not a contingent liability. Instead, the entity must set a provision.
Contingent liabilities are assessed continually to determine whether an outflow
of resources embodying economic benefits has become probable. If it becomes
probable that an outflow of future economic benefits will be required for an item
previously dealt with as a contingent liability, a provision is recognized in the
financial statements of the period in which the change in probability occurs (except
in the extremely rare circumstances where no reliable estimate can be made).

Table 5.1 Summarizes the key requirements of BAS 37 in relation to contingent

liabilities
Obligation/Probability Treatment
Obligation and probability of outflow of Accounting treatment in accordance
economic benefits with BAS 37
Present obligation that probably requires an A provision is recognized.
outflow of resources
Present obligation that may (but probably will Disclosed as a contingent liability.
not) require an outflow of resources
Present obligation where the likelihood of No disclosure required.
outflow of resources is remote
Possible obligation Disclosed as a contingent liability.
Illustration 8 - Provision Vs Contingent Liabilities:

During the year 2011, ABC Co. was sued by the community for health related issues
due to contamination. At the end of the year, the lawyer advised that it is likely the
company would not be found liable.
The above case implies possible obligation. Hence, it should be disclosed as
contingent liability unless the chance of payment is remote.
At the end of 2012, the lawyer advised ABC Co. that due to further developments in
the case, it became probable that the company would be found liable.
Here the present obligation exists, hence, a provision is recognized if the amount of
damages can be reliably estimated. (Dr. Expenses, Cr Provision)
However, if the amount of damages cannot be reliably estimated, it should be
disclosed as contingent liability unless the chance of payment is remote.
It is important to know the difference between provisions and contingent liabilities

and be able to apply it correctly when producing financial statements. A provision is

a liability with uncertain timing or amount but it satisfies the definition of a liability
and most importantly, it satisfies the recognition criteria.
A contingent liability on other hand either does not satisfy the definition of a liability
or recognition criteria of liability.
NO NO
YES YES
NO YES
YES NO
NO (rare)
YES
Figure 5.2 Decision Tree to summarize the main recognition requirements of the
BAS 37.
5.4 Contingent Assets

Contingent Assets are possible assets whose existence will be confirmed only by the
occurrence or non-occurrence of one or more uncertain future events not wholly
within the control of the entity.
Contingent assets are not recognized in the statement of financial position. They are
disclosed in the notes to the financial statements. An example of contingent asset
is a claim that an entity is pursuing through legal processes, where the outcome is
uncertain.

Illustration 9
Jattu Transport Company lost a consignment worth Nu.3 million during transit of
goods from Thimphu to Kolkata. It is however, covered by an insurance policy from
RICBL. Before year-end, Jattu Transport Company received a letter from RICBL
that a Cheque was in the mail for 90% of the claim.
Kendhen Co. that entrusted Jattu Transport Company with the delivery of the
consignment has filed a lawsuit for Nu.3 million along with consequential damage
of Nu. 1 million resulting from delay. According to the legal advisor of Jattu
Transport Company, it is probable that the company has to pay Nu. 3 million, but it
is a remote possibility that it would have to pay additional Nu. 1 million since it was
not mentioned in the contract.
Requirement:
What provision or disclosure would Jattu Transport Company need to make?
Solution:
The Jattu Transport Company need to recognize contingent asset of Nu.2.7 million
(Nu.3 million X 90%), that is the amount which is virtually certain. Further, it
also needs to make a provision of Nu.3 million towards the claim of Kendhen Co.
However, the probability of claim of Nu.1 million is remote; hence, no provision or
disclosure would be required.
Illustration 10
During 2019, ABC limited company gives a guarantee of certain borrowings of XYZ
limited company, whose financial condition at that time is sound. During 2020, the
financial condition of XYZ limited company gets worse and at 31 December 2020,
XYZ limited company files for protection from its creditors.
What accounting treatment is required in the books of ABC limited company:
a. At 31 December 2019
b. At 31 December 2020?
Solution
a. At 31 December 2019, there is a present obligation as a result of a past obligating
event. The obligating event is the giving of the guarantee, which gives rise to
a legal obligation. However, at 31 December 2019, no transfer of resources
is probable in settlement of the obligation. No provision is recognised. The
guarantee is disclosed as a contingent liability unless the probability of any
transfer of resource is regarded as remote.
b. At 31 December 2020, as above, there is a present obligation as a result of a past

obligating event, namely the giving of the guarantee. At 31 December 2020, it

is probable that a transfer of resources will be required to settle the obligation
as XYZ limited company is seeking protection from creditors. Therefore, there
is a need to recognize a provision for the best estimate of the obligation.
Table 3.2 Summary of the key requirements of BAS 37 in relation to contingent
assets:
Probability Treatment
Probability of inflow of economic Accounting treatment in accordance with BAS
benefits 37
Virtually certain When the realization of income is virtually
certain, the asset is not a contingent asset and it
is appropriate to recognize the asset.
Probable (but not virtually If future benefits are probable, but not virtually
certain) certain, contingent asset is disclosed.
Not probable If, inflow of economic benefits are not probable;
no disclosure is required for the contingent
assets.
5.4.1 Disclosure
Contingencies are disclosed in the form of notes in the financial statements while
provisions are recognized in the statement of financial position. Table XXX is the
sample of financial report of Indian Oil Corporation Limited, 2017 -2018 exhibiting
how contingencies and provisions are treated.
BALANCE SHEET AS AT MARCH 31, 2018

(In Crore)
Particulars Notes No. March-2018 March-2017
Current Liabilities
a) Financial Liabilities
i) Borrowings 21 36,807.56 30,072.76
ii) Trade Payables 22 33,106.05 30,134.29
iii) Other Financial Liabilities 17 40,815.69 36,348.12
b) Other Current Liabilities 20 10,991.38 12,775.47
c) Provisions 18 14,161.60 18,924.73
d) Current Tax Liabilities (Net) 7 - 56.97
135,882.28 128,312.34
Total 280,739.91 259,213.27

NOTE-18: PROVISIONS
Non Current Current

March-2018 March-2017 March-2018 March-2017
Provision for Employee Benefits 2,019.66 2,923.38 293.03 373.69
Decommissioning Liability A 3.66 3.60 - -
- - 32,320.69 36,418.41
- - 18,452.12 17,867.37
13,868.57 18,551.04
TOTAL 2,023.32 2,926.98 14,161.60 18,924.73
B. CONTINGENT LIABILITIES
B.1 Claims against the Company not acknowledged as debt
Claims against the Company not acknowledged as debt amounting to 8025.58 crore
(2017: 9251.66 crore)
D. CONTINGENT ASSETS
(in Crore)
March-2018 March-2017
a. A customer had lodged a claim against the company challenging the pricing 112.98 96.00
mechanism of utilities provided. The matter was referred to arbitration and award
was given in favour of the company. During the year Customer has approached
Honourable High court challenging the award of arbitration and the case is pending
with Honourable High court for final adjudication. Honourable High court vide its
interim orders dated 28.08.2017 and 19.04.2018 has directed the customer to deposit
the principal amount and interest amount respectively in the Registry of the court.
Court has also directed that the amount deposited by the customer shall be released
to the company upon furnishing an unconditional Bank Guarantee of the equivalent
amount. The management has treated a portion of the same as contingent asset
pending adjudication of matter with Honourable High Court.
b. Contingent Asset in respect of M/s Khazana Projects and Industries (P) Ltd. for the 3.48 3.36
amount of risk & cost claim along with 15% supervision charges admitted by the
Arbitrator in favour of the company.
Indian Oil Corporation Limited. (2018). Annual report
Exercises:
Choose the correct answer
1. In relation to provisions, for a present obligation to exist, which one of the
following factors must be present?
A The entity must have a legal obligation.
B There should be a future outflow of economic benefits.
C The obligation must be capable of being reliably measured.
D The entity must have no realistic alternative to settling the obligation.

2. ABC Co. is involved in legal dispute with a supplier. The supplier is seeking
damages of Nu. 100,000. ABC’s lawyers have advised that it is 90% probable
that the entity would not be found liable. Which one of the following is most
appropriate option for ABC Co. when preparing its financial statements?
A Do nothing.
B Disclose it as contingent liability.
C Recognize it as a provision in a financial statement.
D Recognize it as a contingent liability in a financial statement.
3. An oil industry causes contamination and operates in a country where there is
no environmental legislation. However, the enterprise has a widely published
environmental policy in which it undertakes to clean up all contamination that
it causes. The enterprise has the record of honoring this published policy.
Which one of the following is most appropriate option for oil industry when
preparing its financial statement?
A Do nothing since there is remote possibility of payment.
B Disclose it as a contingent liability since there is no legal obligation to make
a payment.
C Disclose it as a provision in the notes of the financial statements since there
is no legal obligation.
D Recognize it as a provision since there is an obligating event, which give rise
to a constructive obligation.
4. An entity is taking legal action against its competitor for patent infringement
relating to a patent that had been granted to the entity on one of its products.
The outcome of the case is uncertain. However, it is probable that the court will
order the competitor to pay damages to the entity.
Which one of the following is the best option for the entity?
A Neither asset should be recognized nor contingent asset, should be disclosed.
B Recognize it as an asset since it is virtually certain that it will receive
economic benefits.
C Disclose it as a contingent asset since inflow of economic benefits is probable,
but not virtually certain.
D Recognize it as a provision since there is a chance that the court would rule
in favour of the competitor.
5. A company sells goods with a warranty for the cost of repairs required in the
first two months after purchase. Past experience suggests:
88% of the goods sold will have no defects
7% will have minor defects
5% will have major defects

If minor defects were detected in all products sold, the cost of repairs will be
Nu. 24,000; if major defects were detected in all products sold, the cost would
be Nu. 200,000. What amount of provision should be made?
A Nu. 1,680
B Nu. 10,000
C Nu. 11,680
D Nu. 197,120
Extended Learning Question

1. The following are likely to be provisions within the scope of BAS 37. Justify.
a. Obligation to repair or replace goods sold if found defective.
b. Warranty provided for a car sold by a supplier.
2. Paldon Electronics faces 100 warranty claims relating to sale of mobile phones.
For each claim, there is a 20% chance that it will not cost the entity anything.
There is 80% chance that the cost of each claim will be Nu.100. Using the
expected value method, calculate the best estimation of provision.
3. Sonam Electronics faces warranty claims relating to sale of mobile phones. It is
determined that there is a 20% chance that it will not cost the entity anything.
There is 80% chance that it will cost Nu. 100. Calculate the amount of provision.
4. Do you believe that the reporting of contingent assets will have an effect on the
decisions of stakeholders? Why?
5. A retail store has a policy of refunding purchases made by dissatisfied customers.
Even though it is under no legal obligation to do so, its policy of making
refunds is generally known. Should provision be recognized? Justify using the
recognition criteria.
Case Study 1
SDP shop in Thimphu receives a claim for Nu. 50,000 from a customer in respect
of injuries suffered when the customer slipped on the wet floor of the shop. The
claim is submitted at the court. The shop’s defense was that there was a wet floor
signpost to warn the customers. However, since the shop floor was poorly lighted,
all customers blamed that the signpost was hardly visible. The legal opinion is that
the damages could range from Nu.5,000 to Nu. 7,000 depending on the court’s
opinion on the extent of blame to be attached to the SDP shop.
Required:
1. Differentiate between ‘liability’ and ‘provision’.

2. Discuss whether there is a present obligation arising from past event in the
above case.
3. Should provision be recognized?
Case Study 2
Sheka Enterprise deals with cosmetic products located in Haa. Dawa is a regular
customer who buys face cream from Sheka Enterprise. Of late, Dawa had sued Sheka
Enterprise, seeking damages for skin burn sustained from using the cream. Sheka
Enterprise disputes liability on grounds that the customer did not follow directions
in using the product.
Up to date, the board approved the financial statements for the year ending 31
December 2011; and the entity’s lawyers advised that it is probable Sheka Enerprise
will not be found liable. However, when the enterprise prepares the financial
statements for the year ending 31 December 2012, its lawyers advised that, owing
to developments in the case, it is now probable that the entity will be found liable.
Required:
1. Should provision be recognized on 31 December 2011? Why?

2. Should provision be recognized on 31 December 2012? Why?

Chapter 6: Accounting for Equity Shares and Debt Finance
Chapter 6
Accounting for Equity Shares
and Debt Finance
• Explain the concept of equity capital and the characteristics of equity shares
• Differentiate between equity shares and preference shares,
• Explain the concept of debt finance and the characteristics of debt securities,
• Differentiate between equity and debt securities,
• Discuss the advantages and disadvantages of debt finance, and
• Record equity (including issue of bonus and rights shares) and debt capital
transactions and report them in the financial statements.
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6.1 Conceptual Background

Let us recall the knowledge of accounting equation that we have learnt in chapter 3
in Class XI Accountancy. Accounting equation presents three aspects in business.
These are: (i) assets, on one side of the equation (ii) equity and (iii) liabilities on
the other side of the equation. This equation is balanced at any point of time. That
means, the total of the economic resources of the business is equal to the sum of
owners contribution and the contributions made by others other than the owners
or members of the business. The contribution from member or owner represents
equity and the latter part of the contribution from others represent debt finance of
the business.
So far, we have covered many items of assets, liabilities, income and expenses related
to the business. Especially in the introductory part of class XI Accountancy we
discussed quite at length the recording of those items. That time we used mostly the
term transaction or events rather than assets, liabilities, equity, income and expenses.
However, as we progress on to class XII, our discussion focus more on these aspects
of economic resources and claims against the business from the resource providers.
Recall the objectives of financial accounting and financial reporting in business.
Business entities are economic units that organize resources and carry out economic
activities and at the year end the business entity must report their performance to
those resource providers or the equity and debt providers, particularly if the business
entity is not operated by the owner himself/herself. Assets are present economic
resources which are expected to be used by business to generate income either
by itself or to be combined with other assets to generate income for the business.
Liabilities are present obligations for providing economic resources or services to
the business. These liabilities are also time bound obligations, that means, business
must settle these obligations within a certain time period. When business settle
these liabilities, there will be an outflow of economic resources which will result in
to a decrease of assets in the business. Thus, a business will see a continuous change
in the amount of assets and liabilities as and when it carries out economic activities
which we have been calling it as business transactions or events.
Also, reflect on those assets and liabilities in the business. Not all the assets in the
business are the same. Similarly, liabilities differ from one to another. For example,
property, plant and equipment is an asset. However, by nature and so by definition,
PPE is a physical asset which is used in the production of goods or providing
of services to the customers, or a business uses such asset to as owner occupied
for administrative functions or to earn a short term rental income. PPE can be
clearly differentiated from the inventory. Inventory is also an asset with physical
substance. However, inventory is held by a business for the purpose of sale or used
in the production of another type of inventory. What about intangible assets such
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as purchased brand, patent, legal rights etc.? These are also assets but the major
difference with the former assets is that intangible asset does not have a physical
substance and some of the intangible assets do not have a finite life such as brand
and trademarks.
Now let us think about a case where a business is acquiring some shares or securities
issued by another business entity or by a government (e.g. a government treasury
bond). Many business entities also continuously depend on the borrowed funds
either from banks or other money lenders. If a business has surplus cash, it might
decide to invest in corporate bonds, commercial papers and other loan notes, as
well as invest in fixed term deposits with commercial banks. We will not touch
on complex financial arrangements that create a lot of financial products which
we will call it later as financial assets and financial liabilities. In this chapter, we
will introduce some of the important concepts on financial instruments, financial
assets and financial liabilities. And accordingly, we will discuss and illustrate the
accounting methods for these types of assets and liabilities in line with the current
accounting standards.
6.2 Financial Instrument

Before we discuss the concepts on financial assets and financial liabilities, let us
understand the concept of financial instrument. Financial instruments are notes,
document or certificates that carry a promise to pay or receive certain amount of
money after a certain period of time. Financial instrument thus involve two or more
than two parties because one party will promise to pay and another party will have
the right to receive that amount from a party who promises to pay the amount on a
certain time. The promise to pay and the right to receive the payment thus give rise
to a contract, that is, an agreement that one party promises to pay and the other party
has the right to receive the payment on a certain time. Once the contract is created,
then it becomes legally enforceable especially under the contract act of the country.
For example, in Bhutan, such contracts can be enforceable under The Contract Act
of the Kingdom of Bhutan 2013 (འབྲུག་གི་འགན་འཛིན་བཅའ་ཁྲིམས་ སྤྱི་ལོ་ ༢༠༡༣).
The Contract Act of the Kingdom of Bhutan 2013 defines contract as:
An agreement shall amount to a contract and shall be enforceable at law if it is made

with the free consent of competent parties for a lawful consideration and for a lawful
object and is not declared to be void or illegal by this Act or by any other law in force
in the Kingdom of Bhutan (Para 16).
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A contract is an agreement between two or more parties that creates enforceable

rights and obligations. Enforceability of the rights and obligations in a contract is
a matter of law. Contracts can be written, oral or implied by an entity’s customary
business practices. The practices and processes for establishing contracts with
customers vary across legal jurisdictions, industries and entities.
6.2.1 Definition of Financial Instrument
Financial instrument (also called securities) is a contract that gives rise to a financial
asset of one entity and a financial liability or equity instrument of another entity.
This definition underlines the importance of a contract in accounting for a financial
instrument. Without a valid contract we cannot account a financial instrument.
When a business enters in to a contract with its customer to sell a goods, business
entity promises to deliver the goods as agreed and the customer promises to make
the payment or consideration to the business entity. This leads to a formation of a
contract and the parties to the contract are expected to perform their obligations
as agreed in the contract. In this contract, once the business entity delivers the
promised goods to the customer, customer will become liable to make the payments,
i.e. the consideration; and the business entity will become entitled to receive the
payments. Therefore, the business entity will have the contractual right to receive the
consideration and the customer will have the contractual obligation to pay the fixed
amount of consideration to the business entity. For a business entity, the contractual
right to receive a fixed amount of money from the customer is a financial asset;
and for a customer, the contractual obligation to pay a fixed amount of money to
the business entity is a financial liability. Since in the contract there is a financial
asset for a business entity and a financial liability for a customer, this satisfies the
definition of a financial instrument.
Once the contract gives rise to a financial instrument, the parties to the contract
will need to account these financial assets and financial liabilities in their books of
accounts.
Let us consider the following case.
On 15 April 2020, a business entity sold goods to a customer and a customer promises
to pay Nu. 120,000 as a consideration after 3 months. In this case, you will see a
business promises to deliver the goods to the customer and a customer promises to
pay the consideration of Nu. 120,000 after a period of 3 months. Therefore, business
will have the contractual right to receive Nu. 120,000 on 15 April 2020 and the
customer will have the contractual obligation to pay Nu. 120,000 after three months
from the date of sale.
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Thus on 15 April 2020 business entity will recognize a financial asset as follows:
Trade receivables Dr 120,000
Revenue from sale of goods Cr 120,000
Trade receivables is a financial asset and it will be reported as current asset in the
statement of financial position of the business entity. The customer will account a
financial liability as follows:
Inventory Dr 120,000
Trade payables Cr 120,000
Trade payables is a financial liability and this will be reported under current liabilities
in the statement of financial position of the customer.
When we apply the definition of a financial instrument in business, it will cover
not only those contracts related to sale of goods or services, but also many other
contracts such as the issue of equity shares and preference shares to the public, issue
of bonds and commercial papers, purchases of other companies’ shares and bonds,
borrowing short term and long term funds from banks and lending money to other
borrowers on a commercial borrowing rates. All these contracts will give rise to
financial instruments which we will discuss in the following sections.
6.3 Issue of Equity Shares and Preference Shares

Shares are units of ownership of a business entity measured as a number of units
sold in the market or subscribed at the time of formation of a business entity. Each
share is measured by putting a value to it at the time of formation of a business entity
or when the entity is listed on the stock exchange. The value of shares are calculated
as total amount of capital intended to be raised divided by the number of shares to
be issued to the subscribers. For example, if a business entity want to raise Nu. 20
million through issue of 100,000 shares, the value of each share will be calculated as
Nu. 20 per share. The business entity issue a share certificate to the buyer of shares
and he/she becomes the shareholder of the business entity.
A business entity may issue either an equity shares or a preference shares to raise
the intended amount of capital from the investors. Equity is defined as the residual
interest in the asset of the business after deducting the liabilities (Asset – liabilities
= Equity).
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6.3.1 Nature of equity shares
6.1 Share price in the stock market
Equity shares come with a higher risk of investment. This means, the investors do
not have the right to claim returns on their investment if the business entity fails to
generate sufficient income to pay back the equity shareholders. The return on equity
investment comes in different forms. Firstly, the general and the most common return
on equity investment is paid in the form of a dividend to the investor. Secondly, the
equity investor may sell a whole or a part of investment in the market when the
share price is favourable. For example, an investor purchases 1,000 number of shares
of a business at Nu. 20 on 1 March 2020. His investment amounts to Nu. 20,000 on
1 March 2020. If this investor wish to sell half of his shares in the market when the
share price rose to Nu. 25, he gets a return of Nu. 2,500. The equity investor may also
be benefitted by issue of rights shares by the business entity. This will be discussed
in the later part of the chapter.
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Equity investors may be paid a dividend. Dividend is a share of profit earned by the
business for the year. The amount of dividend paid to the investor will depend on
the amount of distributable profit earned by the business during the financial year.
The equity investors do not have the right to claim dividend in case the business
has not generated sufficient profit during the year. The business cannot borrow
funds from others to pay dividend to its equity investors. Also, we must understand
and appreciate that business may not pay dividend to equity investors even if the
business entity has generated sufficient profit because the business entity may like to
retain the distributable profit in the business and invest the fund in other profitable
business projects. Some equity investors would support this investment decision
of the business which would generate income or economic benefits to the business
in future; while some equity investors might prefer to be paid dividend to them.
The later type of equity investors are normally called short term investors. These
investors are driven by their short term investment goals rather than seeking growth
opportunities of business.
Equity shares carry voting rights that enable the investors vote in the annual
general meeting and other forums to make a decision for the business. The equity
shareholders of a registered company uses such voting rights to elect the board of
directors, auditors and other key managerial personnel as per the Companies Act of
the country. We will discuss the method of accounting for dividend in the later part
of the chapter.
6.3.2 Preference shares and class of preference shares

As the name suggest, preference shares are shares that carry certain preferential
rights in terms of dividend payment and the repayment of investors’ money at the
time of liquidation of the business entity. We must understand that unlike equity
shares, preference shares are classified as redeemable preference shares and non-
redeemable preference shares. Redeemable preference shares are issued with the
intention to redeem the shares after certain time period. Therefore, redeemable
preference shares are treated as a debt finance or a liability. You will learn this in
detail in the following sections. On the other hand, non-redeemable preference
shares are treated same as equity shares with the difference that preference shares
may not carry voting rights.
The redeemable preference shares carry a right to the investors to claim a dividend
as a fixed income even at the time when the business entity fails to generate sufficient
income to pay the dividend. As such, preference dividend is a fixed charge or an
expense to the business entity.
At the time of writing this text, we did not find any business in Bhutan that has
issued any type of preference shares though it has several advantages to the business.
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6.4 Financial Asset, Financial Liability and Equity Instrument

Let us recall the concept of a financial instrument in the previous sections. Financial
instrument is a contract that give rise to a financial asset of one entity and a financial
liability or equity instrument of another entity. Take an example of a company that
issues a bond on the Royal Securities Exchange of Bhutan Limited (RSEBL) to raise
a capital amount of Nu. 30 million. These bonds are issued for a period of 10 years.
Can you analyse this contract and see whether there is a financial instrument if the
investors have subscribed these bonds.
Obviously, there is a contract between the bond issuing company and the investor
when the investor subscribed to these bonds. The issuing company will have received
a fixed amount of cash. This creates a contractual obligation to the issuing company
to repay not only the principal amount of investment but also an interest what we
normally call as ‘coupon’ on a regular basis (say monthly, quarterly, half yearly) as
agreed in the contract. At the same time, the investor will have a contractual right
to receive the coupon interest and the principal amount on the date of redemption
of the bond, that is, after 10 years. For the issuing company, they will recognise a
financial liability while the investor will recognize a financial asset. Therefore, there
is a financial instrument in this contract. The issuing company will account financial
liability in their accounting system including the coupon interest paid to the investor,
and report these expense and financial liability in the financial statements.
a) Definition of a financial asset

Financial assets are:
• Cash,
• Equity instruments of another entity (e.g. shares), and
• Contractual right to receive cash or another financial asset of another entity
(e.g. trade receivable).
The definition of a financial asset is quite explanatory by itself. However, we must
understand that financial assets include cash in hand and cash at bank, investment
in other company’s shares.
b) Definition of a financial liability

Financial liability is a contractual obligation to deliver cash or another financial
asset to another entity. This would include issue of bonds, commercial borrowings,
issue of other loan notes and commercial papers, trade payables etc.
c) Equity instruments
Equity instruments are shares issued by the entity for public subscriptions. Note that
we have also discussed about equity instruments of other companies. These equity
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instruments are financial assets.

d) Recognition of financial assets, financial liabilities and equity
instruments
An entity should recognise a financial asset or financial liability when the entity
becomes a party to the contractual provisions of the instrument rather than when
the contract is settled. Financial assets and financial liabilities are derecognized
when the contract is settled or when an entity ceases to be a party to the contract.
e) Issue of bonds and other loan notes
Bonds or loan notes are financial instruments that carry a promise to pay to the
investor a periodic fixed interest called ‘coupon’ and the principal amount on the
date of maturity. Thus, bonds or loan notes are issued for a certain time period and
carry a fixed charge of interest like a commercial borrowing. Unlike equity shares,
bonds are normally issued at a denomination of Nu. 100 or Nu. 1,000 or more,
and are quoted at a fixed coupon interest rate such as 7% Nu. 1,000 bonds. That
means, each bond is issued at a nominal value of Nu. 1,000, and that bonds carry
7% coupon interest payable to the investor. Coupons or bond interests are usually
paid quarterly, half yearly or annually. Though most of the bonds are issued with a
coupon interest, some bonds are issued without coupon payments. These bonds are
called deep discount bonds and they are repaid either at par or at a premium. Bonds
and other loan notes may be issued as secured or unsecured. A secured bonds are
issued with the issuer’s pledge of a specific asset (such as an equity shares of another
company). In the event of default, the investor can recover the investment from the
asset.
f) Effective interest rate
We must understand the difference between coupon interest rate and the effective
interest rate in the issue of bonds and loan notes. While the coupon interest is a
periodic interest payment made to the investor on calculated on the nominal value
of the investment, effective interest rate is the rate of return expected by the investor
on his investment which is calculated as a compound interest or an internal rate of
return (IRR). For the calculation of the effective interest rate, an entity estimates the
expected cash flows considering all contractual terms including any fees, transaction
costs, and other premiums or discounts. Because transaction costs are included as
part of the initial carrying amount of the financial instrument, the recognition of
these costs in profit or loss is spread over the term of the instrument through the
application of the effective interest method.
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Financial assets can be categorized in to two types.
Financial Assets
Debt Instrument Equity Instrument

(Contractual right to receive fixed (No contractual right to receive fixed
amount of cash) amount of cash)
Figure 6.2 Classification of financial assets
6.4.1 Classification and Accounting of Financial Assets

Financial assets can be acquired either in the form of a debt asset (e.g. an investment
in bonds, trade receivables) or an equity instrument of other entity. Financial assets
must be classified and accounted by following one of three methods:
1) amortised cost,
2) Fair Value Through Profit or Loss (FVTPL) or
3) Fair Value Through Other Comprehensive Income (FVTOCI)
In this text we will discuss and apply the first two methods. By default, all financial
assets that are debt instruments are classified and accounted as at amortised cost
method and financial assets that are equity instruments are classified and accounted
as at FVTPL method.
Financial assets that are classified as at amortised cost are initially measured at fair
value plus transaction costs. Subsequently, the financial asset is accounted using the
amortised cost method. See the example below.
Example:
Company A purchased bonds of company B with a nominal value of Nu. 1,000 at
the beginning of 2020 for Nu. 1 million. Transaction cost in relation to the purchase
of bonds was Nu. 5,000. Company B paid 8% coupon annually. The bond matures in
three years. Effective interest rate is 10%.
In the above example, Company A has the contractual right to obtain a fixed coupon
payment for three years paid annually as well as the principal amount after three
years when the bond (debt instrument) matures. Company B has the contractual
obligation to deliver cash for three years paid annually in the form coupon interest
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and the principal amount when the bond matures. Thus, Company A recognizes a
financial asset and Company B recogises a financial liability.
The financial asset will be initially measured as follows:
Nominal value Nu. 1,000,000
Transition cost Nu. 5,000
Total amount Nu. 1,005,000
On the date of purchase of debt instrument, Company A will pass the following
entry.
Financial asset Dr 1,005,000
Cash Cr 1,005,000
Table 1: Accounting in the subsequent years (after initial recognition)

Year Cost Effective interest Coupon interest Carrying Amount
(10%) (8%)
2020 1,005,000 100,500 80,000 1,025,500
2021 1,025,500 102,550 80,000 1,048,050
2022 1,048,050 104,805 1,072,855
At the end of third year, Company A will be repaid Nu. 1,072,855. This include the
amount of investment plus any interest payable on the investment. See the total
effective interest over three years is Nu. 307,855 whereas the total coupon interest
paid over three years is Nu. 240,000. This means, Company A has received only
Nu. 240,000 interest out of Nu. 307,855 interest. The difference of Nu. 67,855 is
accounted and received along with the initial investment made in the bond (inclusive
of transaction cost) as a repayment at the end of third year, i.e. 1,005,000 + 67,855.
At the end of first year, Company A will recognize an income of (equivalent to
effective interest) of Nu. 100,500 and receive a coupon interest of Nu. 80,000. These
will be recorded as follows:
Financial asset Dr 100,500
Interest on financial asset Cr 100,500
Cash Dr 80,000
Financial asset Cr 80,000
Similarly, in the second year, Company A will recognize Nu. 102,550 as interest
income while it will receive a coupon cash interest of Nu. 80,000.
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Cash Dr 80,000
Financial asset Cr 80,000
In the third year, when the bond matures, Company A will be paid Nu. 1,072,855.
This will be recorded as follows:

Cash Dr 1,072,855
Financial asset Cr 1,072,855
6.4.2 Accounting of financial asset (Equity instrument)

When a business entity acquires equity shares of another entity, this will be treated
as acquiring an equity instrument. By default, equity instruments are classified
and accounted as at FVTPL. When FVTPL method is applied, the equity shares
must be remeasured subsequently at the fair value. Fair value of equity shares can
be obtained from the stock exchange if the shares are actively traded on the stock
exchange. Otherwise, entity must apply other alternative ways to obtain a fair value
for such shares. The alternative method may include valuation of equity shares by
using discounted cash flow or dividend methods. The valuation method will not be
covered in this text.
When the equity shares are remeasured at fair value, the difference between fair
value of equity and its carrying amount will be treated in the income statement. That
is why, this method is called fair value through Profit or loss method. If the business
entity chooses this method, any change in the fair value of the equity instrument will
immediately affect the performance of the entity.
Example:
KCT Company acquired 10,000 equity shares of LNT Company at Nu. 20 per
share in April 2020. These shares were traded at Nu. 23 on the stock exchange in
December 2020 and KCT Company measured the shares on 29 December 2020
when the company was finalizing its accounts for 2020. It cost KCT Company Nu.
5,000 as acquisition cost.
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In this example, KCT Company will measure the equity instrument initially at Nu.
200,000 that is the fair value of the shares.
Financial asset (equity instrument) Dr 200,000
Cash Cr 200,000
Shares acquisition expense Dr 5,000
Cash Cr 5,000
Subsequently, equity shares will be remeasured at fair value and the difference
between carrying amount and fair value will be posted to the income statement.
Carrying amount of equity shares Nu. 200,000
Fair value (as per stock market) Nu. 230,000
Change in fair value (difference) Nu. 30,000
Income due to change in FV Cr 30,000
In the statement of financial position as at 31 December, the financial asset (equity
instrument) will be reported at Nu. 230,000 instead of Nu. 200,000.
6.4.3 Classification and accounting of financial liabilities
Financial liabilities by default are classified and accounted as at amortised cost. This
means, the carrying amount of the debt is not adjusted for a change in the market
interest rate. However, the carrying amount of the debt is increased by the effective
interest rate and reduced by the amount of coupon interest rate paid to the investor.
Unlike FVTPL method as discussed in the previous section, amortised cost method
ignores change in the fair value of the financial liability and thus does not affect the
income statement. Effective interest is treated as a finance cost for raising the capital.
Financial liabilities are initially recognized at fair value less transaction costs.
Example:
A Construction Company (CC) raises finance by issuing Nu. 2 million 6% four-year

bonds on the first day of the current accounting period. The bonds are issued at a
discount of 10%, and will be redeemed after four years at a premium of Nu. 111,469.
The effective rate of interest is 12%. The issue costs were Nu.10, 000.
In this example, Construction Company (CC) has received cash from the investor
and thus creates a financial liability that it need to repay. The liability will be classified
and accounted for at amortised cost unless it is indicated to be classified as fair value
through profit or loss (FVTPL), and, thus, initially measured at the fair value of
127 Reprint 2023

amount received less the transaction costs. The initial measurement will be done as
follows:
Nominal value of bond 2,000,000
After discount value 1,800,000 (90% of 2,000,000)
Less: Transaction cost (10,000)
Initial recognition amount = Nu. 1, 790,000
Year: Beginning
Cash Dr 1,790,000
Financial liability Cr 1,790,000
Year Cost Effective interest Coupon interest Carrying

(12%) (6%) Amount
Year 1 1,790,000 214,800 120,000 1,884,800
Year 2 1,884,800 188,480 120,000 1,953,280
Year 3 1,953,280 195,328 120,000 2,028,608
Year 4 2,028,608 202,861 120,000 2,111,469
Year 1: Year end
Finance cost Dr 214,800

Financial liability Cr 214,800
Financial liability Dr 120,000

Cash Cr 120,000
The accounting treatments of the finance cost and coupon interest will remain same
for the remaining three years. In fourth year, Construction Company will need to
repay a total amount of Nu. 2,111,469 (2,000,000 nominal value + 111,469 premium).
Finance cost Dr 202,861

Financial liability Dr 202,861
Financial liability Dr 2,111,469

Cash Cr 2,111,469
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The total effective interest of Nu. 801,469 can be verified as follows:

Coupon interest paid 480,000
Discount allowed 200,000
Transaction cost 10,000
Premium paid 111,469
801,469
6.5 Regulations of Bonds Issue

The issue of bonds are regulated by the financial or capital market authorities. In
Bhutan, the Regulations for Issue of Corporate Bond, 2012 guides the issue of bonds.
It defines ‘bond’ as a long term debt sold to the investors by the issuer. Corporate
bonds in Bhutan are secured and issued at a face value of Nu. 1,000. These bonds
are so far issued at 6-10% coupon rate and for a period of 7-10 years. Ownership
of a bond certificate carries certain rights. The regulations of corporate bond issue
protect the interest of investors and ensure efficient market for issue of bonds. On
purchase of bonds, individual bondholders acquire two rights:
i) The right to receive the face value of the bond at a maturity date, and
ii) The right to receive periodic interest payments, usually semi-annually or
yearly, at a specified percent of the bond’s face value.
The use of corporate bonds to raise long term debt finance in Bhutan is a recent
development as indicated by the increasing number of companies issuing bonds.
As of August 2019, there are 19 companies that have issued corporate bonds on the
Royal Securities Exchange of Bhutan Limited (RSEBL).
Table 3: Listed bond in RSEBL

Sl.No. Name Maturity Period Rate (%) Effective date Maturity date
(Year)
9 TBL DEBTS (G021) 10 Years 6.00 2014-04-09 2024-04-08
10 BDBL DEBTS (G020) 10 Years 6.00 2014-04-09 2024-04-08

11 BNBL DEBTS (G018) 10 Years 6.00 2014-04-09 2024-04-08
12 RICB DEBTS (G017) 10 Years 6.00 2014-04-09 2024-04-08
13 BIL DEBTS (G016) 10 Years 6.00 2014-04-09 2024-04-08
14 DPNB DEBTS(G015) 10 Years 6.00 2014-04-09 2024-04-08
15 DAC BONDS - I 10 Years 9.00 2014-02-28 2024-02-27
(G013)
16 RICB BONDS - III 7 Years 9.50 2014-01-15 2021-01-14
(G012)
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Box 6.1 Issue of bond

Dungsam to raise another Nu 1.5B in bond
Bond: The Dungsam Cement Corporation Limited (DCCL) has floated its third series of
bond worth Nu 1.5B (billion) at eight percent coupon rate to prepay the company’s high
interest bearing loans.
However, Nu 1.2B of the total issue size has been privately placed to commercial banks.
Bank of Bhutan was allotted Nu 935M (million), Druk PNB was allotted Nu 250M and
Bhutan Insurance Limited was allotted Nu 15M. This leaves behind Nu 300 for public
issue.
An official from Druk Holding and Investment (DHI), Dungsam’s parent company, said
private placement of bond was issued because the market cannot absorb the total size of
bond issued. “We are not quite sure whether Nu 300M would be fully subscribed or not,”
he said.
This was because the coupon rates are competitive. Royal Insurance Corporation of
Bhutan Limited (RICBL) has also issued Nu 1.5B corporate bond at 9.5 percent coupon
rate. Both DCCL and RICBL have the same face value of Nu 1,000 a unit with maturity of
seven years.
This, the official said has attracted some financial institutions and individual investors. He
said a meeting was held with all the financial institutions in February this year and most of
them were committed to invest in the bond. But when RICBL’s fourth series of bond was
issued, few banks chose to invest in RICBL.
DCCL has an outstanding debt of Rs 1.13B availed from a consortium financing of State
Bank of India, Union Bank, Punjab National Bank, Export and Import bank of India. With
the bond issued, the company expects to prepay Rs 1.05B.
This according to official would lower the cost of borrowing. For the same, DCCL also
borrowed about Nu 530M from Druk Green Power Corporation at five percent interest.
In an earlier interview, the chairman of DHI, Dasho Sangay Khandu said this is an inter-
corporate borrowing approved by the DHI board to reduce the cost of borrowing by pre
paying some high interest bearing loans.
DHI also serves as a guarantor for the bond issued and is liable if the obligations are not
met. This is because bond is a debt instrument issued by a company when it wants to raise
money from the public to invest in various areas or to meet its debt obligation.
Unlike shares, which are equities, bonds are debt instruments. When an individual
subscribes to a bond, he does not hold any ownership in the company, rather the company
is obliged to pay back the investment made by the individual with interest.
Bonds are less risky, as they are secured against a company’s assets.
Dungsam floated bonds worth Nu 700M in October last year and another bond worth Nu
1.2B in March, the same year. The second series bond of Nu 700M was used to pre-pay the
loan with NPPF.
Kuensel, May 20, 2015
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6.6 Treasury Bills

Treasury bill is a debt instrument issued by the Government to mobilize fund from
the market. It is a market instrument which can be negotiated and traded freely. As
per Operation Guidelines of the Government regarding the issue of treasury bills,
the maturity period varies between 30 days to 364 days. Generally, it can be used for
financing temporary revenue shortfalls in the government budget. This approach is
a market based system practiced internationally that supports the development of
domestic debt and money market. The treasury bills are usually issued at discounted
rate and repaid at face value. For example, if the face value is Nu.100 and interest rate
5%, it will be issued at Nu.95 repayable at Nu.100.
Treasury bills with short term maturity of less than 90 days qualify as cash equivalents
of a business entity which can be converted into a known amount of cash without a
significant risk. The other treasury bills with maturity dates of more than 3 months
should be treated as current liabilities.
Investment in Treasury Bills
Financial asset (TB) Dr (Net of discount, if any)
To cash
Financial asset (TB) Dr (interest income)

Interest income
Cash Dr (Interest received)

Financial Asset Cr
Cash Dr
Financial asset Cr (redemption of TB)
Accrued interest on investment
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6.7 Commercial Papers

Commercial Paper (CP) is a money market instruments that are issued for a specified
amount and are payable on a fixed date. The CP shall be issued for a maximum
maturity period of one year (Guidelines for public issue of Commercial Papers,
2017). Companies may raise short term capital through issuance of commercial
papers, if:
i. The net worth of the company is not less than Nu. 5 million as per the latest
audited financial statements.
ii. Instrument is backed by collaterals such as time deposits, receivables,
inventories and other qualified assets alternatively. The company may also
seek corporate guarantee from its holding company; or financial guarantee or
standby credit facility from any financial institutions, provided that the issuer
and the financial institutions are not related parties as defined in the Financial
Services Act, 2011.
The Guidelines further stipulates that:
i) Commercial papers are issued in a denomination of Nu. 100,000 and
multiples thereof.
ii) CPs shall be issued for a maximum maturity period of one year from the
date of issue.
iii) The size of the CP to be issued shall not exceed more than the value of the
collateral, or the extent of the guarantee or standby credit facility provided.
Box 6.2: Treasury bill auction notice by RMA
Treasury Bills of Nu. 3,000 million in the name of the Royal Government of Bhutan is
offered for sale. The Bills shall be auctioned under Multi-price Method and issued through
the Royal Monetary Authority of Bhutan.
Submission of Tenders : Tenders must be submitted in sealed envelope to Director,
Department of Banking, RMA not later than 9:30 AM on JUNE 24, 2020 and tenders shall
be irrevocable after submission.
Treasury Bills No. R 322
Auction/Settlement Date JUNE 24, 2020
Days to Maturity 41
Maturity Date/Settlement Date AUGUST 04, 2020
Amount Nu. 3,000 million
Eligibility : Any Bhutanese persons including firms, companies, corporate bodies,
financial institutions, trusts etc. can subscribe the Bills.
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Need for and advantages of debt finance

The debt finance increases the return on common stock which directly benefit
shareholders. However, the use of debt also has risks and costs. Debt increases
solvency risk, and therefore it may hamper the required return to shareholders.
Further, net income is reduced by interest paid on debt. The cost of debt finance
can also be negotiated with the lending institutions. The interest expense on debt
finance provides a tax shield to the borrowing entity.
6.8 Accounting of Commercial Loan and Loan Amortization

A business entity may enter in to contract with commercial banks and other financial
institutions to borrow funds at a certain interest rate. The difference between
a commercial loan and bond is that bond is traded on the stock exchange and is
denominated like a share called a nominal value. Bonds also carry a coupon interest
rate which may or may not be equal to an effective interest rate. Commercial loans
are more common than the issue of bonds in the market. In the following example,
we will illustrate how a business entity account a commercial loan through loan
amortization over the loan period.
Example:
Lucky Company took Nu. 3.5 million commercial loan from AB Bank at 7 % interest
rate. The loan will be repayable within 5 years.
How do we approach the loan repayment? Before we recognize a loan interest
expense and amortise the loan, we need to find out the loan installment payment
amount.
Given:
The loan amount of Nu. 3.5 million
Loan period of five years, and
Loan interest rate of 7 %
Go to annuity table and find out the annuity factor for 7% interest for 5 years.
Annuity factor = 4.100
Loan instalment amount = 3,500,000/4.100 = Nu. 853,659
Year Loan Installment Interest Principal Carrying
Amount Payment Component Amount Amount
Year 1 3,500,000 853,659 245,000 608,659 2,891,341
Year 2 2,891,341 853,659 202,393.90 651,265 2,240,077
Year 3 2,240,077 853,659 156,805.38 696,853 1,543,224
Year 4 1,543,224 853,659 108,025.66 745,633 797,591
Year 5 797,591 853,659 55,831.36 797,827 (236)
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Accounting entries in the first year:

Bank Dr 3,500,000
Financial liability (loan) 3,500,000
Financial liability (loan repayment) Dr 608,659
Finance cost (loan interest) Dr 245,000
Cash Cr 853,659
Accounting entries in the subsequent years will remain same for recognition of
finance cost or loan interest and the loan repayment till fifth year. For reporting
in the financial statements, the proportion of loan amount payable within the next
accounting year should be presented as current liability and the remainder will be
presented as non-current liability. In the above example, the financial statements in
the first year should split the carrying amount of Nu. 2,891,341 into current and no-
current portion of liability. Of the carrying amount of Nu. 2,891,341, Nu. 651,265
should be presented as current liability and Nu. 2,891,341 as non-current liability.
6.9 Terminologies Used in Share Capital

Companies Act normally provides different nomenclature for shares of the company.
These are referred to as authorised, issued, called-up and paid-up share capital.
Students must be familiar with these nomenclatures.
Authorised (or legal) capital. This is the maximum amount of share capital that
a company is empowered to issue. The amount of authorised share capital varies
from company to company, and can change by agreement. For example, a company’s
authorised share capital might be 2,000,000 ordinary shares of Nu. 10 each. This
would then be the maximum number of shares it could issue, unless the maximum
were to be changed by agreement.
Issued capital. This is the par amount of share capital that has been issued to
shareholders. The amount of issued capital cannot exceed the amount of authorised
capital. Continuing the example above, the company with authorised share capital of
2,000,000 ordinary shares of Nu 10 might have issued 1,000,000 shares. This would
leave it the option to issue 1,000,000 more shares at some time in the future. When
share capital is issued, shares are allotted to shareholders. The term ‘allotted’ share
capital means the same thing as issued share capital.
Called-up capital. When shares are issued or allotted, a company does not always
expect to be paid the full amount for the shares at once. It might instead call up only
a part of the issue price, and wait until a later time before it calls up the remainder.
For example, if a company allots 500,000 ordinary shares of Nu. 10, it might call up
only, say, 75 cents per share. The issued share capital would be Nu. 5,000,000, but the
called-up share capital would only be Nu. 3,750,000.
Paid-up capital. When capital is called up, some shareholders might delay their
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payment (or even default on payment). Paid-up capital is the amount of called-up
capital that has been paid. In the statement of financial position, companies report
the paid up capital.
NOTE 5.22- SHARE CAPITAL
As at As at As at
31.12.2018 31.12.2017 01.01.2017
AUTHORISED CAPITAL
100,000,000 Shares of Nu. 100 each 10,000,000,000.00 10,000,000,000.00 10,000,000,000.00
ISSUED AND PAID-UP CAPITAL
30,000,000,000.00 30,000,000,000.00 30,000,000,000.00
* Out of the above, 27,000,000 shares of Nu. 100 each were issued as fully paid Bonus shares by way of
capitalization of Reserves.
Source: Annual Report, BOBL 2018
6.9.1 Issue and transfer of shares

Shares of a public limited companies or a listed companies can be transferred from
one investor to another through a stock exchange trade facilitations. Companies
listed on stock exchange, for example, Royal Securities Exchange of Bhutan Limited
are quoted, which means the market value of the shares are quoted. Market value
of shares is the price at which an investor is prepared to purchase shares of the
company from the current shareholders. Let us say a shareholder of company A is
currently holding 1000 shares at Nu.10 and he intends to sell these shares at Nu.11
each. This transfer of shares from one investor to another will not affect the financial
position of company A. Apart from updating the shareholders register, company A
need not bother with the transfer of shares from one to another investor. As such,
a company need not make any accounting records for transfer of shares. Shares in
private companies do not change hands very often, hence their market value is often
hard to estimate.
Figure 6.3 Share price movement
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There are twenty one listed companies on the securities exchange as of August 2019.
The shares of these companies are traded on the securities exchange facilitated by
the stock exchange brokers. The market value of shares and the trading volumes of
shares are accessible on the securities exchange.
Entity raising finance must be able to classify the financial instrument either
as financial liability (debt) or equity instrument (shares). This distinction is so
important as it will directly affect the calculation of the debt equity or a gearing
ratio. Debt equity ratio measures the proportion of debt finance in the overall capital
structure of the entity. Too much of debt finance will erode the equity value and
increase the financial risk. The business will also have huge interest cost to service
the debt. The distinction will also affect the measurement of profit as the finance
costs associated with financial liabilities will be charged to the income statement,
thus reducing the reported profit of the entity, while the dividends paid on equity
shares are an appropriation of profit rather than an expense.
Equity instruments are initially measured at fair value less any issue costs. Usually
equity shares are recorded at a nominal value, with the excess amount received
recorded in a share premium account and the issue costs being written off against
the share premium.
Example:
A Company issues 1,000,000 equity shares at Nu. 10 for cash consideration of

Nu.12.50 each. Issue costs are Nu.100, 000.
In the above example, the company has raised finance (received cash) by issuing
financial instruments. Equity or ordinary shares have been issued, thus the entity
has no obligation to repay the monies received; rather it has increased the ownership
interest in its net assets. As such, the issue of ordinary share capital creates equity
instruments.
The issue costs are written off against share premium.
The issue of ordinary shares can be recorded by making the following entries.
Cash Dr 12,400,000
Ordinary shares Cr 10,000,000 [Nominal value]
Share premium Cr 2,400,000
The cash amount of Nu. 12,400,000 is after deducting the issue cost of Nu. 100,000.
The nominal value of Nu. 1,000,000 equity multiplied by Nu. 10 i.e. Nu. 10,000,000
is recognized as ordinary share capital and Nu. 2,400,000 (after deducting the issue
cost) is credited to share premium account. The share premium money may also be
136 Reprint 2023

used for issue of bonus shares. However, it cannot be used for all purposes.
If the shares being issued were redeemable, such as redeemable preference shares,
then the shares would be classified as financial liabilities (debt) as the issuer would
be obliged to repay back the monies at some stage in the future.
6.9.2 Measurement of equity instruments

Equity instruments are NOT re-measured. Any change in the fair value of the shares
is not recognised by the entity, as the gain or loss is experienced by the investor, the
owner of the shares. Equity dividends are paid at the discretion of the entity and
are accounted for as reduction in the retained earnings, so have no effect on the
carrying value of the equity instruments.
MEASUREMENT OF EQUITY INSTRUMENTS
INVESTORS COMPANY
STOCK
EXCHANGE
DIVIDEND PAID
Figure 6.4 Measurement of equity instruments
6.9.3 Components of equity

The equity of the business entity consists of paid up share capital, reserves and
retained earnings. Share capital is the permanent investment of business owners in
the business. Shareholders are the owners or members of the company as long as
they continue to hold those shares they subscribed on formation of the company or
subscribed later from the primary and secondary markets.
6.9.4 Reserves
Reserve means an appropriation of profits or other surpluses to strengthen the
liquid resources of the business entity. The company may create any type of reserve
forming a part of the equity or shareholders’ fund. General reserve is one that is
often used in companies which represent the part of shareholders’ fund. General
reserve may be used for both known and unknown future obligations. There are
also other types of reserves such as revaluation reserves that arise from the upward
revaluation of non-current assets. The revaluation reserves are capital in nature and
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it cannot be used to pay dividends to shareholders. The creation of reserves depend

on the company’s financial management policies and attitude towards risk. Most of
the reserves are created by transferring profit from retained earnings. The entry for
transferring profit from retained earnings to reserve is given below.
Retained earnings a/c Dr
To general reserve/reserve a/c
(Recognition of general reserve/reserve)
The significance of this is that the management of the company want to signal to
shareholders and others that they do not intend to pay profits as dividends but apply
such funds in growth and development projects.
The above entry will not change the shareholders’ fund position as this is simply
a transfer from one component to another component of shareholders’ fund. The
statement of changes in equity requires management to show all changes in equity
resulting from profit or loss, contributions by and distribution (dividends) to owners
during the reporting period.
Sources of internal
financing
ing
ial
the re erprise
Strengthen
Enha tion of
the Financ
Position
Ent
puta
ncing
F
He acil
av itat
wh y A in ng l
en m g e epi apita
Ne oun K gC
ed t n ct
ed rki
Wo Inta
Figure 6.5 Significance of reserves
6.9.5 Retained Earnings

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Retained earnings represent the net income earned by a company over its life that
has not been distributed as dividends to shareholders. In fact, the total shareholders’
fund is equal to the share capital contributed by shareholders and the retained
earnings. Various reserves are created out of retained earnings.
Shareholders’ fund = Share capital + Retained earnings
Retained earnings is an amount of net income accumulated over the entire life of
the company and does not represent net income and dividends of a specific year.
The amount of retained earnings does not mean that shareholders have the right to
claim.
Retained earnings link income statement with the statement of financial position.
That is, the net income from income statement is transferred to retained earnings and
after deducting dividends (and any amount transferred to reserves), the balancing
figure is transferred to statement of financial position in the equity section. This is
depicted in the diagram below.
Income Statement Statement of financial Position

Income Assets
Expenses --------
Net profit --------
--------
Total assets
Equity
Retained earnings Retained earnings
Opening balance Liabilities
+ Net profit Total equity and liabilities
-Dividends paid
Closing balance
Figure 6.6 Link between income statement and statement of financial position
6.9.6 Issue of bonus shares

Sometimes a company issues new shares called bonus shares which is also called
scrip issue to its existing shareholders without consideration. Literally, this means
shares are issued without receiving any cash payment from the shareholders. Does
that make any commercial sense? Yes, there are number of reasons why companies
issue bonus shares even though no cash or consideration is received from issue.
Some of these reasons are explained below.
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i. Bonus shares can be issued to existing shareholders in place of cash dividend.

This means, if the company has shortage of cash, company can use scrip issue
or bonus shares to reward their shareholders.
ii. Bonus shares has the effect of increasing the number of issued shares in the
market. This will prevent increase in share price which will promote new
investment for the company.
iii. Bonus shares issue will also boost confidence of shareholders when the
company invest cash resources for new investment projects without disbursing
to the shareholders as dividend payments.
iv. Bonus share issue will also retain the control of the company within the
existing shareholders rather than splitting the control over increasing number
of shareholders.
The number of bonus shares issued will depend on the number of shares already
issued. Generally, a proportion or a ratio is used to decide the number of issue of
bonus shares. For example, a company may use proportions such as ‘one for three’
or ‘one for five’. This means, for every three or five shares owned by the shareholder
one new share will be issued. This will be recorded as follows:
Share premium or retained earnings a/c Dr
To share capital Cr
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༄༅༅། ། ཀྲི་ དངུལ་ཁང་། ཚད་འཛིན།

T BANK LIMITED
Your Personal Bank
TBL/HQ-CSCO/RSEBL/5-2018/974 13 March 2018
Chief Executive Officer

Royal Security Exchange Bhutan Limited
Thimphu
Bhutan.
Dear Sir,
Subject: T-Bank Limited – Bonus Issue
Referring to the RMA’s letter no. RMA/FRSD/34/2016-17/2391 dated December 2016, all the banks
are required to increase the minimum paid-up capital to Nu.600 million by 1st January 2019. To
comply with the above directive, the bank has approached RMA for approval of issuance of bonus
share and right issue.
Accordingly, RMA vide it letter no. RMA/FRSD/28/2017-2018/4431 dated 7th March 2018
(enclosed) has approved issuance of bonus share at the ratio of 3:1.25 (amounting to Nu.125 million
from the General Reserve) and remaining of the capital through right offer. The proposal also
discussed and approved during the 36th Board Meeting held on 9th March 2018 and was ratified by
all the shareholders during the 8th ADM held on 9th March 2018 to issue bonus share at the ratio
of 3:1.25 to the shareholders.
.
In line with your rules Governing the Official Listing of Securities Chapter 6, subsection 9, we
would like to request you to kindly accord necessary approval accordingly and also to set the record
date as 21st March 2018 for the eligibility of bonus share.
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Example
A company raised Nu. 200 million five years ago by issuing 20 million shares at
Nu. 10 each. In order to keep up the dividend culture of the company, the company
management decided to issue bonus shares of 3 for 8 in the current accounting
period. Company has a share premium amount of Nu. 80 million which will be used
to pay the bonus shares.
In the above example, a company is issuing bonus shares at the ratio of 3:8.
Total number of shares in issue = 20,000,000 shares
Number of bonus shares issued = 20,000,000 x 3/8 = 7,500,000 shares
Nominal value of shares = Nu. 10
Therefore, bonus share capital = 10 x 7,500,000 = Nu. 75,000,000
As per the management decision, share premium will be used to issue bonus shares.
This will be recorded as:
Share premium a/c Dr 75,000,000
To share capital 75,000,000
The balance of share premium in the statement of financial position is now reduced
to Nu.5 million.
6.9.7 Rights issue

Companies also issue shares in the form of rights issue to its existing shareholders
but for a consideration or a price money. However, the rights issue is made at a
price below current market value. This encourages existing shareholders to invest
in company’s shares so that it can help company to meet its demand for fund. As
discussed in bonus shares, rights issue can also help companies to retain its control in
the hands of the existing shareholders by increasing their shareholdings. The rights
issue is made on the same basis as bonus shares among the existing shareholders
using the fixed ratio such as ‘one for two’ or ‘two for five’ shares owned by the
shareholders. However, unlike bonus shares, the shareholders have the option as to
whether to buy the new shares or not. Though rights issue is made at a price below
market value, the share price will definitely be above the nominal value which may
not attract shareholders to make additional investment in the same company. If the
shareholders choose not to buy the new shares, company may not be able to raise
share capital through such rights issue. Thus, there is no guarantee that company
can raise funds through rights issue.
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Example
A limited company makes a right issue to its existing shareholders for 2 for 5 shares
at Nu. 12 per share. These shares are currently traded at Nu. 15 on the market. Shares
were originally issued at Nu. 10. There were 3 million shares on issue.
In the above example, company will issue 3 shares for every 5 shareholding of the
existing shareholder.
Existing shares issue = 3 million (Nu. 30 million)
Rights issue = 2 for 5 shares
Number of right shares = 2/5 x 3,000,000 = 1,200,000 shares (= Nu. 12 million)
Bank Dr 14,400,000
Share capital Cr 12,000,000
Share premium Cr 2,400,000
After issue of rights shares, company’s share capital will be Nu. 42 million (30 million
+ 12 million). Total equity will be Nu. 44.4 million.
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Box 6.3: Right issue

DPL shares oversubscribed in the rights auction
Despite suffering losses for the sixth consecutive year, the Dungsam Polymer Limited
shares in the auction was oversubscribed by 7,315 number of shares. The DPL issued
7,000,000 rights shares to raise Nu 70 million at the face value of Nu 10 per share at the
ratio 8:7 (For every 8 shares, 7 rights shares). The subscription opened from October 22
to November 14 this year.
By the end of the subscription period, 668 existing shareholders subscribed a total of 3.8M
shares. The remaining 3.15M unsubscribed shares was auctioned in the secondary market.
On the closing date of the rights auction, a total of 25 bidders placed orders for 3.16M
shares at multiple pricing starting from Nu 11 to Nu 23 a share. Rights offer is an issue of
shares offered at a special price by a company to its existing shareholders in proportion to
their holding of old shares.
Unlike in the past where the company offering rights issue took back the unsubscribed
shares, the Royal Securities Exchange of Bhutan (RSEB) has developed new regulation to
auction the unsubscribed shares through its online platform. This makes it possible for
individuals who don’t own DPL shares to participate. However, the company can only
claim the initial offer price, which is Nu 10 a share. Anything above Nu 10 goes to the
existing shareholders who did not subscribe to the rights issue since it culminates into
selling their rights to others.
For instance, if an existing DPL shareholder has one share and that person did not subscribe
the rights issue, his rights will be put up in the auction. If it is sold at Nu 15 in the auction,
Nu 10 will go to the company and this shareholder will get to keep the remaining Nu 5.
This new practice, according to the officials from the RSEB would provide everyone an
opportunity to participate in share trading. Consequently, the total market value of shares
in the country has increased from Nu 28B in mid-June to Nu 31.29B in August this year,
up by over Nu 3B in a period of about two months. This further increased to more than
Nu 36 as of yesterday.
This also means that the stocks of 21 listed companies are worth Nu 36B, according to
the figures from the Royal Securities Exchange of Bhutan. With no initial public offerings
(IPO), this drastic increase in market capitalisation is attributed to improvement of share
trading in the secondary market, especially the rights and bonus issue. According to RSEB,
share trading in the secondary market has increased by about 300 percent in the first five
months this year compared with the same period in 2017.
Record show that as of May this year, shares worth Nu 125M was traded in the secondary
market. Last five years data (as on May for each year) revealed that there is a huge
improvement in transaction pattern in the secondary market. The improvement in the
secondary market could be due to change in the trading process from continuous to call
market, which discouraged the negotiated trade as practiced earlier.
Kuensel, December 19, 2018
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6.9.8 Accounting for dividends

Dividend is one of the returns on investment in equity and preference shares. In
other words, dividend is a portion of company’s profit that is distributed to the
current shareholders of the company. Dividend can be viewed in two forms.
6.9.9 Proposed dividend
Company directors may propose a dividend for the year after finalizing the accounts
and knowing the profit of the company for the year before the annual general meeting.
If the financial statements are prepared after the directors’ proposal of the dividend,
the proposed dividend will be disclosed in the notes of the financial statements. The
proposed dividend will not be recognized as an expense or a liability because the
proposed dividend still need to be discussed and endorsed in the annual general
meeting. Obligation of dividend will arise only when the dividend is endorsed
(declared) in the annual general meeting of shareholders.
6.9.10 Declared dividend
Dividend once endorsed or declared in the annual general meeting will be an
obligation to the company to the current shareholders. Thus, declared dividend is
recognized as an expense that is deducted from the retained earnings or equity,
and the same is also recognized as a current liability in the statement of financial
position.
Dividend expense Dr [SOCE]
To dividend payable [current liability]
Retained earnings Dr [SOCE]

To paid up dividend Cr [SOCE]
6.9.11 Preference dividends

Preference shareholders have the right to receive dividends before ordinary
shareholders, if any dividend is proposed or declared for ordinary shares. If it is
redeemable preference shares, the preference dividend is accounted as expense in
the Statement of Income and a dividend liability is recognized as current liability.
Preference dividend expense (finance cost) Dr
To preference dividend liability
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6.10 Presentation of Equity and Debt Finance in the Financial

Statements
The paid up share capital and other components of equity such as reserves and
retained earnings are presented under the heading ‘Equity’. Debt finance in any form
such as bonds, term loans and commercial papers are presented under the heading
‘Liabilities’. Depending on the maturity dates of those debt finance, liabilities are
further classified and presented as ‘non-current liabilities’ and ‘current liabilities’.
This is given in the following annual report of Bhutan Telecom Limited for 2018.
Bhutan Telecom, Annual Report 2018
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Exercises:
a. Discuss in group how companies like DGPC, FCB and BPC raise capital
without issuing shares in the market. Present the discussion outcome to the
class.
b. A reporting entity issued Nu. 3 million 10% coupon bonds in the beginning of
the year 2020. The bonds will be redeemed after 7 years at par. Effective interest
rate is 12%. It cost Nu. 200,000 as issue cost. Company applies amortization
cost method to account such bonds. Analyse the transactions and provide an
appropriate accounting treatment for the same.
Present the items in the financial statements for the year ended 31 December
2020.
c. A company chose to make a rights issue to raise Nu. 25 million. There are
100 million shares in issue at present. Shares were originally issued at Nu. 10
eight years ago. Company incurred Nu. 0.5 million to issue the shares earlier.
Company management makes an offer of 1 for 10 shares to the shareholders.
Only 60% of the rights offered to the existing shareholders were subscribed.
The remainder of the rights issue was made to the public on 1 July 2020. Shares
were traded at Nu. 20 when the rights issue was made to the public. The rights
issue made to the public were fully subscribed.
Discuss in group and propose how the rights issue will be accounted and
presented in the financial statements.
d. ‘Company should use scrip or bonus shares in place of cash dividend’. Organize
a class debate ‘for’ and ‘against’ this statement.
e. A company issuing an equity instrument is not required to remeasure the
fair value of the equity instruments at the time of preparing the financial
statements.
Explain why you think remeasurement is not required.
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Chapter 7: Accounting for Partnership Firm
Chapter 7
Accounting for Partnership
Firm
• Explain the meaning of partnership business and partnership agreement

• Allocate salary, profits and losses and interest in the capital account
• Describe the effects of the entries at the time of admission and withdrawal
of a partner
• Prepare relevant accounts upon the dissolution of partnership firm
Bhutan has seen a tremendous change in economy over a period of time right from
barter system to modern economy. At present most business undertakings in Bhutan
are predominated by small and medium scale businesses in the form of sole trading
and partnership. However, in spite of the fact that Bhutanese economy is driven
by small and medium scale businesses, Bhutan lacks relevant business act in place
to govern the activities, especially that of partnership firms which is still popular.
Robust partnership agreements have substituted the requirement of partnership act
in resolving the issues up to certain degree at present. While Bhutan still waits for
a partnership act, key aspects of the financial statements of partnership firm are
secured under Bhutanese Accounting Standards.
This chapter will focus on accounting treatment of partnership capital, allocation of
profits and losses, interest and salary. Additionally, the accounting treatment relating
to admission and withdrawal of partners and liquidation of partnership firm will be
discussed in brief. Since Bhutan lacks explicit and common standard of partnership
law, very little aspects of partnership accounting can be discussed.
7.1 Meaning of Partnership

A partnership business is a business owned by more than one person carried out
with the motive to earn profit. Each partner holds the power to legally bind all other
partners by his or her actions in the interest of the partnership and is liable for all
partnership debts up to the extent of personal assets.
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Since partnership business operates on the basis of mutual trust, value and
commitment, the need for partnership agreement is crucial in resolving issues
arising in normal operation of the business. Despite the fact that agreement can
be verbal, written agreement would be generally preferred to avoid any future
legal complications. Partnership agreement can be defined as a written agreement
between two or more partners to carry out legal business.
7.2 Partnership Accounting

Although the presentation of asset and liability in statement of financial position
is similar to incorporated business, the presentation of the equity section differs as
follow:
Partnership Corporation
Partner’s Capital Shareholder’s Equity
A’s Capital 50,000 Share Capital 50,000
B’s Capital 30,000 Retained Earnings 30,000
Total 80,000 Total 80,000
In partnership accounting, partner’s capital account and partner’s drawings account
for each partner is maintained in the general ledger.
Practical Problem 1
In a team, discuss and share the differences between Sole Trading, Partnership and
Incorporated businesses.
7.2.1 Partnership capital accounts

Partnership capital account comprises of individual capital account of partners and
records of their capital contributions. For instance, the following journal records
contribution of Nu. 1,000 by Mr. A.
Cash A/c Dr 1,000

To A’s Capital A/c 1,000
(Being the capital contribution made by Mr. A)
If assets are contributed instead of cash, then respective asset account will be debited
instead of cash account.
7.2.2 Partnership drawings account

Partnership drawings account records any withdrawals from the business. Each
partner maintains his/her drawing account. The following journal entry records A’s
drawing of Nu. 1,000 made during the year;
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A’s Drawing A/c Dr 1,000

To Cash A/c 1,000
(Being the amount withdrawn from the business by A)
If a partner withdraws asset instead of cash, then respective asset account is credited
in place of cash account. At the year end, each partner’s drawing account is closed to
their capital account. The following journal entry records A’s drawing to his capital
account provided there are no further drawings.
A’s Capital A/c Dr 1,000
To A’s Drawings A/c 1,000
(Being the A’s Drawing account transferred to his capital account)
7.2.3 Interest on Drawings

The partnership deed provides provision to charge certain interest on drawings made
by the partners. It discourages partners from withdrawing excessive amount from
the partnership business. The method of charging interest is decided by partners
and is specifically mentioned in partnership agreement. This chapter deals with
simple interest method of charging interest computed as;
Interest = Total amount withdrawn × Rate × Time
7.2.4 Allocation of partnership profits and losses

Profits and losses in partnership business are distributed as per the agreed ratio
mentioned in the partnership agreement. However, if nothing is mentioned in the
partnership deed, it is assumed that distributions are made evenly.
7.2.5 Salary and interest allocations

Salaries are normally paid to the partners based on time and effort devoted by
individual partners to the business. Interest on capital is usually paid to compensate
the difference in capital contribution made by the partners. In nutshell, salary and
interest allocations are required in order to maintain equity among the partners
before distributing the profit. The mode of salary and interest allocation is stated
in partnership deed. In any case, if the partnership deed do not explicitly mention
anything on salary and interest allocation, then no salary and interest allocation is
permissible.
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7.2.1 Profit and loss appropriation account

A profit and loss appropriation account is prepared in order to allocate salary,
interest and profit and loss to partners. Therefore, profit and loss appropriation
account shows how profits and losses of the partnership firm are distributed among
the partners. It does not include items which are charged against the profit of the
firm. It is a nominal account in nature.
Illustration 1 demonstrates how salary, interest and profit and loss allocations are
made to the partners.
Illustration 1
On 1st January 2018, A and B with Nu.10,000 each as capital agreed to share
remaining profits and losses in the ratio of 3:2 after allocation of salary and interest.
During the year ending 31st December 2018, they earned net profit of Nu. 200,000.
On 1st July 2018, A withdrew Nu. 20,000 and B withdrew Nu. 10,000 from the
business for personal use. The partnership deed provides that:
i) interest on capital to be allowed at 10% p.a.,
ii) interest on drawing to be charged at 10% p.a. using simple interest method,
and
iii) salary of Nu. 5,000 p.m. to be paid to Mr A and Nu. 6,000 p.m. to be paid
to Mr B.
Required
Show how interest, salary and profits or losses are allocated to A and B.
Solution
Profit and Loss Appropriation Account (Apply Nominal Account Rule)

Particulars Amount Amount Particulars Amount Amount
To Salary: By Net profit 200,000
A: 5,000 X 12 60,000 By Interest on Drawing:
132,000
B: 6,000 X 12 72,000 A: 20,000 X 10% X 6/12 1,000
To Interest on Capital: B: 10,000 X 10% X 6/12 500 1,500
A: 10,000 X 10% 1,000
B: 10,000 X 10% 1,000 2,000
Net Divisible Profit:
A: 69,000 X 3/5 40,500
B: 69,000 X 2/5 27,000 67,500
TOTAL 201,500 TOTAL 201,500
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A statement of partner’s capital is calculated after preparing profit and loss

appropriation account.
A and B Partnership
Statement of Partner’s Capital
For the Year Ended December 31, 2018
A (Nu) B (Nu) Total (Nu)
Bal. on 1/1/18 10,000 10,000 20,000
Add: Net Divisible Profit 40,500 27,000 67,500
Add: Salary 60,000 72,000 132,000
Add: Interest on Capital 1,000 1,000 2,000
Add: Additional Capital - - -
Less: Drawings (20,000) (10,000) (30,000)
Less: Interest on Drawings (1,000) (500) (1,500)
Bal. on 31/12/18 90,500 99,500 190,000
The capital balance then will appear in statement of financial position as;
Partner’s Capital
A’s capital Nu. 90,500
B’s capital Nu. 99,500
Total partners’ capital Nu. 190,000
Practical Problem 2
a. Considering information provided in illustration 2, what would happen if
there was no partnership agreement between A and B? Prepare statement of
partner’s capital to show how it would appear in statement of financial position.
b. Pema and Dema want to start a software solution business. Pema is willing to
contribute Nu. 100,000 but will not be working. Dema on other hand will not
be contributing any capital but will be working full time. They have agreed to
split profits equally. As a commerce student you are approached to confirm
their thoughts. What do you recommend?
7.3 Admission of Partners

When a new partner is admitted, a new partnership agreement will be required
since the provisions of old partnership agreement will no longer be valid.
The existing partner may consider the change in the value of assets and liabilities.
Hence, revaluation of assets and liability may be required. Any gain or loss on
revaluation will be transferred to capital account of existing partners. However,
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it becomes problematic for some because this leads to a deviation of the financial
statement of partnership from historical cost principle. Others contend that
revaluation isn’t an issue since when a new partner is admitted, the existing
partnership is dissolved and a new partnership is formed. For this chapter, it will be
assumed that revaluation of assets and liabilities does not take place.
New partner can be admitted either by purchasing an existing partner’s interest or
by investing in partnership business.
7.3.1 Purchasing an existing partner’s interest

Under this method a new partner acquires the interest of existing partner. Such
transactions are private in nature and they do not have any effect on the assets and
total capital of the partnership firm. The following journal entry is recorded in the
books:
Existing Partner’s Capital A/c Dr XXX
To New Partner’s Capital A/c XXX
(Being the existing partner’s interest bought by new partner)
Assume A and B are partners with the capital balance of Nu.10,000 and Nu.5,000
respectively. C is admitted as a new partner and purchases half of the B’s share. The
following journey will be recorded in the books;
B’s Capital A/c (5,000 / 2) Dr 2,500
To C’s Capital A/c 2,500
(Being C admitted by purchasing half of B’s share)
7.3.2 Investment in the partnership

Under this method, a new partner brings in cash or other assets instead of buying
existing partner’s interest. It increases both the net asset and the total capital of
partnership firm.
Assuming that A and B are partners with the capital balance of Nu.150,000 each. C
is admitted as a new partner and brings Nu.75,000 for 20% share. The book value of
new partner’s share of capital is calculated as follow:
Total capital of A and B (150,000 + 150,000) 300,000
C’s investment 75,000
Total Capital 375,000
C’s share of capital (375,000 X 20%) 75,000
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Since, C’s share of capital is equal to C’s investment in the business, the following
journal entry will be recorded in the books of accounts:
Cash A/c Dr 75,000
(Being cash or other assets brought in by the new partner)
Sometimes, the share of capital of new partner may not be equal to the new partner’s
investment. In such case, the bonus method or goodwill method may be adopted.
For this chapter, bonus method will be followed since BAS 38 restricts recognition
of internally generated goodwill.
7.3.3 Bonus to the new partner

The partnership may want to add a new partner who can bring certain specialized
skills, management abilities, or some other desirable business strengths. A bonus is
paid to new partner when the share of new partner’s capital is greater than the new
partner’s investment in the partnership business. In such case, the bonus amount is
debited to existing partner’s capital account in profit sharing ratio.
Illustration 2 explains the treatment of bonus paid to new partner.
Illustration 2
A and B are partners sharing profits and losses equally. C is admitted as new partner and
brings cash of Nu.4,000 for one-fifth share in the partnership firm. The following is the
Capital balance of A and B before admitting C.
Capital Account Amount

A’s Capital 10,000
B’s Capital 10,000
Total 20,000
Required
Prepare a journal entry to record the amount of bonus paid to the new partner.
Solution:
C’s share of capital (24,000 X 1/5) 4,800
From the above calculation we can conclude that C is actually required to bring in
Nu. 4,800 for one-fifth share instead of Nu. 4,000. Therefore, the difference amount
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of Nu. 800 (4,800 – 4,000) will be debited to A and B’s capital account in profit
sharing ratio. The following journey entry is recorded;
Cash A/c Dr 4,000
A’s Capital A/c Dr 400
B’s Capital A/c Dr 400
(Being bonus paid to C on admission)
7.3.4 Bonus to the existing partner

If the partnership business is particularly successful and profitable, the existing
partners may require the new partner to pay them a bonus as compensation. A
bonus is paid to existing partner when the share of new partner’s capital is less than
the new partner’s investment in the partnership business. In such case, the bonus
amount is credited to existing partner’s capital account in profit sharing ratio.
Illustration 3 will briefly discuss on treatment of bonus paid to the existing partner;
Illustration 3
A and B are partners sharing profits and losses equally. C is admitted as new partner
and brings cash of Nu. 13,000 for one-fourth share in the partnership firm. The
following is the Capital balance of A and B before admitting C.
Capital Account Amount
20,000
Required
Prepare a journal entry at the time of admitting C.
Solution:
C’s share of capital (33,000 X 1/4) 8,250
From the above calculation we can conclude that C is actually required to bring
in Nu. 8,250 for one-fourth share instead of Nu. 13,000. Therefore, the difference
amount of Nu. 4,750 (13,000 – 8,250) will be credited to old partners’ capital account
according to profit sharing ratio. The following journey entry is recorded;
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Cash A/c Dr 13,000

To A’s Capital A/c 2,375 2,375
To B’s Capital A/c 2,375 2,375
To C’s Capital A/c 8,250 8,250
(Being the bonus paid to A and B on admission)
Practical Problem 3
Considering the information from illustration 3, show the change in the statement
of financial position of the partnership firm after C’s admission.
7.4 Withdrawal of Existing Partner (Retirement)

When the existing partner withdraws from a partnership, settlement of outgoing
partner’s ownership is made in accordance with the provisions mentioned in the
partnership deed.
The accounting treatment during withdrawal of existing partner involves sale to new
partner, sale to one or more existing partners and through a payment of partnership
assets to the withdrawing partner.
7.4.1 Sale to new partner

Under this method, the payment for the ownership interest is a private transaction
and the existing partner must approve it. Such transaction does not have any effect
on assets and total capital of the partnership firm.
Suppose A, B and C are partners with a capital balance of Nu.5,000, Nu.4,000 and
Nu.3,000 respectively. C withdraws from the firm and sells it to D who will be
admitted as a new partner. In this case, the following journal entry will be recorded
in the books of accounts;
C’s Capital A/c Dr 3,000
To D’s Capital A/c 3,000
(Being C’s capital transferred to D)
a) Sale to remaining partner
Here, the remaining partner acquires the partnership interest of withdrawing
partner. Such transaction is private in nature and do not have any effect on assets
and total capital of the partnership firm.
Assuming A, B and C are partners with a capital balance of Nu. 5,000, Nu.4,000 and
Nu. 3,000 respectively. C withdraws from the firm and sells his partnership interest
to the remaining partner equally. In this case, the following journal entry will be
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recorded in the books of accounts;

To B’s Capital A/c 1,500
(Being C’s capital transferred to A and B)
7.4.2 Payment from partnership assets

Under this method, the asset of the partnership firm is used to pay off the
withdrawing partner’s interest. This method reduces the net assets as well as total
capital of the partnership firm. Some partnership agreements provide that the book
value of assets should be revalued with the fair value of the assets at the time of
partner’s withdrawal. However, this would violate the historical cost principle and
going concern assumption.
For this topic, asset revaluations will not be recorded, instead, a bonus method
approach will be used.
7.4.3 Bonus to withdrawing partner

A bonus is paid to withdrawing partner when the amount paid to withdrawing
partner is greater than the withdrawing partner’s capital balance. In such case,
bonus paid to withdrawing partner is debited in remaining partner’s capital account
in their profit sharing ratio. Illustration 4 explains the treatment of bonus paid to
withdrawing partner.
Illustration 4
A, B and C are partners sharing profits and losses in the ratio of 3:2:1. C retires from
partnership firm and is paid Nu. 12,000. The following is the statement of financial
position of A, B and C:
Assets
Cash 53,000
Other Assets 50,000
103,000
Capital and Liabilities
C’s Capital 11,000
Loans 70,000
103,000
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Required
Prepare a journal entry to record C’s withdrawal
Solution:
Since C is paid excess of Nu. 1,000 (Nu. 12,000 – Nu. 11,000), the excess amount is
a bonus to the withdrawing partner and will be debited to A and B’s capital account
in the ratio of 3:2. The following journal entry is recorded:
A’s Capital A/c Dr 600
B’s Capital A/c Dr 400
To Cash A/c 12,000
(Being the bonus paid to C)
Suppose, if the partnership firm do not have adequate amount to pay C’s share of
interest, C’s loan account is credited instead of cash.
7.4.4 Bonus to remaining partners

A bonus is paid to remaining partners when the amount paid to withdrawing
partner is less than the withdrawing partner’s capital balance. In such case, the bonus
amount is credited to remaining partners’ capital account in their profit sharing
ratio. Illustration 5 explains the treatment of bonus paid to remaining partners.
Illustration 5
Considering the information provided in illustration 4, what would happen if C was
paid Nu.9,000 instead of Nu.12,000?
Solution:
If C is paid Nu.9,000 then the difference of Nu.2,000 (11,000 – 9,000) will be treated
as bonus to the existing partner and will be credited to A and B’s capital account in
the ratio of 3:2. Therefore, the following journal entry will be recorded:
To B’s Capital A/c 800
To Cash A/c 9,000
(Being the bonus paid to A and B)
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Practical Problem 4
a. List down various reasons why would a partnership firm pay bonus to the
withdrawing partner?
b. Why would a partnership firm pay bonus to the remaining partners?
c. Considering the illustration 5, show the change in the statement of financial
position of the partnership firm after C’s withdrawal.
7.5 Death of a Partner

In case of death of a partner, partnership gets dissolved and all accounts are closed
to ascertain the net income earned till the date of death. The partnership agreement
may demand audit and revaluation of assets. The balance of the deceased partner’s
capital account is then transferred to death partner’s executor account as a liability.
Remaining partners may continue or liquidate partnership firm. If the partnership
continues, the mode of payment to death partner’s executor account is same as
withdrawal of partner. However, for this chapter, the death of partner will not be
further discussed.
7.6 Liquidation of Partnership Firm

Liquidation of partnership firm means complete termination of the firm. All assets
are sold except for cash and cash equivalents since they are already in liquid form
or can be easily converted into cash in short period of time. All liabilities are paid
off and after disposal of assets and payment of liabilities, the remaining cash or any
unsold assets are distributed to the partners in profit sharing ratio. For this purpose,
realisation account is prepared to ascertain the profit or loss incurred during the
process of liquidation. Realisation account is nominal account in nature.
7.6.1 Cash Equivalents

Cash equivalents are short-term, highly liquid investments that are readily
convertible to known amounts of cash and which are subject to an insignificant risk
of changes in value. Example of cash equivalent includes treasury bills and short
term investments.
Illustration 5 examines the accounting treatment at the time of dissolution;
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Illustration 6
A, B and C are partners sharing profits and losses in the ratio of 5:3:2. The following is
the statement of financial position of A, B and C partnership firm on 31st December
2018.
Assets
Cash 53,000
PP&E 50,000
103,000
C’s Capital 11,000
Loans 50,000
Trades Payable 20,000
103,000
On 1st January 2019, the partnership was dissolved and assets realized amounted to
Nu. 80,000. Liabilities were paid off and realization expenses amounted to Nu. 2,000.
Identify accounting treatment required at the time of dissolution of the firm.
Solution:
Step I
Prepare realisation account to convert all non-cash assets to cash and pay off all the
liabilities.
Realisation Account (Apply Nominal Account Rule)
Particulars Amount Amount Particulars Amount Amount
To Assets By Liabilities
Property, Plant & Equipment 50,000 Loan 50,000
Trades Payable 20,000 70,000
By Cash A/c (Assets
To Cash A/c (Liability Paid) 70,000 80,000
Sold)
To Cash A/c (Realisation
2,000
Expenses)
To Capital A/c
A’s Capital A/c (28,000X5/10) 14,000
B’s Capital A/c (28,000X3/10) 8,400
C’s Capital A/c (28,000X2/10) 5,600 28,000
Total 150,000 Total 150,000
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In case, if the assets are taken over by the partners, the following journal entry is
recorded:
Partner’s Capital A/c Dr XXX
To Realisation A/c XXX
(Being the asset taken over by old partners in their profit sharing ratio)
If the liability is taken over by old partners, the following journal entry is recorded:
Realisation A/c Dr XXX
To Partner’s Capital A/c XXX
(Being the liability taken over by old partners in their profit sharing ratio)
Step II
Prepare Capital statement of partners to calculate amount payable to the partners.
Capital Statement of A,B and C
A (Nu) B (Nu) C (Nu) Total (Nu)
Capital balance 11,000 11,000 11,000 33,000
Profit on realization 14,000 8,400 5,600 28,000
Loss on realization (Less) - - - -
Assets taken over by partners (Less) - - - -
Liabilities paid by partners (Add) - - - -
Balance (Credit) 25,000 19,400 16,600 61,000
Step III
Prepare Cash account to ascertain cash balance available.
Cash and Cash Equivalent A/c (Apply Real Account Rule or Asset Rule)
To balance b/d 53,000 By Realisation A/c (Liabilities Paid) 70,000
To Realisation A/c (Assets By Realisation A/c
80,000 2,000
Sold) (Realisation Expense)
Balance (Debit) 61,000
Total 133,000 Total 133,000
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Step IV
Pass the following journal entry in the books of accounts to settle the amount due
to the partners;
A’s Capital A/c Dr 25,000
B’s Capital A/c Dr 19,400
To Cash/Bank A/c 61,000
(Being the amount paid to partners in full settlement)
Sometimes, the sale of partnership may result in debit balance in one of the partner’s
capital account after allocation of losses. Partner with a debit capital balance need to
bring cash equivalent to the amount of debit capital balance or partners with credit
capital balance have to bear the deficit capital balance as per the profit and loss
sharing ratio. However, this method will not be covered up in this chapter.
Practical Question 5
Considering the information from illustration 5, prepare realization account,
statement of capital account, cash account and pass journal entry to settle the
account of partners’ capital account if:
i) property, plant and equipment worth Nu. 5,000 is taken over by A,
ii) remaining property, plant and equipment is sold for Nu. 75,000,
iii) loan amount of Nu. 3,000 is paid by B,
iv) remaining liability paid fully, and
v) realisation expenses amounted to Nu. 2,000.
Exercises:
1. On 1st January 2018, Sonam and Karma decided to form a partnership firm.
The partners agreed to the following terms;
Partners Capital Contribution Salaries Profit Sharing Ratio
Sonam 200,000 30,000 60%
Karma 100,000 20,000 40%
Interest on capital is charged @10% p.a. on the opening balance of capital every year.
During the year, each partner withdrew Nu.25,000 from the firm.
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With reference to the above information, answer the following questions:

a. Assume that at the end of 2018, the partnership firm reported net profit of
Nu.150,000. Which of the following amount would be reported for Sonam’s
Capital?
A Nu. 267,000
B Nu. 133,000
C Nu. 200,000
D Nu. 130,000
b. Assume that at the end of 2018, the partnership firm reported net profit of
Nu.100,000. Which of the following amount would be reported for Karma’s
Capital?
A Nu. 240,000
B Nu. 113,000
C Nu. 123,000
D Nu. 237,000
c. Suppose if Dorji is admitted as a new partner for 20% share on 1st January
2019 and brings Nu.100,000 as cash, which of the following amount would
be reported for Dorji’s Capital if the partnership reported net profit of Nu.
100,000 at the end of 2018?
A Nu. 100,000
B Nu. 90,000
C Nu. 80,000
D Nu. 70,000
d. Dorji is admitted as a new partner for 20% share on 1st January 2019 and
brings Nu. 80,000 as cash. The partnership reported net profit of Nu. 100,000
at the end of 2018. What would be the new capital balance of Sonam after
admission of Dorji assuming that Dorji and Sonam are equal partners?
A Nu. 232,000
B Nu. 233,000
C Nu. 234,000
D Nu. 235,000
2. Druk, Dhom and Tag are partners sharing profits and losses in the ratio of 5:2:3.
Their capital balances at the end of December 2016 are Druk; Nu. 200,000,
Dhom; Nu. 120,000 and Tag; Nu. 150,000
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On 1st January 2017, Druk decided to withdraw from the partnership firm. You are
required to prepare journal entries to record Druk’s withdrawal if;
i) Druk is paid Nu. 200,000
ii) Druk is paid Nu. 180,000
iii) Druk is paid Nu. 250,000
3. Yangchen and Sheldon are partners sharing profits and losses in the ratio of
2:1. Their capital balance on 1st January 2012 are: Yangchen – Nu. 200,000 and
Sheldon – Nu. 100,000.
The partnership agreement provides that the profits and losses to be shared in
the ratio of 2:1. Interest of 10% p.a. to be allowed on the opening capital balance
and salary allowance of Nu. 40,000 and Nu. 30,000 to be paid to Yangchen and
Sheldon respectively.
During the year, Yangchen and Sheldon withdrew Nu. 50,000 each for private
purpose and the net income earned before charging interest and salary amounted
to Nu. 80,000.
On 1st January 2013, Keldon was admitted as a new partner and contributed
Machinery worth Nu. 120,000 for one-fourth share. The bonus method was used
to admit Keldon. A new partnership agreement was amended as follows;
i) Interest of 12% p.a. on the opening capital balance.
ii) Annual salary of Nu. 30,000 and Nu. 20,000 to Yangchen and Sheldon
respectively.
iii) Profits and losses to be shared in the ratio of capital balance of Yangchen,
Sheldon and Keldon on 1st Jan 2013.
During the year 2013, the partnership firm earned a net income of Nu.150,000
before charging interest and salary.
Prepare appropriation account, necessary journal entries and statement of
partners’ capital account from 1st January 2012 to 31st December 2013.
4. Apa, Ama and Bum are partners sharing profits and losses in the ratio of 5:3:2.
They decided to liquidate their business on mutual agreement, moreover Apa
wanted to sue Ama and Bum since they have been misusing the partnership
firm property. The following is the statement of financial position of Apa, Ama
and Bum partnership firm on 31st December 2018 before the dissolution of a
firm.
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Assets
Cash 100,000
Trades Receivable 50,000
Inventory 50,000
Land 100,000
300,000
Apa’s Capital 90,000
Ama’s Capital 80,000
Bum’s Capital 60,000
Loans 20,000
Trades payable 50,000
300,000
On 1st January 2019, the partnership was dissolved. Only 90% of the trade receivables
were realized and inventory worth Nu. 20,000 were taken over by Ama at Nu. 15,000,
only 80% of the remaining inventory was realized. Land was sold for Nu. 100,000.
Trade payables were paid off @ 10% discount. Bum decided to pay off loan and
Realisation expenses amount to Nu. 10,000.
Required:
i) Identify any two factors that could lead to dissolution of a firm from the
case.
ii) What would happen if partnership distributes non-cash assets to partners
to liquidate the firm instead of selling it?
iii) Prepare realisation account, cash account, and partners’ capital statement
and provide journal entries to settle the amount due to partners.
Case Study 1
Tashi and Sonam are partners sharing profits and losses equally and runs restaurant
situated in Thimphu. Their business has been performing well beyond their
expectation and most of the customers are employees working under different
organizations. Tashi wanted the business to grow further in terms of profit and even
sacrificed her lunch time to cater the needs of regular customers while Sonam, on
the other hand, took longer lunch hours. Furthermore, Sonam makes significantly
larger withdrawals compared to Tashi and contends that he generally maintains
proper drawing’s account. Sonam’s drawings to date are double of Tashi’s.
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Required:
i) Who are the stakeholders in this situation?
ii) Identify the problems with Sonam’s actions and discuss the ethical
considerations.
iii) How might the partnership agreement be revised to accommodate the
differences in Tashi and Sonam’s work and withdrawal habits?
Case Study 2
Pema, Tashi and Dorji graduated with a bachelor’s degree in Commerce from Gedu
College of Business Studies in the year 2017. They always wanted to start a garment
business which requires initial capital investment of Nu.1 million. Three of them
choose to arrange the required capital from friends and relatives and were successful
in acquiring the finance. A trade license was obtained online within two days. On
1st January 2019, they started a garment business with initial capital investment of
Nu. 1 million as follow:
Pema – Nu. 500,000
Tashi – Nu. 300,000
Dorji – Nu. 200,000
They consulted the legal firm and have developed partnership agreement which
contained the following provisions;
i) Any profits or losses arising out of conduct of business were to be shared in
the ratio of 5:3:2.
ii) Annual salary of Nu. 12,000, Nu. 10,000 and Nu. 8,000 to be paid to Pema,
Tashi and Dorji respectively.
iii) 10% p.a. interest to be allowed on opening capital balance only.
Most of the marketing strategies were developed by Pema since she possessed
expertise in marketing area. Tashi and Dorji always expected that their business may
reach an end without Pema. Moreover, Tashi and Dorji knew that their personal
property would be at greater risk to meet the liabilities of the creditors.
During the year, Pema, Tashi and Dorji withdrew Nu.10,000 each for personal use.
On 1st July 2019, Pema introduced additional capital of Nu. 20,000. The net income
for the year ended December 31, 2019 amounted to Nu. 100,000.
Required:
i) Identify two advantages and disadvantages of partnership business from the
case.
ii) Do you think that interest of 10% p.a. on the opening balance of the capital
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is fair enough? Why?

iii) If Pema withdraws from the partnership firm, what strategies can be adopted
by Tashi and Dorji to continue the partnership firm?
iv) Prepare Profit and Loss Appropriation Account showing the division of net
income among the three partners.
v) Prepare a Statement of Partner’s Capital Account to ascertain the balance of
capital on 31st December 2019.
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Chapter 8: Financial Statements of a Limited Company
Chapter 8
Financial Statements of a
Limited Company
• Explain the purpose of adjusting entries

• Explain the concept of financial statements and company’s annual report
• Prepare statement of income with proper analysis of expenses based on the
nature or the function
• Prepare statement of financial position
• Prepare statement of cash flows
• Prepare statement of changes in equity
• Calculate basic earnings per share and disclose the information in the
financial statements
• Explain and draft short accounting notes and accounting policies
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As you will recall from class XI, business entities prepare financial statements to
report their performance and financial position at the year-end to its capital providers
(shareholders in terms of companies) and other stakeholders. The management of
the entity also reports other aspects of its business to its shareholders and other
stakeholders. These other aspects of reporting include management financial
review, directors’ report, corporate governance report, and auditors report. All these
information along with financial statements of a company is compiled in a single
document called an ‘annual report’ of a company. Company’s annual report, thus
informs shareholders and other stakeholders not only about company’s financial
matters but also the overall affairs of the company.
This chapter is a continuation of chapter 10 of class XI Accountancy text. The basic

concepts and other underlying theories related to financial statements are covered in
class XI. In this chapter, you will gain further understanding of company’s financial
statements and learn the techniques of preparing financial statements in line with the
current financial reporting standards. The chapter also introduces a basic concept
and reporting of earnings per share in the financial statements.
8.1 Approach to Preparing Financial Statements of a Limited

Liability Company
As you know financial statements of an entity are a primary source of information
to many investment decision makers and regulatory authorities. The management
of an entity must therefore engage professional skills and knowledge to prepare
financial statements and to ensure that financial statements present true and fair
view of the entity’s financial performance and the financial position. The preparation
and presentation of financial statements is a part of financial reporting of the entity.
BAS1 Presentation of Financial Statements provides essential guidelines to entities
who prepare financial statements to the external users.
It is important for the student to understand the procedures and the principles used
in the preparation and presentation of financial statements of an entity.
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A summary of this process is presented in the diagram below.
GENERAL LEDGER TRIAL BALANCE

Close all accounts and pass Pick up all balances from the
adjusting entries including ledger accounts and place them
closing entries under DEBIT or CREDIT
column and get the total of
debit and credit equal.
ACCOUNTING POLICIES
Provide a brief and succinct
descriptions for each significant FINANCIAL STATEMENTS
transactions about the Transfer all income and expense items to
recognition, measurement and Statement of Income
disclosure of these transactions. Transfer all assets, liabilities and equity to
Prepare Statements of Cash Flows and
Statement of Changes in Equity
Provide detail notes and explanations for
items of assets, liabilities, equity, income
and expenses to support the amounts
reported in the financial statements
Figure 8.1 Process of preparing financial statements
You would have gained some knowledge and skills of identifying business transactions
and recording them, and later posting them to ledger accounts in class XI. You have
also learnt the concept of trial balance and steps to prepare trial balance including
an adjusted trial balance. All now you have to do is to gain further knowledge and
skills in the preparation of financial statements with the trial balance given to you.
Before we discuss in some details on the preparation and presentation of financial
statements, let us review the purpose of trial balance and its limitation so that we are
not carried away by the purpose of trial balance.
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8.1.1 Trial balance and its purpose

Trial balance presents a list of account
balances of assets, liabilities, capital,
income and expenses extracted from
general ledger and arranged in ‘debit’
and ‘credit’ columns for which we
expect the total of debit column equals
the total of credit column.
We expect the total of debit should
equal the total of credit because
we used double entry system when
recording the transactions in the journal. For every debit we have a credit account
with the same amount. What if the debit column and credit column are not equal?
In principle, this indicates some error in recording of transactions in the journal
or posting of transactions to the ledger accounts. Entities where internal control
system is weak, errors can occur at any time and in any part of bookkeeping process.
Trial balance is prepared to detect such errors in the bookkeeping process so that
the errors are rectified prior the preparation of financial statements. Remember only
when the total of debit and the credit columns are different the preparer of financial
statements will seek to search for errors. The trial balance will still show the amounts
of debit and credit columns equal despite having errors in the accounting records
and ledger accounts. That is the limitation of trial balance.
A detail discussion on errors and the rectification of errors can be read in chapter 5
of class XI Accountancy text. Also, you must understand the steps discussed in the
same chapter how to prepare trial balance.
In the computerized accounting system, trial balance is automatically generated by
the system. Trial balance prepared for the preparation of financial statements can be
of two types:
i) Unadjusted trial balance, and
ii) Adjusted trial balance.
These are actually not different types of trial balance but because entities have some
adjusting or updating entries to be passed before closing of accounts and preparation
of financial statements for the year, the trial balance before passing these entries
is named as unadjusted trial balance. The adjusted trial balance is used for the
preparation of financial statements. The trial balance of the entity also gets updated
during the audit of the financial statements for any observations and findings of the
auditors that require additional recognition or rectification of the existing entries.
For example, if the auditor has observed that the entity has undercharged depreciation
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of an asset, he would ask management to provide additional depreciation that will

result in passing an additional entries to adjust the depreciation expense. The trail
balance gets updated with such auditor’s observations before it is finalized and use to
prepare the financial statements which will be issued to the shareholders and others.
8.1.2 Adjusted trial balance

The trail balance prepared before passing adjusting entries is called unadjusted trial
balance. This means, the unadjusted trial balance contains account balances of only
those transactions and events that are recorded and posted during the accounting
period. You have learnt in the previous lessons that there are other categories of
transactions and events in accounting which are implicit in nature. These implicit
transactions such as accruals and prepayments, irrecoverable debts and depreciation
do not occur like other transactions and events. These transactions also do not
generate any source documents or physical evidence to show that transactions
have occurred. Since the bookkeeper does not receive any external notification (in
the form of documents), these transactions are usually recorded at the year-end as
adjusting entries. Adjusting entries are necessary in accrual accounting to ensure
that income and expenses for the year are recognized as required by the accounting
standards.
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Illustration 1
The following question illustrates the concept and the process of writing up the
adjusted trial balance.
A reporting entity prepared a trial balance as at 31 December 2019 as follow.
Debit Credit
Sales 1,420,000
Purchases 650,450
Property, plant and equipment- land 600,000
Property, plant and equipment- buildings 513,600
Property, plant and equipment, equipment 230,500
Accumulated depreciation – building 171,200
Accumulated depreciation-equipment 138,300
Investment 600,000
Inventory 323,350
Interest on borrowed funds 100,100
Loans 300,000
Share capital 1,166,500
Retained earnings 452,000
Interest income 120,000
Salary and wages 350,000
Cash 200,000
Bank balance 100,000
4,168,000 4,168,000
During the closing time of the year, the following information have been provided
to the accounts executives:
i) Salary and wages payables Nu. 85,000
ii) Accrued income from interest Nu. 50,000
iii) Management assessed at the year-end the condition of the inventory
and reported Nu.200,000 inventory as immoveable and no sales value is
expected from this inventory.
iv) Company legal office has been informed by the district court that a
compensation of Nu. 120,000 has to be paid to an employee who has suffered
from injury at work.
v) In the current economic scenario, company will continue to face difficulty
to collect its debts. An allowance of 10% is estimated for the current year on
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the total trade receivables.

vi) An inventory of Nu.60,000 was distributed as donations to Disabled Persons
Association. This was not recorded earlier.
vii) Paid insurance premium of Nu.55,000 in advance.
viii) A credit note issued in favour of a customer who returned goods valued Nu.
110,000 has been misplaced. This must be provided for accordingly.
ix) Buildings and equipment are depreciated over a useful life of 30 years and 5
years respectively using straight line method.
Required:
Prepare the adjusted trial balance for the year ending 31 December 2019.
Solution
The trial balance given in the question is an unadjusted trial balance. This trial
balance has been prepared from the general ledger account balances before the
adjusting entries. As you see in the illustration, there are still some transactions
that need to be recorded at the year-end before preparation of the draft financial
statements. However, not all transactions recorded at the year-end are adjusting
entries. Adjusting entries ensure that all items of income and expenses of the year
are recorded as per the accrual or matching principle.
Adjusting entries
i) Salary and wages Dr 85,000

To accrued salary and wages 85,000
ii) Accrued interest- income Dr 50,000
To Interest income 50,000
iii) Immovable inventory written off Dr 200,000
To inventory** 200,000
iv) Administrative expense-compensation Dr 120,000
To accounts payable 120,000
v) Irrecoverable debt expenses Dr 50,000
To Allowance for irrecoverable /doubtful debt 50,000
vi) Administrative cost-donations Dr 60,000
To inventory ** 60,000
vii) Prepaid insurance Dr 55,000
To cash 55,000
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viii) Sales return DR 110,000

To Trade receivables 110,000
ix) Depreciation-buildings Dr
To accumulated depreciation –buildings
x) Depreciation – equipment
To accumulated depreciation-equipment
Inventory**
• Many entities use purchases account to record goods purchased for resale
or materials purchased for industry production. The alternative approach is
to record to inventory account and recognize them as a current asset. The
journal entries will be written as follow:
On purchase of goods
Inventory Dr
To Cash/Bank/Trade payables
On sale of goods/issue of materials
Cost of goods sold/cost of materials issued Dr
To inventory
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Adjusted trial balance

Particulars Debit Credit Adjustment Adjustment Balance
Debit Credit Debit Credit
Sales 1,420,000 1,420,000
Purchases 650,450 650,450 -
PP&E - Land 600,000 600,000 -
PP&E - Buildings 513,600 513,600 -
PP&E - equipment 230,500 230,500 -
Accumulated depre- building 171,200 17,120 188,320
Accumulated depre- equipment 138,300 46,100 184,400
Depreciation- Building 17,120 17,120
Depreciation - equipment 46,100 46,100
Investment 600,000 600,000
Inventory 323,350 260,000 63,350
Trade receivables 500,000 110,000 390,000
Trade Payables 400,000 - 400,000
Interest on borrowed funds 100,100 100,100 -
Loans 300,000 - 300,000
Salary and wages 350,000 85,000 435,000 -
Share capital 866,500 866,500
Retained earnings 452,000 452,000
Interest Income 120,000 50,000 170,000
Cash 200,000 55,000 145,000
Bank 100,000 100,000
Accrued salary and wages 85,000 85,000
Accrued incomes-interest 50,000 50,000
Other accounts payable 120,000 120,000
Administrative cost- 120,000 120,000
compensation
Irrecoverable debt expenses 50,000 50,000
Allowances for irrecoverable/ 50,000 50,000
doubtful debt
Administrative cost-donations 60,000 60,000
Prepaid insurance 55,000 55,000
Sales returns 110,000 110,000
Total 4,286,220 4,286,220
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Recapitulation of adjusting entries

a) Accruals –accrued income and accrued expenses
The conceptual framework requires that the financial statements should be prepared
on accrual basis except statement of cash flows that is prepared on cash basis. The
essence of accruals is that income and expense should be recognized and recorded
for as they occur in each accounting period and not as when the cash is received
or paid. Accrued income is an income that has been earned or due to be received
but the entity has not yet received at the time of preparing financial statements for
the year. Similarly, the expense incurred but not yet paid until the next accounting
period should be recognized as an accrued expense. Some entities use terms like
‘outstanding’ or ‘dues’ to denote such accruals. All accruals must be adjusted or
accounted for in the current year’s financial statements to ensure that financial
statements faithfully represent the economic activities undertaken by the entity
during the reporting year.
Illustration 2
Pema commenced a computer software development business in 2019 in Mongar.
She drafted her first financial statements for her business for the year ending 2019
as presented below.
Amount (Nu)
Sales 200,000
House rent (30,000)
Salary for staff (45,000)
Utility bills (10,000)
At the time of preparing the financial statements for the year she finds that she need
to pay two months’ house rent and three months’ staff salary. She also realizes that
one month’s telephone bill of Nu. 800 was unpaid. Pema has some income of Nu.
50,000 from her business saving account that is yet to be received.
Required:
Prepare the revised financial statement for Pema making the necessary adjusting
entries.
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Solution
Revised Statement of Income for the year ending 31 December 2019
Note Amount (Nu)
Sales 1 250,000
House rent 2 (36,000)
Salary for staff 3 (60,000)
Utility bills 4 (10,800)
Revised Statement of Financial Position of Pema as at 31 December 2019
Note Amount (Nu)

Current liabilities
Accrued expenses 5 21,800
Notes Amount (Nu)

(1) Income
Income for sales of goods 200,000
Add: Accrued interest income 50,000
250,000
(2) House rent adjustment

Rent paid 30,000
Add: Rent accrued 6,000
Rental expense for the year 36,000
(3) Staff salary adjusment

Salary paid 45,000
Add: Salary accrued 15,000
60,000
(4) Utility bills

Utility bills paid 10,000
Add: Bills accrued 800
10,800
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Note
(5) Accrued expenses
House rent 6,000
Staff salary 15,000
Telephone bills 800
21,800
The T-shape accounts of accruals is presented below.

House rent account
Income Statement 36,000 Cash 30,000
Accrued rent expense 6,000
36,000 36,000
Staff salary account

Income expense 60,000 Cash 45,000
Accrued salary expense 15,000
60,000 60,000
Utility bills account

Income statement 10,800 Cash 10,000
Accrued bills 800
10,800 10,800
Accrued rent account

Balance c/d 6,000 Rental expense 6,000
6,000 6,000
Accured staff salary account

Balance c/d 15,000 Rental expense 15,000
15,000 15,000
Accrued Bills account

Balance c/d 800 Rental expense 800
800 800
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b) Prepaid expenses
In order to calculate the correct profit or loss for the year, the income earned
during the year must be matched with the expense relating to that accounting year.
That way the expense incurred for the year is matched with the economic benefits
received by the entity during the year. What if the payment made during the year
is expected to bring economic benefits in the following accounting period? As per
the accruals and matching principle, since the economic benefits is expected to
flow in the following accounting year, the recognition of the expense is deferred to
the following accounting year. That means the amount paid this year is recognized
as expense only in the following accounting period. As you remember, since the
payment made this year will bring economic benefits in the subsequent years, a
proportion or the entire amount of the payment made is recognized as an asset in
the current financial statements.
Illustration 3
A fast food restaurant in the capital city made an agreement with the local
municipality to lease a house where the restaurant will pay a monthly leased rent of
Nu. 20,000. On 1 January 2019, when the agreement was signed the restaurant paid
360,000. The restaurant also further paid Nu. 1,000 as legal fees.
Required:
Show how the transactions will be recorded and presented in the financial statements
Solution
Journal entries
1 January 2019 (on payment of cash)
Prepaid rent Dr 360,000
To cash 360,000
Legal charges Dr 1,000

To cash 1,000
31 December 2019 (on closing of the year)
Rental expenses Dr 240,000
To prepaid rent 240,000
The ledger accounts are prepared as follows:
Rent account
Income statement 240,000 Prepaid rent 240,000
240,000 240,000
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Prepaid rent account

Cash 360,000 Rent 240,000
Balance c/d 120,000
360,000 360,000
Cash account
Opening cash balance xxxx Prepaid rent 360,000
Cash sales xxxx Legal charges 1,000
361,000
Amount (Nu)
Income xxxx
Expenditure
Opearting expenses 240,000
Current Assets Amount (Nu)

Prepaid expenses 120,000
Cash xxxxx
c) Deferred income
In the previous section you have learnt that the expense incurred but not paid is
recognized as current liabilities. The reason is that an entity has already consumed
goods or services and created a present obligation to the service provider. What if
an entity receives cash payment for the income to be received in the following years
(the income is yet to be earned)? In this case, an entity has already received the
economic benefits but it has not discharged its obligations or rendered services to
earn that income. This is called deferred income as the amount received is deferred
to the next accounting period for recognition as an income. In the current year, the
amount is reported as a liability.
Illustration 4
Kezang car washing service in Thimphu received Nu. 100,000 from its customers on
1 July 2019. Some of these customers made the payments for future services as and
when they require. On 31 December 2019 at the closing time, it was calculated that
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five customers have still not received the service that amounted to Nu. 35,000.
Required:
Make the adjusting entries and present the information in the financial statements.
Journal entries
At the time of receiving cash
Cash Dr 100,000
To deferred income 100,000
At the year-end
Deferred income Dr 65,000
To sale income 65,000
Ledger accounts
Cash account
Deferred income 100,000 Balance c/d 100,000
100,000 100,000
Sales account
Income statement 65,000 Deferred income 65,000
65,000 65,000
Deferred income account

Sales income 65,000 Cash 100,000
Balance c/d 35,000
100,000 100,000

Income
Revenue 65,000
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Current Assets
Cash 100,000
Current liabilities
Deferred income 35,000
8.1.3 Financial statements – definition

Financial statements are defined as the general purpose financial statements intended
to meet the needs of users who are not in a position to require an entity to prepare
reports tailored to their particular information needs.
The objective of financial statements is to provide information about the financial
position, financial performance and cash flows of an entity that is useful to a wide
range of users in making economic decisions. Financial statements also show the
results of the management’s stewardship of the resources entrusted to it (BAS1/
IAS1).
Chapter 10 of class XI Accountancy provides a comprehensive discussion on the
need, purpose and types of financial statements. It also gives you some fundamental
principles underlying the financial statements. So the learner must revise those
lessons thoroughly in order to successfully learn the lessons outlined in this chapter.
Let us now begin with some basic questions. Who is responsible for financial
statements? Why it is so important to discuss about the presentation of financial
statements? How can the people responsible for financial statements ensure financial
statements present true and fair view of the entity’s financial performance, financial
position and cash flows? This chapter will mostly focus on answering these questions
through illustrations and student learning activities. You will appreciate that each
practical illustration will address a specific concept or an issue related to financial
statements which ultimately will help you to gain the necessary technical skills to
prepare and present financial statements of the entity and, an analytical skills to
identify issues in financial reporting.
8.1.4 Presentation of financial statements

BAS1/IAS1 requires that an entity shall present with equal prominence all of the
financial statements in a complete set of financial statements. In the next section,
we will briefly discuss what we have already learnt in class XI about the important
features of financial statements.
a) Materiality and aggregation
In the presentation, an entity should present separately each material class of items
184 Reprint 2023

and items of a dissimilar nature or function unless they are immaterial. In the
following illustration, you will learn this requirement.
Illustration 5 (Materiality and aggregation)

Nagtsho Automobiles prepared an unadjusted trial balance before drafting its
financial statements for 2019. You are required to prepare the statement of income
for the year 2019 with proper classification and aggregation of items in the financial
statement.
Amount (Nu)
Interest on deposits 150,000 CR
Interest on non-government bonds 200,000 CR
Interest on bank loan 300,000 DR

Training and development 200,000 DR
Bank fees and other charges 85,000 DR
Machinery – 670,600 DR
Depreciation –machinery 230,500 DR
Sales revenue 4,100,000 CR
Cost of sales 607,500 DR
Bonus 100,000 DR
Income from government grants 116,000 CR
Dividend income 500,000 CR
Computer Software 345,200 DR
Amortisation –computer software 120,000 DR
Impairment –computer software 100,000 DR
Entertainment 120,000 DR
Income from sale of tender forms 56,400 CR
Gratuity 353,200 DR
House rent received from employees 198,000 CR
Repair and maintenance-office buildings 230,000 DR
Consultancy charges 150,000 CR
Repair and maintenance- computers 150,000 DR
Repair and maintenance- vehicles 110,000 DR
Travel 90,750 DR
Salaries and wages 300,000 DR
License fees 76,000 DR
Leave encashment 223,000 DR
Terminal benefits 125,600 DR
Brand management 230,500 DR
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Furniture and fittings 560,000 DR

Deprecation –F&F 200,000 DR
Medical benefits 100,000 DR
Staff welfare costs 345,000 DR
Meeting expenses 75,400 DR
Office equipment 400,000 DR
Depreciation –OE 150,000 DR
Impairment – office equipment 60,000 DR
Statement of income of Nagtsho Automobiles for the year ended 31 December
2019
Note Amount (Nu)
Sales revenue 4,100,000
Other income 1 870,400
Total income 4,970,400
Cost of sales (607,500)

Expenditures
Employee remuneration and benfits 2 (1,746,800)
Repairs and maintenance costs 3 (490,000)
Depreciation and amortisation 4 (860,500)
Other expenses 5 (742,650)
Finance cost 6 (35,000)
Profit before tax
Total expenditures (4,482,450)
Tax (30%) (146,385)
Notes
(1) Other income
Income from government grants 116,000
Dividend income 500,000
Income from sale of tender forms 56,400
House rent received from employees 198,000
870,400
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(2) Employee remuneration and benefits

Salaries and wages 300,000
Training and development 200,000
Bonus 100,000
Leave encashment 223,000
Gratuity 353,200
Terminal benefits 125,600
Medical benefits 100,000
Staff welfare costs 345,000
1,746,800
(3) Repairs and Maintenance cost

Repair and maintenance-office buildings 230,000
Repair and maintenance- computers 150,000
Repair and maintenance- vehicles 110,000
490,000
(4) Depreciation and amortisation

Amortisation –computer software 120,000
Deprecation –F&F 200,000
Depreciation –machinery 230,500
Depreciation –OE 150,000
Impairment –computer software 100,000
Impairment – office equipment 60,000
860,500
(5) Other expenses

Travel 90,750
License fees 76,000
Brand management 230,500
Entertainment 120,000
Consultancy charges 150,000
Meeting expenses 75,400
742,650
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(6) Finance costs

Interest from deposits 150,000
Interest on non governmnet bonds 200,000
Interest on bank loan 300,000
Bank fees and other charges 85,000
(35,000)
b) Frequency of reporting
An entity presents a complete set

of financial statements (including
comparative information) at least
annually. However, entities of
government interest or a public limited
companies may be required to issue
an interim reports before the annual
report. Interim reports are issued for a
period less than 12 months.
c) Comparative information
Entities present comparative information of the preceding period for all amounts
reported in the current period’s financial statements. An entity must present, as a
minimum, two statements of financial position, two statements of profit or loss and
other comprehensive income, two separate statements of profit or loss (if presented),
two statements of cash flows and two statements of changes in equity, and related
notes.
Particulars Note No. 2018 2017
Income
Electricity revenue 15 11,445,445,454.64 11,953,372,682.94
Interest earned 16 102,724,721.30 120,889,001.79
Other income 17 133,810,947.66 202,983,418.74
11,681,981,123.60 12,277,245,103.47
Expenditure
Wheeling charges 609,835,005.46 742,351,161.01
Insurance 112,845,830.50 113,043,211.21
2018
Running and and 2017
maintenance -2 years
expenses 18 387,811,614.50 443,656,365.04
comparative
Employees’ information
remuneration and benefits 19 858,018,229.97 847,624,681.20
Finance cost 20 287,355,111.39 345,415,270.69
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Entities reporting in some jurisdictions may be required to present comparative

information for more than one preceding year.
2017, 2016 and 2015 -3 years

comparative information
Source: Rio Tinto Annual Report 2018
d) Consistency of presentation
An entity should retain the presentation and classification of items in the financial
statements from one period to the next unless:
i) there is a change in the nature of the entity’s business operations or a review
of the financial statements and such a change would be more appropriate,
or
ii) an accounting standards requires a change in presentation.
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Financial statements presented consistently

over accounting year 2015-2017
Source: DGPC Annual Report 2017
In the following sections, you will learn about the details of each financial statement
and the method to present each of these financial statements. Remember, the
objective of preparing financial statements is to provide a relevant and faithful
information to the information users who will depend on such information to make
their investment and other economic decision.
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8.2 Statement of Income

An entity presents a single statement of comprehensive income, with statement of
income and other comprehensive income presented in two sections. The standard
permits to use names like statement of profit or loss and other comprehensive income,
statement of comprehensive income. Entities also simply use the name statement
of income. However, in the industry, many entities both within and outside the
country use the name ‘statement of comprehensive income’. In our class XI and class
XII texts, we deliberately chose to use the name ‘statement of income’ since we do
not delve into other comprehensive income part at class XI and class XII.
An entity shall not present any items of income or expense as extraordinary items,
in the statement of income or in the notes. An extraordinary item is an item of
income or expense arising from events that are unusual and infrequent in nature.
For example, an entity incurs a huge expense in 2019 due to restructuring or a fire in
its factory. Earlier this type of expense or income was recognized as an extraordinary
item in the financial statements. This presentation is no longer permitted by BAS/
IAS. Extraordinary items are further explained in notes accompanying financial
statements.
An entity must present the statement of income with a proper classification of items
of income and expenses. BAS1/IAS1 specifies two types of presentation of income
and expense items in the statement of income using a classification based on either
their nature or their function within the entity, whichever provides information that
is reliable and more relevant.
i. Nature of expense method
ii. Function of expense method (also called cost of sales method)
8.2.1 Nature of expense method

An entity using this method aggregates expenses within statement of income according
to their nature (for example, depreciation, purchases of materials, transport costs,
employee benefits and advertising costs), and does not reallocate them among functions
Revenue X within the
Other income X entity. This
Raw materials and consumables used X method
Changes in inventories of finished goods and work in progress X may be
Employee benefits expense X simple to
Depreciation and amortisation expense X apply
Other expenses X
Total expenses (X)
Profit before tax X
Tax (X)
Profit after tax X
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Materials consumed and consumables used = opening inventory of materials or

consumables + purchases – closing inventory of materials
Remember that this is not the exhaustive list of classification. Student should read
different entities’ financial statements to understand how entities apply this method
to classify and present expenses in the income statement. One of the examples is
given below.
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8.2.2 Function of expense method

Revenue X The second method
Cost of sales (X) classifies expenses
Gross profit X according to their
Other income X function as part of cost of
Distribution costs (X) sales or, for example, the
Administrative expenses (X) costs of distribution or
Other expenses (X) administrative activities.
Profit before tax X At a minimum, an entity
Tax (X) discloses its cost of
Profit after tax X
sales under this method
separately from other expenses. In the next page, Kuensel Corporation Limited, for
example, presents its income statement in this structure.
This method can provide more relevant information to users than the classification
of expenses by nature, but allocating costs to functions may require arbitrary
allocations and involve considerable judgment. An example of a classification using
the function of expense method is as follow:
Kuensel Corporation Limited Annual Report 2017

It is observed that most of the companies adopting BAS seem to be following the
first method of presentation of statement of income (nature of expense method).
Entities applying the second method present cost of sales but do not exactly classifies
193 Reprint 2023

other expenses into functions as depicted in the example. This is permitted by the
standards.
8.3 Statement of Financial Position

Before this statement was called ‘balance sheet’ and later on it was renamed as
statement of financial position to emphasize on the financial reporting of the assets,
liabilities and net assets of the reporting entity.
The statement of financial position should, at minimum, present the following line
items of assets, liabilities and equity.
Assets
i) Property, plant and equipment
ii) Investment property
iii) Intangible assets
iv) Financial assets (excluding amounts shown under (vii)and (viii))
v) Biological assets
vi) Inventories
vii) Trade and other receivables; and
viii) Cash and cash equivalents
ix) assets classified as held for sale
i) Issued capital and reserves attributable to owners of the parent
ii) Financial liabilities (excluding amounts shown under (iv)
iii) Provisions
iv) Trade and other payables;
v) Liabilities for current tax,
vi) Deferred tax liabilities
An entity can present additional line items including by disaggregating the line items
listed above, headings and subtotals in the statement of financial position when such
presentation is relevant to an understanding of the entity’s financial position. Read
the statement of financial position presented in the next page to understand the way
how assets and liabilities are classified and aggregated.
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Bhutan Telecom Limited Annual Report 2017
The Standard does not prescribe the order or format in which an entity presents items.
An entity uses its own judgment about whether to present the items in the order of
liquidity or long term assets. The financial institutions or financing companies may
present the items in the order of liquidity due to the nature of their business, while
manufacturing and trading companies may present the other way. An example of
the liquidity approach can be seen in the statement of financial position of Bank of
Bhutan Limited in the following page.
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BANK OF BHUTAN LIMITED

STATEMENT OF FINANCIAL POSITION AS AT 31ST DECEMBER 2017
ASSETS Note As at 31.12.2017 As at 31.12.2016
Cash & Balance with RMA 2.1 11,385,835,097.67 14,078,764,442.75
Loans & Advances to Banks 2.2 3,239,673,269.02 3,297,561,164.06
Loans & Advances to Customers 2.3 26,386,692,805.47 20,725,407,844.74
Investment Securities 2.4-A 8,990,938,616.44 5,502,626,800.00
Investment in Associates 2.4.B 37,811,000.00 37,811,000.00
Investment in Portfolio Companies 2.4-C 80,193,710.45 80,193,710.45
Prepayments & Accrued Income 2.5 109,846,304.06 104,055,083.25
Deferred Tax Assets 2.6 55,530,549.64 49,259,265.00
Other Assets 2.7 181,190,715.02 303,621,892.46
Property, Plant & Equipment 2.8-A 404,120,309.17 396,952,980.02
Intangible Assets 2.8-B 126,315,866.38 117,161,990.36
Capital Work-in-Progress 2.8-C 134,131,375.43 79,952,768.26
TOTAL ASSETS 51,132,279,618.74 44,773,368,941.34
LIABILITIES
Deposits by Banks 2.9 58,726,219.18 139,956,391.63
Customer Deposits 2.10 42,838,187,176.70 36,492,874,675.65
Subordinated Liabilities & Other Borrowed 2.11 - 500,000,000.00
Funds
Provision for Liabilities & Charges 2.12 13,514,114.03 26,735,506.19
Retirement Benefit Obligations 2.13 133,541,219.98 123,836,170.00
Accruals & Deferred Income 2.14 1,366,552,100.09 1,143,994,251.44
Current Tax Liabilities 2.15 69,908,079.68 230,388,901.84
Other liabilities 2.16 752,677,112.67 609,393,028.26
TOTAL LIABILITIES 45,233,106,022.33 39,267,178,925.01
EQUITY
Share Capital 2.17 3,000,000,000.00 3,000,000,000.00
A
Retained Earnings 2.18 1,360,321,072.38 1,330,145,266.27
Reserve Fund 2.18 1,333,120,806.30 979,362,937.39
Other Reserves 2.18 205,731,717.74 196,681,812.67
TOTAL EQUITY 5,899,173,596.42 5,506,190,016.33
TOTAL LIABILITIES & EQUITY 51,132,279,618.75 44,773,368,941.34
SOFP presented in liquidity order. Property, plant and
equipment presented after liquid assets. CompareSource:
this BOBL Annual Report 2017
presentation with Bhutan Telecom Limited.
8.3.1 Current/non-current distinction

An entity should present current and non-current assets, and current and non-
current liabilities, as separate classifications in its statement of financial position
except when a presentation based on liquidity provides information that is reliable
and more relevant. When that exception applies, an entity should present all assets
and liabilities in order of liquidity.
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a) Current assets
An entity classifies an asset as current when:
i) it expects to realise the asset, or intends to sell or consume it, in its normal
operating cycle (usually twelve or less than twelve months)*;
ii) it holds the asset primarily for the purpose of trading;
iii) it expects to realise the asset within twelve months after the reporting
period; or
iv) the asset is cash or a cash equivalent.
All other assets are classified as non-current. The ‘non-current’ assets include
tangible, intangible and financial assets of a long-term nature.
Current assets include assets (such as inventories and trade receivables) that are
sold, consumed or realised as part of the normal operating cycle even when they
are not expected to be realised within twelve months after the reporting period. For
example, manufacturing of an aircraft would take longer than twelve months. So all
inventories related to manufacturing of an aircraft will be treated as current assets
even if inventories were to last for more than twelve months after the reporting date.
b) Current liabilities
An entity presents a liability as current when:
i) it expects to settle the liability in its normal operating cycle,
ii) it holds the liability primarily for the purpose of trading,
iii) the liability is due to be settled within twelve months after the reporting
period, or
iv) it does not have an unconditional right to defer settlement of the liability for
at least twelve months after the reporting period. Example, the portion of a
loan payable within the next accounting period.
All other liabilities are classified and presented as non-current.
There are some current liabilities, such as trade payables and some accruals for
employee and other operating costs, which are part of the working capital used
in the entity’s normal operating cycle. An entity classifies such operating items as
current liabilities even if they are due to be settled more than twelve months after
the reporting period.
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An entity discloses the following, either in the statement of financial position or the
statement of changes in equity, or in the notes:
i) the number of shares authorised;
ii) the number of shares issued and fully paid, and issued but not fully paid;
iii) par value per share, or that the shares have no par value;
iv) a reconciliation of the number of shares outstanding at the beginning and
at the end of the period; and
v) the rights, preferences and restrictions attaching to that class including
restrictions on the distribution of dividends and the repayment of capital.
An entity without share capital, such as a partnership or trust, also disclose a similar
information, showing changes during the period in each category of capital interests.
8.4 Statement of Cash Flows

It is important for the student to know the difference between cash flow and net
profit. An entity may have high net profit without cash and vice versa. In reality,
investors and many other stakeholders analyse cash flow statements since it provides
a more valid information. Net profit could be sometimes manipulated by non-cash
transactions such as depreciation, inventory obsolescence, revaluation of assets and
various provisions.
Cash flow provides a very useful information about the ability of the entity to
generate cash and cash equivalents and the needs of the entity to utilise those cash
flows. IAS7/BAS 7 provides detail guidelines for the presentation and disclosure of
cash flow information.
The statement of cash flows not only shows how much cash the entity generated
over the year, but also how the cash was generated. For example the entity might
generate cash flows out of increased sale, disposal of property, plant and equipment
or taking a short-term or a long-term commercial borrowings. The assessment of
cash flows is a significant investment decision for many investors. Therefore, it is
critically important for the entity to prepare and present a statement of cash flows
with the details of the sources and application of cash flows.
c) Cash and cash equivalents
The accounting standard recognizes cash as both ‘cash’ and ‘cash equivalents’. Cash
comprises cash on hand and demand deposits with banks. Cash equivalents are
short-term, highly liquid investments that are readily convertible to known amounts
of cash and which are subject to an insignificant risk of changes in value. The short-
198 Reprint 2023

term investments in government treasury bills and other similar instruments with
maximum of 3 months and less maturity days are considered as cash equivalents.
Cash flows are inflows and outflows of cash and cash equivalents.
d) Presentation of cash flows

IAS7/BAS7 specifies the structure of the statement of cash flows and requires to
disclose cash flows by categorizing cash flows from:
i) operating activities;
ii) investing activities; and
iii) financing activities.
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a. Operating activities
Operating activities are the principal revenue-producing activities of the entity and
other activities that are not investing or financing activities. This is the cash and
cash equivalents generated from the main revenue generating activities of the entity
such as the sales of goods or inventory as opposed to revenue generated from sale
of entity’s property, plant and equipment or from issue of shares. For a business, this
is the most important source of cash as it is directly related to the capacity and the
competitiveness of the entity to earn revenues. As such, cash flows from operating
activities of a business entity might largely differ from one to another entity. The
cash flows from operating activities will also depend on the market competition,
and management’s ability to respond to such competition and other larger economic
conditions.
Student must understand that
different entities engage in
different operating activities.
For example, Penden Cement
Authority Limited (PCAL)
produces cement which is the
main revenue generating activity
of the company. Whereas, Druk
Air Corporation Limited provides
travel and freight services. Thus,
PCAL generates cash flows from operating activities through production and sale of
various types of cement grades such as Portland Slag Cement, Portland Pozzolana
Cement and Ordinary Portland Cement. Druk Air Corporation Limited, on the
other hand, generates cash flows from the sale of air tickets and freight services.
Operating activities generally are profit making activities which includes the
following:
• Cash receipts from the sale of goods and the rendering of services;
• Cash receipts from royalties, fees, commissions and other revenue;
• Cash payments to suppliers for goods and services;
• Cash payments to and on behalf of employees;
• Cash receipts and cash payments of an insurance entity for premiums and
claims, annuities and other policy benefits;
• Cash payments or refunds of income taxes unless they can be specifically
identified with financing and investing activities; and
• Cash receipts and payments from contracts held for dealing or trading
purposes.
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b. Investing activities
Investing activities are the acquisition and disposal of long-term assets and other
investments not included in cash equivalents.
Examples of cash flows classified in investing activities are:
• Cash payments to acquire property, plant and equipment, intangibles and
other long-term assets (including capitalized development costs and self-
constructed PPE);
• Cash receipts from sales of PPE, intangibles and other long-term assets;
• Cash payments to acquire and cash receipts from sales of equity or debt
instruments of other entities and interests in joint ventures (but not for trading
or dealing purposes); and
• Cash advances and loans made to other parties, and cash receipts from their
repayment (other than advances and loans made by a financial institution –
these would go to operating part)
c. Financing activities
Financing activities are activities that result in changes in the size and
composition of the contributed equity and borrowings of the entity.
Examples of cash flows arising from financing activities are:

• Cash proceeds from issuing shares or other equity instruments;
• Cash payments to owners to acquire or redeem the entity’s shares;
• Cash proceeds from issuing debentures, loans, notes, bonds, mortgages and
other short-term or long-term borrowings;
• Cash repayments of amounts borrowed; and
Cash flows from investing and financing activities are presented in gross amount.
For example, the amount received from sale of property, plant and equipment item
cannot be netted off with the purchase of a similar item of property, plant and
equipment.
e) Reporting cash flows from operating activities

An entity may report cash flows from operating activities using either:
a. the direct method, whereby major classes of gross cash receipts and gross cash
payments are disclosed; or
b. the indirect method, whereby profit or loss is adjusted for the effects of
transactions of a non-cash and non-operating nature, and the movement in
working capital.
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a. Indirect method
In this method, the cash flows from operating activities is calculated by taking the
profit or loss before tax (PBT) and then adjust for:
i) non-cash transactions (such as depreciation, unrealized gains and losses),
ii) non-operating activities (i.e. activities of investing and financing), and
iii) changes in working capital over the period (i.e. changes current assets and
current liabilities except cash and cash equivalents).
Cash from operating activities

Profit before tax (PBT) xxxxx
Adjustments for non-cash items
Non-cash gain/income (xxxx)
Non-cash expense/losses (xxxx)
Changes in working capital
Increased inventories (xxxx)
Increased receivables (xxxx)
Increased payables xxxx
Cash from operations xxxxx
Interest paid (xxxx)
Tax paid (xxxx)
Net cash from operating activities xxxxx
b. Direct method
When the direct method is used, cash from operating activities is calculated by
taking the gross cash receipts and deduct gross cash payments from the receipts.
Cash from operating activities
Cash receipts from customers xxxxx
Cash paid to suppliers (xxxx)
Cash paid to employees (xxxx)
Cash from operations xxxxx
Interest paid (xxxx)
Tax paid (xxxx)
Net cash from operating activities xxxxx
c. Direct vs indirect method

Direct method provides more understandable information not disclosed under
indirect method. However, in practice, entities prefer indirect method because it’s
easier to get the information based on the accounting records.
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d. Interest and dividends

Cash flows from interest and dividends received and paid should each be disclosed
separately. Each should be classified in a consistent manner from period to period as
either operating, investing or financing activities. Read the statement of cash flows
provided in the following page and note the interest and dividend reported under
operating activities. In fact, an entity has a choice for presentation of each of these
items as outlined below.
• Interest and dividends paid can be classified either as operating cash flow, or
financing cash flow.
• Interest and dividends received can be classified either as operating cash flow,
or investing cash flow.
What is important is that the entity must continue to use the same approach
consistently over the years.
e. Taxes on income
Unlike cash flows of interest and dividend, cash flows arising from income taxes
are classified as cash flows from cooperating activities unless an entity is able to
identify taxes with financing and investing activities.
f. Reconciliation of cash flows
The cash and cash equivalents in the beginning and at the year-end should be
reconciled.
Cash inflow for the year xxx (A)-(B)
Cash and cash equivalents in the beginning xxx (A)
Cash and cash equivalents at the year-end xxx (B)
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Statement of Cash flows

for the year ended December 31, 2018
Amount in Nu.
Profit before taxation 6,679,062,222.35 7,224,454,011.36
Adjustment for
Depreciation / amortization 2,301,679,892.39 2,267,598,498.36
Foreign exchange loss 197,729,976.76 (127,013,702.07)
Loss/(gain) on sale of property plant & equipment (7,160,424.78) (1,851,728.90)
Investment income (102,724,721.30) (120,889,001.79)
Interest expenses 287,355,111.39 345,415,270.69
(Increase)/decrease in trade receivables and other receivables 51,132,589.90 231,138,856.41
(Increase)/decrease in inventories 87,689,476.94 4,596,451.15
(Increase)/decrease in prepayments and advances (118,959,632.25) 90,475,182.43
(Increase)/decrease in assets classified as held for sale (1,459,732.80) (294,185.37)
Increase/(decrease) in trade and other payables (2,987,654.95) 63,289,869.34
Increase/(decrease) in other current liabilities (166,259.43) (192,854.40)
Increase/(decrease) in employee benefit obligation 49,096,646.48 62,419,143.87
(Increase)/Decrease in Other asset (180,361.14) (152,941.14)
Cash generated from Operation 9,420,107,129.56 10,038,992,869.94
Income tax paid (2,257,686,446.22) (2,627,327,762.52)
Net cash from operating activities 7,162,420,683.34 7,411,665,107.41
Cash flows from investing activities
Purchase of PPE & intangibles assets (1,035,724,340.41) (1,134,494,242.22)
Sale of PPE & intangible asset - (84,730.01)
Payment for investments in subsidiaries and joint ventures (1,165,592,363.48) (911,044,894.36)
Proceeds from held-to-maturity investments 688,964,315.07 (12,771,974.07)
Interest received (48,786,827.25) 153,572,383.31
Net cash used in investing activities (1,561,139,216.07) (1,904,823,457.36)
Cash flows from financing activities
Issue of share capital 230,520,000.00 832,822,000.00
Repayment of loan (1,510,039,544.60) (1,556,664,756.55)
Interest paid (244,461,538.19) (351,238,360.67)
Dividend paid (4,905,354,484.00) (4,253,351,834.07)
Net cash used in financing activities (6,429,335,566.79) (5,328,432,951.29)
Net increase/(decrease) in cash and cash equivalents (828,054,099.52) 178,408,698.76
Cash and cash equivalents at the beginning of the period 1,277,226,091.22 1,098,817,392.45
Cash and cash equivalents at the end of the period 449,171,991.70 1,277,226,091.21
Component of cash and cash equivalents
Cash in hand 951,803.43 1,661,965.81
Balances in current accounts with banks 448,220,188.27 1,275,564,125.41
Total 449,171,991.70 1,277,226,091.22
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Illustration 6
A reporting entity drafted its financial statements for the financial year ending 31
December 2017 as given below. Using the draft financial statements, you are required
to prepare a statement of cash flows using a direct method and as per the current
accounting standards for reporting cash flows.
Amount (nu.)
Sales revenue 2,460,000
Cost of sales (1,780,000)
Gross profit 680,000
Operating expenses (424,000)
Interest (24,000)
Taxation (48,000)
2017 2016
Amount (Nu) Amount (Nu)
Non current assets
Property, plant and equipment 720,000 540,000
Accu depreciation (190,000) (145,000)
Investments 140,000 115,000
Current assets
Trade receivables 438,000 412,000
cash and cash equivalent 51,000 48,000
1,577,000 1,285,000
Equity capital 800,000 600,000
Share premium 55,000 40,000
Retained earning 311,000 217,000
Non current liabilities

12% Bank Loan 200,000 250,000
Current liabilities
Trade payables 166,000 139,000
Taxation 45,000 39,000
1,577,000 1,285,000
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Statement of changes in equity for the year ended 31 December 2017

Amount (Nu)
Accumulated profit 217,000
Dividend paid (90,000)
Accumulated profit c/f 311,000
Solution
Statement of cash flows for the year ended 31 December 2017
Cash flow from operating activities Amount (Nu) Note
Sales 2,434,000 1
Purchases 1,856,000 2
Expenses 379,000 3
Cash inflow from operation 199,000
Interest 24000
Dividend paid 90,000
Tax paid 42000 4
43,000
Cash flow from Investing activities
Purchase of new PPE 180,000 5
Additional cash Investments 25,000 6
Cash outflow from investing activities 205,000
Cashflow from Financing activities

Cash from Equity capital 200,000 7
Cash from Share premium 15,000 8
12% bank loan paid 50,000 9
Cash inflow from financing activities 165,000
Cash inflow for the year 3,000 Reconciliation
Opening cash balance 1.1.2017 48,000 of cash and cash
equivalent before
Closing cash balance 31.12.2017 51,000
and after year-
Net cash inflow in the year 3,000
end
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Working Notes
(1) Calculation of Cash revenue
Trade receivables account
Bal b/f 412,000 Cash 2,434,000
Sales revenue 2,460,000 Balance c/d 438,000
2,872,000 2,872,000
(2) Calculation of purchases

Cost of Sales
Opening inventory 315,000
Purchaes 1,883,000
Closing inventory 418,000
(1,780,000)
COS= OS + P - CS
Calculation of cash purchases

Trade payables
Cash purchases 1,856,000 Balance b/f 139,000
Balance c/d 166,000 Purchases 1,883,000
2,022,000 2,022,000
(3) Calculation of cash expenses

Expense account
Depreciation 45000 SOCI 424,000
Cash expense 379,000
424000 424,000
(4) Cash tax expense paid

Tax account
Tax payable 48000 SOCI 48000
Tax liability account
Balance c/d 45000 Bal b/f 39000

Cash tax paid 42000 Tax expense 48000
87000 87000
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(5) PPE
PPE Account
Balance b/f 40,000 balance c/d 720,000

Cash purchases 180,000
720,000 720,000
(6) Investment
Investment account
Balance b/f 115,000

Cash investment 25,000 Balance c/d 140,000
140,000 140,000
(7) Cash Equity Brought in
Equity account
Additional cash 200,000

Balance c/d 800,000 Balance b/f 600,000
800,000 800,000
(8) Share premium
Share premium account
Balance b/f 40000

Balance c/d 55000 Cash paid 15000
55000 55000
(9) 12 % Bank Loan
12 % Bank Loan
Loan paid 50,000 Balance b/f 250,000

Balance c/d 200,000
250,000 250,000
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8.5 Statement of changes in equity

An entity presents a statement of changes in equity as required by the accounting
standards. The statement of changes in equity includes the following information:
i) for each component of equity, a reconciliation between the carrying amount
at the beginning and the end of the period, separately (as a minimum)
disclosing changes resulting from:
a. profit or loss;
b. other comprehensive income; and
c. for each component of equity, the effects of retrospective application or
retrospective restatement recognised in accordance with BAS 8;
d. transactions with owners in their capacity as owners, showing separately
contributions by and distributions to owners and changes in ownership
interests in subsidiaries that do not result in a loss of control.
In class XI and XII, student will be required to present statement of changes in equity
due to change in profit or loss of the entity.
An entity can present, either in the statement of changes in equity or in the notes,
the amount of dividends recognised as distributions to owners during the period,
and the related amount of dividends per share. Dividend amount is not reported as
part of statement of income.
Source: Bhutan Telecom Annual Report 2017
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Reconciliation of carrying amount of equity at the beginning and at the end of

the year
Carrying amount of equity at the beginning X
Add: Net profit for the year X
Add: Revaluation surplus X
Less: Dividend paid (X)
Less: Adjustment for previous year’s errors/estimates (if there is) (X)
Carrying amount of equity at the end of the year X
Illustration 7
An entity reported a net profit of Nu. 2,450,000 for the year ended 2019. The
statement of changes in equity as at 31 December 2018 showed the balances of each
component of equity as follows:
Equity capital Nu. 10,000,000
Retained earnings Nu. 4,500,000
General reserve Nu. 2,000,000
Management proposed and after some time declared a dividend of Nu. 800,000
for 2018. There was an error of Nu. 600,000 due to under charging of depreciation
expense in 2018.
Required:
Prepare statement of changes in equity for the year ended 31 December 2019.
Solution:
8.6 Notes
Notes are an important part of financial statements. Notes present information
about the basis of preparation of the financial statements and the specific accounting
policies used. Notes provide justification of the amounts and items presented in
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the financial statements, thus it is relevant to an understanding of the financial

statements.
8.7 Disclosure of Accounting Policies

An entity should disclose its significant accounting policies comprising:
(a) the measurement basis (or bases) used in preparing the financial statements; and
(b) the other accounting policies used that are relevant to an understanding of the
financial statements.
It is important for an entity
to inform users of the
measurement basis or bases used
in the financial statements (for
example, historical cost, current
cost, net realisable value, fair
value or recoverable amount)
because the basis on which an
entity prepares the financial
statements significantly affects
users’ analysis of the financial
statements. In deciding whether
a particular accounting policy
should be disclosed, management considers whether disclosure would assist users
in understanding how transactions, other events and conditions are reflected in
reported financial performance and financial position.
An example of an accounting policy on contingent liabilities and contingent assets
is given below:
Contingent Liabilities and Contingent Assets

Contingent liabilities are not recognized but disclosed for all possible obligations that
arises from past events and whose existence will be confirmed only by the occurrence or
non-occurrence of one or more uncertain future events not wholly within the control of
the entity.
Contingent assets is also not recognized but disclosed for all possible assets that arises
from past events and whose existence will be confirmed only by the occurrence or non-
occurrence of one or more uncertain future events not wholly within the control of the
entity.
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Illustration 8
Apple Company’s statement of financial position is presented below.
2017 2018
Noncurrent assets
Current assets:
Inventory 324,000 396,000
Cash and cash equivalent 12,000 3,000
1,341 1,431
Equity and liabilities:
Equity shares 700,000 870,000
Noncurrent liabilities:
6% loan 200,000 150,000
Current liabilities:
Taxation 42,000 45,000
Bank overdraft - 11,000
1,314 1,431
Further, the extract of the statement of comprehensive income is given below:
Interest (12,000)
Taxation (45,000)
Accumulated depreciation of property, plant and equipment for 2017 and 2018 are
Nu. 240,000 and Nu. 320,000 respectively.
Required:
i) Explain the purpose of preparing statement of cash flows.
ii) Prepare a statement of cash flows for the year ended 31 December 2018
using the indirect method.
Solution
i) Purpose of preparing statement of cash flows

All business transactions involve cash. Cash is used to procure all goods or
services needed for the entity. Besides, cash is also used to pay all utility bills,
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employee remunerations and government tax without which the business entity
cannot operate. Cash is also required to support entity’s capacity development
such as training and development, development of organizational processes
and further to acquire property, plant and equipment. The decision related to
financing and investment projects involve cash.
It is very important for management to keep proper records of all cash
transactions and report to the investors. A large group of investors actually
prefer the report on cash flows over the income statement as they think income
statement prepared under accrual accounting is subject to manipulation and
distortion. There are corporate cases that support this apprehension of the
investors.
Statement of cash flows as required by the current accounting standards (IAS7/
BAS7) provides a comprehensive information on cash inflows and cash outflows
for the reporting year. Further, cash flows are presented as cash flows from
operating, investing and financing activities of the entity. This helps investors
to assess the sources and application of cash resources in the entity and get the
necessary confidence to invest or discontinue the investment in the entity.
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(ii): Preparation of cash flow statement

Amount
Add: Depreciation 80,000
Changes in working capital
Less: Increase in inventory 72,000
Add: Decrease in receivables 26,000
Less: Increase in payables 33,000
Interest paid 12,000
Dividend paid 30,000
Tax paid 42,000
Net cash flow from operating activities 20,000
Cash flow from investing activities

Purchase of PPE 160,000
Cash flow from financing activities
Equity capital 170,000
Loan paid 50,000
Net cash from financing activities 120,000
Net cash outflow -20,000
Opening cash balance 12,000
Cash and cash equivalent (31.12.2018) -8,000
Cash and cash equivalent (31.12.2018) 3,000
Bank overdraft (31.12.2018) 11,000
Net cash and cash equivalent (31.12.2018) -8,000
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Workings
2018 2017 Difference
320,000 240,000 80,000
396,000 324,000 72,000

412,000 438,000 26,000
265,000 298,000 33,000
Movement of retained earnings

Opening balance 74,000
Profit for 2018 46,000
Dividend paid (bal fig) 30,000
Closing balance 90,000
940,000 780,000 160,000
870,000 700,000 170,000

200,000 150,000 50,000
Illustration 9
On completion of his first year of business as a dealer in traditional arts and crafts,
Sangay prepared his financial statements as shown below. The only mistake he has
made is that he has failed to take into account the unsold items costing Nu. 121,000
remaining in hand on 31 December 2019.
Statement of comprehensive income for the year ended 31 December 2019
Sales 640,000
Cost of goods sold (516,000)
Gross Profit 124,000
Other Expenses (94,000)
Profit 30,000
Noncurrent assets 240,000
Loan to staff 15,000
Cash and cash equivalent 75,000
330,000
330,000
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Required:
i) Define inventory as per BAS2 and provide recognition entry for sale of
inventory.
ii) Redraft the financial statements correctly.
Solution
Definition of inventory and cost of goods sold entry
BAS2 defines inventory as assets:
i) held for sale in the ordinary course of business (e.g. vehicles in automobile
show rooms)
ii) in the form of materials or supplies to be consumed in the process
of production or rendering of services (e.g. raw materials in cement
manufacturing company or items of stationery to be consumed)
Revised financial statements
Stament of income for the year ended 31 December 2019
Sales 640,000
CoGS 516,000
Less: Inventory 121,000 395,000
Other expenses 94,000
iii) Net profit 151,000

Current assets
Invetory 121,000
Loan to satff 15,000
Cash and cash equivalent 75,000
451,000
retained earnings 151,000
451,000
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Exercises:
1. Identify the impact of each of the following accounting errors on the trial
balance.
i) Nu. 150,000 received from customer has not been entered in the cash book
ii) Nu. 5,500 paid for servicing a vehicle has been posted to the motor vehicle
account.
iii) Nu. 10,000 given as a loan to the employee has been posted to the salaries
account.
iv) Nu. 14,000 paid as rent has been entered in the cash account but has not
been posted.
2. Bhutan Agro Industries Limited (AGIL) produces canned fruits, and juices,
pickles and bottled water for local and international markets. All these products
are produced under strict quality control and manufacturing facilities such
as hotline fill, hot fill pet blowing machine and canning line. The company
recognises revenue when it transfers all risks and rewards of ownership of goods
to the customer.
A total sales of Nu. 3, 567,000 was made in 2019. The company management
provides the following information on costs and expenses incurred during the
accounting year.
Purchase of raw materials Nu. 870,000
Opening raw materials Nu. 500,000
Closing raw materials Nu. 120,000
Salaries and wages paid to the staff (60 % staff work in the factory) Nu. 670,500
Depreciation of PP&E (50 % of expense is allocated to factory) Nu. 200,000
Some customers paid advance payment Nu. 345,000
Insurance premium was paid (includes 2 months prepaid) Nu. 280,000
Audit and other monitoring cost Nu. 100,000
Management entertainment cost Nu. 80,000
Board remunerations paid Nu. 120,000
Income from investment in other entities shares Nu. 543,500
Interest expense on borrowed fund Nu. 123,000
Other factory cost Nu. 90,000
Depreciation on marketing van (recently purchased) Nu. 50,000
Sales promotion and trade fair Nu. 200,000
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A dividend of Nu. 320,000 was proposed. Currently, 30% of corporate tax is

levied on the book profit.
Required:
i) Explain the need of accounting policies for the reporting entity.

ii) Prepare statement of comprehensive income classifying the expenses by its
function.
3. Phunsum Souvenirs Shop (PSS) provides printing and photo copy services to
students. It employs five students on part time basis and a full time manager to
run its day to day operation. PSS reports to its stakeholders on a yearly basis by
preparing financial statements.
Purchases and sales system
The main purchases of PSS consist of computer papers, cartridge and loose
tools. The purchases are expensed when the items are issued. A proper matching
of income earned with expense incurred during the accounting period is made
in order to ensure a faithful representation of the financial reporting. In 2018,
PSS purchased 150 reams of papers from Harayana stores, Phuntsholing at Nu.
450 per ream. By the year end, 60% purchases were issued for printing and
photo copies.
PSS charged Nu.5 per paper for both printing as well as photo copy. Each ream
of paper contains 300 pages. There were no record of any misuse or waste of
paper in the process of printing and photo copy. The 25% of the sales were
achieved in the month of November.
The shop receives online print orders from students before 24 hours. The print
or photo copy orders are then sorted out by names and left in alphabetical order
to be picked up for printing. Once the printing is done, the printed materials are
kept on the shelves for collection and payment. The student customers make
payments using mBoB system to prevent administrative errors and mishandling
of cash. PSS made a significant progress in digitalizing its business. Generally
PSS gives its student customers a credit period of 90 days. However, once the
invoice accumulates Nu. 5,000, a reminder is send to the customers. PSS has
also worked out with the college management a clearance system whereby all
students sitting for the examination/graduation/withdrawing from the college
must obtain a clearance from the service centers. This mechanism has actually
helped PSS to reduce its irrecoverable debt.
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Property, plant and equipment

PSS purchased 2 photocopy machines in 2011 at Nu. 150,000 each and 2 HP
Laser Jet printers for Nu. 30,000 each. Until 2013, PSS did not keep any records of
its properties, it was only in 2014 January that PSS began to maintain a system of
recording and developed its accounting policies as per the Bhutanese Accounting
Standards for SMEs. Accordingly, PSS adopted historical basis of measurement
and a straight line method to account its properties and equipment. The useful
life of the photo copy machines and printers were estimated as five years. No
scrap value is expected for these properties.
Intangible assets
PSS purchased an accounting system at Nu. 120,000 on 1 March 2018. The
system has an estimated useful life of 5 years. Non-current assets acquired
during the year are depreciated/amortised on time proportion. The total cost of
Nu. 100,000 was incurred in advertisement during the year. PSS management
intends to capitalize this cost since they expect that this will bring in additional
sales of about 30% in the next 3 years.
Accruals
PSS has Nu. 40,000 of employee salary payable at the year-end. They received
Nu. 70,000 from customers in advance.
PSS adopted calendar year as its accounting period.
Required:
Prepare an extract of statement of income and statement of financial position of
PSS business for the year ended 2018.
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4. Rinchen furniture house trades in all types of furniture at a price set always at
20% above cost. The 2018 year-end trial balance of his business appears as stated
below. He did not take year-end inventory but reports that he has taken for his
own use inventory costing Nu.7,000 and has given free to his old school’s library
furniture costing Nu.15,000.
Debit Credit
Inventory (1.1.2018) 228,000
Staff salary 34,000
Sales 900,000
Rental charges 48,000
Purchases 688,000
Cash and bank 12,000
Capital 300,000
Drawings 10,000
1,200,000 1,200,000
Required:
i) Explain the purpose of preparing trial balance.
ii) Prepare a statement of income for the year ended 31 December 2018.
iii) Prepare a statement of financial position as at 31 December 2018.
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Chapter 9: Analysis and Interpretations of Financial Statements
Chapter 9
Analysis and Interpretations of
Financial Statements
• Explain the need to analyse and interpret financial statements

• Perform some basic financial statement analysis using ratio analysis and
common size analysis
• Calculate accounting ratios and provide basic interpretations of these ratios
• Discuss the limitations of accounting ratios
• Explain the concept and purpose of common size analysis
• Perform basic common size analysis of income statement, financial position
and cash flows.
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Financial Statement analysis involves assessing the performance of the entity by

applying the financial statement analysis tools. Financial statement analysis can
be made by management to obtain critical information for management decision
making, as well as by the external investors who would make investment decisions.
Banks and insurance companies might do the same analysis of company’s financial
statements in order to advance loans and enter into contracts with insurance clients.
This chapter will explain the purpose of financial statements analysis and illustrate
how financial statement analysis tools such as common size statements, trend
analysis and accounting ratios are applied to assess business performance and make
other related interpretations. In the introductory part of class XI text, a brief analysis
of a financial statements was included to raise this importance.
9.1 The Need and The Purpose of Financial Statement Analysis

Financial statement analysis is an application of commercial sense with some
financial tools to financial statements of an entity to obtain some valid information
which can be used to make business or investment decision. Financial statements
analysis performed by management is basically to gather management information
that is used to make internal management decision. This information is called
management accounting information. Conversely, external investors and other
analysts perform financial statement analysis of an entity to assess the potential
return from investment and the risk associated in the investments. The current and
the potential investors assess both short-term as well as long-term liquidity position
of the entity to ensure that they receive a fair return on their investment. Also, these
investors expect that the entity should plough back earnings for future growth and
produce a significant long term returns. Thus, through financial statement analysis,
investors can predict the expected returns in future.
9.2 Listing of Companies on Stock Exchange and The

Importance of Quality Financial Statements
A registered company may be listed on the national or international stock exchange
if it wants to raise capital through issue of shares or debt securities to the public.
Once the company is listed on the stock exchange, the listed company is subject
to stock exchange regulations and Companies Act of the country. This includes a
requirement to file with the stock exchange and the company registrar a copy of the
annual audited financial statements. The listed companies must also disclose in the
income statement the earnings per share (EPS) ratio to assist investors understand
the earnings capacity of the company for each equity share. Details of earnings per
share is discussed in the accounting ratios.
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At this time, student should know that the value of a company is determined by the
share price on the stock exchange. For example, if the company has issued 1,000,000
equity shares and these shares are traded at Nu. 12 per share on the stock exchange,
the company will be valued at Nu. 12,000,000.
What determines value of shares on the stock exchange? The share price on the
stock exchange is determined by the demand and supply of shares. The demand and
supply in turn are affected by other factors such as the profitability of the company,
free cash flows, management goals, entity’s control over source of materials and
other supplies etc. Any changes in these factors might induce change in demand
and supply for shares on stock exchange and bring changes in share price.
The efficient market hypothesis states that share price fully reflect all available
information in the market. This means, the information about company’s earnings,
for example, of the year gets incorporated in the share price once the news or
information on the company’s earnings is made available in the market.
9.3 Financial Statement Analysis Tools

There are different methods of financial statement analysis. This chapter will largely
focus on analyzing financial statements using accounting ratios. However, learners
should be aware that there are other methods employed in the analysis of financial
statements. This chapter will briefly touch on trend analysis and common size
statement and then explore in more detail into ratio analysis.
9.3.1 Trend analysis

Trend analysis involves analyzing financial statements to understand the
performance of business over an extended period of time, say months, quarterly,
or yearly. Through studying the financial data over the period, trend analysis can
track changes in the amounts of assets, liabilities, income and expenses and their
relationship over a period of time that will produce an important information for
managerial and investment decisions. BAS1/IAS1 requires entities to present at least
two comparative financial statements to assist the users compare the results of the
entity for two years. However, trend analysis require the data for more number of
periods, weeks, months and years to overcome the unusual occurrence of factors
that would distort the results. Given below is a trend analysis of monthly sales for
two years.
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Variance
Month 2019 2018
Amount %
January 65076278 45583652 19492626 43%

February 70382889 56503348 13879541 25%
March 79742917 60458411 19284506 32%
April 76662811 56524736 20138075 36%
May 70981466 59839813 11141653 19%
June 90114514 61777509 28337005 46%
July 87606756 60093718 27513038 46%
August 87769363 64148666 23620697 37%
September 93876281 71125934 22750347 32%
October 86245203 61391274 24853929 40%
November 83262411 64492109 18770302 29%
December 114742511 103108079 11634432 11%
1006463400 765047250 241416150 32%
Figure 9.2 Trend analysis

Trend analysis is also used by traders to predict movement of share prices in the
stock exchange based on the past events or the observed data.
a) Basic calculation in trend analysis
Trend analysis is normally calculated as percentage change in the items in financial
statements over its previous year. That is,
Current year's amount - Previous year's amount
Percentage change = # 100
Previous year's amount
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b) Common size analysis

Common size analysis is useful in evaluating performance of entity over time or
comparing performance of entities that are significantly different in size.
Financial statements items are expressed in relative percentages of the total. Generally
all items in the statement of income are expressed as percentages of total sales where
the total sales is considered as 100%. Similarly, items in the statement of financial
position are expressed as percentage of total assets. Let’s consider the following case.
The trading company prepared its financial statement as follows. The management
wants to understand its financial position, and in particular, the movement of
its working capital. The management accountant can perform the common size
statement analysis to obtain that information as follow:
2018 2019
Non-current assets:
Accumulated depreciation (82,400) (92,800)
Development cost 3,200 5,100
Investment 3,900 8,250
Current assets:
Inventory 18,400 28,480
Cash and cash equivalents 1,100 1,400
Total 329,000 357,050
Equity and liabilities:
Equity shares of Nu.1 each 100,000 120,000
6% preference shares of Nu. 1 10,000 10,000
Non-current liabilities:
8% bank loan 5,000 5,000
Deferred tax 420 540
Current liabilities
Accrued expenses 1,280 940
Tax liabilities 7,480 7,580
Total 329,000 357,050

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Common size statement analysis
2018 2019
Non-current assets
Property, plant and equipment 275,600 83.8% 374,000 78.8%
Development cost 3,200 1.0% 5,100 1.4%
Investment 3,900 1.2% 8,250 2.3%
Current assets
Inventory 18,400 5.6% 28,480 8.0%
Trade receivables 26,800 8.1% 32,620 9.1%
Cash and cash equivalents 1,100 0.3% 1,400 0.4%
329,000 100.0% 357,050 100.0%
Equity shares of Nu.1 each 100,000 30.4% 120,000 33.6%
6% preference shares of Nu. 1 10,000 3.0% 10,000 2.8%
Retained earnings 183,020 55.6% 196,920 55.2%
8% bank loan 5,000 1.5% 5,000 1.4%
Deferred tax 420 0.1% 540 0.2%
Current liabilities
Trade payables 21,800 6.6% 16,070 4.5%
Accrued expenses 1,280 0.4% 940 0.3%
Tax liabilities 7,480 2.3% 7,580 2.1%
329,000 100.0% 357,050 100.0%
Reading the common size statement, both trade receivables as well as inventory
have increased from 8.1% and 5.6% to 9.1 % and 8% from 2018 to 2019 indicating
that the company has some difficulty in collecting its debt or has taken customers
who took a longer credit terms. At the same time, the company’s trade payables have
decreased from 6.6% to 4.5% showing that company now is taking less credit terms
from suppliers and require more cash to pay them. The company is facing a longer
working capital cycle, which means it is taking a long time to turn its current assets
in to cash.
9.3.2 Ratio analysis

One of the popular methods of financial statement analysis is that of the ratio
analysis. As the name suggests, ratio analysis involves constructing financial ratios
of the items from various financial statements. Depending on the information
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need of the user, multiples of financial ratios can be constructed. Ratio analysis is
a quantitative method of analyzing financial information contained in the financial
statements of an entity. Ratio analysis can be used to assess entity’s operating and
financial performance over the years or compare entity’s performance with other
entities in the industry. The method of constructing ratios is presented in the next
section.
a) Constructing financial ratios
The oxford dictionary defines ratio as “the quantitative relation between two amounts
showing the number of times one value contains or is contained within the other”.
Financial ratio, also called accounting ratio expresses a similar relationship between
amounts of various items of financial statements that helps the users to draw some
conclusions from the relationship. Ratios can be calculated either as:
i) Pure ratio (e.g. A and B shares profit in the ratio of 2:1), or
ii) Percentage form (e.g. Company A’s profit is 30% higher than company B’s
profit), or
iii) Times cover (e.g. current assets cover current liabilities two times)
b) Types of accounting ratios

Depending on the information need of the users, numerous accounting ratios can
be developed and used to analyse the financial statements. Some of the commonly
used accounting ratios have been discussed below:
Let’s consider the case where a reporting entity has prepared and subsequently
audited its financial statements for 2019. The same financial statements have been
issued for public on 31 March 2020 as given below.
Sales revenue 348,000

Cost of sales (224,000)
Operating expenses (78,500)
Income from dividend 300
Impairment loss (2,000)
Interest paid (400)
Tax (8,900)
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2018 2019
Non-current assets
Development cost 3,200 5,100
Investment 3,900 8,250
Current assets
Inventory 18,400 28,480
329,000 357,050
Equity shares of Nu.1 each 100,000 120,000
6% preference shares of Nu. 1 10,000 10,000
8% bank loan 5,000 5,000
Deferred tax 420 540
Current liabilities
Accrued expenses 1,280 940
Tax liabilities 7,480 7,580
329,000 357,050
Further, the entity issued 2,000 equity shares of Nu. 1 each on 1 April 2019.
The entity also got listed on the stock exchange on 31 December 2019.
Let’s consider the above case and discuss different types of accounting ratios.
i) Profitability ratios
As their name suggests, profitability ratios measure the entity’s ability to earn profits.
Profit is the primary objective of the business and the basis to give investors the
return they require. Profit also provides funds for reinvestment in the business.
There are three ratios commonly used to assess profitability of the business.
a. Return on capital employed (ROCE)

Operating Profit
ROCE =
Noncurrent Liabilities + Total Equity
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Return on capital employed (also known as return on investment or ROI) measures

the return that is being earned on the capital invested in the business. Every investor
needs a return on their investment for the risk they take to invest in the company.
The operating profit (profit before interest and tax) represents the profit available to
pay interest to debt investors and dividends to shareholders. The capital employed
is calculated as the sum of non-current liabilities and the total equity. Generally, the
higher the ROCE figure, the better it is for investors. The ROCE calculated should be
compared with returns on offer to investors on alternative investments of a similar
risk.
Referring to the case:
Operating profit (profit before interest and tax) = 43,800
Capital employed:
Capital employed for the year is the average of the opening and closing balances of
capital plus non-current liabilities. That is,
_Opening equity + Non current liabilities i+ (Closing equity + non current liabilities)
2
(298, 440 + 332, 460)

= 2
= Nu. 315, 450
43,800
ROCE = 315,450 = 13.9 %
Management use ROCE when making investment and financing decisions. For
example, when borrowing money from the banks, it would not make sense to
borrow at 15% if the ROCE is 13.9 % since the cost of capital is higher than the
return generated by the borrowed capital. Similarly, management might use ROCE
in making a decision to acquire or dispose an asset or a project. The return on the
new investment project should be always higher than the entity’s ROCE.
Lower ROCE would indicate over capitalization, that is, returns are not commensurate
with the capital employed.
Return on Equity (ROE)

Sometimes, instead of return on total capital employed, the shareholders or the
equity owners of the business might be interested to find out the return on their
investment. In such as case, ROE can be used.
Profitaftertax (afterany predi
. vidend) N etprofit
ROE = # 100 or
Averageequity + reserves TotalEquity
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43400 - 600 - 8900 #

= 599940 ' 2 100 =11.30%
ROE provides a return on the capital employed by the owners of the company. That
is why, the interest and dividends paid to any preference shares are excluded from
the calculation.
Comparison between ROCE and ROE

On comparing ROCE with ROE, ROCE (13.9%) is less than ROE (14.3%). This is
because, ROCE considers other capital employed such as preference shares and debt
(e.g. loan) which are much cheaper than the equity capital. This low cost capital
helps to increase return on equity holders.
b. Return on sales (ROS)

Operating profit
ROS= Revenue x 100
Return on sales (also known as operating margin) looks at operating profit earned as
a percentage of revenue. The higher the ratio is better. Low ratio is generally because
of prices being too low or costs being too high.
Operating profit
# 100
Return on sales (ROS) =
Salesrevenue
45,500
= 348,000 # 100
= 13%
Operating profit excludes non-operating income and expenses like dividend
received and interest expense since these non-operating income and expenses do
not have a meaningful relationship with sales. Operating profit margin of 13% by
itself is meaningless unless compared with other companies in the industry or with
the industry margin. It would not make any sense if the operating margin of one
entity is compared with another entity operating in different industry. The operating
profit margin in manufacturing industry generally ranges from 8% to 10% while it
is around 3% in retail and wholesale industry, where entities deal in high-volume
low-margin products.
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c. Gross profit margin

Gross Profit
Gross profit margin = Revenue x 100
Gross profit margin on the other hand focuses on the entity’s trading (main revenue
earning) activities. In simple terms, the higher the ratio the better it is, with poor
performance often being explained by prices being too low or costs being too high.

124,000
Gross profit margin = 348,000 # 100
= 35.6%
Unlike the operating profit margin, gross profit margin does not reflect the ability of
the entity to make profit. It simply indicates how the entity is buying and selling its
products and at what price levels, i.e. whether it is selling higher volumes at low price
or vice versa. Companies operating in designing and fashion products are known for
low-volume high price trading policy to earn higher gross margin as compared to
supermarket that deals with high-volume low-price trading policy and making low
gross margin. Learner must once again know that gross margin of an entity must be
compared with similar entities in the same industry in order to make comparisons
more meaningful. The gross margin will also depend on market competition and
the ability of the management to control cost of sales within its own operation. For
example, entities having a cheaper source of raw materials or supplies of inventory
can expect to have higher gross profit margin than the entity acquiring inventory
and supplies of goods at much higher price.
ii) Liquidity ratios

Liquidity ratio measures the ability of the entity to meet its short-term financial
obligations.
There are two ratios commonly used to assess liquidity position:
a. Current ratio
Currentassets
Current ratio = Currentliabilities
The current ratio measures entity’s ability to meet its liabilities which are payable
within twelve months out of the assets which can be converted into cash within the
same period. Normally or the rule of thumb says current ratio of 2: 1 is satisfactory.
However, current ratios vary between industrial sectors, and many companies
operate safely at below the 2:1 ratio.
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A very high current ratio is also not necessarily good. It could indicate that a
company is too liquid. Cash is often described as an ’idle asset because it earns no
return, and carrying too much cash is considered wasteful. A high ratio could also
indicate that the company is not making sufficient use of cheap short-term finance.
Referring to the case
62,500
Current ratio = 24,590
= 2.5 times
Simply saying, current ratio of 2.5 times means that an entity has current assets
2.5 times more than the current liabilities held at the year-end. This gives a sense
that the entity can meet its current liabilities even with 50% of its current assets
are realized in cash. Conventionally current ratio of 2 or more is considered
satisfactory. However, current ratio like other ratios should be interpreted on
a case basis. For example, supermarkets normally have a negative current ratio
whereas manufacturing or wholesale businesses have higher current ratio. Similarly,
fashion and design industry also operates in low current ratio due to fast changing
fashion in the market. Likewise, the nature and buying behavior of customers will
also determine the current ratio of the business. The low current ratio does not
necessarily indicate a problem.
b. Acid test
Current assets- Inventory
Acid test ratio = Current Liabilities
The acid test (also known as quick ratio) recognises that inventory often takes a long
time to convert into cash. It therefore excludes inventory values from liquid assets.
Normally or the thumb rules require an acid test ratio of 1:1 but once again many
successful companies operate below this ratio.
In practice a company’s current ratio and acid test should be considered alongside
the company’s operating cash flows. A healthy cash flow will often compensate for
weak liquidity ratios.
Refereeing to the case
62, 500 - 28,480

Acid test ratio = 24,590
= 1.4 times
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Comparatively, acid test ratio provides a better measure of entity’s liquidity position
than current ratio since acid test ratio considers only part of the most liquid current
assets.
iii) Activity ratios
Activity ratios measure an entity’s ability to convert entity’s assets into cash or sales.
They measure the efficiency of the business in managing its assets. There are four
commonly used ratios:
a. Asset turnover
Revenue
Asset turnover = N on currentliabilities+ totalequity
This measure the ability of the entity to generate sales from its capital employed. The
same ratio can also be calculated as
Revenue
Asset turnover = Non current assets
Generally higher ratio is better. However, high asset turnover ratio would also
indicate the problem of overtrading, which means there are few assets or less capital
employed in business to generate too much of sales. This can cause sustainability
issues of the business.
348,000
Asset turnover = 332,460
= 1.1 times
Asset turnover of 1.1 times indicates that an entity has been able to achieve a sales
level of 1.1 times that amount of capital employed. The ratio should be compared
with similar entities in the industry to draw any meaningful conclusions. An entity
having higher than 1.1 times of asset turnover ratio would generally mean that entity
has been able to use its capital more efficiently than this entity. However, as discussed
above, higher asset turnover ratio would also indicate ‘over trading’, means ‘doing
too much business with too little capital’.
a. Receivables days:
Trade receivables #
Receivables days = Credit sales 365 days
This measures the ability of the entity to collect its debts in term in of number of
days. For liquidity purposes the faster money is collected the better. Also, generally,
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the longer the credit terms, the higher the level of bad debts. However, too much
pressure on customers to pay quickly may damage a company’s ability to generate
sales.
32, 620
Receivable days = 348, 000 # 365 days
= 34.21 days
The ratio of 34.21 days means an entity’s sales is held up in receivables for 34.21 days.
Once again whether the 34.21 days ratio is good or bad depends on the credit term
of the business. Entities in large retail shops with ratio of 34.21 days would be quite
reasonable as compared with a smaller retail shops that would need much faster
circulation of cash. That way, entities with long term contract purchase and supplies
of goods would operate with even higher receivable days.
b. Inventory days
Inventory
#
Inventory days = Credit sales 365 days or
Inventory
Inventory days = Purchases # 365 days
This measure how long a company carries inventory before it is sold. Again
for liquidity purposes the shorter this period the better, as less cash is tied up in
inventory. Also long inventory holding periods can result in obsolete inventory
and additional storage costs. On the other hand, too little inventory can result in
production stoppages and dissatisfied customers.
28, 480
Inventory turnover = 234, 080 (Purchases = Cost of sales – Op inventory + Cl inventory)

= 44.41 days
The ratio of 44.41 days means the purchases are held up in inventory for 44.41 days
or it takes almost 44. 41 days to convert those inventories into cash. Whether the
ratio of 44.41 days is good or bad depends on the nature of business. Entities trading
in consumer goods like refrigerators and washing machines would operate with
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higher inventory days compared to those trading in grocery items or short shelf
lives.
c. Payable days
Trade Payables
Payable days = Purchases (cost of sales) # 365 days
This measures the number of days the entity takes to pay the suppliers. Because the
purchases figure is often not available to analysts external to the business, the cost of
sales figure is often used to approximate purchases. Long payment periods are good
for the customer’s liquidity, but can damage relationships with suppliers.
Referring the case:
16,070
Payable days = 234,080 # 365 days
= 25.06 days
Whether the ratio is satisfactory depends on credit terms. An entity with 30 days of
credit terms, 25.06 ratio is satisfactory. As discussed above, increased payable days
can indicate failure of the entity to pay suppliers on time which might jeopardize the
relationship with customers.
iv) Gearing ratios
This measures an entity’s ability to meet its long-term debts. There are two ratios
commonly used.
a. Capital gearing
Non current liabilities
Capital gearing = Equity capital employed # 100
This is also known as the ‘debt to equity’ ratio or ‘leverage’. Capital gearing measures
the risk due to high proportions of borrowed funds (long term debts) in the capital
structure of the company. Borrowed funds carry risk as the interest and capital
repayment are legal obligations, and an entity must meet this obligation to avoid
insolvency. Why should companies borrow funds? Companies depend on borrowed
funds to finance their business because the borrowed funds are less costly than
equity shares as they are secured. Moreover, the interest paid on borrowed funds are
corporate tax deductible.
Capital gearing ratios depend on industries. Entities requiring high investment in
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property, plant and equipment are generally highly geared. However, in general
practice, too high gearing may be considered risky, i.e. when an entity is carrying a
large proportion of debt finance that exceeds the equity.
15, 000
Capital gearing = 316, 920 # 100
= 4.7%
Highly geared company should have ratio of more than 100%.
b. Interest cover
Operating profit
Interest cover = Finance costs
This is also known as income gearing. It measures how many times a company’s
operating profits exceed its interest payable. The higher the figure, the more likely
a company is to be able to meet its interest payments. Anything in excess of four is
usually considered to be safe.
43, 400 + 400

Interest cover = 400
=110 times
Interest payments are covered 110 times by its earnings. An entity operating with
high proportion of debt finance should have interest cover ratio much lower
than what is depicted in the case. Student should read the financial statements of
companies to make this assessment more realistically.
c. EPS
Earnings per share measure the ability of an entity to generate profit to each equity
share in issue. Entity listed on stock exchange is required to publish earnings per
share (EPS) in its income statement to assist investors make estimate of what each
equity share in the company is able to earn. Generally higher EPS is better.
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Calculation of EPS
EPS is calculated as the ratio between profit distributable to the equity shareholders
and the weighted average number of equity shares issued. It is possible that equity
shares may be issued at any time of the year. This requires calculation of the weighted
average of the number of shares issued in the year taking in to account of the time
proportion of the shares issued.
Profit after tax - Pref dividend
Eps = weighted avergae noof equity shares # 100
Referring the case

34,500 - 600
Eps = # 100
115,000
= Nu. 29.5
Weighted average no of shares outstanding for the year
100,000 shares x 3/12 = 25,000 shares
120,000 shares x 9/12 = 90,000 shares
Weighted average shares on issue for the year 2019 = 115,000 shares
9.3.3 Cash flow analysis

The statement of cash flows is one of the primary financial statements of an entity
and learner should be able to explain the performance of an entity based on all of
the financial statements including the cash flows given. To do this, learner should
understand cash flows from different activities of an entity and its implications for
the business.
One of the first things to note is student should not simply comment on the overall
change in the total cash and cash equivalents figure in the year in the statement of
cash flows. An increase in this figure does not necessarily mean that the entity has
237 Reprint 2023
performed well in the year. A situation could arise where an entity is struggling to
generate cash and raised a bank loan or issued additional equity capital. This means,
an entity’s over all cash position increases in the year but is clearly not a sign that
the entity has performed well. Similarly, an entity which has differed acquisition of
a critical asset to the future for want of cash could mean that the entity has serious
cash flow issues but that will have not affected the cash position of the entity for the
year since it has postponed its acquisition to the next financial years.
A good analysis will examine the statement of cash flows in detail and look for the
reasons behind the changes in cash flows and commenting on the performance of
the entity. As discussed in the previous chapter, the statement of cash flows contains
cash flows from three activities of business. Each of these cash flows provides useful
information about an entity’s performance.
a) Operating activities
Cash flows from operating activities show how much cash the business can generate
from its core activities (what in previous chapters was referred to as main revenue
generating activities) before looking at one-off items such as asset purchases or
sales and raising money through debt or equity. In fact, the cash generated from
operation is effectively the cash profit from operations. The cash generated from
operation should be compared to the profit from operations to show quality of the
profit. The closer the cash generated from operations to the operating profit, the
better the quality of profit. What if the profit from operations is significantly larger
than the cash generated from operations? In that case, the entity is not able to turn
that profit into cash which could lead to problems like short term liquidity.
Examine the changes in working capital (a lot of cash flows occur as a result of
change in current assets and current liabilities). Large increases in trade receivables
and inventories could mean problems for cash flow and should be avoided if possible.
This could mean an entity has potential irrecoverable debts, or may be that a large
customer has been given an increased payment terms.
What if the entity has increased trade payables? This shows that the entity has taken
a long credit terms from the suppliers or delaying payments to them in order to
improve its cash flow position at the end of the year.
The cash generated from operation should be positive figure. This is to ensure that
the entity has enough cash to fund its day to day operations. The entity’s cash from
operations should also be enough to pay government tax liabilities and interests on
borrowed money without the need to take on extra dent or issuing shares or selling
assets.
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b) Free cash
The cash flows from operations after deducting the tax and interest is normally
called ‘free cash’. The entity should carefully plan to use this free cash. An entity may
use free cash to pay its dividends or purchase non-current assets, to generate returns
in the future, without having to resort to borrowed money.
c) Cash flows from investing activities
The cash flows from investing activities arise from the activities related to non-
current assets. For example, an entity may buy or sell its non-current assets which
could increase or decrease the overall cash. The investment decision will also affect
the operation of the business. Say, an entity buys a new plant and machinery to
replace its old plant and machinery. This will help the production and generate cash
revenue. However, an entity should not sell assets to finance its operation or pay
dividends. This may indicate that management is not able to generate any cash from
business and most likely to face financial distress.
d) Cash flows from financing activities
Cash flows from financing is concerned about how the operations and assets are
financed in the business. It is always better to have the operations and purchases of
new assets financed through cash from operations. This indicates that an entity is
generating significant levels of excess cash.
While an entity may use borrowed funds to finance non-current assets, it is also
important to assess the future risks. For example, taking out loans will lead to higher
interest charges and will increase the level of gearing for the entity. Generally, the
banks do not provide loans to borrowers who have already taken high amount of
loans from other loan providers. Raising finance through issue of shares may save
the business from paying the interest; however, this will lead to increased number of
shareholders and future dividend payments.
e) Use of graphical presentations
Learners must explore the use of excel sheets to analyse financial statements and
presenting the financial information and the results of financial statement analysis in
graphical representations such as pie charts, dotted lines and bar charts to enhance
the understandability and quality of information to the users.
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Exercises:
1. In groups, identify and discuss the limitations of accounting ratios. The

discussion should use prior knowledge related to accounting concepts and
practices.
2. ABC Company Limited prepared a summary of its income statement for the
year 2019 as follow:
Particulars Amount
Cost of sales 98,550
Gross Profit 65,700
Operating expenses 39,420
The company also projected an income statement for 2020 as given below:
Particulars Amount
Cost of sales 129,600
Gross Profit 86,400
Operating expenses 50,760
The company’s capital as at 31 December 2019 is Nu.7.5 million. Company directors
are proposing to raise additional capital of Nu. 1.5 million by issue of shares
and expect that the performance will be same as projected. Assuming that their
expectations materialize:
i) Calculate ROCE for 2019 and 2020.
ii) Explain how directors can improve the performance by improving the
operating margin and the asset turnover in 2020.
3. Dorji Apparels and Pema Garments both trade in ready-made cloths. Dorji
Apparels focuses on more expensive end of the market and Pema Garments at
the cheaper end.
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The financial statements of the two companies are presented below.

Dorji Apparels Pema Garments
Revenue 2,840,000 18,460,000
Cost of sales 1,988,000 16,712,000
Gross profit 852,000 1,748,000
Administrative expenses 429,000 426,000
Distribution cost 184,000 216,000
Operating profit 239,000 1,106,000
Interest 40,000
Profit before tax 199,000 1,106,000
Tax expense 39,000 220,000
Profit after tax 160,000 886,000

Dorji Apparels Pema Agrments
Property, plant and equipment 3,200,000 1,840,000
Current assets
Inventory 548,000 414,000
3,480,000 1,810,000
Equity shares 2,000,000 900,000
Retained eranings 669,000 354,000
8% bank loan 500,000
Current liabilities
Trade payables 266,000 328000
Taxation 45,000 228000
3,480,000 1,810,000
Required:
Comment on the comparative profitability of the two companies.
4. B-Mart deals in all brands of washing machines. It reports gross profit for the
year along with comparative financial statements as follow:
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2019 2018
Sales 884,000 876,000
Inventory (Op) 128,000 116,000
Purchases 726,000 652,000
Inventory (Cl) (164,000) 690,000 (128,000) 640,000
Gross Profit 194,000 236,000
Required:
i) Calculate gross profit ratios.
ii) Explain possible reasons for the change in relations between sales and gross
profit.
5. Blue Poppy limited prepared its statement of income for the year ended 31
December 2019 as shown below. The company also presents a summary of its
capital employed.
Amount (Nu)
Interest on bank loan (400,000)
Tax (80,000)
Pref Dividend (180,000)
Equity and liabilities Amount (Nu.)

Equity shares 4,000,000
6% Pref shares 3,000,000
Reserves 500,000
7,500,000
8% Loan 5,000,000
12,500,000
Required:
i) Calculate capital gearing of the company.
ii) Explain how high gearing affects equity shareholders.
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Chapter 13: Stores Ledger
Chapter 13
Stores Ledger
• Define cost, cost centre and cost unit

• Describe the terms- bin card, stores and stock
• Explain the term stores ledger
• Assess the importance of preparing stores ledger
• Differentiate periodic and perpetual systems of stock verification,
• Illustrate different methods of stock valuation- FIFO and weighted
average method,
• Interpret the treatment of normal and abnormal loss, and transfer of
materials, and
• Prepare stores ledger.
13.1 Cost Concepts

According to Council of the Institute of Cost Accountants of India, “Cost is a
measurement, in monetary terms, of the amount of resources used for the
purpose of production of goods or rendering services”. Manufacturing of goods
or rendering services involves consumption of resources. For example, material
cost is the price of materials consumed for manufacturing a product or for
rendering a service.
Broadly, the cost concepts include the following:
a) Cost of Purchase
The cost of purchase means the purchase price including duties and taxes,
fright inward and other expenditure directly attributable to the acquisition
of goods and services. For the purpose of determining the costs of purchase,
trade discount, rebate, duty drawbacks and other similar items are deducted.
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Accountancy for class XI
b) Cost Centre
According to Council of the Institute of Cost Accountants of India, Cost Centre
means “any unit of an entity selected with a view to accumulating all cost
under that unit”. The unit can be a product, a service, division, department,
section, group of plant and machinery, group of employees or combination of
several units.
c) Cost Unit
According to Council of the Institute of Cost Accountants of India, “Cost unit
is a form of measurement of volume of production or service”. It means the
cost attributable to unit or quantity of product, service, time or combination
of these.
The followings are the examples of cost units:
Products or services Unit of measurement
Power Cost per mega-watt per hour or kilo-watt per
hour
Books / pen / pencil etc. Cost per number
Transport Cost per kilometre per passenger
Petroleum products Cost per litre
Rice, vegetables etc. Cost per kilogram
13.1.1 Classification of Cost

For the purpose of controlling cost and other decisions related to production, the
cost can be broadly classified into three types:
a) Material Cost
Material Cost is the cost of material of any nature used for the purpose of
production of goods and services.
b) Labour Cost
Labour Cost is the remuneration paid to either permanent or temporary
workers of an undertaking for their services in the form of wages, commission,
bonus, etc.
c) Expenses
Expenses are cost of services other than material or labour cost which are
involved in operation of the business.

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13.1.2 Components of Cost
Figure 13.1 Components of cost

a) Prime Cost
Prime cost is the sum total of all the direct materials cost, direct labour cost and
direct expenses.
Direct Material Cost + Direct Labour Cost + Direct Expenses = Prime Cost
i. Direct material Cost
Direct material Cost is the cost of material which can be directly identified
and can be allocated to cost unit conveniently. For examples, cost of raw
materials and insurance, freight inward, taxes and duties which are directly
attributable to the acquisition.
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ii. Direct Labour Cost
Direct labour cost is the wages paid to the labour who are directly engaged
in the production process; altering the composition or condition of raw
materials in order to produce a product in a manufacturing concern.
For examples, the wages, Provident Fund, gratuity, overtime, incentives,
bonus, leave encashment, wages for holidays and idle time etc. for workers.
iii. Direct expenses
A direct expense includes any expenditure other than direct material
and direct labour engaged in the production process; altering the
composition or condition of raw materials in order to produce a product in
a manufacturing concern. Examples; hiring of equipment for a particular
job, cost of special layout, design or drawings, fees paid to architects of a
building etc.
b) Overhead cost
Overhead cost is the aggregate cost of indirect materials, indirect labour and other
expenses which cannot be easily charged to specific cost units. Thus overhead
costs are all expenses other than direct expenses. Overheads can be subdivided
into:
i. Factory overhead,
ii. Office and administration overhead, and
iii. Selling and distribution overhead.
Each of these overhead cost comprises of indirect materials, indirect labour and
indirect expenses.
Indirect Material+ Indirect Labour + Indirect Expenses = Overheads
a) Indirect Material
Materials used in the manufacture of goods which cannot be directly
identified in the job or the product. For example, consumable stores, spare
parts and lubricants.
b) Indirect labour
Indirect labour is wages which cannot be conveniently identified with or
allocated to cost units. Examples of indirect labour are salaries of staff in
the administration and accounts department, salaries of security staff etc.
c) Indirect expenses
Indirect expense includes any expenditure other than indirect material
and indirect labour which cannot be easily identified and allocated to the
cost unit. Examples of indirect expenses are insurance, taxes, duties, etc.

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Learning Activity 1
Mr. Dubjur a capenter owns a furniture house and he incurs expenses on the
items listed in Table 1. You are required to answer the following questions after
studying the cost items in the table.
Sl Cost items for Mr. Dubjur

No
1 Wood
2 Nails
3 Glue
4 Polish
5 The wages paid to the carpenters
6 Wages paid to store-keeper
7 Cost of design of furniture
8 Minors repairs and maintenance of equipment’s used for making furniture
9 Ply wood
10 Paint brushes
11 Sandpaper
12 Wages to sweeper
13 Telephone bills
14 Water bills
15 Electricity bills (office)
16 Transportation
Questions:
i) Classify the cost given in Table 1 into direct materials, direct labour,
direct expenses, indirect materials, and indirect labour and indirect
expenses?
ii) What criteria did you apply to classify?
iii) Why is classification of cost necessary?
13.2 Inventory
Learning Activity 2
Ever Green Central School provides boarding facilities to the students. Mr Kinley
is the mess in charge who keeps the records of receipts and issue of ration. The
following are the items received by him.
In the beginning of the year, he has in store, 15 bags of red rice which was
purchased at Nu. 1,350 each. In the first month of academic year he purchased 30
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bags of white rice, each bag costing Nu. 1500. At the end of the first month, the
school administration wanted to know value of rice left in the store. On counting
physically he found out that there were 12 bags of rice.
i) What is the value of rice remaining in the store?
ii) Which rice do you think the students where served during the first week
of the month? Give reasons?
Business may be classified under Trading (merchandising), Manufacturing
and Service undertaking. Accounting for inventory is common to all types of
business. For a trading business, the goods purchased for resale is the inventory,
for a manufacturing concern inventory comprises of raw materials, works in
progress and finished goods. For service organisations like cable service, schools
and hospitals, inventory consists of the materials and supplies needed to provide
the service.
As per Bhutanese Accounting Standard (BAS - 2), inventories are assets:

(a) held for sale in the ordinary course of business;
(b) In the process of production for such sale; or
(c) In the form of materials or supplies to be consumed in the production
process or in the rendering of services.
Inventory valuation is normally made at the lower of cost or net realizable value.
This valuation is taken from (BAS - 2). This valuation applies the prudence
concept and is shown with the help of Figure 13.1
Is the cost price lower than selling price?
Yes No
Value stock at cost price Value stock at selling price

(Net realisable value)
Figure 13.2 principle of stock (inventory) valuation

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Illustration 1 (principle of inventory valuation)
Karma Clothing Store at Thimphu bought 30 T-shirts on 1st January with each
item costing Nu. 200 each and on 1st July they sold 20 items for Nu. 350 each.
Again on 15th August they sold 5 items @ Nu 360 each. At the end of the year the
market realizable value is Nu 300 per item. What would be the value of remaining
5 T-shirts?
Solution
Opening Stock + Receipts – Issues = Closing Inventory
Inventory valued at cost Inventory valued at Net realizable value
= 0 + 30- 25 = 5 T-shirts = 0 + 30- 25 = 5 T-shirts
Value of closing inventory = Value of closing inventory =
5 T-shirts ×200 = Nu 1,000 5 T-shirts ×300 = Nu 1,500
In this case the value of inventory will be Nu. 1,000 because the cost is less
than market value.
13.2.1 Stores
It includes materials and supplies which will be used in the process of production.
It consists of consumable items which will be issued to the production units as
and when required. Example: glue and nails in a furniture house.
13.2.2 Bin card

Bin Card consists of two terms, ‘Bin’ and ‘Card’. Bin refers to a place, cupboard
or a box where materials are kept. A card is attached to this bin to show the stock
position of the bin. This card is known as bin card.
Thus, bin card is a record maintained by the store-keeper to record the stores
received, issued and balance in hand at any time which is expressed in terms of
quantity only.
13.3 Stores Ledger

Stores Ledger is subsidiary ledger which is maintained by cost department. A
separate account is opened for each item of materials in the store to record both
the quantity and cost of materials received, issued, returned, and balances in
hand.
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13.3.1 Documents used in stores procedure

a) Bill of Materials
A document prepared by a particular job dealing in that material and sent
to the stores department. It shows the quantity of materials required.
b) Purchase Requisition
This is a document prepared by the stores department and it is sent to the
procurement department when it reaches the reorder level. It shows the
quantity of materials required by the stores department.
Chartered Institute of Management Accountants (CIMA) defines Purchase
Requisition as “an internal instruction to a buying office to purchase goods
or services. It states their quantity and description and elicits a purchase
order”.
c) Purchase Order
This is a document prepared by purchase department which generally
shows the name of the item, item code, quantity required etc.
d) Material Inspection Note
After receiving the materials, the Inspection Department thoroughly
inspects whether the quality of material is in accordance with the purchase
order and the quality of material received and it prepares a note called
‘material inspection note’. Copies of the note are sent to the supplier and
stores department.
e) Goods Received Note (GRN)
Once the inspection is completed, GRN is prepared by the stores
department, and copies of GRN is sent to the purchasing department,
costing department, accounts department and production department,
which initiated purchase requisition.

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A specimen of Store Ledger
Name of material............................ Folio..............................................

Material Code No............................ Maximum Level.............................
Bin Card No.................................... Minimum Level.............................
Ordering Level...............................
Ordering quantity..........................
Receipts Issues Balance

Date GRN Qty Rate Amount SR Qty Rate Amount Qty Rate Amount Remark
No (kg) No. (kg) (kg)
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13.3.2 Necessities to prepare stores ledger

Store Ledger is prepared mainly because it provides a continuous record of the
stores received, issued and discloses the balance in hand at any time, both in
quantity and value. It assists in planning since information about stock in hand
would be available.
13.4 System of Inventory Verification

Depending on nature and size, a business can choose the system of inventory
valuation. The systems are periodic inventory system and perpetual inventory
system.
13.4.1 Periodic inventory system

Periodic Inventory System is a method under which verification of the store items
is done at the end of the period. Under this method stock verification is done by
actual counting, weighing and measuring of items in stock. During the period of
stock verification, materials are not issued from the store therefore this method
is suitable for small and medium sized business.
13.4.2 Perpetual inventory system

Perpetual Inventory System is a system of recording stores balances after every
receipt and issue to facilitate regular checking and to prevent closing down of the
operation for stock taking.
Difference between periodic and perpetual systems

Basis of Distinction Periodic Inventory Perpetual Inventory
System Systems
The value of inventory is Inventory is ascertained
determined on the basis on the basis of records
Basis of Ascertaining
of an actual physical maintained on
Inventory
count/measure/weight at continuous basis.
a given point of time.
Inventory is directly Inventory is calculated
calculated by applying as a residual figure as
the method of valuation under: Closing Inventory
Calculation of inventory
of inventories like FIFO = Opening Inventory +
or LIFO. Purchase – Cost of goods
sold.

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Cost of materials issued Cost of Materials issued

is calculated as a residual is directly calculated by
figure as under: cost applying the method of
Calculation of cost of
of materials issued = valuation of inventories.
goods sold
Opening Inventory +
Purchases – Closing
Inventory.
It does not facilitate It facilitates the
Continuous Stock
the continuous stock continuous stock
Checking
checking. checking.
Under periodic Errors can be traced
inventory system it easily because the
Transaction becomes difficult to trace details regarding the
investigations. errors as it is done at movement of materials
the end of the reporting are maintained on
period. continuous basis.
13.5 Methods of inventory valuation

As inventory is usually purchased at different rates over an accounting period,
there is a need to determine what cost needs to be assigned to inventory. For
instance, if a company purchased inventory thrice in a month at Nu. 50, Nu. 60
and Nu.70, what cost must be attributed to inventory at the month end? Inventory
cost at the end of an accounting period may be determined in the following ways:
a) First In First Out (FIFO)
b) Weighted Average Method
13.5.1 First In First Out

FIFO is an inventory valuation technique, in which the inventory received first
is assumed to have been issued first. Issue takes place in the order of receipts.
Closing inventory comprise of the goods which are received most recently.
Illustration 2
Riders Ltd purchased 15 bikes during January and sold 10 bikes, details of which
are:
January 1 Purchased 6 bikes @ Nu. 50,000 each
January 5 Sold 2 bikes
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Calculate the value of closing inventory by applying FIFO method of pricing the issues?
254
Solution: The value of 5 bikes held as inventory at the end of January may be calculated as:
Jan 1 6 50,000 300,000 2 50,000 100,000 6 50,000 300,000
Jan 5 3 50,000 150,000 4 50,000 200,000
Jan 10 1 50,000 50,000
9 70000 630,000 1 50,000 50,000
Jan 15
9 70,000 630,000
1 50,000 50,000 5 70,000 350,000
Jan 25
4 70,000 280,000
The value of closing inventory:

5 units @70,000 = 350,000
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13.5.2 Weighted Average Method

In this method, the rate of issue of materials is computed by dividing the value of
materials by units available. Therefore, inventory cost under Weighted Average
Price Method will be the average cost of materials available for issue on a
particular point of time.
Opening inventory Goods Available Closing Inventory
First In First Out
Net Purchases Cost of Goods Issued

Opening inventory Goods Available Closing Inventory
Weighted
Average
Price Method
Net Purchases Cost of Goods Issued
Illustration 3
P.T Kuenzop Pvt. Ltd. uses iron slabs to manufacture Bhukari. The company has
the following records for the purchase of iron slabs:
Quantity (Units) Rate (Nu)
50 60
30 65
40 65
70 70
25 72
Inventory at the end of accounting period shows a balance of 80 units.
Assuming that the records of issues are not maintained on a daily basis,
compute the value of closing inventory using weighted average price method.
Solution
Quantity (Units) Rate (Nu) Amount (Nu)
50 60 3000
30 65 1950
40 65 2600
70 70 4900
25 72 1800
215 14,250
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Tqtal cost of goods available for issue

Price per unit= Units available for issue
14250
Price per unit (WAP)= 215 = 66.279
Value of closing inventory of 80 units will be, 80 units x Nu 66.279 = Nu. 5,302
Important Note:
The illustration is based on the periodic inventory system where the record of
date and quantity issued is not maintained on a daily basis.
If the purchase date, and the date and quantity issued are given, then the rate
changes after every new receipt.
Illustration 4
Riders Ltd purchased 15bikes during January and sold 10bikes, details of which
are-
January 15 Purchased 9bikes @ Nu. 70,000 each
Calculate the value of closing inventory by applying Weighted Average Method
of pricing the issues?

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If a stores ledger is to be prepared for the transactions in illustration 2 under Weighted Average Method, it would
appear as given here.

Jan 1 6 50,000 300,000 6 50,000 300,000
Jan 5 2 50,000 100,000 4 50,000 200,000
Jan 10 3 50,000 150,000 1 50,000 50,000
Jan 15 9 70,000 630,000 10 68,000 680,000
Jan 25 5 68,000 340,000 5 68,000 340,000
Tqtal cost of goods available for issue

Price per unit= Units available for issue

50, 000 + 630, 000 =
10 68, 000
Note: Available quantity for issue on 25th Jan consists of:

Balance on 10th Jan 1 unit @ Nu 50,000 = 50,000
Receipts of 15th Jan 9 units @ Nu 70,000 = 630,000
10 units 680,000
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Illustration 5
Mr. Dorji is working as a storekeeper in one of the referral hospitals. His daily
work is to maintain the record receipts and issue of medicines in order to maintain
the required stock of medicine in the store. Due to the outbreak of malaria, the
number of patients has increased drastically. Therefore, the management wanted
to know the stock of Doxycycline Capsules (100 mg) in the store and he was asked
to prepare the store ledger account with the help of the following information
applying the First In First Out method of pricing medicine under the Perpetual
Inventory and Periodic Inventory Control System.
Date Particulars Units (Strips) Per Unit Cost Nu.

January 1 Opening Stock 2000 7
January 10 Purchases 4000 8
January 12 Issue 3000 -
January 15 Purchase 5000 9
Solution: Calculation of Closing Inventory under FIFO method (Periodic
System)
Opening Stock + Purchase – Issues = Closing Inventory
2000 + (4000+5000) - (3000+3500+2500+1500) = 500 Strips
The closing inventory of 500 strips is form the latest purchase (15th Jan) @ Nu.
9 per strip.
Therefore the value of closing inventory is 500 Strips × Nu. 9 = Nu. 4500

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Solution: Store Ledger under FIFO Method (Perpetual System)
Date GRN Qty Rate Amount S R Qty Rate Amount Qty Rate Amount Remark
Jan 1 2,000 7 14,000 Opening Bal.
4,000 8 32,000 2000 7 14,000
Jan 10
4000 8 32,000
2,000 7 14,000 3,000 8 24,000
Jan 12
1,000 8 8,000
5,000 9 45,000 3,000 8 24,000
Jan 15
5,000 9 45,000
3,000 8 24,000 4,500 9 40,500
Jan 19
500 9 4,500
Jan 25 2,500 9 22,500 2,000 9 18,000
Jan 30 1,500 9 13,500 500 9 4,500
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Learning Activity 2
You are a newly appointed accountant of YBM Bricks and you presented the
following statement to show the value of closing stock of cement on 31st Dec,
2016 to the management.
Date Quantity received Rate (Nu.)
21/2/2016 800 320
15/5/2016 900 350
10/7/2016 1,200 355
13/9/2016 1,100 350
24/12/2017 700 365
Closing inventory (on physical count) shows 850 bags.
Value of closing inventory on the basis of FIFO method
700 Bags @ Nu. 365 = 255,500
150 Bags @ Nu. 350 = 52,500
308,000
The management advised you that the business need to prepare final accounts
following the principle of consistency and that the business had been following
weighted average price method and maintaining continuous records. You are
furnished with the following additional information.
24/5/2016 Issued 1100 bags
12/8/2106 Issued 950 bags
14/10/2016 Issued 800 bags
25/12/2016 Issued 900 bags
Find out the value of closing inventory with the help of a stores ledger.
13.11 Treatment of Loss of Materials

Sometimes materials may be lost or destroyed while in the store. This loss of
materials can be classified as normal loss or abnormal loss.
a) Normal Loss
Normal loss arises due to unavoidable, inherent and natural causes, such as
leakage, drying, evaporation, etc. The business cannot prevent such loss with
any effort. Such loss is spread over the remaining quantity by inflating the unit
price of inventory to be issued.
b) Abnormal loss
Abnormal loss arises accidentally or out of negligence like theft, fire, etc. and
they do not occur frequently. Abnormal loss is excluded from cost and it will
be debited in statement of income. It will be shown in issue column of store
ledger at the normal issue price.

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13.12 Surplus of Material

Any surplus of materials found at the time of physical verification may be
treated as a new receipt at the latest purchase price.
Illustration 6
The following is the extract of receipts and issue of Petrol by BOC, Gelephu.
Purchases:
1th January, 2017 1000 ltr. @ Nu.40 per ltr.
3rd January, 2017 500 ltr. @ Nu.42 per ltr.
Issues:
2nd January, 2017 600 ltr.
15th January, 2017 950 ltr.
On 1st January, 2017 the inventory was 500 ltr. @ Nu.40 per ltr. The stock
verification on 16th January revealed a shortage of 70 ltr. Show the store ledger
by adopting FIFO method, assuming:
i). that the loss was due to evaporation.
ii). that the loss was due to theft.
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Solution
262
i). If the loss is treated as normal
Store Ledger Account
Date GRN Qty Rate Amount SR No. Qty Rate Amount Qty Rate Amount Remark
No (kg) (kg) (kg)
Jan 1 500 40 20,000
1,000 40 40,000 500 40 20,000
Jan 1
1,000 40 40,000
500 40 20,000 900 40 36,000
Jan 2
100 40 4,000
500 42 63.000 900 40 36,000
Jan 3
500 42 21,000
900 40 36,000 400 42 16,800

Jan 15
50 42 2,000
Jan 16 Shortage 70 330 50.91 16,800 Normal loss
Note:
i). The normal loss has been entered only in the quantity column.
ii). The price has been inflated as under:
Nu.16, 800 ÷ 330 = Nu.50.91
Closing inventory =330 Litre × 50.91 = Nu. 16,800
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ii). If the loss is treated as abnormal
No (kg) (kg) (kg)
Jan 1 500 40 20,000
1,000 40 40,000 500 40 20,000
Jan 1
1,000 40 40,000
500 40 20,000 900 40 36,000
Jan 2
100 40 4,000
500 42 63.000 900 40 36,000
Jan 3
500 42 21,000
900 40 36,000 400 42 16,800
Jan 15
50 42 2,000
Shortage 70 42 2,940 330 42 13,860 Abnormal
Jan 16
loss
Note:
The abnormal loss has been entered in the issue column with its original rate.
The price or rate will remain same.
Closing inventory = 330 Litre ×42 = Nu. 13,860
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Learning Activity 3
Druk Mentse Central School was established as one of the pilot centre schools
in Bhutan. The school management has recently discovered some gaps in its
procurement and inventory management which was raised as a matter of concern
especially in the context of how poor inventory management would affect service
delivery and competitiveness of autonomous school.
All purchases and issues of inventories are carried out by the school administrative
officer who has no prior experience in procurement and inventory management.
On several occasions she was found losing temper and being reactive when her
colleagues questioned about inefficiencies in the school inventory management.
Under the supervision of school principal, she maintains a stores ledger to record
items of inventories on a daily basis. Although there was no audit observation in
the previous financial years, there were traces of unethical issues which required
immediate attention.
As a public institution, the school is required to prepare and present the statement
of financial position and statement of income and expenditure for its stakeholders.
It is first time that Druk Mentse School is valuing inventories for reporting. The
administrative officer needs your assistance to value the inventories for the year
ended 31 December 2019 to be reported in its financial statements. She provides
the following information on procurement and issue of inventories to enable you
to perform the task.
Date Particulars Unit Unit cost Amount
Jan-19 Opening
inventories
Stationery 560 1000 560,000
Electric 810 300 243,000
fittings
Vehicle spare 125 560 70,000
parts
Feb-19 Purchases
Stationery 100 1230 123,000
Electric 115 400 46,000
fittings
Mar-19 Issues
Electric 450
fittings

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Vehicle spare 100

parts
Jun-19 Issues
Stationery 350
Sep-19 Inventories
written off
Stationery 50
because of
damage
Electric 100
fittings
because
of inferior
quality
Oct-19 Purchases
Computer 85 2,300 184,000
accessories
Required:
i) Calculate the amount of inventories consumed during the financial year
2019.
ii) Calculate the value of inventory to be reported in the financial statements
for the year ended 2019.
iii) Suggest how inventory management of the school can be improved.
iv) Suggest the most appropriate method of inventory valuation for the
school.
Learning Activity 4
Samten Central School is one of the boarding schools in Bhutan and Mr Karma
was the mess in charge for the academic year 2017. As mess in charge his work is
to receive the vegetables from the suppliers and issue daily to the head cook. The
following is the receipts and issue of vegetables for a period of one month. The
school administration wanted to know the closing stock of vegetables.
Therefore, he was asked to prepare Store Ledger using First In First Out [FIFO]
and Weighted Average Method of pricing the issues.
December 1st: Balance in hand 1,500 kg @ Nu.3.5 each.
December 4th: Received 3000 kg costing Nu.6, 000
December 24th: Received 4000 kg costing Nu.12,000
December 12th: Issued 3000 kg
December 30th: Issued 4,500 kg
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Required:
a) Show the closing inventory of vegetables for the month of December.
b) Compare the inventory under two methods and give reason why the
inventory appears to be different between two methods.
c) Suggest which method is best to prepare store ledger for vegetables.
13.13 Return of Materials

Return of materials is broadly divided into return from the issue (departments)
and return to the suppliers.
a) Return from the issues / departments / jobs
Return from the issues means return of materials from different departments
or jobs to the store. The return from the issues is treated as new purchase of
materials or it is treated as new receipts but it is priced at the original price
at which it was issued and entered in the Stores Ledger after the last purchase
entry.
Illustration 7
Prepare a Stores Ledger Account under the Weighted Average Price Method of
pricing the issues of stores, using the following information when the shortage of
20 units is treated as abnormal loss.
2015 Receipts and issues of materials Units
July 1 Balance in hand @ Nu. 3 per unit 200
July 2 Received @ Nu.3.20 per unit 400
July 10 Issued 200
July 14 Received @ 3.30 per unit 200
July 18 Issued 300
July 23 Returned from issues on 10th January 30
July 28 Wastage 20
July 30 Issued 300

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No (kg) (kg) (kg)
July 1 200 3 600
July 2 400 3.20 1,280 600 3.13 1880
July 10 200 3.13 626 400 3.13 1252
July 14 200 3.30 660 600 3.186 1912
July 18 300 3.186 955.8 300 3.186 955.8
30 3.13 93.9 Return 330 3.181 1049.7
July 23
from job
July 28 Shortage 20 3.181 63.62 310 3.181 986.11
July 30 300 3.181 954.3 10 3.181 31.81
i). Closing Stock = 10 units @ Nu. 3.181 = 31.81
b) Return of materials to the suppliers

Return of materials to the supplier means that the materials returned to the suppliers from the previous purchases.
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Illustration 8
From the following information you are required to prepare Stores Ledger
Account assuming that the issues are to be priced on the basis of Weighted
Average Method for the month of May, 2016.
May 1 Received @ Nu.100 per unit 50
May 3 Issued 15
May 10 Received @ Nu.110 per unit 10
May 15 Issued 20
May 20 Returned to suppliers -5 units of the quantity received on 1st
May, 2016 5
May 25 Received replacement from suppliers against return dated
5
20th May, 2016
May 28 Stock surplus 6
Solution
Date GRN Qty Rate Amount SR Qty Rate Amount Qty Rate Amount
July 1 50 100 5,000 50 100 5,000

July 3 15 100 1,500 35 100 3,500
July 10 10 50 500 45 88.89 4000
July 15 20 88.89 1778 25 88.89 2222

July 20 5 88.89 444 20 88.89 1778
July 25 5 88.89 444 25 88.89 2222
July 28 6 88.89 533.33 31 88.89 2756

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Learning Activity 5
Mr. Wangda is the store in charge of Dolma Enterprise which supplies the note
books to different schools in Bhutan. He has recorded the following receipts and
issue of books.
2017 Receipts and issues of materials No of Books
July 1 Balance in hand @ Nu. 30 per Book 150
July 2 Received @ Nu.35 per Book 300
July 8 Issued 200
July 12 Received @ Nu. 40 per Book 100
July 16 Issued 200
July 20 Wastage 10
July 24 Issued 110
Required:
1) Show Stores Ledger Account under FIFO Method when the wastage is
treated as:
a) normal loss.
b) abnormal loss
2) Prepare Stores Ledger Account under Weighted Average Method when
the wastage is treated as :
a) normal loss.
b) abnormal loss.
Learning Activity 6
The following information has been obtained from the books of accounts of
Karma Manufacturing Co. Ltd. pertaining to material A. Prepare Stores Ledger
using FIFO method of pricing the issues.
January 1 Balance in hand @ 2.5 per unit 150
January 2 Received @ Nu.2 per unit 250
January 12 Issued 200
January 16 Received @ Nu. 2.4 per unit 100
January 18 Returned from the issues on 12th January 10
January 25 Returned to suppliers received on 16th January, 2019 15
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13.14 Treatment of Transfer of Materials

Transfer of excess material from one job to another job or from one department
to another department should be avoided as far as possible. This is because record
for transfer may not be made and actual material cost of jobs or departments may
be inaccurate. However, sometimes the material may be allowed to be transferred
to avoid delays and handling charges. The transfer is to be allowed only with
preparation of material transfer note so that the cost of material transferred is
debited to the job receiving the material and credited to the job transferring
the material. Therefore, the transfer of materials from one job / department to
another does not appear in the Store Ledger.
Illustration 9
ABC Limited furnishes the following transactions in stores for July, 2015.

January 1 Stock in hand @ Nu. 160 per unit 30
January 2 Issued (Requisition No.50) 15
January 12 Receipts@ Nu.161 per unit (G.R.N. No. 15) 50
January 16 Transfer from job 180 to 182 8
January 20 Issued (Requisition No.51) 10
January 25 Transfer from Department A to Department B 2
Prepare Store Ledger Account applying FIFO method.
Solution Stores Ledger Account
Receipts Issues Balances
Date
GRN Qty Rate Amt S R Qty Rate Amt Qty Rate Amt
2015
Jan 1 30 160 4,800
Jan 2 50 15 160 2,400 15 160 2,400
15 50 161 8,050 15 160 2,400
Jan 12
50 161 8,050
51 10 160 1,600 5 160 800
Jan 20
50 161 8,050
Note:
i) Transfer of materials from one job to another or from one department to
another will be not recorded in the Store Ledger Account.
Closing Inventory = 5 units ×160+ 50 units ×161= Nu. 8,050

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Learning Activity 7
Mr. Wangchuk runs a computer supplies business. One of the items stocked is
the ‘keyboard’ of computer. To show how the stores ledger records would appear
under FIFO method the following data is used:
JMay 1 Opening balance @ Nu 15 25
July 3 Receipts from Karma & Co. @ Nu. 20each 50
July 10 Issued 30
July 22 Transfer job 180 to job 184 10
July 28 Receipts from Dorji& Co. @ Nu. 22 each 10
Exercise
1. Questions for short answer
1) How bin card and store ledger are similar in nature.
2) Explain in your own words the following terms:
a) Purchase Requisition Note
b) Stores Requisition Note
c) Goods Received Note
3) What is a purchase requisition? Give a specimen form of purchase
requisition and state the information contained therein.
4) Distinguish between FIFO and weighted Average Method of stock
valuation.
5) What is purchase order? Give a specimen form. What main points,
clauses and instructions must appear on the face of a purchase order?
6) Distinguish between ‘Store Ledger’ and ‘Bin Card’. Give a specimen of
each.
7) What is the objective behind fixing maximum, minimum, re-order
levels?
8) Discuss in detail ‘Perpetual Inventory System.’
9) What are the objectives of inventory control? How this control is
exercised?
10) What do you understand by ‘pricing of issues’? Explain any two methods
of pricing of the issues.
11) What factors should be taken into consideration while fixing a method
of pricing of the issues?
12) Beginning inventory was Nu. 26,000, ending inventory was Nu. 18,000
and inventory issue was for Nu. 94,000. What was the amount of
inventory purchased?
13) On first January 2017 inventory was 37,000. Inventory purchased for
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the month of January were Nu. 54,000 and the inventory balance on 31
January was nu. 19,000 what was the value of inventory issued?
2. Essay type questions
1) Explain the following concepts in your own words:
a) Cost of purchase
b) Cost Centre
c) Cost Unit
2) State and explain the advantages of FIFO method over Weighted Average
Method of inventory valuation.
3) What is perpetual inventory? Why this method is preferred to periodical
Inventory?
4) How finished goods are valued for the purpose of balance sheet?
5) Why inventory is to be valued at cost or market price, whichever is
lower?
3) Dechen Bakery supplies ‘Birthday Cakes’ which are delivered to its customers.
The business uses the first in first out (FIFO) method for valuing its inventories.
As an accountant, you are required to complete the following Stores Ledger
Account for the month of May 2017. The following additional information is
given.
a) Issued on 12th May, 2017 = 700 kg
b) Issued on 20th May, 2017 = 1,200 kg
Receipts Issues Balances

May
2017 Qty Rate Amt Qty Rate Amt Qty Rate Amt Remarks
(kg) (kg) (kg)
1,000 ? 10,000 Opening
1
Balance
1,000 ? 10,000
8 800 ? 9600
800 ? 9,600
? ? 3,000
12 700 ? ?
? ? ?
? 10 3,000
18 300 ? 3150 800 ? 9,600
300 10.5 ?
300 10 ?
20 8,00 ? 9,600 200 ? 2,100
? 10.5 5,250

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4. The following are the receipts and issue of nails in a furniture house for the
month of February, 2017
Date Particulars
2.2.2017 Received 200 Kg @ Nu. 100
11.2.2017 Received300 Kg @ Nu. 120
17.2.2017 Issued 250 Kg
21.2.2017 Received 250 Kg @ Nu. 130
26.2.2017 Issued 200 Kg
You are required to:
1) Ascertain the value of inventory under FIFO and Weighted Average
Price Methods.
2) Comment on the difference in closing inventory under the two methods.
5. Druk Info-Tech supplies spare parts of the computer. Mouse is one of the
items stocked. To show how the stores ledger records would appear under FIFO
and Weighted Average Method, the following data is used:
Date Balance, receipts and issues Units Cost per unit Total Cost
2015
July 1 Balance in hand 300 250 75000
July 18 Receipts 200 280 -
July 25 Issues 450 - -
You are required to complete the table below to show the total issue value and the
total inventory value according to FIFO and Weighted Average Method.
Date Description FIFO Method Weighted Average

(Nu.) Method (Nu.)
July 25 Total issue value ? ?
July 25 Total closing inventory value ? ?
What will be the effect on the gross profit if other things remain constant?
6. The stock of materials as on 1st July 2017 was 100 kg at Nu.2 each. The
following purchases and issues were made. Prepare the Store Ledger Account by
adopting Weighted Average Method.
i). If the loss is treated as normal loss
ii). If the loss is treated as abnormal loss
2017
July 5 Purchased 100 kg at Nu.2.20 each.
July10 Purchased 160 kg at Nu.2.40 each
July20 Purchased 180 kg at Nu.2.50 each
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July2 Issues 160 kg
July7 Issues 100 kg
July12 Issues 100 kg
July28 Issues 200 kg
On 22nd July, 2017 the stock verification revealed a shortage of 18 kg
7. From the information given prepare Stores Ledger for the month of July
2015 of Mr. Karma Limited using the Weighted Average Method when the
shortage is treated as abnormal loss.
Date Receipts and issues of materials Units
2015
July 8 Purchased @ Nu.25 per units 550
July 14 Purchased @ Nu.23 per units 700
July 24 Purchased @ Nu. 26 per units 350
July 28 Purchased @ Nu. 28 600
July 4 Issued 500
July 10 Issued 600
July 16 Issued 300
July 26 Issued 200
July 27 Issued 600
July 31 Issued 250
The opening balance on July 1st, 2015 is 1,000 units @Nu. 25 each. A shortage
of 25 units was noticed on 9th July, 2015.
8. The following is the record of receipts and issue of a certain materials in a
factory.
Date Receipts and issues of materials Units (kg)
2015
January 1 Purchase @ Nu.30 per kg 600
January 4 Purchases @ Nu.28 per kg 1,400
January 16 Purchases @ Nu.26 per kg 2,000
January 6 Issued 1,000
The stock on January 1st was 200 kg @ Nu. 32 per kg. On 26th January, stock
verification revealed a shortage of 500 kg which is treated as normal loss. Show
the Stores Ledger Account by adopting the Weighted Average Price Method.

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9. The stock of a material as on 1st July was 200 units at Rs.2 each. The
following purchases and issues were made subsequently. Prepare Sores Ledger
Account showing how the value of the issues would be recorded under
Weighted Average Method when the shortage is treated as abnormal loss.

July 6 Purchases @ Nu.2.20 each 100
July 11 Purchases @.2.40 each 150
July 18 Purchases @ Nu. 2.50 each 180
July 2 Issued 150
July 8 Issued 100
July 13 Issued 100
July 28 Issued 200
Physical verification on 21st July revealed a shortage of 10 units and 15 units
on 25th July, 2016.
10. From the receipt and issue of materials during the month of July, 2017,
prepare Store Ledger Account according to FIFO method.

January 1 Stock in hand @ Nu. 10 per unit 50
January 2 Purchased @ Nu.12 per unit 20
January 16 Purchased @ Nu.13 per unit 100
January 18 Returned to suppliers received on 12th January, 2017 10
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Chapter 11: Budgeting Process And Variance Analysis
Chapter 11
Budgeting Process and
Variance Analysis
• Explain the meaning of budgeting and master budget.

• Prepare operating budget and financial budget.
• Identify ethical issues in budgeting.
• Explain the meaning of standard cost and variance.
• Compute direct material variance, direct labour variance and manufacturing
overhead variance.
The success of business depends on its ability to visualize the future specifying the
desired goals and determining the amount of resources required for achieving those
goals. In the complex and competitive business environment, the survival and success
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of the business requires proper budgeting. Mangers should be able to predict the
factors affecting their business with reasonable precision along with problem solving,
organizational and monitoring skills required to meet the challenges business might
face with the change in future conditions. Managers should focus on the economy
and efficiency of the resources and should keep track on how these resources are
used. Moreover, manager should be in a position to fix the accountability of business
personnel involved in case of inefficient use of resources. Variance analysis is one
such tool which will assist managers in fulfilling the desired goals by controlling the
budgeted activities.
In this chapter, first part deals with the budgeting process and preparation of
the master budget while second part highlights the importance and application
of variance analysis, bringing together, the planning and control functions of
management.
11.1 Budgeting
The process of formalizing qualitative plans into quantitative format with proper
documentation is called budgeting. The end result of this process is a budget. The
organization prepares plan and arranges resources in line with the availability of the
budget.
The budget usually is prepared for a set time, most commonly one year with sub-
period budgets for each of the quarters or months. The budgeting process ultimately
results in preparation of master budget.
11.1.1 Types of budget

a) Master budget
A master budget is a comprehensive budget for a specific period consisting of many
interrelated operating and financial budgets. Operating budget involves preparation
of sales budget, production budget, direct materials budget, direct labour budget,
factory overhead budget and selling and distribution overhead budget. Financial
budget includes cash budget, budgeted income statement and statement of financial
position. The master budget begins with the preparation of sales budget.
Figure 11.1 shows the process of preparing master budget.
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OPERATING BUDGET
Direct Material
Production Budget
Budget
Sales Budget Direct Labour

(Foundation) Budget
Selling & Factory Overhead

Distribution Budget Budget
FINANCIAL BUDGET
Cash Budget
Budgeted Income Budgeted Statement of

Statement Financial Position
Figure 11.1 Preparation of master budget
b) Sales budget
A sales budget is regarded as the foundation of the entire budget. The starting point
in preparing a sales budget is sales forecasts, which requires detail information
about the market condition, preference of the consumers, past sales records and
competitor’s action and operating plans. A sales budget shows expected sales in
units at their expected selling prices.
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Illustration 1
Jigme Co. is a manufacturer of toys in Bhutan and is preparing budgets for the
quarter ending June 30. The following is the budgeted sales for the next five months:
April 20,000 toys
May 50,000 toys
June 30,000 toys
July 25,000 toys
August 15,000 toys
The selling price is Nu.10 per toy.
Solution:
Sales Budget
April May June Quarter
Budgeted Sales (Toys) 20,000 50,000 30,000 100,000
Selling Price Per Toy 10 10 10 10
Total Revenue 200,000 500,000 300,000 1,000,000
After preparing sales budget, the next step is to calculate the cash receipt budget.
Cash collection budget

It records the cash collected on account of sales. Illustration 2 explains the collection
pattern from the sale of toys from customers.
Illustration 2
On March 31, accounts receivable balance amounted to Nu.30,000 which will be
collected in full. Jigme Co. follows the following collection pattern for collecting
cash on account of sale;
70% collected in the month of sale,
25% collected in the month following sale,
5% is uncollected.
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Solution:
Cash Collection Budget

Total Revenue From Sales Budget 200,000 500,000 300,000 1,000,000
Accounts Receivable Balance 30,000 30,000
April Month Collection
70% of 200,000 140,000 140,000
25% of 200,000 50,000 50,000
May Month Collection
70% of 500,000 350,000 350,000
25% of 500,000 125,000 125,000
June Month Collection
70% of 300,000 210,000 210,000
Total Cash Collection 170,000 400,000 335,000 905,000
(Note: 5% is uncollected amount and does not require calculation. 25% of June
collection will be collected in the month of July)
c) Production budget
A firm prepares a production budget after determining the expected number of
units for sale. A production budget is a plan for acquiring the resources needed to
carry out the manufacturing operations to satisfy the expected sales, and maintain
the desired ending inventory. Production budget forms basis for calculating direct
materials budget, direct labour budget and factory overhead budget. Illustration 3
explains the preparation of production budget from budgeted sales in units.
Illustration 3
On March 31, there were 4,000 toys of inventory of finished goods. The management
of Jigme Co. wants ending inventory to be equal to 20% of the following month’s
budgeted sale of toys.
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Solution:
20% of May month's sale in Unit
Production Budget
Sales In Units (Toys) 20,000 50,000 30,000 100,000
Add: Desired Ending Inventory 10,000 6,000 5,000 5,000
Total Required Inventory 30,000 56,000 35,000 105,000
Less: Opening Inventory 4,000 10,000 6,000 4,000
Total Units To Be Produced 26,000 46,000 29,000 101,000
Practical Problem:
Jachung Co. is the manufacturer of biscuits located at Thimphu. The following is the
budgeted sales of the firm for the year 2018.
First quarter 70,000 units
Second quarter 90,000 units
Third quarter 120,000 units
Fourth quarter 110,200 units
The firm expects each unit to be sold for Nu.6. The management prefers to maintain
closing inventory of finished goods equal to 10 percent of next quarter’s sales. The
closing inventory of finished goods at the end of the fourth quarter is estimated to be
10,000 units. The opening inventory of finished goods of first quarter is 9,000 units.
All sales are on credit. The firm expects to collect 70% of sales in the quarter of sales
and the remaining in the quarter following the sale. Accounts receivable at the end
of 2017 amounted to Nu.200,000.
Prepare sales, production and cash collection budget.
d) Direct materials budget

The information in the production budget serves as basis for preparing several
manufacturing-related budgets. A direct materials budget shows the amount of
direct materials required for production and their budgeted cost.
A direct material purchases budget shows the amount of direct materials to be
purchased to meet production and ending-inventory of raw materials requirements.
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Illustration 4
On March 31, there were 13,000 Kgs. of raw materials. Jigme Co. requires 5 Kgs.
of material for a production of one toy. Management of Jigme Co. wants ending
inventory of raw materials of each month equal to 10% of the following month’s raw
materials. There is no opening and closing inventory of work in process. The cost of
the raw material is Nu.0.4 per Kg.
Solution:
Direct Materials Budget
Production In Units (Toys) 26,000 46,000 29,000 101,000
Required Raw Materials Per Toy 5 5 5 5
Total Required Raw Materials 130,000 230,000 145,000 505,000
Add: Desired Ending Inventory 23,000 14,500 11,500 11,500
Total Inventory Required 153,000 244,500 156,500 516,500
Less: Beginning Inventory 13,000 23,000 14,500 13,000
Raw Materials Required To Be 140,000 221,500 142,000 503,500
Purchased
Cost of Raw Materials Per Toy 0.4 0.4 0.4 0.4
Cost of Raw Materials to be purchased 56,000 88,600 56,800 201,400
July Production June Ending Inventory

Sales in units 25,000 July Production in Units 23,000
Add: Desired Ending Inventory 3,000 Required Raw Materials per toy 5
Total units required 28,000 Total Units Required 115,000
Less: Beginning Inventory 5,000 Inventory percentage 10%
Production Required 23,000 June Desired Ending Inventory 11,500
Direct material cost per unit = 5 kgs. of materials required per toy × Nu. 0.4 per toy
= Nu.2
Cash payment budget
It records cash paid on the account of total raw materials required to be purchased.
Illustration 5 will briefly discuss on cash payments towards raw materials acquisition.
Illustration 5
Jigme Co.’s accounts payable balance on March 31 is Nu.12,000. The management of
Jigme Co. decided to pay half of a month’s purchases in the month of purchase and
the other half in the following month. The cost of the raw material is Nu.0.4 per Kg.
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Solution:
Cash Payment Budget
Total Cost of Raw Materials 56,000 88,600 56,800 201,400
Accounts Payable Balance 12,000 12,000
April Month Payment
1/2 x 56,000 28,000 28,000
1/2 x 56,000 28,000 28,000
May Month Payment
1/2 x 88,6000 44,300 44,300
1/2 x 88,600 44,300 44,300
June Month Payment
1/2 x 56,800 28,400 28,400
Total Cash Payment 40,000 72,300 72,700 185,000
Note: Half of the cash payments for the month of June will be paid in the month of
July.
e) Direct labor budget

It records the total direct labour cost incurred in the production of units. Illustration
6 explains the calculation of total direct labour cost incurred in the production of
101,000 toys.
Illustration 6
The management of Jigme Co. calculated that each toy requires 0.1 hours of direct
labour. The workers have agreed to a wage rate of Nu.8 per hour.
Solution:
Direct Labour Budget
No. of Units (Toys) To Be Produced 26,000 46,000 29,000 101,000
Direct Labour Hours Per Unit (Toy) 0.1 0.1 0.1 0.1
Total Direct Labours Required 2,600 4,600 2,900 10,100
Wage Rate Per Hour 8 8 8 8
Total Direct Labour Cost 20,800 36,800 23,200 80,800
Direct Labour cost per unit = Direct Labour Hour x Wage Rate per Hour
= 0.1 x 8 = Nu. 0.8
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Practical Problem
Jachung Co. is now preparing the budget for direct materials and direct labor.
Each unit of product requires 2 Kgs. of direct materials per unit, and the cost of direct
materials is Nu. 1 per Kg. Management prefers to maintain closing inventory of raw
materials equal to 30 percent of next quarter’s materials needed in production. The
closing inventory of raw materials at the end of the fourth quarter is estimated to be
40,000 Kgs. The opening inventory of raw materials of first quarter is 36,000 Kgs.
Moreover, each unit of product requires 0.1 direct labor hours at a cost of Nu.10
per hour. All materials are purchased on credit. The company expects to pay 60%
of purchases in the quarter of purchase and remaining in the following quarter.
Accounts payable at the end of 2017 amounted to Nu.60,000.
Prepare direct materials, direct labour and cash payment budget.
f) Factory overhead budget

A factory overhead budget often includes all production costs other than direct
materials and direct labor. Unlike direct materials and direct labor, manufacturing
overhead costs include variable cost as well as fixed cost. The factor overhead expense
incurred by Jigme Co. is as follow:
Factory Overhead Budget
No. of Units (Toys) To Be Produced 26,000 46,000 29,000 101,000
Variable Overhead Costs
Indirect Materials 6,000 12,000 7,000 25,000
Indirect Labours 7,000 14,000 8,000 29,000
Other Indirect Expense 8,000 17,000 9,000 34,000
A) Total Variable Costs 21,000 43,000 24,000 88,000
Fixed Overhead Costs
Salaries 20,000 20,000 20,000 60,000
Rent 18,000 18,000 18,000 54,000
B) Total Fixed Costs 38,000 38,000 38,000 114,000
Cash Payments (A + B) 59,000 81,000 62,000 202,000
Factory Overhead cost per unit = Total Overhead Expenses / No. of units to be produced
= 202,000 / 101,000 = Nu. 2
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g) Selling and administration expense budget

Selling and general administrative expenses consist of all expenses incurred on
selling and distributing finished goods. Illustration 7 shows the calculation of selling
and distribution expenses incurred in selling 100,000 toys.
Illustration 7
The management of Jigme Co. has determined selling and distribution expenses @
Nu. 0.5 per toy sold.
Solution:
Selling and Distribution Overhead Budget
Sales in Units (Toys) 20,000 50,000 30,000 100,000
Selling Price per Unit (Toy) 0.5 0.5 0.5 0.5
Cash Payments 10,000 25,000 15,000 50,000
h) Financial budget
Once an operating budget is prepared, the currency values (ngultrum) of operating
budget is used in preparing financial budget consisting of cash budget and budgeted
income statement.
Practical Problem
The following is the manufacturing overhead expenses and selling and distribution
expenses of Jachung Co.
Variable Overhead Cots Selling & Distribution Expenses
Indirect Materials Nu. 0.2 per unit Advertising Nu. 20,000
Indirect Labour Nu. 0.1 per unit Depreciation Nu. 15,000
Other Expenses Nu. 0.3 per unit
Fixed Overhead Costs of Each Quarter
Salaries Nu. 30,000
Rent Nu. 25,000
Note:
• Selling and distribution expenses are fixed for all quarters.
• Depreciation does not result in outflow of cash, hence it is excluded from cash
budget.
Prepare manufacturing overhead and selling and distribution overhead budget.
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i) Cash budget
It shows all the planned cash inflows and outflows incurred on budgeted activities.
Since business cannot survive without cash, it is important to avoid unnecessary idle
cash or cash deficiencies. Illustration 8 explains how cash is used in production and
sale of toys.
Illustration 8
On April 1, Jigme Co. has a cash balance of Nu.100,000. The management plans to
pay dividend of Nu.25,000 in the month of April, and purchase equipment worth
Nu.143,700 in the month of May. The management further plans to buy equipment
worth Nu.48,300 in the month of June. All payments will be made in cash.
Solution:
Cash Budget
A) Cash Collection (illustration 2) 170,000 400,000 335,000 905,000
Less: Cash Payments
Raw Materials (illustration 5) (40,000) (72,300) (72,700) (185,000)
Direct Labour (illustration 6) (20,800) (36,800) (23,200) (80,800)
Factory Overhead Expenses Paid (59,000) (81,000) (62,000) (202,000)
Selling & Distribution Expenses Paid (10,000) (25,000) (15,000) (50,000)
Equipment Purchased (143,700) (48,300) (192,000)
Dividend Paid (25,000) (25,000)
B) Total Cash Payments (154,800) (358,800) (221,200) (734,800)
Cash Balance (A - B) 15,200 41,200 113,800 170,200
Beginning Cash Balance 100,000 115,200 156,400 100,000
Ending Cash Balance 115,200 156,400 270,200 270,200
Note:
• The beginning cash balance in the quarter is equal to April’s beginning cash
balance since April, May and June constitutes a quarter.
• The ending cash balance of quarter and June month should match.
Cost of goods sold

The final step is to calculate the cost of goods sold which requires per unit of cost of
goods sold. Per unit of cost of goods sold can be calculated as follow;
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Calculation of Cost of Goods Sold

Particulars April May June Quarter
Opening Inventory of raw materials (cost of raw 5,200 9,200 5,800 5,200
materials per toy x opening inventory)
Add: Purchases (Refer Direct Materials Budget) 56,000 88,600 56,800 201,400
Materials Available for Use 61,200 97,800 62,600 206,600
Less: Closing Inventory of raw materials (cost of raw 9,200 5,800 4,600 4,600
materials per toy x ending inventory)
Direct Material Used 52,000 92,000 58,000 202,000
Add: Direct Labour (Refer Direct Labour Budget) 20,800 36,800 23,200 80,800
Add: Factory Overhead (Refer Factory Overhead 59,000 81,000 62,000 202,000
Budget)
Total Manufacturing Cost 131,800 209,800 143,200 484,800
Add: Beginning Work in Progress - - - -
Less: Closing Work in Progress - - - -
Cost of Goods Manufactured 131,800 209,800 143,200 484,800
Add: Opening Inventory of Finished Goods (per unit 19,200 19,200 19,200 19,200
cost of goods manufactured * opening inventory)
Cost of Goods Available for Sale 151,000 229,000 162,400 504,000
Less: Closing Inventory of Finished Goods (per unit 48,000 48,000 48,000 48,000
cost of goods manufactured * Closing inventory)
Cost of Goods Sold 103,000 181,000 114,400 456,000
Note:
1. Opening and Closing Inventory of Raw materials figure is taken from Direct Materials Budget,
Pg: 279
2. Cost of Raw Materials per Toy is Nu. 0.4 per Kg. (Page: 279)
3. Opening and Closing Inventory of Work in Progress is 0 as mentioned in illustration 4, Pg: 279
4. Opening and Closing Inventory of finished goods units is taken from Production Budget, Pg:
278
5. Per unit cost of goods manufactured = Cost of Goods Manufactured / No. of Goods to be
produced = 484,800 / 101,000 = 4.8
6. Opening inventory of finished goods calculation for April month = 4.8 * 4,000 =
19,200
OR
Per Unit Cost of Goods Sold Calculation
Direct Materials Per Unit Cost (From Direct Material Budget) Nu. 2
Direct Labour Per Unit Cost (From Direct Labour Budget) Nu. 0.8
Factory Overhead Per Unit Cost (From Factory Overhead Budget) Nu. 2
Per Unit Cost of Goods Sold Nu. 4.8
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Cost of Goods Manufactured = 4.8*101,000 484,800

Add: Opening Inventory of Finished Goods (4.8 x 4,000) 19,200
Less: Closing Inventory of Finished Goods (4.8 x 10,000) (48,000)
Cost of Goods Sold 456,000
Budgeted income statement

The budgeted income statement estimates the net income from the budgeted
operations. Once the budgeted income statement has been approved, it becomes the
benchmark against which the performance of the period is evaluated.
Jigme Co.
Budgeted Income Statement
For the Three Months Ended June
Revenue from Sales (100,000 x 10) 1,000,000
Cost of Goods Sold 480,000
Gross Profit 520,000
Operating Expenses:
Selling and Administration Expenses 50,000
Net Profit 470,000
Practical Problem
Jachung Co. plans to purchase equipment worth Nu. 50,000 at the end of the fourth
quarter. The cash balance on 2017 amounted to Nu.100,000.
Prepare cash budget to determine the ending balance of cash at the end of fourth
quarter 2018 and budgeted income statement for the year ending 2018.
Ethical issues in budgeting

The ethical and behavioral factors need to be taken into consideration especially
when deciding what is best for individuals and what is best for the business
organization. Most often, people tend to believe that it is smarter to guarantee
less and deliver more, than to guarantee more and deliver less. In addition, most
managers believe that their future budgets will be reduced if they do not use-up all
the budget amounts, so they resort to unethical practices to consume the leftover
budget by indulging into undesired practices. Conflict of interest is another area
which often leads to misallocation of resources such as procurement of inferior
goods if the manager has a good relationship with the suppliers. Therefore, it is
important for an organization to maintain a proper code of ethics in place to avoid
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any unethical issues in budgeting. Unethical practices have a negative impact on the
organisation.
11.2 Standard Cost and Variance Analysis

The master budget is an example of static budget prepared for only one level of
activity (based on sales level as discussed in the first part section of the chapter).
This type of budget may be good for planning phase but are not appropriate for
controlling phase. Business organisations generally use flexible budget which are
based on the actual level of activity. Suppose, if the budgeted sales is Nu.100,000 and
the actual sales is Nu.105,000, the flexible budget will be based on the actual sales
of Nu.105,000. For this chapter preparation of flexible budget will not be discussed
further, however, the concept of standard cost will be discussed.
11.2.1 Standard cost

Standard cost is the cost incurred under normal operating conditions. They are
usually associated with a manufacturing company’s cost of direct material, direct
labour and factory overhead. For example, Bank of Bhutan has a standard time to
resolve complaints made by clients with regard to ATM.
Accounting systems that use standards for product costs are called standard cost
systems. Standard cost systems enable management to determine how much a
product should cost (standard cost) and how much it does cost (actual cost). The
difference between the actual cost and the standard cost are known as standard cost
variance.
11.2.2 Standard cost variance

It is the difference between the actual cost and the standard cost. When actual
results are better than expected results, the variance is known as favourable variance
denoted by the letter ‘F’. When actual results are worse than expected results, the
variance is known as unfavourable variance denoted by the letter ‘U’. The standard
cost variance consists of price variance and efficiency variance.
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Standard Cost Variance
Price Variance Efficiency Variance

The difference between the The difference between the
actual price and the standard actual quantity and the standard
price. quantity.
In order to calculate variance, the following general model for variance analysis can
be adopted:
Actual Quantity Actual Quantity Standard Quantity

x x x
Actual Price Standard Price Standard Price
Price or Rate Usage or Efficiency

Variance Variance
AQ (AP – SP) SP (AQ – SQ)
Standard price is the amount that should have been paid for the resources acquired.
Standard quantity is the quantity allowed for the actual output of good.
The business can adopt various variance analysis techniques to control and evaluate
performance of business and employees. Some of the techniques will be discussed
further as follow:
a) Direct material variance analysis

It is the difference between the standard cost of materials resulting from production
activities and the actual costs incurred. The direct material variance constitutes:
i) material price variance – difference between the actual price paid for the
material and the standard price of the material allocated, and
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ii) material usage variance – difference between the actual quantity of material
used and the standard quantity of the material allocated.
Illustration 9
Jigme Co. has the following direct material standard to manufacture one block of
butter:
1.5 kg per block of butter at Nu.4 per kg.
Last month 1,700 kg of material were purchased and used to make 1,000 blocks of
butter. The material cost a total of Nu.6,630.
Standard Quantity = (Actual unit produced x Standard quantity per unit)

Actual Price = (Actual total cost / Actual quantity)
Solution:
Given that;
Actual Price (AP) = Nu. 6,630 / 1,700 kg = 3.9 per Kg
Standard Price (SP) = Nu. 4 per Kg
Actual Quantity (AQ) = 1,700 Kg
Standard Quantity (SQ) = 1,000 x 1.5 = 1,500 Kg.
Material Price Variance = AQ (AP – SP)

= 1,700 (3.9 – 4)
= Nu. 170 (Favourable)
Material Usage Variance = SP (AQ – SQ)

= 4 (1,700 – 1,500)
= Nu. 800 (Unfavourable)
Actual Quantity Actual Quantity Standard Quantity
x x x
Actual Price Standard Price Standard Price
1,700 Kgs. 1,700 Kgs. 1,500 Kgs.
x x x
Nu.3.9 per Kg. Nu.4 per Kg. Nu.4 per Kg.
Nu.6,630 Nu.6,800 Nu.6,000
Price Variance Usage Variance

Nu. 170 Favourable Nu. 800 Favourable
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Price variance is favourable since the actual price is less than the standard price
indicating that the business has saved Nu.170 in purchasing materials for the
production of butter.
Usage variance is unfavourable since the amount of actual materials used is greater
than the standard materials. The business has incurred extra cost of Nu.800 by using
more amount of materials than expected. This indicates inefficiency of the material
usage.
Relationship between material price and usage variance
The purchase of cheaper raw materials in order to obtain a favourable price variance
might perhaps lead to unfavourable usage variance since the quality of material is
compromised. On the other hand, the purchase of expensive raw materials having
longer service life may result in unfavourable price variance but favourable usage
variance.
b) Labour variance analysis
It is the difference between the standard cost of labour resulting from production
activities and the actual costs incurred. The direct labour variance constitutes:
i) labour rate variance – the difference between the actual wage rate paid for
the labour and the standard wage rate of the labour allocated, and
ii) labour efficiency variance – the difference between the actual hour of
labour used and the standard hour of the labour allocated.
Illustration 10
Jigme Co. has the following direct labor standard to manufacture one block of butter:
1.5 standard hours per block at Nu.12 per direct labour hour.
Last month 1,550 direct labour hours were worked at a total labor cost of Nu.18,910
to make 1,000 blocks.
Standard Quantity = (Actual unit produced x Standard hour per unit)
Solution:
Given that;
Actual Rate (AR) = Nu. 18,910 / 1,550 = Nu. 12.2 per hour
Standard Rate (SR) = Nu. 12 per hour
Actual hours (AH) = 1,550 hours
Standard hours (SH) = 1,000 x 1.5 = 1,500 hours.
Labour Rate Variance = AH (AR – SR)

= 1,550 (12.2 – 12)
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Labour efficiency
Variance = SR (AH – SH)
= 12 (1,550 – 1,500)
Actual Hour Actual Hour Standard Hour
x x x
Actual Rate Standard Rate Standard Rate
1,550 hours 1,550 hours 1,500 hours
x x x
Nu.12.2 per hr. Nu.12 per hr. Nu.12 per hr.
Nu.18,910 Nu.18,600 Nu.18,000
Rate Variance Efficiency Variance

Nu. 310 Nu. 600
Unfavourable Unfavourable
Rate variance is unfavourable since the actual rate is higher than the standard rate
indicating that the business have spent excess amount of Nu. 310 in employing
labour for the production of butter.
Efficiency variance is unfavourable since the amount of actual hour used is greater
than the standard hour. The business has incurred extra cost of Nu.600 by using
more direct labour hours than expected. This indicates inefficiency of the labour
usage.
Relationship between labour rate and efficiency

If workers in a firm are paid higher rates for experience and skills, the labour rate
variance will be unfavourable but since the workers possess experience and skills,
the efficiency of the labour will increase resulting into favourable labour efficiency
variance. In contrast, favourable labour rate variance might indicate a larger portion
of inexperienced workers in the firm, which could result in an unfavourable labour
efficiency variance.
c) 2.3 Variable manufacturing overhead variance analysis
The variable manufacturing overhead variance analysis involves two separate
variances.
i) Variable overhead spending variance – difference between actual costs for
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variable overhead incurred and standard costs for variable overhead allotted.
ii) Variable overhead efficiency variance – difference between the actual
direct labour hours worked and standard direct labour work allotted.
Illustration 11
Jigme Co. applies variable factory overhead on the basis of direct labour hours
(DLHs) and has the following variable factory overhead standard to manufacture
one unit of butter:
1.5 standard DLHs per unit @ a variable overhead rate of Nu.3.00 per DLH.
Last month, 1,550 hours were worked to make 1,000 units of butter, and Nu. 5,115
were spent for variable factory overhead.
Standard Hours = (Actual unit produced x Standard hour per unit)
Actual rate = (Actual total cost / Actual hours)
Solution:
Given that:
Actual Rate (AR) = Nu. 5,115 / 1,550 = Nu. 3.3 per hour
Standard Rate (SR) = Nu. 3 per DLH
Actual hours (AH) = 1,550 hours
Standard hours (SH) = 1,000 x 1.5 = 1,500 hours.
Variable overhead
spending variance = AH (AR – SR)
= 1,550 (3.3 – 3)
Variable overhead
efficiency Variance = SR (AH – SH)
= 3 (1,550 – 1,500)
Actual Hour Actual Hour Standard Hour
x x x
Actual Rate Standard Rate Standard Rate
1,550 hours 1,550 hours 1,500 hours
x x x
Nu.3.3 per hr. Nu.3 per hr. Nu.3 per hr.
Nu.5,115 Nu.4,615 Nu.4,500
Spending Variance Efficiency Variance

Nu. 465 Nu. 150
Unfavourable Unfavourable
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Rate variance is unfavourable since the actual rate is higher than the standard rate
indicating that the business have spent excess amount of Nu. 465 in employing
labour for the production of butter.
Efficiency variance is unfavourable since the amount of actual hour used is greater
than the standard hour. The business has incurred extra cost of Nu.150 by using
more labour hours than expected. This indicates inefficiency of the material usage.
Practical Problem
Lhazon Co. is the manufacturer of chair in Paro. During the year 2017, 1,000 chairs
were produced. The following is the information relating to cost standard developed
by management and actual expenditure incurred.
Direct Materials Direct Labour
The direct material standard to The direct labour standard to
manufacture one chair is 2 kg per chair manufacture one chair is 2 hours per
at Nu.5 per kg. chair at Nu.10 per direct labour hour.
1,250 kg of material were purchased 1,600 direct labours were worked
incurring a cost of Nu. 5,000 incurring a cost of Nu. 17,600.
Factory Overhead
The management calculated variable factory overhead on the basis of direct labour
hours. The direct labour hour standard to manufacture one chair is 2.5 hours per
chair at a variable overhead rate of Nu.10 per direct labour hour.
2,500 hours were worked incurring a variable factory overhead expense of Nu.
5,000.
Calculate the direct material, direct labour and factory overhead variance.
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Exercises:
Choose the correct answer from the following

1. Karma Co. is the manufacturer of bread product. Each bread requires 3 kg of
raw material at the cost of Nu. 2 per kg and 4 direct labour hours at the cost of
Nu.7 per hour.
The production budget for bread for April to June is as follows.
April May June
Production bread (nos.) 7,800 8,400 8,200
On March 31, there was a 3,000 kg of inventory of raw materials. The management
of Karma Co. wants ending inventory of raw materials of each month equal to 10%
of the following month’s raw materials. The ending inventory of raw materials for
June is 3,900 kg.
a. Material purchases amount are paid for in the following month purchase. The
amount to be included in the cash budget for June in respect of payments for
purchases is:
A Nu.25,140
B Nu.52,080
C Nu.50,280
D Nu.26,040
b. Wages are paid 75% in the month of production and 25% in the following
month. The amount to be included in the cash budget for May in respect of
wages is:
A Nu.222,600
B Nu.231,000
C Nu.233,800
D Nu.235,200
2. Tashi Co. is the manufacturer of mineral water. The management derived the
standard direct material to be 2.3 litres at Nu. 2 per litre.
In the month of May, 1,800 bottles of mineral water was produced and 4,000
litres were used at a cost of Nu. 10,000.
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The direct material price and usage variances for May month are:
Material price Material usage
Nu.2,000 (F) Nu.280 (F)
Nu.2,000 (U) Nu.280 (F)
Nu.2,000 (F) Nu.280 (U)
Nu.2,000 (U) Nu.800 (U)
3. During the year, 12,000 labour hours were worked at a standard cost of Nu. 6
per hour. The labour efficiency variance was Nu. 9,000 (favourable). How many
standard hours were produced?
A 12,000
B 16,300
C 10,500
D 13,500
4. During the year, 250 labour hours were worked for a total cost of Nu. 3,500. The
variable overhead expenditure variance was Nu.125 (Unfavourable). What was
the standard rate per labour hour?
A 12.5
B 13.5
C 14.5
D 15.5
Case Study1
Tshokey Co. produces furniture that are sold throughout Bhutan. The management
has a plan to develop direct materials standard to complete production of one unit
of furniture. Assuming that you are a production manager, and you receive an
incentive for favourable material usage variance. The management has asked your
help in developing the standard number of materials required to complete one unit
of furniture.
Required:
i) Describe the ethical conflict that you will encounter being a production
manager in developing standard number of materials.
ii) What measures can Tshokey Co. adopt in order to avoid this conflict?
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Case Study 2
The management of Gongdo Co. has a policy of awarding bonus to the department
heads based on the budgetary performance of the firm. The company has a usual
trend of giving bonus on any excess profit made above the budgeted profit. Dawa as a
sales department head in anticipation of getting more bonus decided to overestimate
expenses and underestimate revenue while designing budget plan. At the year end,
the actual profit was 150% higher than the budgeted profit.
Required:
i) What ethical issues do you see in the case of Dawa?
ii) How would such behavior of Dawa impact firm?
iii) How would the firm address the unethical practices mentioned in the case?
Case Study 3
Om works as a manager in one of the firms in Gedu. Recently, Om has furnished
the following information on material and labour variance analysis for product ‘A’
and Product ‘B’.
Product ‘A’ Product ‘B’
Material Price Variance Favourable Unfavourable
Material Usage Variance Unfavourable Favourable
Labour Rate Variance Favourable Unfavourable
Labour Efficiency Variance Unfavourable Favourable
Required:
What could be some of the possible reasons for favourable and unfavourable
variances in case of Product ‘A’ and Product ‘B’?
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Chapter 12
Application of Spreadsheet in
Accounting
• Apply ms excel in preparation of books of accounts.

• Use functions and formulae to calculate all accounting data.
• Interpret accounting data and generate graphical reports.
• Deliberate on the importance of ms excel in accounting.
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Chapter 12: Application of Spreadsheet in Accounting
There are many accounting software in the market such as Quick Book, Tally, PEMS
etc., which can auto-generate financial statements. Similarly, spreadsheet (MS Excel)
is known for its vast application in accounting. User can prepare different books
of accounts in MS Excel. The chapter deals with preparation of various books of
accounts such as trial balance, statement of income, statement of changes in equity,
statement of cash flows etc. in a single workbook in MS Excel using its functions and
referencing.
Figure 9.1 Process of preparing books of accounts in MS Excel
12.1 Steps in preparing Books of Accounts using MS Excel

Create a workbook in MS Excel and name it as “Books_Accounts”. In this workbook,
create multiple work sheets and label them as Chart of Account, Adjusted Trial
Balance, Notes, Statement of Comprehensive Income, Statement of Change in
Equity, Statement of Cash Flow, Statement of Financial Position and Ratio.
The first sheet, chart of account, contains codes given to every account head. For
example, PP&E is coded 100 and any items under the block PP&E must be coded
within the range of 100 – 199. Similarly, code 200 will be assigned to equity while 300
is coded as liabilities. This is to ease locating errors and finding required information
using account head number or code besides other benefits.
From the given unadjusted trial balance and additional information, prepare adjusted
trial balance in the second sheet by using excel functions. Adjusted trial balance
prepared should be free of errors as it forms the basis for preparing all other books
of accounts.
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Account Title Account No. Balance The figures in the

Property, Plant And Equipment 100 Dr financial statements
Land And Buildings 100.1 Dr are supported by notes
Machinery And Equipment 100.2 Dr
(working) from adjusted
trial balance for better
Vehicles 100.3 Dr
understanding. It can
Intangible Assets 101 Dr
be preapred with the
Goodwill 101.1 Dr
use of functions and
Financial Assets 102 Dr
cell/sheet referencing
Investments And Financial Instruments 102.1 Dr to the respective
Inventories 103 Dr financial statements in
Receivables 104 Dr worsksheet. Statement of
Cash And Cash Equivalents 105 Dr Comprehensive Income,
Equity 200 (Cr) Statement of Change
Issued Capital 201 (Cr) in Equity, Statement of
Retained Earnings 202 (Cr) Cash Flow, Statement of
Profit 202.1 (Cr) Financial Position and
Reserve Fund 202.2 (Cr) Ratio is then prepared.
Capital Reserve 202.3 (Cr) Learning Activity 1 will
Liabilities 300 (Cr) explain the preparation
Borrowings 301 (Cr) of financial statements
Provisions 302 (Cr)
using MS Excel
functions.
Trade And Other Payables 303 (Cr)
Tax Liabilities 304 (Cr)
Revenue 400 (Cr)
Expenses 500 Dr
other incomes 600 Dr
Illustration 1
From the following details, prepare adjusted trial balance, statement of income and
statement of financial position.
Code Particulars Nu. Code Particulars Nu.
200 Share capital 80,000 601.2 Bank Interest 850
110 Inventory on 1.1. 2019 51,000 602.1 Bad Debts 2500
110.1 Purchases 220,000 100.1 Buildings 95,000
400 Sales 330,000 100.2 Plant and Machinery 98,000
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401.2 Returns 3800 602.1 Sundry Debtors 45,000

602 General Expenses 1800 300.2 Creditors 55,500
501.3 Wages 12,000 300.2 Loan 25,000
501.2 Salaries 18,700 112 Cash 1400
602 Traveling expenses 3200 300.4 Reserve Fund 23,000
502.2 Advertisement 1550 602.1 Preliminary Expenses 11,000
600 Rent and taxes 4900 204.1 Profit and Loss
55000
601 Discount Received 2200 Account (Cr.)
Adjustments:
Transfer Nu. 10,000 to Reserve Fund. Provide depreciation on building at 5%.
Inventory on 31.12.2017 was valued at Nu. 12,000, Dividend at 15% on share capital
is to be provided. Depreciation on Plant and Machinery at 10%.
Solution.
a) Trial balance total error
The MS Excel functions can be used to

ascertain the arithmetic accuracy of the
trail balance. It can be done using the
function:
Figure 9.4 wrong Trial balance total
=IF(SUM(Debit)=SUM(credit),SUM(Debit),”Rectify Errors”). This means the

total of debit column should be equal to total of credit column. If debit and credit
balance disagree, the message “Rectify Errors” will be displayed.
b) Statement of income
The Statement of income presented here is prepared using cell references from the
adjusted trial balance. ‘Function of expense’, one of the two methods of preparing
statement of income using MS Excel is shown in fig.9.5.
In financial reports, the sub calculations are shown in notes and only the major items or
events are displayed in the financial statements.
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Statement of Income
For the year ended 31 Dec, 2017
Particulars Notes December December
31, 2016 31, 2017
Revenue 1 296000 326200
Cost of goods sold 2 256600 271000
Gross profit 39400 55200
Other Income 3 1,000 2200
Distribution cost 4 -2,500 -4,750
Administrative expense 5 -18,000 -23,600
Finance Cost 7 -250 -850
Other expenses 6 -1,000 -4,300
Depreciation and amortisation 8 -14,550 -14,550
expense
Profit before tax 4100 9350
Note 1 Revenue
sales return
330,000 3,800
Revenue 326,200
c) Preparation of Statement of Financial Position
Statement of Financial Position is cell referenced to adjusted trial balance, notes
and statement of income presented in other worksheets.
Note 2017 2016
Assets
Non-Current Assets
Property, Plant & Equipment 8 178,450 185,350
Current Assets
Trade Receivables 45,000 36,250
Preliminary Expenses 11,000 12,000
Total Assets 247,850 59,250
Figure 9.6 Extract of Statement of Position
Accumulated Dep
Note 8 Assets
depreciation %
Plant and
machinery 9800 10% 98000
Buildings 4750 5% 95000
Total 14550
Net PPE value 178450
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d) Generation of Reports
MS Excel allows the user to easily auto generate all types of reports based on the
data/figures supplied by different financial statements. It can be customised based
on the need of the users.
Practical Problem
Table shows current ratios of Karma & Co. and Tashi & Co. for the past six years. Present
the information in the form of a suitable graph using MS Excel and interpret it.
2013 2014 2015 2016 2017 2018
Karma & Co. 0.75 0.88 0.93 0.97 0.99 1
Tashi & Co. 1.25 1.17 1.35 1.05 1.02 1
Diagrammatic representation of process of preparing financial reports using MS

Excel
Statements of
Accounts
(Income, Position,
Equity, Cash flows
etc.)
Generate Ratio
Generate graphs
Notes
Calculate percentages
etc.
Chart of
Account
Adjusted Trial
Balance
Figure 9.7 Financial report in MS Excel
The advantage of using MS Excel in the preparation of books of accounts is that,

all financial statements and reports can be interlinked among different worksheets,
such that, if a figure is changed in trial balance, it gets automatically updated in all
other statements and reports.
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12.2 Payroll
This unit deals with the preparation of payroll using MS Excel by lookup function.
A unique identity number is assigned (EID in Figure 9.9) to every employee to
generate required information pertaining to him/her.
Figure 9.9 shows a table

of employees’ details. One
need to fill out a simplified
payslip form by pulling
the information from this
table when an employee’s
ID is selected.
The user will select an
employee ID from a data
Figure 9.9 Employee details (Sheet 1) validation list in cell C3
(Fig.9.10). EID is used to extract the employee’s name, address, and other information
into the payslip from the employee details (sheet 1).
The formulae for the payslip form in Figure 9.10 are shown here:
Name: =LOOKUP(C3,EID,EMPName).
Designation=LOOKUP(C3,EID,Designation)
Experience=LOOKUP(C3,EID,Experience)Category
=LOOKUP(C3,EID,Category)
Basic pay =LOOKUP(C3,EID,Basic_Pay)
Grade =LOOKUP(C3,EID,Grade)
Profession=LOOKUP(C3,EID,Proffession)
Net pay or take home pay=Gross_pay-Grand_Deduction
LOOKUP takes these three

arguments:
Lookup value: The value you
want to find
Lookup vector: The single
column or single row to look in
Results vector: The single
column or single row to return
Figure 9.10 Simplified individual pay slip from
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There are applications of other

formulae. The most used in this
sample is IF function.
It is assumed that out of different
workers in a school, only teachers
are entitled for teaching
allowance. Teaching allowance is
Figure 9.11 Calculation of teaching allowance
based on the number of years of
experience as shown in Table 9.1.
Table 9.1 Teaching allowance entitlements

Teaching
More than 20 years 10 – 19 years 5-9 years Less than 5 years
Experience
% of Basic Pay 30% 20% 15% 10%
All calculations are based on basic pay. The condition or the logical test, a computer
has to consider it to decide if an employee is Teacher or not. If an employee is not
teacher, the computer simply has to display ‘0’ amount as teaching allowance.
Otherwise, it has to calculate different teaching allowance. The formula is explained
here:
Teaching allowance
IF(E4<>"Teaching",0, IF(C6>20,30%*B9,IF(C6>10,20%*B9,IF(C6>5,15%*B9,
IF(C6<5,10%*B9,0)))))
E4 is cell where profession is displayed, C6 is cell where years of experience are

displayed, B9 is cell where basic pay is displayed.
First logical test is done for profession, because if the profession is not “Teaching”,
the computer need not do any calculation. Instead, give ‘0’ directly. If profession is
“Teaching”, then proceed further with more logical test using IF function. Formula
indicates that if the teacher is having more than 20 years of experience, multiply 30%
with Basic pay and similarly for different numbers of years of experience.
Other Allowances are also calculated using IF function and the conditions of the
organization. The Deductions are also calculated using IF function by evaluating the
conditions of the organisation.
The Gross pay is sum of all the allowances, and net pay or take-home pay, is
calculated by deducting all deduction from the gross pay. Common deduction
includes Provident Fund, Tax Deducted at Source and Group Insurance scheme in
Bhutan. Other deductions differ from one organisation to another.
The advantage of using MS Excel function is that an organisation can easily determine
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remuneration payable to employees including gross pay, deductions, net pay, etc.
They can also know the type and number of employees in their organisation.
Exercises:
1. Case study
Gang Chu Pvt. Ltd. employs many Bhutanese workers. As a reward, the government
has provided a qualified accountant for maintaining their payroll.
The company has 2 managers, 3 supervisors, 4 engineers, 30 regular workers and 20
workers on contract. The basic pay for manager is Nu.48,550, engineer Nu.52,350,
supervisor and worker Nu.23,990 each. Contract workers are entitled to contract
allowance of 30% of basic pay. Employees occupying company’s quarter are not
entitled to get house rent allowance but others will get 25% of basic pay. Mangers
are not entitled to get 10% of basic pay as risk allowance. Company deposits 11%
of gross pay of all the employees except contract employees to Provident Fund
Accounts.
The company has also opened a Group Insurance Scheme with RICB to cover
up the risk of death during the tenure of the employees in the company. For this,
managers contribute Nu.500, Engineers contribute Nu.400 and others Nu. 300
every month as premium deductible from the pay. Company deducts 5% of gross
pay as Tax deducted at source. Employee’s relationship is very good and everyone
works as if they are of the same family. Company decided to open a welfare
scheme for themselves and decided to allow accountant to deduct Nu. 500 every
month and deposit in bank. This money is to be used only in the event of death of
employees, employee’s parents, spouse, children and immediate dependents.
Assume yourself as the accountant deputed by the government and prepare
comprehensive payroll for the company.
Hint: At least record details of one each from each level or category of employees.
2. The following you are required to prepare Cost Sheet for the period ended on
31st Dec. 2017 in MS excel.
Consumable material: Nu.
Opening inventory 20,000
Purchases 1, 22,000
Closing inventory 10,000
Direct wages 36,000
Direct Expenses 24,000
Factory overheads 50 % of direct wages
Office and administration overheads 20% of works cost
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Selling and distribution expenses Nu.3 per unit sold

Units of finished goods:
In hand at the beginning of the period (Value Nu. 12500) 500 units
Units produced during the period 12,000
In hand at the end of the period 1,500
Find out the selling price per unit if 20% is the profit on selling price. There is
no works-in-progress either at the beginning or at the end of the period.
3. Prepare cost sheet from the following information.

Cost Sheet for the period ended on 31st Dec. 2017(output 12000units)
Number of units produced: 12000
Particulars Total Cost Cost/unit
Cost of raw materials consumed 132,000 11

Direct wages 36,000 3
Direct expenses 24,000 2
Prime Cost 192,000 16
Factory Overheads 18,000
Works/ factory overheads 210,000 17.5
Office overheads 20% of work cost 42,000 3.5
Total cost of production 252,000 21
Add: Opening inventory of finished goods (500 units @25) 12,500
Cost of goods available for sale (12000+500) 264,500 21.16
Less: Closing inventory of finished goods @ 21 per unit (1500) 31,500
Cost of goods sold (12500-1500=11000 units) 233,000 21.18
Add : Selling & Distribution overheads @ per unit 33,000 3
Cost of Sales 266,000 24.18
Add Profit 20% on selling price (i.e. 25% of cost of sales) 66,500 6.05
Sales (266000*25/100) 332,500 30.23
The selling price per unit is Nu. 30.23.
4. From the following information, prepare cost sheet and find cost per unit.
Direct material Nu. 1, 60,000
Direct Labour Nu. 45,000
Direct Expenses Nu. 15,000
Factory overheads Nu. 35,000
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Office and administration overheads 20% of works cost

Selling and distribution overheads Nu. 45,000
Opening stock of finished goods Nu. 25,000
Closing stock of finished goods Nu.10, 000
Profit on Sales 10%
5. Case Study
Gangri Pvt. Ltd. has been in the business for few years and they have not prepared
any cost sheet until date. You got the job as an accountant in this firm, and manger
asked you to prepare cost sheet and report to him on the next day. You got the
following details:
The company has leftover raw materials of previous year at Nu.12,500 and
procurement officer has purchased new raw material for this year worth Nu.136,000.
Labour worth Nu. 54,000 is been hired for the production and incurred another
Nu.12,000 as direct expenses. Factory cost is 100% of direct wages. Office and
Administration works expenses were 20% of the work cost. The company produced
50,000 units of half-litre bottles of mineral water. They have sold it at Nu.10 per half-
litre bottle, which is also an existing market price. They have closing finished goods
worth Nu 15,000 this year and they had opening finished goods in the beginning of
the year worth Nu. 12,000. The raw material left is Nu.8,500 for current year.
Required: (cost sheet and calculations must be presented in different worksheet)
a. What was the profit per unit at cost until date?
b. How will you make profit of Nu.5 per unit from next production?
c. Which head consumed the major chunk of cash?
Skills to be developed at the end of the chapter;
1. Naming the cell or range of cell
2. Data validation
1. 3. Using IF, And, OR etc. Functions
4. Using Lookup function
Students can explore the use of:
5. ISTEXT function
6. Vlookup function
7. Trim, countif
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Bibliography
1. Anthony, R. (2010). Accounting Texts and Cases. MacGraw-Hill
2. Benedict, A. and Elliott, B. (2016). Financial Accounting: An Introduction. FT
Prentice Hall
3. Alexander, D. and Nobes, C. (2016). Financial Accounting: An International
Introduction. Trans-Atlantic Publication
4. Deegan, C. (2006). Australian Financial Accounting. McGraw-Hill
5. Horgren, C.T., Sundem, G.L., Elliott, J.A. ad Philbrick, D.R.(2017). Introduction to
Financial Accounting. Perason Education
6. ACCA (2017). Financial Reporting (international). BPP Publication
7. IFRS Foundation (2018). Conceptual Framework for Financial Reporting. https://
www.ifrs.org/
8. Weygandt, J.J, Kieso, D.E. and Kimmel, P.D (2017). Financial Accounting. Wiley
and Sons
9. AASBB (2015). Bhutanese Accounting Standards. Kuensel Corporation
10. National Council (2007). The Civil Society Organisations Act of Bhutan 2007.
National Council of Bhutan. Retrieved from http://www.nationalcouncil.bt/assets/
uploads/docs/acts/2014/Civil_Society_Act,_2007Eng.pdf
11. Australia, PWC. (2017). Accounting for Public Sector Entities, Higher Education &
Charities. Retrieved from https://www.pwc.com.au/ifrs/not-for-profits.html
12. Ministry of Finance (2001). Financial Rules and Regulations, Royal Government of
Bhutan
13. Ministry of Finance (2016). Financial Management Manual, Royal Government of
Bhutan.
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312
Assessment
Accountancy Assessment Matrix
Continuous Formative Assessment (CFA) Continuous Summative Assessment (CFA) Summative Assessment (SA)
It is a continuous process of assessing learner’s problems and It is a continuous process of grading learner’s Assesses learner’s cumulative
learning needs; provide feedbacks and to identify the needs performances and achievements. Based on their performances and
for the remedial measures to improve learner’s learning. It performance, teachers provide feedbacks for achievements at the end of
also enables teachers to understand what teaching methods improvement. It also enables teachers to understand each term.
Definition
and materials work best. what teaching methods and materials work best.
Content Application of Accounting Values Content Application of Accounting CK, AC & CK, AC &
knowledge (CK) Concepts(AC) and Attitudes knowledge Concepts(AC) Values and AVA AVA
(Cognitive) (Psychomotor) (AVA) (CK) (Psychomotor) Attitudes (AVA)
(Affective) (Cognitive) (Affective)
Domains
Quiz & debate, Immediate Observation of Home work Project Work Accountancy Term exam Term exam
self & peer interaction with learner’s conduct, – twice in OR case study. Practical
assessment, class learner’s, class team work, each term,
presentation, work, home work, field trip, and class test-
homework, class experiments, excursion, twice in each
work, immediate exhibition, self & peer term.
interaction case studies, assessment
with learner’s, observation, use ,immediate
concept(mind) of ICT in problem interaction with
Techniques
mapping. solving. learners.
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Q&A, rubrics, Checklist and Checklist, Q&A, Rubrics Rubrics Rubrics Paper pencil Paper pencil
checklist and anecdotal records. rubrics and (HW) and test with: test with:
anecdotal anecdotal records. Q&A. MCQ, Fill in MCQ, Fill in
records. the blanks, the blanks,
Matching, Matching,
True or True or False,
False, Short answer
Short answer questions
questions and extended
and extended response
response questions.
Assessment Tools
questions.
Check lists and anecdotal records must be maintained for Home Work Project Work or Accountancy Once in a Once in a
each topic throughout the academic year. and class Case study- once Practical term. year.
test - twice in in a year Twice in a Term
Frequency
each term
T1= 2.5 T1= 2.5 T1= 10 T1=35% T2=35%
T2= 2.5 T2= 2.5 T2= 10
Weighting %

1. Same mode of assessment will be followed in Mid Term and Trail Examination for class 12.
2. Marks for Project Work and Accountancy Practical will be assessed as part of Internal Assessment.
3. The term examination must be conducted out of 100 marks [Section A: MCQ(20×1), Fill in the blanks (5x1), Matching (5x1), True/False(5×1),
N.B
,SAQ(15)], [PART II: EAQ(6×10) answer any 5 questions out of 6 questions]
Assessment
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16.1 Assessment Tools and Techniques
The following section describes the suggestive techniques and tools that are to be
used to assess learner’s performance and achievement.
16.1.1 Homework
Assessment Tools: Checklists/Questions/Rubrics
Example 1(Check list):
Topic: Preparation of ‘Double Column Cash Book
Tick (√) or (X) whichever is appropriate in the relevant columns.

Key area/ Learner Learner Amounts Calculates Balancing Score (by
Name of knows post the are entered the total entries are total tick
students the exact entries without of amount recorded i.e √)
format to the making columns correctly
debit and mistakes correctly
credit side
correctly
Sonam
Dorji
Note: Based on the assessment, the teacher is expected to give feedback only, if
formative assessment is conducted.
Example 2 (Check list):
Topic: Posting transactions in the journal using the golden rule.
Tick (√) or (X) whichever is appropriate in the relevant columns.
Key area/ Draw the Applied Posted Recorded the
Name of journal format the rules accounts transactions in
students correctly of journal correctly chronological
correctly order
Karma Dema
Pema Yangzom
Example 3 (Questions):
Asking question is widely used as an assessment tool in the teaching and learning
process. Questions may be:
i. verbal,
ii. written,
iii. in the form of interviews, or
iv. in the form of self-assessment questionnaires.

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Assessment
Example 4 (Rubrics)
Roll Class Timely Submission
No. Key: Always Usually Seldom Never
√- Yes
1 Karma Dema
2 Pema Yangzom
Roll Class Completion
√- Yes
1 Karma Dema
2 Pema Yangzom
Roll Class Accuracy

√- Yes
1 Karma Dema
2 Pema Yangzom
16.1.2 Class Work

Assessment Tools:
Class work will be assessed in the form of question and answer, and through
observations of results, findings or behaviour.
a) Question and answer:

Questions are widely used as an assessment tool in the teaching and learning
process. It may be verbal, written, in the form of interviews or self-assessment
questionnaires.
b) Observation
Observation is also one of the tools to assess the progress of the learner’s
performance and behaviour. Through classroom activities, teacher can
observe the participation of the learners in the class and ascertain his/
her performance. Observing learners carefully helps teacher to know them
better. The information derived through the observation help teacher to plan,
implement, assess and evaluate the teaching and learning process.
As an assessment tool, observation of learners’ conduct, is important to:
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i. assess learner’s level of performance in learning activities,
ii. assess learner’s behavioural conduct with teacher, friends and
community, and
iii. assess learner’s ability to solve problems through problem solving skill.
It is important to give appropriate feedback in order to assess the progressive
learning by learners. It is expected that the teachers will give class work regularly
to ensure the learners learn progressively.
16.1.3 Experiments
Assessment Tool: Checklist
1. Checklist can be used for assessing the learners’ experiments.
Learners can be asked to carry out small research on how well the financial
information depicted by the financial statements of the company is used by the
various end users.
End Users Often Sometimes Never Purpose for
which such
information
is used
Government
Taxation Authority
Managers
Financial Institutions
16.1.4 Class Presentation

Tips for class presentation (Skills)
1. Rehearse your presentation in front of your friends.
2. Speak, don’t read.
3. Keep eye contact.
4. Use decent gestures.
5. Ensure that your body do not block the audience from the information
you have in charts, etc.
6. Be precise. Stay within the time limit.
Content
1. State the central idea.
2. Explain the main points
3. Support the main point with evidence from other sources.
4. Conclude or restate main points.

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Assessment
Assessment Tips
Class presentation can be assessed based on the following criteria.
1. Effective oral communication (flow of language)
2. Introduction of topic/central idea to the audience.
3. Content (relevance, appropriateness).
4. Supporting materials/ Conclusion
5. Eye contact and other body gestures.
6. Timeliness.
16.1.5 Mind mapping

Meaning
Mind mapping was developed as an effective method for generating ideas about
learner’s interaction among themselves. The teacher’s interaction with learners is
an integral part of the teaching and learning process. It is also the most effective,
brain friendly way to turn the unorganised, fleeting ideas and thoughts into a
structured visual map.
Purpose of Mind Mapping:
1. For introducing ideas/concepts/principles etc. at the initial stage.
2. For generating, visualizing, organising, note taking, problem solving,
decision making and revising.
3. For brain storming a topic.
4. Stimulating creative thinking and creative solution to problems.
5. Assess learner’s display of integrity, honesty, and attitudes.
Tips for mind mapping
1. Place the centre theme/ main idea in the centre of the page.
2. Use line, arrows, branches and different colours as ways of showing the
connection between the central theme or main ideas.
3. Draw a simple diagram to show the relationship of ideas.
4. Choose different colours to symbolise different things.
Assessment Tips
1. Relevance of the map in terms of audience/context
2. Logical organisation of main and sub-topics/ideas.
3. Use of icons/symbols to add up to the meaning.
4. References cited.
5. Emphasis or the main focus of the map.
6. Prominence or user friendliness.
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Example of Mind Map
16.1.6 Class Test

Meaning
As a summative assessment, the role of the class test is to grade learner’s learning
over a concept, skill, topic or a chapter taught in the class itself. Normally class
tests can be either in the form of oral or written test consisting, set of questions
answerable within a class time.
Purpose/Objectives
1. To assess what learners have learned after the completion of a lesson.
2. To analyse the result for ascertaining strengths or weaknesses of learners.
3. To revise the lesson taught and check the knowledge.
Sample of a class test blue print
Number of questions to
Level of thinking Total marks
be asked
Creating 1 1
Evaluating 1 1
Analysing 2 2
Applying 2 2

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Assessment
Understanding 2 2
Remembering 2 2
Note: Class test may be done out of 10 marks.
16.1.7 Field trip/Educational excursion

Assessment Tool: Check list/rubric
Tick (√) if the learners have the required material and cross (X) if not.
Class ………….. Date……… Contact Nos. of Field Staff:
Other materials
Questionnaire
Pen/Pencil
Note book
Camera
Sl. No.
Name
1 Sonam Tashi
NOTE: If a field trip covers a long distance travel resulting in night halts, necessary
logistics, food and transportation has to be taken care of.
Sample rubric for field trip
Name:…………................……………Class: ……… Section: ………………
Indicators 4 3 2 1
Punctuality/ Arrives before Arrives just Arrives late Arrives very
Timeliness time on time late
Showed Behaved well Needs several Does not
exemplary most of the reminders follow
Behaviour
behavior to times while on trip instructions
the group
Actively Participated Participated Refuses to
participated all times and few times but participate
(very interacted did not take or to take
Participation interactive, with members notes. notes. Mere
takes note, and others observer.
inquisitive) but did not
make notes.
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Exemplary Field report Field report Sketchy

field report inclusive of inclusive Field report
inclusive layout and of layout, without
Report of excellent organization not well proper
writing layout, of content but organized organization/
organization without his/ content, and content/
of content and her reflection without his/ reflection.
reflection. her reflection.
Legend: Outstanding = 4; Very Good = 3; Good = 2; Fair = 1
16.1.8 Immediate Interaction with Learners

Assessment Tools: Anecdotal records
Anecdotal record (or anecdote) is like a short story that a teacher uses to record
a significant incident observed during teaching and learning process. It is usually
written like a journal. Teacher identifies who, what, where, when and how of a
particular incident, focusing on the subject’s specific conducted. In classroom,
teachers use anecdotal records for assessment of skill development of learners.
The recorded observations are intended to identify the learner’s current skill
level, interests and skills to develop next lesson. Anecdotal records should always
be objective in recording of the learner’s actions and behaviours. These records
enable the teacher to make a judgement about the learner’s progress and helps
teachers to enhance teaching. These tools can be used while preparing the Ledger
Account, Bank Reconciliation Statement, Financial Statements, journalising the
transactions etc. in accounting.

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Assessment
16.1.9 Observation
Assessment Tool: Anecdotal records/Rubric
A simple rubric illustrated below can be designed to measure the degree of moral
standards in terms of ethical and moral values. However, the following rubric is
just a sample for reference purpose.
Partially
Exceeds Meets Never Meets
Criteria Meets
Expectations Expectations Expectations
Expectations
Shows complete Shows complete Does not show Does not show
interest on any interest on any much of interest any interest
work assigned work assigned on any work on any work
Interest and always and mostly assigned and assigned and
completes work completes work mostly fails to never completes
on time. on time. complete work work on time.
on time.
Always Maintains Maintains Rarely maintains
maintains honesty in work honesty in work honesty in
honesty in most of the most of the work and
Honesty work and takes time and takes time but takes does not take
responsibility for responsibility for responsibility for responsibility for
his/her action. his/her action. his/her action his/her action.
only when told.
Demonstrates Demonstrates Demonstrates Fails to
adaptability for adaptability for adaptability demonstrate
work assigned work assigned for the work adaptability
and completes and completes assigned with and can never
Adaptability multiple tasks multiple tasks difficulties complete
without any with little and takes time multiple tasks
support. support. to complete even with
multiple tasks support.
with support.
Demonstrates Demonstrates Demonstrates Never
sense of sense of sense of demonstrates
belongingness belongingness belongingness sense of
all the time and most of the time rarely and takes belongingness
Due care takes good care and takes good good care of and never
of resources care of resources resources upon takes good care
provided for provided for reminder only. of resources
learning activity. learning activity. provided for
learning activity.
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Assessment Tool
Quiz and debate can be assessed using question and answer, and rubrics.
Quiz and debate can be conducted by dividing the class into groups or amongst
the classes.
a) Questions and answer

Asking question is a process through which teacher interacts with learners in
the class to assess the content knowledge of the subject. Therefore, questioning
is critical to the way teachers manage the class, engage learners in content
learning and encourage them to participate in enhancing their understanding.
Asking question is widely used as an assessment tool in the teaching and
learning process. Questioning may be in the form of:
• verbal questioning,
• written question,
• interviews, and
• self-assessment questionnaires.
b) Rubrics:
Criteria Excellent Very Good Good Poor
Clearly Understood Seemed to have Unclear about
understood the the topic in understood the the topic.
Understanding topic in depth depth but there main points
of topic and presented was a lapse in at the surface
information convincing the level.
convincingly. audience.
Thoughts were Thoughts were Flow of Thoughts
well organized organized but thoughts was were jumbled
Organization
and presented presentation broken. up and
perfectly. seemed vague. disorganized.
FIVE or FOUR strong THREE Debate lacked
More strong arguments arguments arguments/
arguments were clearly were presented. arguments
Arguments
were clearly presented. were
presented. ambiguous/
unclear.

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Assessment
FIVE or FOUR support THREE TWO or LESS

Evidences MORE support materials/ support than two
(facts, materials/ evidences cited materials/ evidences cited
examples, evidences cited to prove the evidences cited to prove the
statistics etc.) to prove the arguments. to prove the arguments.
arguments. arguments.
Offered Offered Offered Offered
FOUR or THREE strong TWO strong ONE strong
MORE strong evidences to evidences to evidence to
Rebuttal
evidences to refute opposing refute opposing refute opposing
refute opposing points. points. points.
points.
Used all of Used any Used any Used any ONE
the following THREE of TWO of the of the following
convincingly the following following convincingly
and convincingly convincingly and
persuasively: and and persuasively:
Delivery
- gesture persuasively: persuasively: - gesture
- tone - gesture - gesture - tone
- eye contact - tone - tone - eye contact
- audibility - eye contact - eye contact - audibility
- audibility - audibility
Each member Each member Each member More than one
of the team of the team of the team arguments
presented presented presented were
an argument different a different overlapping,
Team work
that was built argument with argument with repetitive or
on from the no overlapping at least one contradictory
previous points. overlapping among team
arguments. point. mates
16.1.11 Self and Peer Assessment

Assessment Tool
Peer and self-assessment can be assessed using the check list. In teaching
Accountancy, teacher can make a listing of Accounting concepts and principles
that the learners would have learnt; skills that they would have developed; and
Accounting values and attitudes that they should exhibit at the end of every topic.
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16.1.12 Reflective Writing
Meaning
Reflective writing is evidence of reflective thinking. In an academic context,
reflective thinking usually involves:
1. looking back at something (often an event, i.e. something that happened,
but it could also be an idea or object),
2. analysing the event or idea (thinking in depth and from different
perspectives, and trying to explain, often with reference to a model or
theory from one’s discipline/subject area), and
3. Thinking carefully about what the event or idea means and an ongoing
progress as a learner.
Stages in Reflective Writing
1. Description –
a. What happened?
b. What is being examined?
2. Interpretation-
a. What is most important / interesting / useful / relevant about the object,
event or idea?
b. How can it be explained e.g. with theory?
c. How is it similar to and different from others?
3. Outcome
a. What have I learned from this?
b. What does this mean for my future?
Assessment Tool
A learner will be required to complete one Reflective Writing in the year. It
should be started in term I and the draft will be evaluated out of 2.5 marks and
included in Term I result. In term II, the same work should be continued and
final work will be evaluated out of 2.5 marks. The following rubric can be used
as a reference.

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Assessment
Criteria 4 3 2 1
Description
Learner provides
Clear and focused
a description of
on the specific Situation/Event Vague and
the experience, Vague
aspects that described but inadequate
observation, activity, description.
challenge the not precise. description.
reading, etc. upon
student.
which he or she is
reflecting.
Interpretation
Some response Learner
Learner provides a
Clear and focused but limited to provides vague
description of their
description of the one domain description Very vague
intellectual and
feelings, thoughts, (e.g., only of intellectual description.
emotional response
and questions. emotional, and emotional
to the experience.
intellectual). responses.
Minimal
reflection –
Critical reflection –
Reflection No personal
Critical evaluation
– Making reflection or
(questioning,
connection limited to
examining
Outcome between description
more closely)
Evidence that student’s of general
student’s personal
the learner has personal opinions and Inadequate
assumptions, habits,
questioned or assumptions, behaviours and vague
or values and
evaluated their prior habits, or values without reflection.
their connection
perceptions, actions, and the opinions reflection on
to the opinions or
or beliefs. or behaviours underlying
behaviours upon
upon which assumptions,
which the student is
the student is habits, or values
reflecting in light of
reflecting. driving those
other perspectives.
opinions or
behaviours.
Reflective Journal can also be assessed through self and peer assessment in order
to:
• identify their strengths and weaknesses and of their peers,
• transcend from passive learning atmosphere to active learning one, and
• enable them to better understand assessment expectations, and work
towards improving their own performance.
Peer and self-assessment can be carried out occasionally depending upon the
availability of time. Following rubric may be used.
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Peer and Self-Assessment
Name.................................................Class………….. Period.............Date..................
Indicators Always Mostly Sometimes Rarely
Shows enthusiasm in work
Contributes ideas
Accepts others views/opinion
Shows willingness to work as a team
16.1.13 Computer Practical (MS Excel)

Meaning and purpose
As learners learn to use MS Excel in problem solving, the components like format,
spelling and accuracy of the data are key factors required to get correct end
result. For these reasons, a assessment tool is required to assess learner’s ability
to solve problem in excel. The performance rubrics chart is preferred tool for
assessing the task, which describes degree of proficiency in the use of MS Excel in
solving a problem by a learner. The performance chart range from 1 to 4 points.
Students can analyse themselves in which level they fall and know the reason for
such score. Teachers can use analytic rubrics to assess learner’s problem solving
skills using MS Excel. Teachers can also use this rubric for differentiated teaching
method to focus on particular topic to a identified group of learners.
Assessment Tool
Rubric is used to assess learner’s competency over the use of MS Excel for
assessing problem solving skill.
Level 4 3 2 1
Formulae ONE value TWO values More than
were used to is manually are calculated TWO values
Formulae calculate all calculated without using are calculated
numerical without using formulas. without using
values. formula. formulas.
All data 1-2 data/figures 3 or 4 data/ More than 4
required and shown in the figures data/figures
shown in the worksheets are shown in the shown in the
Required Data
worksheets are inaccurate/ worksheets are worksheets are
accurate. wrong. inaccurate/ inaccurate/
wrong wrong.

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Assessment
The graph/ The graph/ The graph/ The graph/
diagram diagram has diagram has diagram has
required for any ONE of any TWO of any THREE
the task is the following the following OR MORE of
correct in issues: issues: the following
all respect - Wrong figures - Wrong figuresissues:
(figures, - Wrong - Wrong - Wrong figures
Graph/ labelling of labelling of labelling of - Wrong
Diagram axes/columns/ axes. axes. labelling of
rows, range - Inappropriate - Inappropriateaxes.
and numerical range or range or - Inappropriate
values, legend) numerical numerical range or
value. value. numerical
- Legend is - Legend is value.
missing. missing. - Legend is
missing.
All possible One solution Two solutions Three or more
Critical solutions are worked out is worked out are solutions
Analysis accurately inaccurate. inaccurate. worked out are
indicated. inaccurate.
16.1.14 Case Study

Meaning
• It is a written description which provides detailed information about a
person, group or thing, and their development for the specific period
of time.
• It is an enquiry methodology that is commonly used by learners in
examining an in-depth study of a single individual, group or event to
explore the causes of underlying principles.
• Case studies are examination of persons, groups, events, decisions,
periods, policies, institutions or other systems that are studied
holistically by one or more methods.
Purpose
• describe an individual situation (case), e.g. a person, business,
organization, or institution, in detail;
• identify the key issues of the case (question or topic should tell you what
to focus on);
• analyse the case using relevant data and information;
• suggest solutions for particular case (particularly for problem-solving
case studies), and,
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• to develop critical thinking skills.
Procedure
• Select the situation/ topic on which to write up the case to be studied.
• Collect as much information as possible about the situation.
• Analyse all of the elements surrounding the situation.
• Determine the final solution implemented.
• Gather information about why the solution worked or did not work.
After gathering the information learner can proceed by:
a) Describing the situation/problem
The reader needs to have a clear understanding of the situation for which a
solution is sought. One can explicitly state the problem posed in the study.
One can begin by sharing quotes from someone intimate with the situation or
one can present a question.
b) Give background
Background is the information one has discovered that describes why there
is a problem. This will consist of facts and figures from authoritative sources.
Graphs, charts, tables, photos, videos, audio files, and anything that points to
the problem is useful here. One might include anecdotal information as well.
c) Describe the solution
This section discusses the solution and the thought processes that lead up
to it. It guides the reader through the information to the solution that was
implemented. This section may contain the author’s opinions and speculations.
d) Evaluate the response to the solution
If the case study is for a recent situation, there may not have been enough time
to determine the overall effect of the solution.
e) Telling the whole story
Case study-writing is about telling the story of a problem that has been fixed.
The focus is on the evidence for the problem and the approach used to create
a solution. The writing style guides the readers through the problem analysis
as if they were part of the project. The result is a case study that can be both
entertaining and educational.

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Assessment
Assessment Tool: Rubrics
Name : _________________Class____________Year__________
Outstanding Satisfactor y
Standards Very good (3) Good (2)
(4) (1)
Identifies and Identifies and Identifies and Identifies and
Identification understands understands understands understands few
of the issues/ all of the main most of the main some of the of the issues in
problems issues in the case issues in the case issues in the case the case study.
study. study study.
Insightful Analysis of Analysis of two Imperfect and
and thorough all the issues or three issues. incomplete
Analysis of the
analysis of all the without analysis of the
issues
issues. thoughtful issues.
analysis.
Well Appropriate Artificial and Little or
Comments
documented, with few thought inappropriate no action
on effective
reasoned and out comments solutions to most suggested and
solutions/
appropriate about solutions, of the issues in in appropriate
strategies (The
comments on or proposals the case study. solutions to all of
solution may
solutions, or for solutions, to the issues in the
be in the case
proposals for some issues in case study.
already or
solutions, to all the case study.
proposed by
issues in the case
you)
study.
Excellent Good research Limited Incomplete
research into into issues with research and few research and
Research / issues and clearly some clearly documented links to any
Reference documented documented links to readings.
reasons or links to material readings.
arguments. read.
Very clear Clear flow Most ideas have Hard to follow
and concise of ideas. a flow but focus the flow of
flow of ideas. Demonstrates is lost at times. ideas. Lack of
Delivery/flow
Demonstrates interest in the Limited evidence enthusiasm and
and enthusiasm
passionate topic. of interest in the interest.
interest in the topic.
topic.
Visuals Use of visuals Limited use of No use of
augmentation related to the visuals loosely visuals.
and extended material. related to the
Visuals
conception of material.
issues in unique
ways.
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16.1.15 Team Work
Assessment Tool: Rubric
The following rubrics can be used as a sample to assess learner’s performance in
group related works. The focus should be more on the use of soft skills.
Criteria Exceeds Meets Partially Meets Never Meets
Expectations Expectations Expectations Expectations
(excellent = 4) (very good = 3) (good = 2) (satisfactory = 1)
Team members Members respects Some of the Communication
communicate the view of others, members do is limited,
openly, and however there are not respect the members do not
Communication respect the few members who views of others respect views of
Skills view of other cannot openly and most of others and fails
members. communicate. the members to discuss on
do not freely important topics.
communicate.
Team members Team members Team members Team members
can easily can easily adapt struggle to cannot adapt
adapt to change to change in plans adapt to change to change
in plans and and can complete in plans, and in plans and
Adaptability
can perform multiple tasks complete cannot complete
multiple tasks with little support. multiple tasks multiple tasks
without any with more even with strong
support. support. support.
Team members Most of the time, Team members Team members
consistently team members stay focused on rarely stay
stay focused stay focused on activity assigned focused on
on activity activity assigned, some of the activity assigned
Time
assigned, and completes time, and takes and always fails
Management
and always activities on time time to complete to complete
completes the activities. activities on
activities on time.
time.
Team members Team members Team members Team members
always support mostly support the mostly support are disoriented,
the idea and idea and efforts the idea and and does not
efforts of others of others and can efforts, but support each
Cooperation and can quickly resolve conflicts requires the help other and always
resolve conflicts most of the time from outside fails to resolve
without the on their own. to resolve the conflicts.
support from conflicts.
outside.

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Assessment
16.4.16 Project Work
Meaning
Project work is a learning experience which gives an opportunity to learner’s for
acquiring knowledge from different field of learning and critically and creatively
apply it to real life situations. It helps them to enhance their knowledge and skills
like collaboration, communication and self-learning, and prepares them to face
challenges ahead in life.
Purpose
The purpose of giving project work in Accountancy is to allow learners to
enhance their knowledge and enables them to acquire skills like collaboration,
communication and independent learning and prepare them for lifelong learning.
It enable learners to demonstrate results and findings of their investigations, and
make rationale decisions in their life. It will also help them to explore new ideas,
learn new techniques and put into practice the concepts learnt in other subjects.
The project will further develops competence to read, analyse and interpret the
accounting data of the enterprise. Following are the steps to be followed while
writing Accountancy project work.
1. Selecting a topic on accountancy project.
2. Literature review.
3. Planning the project.
4. Collecting data and related information.
5. Writing hypothesis based on information gathered.
6. Executing the project.
7. Conclusion.
8. Preparing the project report.
Criteria for the assessment of project work

Criteria
Name Presentation
Content Finding Research References Total
and format
(4) (4) (4) (4) (20)
(4)
Karma Dorji
Sonam Rinchen
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Assessment Tool: Rubric
4 3 2 1 Total
Content is new, Content is Content is not Content is
Content relevant. not new but new and not so not new and
relevant. relevant. relevant.
Excellent Only one area Only two Three or
presentation. of format is aspect of more aspect
Presentation Correct format not correct. format is not of format is
and format is followed and Report has a correct. Report incorrect.
report is free of few errors. has some errors Report has
errors many errors.
Finding is Finding is Finding is not Finding is not
supported supported supported by supported
by the facts by the facts enough facts by facts and
and figures. and figures. and figures. figures.
Finding
Explanation Insufficient
is made on explanation on
each facts and each facts and
figures. figures.
Research done Research done Research done Research not
on the topic on the topic and a few ideas done and
Research and all ideas and most ideas are clear and ideas are not
are clear and are clear and explained. clear and not
explained. explained. explained.
Five or more Three or four One or two No references.
Reference references are references are references are
cited. cited. cited.
Project Work shall include the following components:

1.
2.
3.
Project file.
Title of the project work.
Acknowledgment.

4. Table of content.
5. Introduction.
6. Content/ theory
7. Case study.
8. Findings.
9. Conclusion.
10. Bibliography/ references.

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Assessment
Bibliography
1. Accounting and Auditing Standards Board of Bhutan (2015). Bhutanese
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ACCOUNTANCY

Department of School Education

Provisional Edition 2019

Book Cover Design:

Research and Writing:

Accounting plays a vital role in organizational management. It accumulates

UNIT TWO: COST ACCOUNTING

UNIT THREE: MANAGEMENT ACCOUNTING

Taxation is one of the important components of financial decisions of business.

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1.1 Accounting for Sales Tax Collected from Customers

Credit sales are similarly subject to sales tax.

1.2 Accounting for Sales Taxes on Purchases and Expenses

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1.3 Accounting for Current Tax

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1.4 Difference between Accounting Income and Taxable Income

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of disposal that is in contradiction to the accounting approach.

1.5 Accounting for Deferred Tax

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Statement of comprehensive income for the year ended 2019

Profit after tax 420,000

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Statement of Comprehensive Income

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Statement of Financial Position

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Statement of Cash Flows

(Increase)/decrease in inventories 4,596,451.15 (10,570,333.02)

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Statement of financial position as at 31 December 2020

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Bumper 50 15,000 750,000

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1.6 Business Income Tax (BIT)

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b) Small, Cottage/Micro Business Units

Allowable deductions are grouped into the following broad categories:

Table 1.1 Employee Salary ceiling for BIT purposes

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iv) Conveyance or Transport Facility

• Telephone facilities provided to an employee is a deductible expense. The

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Monthly salary schedule of Zeko Enterprise:

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g) Contribution to Provident Fund and Gratuity Fund

j) Human Resource Development Expenses

vii. Any other expenses of similar nature.

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i) License Registration & Renewal Fees

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c) Publicity & Advertisement

1.1.6 Irrecoverable Debts

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