Study Guide
David Austen
Estellita Louisy
Seema Deosaran-Pulchan
Theodora Sylvester
OXFOlill
UNfVERSl1' Y PltSSS
Great Clarendon Scree,. Oxford , OX2 6DP, United l<Jngdom
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The exam-style questions and answers th ac appear in t his
book and on t he accompanying website have been written
by t he am hors. In an examination. che quesdons and the
way the quescions are marked m ay be different.
Access your support webslle tor answers and
add tlonal aetlvil,es here:
www.oxfordsecondary.com/9780198437314
Contents
Introduction
Section 1 Accountlng as a profession
1.1 lntroductr-on to acoounting
1.2 Ethical pnnciples and accou nling
Practice exam ques:ions
4
Practice exam Quest,ons
6
8
9
Section 2 Accounting as a system
2.1 Concep:s, the accounting cycle
and business organisations
10
2.2 Financial statements, technology and accounting 12
2.3 The statement of financial cos.lion (balance sheet) 14
2.4 The class lied statement of financia
position (balance sheet)
16
2.5 The effect of transact10ns on the statemen:
of financial ooS'tion (balance sheet)
18
Practice exam ques:ions
20
Section 3 Books of original entry
3.1 lntreduct,on
3.2 Preparing source documents; oiscounts
3.3 us,ng S01.Jrce documents to make emries
in the purchases and sales books
3.4 The returns ou~,vards and returns inwa'ds beaks
3.5 The three-column cash book
3.6 The petty cash book
3.7 The general journal
3.8 Balanc•ng casn books and posting books
of orig nal entry totals
Practice exam questions
Section 4 Ledgers and the trial balanee
4.1 Preparing ledger accounts
4.2 Posting transact,ons
4.3 Balanc,ng accounts
4.4 CIOsing accounts
4.5 lnte(J)reting entries and preparing a trial t:alance
4.6 'Norked example: preparing books of
original entry and double-en1,y records
Practice exam questions
Section 15 Preparation and analysla of sole
trader financial statements
5.1 lntr<Xluct,on
5.2 More about income statements
5.3 Journal entries and tne income statement
5.4 The capital account and ser,nce business
income Slatements
5.5 Classified statements of financial posttion
(ba~nce sheets) ,n vertical slyle
5.6 'Norked example: so!e trader financial statements
5.7 Rat,os and pro~tabll ty
5.8 Rat,os and financial posrt.cn
5.9 Recommendations based on ratio analyS.s
5.1 O ~Vorked example: reporting on performance
Practice exam questions
22
24
26
28
30
32
34
36
38
40
43
46
48
50
52
60
62
64
66
68
69
70
74
76
78
80
82
Section 8 Accounting adjustments
6. 1 Accounting concepts and adjustments
6.2 Expense and income adjustments
6.3 Expense and income adjustments ano
financial statements; bad debts
6.4 Crea!lng a provision for doubtful debts
6.5 More about provis~:ns for doubtful debts
6.6 Deprec.ation
6. 7 Worked example: adjustments
84
86
89
91
93
96
Section 7 Control system
7.1 lnt:oductlon
7.2 More about errors and the trial balance
7.3 Correcting profits
7.4 'No~<ed example: correcting error$
7.5 Control accounts
7.6 1No6,ed example: control acocunts
7.7 Bank teconcil ation statements
7.8 Worked example: preparing a bank
reconcilation statement
Practice exam quest ens
Section 8 Accounting for partnerships
8.1 lntroducilon
8.2 The accounts of partners
8.3 More about partnerships
8.4 Partnership statements of financial pos1t10n
8.5 INorked examc'e: partnerships
Practice exam quest ens
98
102
104
107
109
110
113
116
118
120
122
124
126
128
130
132
134
Section 9 Accounting for limited liability companies,
co-operatives end non-profit organisations
9.1 lnt:oduetlon
9.2 Types of I mtted liabillty company, co-operative
136
and non-profit organisation
9.3 How ca;:,ltal is calsed by I mi'.ed llabilAy
companies and co-operatives
9.4 Journal e'1trles for the issue of sha,es
and debentures; dividend calculations
9.5 The apc,opriatoon account; the limlted
company's ,noorr,e statement
9.6 Company statements of finarcial position
{calanoe Sl1eets)
9.7 V'/orked example: preparing company finane<al
statements
9.8 Final accounts of co-operat1VeS
9.9 Worked example: co-operatNes
9.10 Non-p,oflt organisat ons
Practice exam quest,ons
138
140
i42
·44
146
148
151
153
157
159
Section 10 Manufacturing and Inventory control
10.1 Accounts of manufaciurers
t0.2 More abOut manufactunng accoums
t0.3 The income statement and staterr.ent of
161
163
financial pos t<On {balance sheet)
10.4 Worked example: mam.naclunng accounts
10.5 Basic costing p:ocedures
t0.6 V'/orked example: costing p<0cedu,es
10.7 !rventory va'uattor,
Practice exam Questions
165
166
170
173
176
177
s.ctlon 11 Accounting for the entrepreneur
11.1 Payroll accounting
11.2 More about payroll
t t.3 Calculat ng net pay
t1.4 Budgets ands mple business plans
1 t.5 Worked examole: preparing budg&1s
and cash flow forecasts
Praciice exam Questions
Index
179
181
183
185
187
190
192
This Study Guide has been developed exclusively with
1he Caribbean Examinations Council (CXCe) to be
used as an additional resource by candidates . both In
and out of school, following the Caribbean Secondary
Education Certificate (CSEci program me.
It has been prepared by a team with expertise in
the CSEC<t syllabus, teaching and examination. The
contents are designed to support learning by providing
tools to l1elp you achieve your best in CSEC<ll Principles
of Accounts and the features included make it easier
for you to master the key concepts and requirements
of the syllabus. Do remember to refer to yovr syllabus
for full guidance on the course reqvirements and
examination format!
Features
As you work through this Study Guide you will come
across the following features:
. .
-
,. '
-· .
;
DID YOU KNOW?
Debit notes are not often encountered. As well
as being issued to prompt the receipt c f a credit
note, they are sometimes issued by a business
to correct an undercharge on an invoice issued
to a customer.
The Did you know? boxes provide you with additional
information to set your learning in context.
EXAM TIP
It <s worti1wl1ile
)>Ytl ct<Sii,cg bt1Lt1..,,cii,cg
t!CCOIA.11\.tS Cl.s tl1t.s is
oftell\. "'-llt olo"'e well i..,,
ex.ti""-'~ t io ""5.
LEARNING OUTCOMES
1n this unit you will learn about:
• the concept and purposes of accounting
• the users of accounting Information.
The Objectives boxes tell you which objectives from the
specification the content you are about to read relates to.
KEY TERM
Ethical principles of accounting: the moral
principles and standards that govern the
conduct of those working In the profession.
The Key terms boxes provide definitions of the words
or phrases highlighted in bold in the text. Being able
10 use technical vocabulary will help you in your exam,
and the key terms are also collected togelher In a
glossary on 1he support website.
LINK
%
Section 10 explains the accounts
of manufacturing organisations
and Section 5 Includes a focus
on seNice businesses.
The Link boxes explain links between content in
different sections of tne Study Guide, helping you build
a rounded picture of the subject.
Exam tips are designed to help you overcome common
mistakes or misconceptions.
SUMMARY QUESTIONS
1. Why is accounting important?
2. lden11fy two internal and two external users of
aocounting Information.
3. Describe the main difference between the
work of a bookkeeper and the work o' an
accountant.
4. fden1ify one emerging career for:
a. a bookkeeper
b. an accountant.
The Summary questions box contains questions you
can use lo test your understanding of each topic. The
answers are provided on the support website.
Command words
The syllabus Is divided into eleven sections, and each
section is based around specific learnir,g objectives tnese are a list of what you should know, understand
or be able to do as a result of learning the Principles
of Accoun!s. This study guide guides you through ,he
objec,ives.
Each objective slarts wtth a command word, whioh l ells
you what you need 10 do. Belov,1 is a list of the mo51
common command words, wlrn a brief description of
whal each of them means:
• Define: Set out a clear definrtion of what a specttic
term means.
• Distinguish between : Explain the difference
between one thing and anotner.
• Identify: Indicate what something is.
• State: Express some'.hing clearly.
• List: Provide an appropriate list of particular aspects
or features.
• Outline: Sel out the key aspecls of.
• Describe: Sel out in words.
• Interpret information: Show wha11r.e informalion
you are supplied wtth means.
• Construct/draw up: Prepare, a financial statement.
• Classify: Arrange according to shared
characteristics.
• Explain: Make an idea clear to the reader.
• Discuss: Set out a brief discussion.
• Evaluate: Assess in order to make a judgement
about something, weighing up t11e arguments for and
again51 and arriving at a measured conclusion.
Make sure lhat you understand these command words,
so that wr en you are faced with them in an assessrnen1,
you know what 1he examiner wanls. Questions lhat use
command words like ·evaluate' and 'disouss' will usually
be worth higher marks than questions that simply ask
for lists or ask you to identify something.
Study skills
The key to revising is to start early and to plan your
revision in an organised way. Allocate sufficienl time
to revise all eleven sections of the syllabus so that you
build up S1rength across the syllabus. The reality is that
you probably vvill no'. be able to do as much revision
as you originally plan. However, if you are organised
and break up your revision into lots o' small sessions.
lhen you will look back and surprise yourself by how
much you have coveredl Don't forge1 to work through
some queS1ions and check your answers against mark
schemes so that you can identify the areas you need to
focus on to improve your understanding.
The greal thing about revising Principles cf Accoums is
lhat the principles you are learning aboUt apply to real
world conteXis. Every day you witness businesses and
other organisations in action. To help you revise, relale
whal you see to the principles of accounts you have
been learning, and talk about them to your friends and
people you share your home wtth. Amaze lhem wtth your
grasp of this exciting field. Al the same lime, follow lhe
business news in your national paper. on the Internet and
in television reports. and particularly any reports about
companies' financial results. This will help to consolidate
your learning ot accoun1ir,:J principles and terms.
This Study Guide is supported by a webstte w'nich
includes a glossary o' the key terms and answers to
the questlons in the Study Guide as well as elecironic
aciivities lo assisl you in developing good examinalion
techniques:
• On Your M arks activities provide example
examination-slyle short answer and essay type
queS1ions, 1J1Jith example candidate answers and
feedback from an examiner to show where answers
could be improved. These activities will build your
understanding, skill level and confidence in answering
examination questions.
• Test Yourself activttles are specifically designed to
promote experience of multiple-choice examination
Que$lions.
So to recap:
• Revise regularly In small chunks.
• Study the lists and tables provided in this book to
support your learning.
• Work lhrough queslions and check model answers
to improve your skills and develop confidence.
• Think aboul how command words hold lhe key lo
specific objeciives.
• Learn from tne real world and talk about aocounting
principles lo others.
• Explore the On Your Marks activities to find out how
marks are awarded.
• Practice answering multiple-choice questions wtth
the Test Yourself aciivities.
• Back yourself to do well.
This unique combination of focused syllabus content
and imeraciive examination practice will provide you
with invaluable support to r elp you reach your full
potential in CSEC~ Principles of Accounts.
'4 Access yoor support website for additional
~ content and activities t,ere:
www.oxfordsecondary.com/9780 198437314
Introduction to accounting
LEARNING OUTCOMES
In this unit you will learn about:
• the concept and purposes of
accounting
• the users of accounting
Information.
The concept and purposes of accounting
It is important for those individuals responsible for the success of
businesses to know:
• whether a profit is being made, because this is the main reason for
having a business - Is the business profitable?
• whether there are sufficient funds to meet all the commitments of
the business on time - Is the business liquid?
• that they are making the best use of the funds that have been
Invested In the business - Is the decision-making sound?
Accounting will provide accurate and comprehensive financial
information to those responsible for running a business, to help them
make decisions that will support its survival and success.
The users of accounting information
The following table lists the main users of accounting Information.
Internal users of accounting information
Owner(s)
\.Yill have invested personal savings in a busine5$ and be dependent on the success of the
business (i.e. profrts, :survival, etc.) for his or her livelinood
Manager
Will be concerned about the performance of the business and will wish to Identify any
weaknesses and problems so that steps can be taken to rectify these and to ca,pttalise on
business opportunities
Employees
Dependent on tl1e success of the business for job seet,rily, Increases in pay and promolion
opportunities
External users of accounting information
Cus1omers
Dependent on the success of 111e busine5$ lo ensure that the goods or services they wish to
buy are of good quality and available when they are needed
Suppliers
\.Yill be concerned that ,he business can pay for goods or services on l ime, and aboU1 the
po5$ibility of repeat and growing orders
Banks
May have lent funds to a business and will therefore wish to ensure that interest payments and
loan repayments can be made when due
Potential
Investors
\,Viii carefully consider the possible returns on any Investment made and the risks involved
GovernmenV \,VIII want to know the profit being made by the business so that accurate tax assessments can
Tax atrthorities be made
Competttors
\,Viii wish to compare their own resuhs with those of the business
Local
community
\.Yill consider the impact of the busine5$ on the environment, tr e contribution made to the local
economy and the possibiltty of employment opportvntties
It is important to remember that access to the accounting records of
sole trader and partnership businesses is limited to internal users and
government/tax authorities.
Traditional and emerging careers in accounting
The provision of accounting Information relies on the work of two
different groups of Individuals - bookkeepers and accountants whose responsibilities are summarised in the following table:
Bookkeeping
Main responsibility
Examples
The recording of financial
information, particularly
transactions. in a systematic way
• Preparing accounts by entering and posting transactions
(probably using a computer soltware prcgram)
• Preparing trial balances
• Checking the records tor accuracy
• Preparing payroll and inventory records
• Assisting the work of the accountant(s)
Accounting
The selecting, classifying and
summarising of financial data
in ways that provide owners of
business and others wtth useful
information to help them assess
per'ormance and make informed
decisions
• Preparing financial statements
• Preparing budgeis
• Supervising the work of bookkeepers
• Analysing fl'lancial statements
• Making recommendations and providing advice on how
to improve performance
• Preparing tax assessments
The fcilowing table gives examples of both traoitional and emerging
careers in bookkeeping and accounting:
Traditional careers
Bookkeeper
Accounting
Emerging careers
• Accounts receivable clerk • Bookkeeping
software specialist
• Payrcll clerk
• Payroll software
• General ledger clerk
operative
• Accounts manager
• Tax accountant
• Internal auclhor
• Management accountant
• Accounting soltware
developer
• Environment
accountant
• E-commerce
specialist
SUMMARY QUESTIONS
1. \Nny is accounting
Important?
2. Identify two internal and two
external users of accounting
Information.
3. Describe the main oifference
betvveen the v1or1< of a
bookkeeper and the work of
an accountant.
4. Identify one emerging career
for:
a. a bookkeeper
b. an accountant.
Ethical principles
and accounting
LEARNING OUTCOMES
In this unit yov will learn about:
• ethical Issues in the field 01
accounting
• the results ol inappropriate
application of ethical
principles of accounting.
KEY TERM
Ethical principles of
accounting: the moral
principles and standaros that
govern the conduct of those
working in the profession.
Ethics is about moral principles and standards of behav1our. In
accounting it Is vital that clients can have complete trust in their
accountant, since the accountant has access to so much information
that Is both confidential and sensitive. Accountants are required
to abide by certain ethical principles to demonstrate honesty and
fairness and to ensure public trust ls maintained.
The ethical principles of accounting are summarised as follovvs:
Ethical principle
Description
Integrity
Being slraightfcrward and honest irl all
professional and business relationships
Objectivity
Avoiding bias, conflicts of interest or the
undue influence of others when making
professional judgements
Prof~sional competence
and due care
Keeping knowledge and skills al the
appropriate level in order to deliver the
services to clients diligently
Confidentiality
Avoiding ,he disclosure of information to
others without expressed permission; not
using a client's Information for personal
advantage
Prol~sional behaviour
Taking personal responsibility !or
adopting the highest standards of the
profession by complying with legal
requirements and regulations and
avoiding any aclion that would discredit
the profession
Maintaining ethical principles requires strength of character and
courage. Where there is a failure to apply ethical principles the
following consequences could arise:
• Law suits
• Loss of Job
• Loss of integrity/reputation
• Fines
• Imprisonment
SUMMARY QUESTIONS
1. What is meant by the term ethical principles of accounting?
2 . What could be the consequence of:
a. mahgnlng a colleague
b, missing a deaollne for filing tax documents
c . fraudulent activities?
Practice exam questions
Paper1
1 Which one of '.he following would you expect to
be Included In tne duties of a bookkeeper?
A preparing b:.idgets
I and II Only
B I and Ill only
C II and Ill only
D I, II and Ill
A
3 Which o' the 'allowing Is not an etnical pnnciple
B preparing a cash book
C a'>alyslng financial S1atemeots
D make :ax assessments
of account Ing?
A objectivtty
B duecare
C lntegmy
D ace1;racy
2 Which of the fellowing would you expect to be
incli.,ded in the duties of an accounta'lt?
I developing financial sys1ems
II
preparing trial balances
Ill working with avdltors
Paper2
1 The users of accounting Information
Dwight Is the owner of small retail business. He
runs the business on his ov✓n. He purchases
goods on credtt and has recently taken out a
bank loan. The busi~ess made a profit during
the financial year just ended.
a Identify four users of accounling information
about this retail business from the information
available.
b State the Interest In the business of the four
users identified in answer to a.
2 Complete the following table, Identifying who
would be responsible for each task. Answer
either 'bookkeeper' or 'accountant'
Task
Preparng an Income statement
Recording cash takings
Prepar,rg a saes budget
Calculating an emp!oyee's pay
Prepanng a cap,ta1 account
Analysing a s1aternem oi flnanc,al
position (balance sheet)
Prepanng a report on the
performance of a business
Maintain ng records o1 inven tory
Posting ihe cash book entries to
ledger accounts
Carried out by
3 In eacn of the following situations slate tne
elhical principle of accounting 1hat should
be applied by Seema, who works In a firm of
accountants.
Situation
Ethical principle
Seema Is about to make
a tax assessment ior a
client, out she has Just been
Informed that the government
has made changes to tax
regulations.
A c'lem has asked ior
depreciation cnarges to be
reduced In the current 1noome
Statemem so that profits are
shown at a higher value.
A friend has asked Seema
whether h WOUid be a good
Idea to Invest some savings
In a ouslness that happens
to be a client of the firm of
accountams.
Seema has become aware
that a fellow emp.oyee may
nor be acilng m the best
Interests of one of ihe firm's
clients.
,
, -
-9
I
:
Concepts, the accounting
cycle and business
organisations
Concepts and conventions th at guide
the accounting process
LEARNING OUTCOMES
In 1his unit you will learn about:
• the concepts and
conventions that guioe the
accounting process
• the accounting cycle
• different types of business
organisation.
There are a number of fundamental rules that must be followed when
preparing financial statements. These rules are often re!erreo to as
accounting 'principles·, 'concepts' or 'conventions'; the following
are examples:
Concept
Description
Accrual
{matching)
In order to calculate pro'tt. income for a financial
period is ma1ched with expenses tha1 rela1e 10 that
accounting period, whether paid or no:.
Pn;dence
Wnere 1here is doubt, asset and profit values should
(conseivalism) be understa1ed rather than overstated.
Consis1ency
Accounting policies should be carried out In 1he
same way year after year so 1hal compariscns of
performance can be made on a valid basis.
Separa1e
en1ity
Only transactions affeC1ing the financial position of a
business are recorded in tts books of account. The
owner's private financial affairs are not recorded.
The accounting cycle
In order to prepare accounting records it Is essential that a particular
sequence of events and processes is followed. This sequence is
often referred to as the ·accounting cycle' (see opposite). The term
'cycle' is used because the seouence of activities is continuous.
Types of business organisation
What is a business? Businesses are organisations that provide goods
and/or services in order to make a profit.
LINK
%
SeC1ion 10 explains the aocoJnts
of manufactunng organisations
and Section 5 includes a focus
on service businesses.
There are a number of ways of classifying businesses. Businesses
can be classified by what they do, for example:
• Provide raw materials through mining, farming, fishing, etc.
• Manufacture goods, turning raw materials Into finished products
• Sell goods to the general public (retailers) or to other businesses
(wholesalers)
• Provide seivices to r businesses and the general public
Step 1
Coect
source
doc uments
Step 2
Steps
Prepare and-of•
year financial
statements
Step4
Prepare a trial
balance to cnecl<
the accuracy of
the double entry
Extrac: ~Y facts
from source
docu=ts a'id
reoord In books of
original entry
Step3
Pos: lnformatlor
from !looks of
or glna eritry :o
ledger accounts
The acoounting eye~.
It is also possible to think about businesses in terms of who owns
them, for example:
• Sole trader one individual owns and controls the business.
If successful, the profits maole by the business belong to this
Individual; If unsuccessful, the Individual can lose whatever has
been invested as well as private resources. Much of this book is
concerned with the accounting records of sole traders.
• Partnerships several individuals own the business. Partners jointly
control the business, sharing profits between them. They are also
jointly responsible for the debts of the business, and can lose their
private resources If the partnership Is unsuccessful.
• limited liability companies (corporations) owned by
shareholders vvho:
• contribute the funds needed to establish and run the company
• are rewarded wlth some 01 the profits made by the company if
successful
• carry a responsibility for the debts of the company that is limited
to the amount they have Invested
• are not at risk of losing their private funds if things go wrong.
unlike sole traders and partners.
• Co-operatives are organisations that are formed and controlled
by members. They are run to provide their members with goods
and seNices rather than to make a profit. \II/hen successful.
co-operatives may rewaro their members ln a number of ways
including some share of any surplus made, but usually surpluses
are reinvested In the organisation.
• Non-profit organisations include clubs and societies that are
formeo by their members so that they can meet for particular activlties:
perhaps social or sporting activities. These organisations do not aim to
make a prom, but have to be financially viable In order to survive.
LINK
%
There is more detailed
information about accounting
for partnersr ips l'l Section 8
and acoounting for limited liability
companies, co-operatives and
non-proftt organisations in
Seciion 9.
SUMMARY QUESTIONS
1 . What ls an accounting
concept or convention?
Give one example to
illustrate your answer.
2. Llst the seouence of
activities that make up the
accounting cycle starting
with collecting source
documents.
3. Describe two different types
of business organisation.
Financial statements,
technology and
accounting
LEARNING OUTCOMES
In this unit yov will learn about:
• the main financial statements
prepared by various business
organisations
• the role and Impact
of technology on the
accounting process.
Financial statements
The main financial statements produceo by business organisations
are as follows:
• Income statement This records the profit or loss made by a
sole trader, partnership or limited company. comparing revenue
{income) with costs. In the case of partnerships and limited
liability companies, the Income statement is accompanied by an
appropriation account showing how profits are to be distributed.
• Income and expenditure account This records the surplus or
deficit made by a co-operative society.
• Statement of financial position (balance sheet) This sets out
for all organisations details of resources owneo by the organisation,
its liabilities and its net value. It helps identify the organisation's
ability to meet its commitments on lime, and also whether its
resources are being used efficiently.
• Cash flow statement This provides summarised details of the
inflows of cash and the outflows of cash during a financial period.
The statement gives users Information about some of the Important
decisions made by the owner{s) of a business and how they will
affect the business's cash funds during a financial period.
Technology and accounting
Nowadays accounting records are usually produced using electronic
systems and specialised accounting software packages. A wide
variety of these is available, including Sage, QuickBooks and
Microsoft Dynamics.
Their main features are described below.
Automatic processing
The computer operator extracts Information from source documents
and inputs the relevant data into the software program. The other
accounting processes are automatic: ledger accounts are updated
Instantly and trial balances and other financial statements can be
produced on demand.
Integration of functions
As VI/ell as the main financial records, most software packages will also
produce inventory records, generate documents such as invoices and
credit notes and. In some cases, produce payroll records.
Management information
Managers can often be provided with aoditional information to
help run the business. such as details of amounts due from credit
customers, analysed according to the age of the debt, i.e. the length
of time it has been outstanding.
Advantages and disadvantages of computerisation
The benelits and potential dravvbacks of computerised accounting
processes are summarised below:
Benefits
Potential drawbacks
Greater accuracy due to automation of
Capital expenditure: There could be a heavy initial outlay on
processes
compUier equipment and soflvvare programs; there is also likely 10
be the need to update at frequent Intervals.
Greater speed because updating and
Training costs: Staff will need support In using new equipment
calculations are carried out virtually
Instantaneously
and software programs. and skills will need updating from time
to time.
Easier access to information using
Risk of data loss: Systems can 'crash', arid security of data can
compuler software to find particular details
be a serious issue.
More information available to help with
Maintenance and support costs: Businesses have to invest in
management and decisicn making
technical suppcrt to ensure systems provide conllnual service.
Reduction in staffing costs may be
Period of transition: It is sensible to ruri old (manual) systems
possible because record keeping Is mainly
aulomatic
alongside new computerised systems at least for a time to ensure
that everyl),ing works as it should.
Additional functions
Computerised accounting systems can Include some uselul adoitional
functions, such as:
• Inventory control Inventor'/ records can be automatically updated
every time there Is a purchase ol goods, a sale ol goods, returns of
goods. etc.
• Credit control Computerised records of accounts receivable can
show how much is owed by each customer and for how long any
debt has been outstanding. This can help raise awareness of late
payers. Similarly, computeris~d records can be used to provide
details of amounts owed to credit suppliers, making it easier to
ensure that valuable cash discounts are not missed.
• Payroll Computer software programs can produce all the
necessary detailed information about wage and salary calculations,
payslips, payroll registers, etc.
• Management reports Soft1Jo1are programs can automatically
provide trial balances, income statements, statements of financial
position (balance sheets), ratio analysis and audit trails.
SUMMARY QUESTIONS
1. State the Importance of:
a. Income statements and
b. statements of financlal position (balance sheets)
to business organisations.
2. Why would you recommend a business switches to a
computerised accounting system? Descrtbe 1hree reasons
for doing so.
3. Give two reasons why some busine$ses choose not to have
a computerised accounting system.
The statement of financial
position (balance sheet)
LEARNING OUTCOMES
In 1his unit you will learn about:
The components of the statement of financial
position (balance sheet)
KEYTERMS
A statement of financial position (balance sheet) Is a financial
statement that gives some important information about a business 10
Its owner, manager, or other interested individuals. II can be prepared
at any point in lime, but the statement of financial position is always
prepared for the end of the financial period of a business. It gives
details of:
• assets - the resources owned by the business
• liabilities - the amounts owed by the business to other individuals,
businesses or organisations
• capital - the net value of the business, which also represents the
owner's investment in the business
• how total assets = total capital + total liabllllies.
Statement of financial
Typical assets for a small business include:
position (balance sheet):
a statement that shows an
organisation's assets, llabllitles
and capital at a particular date.
• cash at bank
• cash In hand
• land
• premises
• equipment
• fixtures and fittings
• inventory
• accounts receivable
• the components ot the
statement of 'inancial
position (balance sheet)
• exaMples of assets and
llabllltles
• how to construct a statement
of nnanclal position (balance
sheet).
Cash at bank: the amount
of funds In the bank current
account of a business.
Cash in hand: the amount
of cash - notes, coins, etc. kept on the premises of the
business.
Accounts receivable:
• vehicles
Typical liabilities for a small business Include:
• bank loans
• accounts payable
• bank overdraft
A simple balance sheet (statement of fi nancial
position)
amounts owed to a business
by customers.
The link between the assets, llabllltles and capllal ot a business Is
referred to as the accounting equation: Assets = Capital + Liabilities
Accounts payable: amounts
~Vhatever assets are owned by the business must have been
purchased v,tith finance supplied by the owner (capital) and by
external parties Uiabilities).
owed by a business to suppliers.
,-ILLUSTRATION 1 The accounting equation
Isaac opened a business called 'The VIiiage Stores· on 1 May
2019. On this date he invested $40 000 (his capital} and borrowed
$10 000 from the bank (a liability). So, at lhis date the business
will have total assets of $50 000. Here ls the accounting equation
using this Information:
Assets = Capital + Liabllilies
S50 000 = $40 000 + $ 10 000
A statement of financial position (balance sheet) shows a detailed lisl
of lhe assets and liabilities of a business as well as its capital. The
information shown is always for a particular dale.
/ ILLUSTRATION 2 A simple statement of financial position
(balance sheet)
Here is a statement of flnanc ial position (balance sheet) baseo on
lhe detail In Illustration 1 abool Isaac's business.
The VIiiage Stores
Statement of financial position
(balance sheet) at 1 M ay 2019
s
ASSETS
Furniture and fittings
Vehicle
Eqvipment
Inventory
Cash at bank
Cash in hand
CAPITAL
LIABILITIES
Bank loan
17 000
15000
8000
7 500
2000
500
50000
Note: this statement
of financial position
{balance sheet) has been
sel out In what is caJled
the vertical format, where
there Is just one details
column and one column
for entering values. This
format is now widely
used by businesses.
40000
10000
50000
Guidance on preparing a simple statement
of financ ial position (balance sheet)
• The title should include the name of the business, or, if this is not
available, the name of the owner.
• The heading should always be 'Statement of financial position at
(a particular date)' (or 'Balance sheet at (date)').
• Abbreviations should be avoided when preparing financial
statements such as a statement of financial posttion (balance sheet).
• Assets are shown first wtth their values clearly set out In a separate
column; the list starts with the subheading 'ASSETS',
• It is Important to set out figures carefully in a vertical list to make It
easy to calculate totals.
• The values for assets are totalled. In accounting a final total should
be double underlined.
• Capital and liabilities are shovvn next, in the second part of the
statement of financial position (balance sheet). Once again there
is a separate column for values. Subheadings 'CAPITAL' and
'LIABILITIES' are used.
• A total of the values for capital and liabilities is shown at the end of
the statement of financial position (balance sheet).
• The tolal of the assets must equal capilal + total liabilities.
SUMMARY QUESTIONS
1. What assets would you
expect to be owned by a
hotel?
2. Explain why the value of
the assets of a business is
always equal to the total of
its liabilities and capital.
3. State four rules to be
followed when preparing
a simple statement of
financial position (balance
sheet).
The classified statement
of financial position
{balance sheet)
LEARNING OUTCOMES
In this unit yov will learn about:
• non-current and current
assets
• non-current and current
liabilities
• preparing classified
statements of 'inanclal
position (balance sheets} in
order of permanence and In
order of liouioity.
Types of asset
Assets can be divided Into two categories:
Non-current assets: those assets tha1 a business intends to
keep and make use of for a long period (more than one year).
Typical examples of non-current assets are: premises, machinery,
equipment, furniture, fixtures, fittings and vehicles.
Current assets: those assets that are freo,uently changing in value;
they are assets that are quickly turneo into cash and are of benefit to
the business for a short period of time (less than one year}. Typical
examples of current assets Include inventories, accounts receivable,
cash at bank and cash in hand.
Types of liability
KEY TERMS
Liabilities can also be divided Into two categories:
Non-current asset: a resource
Non-current liabilities: amounts owed that will be settled in the
owned by a business that will
be of benefit for a long pertod
(more than one year),
Current asset: a resource
owned by a business that •..viii
be of short-term benefit (less
than one year}.
Non-current liability: a liability
that will be settled in the longer
term (more than one year).
Current liability: amounts
longer term (more than one year}. A typical example of a long-term
liability is a bank loan (bank loans are normally repayable over a
number of years).
Current liabilities: amounts owed that will be settled in the shorter
term (less than one year). Typical examples of current liabilities
include accounts payable and bank overdrafts.
Preparing a classified statement of fi nancial
position (balance sheet)
The presentation of a simple statement of financial position (balance
sheet} can be improved by setting out the details to show the
different categories of asset and liability.
owed by a business that will
be settled in the shorter term
(within one year).
Assets are normally shown in an order that reflects how long each
asset is expected to benefi1 the business. This is called order of
Order of permanence: the
permanence:
sequence used to list items on
a statement of 1inancial position
(balance sheet) beginning wtth
Items likely to be used by the
business for the longest period.
• In the first part of the statement of financial position (balance sheet}
non-current assets are recorded first, starting with premises.
Order of liquidity: the
• In the second part of the statement of financial position (balance
sheet} capital precedes non-current liabilities; current liabilities are
placed last.
sequence used lo list Hems on
a statement of financial position
(balance sheet) beginning wtth
cash ano ending with the Items
least likely to be turneo
Into cash.
• Current assets are recorded next in the order: inventories,
accounts receivable, cash at bank and cash in hand.
/
Preparing a classified statement ol
ILLUSTRATION 1 financial position (balance sheet) in order
oi permanence
Hightown Retail Store
Statement of financial position (balance sheet)
at 30 September 2019
s
$
NON-CURRENT ASSETS
Shop premises
Fixtures and littings
Equipment
50000
9000
7000
66000
CURRENT ASSETS
Inventories
Accounts receivable
Cash al bank
Cash in hand
6200
700
3400
200
10 500
76500
CAPITAL
62000
NON-CURRENT UABILl1Y
Bank loan
10 000
CURRENT LIABILITIES
Accounts payable
DID YOU KNOW?
Alternative format
terns in a classttied statement
of financial position (balance
sheet) can be recorded in
order of liquidity, where
assets that are alreaoy In the
form o' money are placed first
and assets that are the least
likely to become money in the
near future are placed last.
For example, current assets
will precede non-current
assets and should start with
cash in hand ano finish wtth
inventories. In other words the
complete reverse of the order of
permanence. In the second part
of the statement of financial
position (balance sheet) current
liabilities precede non-current
liabilities; capital is placed last.
4 500
76500
SUMMARY QUESTIONS
Guidance on preparing a classified statement
of fi nancial position (balance sheet)
1. Explain the difference
betv,1een:
• Have two money columns in each part of the statement ol financial
position (balance sheet).
a . a non-current asset and
a current asset
• Use the terms 'non-current assets', 'current assets', etc. as
subheadings.
b. a non-current liability
and a current liability.
• Use the first money column for the detail and the second money
column for the subtotals. Rule a subtotal line (a single line) in the
lirst money column in these situations, ano rule a double line below
the total In the second money column.
• When using the order of permanence. non-current assets start with
land and/or premises; other non-current assets are placed in the
order of their value.
2. What is meant by the terms
·order of permanence· and
·order of tiouloity' when
preparing a classified
statement of ' inancial
position (balance sheet)?
3. What is the correct order
of current assets when
preparing a statement
of financial position
{balance sheet) in order of
permanence?
The effect of
transactions on the
statement of financial
position (balance sheet)
LEARNING OUTCOMES
In this unit you will learn about:
• cash and creoit transactions
• how transactions affect the
accounting equation
• how to record transactions
using statements of financial
position (balance sheets).
A transaction is a financial activity or event. Each transaction has two
effects and this idea ls the foundation of what is usually calleo the
double-entry accounting system.
Transactions can be divided into t\lvo categories:
Cash transactions: that involve the immediate use of money
affecting either cash in hand or cash at bank.
Credit transactions: where the payment er receipt cf money Is
delayec until a later date affecting the amount owed to suppliers
(accounts payable) or owed by customers {accounts receivable).
ILLUSTRATION 1 Example of the twofold effect of a transaction
Here are some examples of everyday transactions that could affect a small business. In each example,
the tv1ofold effect of 1he transaction is stated.
Transaction
Purchased some equipment and paid by cheque
One of the effects ls:
Equipment Increases
The other effect Is:
Cash at bank decreases
Purchased a vehicle en credit
The owner inveS1ed more casn in the business
Vehicles Increase
Cash (in hand or at
bank) increases
Cash in hand Increases
Cash at bank decreases
Cash at bank decreases
Accounts payable increases
Capital increases
Sold some unwanted furniiure for cash
Paid a credit supplier an amount due by cheque
The owner withdrew a cheque for private use
KEY TERMS
Cash transaction: a financial
actlvity Involving the use of
money.
Credit transaction: a financial
activity where the payment or
receipt of money Is delayeo.
LINK
The process of recording
transactions and tr.a rules of
double entry are developed
fur.her In Sections 3 and 4.
%
Furniture decreases
Aocounts payable decreases
Capital decreases
Every time a transaction occurs it is possible to work out its effect on
the statement of financial position (balance sheet) of a business. This
process is the simplest way of recording transactions. It Is Important
to realise:
• each transaction affects tvvo statement of financial position
(balance sheet) items
• after the effect of the transaction has been recorded the
accounting equation should still hold true, i.e. total assets equal
total liabilities and capital.
Guidance on recording transactions using the
statement of financial position (balance sheet)
• For each transaction, Identify the two items that will be affected
{note that various combinations of assets, assets and liabilities,
assets and capital are possible).
• For each Item, decide whether its value will increase or decrease
when the transaction occurs.
• Prepare a nev, statement of 11nancial position {balance sheet)
and check that the totals still agree
the accounting equation
still holds}. If the statement of financial position (balance sheet}
totals do not agree a mistake must have been made, and it will be
necessary to check the changes that you have made.
o.e.
,, ILLUSTRATIO N 2 The effects of transac1lons on statement of financial position (balance sheet) Items
Faye has Just opened a business.
Her first statement of financial
position (balance sheet} is as
follows:
Transaction 1: Faye purchased
Transaction 2: Faye repaid
some additional equipment and
$1 ooo of the bank loan by
paid by cheque S3 000. The
cheque.
changes have been shown In bold.
Statement of financial
position (balance sheet)
at 1 March 2019
Statement of financial
position (balance sheet)
after Transaction 1
Statement of financial
position (balance sheet)
after Transaction 2
$
$
$
15 000
Equipment
Vehicle
25000
15 000
Cash at bank
2 000
Cash at bank
1 000
Cash in hand
1 000
43000
Cash In hand
1 000
42000
35000
Capltal
35000
Capital
35000
8000
43000
Bank loan
8000
43000
Bank loan
7 000
Equipment
Vehicle
Cash at bank
Cash in hand
22000
15 000
5000
1 000
43000
Capital
Bank loan
Equipment
25000
Vehicle
Transaction 3 : Faye lnvestoo
Transaction 4 : Faye purchased
a further $6 000 in her business
from her private funds. This
amount was paid Into the bank
account of the business.
some additional equipment
on credit. The amount due is
$4 000.
Statement of financial
position (balance sheet)
after Transaction 3
Statement of financial
position (balance sheet)
after Transaction 4
$
$
Equipment
29000
Equipment
Vehicle
25000
15000
Cash at bank
7 000
Vehicle
Cash at bank
Cash In hand
Cash In hand
1 000
48000
15 000
7000
1 000
52000
Capttal
41 000
Capital
41 000
Bank loan
7000
Bank loan
7000
48000
Account payable
4000
52000
For each transaction notice how two ttems change and how the
accounting equation always holds true.
42 000
am ·•·•
•l••"'iil,ll•"'""~·. ,
1. \/\/hat is the difference
between a cash transaction
and a crecm transaction?
2 . Give one example of a
transaction that affects only
assets on the statement oi
financial position {balance
sheet) o' a business.
3 . Give one example of a
transaction that affects
an asset and a liability on
the statement of financial
position (balance sheet) of
a business.
4. Give one example of a
transaction that affects
an asset anci capital on
the statement of financial
position (balance sheet) o'
a business.
/
Practice exam questions
Paper2
a Calculate the 1otal value of assets.
1 lden:lfying assets, liabillties and capital
Here is a fist of assets and liabilities and
references to capital. Read 1nrough the list and
Identify whicn Items are assets. liabilities. capital.
a motor vehicle
b cash in hand
c bank loan
b
c
d
4 Preparing a classr.led statement of financial
position (balance sheet)
d owner's inve~men1 In ihe business
e acco1.1n1s payable
f machinery
g accoun1 receivable
h bank overdraft
Nisha owns tne 'Take a Break Caf$'.
On 31 August 20191ne assets and tiabillt1es
of the business were as follows:
$
Bank overdraft
Bank loan (repayable 2025)
Cale prem ses
Cash nhand
Equipment
Fixtures and fittings
lnvehtory
Accounts oayable
2 Using the accounting equation
The following table shows details aboJt some
businesses' total assets, liabilities and capita!.
Use the accoun11ng equation to find the missing
figure In each case.
Total
assets
Capital
Assets
= Capital
$
Business A
Business B
BusinessC
72000
160000
$
Total
liabilities
T
Uabilities
$
13000
124 000
160000
c
36000
3 Preparing simple Statements of financial position
(balance sheets)
Avlanne opened a business selling beachwear
on 1 June 2019. The assets and liabilities of 1he
business on that date were as follows:
Bank loan
Cash at bank
Cash In hand
Fixtures and flit ngs
Inventory
Shop prem ses
Accounts payab'e
12 000
4 500
1 300
11 900
8300
65000
4 100
300
7 500
72 000
200
8 900
6 300
1 900
800
a Cal01,late the 101a1 value of assets.
b Calculate the 101a1 value of liabilltles.
d
$
Caloolate the 101al value of liablllties.
Use the accounting equa1iqn to calculate the
capital o' tne busir.ess.
Prepare a simple s1atement of financial
position (balance sheet) at 1 June 2019.
e
Use the accounting equation to calculate tne
capital ot 1;-,e busiress.
Prepare a classi'ied statemen1 of financial
position (balance sheet) at 31 August 2019
setting out the informa11on In order
of permanence.
Prepare a classl'ied statemen1 of fir.ancial
position (balance sheet) at 31 August 2019
setting out tne Information In order of llquidtty.
5 Recording :ransactions using the statement of
financial position (balance sheet)
Seema operied a business on 1 January 2019.
The first s;atement of financial posnion (balance
sheet) of her business was as follows:
statement of financial position
(balance sheet} at 1 January 2019
Statement of financial position
(balance sheet) at 2 October 2019
$
Premises
Cash a1 bank
$
75 000
5 000
80 000
Furnitu<e
Cash at bank
15000
5000
20000
80 000
Capital
Bank loan
16000
"000
20000
The following transactions occurred during the
first few days the business was In operation.
Jan
2
Purchased equ pmem a~d paid by
cheque $3 ooo.
3
Purchased turn !lure and fittings on
credit. The amount due was $8 400.
4
Arranged a bank loan fo< S10 000.
Funds were transferred Into the bank
account of the business.
5
Seema withdrew a cheque for $500
for private use.
6
Paid the credit supp'ler $5 000 by
cheque.
Prepare simple statements of financial position
(balance sheets) to record each of these
transactions.
6 Identifying transactions from a seq.,ence of
statements of 'inancial pos ltion (balance sheels)
Here Is a succession of Statements of financial
position (balance sheets) for a smell business
that opened on 1 October 2019.
statement of financial posit ion
(balance sheet) at 1 October 2019
$
Fumltvre
Cash a1 bank
12 000
8 000
20 000
Caphal
Bank loan
16 000
4 000
20 000
Statement of financial position
(balance sheet) at 3 October 2019
$
Furnltu'e
Cash at bank
15000
"000
19000
Capital
Bank loan
16000
3000
19000
Statement of financial position
(balance sheet) at 4 October 2019
$
Furnllu'e
Cash at bank
15000
3000
18000
Capital
Bank loan
15000
3000
18000
S1artif'9 wrth tne statement of firancial position
(balance sheet) on 2 October 2019, compare
each statement with the previous one and
identify the transactions that must have
occurred on 2, 3 and 4 October 2019.
Introduction
LEARNING OUTCOMES
In this unit yov will learn about!
• the uses of books of original
entry
• cash and credit transactions
• source documents related to
books of original entry.
The books of original entry
In the double-entry system of bookkeeping an transactions must
first be recorded in books of original entry. There are seven books of
original entry and details about transactions are listed in these books
in date order. The books of original entry are then used as the source
for all details shown In the ledger accounts, which you will learn more
about In Section 4. In some cases, the books of original entry provide
totals, reducing both the time needed to make en tries in the ledger
accounts and the volume of detail shown In them.
Book of original entry
Transactions recorded
Alternative names
Purchases book
Purchases on credtt of goods for resale
Purchases day book or purer>ases
journal
Sales book
Sales on credit of goods
Sales day book or sales journal
Returns outwards book
Returns of goods previously purchased on credit
Purchases returns day book or
purchases returns journal
Returns Inwards book
Relums ol goods previously sold on credtt
Sales returns day book or sales
returns journal
Cash book
Receipts and payments affectirg cash In hand
and cash at bank
Perty cash book
Cash payments of small value
General journal
Transactions that cannoi be recorded in the
other books of original entry
Cash and credit transactions
Cash transactions involve the immediate receipt or payment of money.
These transactions could make use of cash (i.e. notes and coins),
cheques. debit cards or credtt cards, and may take place online.
Credit transactions are those where the receipt or the payment is
delayeo. So, a purchase of goods on credtt means that the goods
are received, but the payment takes place at some later date.
Meanwhile, the business has to keep a record of the amount owing
to the supplier: the account payable. Similarly, a sale of goods on
credit means that goods are sent to a customer, bu1 the customer
pays at a later date. Meanwhile, the business will keep a record of
the amount owed by the customer: the account receivable.
Source documents related to books of original entry
Source documents need to be stored caretully as they provioe
evidence that a transaction has occurred. Every entry in the
accounting system should be traceable to them.
When a source document is receiveo or issued, key information is
extracted from the document and recorded in one of the books ol
original entry.
Book of original entry
Source document
Notes
Purchases book
Invoice received from a
supplier
Usually referred to as a 'purchase invoice'. used to
make entries in the purchases book
Sales bock
Invoice issued to a
cwstomer
Usually referred to as a 'sales invoice', oopy used to
make entries in the sales book
Returns outwards book
Credit note received from
a supplier
Used lo make entries In the returns outwards book
Returns inwards book
Credit note issued to a
cus tomer
Copy used to make entries in the re,ums inwards book
Cash book (receipts)
Cash regiS1er tapes or till
rolls
Provide de'.ails of cash sales
Cash receipts
Copies used to make entries for ,he receipt of cash
Paying-in slip counterfoils
Provide evidence that cash, cheques, etc., have been
paid into tne bank account of tne business
Bank statements
Provide evidence that money has been transferred
directly into the bank account of the business (e.g. a
costomer settling their account by means of a credit
transfer)
Cash book (payments)
Cash recelpis or vouchers Provide evidence that cash was paid (e.g. a cash
receipt from a cash register when making a purchase.
The signature of the recipient is usually shown on
vouchers as proof of receipt of the funds.)
Cheque counterfoils
For paymenis from the bank account
Bank statements
For details about bank charges and payments made
using direct debit and standing order facilities
Petty cash book
Pe1ty cash vouch<lr
Records details of payments made in petty cash should have cash receipts for tr e expenditure attached
General journal
Range of documents
Notes, letters and emails, which could be internal
including Invoice for 1he
documents (e.g. written by 1he owner) or received from
purchase of a non-current olher businesses and organisations
asset, notes, emails
SUMMARY QUESTIONS
KEY TERM
1. Identify the books of original entry that record creoit transactions.
Source document: a written
2. List three source documents that could be used for making
entries for cash and bank payments.
3. Which transaction is shown on a credit note received from a
supplier?
record that provides Information
'rom \Nhich ac001,.1nts can be
prepared. Source documents
provioe evidence that a particular
transaction tool< place.
Preparing source
documents; discounts
LEARNING OUTCOMES
In this unit yov will learn about:
• preparing source documents
• transaction descriptions
Preparing source documents
Source documents record a lot of detailed information about
transactions. Here are some examples of the details that need to be
included (some of which may already be printed on the document).
Document
• distinguishing between trade
and cash discounts
• distinguishing between
discounts allowed and
discounts received
• using source documents
to recoro Information In the
books of original entry.
Details
• Name and address of supplier {preprinted)
• Name and address of cuS1omer
• Date of transaction
• Invoice number
Sales invoice
• Terms of payment (preprinted)
• Details of each product being supplied (quantity,
description, untt price, total price)
• Deduction of any trade discount
• Total amount due
Cheque:
• Date
• Name of payee (individual/organisation being
paid)
• Amoant in words
Cheque
and cheque
counterfoil
• Amount in figures
• Signature of person authorised to make
payment (payer)
• Cheque number (preprinted)
Cheque counterfoil:
• Date
• Payee
• Amount in figures
• Date
• Number
Petty cash
voucher
• Description of ttems paid for
• Amount paid
• Signature of petty cashier
• Signature of person being reimbursed
Transaction descriptions
In orCler to make entries In the accounting system it is necessary to
extract the right Information from each source document. For each
entry the following details will be required:
• date of source document
• any number or reference that will identify the document
• the name of the supplier/customer where personal accounts
will be involved
KEY TERMS
• the nature of the transaction
Trade discount; a reouction in
• the amount of the transaction.
1he price given as a reward for
buying in large quantities.
Trade discount
Cash discount: a reduction
Many businesses are able to obtain a trade discount. This is a
reduction in the unit price of items purchased for resale. However,
the following conditions must be met:
in the amount paid by creoit
customers as a reward for
settling the amount due within
an agreed time limit.
• The businesses must be engaged In the same line of activity.
• A large order must be placed.
Trade discounts are not normaJly avallable to private individuals.
Cash discount
A cash discount is an incentive that a seller offers to a buyer for
settling the invoice Immediately on delivery or for paying a bill owed
before the scheduled due date. Prompt settlement of amounts due
by customers can be critical tor many businesses in ensuring they
have sufficient cash resources.
Discounts allowed and discounts rece ived
• A discount allowed occurs when a customer takes advantage of
cash discount terms. Discounts allowed are given to the customers
of a company so as to Induce those who owe money 10 settle
within a time specified by the company. Discounts allowed benefit
a business because cash resources are received earlier than
anticipated. Customers pay less than the amount owed, therefore
discounts allowed are a reduction in revenue for the business and
are recorded as an expense in the income statement.
• A discount received occurs when a business takes advantage
of cash discount terms offered by a supplier. The buyer of good or
services is granted a discount by the seller. Discounts received are
a reduction In the expense associated with the purchase and are
recorded as income in the income statement of the business.
Discount allowed: cash
discount given to a credit
customer for settling their
account within an agreed time
limit.
Discount received: cash
discount given by a credit
supplier whose account has
been settled within an agreed
time limit.
.-
.
1. Identify the Information that
must be extracted from a
source document In order
to make entries in a book of
original entry.
2 . Explain how a trade
discount differs from a cash
discount.
3 . State one benefit and one
disadvantage of a discount
allowed.
Using source documents
to make entries in the
purchases and sales books
As seen in Un t 3.1. all 1ransactl0l'ISare
firsl tecorde::l ma boo~ of onglnal ent,y or
journal. This unrt wi I look at two of these
in partocular. the ourchases book and the
sares bcok.
LEARNING OUTCOMES
Preparing a purchases book
A purchases book is a record of credit purchases of goods
that are to be resold by a business. It records the follo\lvlng details
concerning these transactions:
Transaction date
Name of supplier
Purchase Invoice
Amount
number
s
In this unit you will learn about:
• using source documents
to make entries into the
purchases and sales books.
KEY TERMS
Purchases book: tli e book of
original entry used to make the
first recoro In an accounting
system oi purchases on credit
of gooos for resale.
Sales book: the book of
original entry used to make the
first recoro In an accounting
system oi sales on credit of
goods in which a business
trades.
The source documents for these entries are the purchase invoices
received from suppliers. The book Is maintained In date order and is
totalled at appropriate Intervals; this could be weekly or monthly, for
example, depenoing on the volume of business.
It is important to note that:
• cash purchases are recorded in the cash book (see Untt 3.5)
• purchases of non-current assets on credit are recorded In the
general Journal (see Unit 3. 7).
Preparing a sales book
A sales book is a record of credit sales of goods in which the business
trades. It recoros the following details concerning these transactions:
Transaction date
Name of customer
Sa/es invoice
number
Amount
s
The source documents for these entries are the sales invoices
Issued by the business and sent to Its credit customers. The book is
maintained In da1e order and Is totalled at appropriate Intervals.
It is important to note that:
• cash sales are recorded In the cash book (see Unit 3.5)
• sales of non-current assets on credtt are recorded in the general
journal (see Untt 3. 7).
Trade discounts and the purchases and sales books
Where a trade discount has been given by a supplier or to a
customer, only the net amount due Is recorded In the books of
original entry. In other words, no record is made in an accounting
system of the actual amount ot the trade discount. It Is the amount to
be paid that matters.
" ILLUSTRATION 1 Preparing a purchases book and sales bock
Navin owns 'IJVheels', a wholesale business selling cycles
and cycle accessories. During June 2019, Navin received the
following purchase invoices from his suppflers.
June 7 Speed Cycles Ltd, Invoice number 74536, for goods,
total value $1 480
June 16 JKD Manufacturers Ltd, Invoice number 84962, for
goods at 11st price $3 200 less 25% trade discount
Here is the purchases bock for June showing these details:
Pages
PURCHASES BOOK
Date
June
Sunntler
7 Soeed Cvcles Ltd
16 JKD Manufacturers Ltd
Tctal purchases
Invoice
number
Folio
74536
84962
Amount
due
$
1 480
2400
3880
During June 2019, Navin issued the following invoices to credit
customers.
June 11 Bestbuy Retail Stores, sales invoice number 2771. ior
goods at list price $1 2<10 less 15% trade discount
June 23 Bike Base, sales invoice number 2772, for gocds at list
price $2 280 less 20% trade discount
Here is the sales book for June showing these details:
Pa,e 12
SALES BOOK
Date
Customer
LINK
Invoice
Amount
number Folio
due
$
Ju~e
11 BeSibuy Retail &.ores
23 Bike Base
Total sales
2771
2772
1 054
1 824
2 878
Additional note:
The expression 'list price' is a reference to the normal selling
price of a product as shown, for example, in the catalogue of
the business. List price ls the price before deducting any trade
discount.
The oetails shown in the purchases book and sales book are used
to make the double-entry records in the ledger account. It is when
these double-entry records are made that entries are made in the
folio column of the Journal.
%
The procedures ior double entry
are covered in Section 4.
SUMMARY QUESTIONS
1 . Not all purchases are
shown in a purchases
book. Which purchases
are shown and which
purchases are not shown?
2. How Is trade discount
treated when preparing
accounting records?
3. A business sold goods on
credit with a list price of
S2 700 less a 20% trade
discount. How much should
be recorded in the sales
book for this transaction?
2'1'.
The returns outwards and
returns inwards books
LEARNING OUTCOMES
Introduction
In this unit yov will learn about:
Goods are returned to their supplier for a number of reasons, tor
example:
• using source documents
to make entries into the
purchases and sales returns
books
• the role o' oebit notes.
• goods were found to be damaged on receipt
• the wrong goods •,vere sent out by the supplier
• goods were received too late so that the ·sell by' date had been
exceeded.
Credit notes
KEY TERMS
Credit note: document useo
to recor<i the amount to be
deducted when goods are
returned.
Returns outwards book: a
bOok of original entry listing
all gooos returned to credit
suppliers.
Returns inwards book: a
book of original entry listing
all goods returned by credit
customers.
Debit note: document used to
record details of goods being
returnee to a supplier and the
amount to be deducted from
the total due.
DID YOU KNOW?
Debit notes are not often
encountered. As well as
being issued to prompt the
receipt of a credit note, they
are sometimes issued by
a business to correct an
undercharge on an Invoice
issued to a customer.
The most commonly used source document for returns is a credit
note. Credit notes are used in the following ways:
• Returns outwards book: goods returned to a supplier that were
previously purchased on credit. In this case a business returns
goods to the supplier and then receives a credit note from the
supplier stating how much can be deducted from the amount due
as shown on the purchase Invoice. The credit notes received are
used to prepare the returns outwards bock.
• Returns inwards book: goods returned by a customer that were
previously sold to that customer on credit. In this case the business
selling the goods would send a credit note to the customer stating
how much can be deducted from the amount due as shown on the
sales invoice. Copies of the credit notes sent are used to prepare
the returns Inwards book.
If a trade discount had been applied to the goods tha1 are being
returned. the same rate of trade discount will be deducted when
preparing the credit note.
Credit notes are also issued if an amount charged on an Invoice Is
overstated in error and needs to be reduced. The amount shown on
the credit note corrects the error.
Debit notes
Just occasionally a debit note could be used as evidence of returns.
This occurs when a business has receiveo faulty goods and Issues a
debt! note to the supplier to request a reduction in the amount due.
Normally, however, In this situation no entries are made In the books
of account of the business until a credit note Is received from the
supplier. In other words, the credit note is the key source document.
A business might receive a debit note from a customer who is
returning goods. The business would use the debit note to make
entrtes In its returns Inwards book.
Summary: source documents and returns
Transaction to be recorded In the accounts
of a business
Returns outwards
Returns inwards
M ost commonly used
source document
The bvslness re1urns goods to a
supplier
A customer returns goods to the
business
Book of orlglnal entry
Credit note received from
Returns outwards
the supplier
book
Copy of credit note issued to
Returns inwards book
the customer
Preparing returns books
Returns books are the 1irst record in the accounting system 01 details shown on credit notes.
The process is similar to that 1or the purchases and sales books (see Unit 3.3).
• Returns books list details in date
order.
ILLUSTRATION 1 Preparing returns books
Sophia owns a wholesale business. During March 2019 the
follovving transactions occurred:
March 8 Returned damaged goods to a supplier, BTL
Manufacturing, and received a credit note
(number 473) for $780
13 Issued a credit note (number B83) to Rockport
Retail Ud tor goods returned by this customer, $370
20 Returned faulty goods to PCP Ud, which had a
11st price of $600 but on which a trade oiscount of
25% had been deducted, and received a credit note
(number T1007) for $450
27 Issued a credit note (number B84) to Trent Stores
Ltd, for goods 11,at had been sold at a list price of
$960 less a Ira de discount of 20%
Here are the returns outwards book and returns inwards book
recording these transactions.
RETURNS OUTWARDS BOOK
Date
March
Supplier
Credit
note
number
Date
Customer
March 13 Rockport Retail Ltd
27 Trent Stores Ltd
Total returns Inwards
Credit
note
number
883
884
• The entrtes are totalled at regular
Intervals.
• Only returns on goods previously
purchased or sold on credit are
recoro'ed.
• The details are used to make
double-entry records In the !eager
accounts of the business.
• The folio columns are completed
(with a reference to the ledger and
the account number} when the
details are posted to the ledger
accounts.
Page3
Folio
Amount
due
473
8 BTL Manufacturing
20 PCP Ltd
T1007
Total re1urns outwards
RETURNS INWARDS BOOK
• The amount of the return is
shown net of any trade discount.
$
LINK
('~
780
450
1 230
In Section 4, Unit 4 .4 you will be
shown how to post in'ormation
from returns books to ledger
acCOU'l!S.
Page4
SUMMARY QUESTIONS
Folio
Amount
due
s
1. Give two reasons v,hy a
business may need to issue
a credit note to a customer.
370
768
1 138
2. Explain the process that
leads to the ~ceipt of a
credit note from a supplier.
The three-column
cash book
LEARNING OUTCOMES
In this unit yov will learn about:
• using source documents to
make entries in a cash book
• how 10 prepare a threecolumn cash book.
KEY TERM
Contra entry: the record In the
cash book of cash transferred
to the bank, or cash •,vithdrawn
from the bank. Contra entries
are Indicated by a letter 'O' In
the folio column.
The book of original entry used for recording cash transactions
is called the cash book. Like all bocks of original entry. it records
informalion taken from source documents and sets transactions out
in date order for posting to the ledger accounts.
A three-column cash book Includes columns to record receipts
and payments affecting both the cash and bank accounts of the
business, as well as additional columns to record cash discounts.
The oiscount columns are not part of the double-entry record of cash
discounts: they are simply a convenient place for the first record of
any discount involved In a transaction by the cashier. \The cashier
is the one member of the accounts team who knows whether a
cash discount has been claimed and given.) Discount columns
are an example of \Vhat Is often referred to as a 'memorandum'
accounting record. 'Memorandum' means a note of something to be
remembereo.
A cash book is both a book of original entry and also a ledger for the
two accounts, cash and bank.
ILLUSTRATION 1 Preparing a three-column cash book
Anita owns a retail business. Her suppliers offer a cash discount for prompt payment, and she offers her
credit customers a cash discount if they settle their accounts promptly. Her accounting system includes
a three-column cash book. On 1 September 2019, page 11 of her cash book showeo opening balances
of $635 cash in hand and $4 838 cash at bank. During the first week of September the following
transactions occurred:
Date
Sept
Source document
Transaction
1
Cheque counterfoil
Payment of supplier, MNH Supplies, $1 140 in full settlement of the
amount due, S1 200
2
Paying-in slip ooumerfol I
Cheque received from credit customer, K Anson, 'or $780, in full
settlement of the amount due, $800
3
Cash receipt In respect of
sundry purchases
Payment for general expe1JSes, $82
4
Bank statement
Bank charges for the month tolalling $73
5
Cash regiSler roll
Cash sales of $1 884
6
Paying-in slip oounlerfoi I
Cheque received from credit customer, Leo Adams. Leo Adams
owed $1 200 at tnis date. The cheque was in full settlement of this
amount less a 2.5% cash discount.
7
Cheque counterfoil
Payment of supplier, Island Traders Ltd. This company was owed
$2 600 on this date. The account was settled In full less a 5% cash
discount
8
Paying-In slip oounterfol I
Cash banked, $1 500
(Continued)
,, ILLUSTRATION 1 Preparing a three-column cash book (Continued)
Here is the three-column cash book recording this information.
Dr
Page 11
CASH BOOK
Discount
Folio a llowed
$
Sept 1 Balances bid
2 K Anson
20
5 Sales
6 Leo
Adams
7 Cash
30
C
Cr
Discount
Cash
Bank
Folio received Cash Bank
$
$
$
$
$
635 4838 Sep1 1 MNH
Supplies
780
3 General
expenses
4 Bank
1 884
charges
1 170
7 Island
Traders
L1d
1 500
7 Bank
C
50
1 140
60
82
73
130
2 470
1 500
190
Notes:
1. The discount allowed column appears on the left-hand side of the cash book as it needs to be
alongside the columns where money received from creolt customers Is recorded.
2. The discount received column appears on the right-hand side of the cash book as it needs to be
alongside the columns wl1ere payments to creoit suppliers are recorded.
3. Discount columns are totalled at regular intervals. These totals are used to update the discount
accounts in the general ledger.
a. The transactions Involving discounts are presented In two different ways: on 1 and 2 September the
amount of the paymenvreceipt and the amount of the discount are given - there are no calculations
involved; on 6 and 7 September, however, the amount of the discount and the amount actually paid/
received have to be calculated.
5. When cash is transferred to the bank (as on 7 September) or cash withorawn from the bank, the
complete double entry for the transaction Is recorded within lhe cash book. To Indicate that this has
happened a C (for contra entry) is entered in the folio column.
6. As usual, the folio column entries are made when Information is posted to ledger accounts; the
exception Is the contra entry on 7 September.
SUMMARY QUESTIONS
1, What is the purpose of the additional columns in a threecolumn cash book?
2. Some of the entries In a three-column cash book are
'memorandum reccrds'. Explain what this term means.
3. Explain when It Is correc1 to enter a letter •c· In lhe folio
columns of a cash book for certain transactions.
LINK
%
Section 4, Unit 4.2 shows how to
post in/orma1ion fyom a threecolumn oash book to tne ledger
accounts, including the discount
accoums.
The petty cash book
LEARNING OUTCOMES
In this unit yov will learn about:
• using source documents to
make entries in a petty cash
book
• preparing a petty cash book.
KEY TERMS
Imprest: a system for petty
cash payments, where a float is
provided to control expenditure
over a given period.
Petty cash voucher: the
$ource document for each petty
cash payment.
In some businesses a separate book of original entry is used to
record small payments in cash. The Idea is to ensure that the main
cash book is not overburdened with the details of what may be
regarded as less Important transactions.
Source documents for petty cash transactions
Responsibility tor keeping the petty cash book is often given to a
more Junior member of staff, and there is usually a strict control on
how petty cash payments are made. Many businesses operate what
is called the im prest system, which works as follows:
• The petty cashier is given responsibility for a maximum amount of
petty cash at any time. This maximum amount Is called the petty
cash float or imprest. The size of the imprest is decided by the
owner or manager of the business. The imprest is set at a level
sufficient to cover petty cash payments for an agreed period of
time. often a month.
• There is often an agreement that petty cash will be used to cover
expenoiture below a particular amount, for example $25. Payments
higher than this amount will be made by the cashier and recorded
ln the three-column cash book rather than by the petty cashier.
• For many transactions the petty cashier will be required to repay an
employee for cash spent on behalf of the business. Whatever the
petty cash transaction. the petty cashier will ensure that a petty
cash voucher is completed and that a receipt or other proof of
payment is attached to the voucher.
ILLUSTRATION 1 A petty cash voucher
Here is an example of a petty cash voucher. tt shows that an employee (Mark Jones) has been repaid for
paying for some postage on behalf of the business.
r,-;;r,r\'7'S",.....,~'7"S'":-ccTr17"'7',.-.r'l"'T'r7':.,....,,...,..,"""".,.._..:-c-i •
Numbe( 178
PETTY CASH VOUCHER
Amount
Item
Reoelv&cJby
$
Lisa Watson Is the petty cashier. She signs 1he
petty cash voucher to confirm tha1 she has
paid out $18.23.
• Mark Jones signs the petty cash voucher to
confirm that he has received $18.23.
• Lisa will attach a receipt, supplied by Mark, for
the amount paid tor the postage. The receipt
Is proof that the payment was made for a valid
reason.
• Petty cash vouchers are numbered. In 1he
example the petty cash voucher Is number
178. Petty cash vouchers usually come in a
pad and are numbered consecutively.
Preparing a petty cash book
A petty cash book is made up of two Important features:
• The first few columns operate as a simple cash account. recording
the amount received (the Imprest) and the payments made with a
record of the relevant petty cash voucher number.
%
LINK
• Additional columns are used to analyse petty cash payments.
The analysis columns are used to arrive at totals for different
categories of payment. The categories are chosen to reflect the
types of payment made by the business. Payments are mostly for
expenses. but occasionally it may be necessary to settle a small
amount due to an account payable.
There Is more on posting
petty cash totals to 1l'e ledger
accounts, including adding folio
references, in Section 4. Unit 4.2.
ILLUSTRATION 2 A petty cash book
Here is a page from the petty cash book of a business.
PETTY CASH BOOK
Receipts Date
Details
Voucher Payments Cleaning
$
200.00
$
Aug
Page6
General
Purchase
Postage expenses ledger
Folio
$
$
$
$
1 Cheque
4 Postage
178
18.23
7 General
expenses
179
26.29
14 Cleaning
180
38.80
19 Pos!age
181
11.43
24 Cleaning
182
37.22
183
33.18
18.23
2629
38.80
11 .43
37.22
29 Supplier
(TXQ Ud)
165.15
33 18
76.02
29.66
26.29
33 18
Every time a payment Is made the amount is recorded twice: once in the paymen1 column and a second time
In the relevant analysls oolumn.
Notes:
1. The transaction on 29 August is an example of petty cash being
used to settle an account payable (in this case 1XO Ltd). The
analysis column heaoing tor this transaction is 'Purchase ledger',
since this Is where the supplier's personal account is recorded.
2. At regular intervals, the payments column is subtotalied. {In this
case the subtotal is $165.15.)
3. At the same tlme, the analysis columns are totalled. These
totals will be posteo to the relevant accounts in the ledger of the
business.
Folio references are added when the double entry for transactions
is completed.
SUMMARY QUESTIONS
1. Many businesses operate
the imprest system of petty
cash. Describe the main
features of the Imprest
system.
2. tdenH!y the main items
of Information that can
be touno on a petty cash
voucher.
3. Explain the purpose of the
analysis columns used In a
petty cash book?
The general journal
Sp ecial note: entrie.S In the general
journal require a good 1.mdetStent:1ing of
the rules of double-entry bookkeeping. It is
recommended, therefore, that You study
Section 4. Units 4. 1 to 4.4 before using
this unit.
LEARNING OUTCOMES
In this unit you will learn about:
• why a seven th book of
original entry Is needeo
• source documen1s useo to
prepare a general journal
• how 10 prepare an entry in
the general Journal.
KEY TERM
General journal: a book oi
original entry useo to make the
first record ot transactions that
it would not be appropriate to
record In the other books of
original entry.
Why a general journal is needed
Most transactions are recorded in the six books of original entry covereo
In Units 3.3-3.6. These six books of original entry are the first record o'
all money transactions and all credit transactions involving the purchase
and sale of goods in which a business trades. A seventh book of
original entry, the general journal, is required to make a first record of
a small group oi transactions that cannot be recorded in the other six
subsidiary books. Here are some examples of these transactions:
• the purchase and/or sale of a non-current asset on credit
• cancelling entries and correcting errors in accounts
• transferring Information from one account to another
• opening a new set of books of account.
Source documents and the general journal
Many different source documents aie used for entries in the general
Journal, for example a purchase invoice for a new non-current asset.
However, less formal source documents may also be used that include
instructions or financial details that need to be recorded in the accounts.
For example, there could be letters and emails received from other
businesses. or emails and notes written by owners and managers.
Preparing a general journal
An entry In a general journal consists of the following elements:
• the date
• the account to be debtted and the amount
• the account to be creoited and the amount
• a brief explanation of the nature of the transaction (often called the
·narrative')
• folio references, which are completed when the journal entry is
posted to the ledger
Each journal entry ls ruled off to separate It from the next entry.
1. Each entry is set out so that debit entries are recordeo first and
credit entries second (with a slight indent in the details column).
2. Usually there is only one account to debit and one account to
LINK
C\)
There Is more Information about tne
correction of errors in Section 7.
credit; just occasionally it is possible to have several accounts
debtted/credited in one journal entry {as in Illustration 1 on
1 February) - this is called a combined entry.
3. The folio column will be completed when the entries are posted to
ledger accounts.
There are further examples of journal entries throughout the book.
ILLUSTRATION 1 Preparing a general Journal
Here are some typical Journal entries.
Opening a new set of books
Page3
JOURNAL
Date
Feb 1
Details
Folio
Vehicles
Bank
Cash
Dr
Cr
$
18 000
4000
500
$
Bank loan
Capital
8000
14 500
Assets and liabilities on opening new books of account
Recording the purchase on credit of a non-current asset
JOURNAL
Date
Page3
Folio
Details
Feb 11 Equipment
Dr
Cr
$
s
2 200
2200
KKZ Office Equipmen1 Ltd
Purchase of new printers for office, invoice number 78328
Recording the correction ,of an error
JOURNAL
Date
Details
Feb 18 Motor expenses
General expenses
Correction - motor expenses had been recorded In the general
expenses accoun1
SUMMARY QUESTIONS
1. What is the purpose of the general Journal?
2. Give two examples of transactions that should be recorded
In the general Journal.
3. Give tv10 examples of source documents used when
preparing journal entries.
4. What are the main elements In a journal entry?
Page4
Folio
Dr
Cr
$
$
110
110
Balancing cash books
and posting books of
original entry totals
Balancing cash books
LEARNING OUTCOMES
At regular Intervals cash books will be balanced. The process for
balancing is the same as outlined tor ledger accounts. which is fully
explained in Section 4, Unit 4.3.
In this unit yov will learn about:
• balancing cash books
• interpreting the balances of
the cash books
• indicating treatment of totals
fr-0m books ot original entry.
ILLUSTRATION 1 Balancing cash books
Here are the cash books from Units 3.5 and 3.6 but now showing how they are balanced at the end of
the month.
Dr
CASH BOOK
Discount
Folio allowed Cash
$
20
5 Sales
780
1 884
6 Leo
Adams
7 Cash
s
1 170
30
1 500
C
50
Sept 8 Balance b/d
$
$
Cr
Bank
s
635 4838 Sept 1 MNH
Sept 1 Balances bid
2 KAnson
$
Folio
Bank
Page 11
Discount
received Cash
2519 8288
Supplies
3 General
expenses
4 Bank
charges
7 Island
Traders
60
Ltd
130
1 140
82
73
2 470
7 Bank
C
1 500
7 Balance
c/d
937 4 605
2 519 8288
190
937 4 605
Notes:
1. The balanced cash book reveals the business has $937 in cash and $4 605 at the bank on
8 September.
2. A credit balance on the bank account would Indicate that the business was overdrawn at the bank.
(Continued)
' ILLUSTRATION 1 Balancing cash books (Continued)
Receipts Date
PETTY CASH BOOK
Folio/
Payments Cleaning Post age
voucher
$
$
Details
s
$
200.00
Aug
7 General
expenses
·4 Cleaning
19 Postage
24 Cleaning
29 Supplier
(TXQ Ltd)
Sept
s
1 Cheque
4 Postage
200.00
34.85
Page6
General
Purchase Folio
expenses ledger
$
178
18.23
179
180
181
182
26.29
38.80
11.43
37.22
183
33.18
165.15
34.85
200.00
Balan ce
c/d
1 Balance
b/d
18.23
26.29
38.80
11.43
37.22
76.02
29.66
26.29
33.18
33.18
Note:
The balanced cash book reveals the business has unspenl petty cash in hand of $34.85 on 1 September.
/
The treatment of totals from books of original entry
At regular intervals the totals shown In the books of original entry will be posted to ledger accounts.
The following table summarises how totals are treated.
Total(s) in book of original ent•ry Treatment
Purchases book
Pos1ed to the debit side of the purchases acoount in the general ledger
Sales book
Reiurns outwards book
Posted to the credit side of the sales account in ihe general ledger
Posted to the credit side of the returns outwards account in the general ledger
Returns inwards book
Petty cash book analysis
columns
Pos1ed to the debit side of the relurns inwards account in the general ledger
• Totals of expe'lSe columns are posted to the relevant expense accounts in
the general ledger.
• Entries in a column /or payments to acoounts payable are posted to the
individual accounts payable aocounts in the purchases ledger. (The total of
this column is for reference only and is not posted.)
Cash book discount columns
• The total of the discounts allowed column is posted to the debit side of the
discounts allowed accoum in the general ledger.
• The total of the discounts received aocount Is posted to the credit side of
tne discounts received accou~.t in the general ledger.
SUMMARY QUESTIONS
1. Explain why the oiscount columns In a cash book are not
balanced.
2. Interpret a credit balance in the bank column of a cash book.
3. Explain how the analysis columns In the petty cash book are
used.
Practice exam questions
Paper1
1 Which source document should be used wnen
preparing a sales book?
4 1Nhich source documents should be used for
making debit entries in a cash book?
A credrt note
A petty cash vouchers and cash register rolls
B delivery note
C lnvoic;;e
B cheqve counterlods ard cash receipts
C paying-in slip counterfoils and cheque
counterlo1ls
D cash regis1er rolls and paying-In slip
counterfoils
D 1111 roll
2 Which source document sho,.ld be used wren
preparing a re1urns lriw,irds book?
A cheque coun!erfoll
B credit nole
C invoice
D receipt
3 Navin owrs a grocery store. Which book of
original en!ry should be used ~or recording the
p... rchase of some shop equipmern on credit?
5 A petty cash book is operated with an Imprest o'
$120. During one month $70 was spent by the
petty cashier. What amourit will be required to
restore 1he Imprest at Ire end o' Ire month?
A $50
B $70
C $120
D $190
A cash bock
B general journal
C purchases book
D sales bock
Paper2
1 Preparing purchases, sales and returns books
Rishiowns a wholesale business s-elling electrical
equipmen t. He has collected the following
source d ocuments for January 2019.
Credit notes received from suppliers
Jan
28
Invoices receiVed from suppliers
Jan
4
Prem'er Electrics ( nvolce number
2729) for goods, $960
23
Excel Supp.ies Ltd (invoice number
3661) for goods, $3 600 less a trade
discount of 25%
10 Premier Electrics (credit note
number 314) for goods, S80.
damaged n trarislt
Excel Supplies Ltd (credit no1e
number 882) for goods, $220 less
a trade discount of 25%, not as
ordered
Credit notes issued to customers
Invoices Issued to customers
17 Haven Retal ers (credh note number
R1 17) for goods, $35, damaged
Items
Jan
29 Bes1prlce Electrics (creel t note
11
19
Haven Retailers (invoice number
$727) for goods, $650
Bestprlce Electrics (lnvoce number
$728) for goods, $2 700 ess a
trade discount of 20%
Jan
number R118i for goods, $180
less trade discount of 20%, not as
ordered
Prepare 1he following for the month of January
2019:
21
Cheque
counterfoil
Payment of
amount due to
supp'ier. DHP
Ltd, $1 800
less a 5% cash
d·soount
25
Paying-In sl p
counterfoil
Cheque received
from customer,
Parkway Ltd,
In settlement
of amount
due, $400 less
a2.5%cash
d·soount
• Purchases book
• Sales book
• Re1urns outwards book
• Returns Inwards book
"fbe books should be totalled at 1he end of 1he
month.
2 Preparing a three-column cash book
Stepren Is a retailer. His accounting sys1em
inclvdes a tnree-cctumn cash book. On 1
Maroh his cash book showed balances of cash
in nand $380 and cash at bank $3 270. He is
able1o provide the following del.ills aboui cash
transactions for Maren 2019.
Source
document
Date
March
Transactions
3
Cash rece pt
In respect
of sundry
purchases
General
exoenses $80
5
Cheque
counterfoi
Rent $880
8
Cash regiSter
ro I
Cash sa'es
$1 290
Prepare the three-column cash book for Marcil
2019. T-re discount columns should be totalled
at lhe end of lhe month. Balance and rule lne
casn book at montn end.
3 Preparing a general journal
On 1 October 2019 N<3vin oper,ed a retail
business. The following list Includes some of the
transactions that occvrred during October 2019
Oct
1
Opened the books of account of
the business wllh the following:
casn at bank $1 800. motor vehicle
$22 000, office equipment S2 800.
bank loan $5 000. cap~al $21 600.
Purchased shop furniture. $8 800,
on cred,t from Rajah Supplies Ltd.
10 Pay ng-ln s ip
counterfoi
Transfer of cash
$1 100 to bank
3
Cheque
counterfoi
Paymem of
supplier, Rex
Ltd, $1 140 (in
settlement of
amount due
$1 200)
11 A mistake had been made when
,eoordlng the payment of rent by
cheque S780. The bookkeeper had
deb led tne wages aooount w,th
$780 Instead of the rent account,
This error was correc!ed.
18 Bank
statement
Bank charges of
$70
20
Cheque receNed
!rom customer.
Astral Ltd, $585
( n settlement
of amount due
S600)
18 SQme of the shop fum~ure
purchased on c,edit from Rajah
Supplies Ltd on 3 October was
,eturned as damaged n transit. The
value of the furniture returned was
$220.
1Ll
Pay ng-ln s ip
counterfoi
Record these transaolions in Navin's gene,al
journal.
•
Preparing ledger accounts
LEARNING OUTCOMES
In this unit you will learn about:
• the different classes of
account
• the different types of ledgers
• 11,e significance of debits
and creoits in each class o'
account
• preparing simple account
formats neatly and
accurately.
In this unit you will stuo'y how leoger accounts are prepared. This
Is often thought of as the core of any accounting system, because
it is !he analysed record of !he financial transactions of a business.
Preparing ledger accounts represents the next step In the accounting
cycle after preparing the books of original entry.
Classes of account
Ledger accounts can be divided into three different classes:
Real accounts
Nominal accounts
Personal accounts
Assets
Expenses
Accounts payable
Liabiltties
Income
Accounts receivable
Capital
Gains
Lesses
Usually regarded as
permanent accounts
Usually regarded as
temporary accounts
Types of ledger
Ledger accounts are grouped together in three different ledgers
General ledger
Purchases ledger
Sales ledger
Assets'
Accounts payable
Accounts receivable
Liabilities
Capltal
Expenses
Income
·Except for cash and bank accounts, which are recorded separately
in the cash book
Transactions and the double-entry principle
In Unit 2.3 tt was shovvn that any transaction (cash or credit):
• has two effects on items in the statement of financial position of
a business
• changes the value upwards or downwards of some combination
of assets, liabilities and capital but with the accounting equation
(A = C + L) always holding true.
The rules for making entries for transactions are summarised In the
following tables.
Making entries in real accounts
ASSET ACCOUNTS
LIABILITY ACCOUNTS
Debit
Credit
Debit
Credit
Increases In assets
Decreases In assets
Decreases In liabilities
Increases In liabilities
Examples:
Examples:
Examples:
Examples:
Receiving cash
Making a cash payment
Paying a credtt supplier
Purchasing an asset
Selling an assei
Repaying a loan
Selling goods on credit
to a customer
Credit customer settles
amount due
Purchasing goods
on credit from
a supplier
Taking out a loan
CAPITAL ACCOUNT
Debit
Credit
Decreases in capital
Increases in capital
Example:
Example:
The owner withdraws capital (drawings)
The owner introduces capital
Making entries in nominal accounts
EXPENSE ACCOUNTS
!)eQ!t
Credit
INCOME ACCOUNTS
Debit
Credit
Expense payments
Receipts of Income
Examples:
Examples:
Paying rent, wages,
repairs, etc.
Sales of goods on
credit or for cash
Purchasing goods for
resale
Receipt of rent from a
tenant, interest received
on Investments
Preparing simple ledger accounts
A ledger account is a record of transactions affecting a particular
aspect of the affairs ol a business. Ledger accounts make use of a
two-sided form that corresponds in shape lo a letter T, and ledger
accounts are sometimes referred to as 'T accounts' . Accounts have
columns to record the date of each entry, details of the transaction
being recorded, a folio column for cross-referencing to the source of
the information, ano money columns to record the amount Involved
In the transaction.
In any account:
• the left-hand side is referred to as the debit side, abbreviated
as Dr
• the right-hand side is referred to as the credit side, abbreviated
as Cr.
LINK
%
You may be wondering about
how a business records
unsold goods (Inventory) In the
accounting system. This topic is
covered In U11it 5.2.
/ ILLUSTRATION 1 A typical ledger account
Here is the typical ruling for a ledger account. A double rule divides the left-hand, debit columns from the
right-hand. credit columns.
Dr
Account title
Date
Details
Folio
$
Cr
Date
Details
s
Folio
And here is an example of a ledger account with some entries.
Dr
Vehicles (Account No. 22)
Date
Details
Folio
$
2019
Date
Cr
Details
Folio
$
Bank
CBS
2400
2019
1
Balance
bid
21 000
18
Bank
CB3
9000
Jan
Feb
6
Notes:
1. Each account should have a number.
2. It Is good practice to state the year on each side of a ledger account before making entries.
3. Every entry should be dated with a month and day. The month does not have to repeated for each
transaction.
4. The folio column is used to record either (I) bid and c/d when recording balances (sometimes a check
mark {.) is useo instead) or (ii) a cross reference to the page In the book of original entry.
KEY TERMS
SUMMARY QUESTIONS
Ledger account: a two-sided
1. Give an example ot each of the following types of transaction:
form used to record details
of transactions affecting a
particular aspect the financial
activities of a business.
Debit side: the left-hand side
of an account (Dr).
Credit side: the right-hand
sice of an account (Cr).
a. affects assets only
b. reduces an asset and a liability
c. increases an asset and capital.
2. What is the oouble entry for:
a. paying for an expense
b. receiving Interest on an Investment
c. purchasing goods for resale
d. selling goods on creolt
e. the owner withdrawing cash for his/her own use?
3. What details are required when making an entry in a ledger
account?
,/
Posting transactions
Posting from the books of original entry
LEARNING OUTCOMES
Here is a table that summarises when accounts are debited ano
credited, based on the Information provided in Unit 4.1:
rn this unit you will learn about:
Debit
Credit
Asse!s (10 increase their value)
Assets (lo decrease 1hek value)
• posting from books of
original entry to ledger
accounts.
Liabilities (when repayments are
made)
Liabilities (10 increase their value or
1he amount owed by tr.e business)
Purchases (when goods are
bought)
Sales (when goods are sold)
Expenses (when payments are
made}
Otner income types
(e.g. rent/in1erest received)
Drawings (for owner's whhdrawals) Capital (to increase Its value)
Every transaction should lead to a matching debi1 and credit entry,
so that the accounting equat,ion A = C + L always holds true.
Entries In ledger accounts are maoe from information recorded In the
seven books of original entry covered In Section 3. As information is
transferred or 'posted' the folio columns in the books of original entry
and In the ledger accounts are completed. Folio references are
made In the following way:
• In the ledger account the initlals of the book of original entry
and the page number are recoroed (e.g. CB12 would mean the
transaction was posted from page 12 of the cash book}.
• In the book of original entry, the account number to vvhich the
information has been posted is recorded (e.g. SL3 would mean
that the Information was posted to sales ledger account number 3).
KEY TERM
Folio references : a system
of cross-referencing entries
for each transaction In the
ledger accounts to which the
information has been posted
and in the book of original
entry from which the entry was
posted.
" ILLUSTRATION 1 Posting from a book of original entry and completing the folio columns
This illustration shows how a purchases book is posted to the Individual accounts payable in the purchases
ledger ot the business, and, at tne end ot tne month, the purchases book total is posted to the purchases
account in the general ledger.
Here is the purchases book of a business for May 2019.
Page5
PURCHASES BOOK
ISupplier
Date
I Invoice number
Folio
s
2019
May
10
ISupaSupplies Ud
Total purchases
Amount due
I
3 228
PL1
3280
GL7
3 280
(Continued)
/ ILLUSTRATION 1 Posting from a book oi original entry and completing the folio columns (Continued)
GENERAL LEDGER
Purchases (Account No. 7)
Dr
Cr
s
2019
May
31
Purcoases book
PBS
PURCHASES LEDGER
Account payable: SupaSupplies Ltd (Account No. 1)
Dr
s
Cr
$
112019
May
10
Purchases PB5
3280
Folio references Indicate that the entries for a transaction have been
completed. It follows that any gaps in folio columns Indicate that a
transaction has not yet been fully posted and, therefore. the double
entry is not yet complete. This can help when checking the accuracy
of the accounts.
ILLUSTRATION 2 Posting a cash book
Dr
CASH BOOK
Discount
allowed Cash Bank
s
2019
July
s
$
1 Balances
bi d
Discount
received Cash Bank
2019
July
300 4000
Lorraine
18 Don
SL1
20 Casn
C
GL2
20
Cr
Pege9
380
$
14 Downtown
Prodocts PL1
20 Bank
$
80
C
$
1 520
180
180
20
GL3
80
GEN ERAL LEDGER
Dr
Discounts allowed (Account No. 2)
2019
July
Dr
Cr
$
31
Cash book CB9
Discounts received (Account No. 3)
112019
July
j
Cr
$
31 Cash book CB9
80
(Continued)
" ILLUSTRATION 2 Pos1ing a cash book {Continued)
PURCHASES LEDGER
Dr
Account payable: Downtown Products (Account No. 1)
$
2019
July
Cr
14
Bank
CB9
1 520
14
Discount
received
CB9
80
$
SALES LEDGER
Dr
Account receivable: Lorraine Don (Account No. 1)
$
Cr
s
2019
July
18
Bank
CB9
380
18
Discount
allowed
CB9
20
In the cash book:
• the C for contra entry is a reminder that the entries for this transaction are already complete
• a follo reference is placeo beside each discount column total.
SUMMARY QUESTIONS
1. An accounts clerk ls posting information from page 2 of a
sales book to an account numbereo 8 In the sales ledger.
What folio reference should appear in:
a. the sales book
b. the sales ledger account?
2. The total of the sta11onery analysis column on page 8 of a
petty cash book Is being posteo to the s1atlonery account
numbered 11 In the general ledger. \t✓hat folio reference
should appear In:
a. the petty cash book
b. the stationery account?
Balancing accounts
Periodically it is necessary to balance many ledger accounts. This
process, together wtth closing some accounts, Is required in order to:
LEARNING OUTCOMES
In this unit yov will learn about:
• how to balance accounts
• how to use pencil footings.
• Make a clear statement about the current value shown in the
account (I.e. the balance) or, In the case of some accounts, that
there is no balance (i.e. the account is closeo}
• Break up ledger accounts into more manageable sections.
%
LINK
• Provide Information for the completion of financial statements such
as trial balances, income statements and statements of financial
position (balance sheets).
Closing accounts is the topic for
u ~it 4 .4.
The balancing process
Unit 4.5 covers trial balances.
At the end of an accounting or financial period, it is necessary to find
the balance on each ledger account In order that a trial balance can
be extracted as part of the accounting cycle. The process is referred
to as 'balancing off accounts' or balancing the ledger.
For income statements and
balance shee:s see Section 5.
DID YOU KNOW?
• Accounts where the en1rles
are all on one side can still be
balanced using the threestep process.
• Accounts with only one entry
do not need to be balanced.
Assets, liabilities and the capital accounts are usually balanced at the
end of a financial period {though accounts can be balanced more
often if desired). The balancing process follows the basic rule of
double entry - that there must be a matching debit and credit entryand involves three steps:
Step 1: Calculating 1he balance at 1he end of 1he period and recording
this on whichever side of the account has the lowest total {,his is referred
to as the balance carried down, er balance c/d).
Step 2: Recording totals on the next available blank line.
Step 3: Making a second record of the balance below the totals on the
opposite side to complete the double entry (tnis is referred to as the
balance brought down, or balance bid).
ILLUSTRATION 1 Balancing an asset account and a liability account
Here are tvvo ledger accounts as they might appear Just before the end of a financial period.
Dr
Account recetvable: Louise Fray
2019
Aug
10
Sales
SB3
$
2019
3 100
Aug
Dr
Bank loan
2019
$
2019
500
Aug
Aug
30
Bank
CBS
Cr
$
12
Bank
CBS
1 800
12
Discount allowed
CBS
200
Cr
$
1
Bank
CBS
8000
(Continued)
/ ILLUSTRATION 1 Preparing a three-column cash book (Continued)
The balance on the asset (account receivable) account is $1 100 (i.e. 11ie total of the debit side S3 100 less the
total of the credit side $2 000).
The balance on the liability (bank loan) account is $7 500 (i.e. $8 000 less $500).
Here are the accounts balanced following the three steps outlined above. To help you identify each step
they are clearly identified In the accounts.
Dr
Account receivable: Louise Fray
$
2019
Aug
10 Sales
Cr
2019
SB3 3 100 Aug
$
12 Bank
CBS 1 800
12 Discount allowed
CBS
31 Balar.ce c/d
Sept
1 Balance bid
Step2
3100
Step3
1 100
200
Step 1
1 100
Step2
3100
Dr
Bank loan
Cr
2019
$
s
Aug
30 Bank
31 Balancec/d
CBS
2019
500 Aug
Step 1
7500
Step2
8000
Sept
1 Bank
CBS 8000
1 Balance bid
Step2
8000
Step3
7500
Note: When the balance of an account is brought down the date used is the first day of the following
month or period.
Using pencil footings
Some inoivlduals find it helpful to make a pencil note of the totals
of each side of an account in order 10 work out the balance. These
pencil footings are entered before carrying out the formal balancing
process. and can be erased when the balancing process is
complete.
Remember that discount columns are totalled rather than balanced
(see Unit 3.5) ano folio references are placed beside or below these
totals
SUMMARY QUESTIONS
1. What benefrts arise from balancing accounts?
2. Describe the three stages in the balancing process.
3 . Explain the difference between the terms 'balance b/d' and
'balance c/d'.
EXAM TIP
rt is wovtl,iwi,iile
l'~Clct.s,"'-0 bcilci"'-ci"'-0
CiC-COL<V\.ts CIS tn.s is
ofte"'- "-Ot clo""e welt i""
GXCI l'l<.i"'-Cltto"'-S.
Closing accounts
Closing accounts that do not have a balance
LEARNING OUTCOMES
In this unit yov will learn about:
• how to close accounts that
do not have a balance
• how lo transfer an account
balance to 1he income
statement and close the
account.
Some asset or llablllty accounts will not show a balance at the end
of the account year. This is because the total of entries on each sloe
of the account is the same. A typical example ls the account of an
account receivable to whom goods have been sold on credit, but
who has paid off the amount due.
To close an account without a balance:
Either: record totals on the next available blank line - this process
is used for accounts where there are a number of entries on
either or both sides of the account.
Or: record double total lines - this process is used where there is
just one entry on each side of the account.
I
ILLUSTRATION 1 Closing accounts that do not have a balance
Here is the account of a credit supplier ln the purchases ledger of a business. The amount due 10 this
supplier has been paid, and !here is no balance on the account, so a total has been added.
I
I
PURCHASES LEDGER
Dr
Account payable: ABC Supplies (Account No. 3)
s
2019
CB9
3 420
Oci
CB9
180
2019
Oct 22 Bank
22 Discount received
Cr
$
1 Balance
b/cf
3600
3600
3600
Here is an acoount receivable in the sales ledger of a business. The amount dve has been paid by this credit
customer. As there is just one entry on eitl>er side of the account, only dovble lines have been added- there
is no need 10 record a tolal.
I
I
SALES LEDGER
Dr
Account receivable: Kris Williams (Account No. 11 )
Cr
2019
s
s
Oct 1
Balance
bid
2019
730 Oct
18 Bank
CBS
730
,
DID YOU KNOW?
An alternative format for keeping accounts records the balance
on the account after each entry is made. This format Is mainly
used when computerised accounting software is used. This
running-balance format follows the same rules of double entry.
Closing accounts by transferring the
account balance
%
LINK
There is more about enlries in
income stalements in Section 5.
Some accounts are closed at the end of a financial year because the
total of the entnes is transferred elsewhere. The accounts that are
closed are those relating to:
• expenses
• purchases
• Income (such as discounts received}
• sales
These accounts are closed at the end of a financial year because the
total amount shown has to be transferred to the income statement.
The procedure is as follows:
SUMMARY QUESTIONS
Step 1: Calculate tne balance of the account and reccrd this on
whicriever side - debit or credit - is :he smaller side (it is likely that there
will be no existing entries on this side of tr e account at this point). The
narrative to use is 'income statement'.
1. Describe the procedure for
closing an account.
2. In which book of original
entry should the transfer
of an account balance to
the Income statement be
recorded?
Step 2: Record totals on the next available blank line (if there is only one
entry on each side of the account just rule a double line).
Step 3: Do NOT bring down :he balance on the aooount. The o:her entry
for the debit or credit in Step 1 will be in the income statement.
ILLUSTRATION 2 Closing accounts at the year end
GENERAL LEDGER
Dr
Administration expenses (Account No. 1)
Cr
2019
s
$
Dec
31
Total entries for year
CB
2019
5600 Dec
31
Income statement
J
5600
Dr
Discounts received (Account No. 3)
Cr
2019
s
$
Dec
31
Income statement
J
2019
850 Dec
31
Total emries for year CB
850
Dr
Purchases (Account No. 4)
Cr
2019
s
$
Dec
2019
31
Purchases book
PB
18970 Dec
31
Cash purchases
CB
3 750
31
Income statement
J
22 720
22 720
22 720
Dr
Sales (Account No. 9)
Cr
2019
$
Dec
31
Income s1atement
J
2019
58000 Dec
$
31
Sales book
SB
38620
31
Cash sales
CB
19 380
58000
Note: The closing entries are first recorded in the general journal and then posted to the ledger
accounts.
58000
Interpreting entries and
preparing a trial balance
Interpreting entries and balances
LEARNING OUTCOMES
In this unit yov will learn about:
• Interpreting entries and
balances
• using balances brought down
to construct a trial balance
• the uses and limitations of
trial balances.
It is a valuable skill to be able to explain the entrles made In any
ledger account. This means stating the following:
The date of the transaction {year. month and day)
The nature of transaction (explaining what caused the entry)
The amount of the transaction
The purpose of a trial balance
• The trial balance is designed to check the accuracy of the
double-entry records.
LINK
%
Tl"e Income statement and
statement of financial position are
covered In Semion 5.
See Section 7. Unit 7 .1 for more
details about the limitations of a
trial balance.
• Because the trial balance lists all the accounts in the accounting
system, it is also a very useful summary to refer to when preparing
financial statements such as the Income statement and statement
of financial position.
However, the trial balance does have limitations. There are several
types of error which are not revealed by a trial balance.
How does a trial balance work?
The trial balance Is based on the principle that for every transaction
there should be a matching debit and creoit entry, so that the total of
all debit entries should equal the total of all credit entries.
To produce a trial balance the following steps are necessary:
Step 1: List all the accounts in tne accounting system.
Step 2: For each account, record its balance in either the debit column
or credtt column of the trial balance. according to the side on 1•/nich the
balance appears in the account.
Step 3 : Total the debit and credit columns of the trial balance -the totals
should agree.
' ILLUSTRATION 1 Preparing a trial balance
In this Illustration, the trial balance of a business is already partly completed. The balances of the accounts
shown are to be added to the 1rial balance for tt to be completed.
GENERAL LEDGER
Or
Fixtures and fittings (Account No. 2)
2019
2019
$
Jan
1
Balance
bid 17 300
May
12
Bank
CB
Dr
Cr
$
Nov
Bank
3
CB
800
3600
Sales (Account No. 5)
Cr
s
2019
$
Jan-Nov
Dec
31
Total entries
SB
53600
Sales book
SB
4100
Trial balance at 31 December 2019
Or
Cr
$
s
Account payable: QX Manufacturer
PL4
Account receivable: E Jones
SL3
Capital
Cash in hand
GL1
CB7
Cash at bank
CB7
390
2740
Fixt ures and f ittings
GL2
20100
General expenses
Purchases
GL3
GL4
5800
39900
Sales
GLS
Wages
GL6
4 130
2 080
27 940
57 700
18 760
89 770
89770
Note: The correct heaoing for a trial balance is always 'Trial balance at ... • (I.e. al a particular date).
SUMMARY QUESTIONS
1. What details should be given when interpreting an entry in a
ledger account?
2. What are the benefits of preparing a trial balance?
3. How do you know which column to record the balance of an
account in when preparing a trial balance?
Worked example: preparing
books of original entry and
double-entry records
Special note: the question used in this v,;orked example has been
designed to Illustrate many of the techniques and procedures
covered in Sections 3 and 4. The question is, therefore, far more
extensive than could be Included In an examination question.
Examination questions could ask you to prepare Just one or a few of
the many elements covered.
The question
To help you follow the answer, each transaction/item of information
has been given a letter of the alphabet, A, a, C and so on. These
letters have been used In the answer to help you Identify where the
entries have been made in the books of original entry
Roslyn starteo business as a wholesaler of sports equipment on
1 May 2019. The accounting system o: the business has been
designed to Include the follov,,ing books of original entry:
• General journal
• Return outwards bock
• Purchases book
• Returns inwards book
• Sales book
• Three-column cash book
There will be three subdivisions of the ledger: purchases ledger, sales
ledger, general ledger.
A
May 1 Business opened wtth the following: delivery vehicle $18 000: cash at bank $6 200; casn in nand
$400; bank loan S8 000
B
2
Paid rent for the month $850 by cheque
C
4
Purchased goods for resale on credit from Dennery Sports Ltd with list price $4 400 less 20%
trade discount
D
6
Cash sales to1alled S960
E
9
Returned goods 10 Dennery Sports Ltd purchased on credtt 4 May wtth list price $350 less 20%
trade discount
F
12
Sold goods on credit to Jamal's Spor:s, $1 200, less 15% trade discoun1
G
14 Transferred cash $500 to 1he bank account
H
18 Jamal's Sports returned goods sold 12 May, $140, less 15% trade discount
I
21
Paid wages in cash $630
J
24
Paid Dennery Sports Lid in full se1tlement of the amount due less a 5% cash discount
K
25
Purchased goods for resale and paid by cheque $720
L
27
Purchased office equipment $1 200 on credit from Interstate Supplies Ltd
M
29
Received cneque from Jamal's Sports for S889 in full settlement of 1he amount due
N
30 Roslyn withdrew cheque for $300 for priva1e use
Prepare the books of original entry and post to the ledger accounts.
The cash book should be balanced on 31 May 2019. No other
accounts need to be balanced. Prepare a trial balance at 3 1 May 2019.
EXAM TIP
r"' i;i"' exi;i .,,._iia,i;itio"" tJ o«.
Getting started
CO«.ld i;ic4c4 pe....cil "-Otes
It Is always a good idea to look carefully through the Information
before you start to prepare your answer. Decide which of the
transactions in the list are stralghtforv1ard and which might need
more thought. Points to note:
to ti-le q«.estio"' 0 "" ti-le
• This is a new business so the first transaction Is to set up an
accounting system.
• There is a purchase on credit that Involves the daouction of a trade
discount.
exi;i.,,._ pi;iper o,a, i;i"-1;1
ketJ poiia,ts ti-li;it vi.cignt
11elp tJDL< wi-leia, t)DL<
prepi;ire 1:1our i;i,a,swer.
For ~i;i,""'-ple, tJOL< CO«.td
pe~~•l """ •,;11icl1 boo~ of
orig,l'\./;ll e"'tt'J:j ta «.Se.
• Some of the goods purchased on credit are returned, so this
transaction also involves a trade discount.
• There is also a sale on credit and a subsequent return by the
customer that Involves a trade discount.
• As well as credit purchases and sales. there are also cash
purchases and sales.
• There is the purchase of a non-current asset on credit.
• The settlement of the account payable and account receivable
includes the deduction of cash discounts.
As the first thing to do is to prepare the books of original entry, it
might also be a good idea to have another look at each transaction
and decide in which book it should be entered. Here is the list of
transactions again with an aoditional column showing which book of
original entry should be used.
A
May 1 The business opened with the following: delivery vehicle St 8 000; cash at bank
$6 200; cash In hand $400; bank loan $8 000
B
2 Paid rent for the month $850 by cheque
4
Purchased goods for resale on credtt from Dennery Sports Ltd with list price
C
$4 400 less 20% trade discounts
D
6 Cash sales totalled $960
E
9 Returned goods to Dennery Sports Lld purchased on credit on 2 May with list
price $350 less 20% trade discount
F
12 Sold goods on credit to Jamal's Sports, $1 200, less 15% trade discount
G
14 Transferred cash $500 to the bank account
H
18 Jamal's Sports returned goods sold on 12 May. $140, less 15% trade discount
I
J
K
L
M
N
21
24
25
27
29
30
General journal
Cash book
Purchases
book
Cash book
Returns
outwards bcok
Sales book
Cash book
Returns
inwards book
Paid wages in cash $630
Cash book
Paid Dennery Sports Ltd in full sel!lement of the amount due less a 5% cash discount Cash book
Purchased goods for resale and paid by cheque $720
Cash book
Purcnased office equipment $1 200 on credh from Interstate SJpplies Ltd
General journal
Received a cheque 'rom Jamal's Sports for $889 in full set:lemem of the amount due Cash book
Roslyn withdrew a cheque for $300 for private use
Cash book
The answer
Preparing the books of original entry
The general journal
The order In which you prepare the books of original entry does
not matter. Here first Is the general Journal. The table shows that
there are tv10 entries to be made corresponding to transactions
A and L.
Page 1
JOURNAL
Date
Folio•
Details
2019
A
May
1 Delivery vehicle
Dr
Cr
s
$
GL1
18000
Bank
CB1
6200
Cash
CB1
400
Bank loan
GL2
8000
Capital
GL3
16 600~
Entries to open books of account
L
27 Office equipment
GL4
Account payabl e: Interstate Supplies Ltd...
1 200
PL2
1 200
Purcnase o' non-current asset on credii, irlVOice no. ......
Notes:
•
Folio references have been included for the sake of comple:eness
In each of the books of original entry.
In practice they would only have been added when the entries were
transferred to the ledger accounts.
.. The 1igure for capital had to be calculated using the accounting
formula A = C L, I.e. assets ($24 600) less !iabilttles (SB 000).
T
... In some accounting systems the acoount of tne credit supplier would
be included irl the general ledger.
This happens when the decision Is made to use the purchases ledger
only for suppliers of goods tor resale.
The purchases book
EXAM TIP
There Is Just one entry to be made in the purchases book (see
transaction C). The other purchases are either for cash (transaction K)
or relate to a non-current asset (transaction L), and so should be
recorded elsewhere.
;O tvscl1A.cle cash j>IA.rc.i,,ases
'"" the -p1A.rch&1ses book.
"TIiie -p1A.rch&1ses book i.s
stri.ctt11 for piA.t-ehases ovc
credit of goods for res&1te.
Page 1
PURCHASES BOOK
It ~s a com mo"" mi.sta lu
Date
I Supplier
Folio
$
2019
C
May
Amount due
I 4 IDennery Sports Ltd
Total purchases
PL1
3 520"
GL5
3520
Note:
• This figure was calculated as fellows: list price S4 400 x 80%
(i.e. less the 20% trade discount).
The sales book
There ls just one entry to be made in the sales book (see transaction F).
The other sale is for cash (transaction D).
Page 1
SALES BOOK
ICustom er
Date
Folio
Amount due
2019
F
$
I 12 IJamal's Sports
May
Total sales
SL1
1 020·
GL6
1 020
Note:
EXAM TIP
• This figure was calculated as follows: list price $1 200 x 85%
(i.e. less 15% nade discount).
The returns books
There Is one entry to be made in each of the returns books (see
transaction E for returns outwards, and H tor returns inwards).
RETURNS OUTWARDS BOOK
ISupplier
Date
Page 1
Folio
E
May
..-esa~.
Amount due
2019
$
I 9 IDennery Sports Ltd
PL1
280'
Total returns outit✓ards
GL7
280
Note:
• This figure was calculated as follows: list price S350 x 80%
Q.e. less 20% trade discount).
Page 1
RETURNS INWARDS BOOK
ICustomer
Date
Folio
2019
H
May
Amount due
$
I 1a
I Jamal's Sports
Total returns inwards
ft ~s '1 C.Ovi.c""'-0.,, vi.cista~
t o Lvsct1-<.ole ci:isi,i stltes i.vs
t"1e s&1tes book. The sates
book is stri.ctli:J foy sa~s
ovs cYeoli.t of goools foY
SL1
119•
GL8
119
• This figure was calc~lated as follows: list price St 40 x 85% (i.e. less
15% trade discount).
The three-column cash book
There are eight transactions th at affect the cash book, including
the opening balances that are to be posted from the journal. The
question also requires that the cash book Is balanced on 3 1 May.
CASH BOOK
Page 1
Disc
Folio Allw Cash Bank
2019
May
$
$
s
Folio
$
2019
1 Balances A J1
400 6200 May
2 Rent
B GL9
6 Sales
D GL6
960
14 Bank
G C
14 Cash
G C
Jamal's
29 Spcns
M SL1
12-
Disc
Rec Cash
500
21
Wages
GL1 0
889
Dennery
24 Sports Ltd J
PL1
31
GL12 12
June
1 Balances
b/d
Balances
1 360 7 589
$
$
850
500
630
162'
3078'
720
25 Pvrchases K GL5
30 Drawings
Bank
N GL11
300
cld
GL1 3
162
230
2 641
1 360
7 589
230 2 641
Noles:
• The cash discount was calculated as 5% of the balance of the supplier's account {purchase $3 520 less
returns $280 $3 240).
=
" The cash discount was calculated as the balance of the customer's account (sales $ 1 020 less returns
$119 $901} less the amount recelveo $889.
=
Preparing the ledger accounts
EXAM TIP
rt is east, to fovget that
the disecu...t eoLu"'->¼
aye Mt baLa""ced . '""stead
t'1elj ave eaek tctaL~d a"'-cl
t~e totals ave po.steel to
clLSeou..,,t aecou"'-tS i"'- the
ge"."e,-al ~clgev - he"'-ce the
f~L~c Yefeve""ces fcv tloiese
cl~sco'-<"'-t acco'-<vcts aye
~'1owv. &1Lo"'9sicle the totals
'"'- tloie cash boo~.
It is now possible to prepare each of the ledger accounts, posting all
ihe information shown In the books of original entry. It Is suggested
that the following steps are taken:
Step 1: Draw up all lhe accounts reqvired with the litles of lhe accounls
shown, using the three subdivisions of the ledger, before making any
entries.
Step 2: Take each book of criginal ernry 111 turn and post the Information
shown to lhe relevant ledger accounts - it is at this point that the
folio references should be added to the book of original entry
and to the entries made in ledger accounts. 11 is importanl lo be
syslema,ic as otherwise some emries might easily be overlooked.
Here are all the ledger accounts wtth postings from the books
of original entry.
GENERAL LEDGER
Dr
Delivery vehicle (Account No. 1)
Cr
~
s
!
!
Cr
2019
May
1
Balance
J1
Dr
18 ~00
Bank loan (Account No. 2)
$
$
Dr
27
lnlersta1e Supplies
J1
J1
8000
2019
May
Cr
$
1
Balance
J1
16 600
Cr
$
1 200
Purchases (Account No. 5)
2019
Cr
$
$
25
Bank
CB1
720
31
Purchases book
PB1
3520
Dr
Sales (Account No. 6)
May
Dr
Cr
2019
$
$
6
Cash
CB1
960
31
Sales book
SB1
1 020
!
Returns outwards (Account No. 7)
$
Dr
2019
May 31
Returns inwards (Account No. 8)
2019
31
Returns in book
RIB1
Dr
~19
~
Rent (Account No. 9)
2019
May
Balance
$
Dr
May
1
Office equipment (Account No. 4)
2019
May
$
Capital (Account No. 3)
Dr
May
2019
May
2
Bank
CB1
!soi
Cr
$
Re1urns oU1 book
ROB1
280
Cr
$
Cr
$
Dr
Wages (Account No. 1O)
2019
May
21
Cash
CB1
Dr
6:0
30
Bank
CB1
Dr
3~0
Cr
$
Discounts allowed (Account No. 12)
2019
May
I
I
I
$
Drawings (Account No. 11)
2019
May
Cr
31
Casn book
CB1
Dr
~2
Cr
$
Discounts received (Account No. 13)
$
1 2019
May
Cr
$
31
Cash book
CB1
162
PURCHASES LEDGER
Dr
Account payable: Dennery Sports Ltd (Account No. 1)
2019
May
$
2019
May
9
Re1urns out
ROB1
280
24
Bank
CB1
3078
24
Disc received
0B1
162
Dr
Cr
$
4
Purchases
PB1
Account payable: Interstate Supplies Ltd (Account No. 2)
$
1 2019
May
3520
Cr
$
27
Office equipment
J1
1 200
SALES LEDGER
Dr
Account receivable: Jamal's Sports (Account No. 1)
2019
May
12
Sales
S81
$
2019
1 020
May
Cr
$
18
Returns in
RIB1
119
29
Bank
CB1
889
29
Disc allowed
CB1
12
Preparing the trial balance
The final task Is the preparation of the trial balance. It is not
necessary to balance the ledger accounts In order to do this, but
you may prefer to carry out this procedure. The accounts which do
not have a balance (for example, the account of the account payable
Dennery Sports Ltd) need not be shown.
Trial balance at 31 May 2019
Dr
Cr
$
$
Account payable: Interstate
Supplies Ud
PL2
1 200
Bank loan
GL2
8000
Capital
GL3
16600
Cash at bank
CB1
2 641
Cash in hand
CB1
230
Delivery vehicle
GL1
18 000
Discounts allowed
GL12
12
Discounts received
GL13
Drawings
GL11
300
Office equipment
GL"
1 200
Purchases
GL5
4 240
Rent
GL9
850
Ret11ms Inwards
GL8
119
Ret11ms outwards
GL7
280
Sales
GL6
1 980
Wages
GL10
EXAM TIP
rt is uis1:1 to foYget to
post tne totals of t11e
~DO~ of DYigi"'-tll ev.t"l:J,
<.e. tl1e total of tne sales
boo~, puyc,I, ases boo~,
YetuYv.s boo~ av.ol
easl, boo~ (olisc-ouvct
eoLu'¾v.s).
162
EXAM TIP
630
28 222
28 222
rt is a co'¾w..av. "'1.ista~e
to ove.-too~ tl-ie casn
av.ol ba~ balav.ces
wne.,,, }>YtJ>aYiv.g a tYial
batav.ee becaKse tl1e¥, aye
YeooYoleol Stj>aYateli:j Y0"'1.
tl-ie teolge... aec,ou"'-ts .
Practice exam questions
Paper1
1 Odette purchased goods from Stephen. How
should ;his transaction be recorded In Stephen's
aocounts?
A debit purchases
credn Odette
B debit Ode:te
credrt sales
C debit Odette
credit purchases
credn Odette
D debit sales
2 Vvhich one of the following statements ,s correct?
A
nominal accounts appear ln the sales ledger
4 On 1 November 2019 a bvslness had a positive
balance In ns bank accourt of S700. During
November S2 300 was paid into the bank and
$3 100 was wrthdrawn from the bank. Tne
balance of the bar k account at 30 November
2019 was:
A debit $100
C credit $100
B debit $1 500
D credit $1 500
5 Which of 1he following accounts should be
B 1he general ledger contains personal accounts
entered in the debt column of a trial balance?
A bank overdraft
B capital
C 1he sales account appears In lhe sales ledger
C drawings
D accounls payable appear in 1he purchases
ledger
3 A bookkeeper had 1otalled lhe returns outwards
book and sales book of a business at tl'e end of
a month. These 1otals should be poS'.ed to the
ledger accounts as follows:
A debit returns outwards account and debit
sales accoun1
B debit returns ou:wards accoun1 and etedit
S<1les accoun1
C credrt r(lturns outwards account and debit
sales accoon1
D credn retvms outwards account and credit
sales accoun1
D sales
6 IA/hich of 1he following accounts should be
entered in the credit column of a trial balance?
A cash In hand
B drawings
C returns inwards
D accounts payable
Paper2
1 Preparing ledger accounts using three
separate ledgers
Prepare a cash book and ledger accounts to
record the following i~formaiion. The accounts
should be maintained In a ge'leral ledger,
purchases ledger and sales ledger.
12 Purohased shop fittirgs and pa·d by
cheque, $11 000
18 Sold goods on credt to M Church,
$3200
23 Toe owner withdrew a cheque for
2019
001
9 Paid shop rem by cheque, S3 000
S600 for private use
1 A business was opened when a
cheque for $45 000 was paid Imo a
business bank accou11t by the owner
us1119 funds from his private resources
24 Paid Best Supp'ies Ltd $1 600 by
cheque In pan settlement oi the
amoum due
3 Purchased goods for resale on cred~
from Best Suppl·es Ltd. $2 400
30 Paid wages in cash. $700
29 Cash sales total'ed $900
2 Posting subsidiary books
Complete the following table to show how
entries i'l some books of original entry should
be posted to ledger aocovnts. The firs! item has
been completed as an example.
Entry In book
of original
entry
a
b
C
An entry lor a
sale on credit
In ihe sa'es
book
Ledger
Debit
or
credit
Sales
Dr
f
g
2019
s
Aug
1 Balance 4200 Aug 12 Bank
19 Sa'es
Account
receivable
Toe total of
the purchases
book
Aug 15 Saes
900 Aug
Toe payment
of wages in
cash In the
cash book
Dr
Toe total of
the returns
outwards book
3 Balancing accounts
Make a copy of tne 'ollowing ledger accoJnts.
Balance ti1e accoums on 31 August 2019 .
100
Returns
Inwards
220
Account payable: W Carlton
$
Toe receipt
01a cheque
from a e<edlt
cuS1omer in the
cash book
1 900
12 Discount
allowed
1 150
2019
An entry lor the
return of goods
by a credit
cuS1omer in the
returns Inwards
book
$
24
Dr
Cr
2019
Ledger
account
d The total of
the stationery
analysis
column in the
petty cash
book
e
Account receivable:
Sandford Stores
Dr
Cr
2019
$
1 Balance
1 800
22 Purchases 2 400
Equipment
2019
Cr
$
Aug 15 Balance 11 900
22 Bank
Dr
4800
Bank loan
Cr
2019
$
1 Ba'ance
11 200
29 Bank
5500
Aug
4 Preparing a trial balance
Prepare a trial balance dated 30 September
2019 irom the followlng information.
$
$
Accounts
payable
5 420
D scounts
allowed
100
Accounts
receivable
12 260
D scounts
received
240
450 Drawings
11 850
Ad'11inistra1fon
expenses
Bankl08n
6000 Motor veil cles
22 800
Capital
22 630 Purchases
44 830
Cash at bank
3 420 Saes
61 690
Cash in hand
270
Introduction
LEARNING OUTCOMES
In this unit you will learn about:
• the purpose of preparing
financial statements
• the components of 'lnanclal
statements
• the Income statement of sole
traders.
KEY TERMS
Gross profit (or income):
the profit made by buying and
selling gooos.
Profit for the year: the profit
made by a business In a
financial year taking account o'
operational expenses. Profit for
the year Is sometimes referred
to as ·net profit' or 'income'.
The purpose of preparing financial statements
Financial statements are designed to inform a wide range of users of
important aspects of the performance of a business. In the case of a
sole trader, the owner and managers will need to know how profitable
the business is and also whether it is generating enough funds to pay
its way. The tax authorities will also need lo have reliable information
aboU1 profits in order to make an accurate assessment of the tax the
business should pay or tax benefits the company should receive.
The components of financial statements
A sole trader's financial statements, prepared at the end of each
financial year, consist of an Income statement and a statement of
financial position (balance sheet).
The income statement of a trading business Is in two sections:
• A trading account section, comparing the sales of the business for
the period to the cost of the goods sold, to give a figure for g ross
profit (or income)
• A profit and loss section, comparing the gross pro'it made by the
business to all t~,e day-to-day running costs of the business, giving
a figure for net profit (or income) for the year (or net loss for
the year).
In the case of a service business lhe income statement consists of
Just one section, recording sales less running costs, to show a figure
for profi1 (or loss) for the year. (Service businesses do not have a
gross profit.)
Other forms of business ownership (for example, partnerships and
limited companies) will have additional financial statements. covered
In Sections 8 and 9 of this book.
A statement of financial position (balance sheet) Is a formal document
setting out details of the assels, liabilities and capital of a business.
It provides the Information required 10 enable users 10 judge the
success or otherwise of a business in lerms of profitabilily and
solvency (the ability to pay its debls).
Both income s1atemen1s and statements of financial position
(balance sheets) are usually set oul In a vertical style these days. This
format is now in common use because it has greater flexibility and
Is more easily understood by those who are not enlirely familiar with
double-entry systems.
Preparing the income statement of a sole trader
to determine gross profit and net profit or net loss
An Income statement (sometimes called a trading and profit and
loss account) sets oul a detailed calculation of the profit or loss for
the year of the business. The transfer of information (sales, income,
expenses) to the Income statement from general ledger accounts is
first recorded In the general Journal (see Unit 5.3). Account is taken
of the value of unsold goods (inventory) when calculating the profit
{there is more on this in Unit 5. 2).
" ILLUSTRATION 1 The format tor a simple income statement
Here is the format for a simple income statement of a business
selling goods, using the vertical style.
Income statement for the year ended 3 1 December 2018
$
Revenue
Less cos1 of sales:
Opening inventory
Purchases
Closing hventory
Ccst of sales
Gross profit/income
$
220000
70000
160000
170000
(20000)
[150 000)
70000
Add discounts received
5000
75000
Less operating expenses:
Administration expenses
Rent
Wages
Total expenses
Profit for the year
75000
17 000
19000
!51 000)
24000
• 'Revenue' Is the term used In an income statement tor the
Income from sales of goods of a business.
• It Is recommended that any figures that are to be deducted in
an Income statement are shown Jn brackets.
~
.
-~~-
SUMMARY QUESTIONS
1 . Which statements make up the financial statements of a
business?
2. Why Is the vertical format now the most commonly used
presentation for 'lnancial statements?
3. Describe the main components of an Income statement.
LINKS
C''b
Financial sta,ements will be
studied carefully and will be
s.ibject to close analysis. In order
that tne financial S!rengths and
weaknesses of ihe business can
be established, often by using
accounting ratios (see Unit 5.7).
Comparisons wi:h previous years
and with the results ol similar
businesses will be made wherever
possible, and reports prepared
setting out recommendations for
improvir g the performance of the
business (see Unit 5.8).
More about income
statements
LEARNING OUTCOMES
In this unit yov will learn about:
• preparing a sole trader's
Income statement 10 record
inven1ory
• how returns are recorded In
an income statement
• how carriage expenses
are recordeo In an income
statement.
Double entry for inventory
The valuation of unsold goods {inventory) Is taken into account at
the end of each financial year. Often the figure Is found by actually
counting the items in the stockroom and working out the value using
the price paid for the items l'1hen they were purchased. Alternatively,
it is now becoming much more common for inventory records to be
kept electronically using software that can produce figures for the
valuation of Inventory.
Once the closing inventory has been valued, general Journal entries
will be prepared such that. when they are posted to the general
ledger, the following results:
• debited to 1he inventory account in the general ledger
• deducted from the value of goods available for sale during the year
ln the income statement (the equivalent of a credit entry).
I
ILLUSTRATION 1 Recoroing the opening and closing valuations of inventories
Here are the entries to record the opening valuation of inventory $8 000, purchases S82 000,
revenue $191 000 and closing Inventory $11 000 of a business.
Dr
Inventory (Account No. 14)
Cr
2018
Jan 1 Balance bid
2018
8 COO Dec 31 Income statement
2019
Jan 1 Income statement
11 000
$
$
8000
Income statement for the year ended 31 December 2018
$
Revenue
Less cost of sales:
Opening inventory
Purchases
Closing inventory
Cost of sales
Gross profit
$
191 000
8000
82 000
90000
(11 000)
(79 000)
112000
The general Journal is used to recoro the opening ana closing inventories, as Illustrated In the
next unit, Unit 5.3.
If a business has a closing inventory, it follows that this will
be the inventory at the beginning of the next financial period
(I.e. the next day). When preparing an Income statement, the
entries for an opening Inventory are:
• creoit the inventory account. to transfer the opening Inventory to
the income statement
• add the opening inventory to the purchases figure ln the income
statement to give the value of goods available for sale (the
equivalent of a debit entry).
EXAM TIP
It is i""-porta "'-l: to
;e""'-l1%ber th1:1t ccin-i.Age
<"-WCI m,; Cl l'Coi CCI n-i.A c.e
0<-<twArols C11-e both ~
expe"'-Ses.
Remember that entries In the general journal always precede entries
in ledger accounts.
Recording returns in the trading section
of an income statement
Goods returned are recorded In the trading section of an Income
statement.
• Returns inward s (sales returns) are deducted from revenue to
EXAM TIP
It is AolvisAble t o oleoluct
Yetun,,.s OUtwArols fY01%
P<-<Yc_hAs~ before ciololi""9
CAYnAge Ol'CWtlYois.
show a net figure for the yea1 under review.
• Returns outwards (purchases returns) are deducted from
purchases to show a net figure for the year under review.
KEY TERMS
Carriage charges and the income statement
Carriage inwards: the cost of
Carriage is the term used to describe the expense of having goods
delivereo.
transporting goods purchased
by a business - It is added
to purchases In the income
statement.
• Carriage inwards refers to the charges paid to have purchases
delivered (a cost of purchases). Carnage inwards is recorded in the
trading section of the income statement.
• Carriage outwards refers to the charges paid by a business to
have its goods delivered to customers (a selling expense). Carriage
outwards Is recorded In the profit and loss section of the income
statement.
See Unit 5.6 for an illustration of a trading section recording returns
and carriage inwards.
SUMMARY QUESTIONS
1 . What is the double entry for recording:
a. a closing Inventory
b. an opening Inventory?
2. What is the difference between carriage Inwards and carriage
outwaids?
3. In what order should the items in the cost o; sales section of
an Income statement be set out?
Carriage outwards: the
cost of transporting goods
to customers - as a selling
expense. it is recoroed in the
second part of the income
statement.
Journal entries and the
income statement
LEARNING OUTCOMES
In this unit yov will learn about:
• preparing journal entries
to recoro transfers to the
income statement.
All transfers to the Income statement should first be recorded in the
general journal.
Remember to start each journal entry by stating the account to
be debited followed by the account to be credlteo. Each journal
entry should conclude wtth a narrative (I.e. a brief explanation of the
reason for the entry) unless you are instructed that narratives are not
required.
I
/ ILLUSTRATION 1 Journal entries and the income statement
A business Is about to prepare Its Income statement for the year ended 31 August 2018. On this oate the
following information is available:
Discounts allowed
Discounts received
lnven1ory
At 1 September 201 7
At 31 Av;iust 2018
$
700
400
7 200
8500
F
E
a
D
Purchases
Returns irwvards
Returns oulwards
Revenue (sales)
Wages
$
51 400
3500
2000
97 700
14 700
C
G
H
A
F
Each of the above items has been given a fetter corresponding to the relevant Journal entry below. Here
are the journal entries required to record this Information in the income statement:
Page3
JOURNAL
Oetalls
A
a
C
D
E
F
Sales
Income statement (revenue)
Transfer of sales to income statement
Income statement
Inventory
Transfer of opening inventory to income statement
Income statement
Purchases
Transfer of purchases to income statement
Inventory
Income statement
Entries to record closing inventory
Discounts received
Income statemem
Transfer of discounts received to income statement
Income statement
Discounts allowed
Wages
Entries to transfer expenses to income statement
Folio
Dr
Cr
$
$
GL6
GL9
97 700
GL9
GL4
7 200
GL9
GL5
51 aoo
GL4
GL9
8500
GL2
400
97 700
7200
51 400
8500
400
GL9
GL1
GL3
15 400
700
14 700
(Continued)
' ILLUSTRATION 1 Journal entries and the income statement {Conlinued)
Page3
JOURNAL
Data/ls
G
H
Folio
Income siatement
Returns inwards
En1ries to transfer returns inwards to income stalement
Relurns oulwards
lnoome staiemen1
Enlries to transfer returns outwards to income Slatement
Dr
Cr
$
$
GL9
GL7
3500
GL8
GL9
2000
3500
2000
And here Is the Income sta1ement.
Income statement for the year ended
31 August 2018 (Account No. 9)
$
Revenue
Less relurns Inwards
Ne1sales
Less cost of sales:
Opening invenlory
Purchases
Less returns outwards
Nel purchases
CoS1 of goods available for sale
Less closing inv-enlory
Cosf of sales
Gross proftt
Add discounts received
A
G
B
C
H
O
E
Less opera1ing expenses:
Disccun1s allowed
Wages
Tolal operating expenses
Profrt for 1he year
F
F
• •
J3
J3
J3
J3
J3
7 200
51 400
(2 000)
49400
56600
(8 500)
J3
(48 100)
46100
400
46500
J3
J3
J3
700
14 700
(15 400)
31 100
J3
1. Which book o~original entry Is used to record transfers of
general ledger accounts to the income statement?
2. What is the double entry to record the transfer of sales
(revenue) to the Income sta1ement?
3. What is the double entry to record the transfer to the income
statement of:
b. olscounts allowed?
97 700
(3 500)
94200
•
a. discount received
$
DID YOU KNOW?
The Income statement is part
of the general ledger and so rt
is shown with a general leoger
account number.
LINK
%
Toe profit (or loss) for the year is
transferred 10 1he capital account.
This is covered in the next urit,
Unit 5.4.
The capital account
and service business
income statements
Updating the capital account
LEARNING OUTCOMES
In this unit yov will learn about:
• updating the capital account
at year end
• preparing an income statement
for a service business.
When the Income statement is complete, the profit (or loss) for the
year, which represents an increase (or decrease) in the value of the
business, is transferred to the capttal account. To complete the
capital account, the total of the owner's drawings is transferred from
the drawings account to the capital account. These transfers should
first appear in the general journal.
ILLUSTRATION 1 Updating a capital account
A business Is about to prepare its
income statement for the year ended
31 December 2018. On this date the
following information Is available:
GENERAL LEDGER
Dr
Cr
2018
$
2018
Dec 31 Drawings J6
27 000 Jan 1 Balance bid
31 Balance c/d 109 000 Dec31
136 100 Profit for year J6
s
Capital at 1 January 2018
Drawings
Profit for 1he year
Capital (Account No. 1)
83600
27000
52500
$
83600
52 200
136 100
2019
Jan 1 Balance bid
Here is the completed capttal account
in the general ledger.
109 100
The income statements of service businesses
SUMMARY QUESTIONS
1. What is the double entry to:
a. transfer total orawings
to 1he capital account
Many businesses provide services rather than sell goods. In the endof-year financial statements there is therefore no need for a trading
section in the Income statement. which insteac:i consists of just one
section showing expenses deducted from revenue to arrive at the net
income for providing services.
I
/ ILLUSTRATION 2 The Income statement of a service business
b. transfer profit for the
year to the capital
account?
Here is a typical example of the income statement of a service
business. In this case the business provides a cleaning service to
local businesses.
2. What entries would be
required to transfer a loss
for the year to the capital
account?
First Class Cleaners
Income statement for the year ended 30 June 2018
3. Descnbe how an income
statement for a service
business dHfers from the
income statement for a
trading business.
$
Revenue (receipts from oustomers)
Less operating expenses:
Cleaning materials
Electricily charges
Motor vehicle running costs
1Nages
Total operating expenses
Proffl 'or the year
$
115600
3700
4 100
6600
39700
(54 100)
61 500
Classified statements of
financial position (balance
sheets) in vertical style
The statement of financial position (balance sheet) is more useful if
the capital section is expanded to show:
LEARNING OUTCOMES
• the balance of capital at the beginning of the year
n this unit you will learn about:
• the profit (or loss} for the year
• preparing a class~ied
statement of financial
position (balance sheet}
In vertical style, to show
working capttal and a
detailed capital section
• how a net profit or loss
affects the capital In a
statemen1 of financial
position (balance sheet},
• the drawings
• the closing balance of capttal.
It can also show a subtotal for working capital. This is found by
deducting total current liabilities from total current assets. Working
capital is often referred to as 'net current assets' (or 'net current
liabilities· when the result Is a negative figure}.
The figure for working capital is important when looking at the
financial performance of a business. It can help users decide vvhether
the business has enough resources to keep the business running
efficiently on a day-to-day basis.
'Nhen preparing a vertical statement of financial position
(balance sheet):
1. The final column (on the right} is used for the main subtotals: noncurrent assets. working capital (net current assets/liabilities}. etc.
2. The second column from the rlght is used to show hov-t the main
subtotals In the final column were calculated.
3. The third column from the right is used when there are yet more
detailed workings to show (in this case the detail leading to the
subtotals for current assets and current liabilities).
4. If necessary, more money columns can be used.
6. The capital section sets out all the details from the capital account
In the general ledger of the business. The figure for profit has been
added to the opening capital figure. The figure for a loss would be
shown in brackets and oeducted from the opening capttal figure.
An example of a vertical statement of financial position (balance
sheet} can be found in Unit 5.6.
1. What is worklng capital and why is It important?
2. A business has total current assets of $37 ooo and total
current llablllt ies o• $42 000.
a. What is the working capital of the business?
b. What al1ernatlve label could be used instead of working
capital on the balance sheet of this business?
Worked example:
sole trader financial
statements
LEARNING OUTCOMES
In this unit yov will learn about:
• updating the capital account
at year end
• preparing an Income
statement 'or a service
business.
The question
Nisha is the owner of a business which sells musical Instruments.
The following trial balance was extracted from the books of the
business on 30 June 2020. the end of the financial year.
Trial balance at 30 June 2020
Dr
$
Accounts payable
Accounts receivable
Bank loan (repayable February 2021)
Capital
Carriage inwards
Carriage outwards
Cash at bank
Discounts
Drawings
Furniture and fittings
General expenses
Insurance
lmereS1 charges
lnventcry at 1 July 2019
Office equipment
Petty cash in hand
Purchases
Rent of premises
Repairs and mainlenance
Returns
Revenue
Slaff wages and salaries
Utilities
Cr
$
14 500
5 920
4500
52 360
680
940
3560
330
21 540
17 900
3 190
2 010
270
23800
34 600
50
64330
8890
1 040
820
67 550
4 240
261 660
290
770
189 240
261 660
At 30 June 2020 inventory was valued at $25 890.
Prepare:
• An income statement for the year ended 30 June 2020
• A statement of financial posilion (balance sheet) at 30 June 2020.
Getting started
Stage 1
When faced with a lot of detail It is worthwhile taking a few minutes
to look through the information to look out for any special features, to
begin to take in some of the information that has been provided. and
to think about how best to start answering the question.
Stage 2
• It is worth noting that the trading section of the Income statement
will be quite complicated as there are returns and carriage charges
mentioned In the list of accounts.
• It is also worth noting that the accounts listed includes 'petty cash
In hand'. It is a common error to think that this is an expense.
However, the item is an asset as it represents unspent cash.
• Some care will be requireo' with the Item 'discounts': it will be
necessary to decide which item is an expense (discounts allowed}
and which item represents income (discounts received}.
• Care will also be required witth the item 'returns': it will be
necessary to decide which amount Is returns inwards and which
Item is returns outwards.
• The bank loan Includes a datte tor repayment. It is important to note
that, since this date falls within the next financial year, the bank
loan should be recorded as a current liability.
• It could be useful to work through the list of Items and decide
which should be recorded In the income statement trading section,
which in the income statement profit and loss section and which
should appear in the statement of financial position (balance sheet}.
You could pencil in 'IT'. 'IP' or 'S' beside each item.
Here is the trial balance again, with the items marked up as suggested:
Dr
$
Accounts payable
Accounts receivable
Bank loan (repayable February 2021)
Capital
Carriage inwards
Carriage outwards
Cash at bank
Discounts
Drawings
Furniture and fillings
General expenses
Insurance
lmerest charges
Inventory at 1 July 2019
Office equipment
Petty cash in hand
Purchases
Rent of premises
Repairs ard mainte,,ance
Returns
Revenue
Slaff wages and salaries
Utilities
Cr
$
14 500
5920
4500
52 360
680
940
3560
330
21 540
17 900
3190
2 010
270
23800
34 600
50
64330
8890
1 040
820
67 550
4 240
261 660
s
s
s
s
IT
IP
s
290 IP
s
s
IP
JP
IP
IT
s
s
770
189 240
261 660
IT
IP
IP
IT
IT
IP
JP
The answer
You are now ready to prepare the first task: the income statement.
Do not forget the Importance of good presentation. Financial
statements are formal documents to be viewed by the owner of the
business and other users. so they should look as if real care has
been taken to show every detail correctly.
Step 1
Here is the income statement using vertical presentation. Three
money columns will be required in order to set out the details
correctly: use the final column for the most significant figure. the
middle money column is used to show how these key figures were
obtained, and the first money column is required when there is yet
more working out to do.
DID YOU KNOW?
It is recommended that, when
preparing the trading section,
returns outwaros is deducted
from purchases before carnage
Inwards Is added to net
purchases.
Nisha
Income statement for the year ended 30 June 2020
$
Revenue
Less re'.urns inwards
Net sales
Cost of sales:
Opening Inventory
Purchases
Less relurns outwards
Carriage inwards
EXAM TIP
It LS worthwhile loo~i"'-0
bi;ic~ to l¾i;f~e 5'-<Yt l::)D'-<
hi;ive _J>Yovi.ded i;i ft.<.ll
hei;i do"'-0 foy the l"'-COl¾t
sti;itel¾e~. It LS best
to i;ivoi.d i;ibbrevii;iti.o=
St.<.ch i;is 'l::Jle '. rt i.s ei;isl::J
to foyget to L~bel cost of
s~l es, g YOSS J>Yofi.t /;I 111,c(
J>Yofi.t for the l::Je~,; so do
chec~ thi;it these hi;ive
bee.,, i.111,clt.<.ded.
Less closing inventory
Cost of sales
Gross profn
Add discounts received
Less expenses:
Carriage outwards
Discounts allowed
General expenses
Insurance
Interest charges
Rent of premises
Repairs and maintenance
Staff wages and salaries
Utiltties
Total expenses
Profit for the year
s
s
189 240
!820)
188 420
23800
64330
(770)
63560
680
64 240
88040
125 890)
62 150
126 270
290
126 560
9<10
330
3 190
2 010
270
8890
1 040
67 550
4 240
(88 460)
38 100
Step 2
The statement of financial position (balance sheet) can now be
prepared. Again. vertical presentation will be used vvith three money
columns.
Nisha
Statement of financial position (balance sheet)
at 30 June 2020
$
Non-current assels
Office equipment
Furntture and fittings
Total non-current assets
Current assets
Inventory
Accounts receivable
Cash at bank
Petty cash in hand
Total current assets
Less Current liabilities
Bank loan
Acccunts payable
Total current liabilities
Working capitaVnet current assets
Capital employed
Capttal:
Opening balance
Add Profit for year
Less drawings
Owf1€r's equity
s
EXAM TIP
$
3Li. 600
17 900
52500
It is Q COl¾l¾O"'- l¾ista)u
to YeCOYlil 'pett11 CAS"1 '""
l-i t:1 vcd' as A"- e><pe=e ,...._
t"1~ i.,.,col¾e stcite""'-e"'-t.
This ite""'- YtpYese...._ts.
~~l'e"'-t petttl ccis"1, so
Lt LS Cl CIA.Y-YeVl,t cisset of
tvie llusi"'-tSS.
25 890
5920
3560
50
35 420
EXAM TIP
4500
14 500
It is A goool iolet:1 to l¾Ake
(19 000)
16 420
68 920
52 360
38 100
90 460
!21 540)
68 920
/;I
fi,"'-t:lt evi~c.k of tJo<.<v
sta:e:"'e~ of fi."'-A"'-CLAL
posLho"" (bciw=e svieet)
to """ake suye tke titLe LS
give""""" fuLL (Avoicl.""g
Abl:lyeviAtio=) Avcd
sull"1ea oli"'-gs "1t:1ve bee""
SVlOW>'\. COYYectLtJ,
Ratios and profitability
LEARNING OUTCOMES
In this unit yov will learn how to:
• calculate simple pro'itabllity
ratios
• use profitability ratios to
assess business peitormance.
In order to examine the key aspects of the performance of a business
It is usual to calculate ratios using some of the key figures contained
in financial statements. Ratios can be used to compare the results of:
• one year against previous years
• one business against similar businesses.
These comparisons help to reveal where improvements have
occurred, or where performance has weakened.
Income statement ratios
There are four ratios that can be used to analyse an income statement:
Formula
Gross profit
Revenue
Name of ratio
Gross profit pe<centage
Gross profit
Cost of sales
Mark-up
Cost of sales
Rate of inventoiy turnover
Average inventory
Net proli1 percen1age
Proffl for year
Revenue
x 100
x 100
x 100
x 100
/ ILLUSTRATION 1 Calculating profitability ratios
Four ratios have been calculated using the following income statement:
Income statement for the year ended 31 December 2018
$
Revenue
Less cost of sales:
Opening inventory
Purchases
Less closing Inventory
Cost of sales
Gross profit
Less operating expenses:
General expenses
Rent
Salaries
Total expenses
Profrl for the year
$
400 000
27000
296000
323 000
(23 000)
(300000)
100 000
9000
17 000
44 000
(70000)
30000
(Continued)
' ILLUSTRATION 1 lcaiculatlng profitability ratios (Continued}
Name of ratio
Formula
Calculation
Result
Gross profit percentage
__G_
ro_ss~pr_o_
ftt__ x
100
Revenue
100 000
400 000
X 100
= 25%
Mark-up
Gross proftt
---~---x100
Cost of sales
100 000
300 000
X 100
= 33.33%
Rate of inven1ory turnover
Cost of sales
-------x100
Average inventory
300 000
25000
Net prom percentage
--------- X
Profit for year
Revenue
100
= 12 times
_ 30_0
_ _00
_ _ X 100
400 000
= 7.5%
What the results mean:
• Gross profit percentage: shows how much gross pro'it is made for every $1 of revenue. In this
case every $1 of sales provided 25c of gross profit.
• Mark-up: shows how muc'.h gross profit Is made for every $1 spent on buying goods for resale.
In this case every $1 of cost of sales provided 33.33c of gross profit.
• Rate of inventory turnover: shows how many times during the year the business managed to sell
the typical amount o' inventory It has for sale at any one time. The average inventory of this
business was sold 12 times during the year, I.e. on average once every month.
• Net proftt percentage: shO'NS how much profit Is made for every $1 of revenue. In this case
every S1 o' sales produced a net proiit of 7.5c.
Positive performance and income statement ratios
It is possible to comment on the performance of a business based
on income statement ratios. However. it Is important to have
equivalent ratios for a previous year (or years) and/or for a similar
business. Here are some ideas about performance that can be
Identified from Income statement ratios.
Gross profit percentage and mark-up percentage
If these figures are increasing this is usually seen as good news for
a business. because it means more gross prom is being maoe In
relation to sales or cost of sales.
Rate of inventory turnover
An Increase In the rate of inventory turnover should be welcome
news for the owner of a business because it could result from selling
goods more quickly, so profit is being made on a greater volume of
sales. However, it could also result from holding a smaller average
inventory, which could reduce customer choice.
Net profit percentage
An increase in this percentage will mean that a business is
making more profit on each Item sold indicating a strength In the
performance of the business.
SUMMARY QUESTIONS
1. Why are ratios important?
2 . A business has revenue
of $400 000 ano a cost of
sales of $300 000. 1/Vhat Is:
a. the gross profit
b. the gross profit
percentage
c. the mark-up
percentage?
3. The Income statement of a
business ior a year records
a cost of sales o' $84 000.
The opening inventory was
S11 1oo ano the closing
Inventory was $12 900.
Calculate the rate of
inventory turnover.
Ratios and financial
position
LEARNING OUTCOMES
In this unit you will learn about:
• the ratios used to analyse
a statement of financial
position (balance sheet) and
their significance
• how to comment on
statement of ' inancial position
(balance sheet) ratios.
Here are three ratios that can be used to analyse the financial
position of a business:
Name of
ratio
Current ratio
Formula
Notes
Current assets
Current liabilities
The result should be
given as xx:1, e.g. 2.5:1
Liquid assets are
current assets less
inventory. The result is
also expressed as xx: 1.
Liquid assets
Acid test ratio
Return on
investment
Current liabilitles
Profit for the year
Capital employed
(or capital invested)
X 100
It is possible to use the
opening, closing or an
average cap11al figore.
ILLUSTRATION 1 Calculating ratios to determine the financial position of a business
Stat ement of financial position (balance sheet) at 3 1 December 2018
$
Non-current assets
Current assets
Inventory
Accounts receivable
Cash at bank
s
s
330000
15 000
12 000
13 000
40000
Less Current liab!ltties
Accounts payable
Working capttal (Net current Assets)
Capital employed
Capttal
Opening balance
Proftt for the year
Less drawings
(20000)
20000
350000
300000
70000
370000
(20000)
350000
(Continued)
' ILLUSTRATION 1 lcaiculatlng ratios to determine the financial posttion of a business (Continued)
Name of ratio
Formula
Calculation
Result
Current ralio
Curren! assels
Currem llabilltles
40000
20000
= 2:1
Acid test ralio
Liquid assets
Currenl llabillties
25000
20000
= 1.25:1
Return on investment
Proftt for the year
Capital employed
(or capita! invested)
70000
- - - - x 100
350000
= 20%
X 100
VI/hat the results mean:
1. The current ratio measures the funds available to meet the debts of the business.
2. The acid test ratio indicates the funds more immediately available to meet the debts of the
business at short notice.
3. The return on investment measures hov,1 much profit is being made compareo to the owner's
investment in the business. ('This ratio could have been based on the closing capital or an
average of opening and closing capital.)
Positive performance and statement of financial
position (balance sheet) ratios
Current ratio
If the ratio Is In line wtth the norm for the type of business being
reviewed, it means that the business is well placed to meet its
commttments and has just the right amount of net current assets/
working capttal.
Acid test ratio
If the ratio is in line with the norm for the type of business being
reviewed, it means that the business is well placed to meet its
commitments in the short term and has just the right amount of llouid
assets.
Return on investment
If the percentage is Increasing this would signal an improving
performance and a more effective use of all the resources of the
business.
LINK
%
There is more lnformallon about
negative performance and
making recommendalions for
improvement in Unit 5.9.
SUMMARY QUESTIONS
1. A business has current
assets of S50 000 (Including
inventory $1O000) and
current liabilities of $20 000.
What is:
a. the current ratio
b. the aclo test ratio?
2. \11/hy is it good news tor a
business when it achieves
tl1e expected current ratio
and when there is an
increase in the return on
investment?
Recommendations
based on ratio analysis
LEARNING OUTCOMES
In this unit yov will learn how to:
• prepare simple reports
evaluating a bwsiness wsing
ratios
• make recommendations to
Improve the performance of
a business.
Improving income statement ratios
Gross profit percentage and mark-up
If the trend in these ratios is declining In relation to previews years, or
is weaker than those for other similar businesses, corrective action
could take the form of:
• increasing selling prices (though this could make the business less
competttlve, causing customers to go elsewhere, with the result
that fewer goods are solo)
• finding cheaper suppliers (though this might result in lower qualtty
gooos being purchased, which could deter customers).
Rate of inventory turnover
If the rate of inventory turnover is falling or is less than for other
similar businesses, the owner might consider:
• attracting more customers and getting cwstomers to buy more,
perhaps by:
• reducing prices (though less profit will be made on each sale)
• advertising more effectively (though this could cost more and so
reduce profit)
• reviewing the products on sale (adding new lines and dropping
slow-selling lines)
• reducing average inventory, which could help reduce storage
costs, but might reduce the choice available to cwstomers. leading
to reduced sales.
Net profit percentage
If the percentage Is falling or less than tor a similar business. the
owner should consider:
• Improving gross profit In relation to sales - increasing gross prom
is likely to result in a higher profit for the year (see above for how to
Improve gross profit margin)
• reducing expenses - if the business can be run more e'ficlently
by cutting out unnecessary expenditure, profits should increase.
However, cutting costs could affect the quality of seNice provided
to customers.
Improving statement of financial position
(balance sheet) ratios
Current ratio
If the ratio is lower than the norm for the type of business being
reviewed, it could result In the business having difficulty paying its
debts/current liabiltties when they fall due and paying for everyday
operating expenses. There are a number of courses of action that
could be taken to strengthen a decreasing ratio, including:
• Introducing more capttal
• borrowing addHionaJ long-term iunds
• reducing drawings
• making more profit
• delaying capital expenditure
• selling off unused non-current assets.
If lhe ratio Is higher than normal. this could mean a business has too
many funds tied up In current assets.
Acid test ratio
DID YOU KNOW?
The ratios described In Units
5.7 and 5.8 can be reviewed
under the following headings
when reporting on the
performance of a business.
Profitability: Are the owners
and managers of a business
successful In Increasing the its
value over time through trading
or providing a seNice?
Liquidity: Are lhe resources
• the measures listed above for improving the v1orking capital ratio
of the business well managed
so that debts are settleo on
time and so that the owner can
receive a reasonable Income?
• reducing the 1unds tied up In Inventories.
Efficiency: Are the owners
If this ratio is too tow, the business ls likely to have more immediate
problems in meeting tts debts. The ratio can be improved by:
Return on capital employed (return on capital invested)
When the trend is declining, or the percentage is lower than for a
similar type of business, an Improvement could be made by:
• Improving pro1its
and managers of the business
controlling key resources so
that the maximum benefit is
derived from the funds tied up
in them?
• reducing the level of capital invested.
How to report on performance
The fcilowing steps should be taken when reviewing the performance
01 a business:
Step 1: Look at the trend in sales.
Step 2: Calculate the ratios described In Units 5.7 and 5.8.
Step 3: Compare the ratios calculated with those for previous years
and/or other similar businesses.
Step 4: Decide how the business is performing overall; where there
are v1eaknesses. make recommendations for improvement.
SUMMARY QUESTIONS
1. A business has not managed Its working capital and liquid
capital well. How coulo these ratios be Improved?
2. The owner of a business has proposed spending more on
advertising ano Increasing selling prices to improve profits.
What risks are associated with these actions?
LINK
In Unit 5.1 0 there Is a worked
example of a report on 1he
performance of a business.
%
Worked example:
reporting on performance
The end-of-year financial statements of a business include the
following information:
For the year ended 31 December 2018
$
Average inventory
48000
Cost of sales
576 000
Gross profit
144 000
Profil for the year
72000
Revenue (cash and credit sales)
720000
At 31 December 2018
$
Capltal employed (cap~al invested)
900000
Current asse1s
90000
Current liabilities
45000
Inventory
46000
Revenue totalled $740 000 in the year ended 3 1 December 2017.
Here is a table showing the ratio calculations for the year ended
3 1 December 2018 alongside the equivalent information for 2017.
Result
Name of ratio
Formula
Calculation
2018
2017
Gross profil
percentage
Gross profit x
100
Revenue
144000 100
720 000 X
20%
23%
Acid test
Liquid assets
Curren! liabilities
44000
45000
0.98:1
0.7:1
Mark-up
Gross profit x
100
Cost of sales
144000
576 000 X 100
25%
30%
Profit for the year x
100
Revenue
72000 100
720 000 X
10%
1-1%
Cost of sales
Average inventory
576000
48000
12 times
11 times
Profit for the year
100
Capita! employed x
72000 100
900 000 X
8%
7%
Current assets
Curren~ llabili'.ies
90000
45000
2:1
1.8:1
Ne: profit percentage
Rate of inventory
1urnover
Return on investment
Current ratio
The report would oraw attention to the following:
Revenue has fallen since 2017 by $20 ooo.
Profitability
Improvements in performance:
The return on investment has improved by 1%, meaning that more
pro'it is being earned per $1 of capital investeo by the owner, so
resources are being useo more effectively.
Weaknesses In performance:
The gross pro'it percentage and mark-up are lower than in 2017,
meaning that less profit is being made on each S1 of sales or S1 oi
cost of sales.
The net profit percentage has decreased by 4% since 2017 meaning
that less profit is being made per $1 of sales.
Liquidity
Improvements in performance:
The current ratio has Improved since 2017, which means that the
business shoulo be able to pay Its debts more easily.
The acid test ratio has improved since 2017. which means that the
business shoulo be able to pay ,ts immediate debts more easily.
Weaknesses in performance: None.
Efficiency
Improvements in performance:
The rate of Inventory turnover has Increased since 2017, which
possibly could mean that a smaller average inventory is being sold
more quickly In 2017.
Weaknesses In performance:
None.
Summary
overall, there is a mixed picture regarding the performance of the
business: liquidity and efficiency have improved since 2017, but In
some respects profitability has weakened.
Possible recommendations:
• Increase sales by considering changing selling prices, advertising
more effectively and making changes to the product lines that are
currently being sold.
• Improve the gross profit percentage and mark-up by either
Increasing prices and/or finding cheaper suppliers.
• Increase the net pro'it percentage - this might be achieved by
Improving the gross profit margin, but would also result from a
stricter control of expenses.
Practice exam questions
Paper1
4 The ow,,er of a business provided tre following
1 Which one o1 the 1ollowlng appears In both the
Income statement and lf'e statement of 1inanclal
posttion (balance sheel) of a sole trader?
A closing Inventory
B drawings
C gross profit
lntormat,on: non-current assets $110 000, current
assets $30 000, current llabilttles $20 000, profit
for 1he yeai $15 000. What is the percentage
return on invesiment 1or 1he business?
A 10.71%
B 12.50%
D accounts receivable
2 The followir g Information has been taken
C 13.64%
from the Income sta!ement for the year erded
31 December 2018 Of a sole trader: revenue
$160 000, coot of sales $100 000, profit for the
year $28 000. Wnat were the expenses for the
year ended 31 December 2018?
$32 000
C $72 000
A
5 Wesl~ provided the following information about
his business: bank overdraft $7 000, Inventory
$10 000, long-1erfT1 loan $20 000, accounts
payable $28 000, accoums receivable S45 000.
INhat was liquid capital ratio of the business?
B $60 000
A 0.82:1
C 1.57:1
D $132 000
3 Jillian had revenue of $800 000. Her expenses
were $200 000 and prcfit for the year was
$120 000. \/\/hat was Jillian's gross profit
percentage?
85%
C 60%
A
D 15%
B 1.29:1
D 1.86:1
B 75%
D 40%
Paper2
1 Preparing the income statement
of a service business
Gler.roy is an electrician. The
following information about his
business Is avaJlable for the year
ended 31 May :Z018.
Prepare an Income Slatement for
me year ended 31 May 2018.
$
Administration e)(penses
$
1 260 Utiltties
1 520
General expenses
740 Vehicle running costs
2 970
Loan imerest
890 Wages of assislant
29 240
Revenue (receipts 1rom
customers)
2 Preparing an income statement to include
carriage charges; updating the capital
account
Mendoza Electrical Supplies' financial year ended
on 31 Augvsl 2018. The 'ollowing informa1lon was
taken 'rom the books of account of 1he business
on tnat da1e.
88 430
s
Capital
(1 September 2017)
s
Other
55 000 expenses
22 440
Carriage Inwards
830 Purchases
75820
Carriage outwards
410 Revenue
117 300
Drawings
14930
Inventories
1 September 2017
11 920
31 August 2018
14 380
Prepare:
a Entries In 1ne general journal to:
i transfer Information from i he general ledger to 1he inoome statement
ii complete 1he capttal account on 31 August 201 8.
b An income statement for 1he year ended 31 August 2018.
c The capttal account in the general ledger showing all '.he entries arising from the Information.
3 Calculating ratios
The following informa1ion has been extrac1ed from the financial statemen1s of the business owned by
Dwight Guzman. The Information is fo< the year ended 31 December 2018.
Items from the income statement
S
Items from the statement of financial position
(balance sheet)
s
Revenue (all on credit)
160 000 Total current assets
37 000
Cost of sales
120 000 Inventory
1.i 000
Average inventory
16 000 Total current liabllities
12 400
To1al cosls
22 000 Capital al 1 January 2018
90000
Profit for the year
18000
Calculaie the following ratios. Slate the formula used. Work lo two decimal places.
• gross profit percentage
• mark-up
• current ratio
• acid test ratio
• rate of invemory 1vrnover
• net profit percentage
• return on investment
4 Reporting on performance
For the year ended 31 December 2017. Dwight Guiman (see also Question 3) catculaled 1he following
ratios for his business. The reverue o' the business for the year ended 31 December 2017 was $150 000.
Gross profit percentage
22%
Current ratio
3.2:1
Mark-up
28%
Acid test ratio
1.7:1
Rate of inventory turnover
9
times
Return on
Investment
18%
Net profit percenlage
13.5%
Prepare a report analysing the performance of Dwight Guzman's business. Compare :he ralios for 2018
wtth 1hose for 2017 (use your answers from Quesiion 3). Use tne following headings in yovr report:
a Profilabillty
b Liquidity
c Efficiency.
Make recommendations to overcome any weakresses in the performance of the business.
•
Accounting concepts
and adjustments
LEARNING OUTCOMES
In this unit you will learn about:
• the accounting concepts
that underpin the need for
adjustments
• why adjustments are made
to 'lnancial statements.
LINKS
%
Expense and Income adjustments
are covered In Units 6.2 and 6.3.
Untts 6.4 and 6.5 explain now to
make, review and alter provisions
for doubtful debts.
Turn to Unit 6.6 for more on
depreciation.
A number of adjustments have to be made to financial statements
to enhance the quality of the information they contain and make it
more useful. These aojustments are made to satisfy a number of key
accounting concepts, four of which are explained here.
The accruals (matching) concept
The accruals concept (sometimes referred to as the matching
concept) establishes that, when calculating profits and losses for a
certain period (normally a year), only the revenue and other income
for that period should be lncluoed and It should be 'matched· to
the expenses for the same period. whether or not all the amounts
concerned have actually been received/paid. Revenue, income and
expenses relating to good ano services supplied or received during
other financial periods should not be included.
Therefore, when preparing an income statement, adjustments have
to be made for expenses and income for the period that are not
yet paid (expense accrualstlncome due) and expenses and income
relating to the next period that have been paid in advance (expense
prepayments/ income received in advanceo} In addition, provisions
for ooubtful debts must be taken into account, and, \"lhen calculating
profit. the wear and tear on current assets (oepreciation) must be
considered.
KEY TERMS
The prudence concept
Accruals concept: In order
It is important that users of accounting information are not misled into
thinking a business is performing better than is really the case. The
prudence concept requires asset values and profits, where there
Is doubt, to be understated rather than overstated, that expenses
and liabilities are recognised as soon as possible where there is
uncertainty, while revenues and assets are only recognised when
they are assured of being received. For example, bad debts are
written off promptly and accounts receivable are adjusted to make a
provision for doubtful debts.
to calculate profit Income for
a financial period is matched
exactly with the expenses that
relate to that perioo, whether
paid or not. The concept is
sometimes called the 'matching
concept'.
Prudence concept: the
principle that requires that,
where there is doubt. asset and
profit values are understated
rather than overstated
(and liabilities ano losses
are overstated rather than
uncterstated).
The consistency concept
The owners of businesses have choices to make when preparing
financial statements. Having chosen particular policies, it is important
that they are implemented In the same way each year. This Is an
application of the consistency concept. As a result the users of
financial statements can make valid comparisons of performance.
For example, a business shoulo apply the same depreciation method
each year and maintain the same percentage provision for doubtful
debts each year, unless there are overwhelming reasons for making
a change in these policies. Where a policy is changed this must be
clearly Indicated in the notes to the financial statements.
KEY TERMS
Consistency concept: 1he rule
that aocountlng policies should
be carried out In the same way
year on year.
The true and fa ir principle
True and fair: the principle
The true and fair principle reflects the idea that it is not acceptable
to manipulate figures in the financial statements In order to present
the finances of the business in a false light to gain some kind of
ao'vantage. Rather, the records must be accurate or at least present
a reasonable estimate of the position.
that aocounling records should
be factually accurate wherever
possible, or otherwise present
a reasonable estima:e of, or
j..,dgment about, tne ~nancial
position.
For example, tt it is expected that some accounts receivable will not
be paid, provision should be made for this to reduce the income
recorded.
Benefits of accounting concepts
Accounting concepts are Important because:
• They help decide the right course of action to take when an
accounting sttuatlon is not clear cut.
• They help reassure the users of accounting information that the
statements would have been prepared in the same way regardless
of who had been responsible for preparing them.
• Users can be confident that the financial statements are reliable.
SUMMARY QUESTIONS
1. What rule ,s covered by the accruals (matching) concept?
2. Why is the prudence concept important?
3. State two ways in which accounting concepts are imports1nt.
Expense and income
adjustments
LEARNING OUTCOMES
In this unit you will learn about:
• preparing journal entries and
leoger accounts lo reftect
adjustments
• tlie treatment of adjustments
in the statement of financial
position (balance sheet).
Adjustments to expenses
Expense accruals
This is the term used when an expense is not fully paid at the year
end. leaving an amount that is due but unpaio.
• At the year end the amount of an expense accrual is added to find
the correct amount to be charged to the income statement for that
expense.
• An accrual is recorded as a credtt balance (whe-i broughl down) in an
expense account as it is a current liabil~y.
Expense prepayments
When a payment for an expense covers more than the year under
review, i.e. part of the payment made for an expense covers the
business at the beginning of the next financial year, it is called a
prepayment.
• The amount of any prepayment must be deducted to find the
correct value of the expense to be charged to the income
statement.
• A prepayment is recorded as a debit balance on an expense
account as it represents a current asset.
Adjustments to income
Sometimes businesses receive Income not Just from sales (revenue)
but also from some activities, such as rent received when a business
lets out part oi its premises to a tenant, and Interest received on
investments ano savings. Other Income items are added to gross
profit in the second part of the income statement.
Income due
This is the income that has yet to be received at the year end.
• The amount of any Income due at the year end Is added to find the
correct amount of income to be shown In an Income statement.
• Income due is recorded as a debit balance (when brought down) in
an income account as it is a current asset.
Advanced income
• This is the amount of any income received that covers more than
the year under review, I.e. part ot the amount received covers the
beginning of the next financial year. It is necessary to deduct the
amount of any income received in advance at the year end to find
the correct value of income to be shown In an income statement.
• Advanced income is recorded as a credit balance on an income
account as it represents a current liability.
All transfers to the Income statement from expense accounts and
Income accounts wlll first be recorded In the general Journal.
' ILLUSTRATION 1 Recording expense and income adjustments
Expenses
During the year ended 31 December 2018 a business has paid wages of $27 300. At 31 December
2018, S400 remains due for wages for the last part of the year.
The business has also paid insurance of $9 500. However, this Includes $1 500 that is Insurance for
January 2019.
Journal entries to record transfers to the Income statement:
JOURNAL
Date
2018
Dec
Details
31
31
Income statement
Wages
Transfer of wages for the year 10 1he Income sta1ement
Income statement
Insurance
Transfer of insurance for the year to the income statement
Dr
Cr
$
$
27 700
27 700
8000
8000
This is how the expense accounts will appear in the general ledger:
Dr
2018
Dec
Cr
Wages
$
31
Cash
31
(total payments for the year)
Balance cld
27 300
400
27 700
s
2018
Dec 31
Income statement
27 700
27 000
2019
Jan 1
Balance bid
400
Dr
Insurance
Cr
2018
Dec 3 1
$
s
Cash
(total payments for the year)
9500
2018
Dec 31
31
9500
2019
Jan
1
Balance bid
Income statement
8000
Balancecld
1 500
9500
1 500
Income
A business has received Interest of $1 450 on an investment during the year ended 31 December 2018.
At 31 December interest of S350 is due but not yet received.
The business has also received rent from a tenant of $3 900. However, this includes rent of $300 for the
month of January 2019.
/
(Continued)
ILLUSTRATION 1 Recording expense and Income adjustments (Continueo)
Journal entries to record transfers to the income statement:
JOURNAL
Date
Details
Dr
Cr
s
s
2018
Dec
31
Interest received
Income sialement
Transfer of interest received for the year 10 the income statement
31 Rent reoeived
Income sialement
Transfer of rent reoeived for the year to the Income stalement
1 800
1 800
3600
3600
In this case the ledger accounts wll I appear as follows:
Dr
2018
Dec
31 Income statement
$
1 800
Interest received
Cr
2018
Dec 31
31
$
1 800
Bank (amount reoeived during 1he year) 1 450
Balance c/d
350
1 800
2019
Jan
1 Balance bid
350
Rent received
20i8
Dr
2018
Dec
$
31
31
Income statemem
Balancec/d
3600
300
3900
Deo 31
Cr
s
Bank (amount reoeived during the year) 3900
3900
2019
Jan
1
Balance b/d
300
/
SUMMARY QUESTIONS
1. What are the differences between an expense accrual ano an
expense prepayment?
2. Explain why:
a. an expense accrual is a current liability
b. advanced income is a current liability
3. Explain why:
a. an expense prepayment Is a current asset
p. income due is a current asset.
Expense and income
adjustments and financial
statements; bad debts
Expense and income adjustments are designed to implement the
accruals concepts when preparing financial statements.
The following is a summary of how they are treated in the statement
of financlal position {balance sheet):
Adjustment
Shown under ...
Expense accrual
Currem liabilities
Prepaid expense
Current assets•
Income due
C.irrent assets•
Income received in advance
Cvrren! liabilities
LEARNING OUTCOMES
In this unit you will learn about:
• how to record expense
and Income aojustments in
financial statements
• bad debts ano how they are
recorded In the books o•
account.
• Plaoed immediately after accounts receivab'e when assets are recorded In
order of permanence
ILLUSTRATION 1 Expense and income adjustments and financial statements
Based on the Information in Illustration 1 of the previous unit. the following details v,1111 appear in the income
statement and statement of f inancial position (balance sheet) of business.
Income statement (extract) for the
year ended 31 December 2018
s
Gress profit
Add:
imeres1 received
rent received
Statement of financial position (balance sheet)
(extract) at 31 December 2018
$
$
XXX
1 800
3600
5400
Less:
insurance
wages
other expenses
8000
27700
s
XXX
XXX
350
1 500
XXX
XXX
XXX
XXX
Profit for the year
CURRENT ASSETS
Inventory
Accounts receivable
Income due (interest)
Prepayments (rent)
Cash at bank
$
XXX
CURRENT LIABILITIES
Accounts payable
Income received In
advance (rent)
Accrvals (wages)
XXX
300
400
(xxx)
WORKING CAPITAUNET CURRENT ASSETS
XXX
Bad debts and the income statement
When a creoit customer is unable or unwilling to pay a business the
amount due it is necessary to write off this toss as a bad debt.
Writing off a bad oebt is a good example of the prudence concept.
Writing off a bad debt as soon as It is unlikely that any amount will be
received ensures:
• the profit for the year is not shown at an unrealistically high figure
• the figure for accounts receivable on a statement of financial
position {balance sheet) represents more closely the amount that is
likely to be received .
Wri1ing off a bad debt
• Prepare an entry In the general Journal debiting the bad debts
account and crediting the account receivable.
• Debl1 the bad debts account In the general ledger.
• Credit the account receivable in the sales ledger.
• At the year's end transfer the balance of the bad debt accoun t to
the Income statement.
" ILLUSTRATION 2 IWriting off a bad debt
The sales ledger of a business Included the account of Selena
Wright who owed $1 220. It has become necessary to write off
this account as the amount has been outstanding for over ten
months and the customer cannot be traced.
The Journal entry ls as follows:
JOURNAL
Date
Details
Bad debts
Account rec.,ivable: Selena VVright
Account of customer written off as a
bad debt
Or
Cr
$
$
1 220
1 220
SUMMARY QUESTIONS
..
1. How are expense adjustments recorded on a statement of
financial position {balance sheet).
2. How are income adjustments recorded on a statement of
financial position (balance sheet).
3. Why is It Important to wrtte bad debts off promptly?
Creating a provision
for doubtful debts
What is a provision for doubtful debts?
LEARNING OUTCOMES
Many businesses experience bad debts during the course of a year.
As a resutt, it ls likely that the total of accounts receivable to be
shown on the end of year statement of financial position (balance
sheet) could easily overstate the amount that will actually be received
during the next financial period. To ensure that this is avoided,
statements of financial position (balance sheets) record the total
of accounts receivable less an estimate tor future bad debts. The
estimate is called a provision for doubtful debts. This procedure Is a
good example of applying three of the accounting rules introduced in
Unit 6.1:
In this unil you will learn about:
• Accruals (matching) concept
• The prudence concept
• The principle that all financial statements should show a true and
fair view of the affairs of the business
Setting up a provision for doubtful debts
The amount of a provision for doubtful debts is usually based on
the past experience of bad debts of the business compared to the
total amount owed by credit customers. This is often expressed as a
percentage of accounts receivable at year end.
When it Is necessary to create a provision for doubtful debts the
following entries are required:
• General journal: recording the amount of the provision and the
entries to be made In the provision for doubtful debts account and
income statement.
• General ledger: a provision tor doubtful debts account is credtted
with the amount of the provision.
• Income statement: the provision is Included in the list of costs/
expenses; this is the equivalent of making a matching debit entry
for the cre<Jit entry in the ledger account.
• Statement of financial position (balance sheet): the provision Is
shown as a deduction from accounts receivable in the current
assets section.
• the treatment of provisions
for doubtful debts in both
the Income statement and
tli e statement of financial
position (balance sheet).
/ ILLUSTRATION 1 Creating a provision for doubtful debts
At 31 December Year 1, a business has total accounts receivable of S44 000. A provision for doubtful
debts of 5% of accounts receivable is to be created.
And here is the entry ln the general ledger:
Here are the journal entries:
Dr
JOURNAL
Date
Year1
Dec 31
Details
Income statement
Provision for
doublful debts
Entries to create
a provision for
doubtful debts
Provision for doubtful debts
Cr
Dr
$
$
$
~
Cr
$
Dec
31
Income sta1ement
2200
2 200
2 200
This is the entry in the income statement:
The entries in the statement of 1inancial position {balance
sheet) look like this:
Income statement (extract) for the
year ended 31 December Year 1
$
$
Gross profit
XXX
Less: expenses
XXX
provision for
doubtful debts
2200
Statement of financial position (balance sheet)
(extract) at 31 December Year 1
$
$
$
CURRENT ASSETS
Inventory
XXX
Accounts receivable
44000
Less provision for doubtful deb'.s 2 200
41 800
Prepayments
XXX
Cash at bank
XXX XXX
XXX
Profit for tne year
XXX
Notes:
1. No entries should be made in the provision for doubtful debts account during the course of a financial
year. If any bad debts actually arise, It Is usual to debit these to a separate bad debts expense
account (as explained In Unit 6.3).
2. The income statement shows profit for the year being decreased when the provision Is created. Profits
are decreased by the amount of the provision, because the owner of the business believes that this
amount of profit will not be achieved.
3. The entries In the statement of financial position (balance sheet) are deslgneo to show clearly not cnly the
total of accounts receivable accorcting to the sales ledger, but also 111/hat is actually likely to be received.
,
1. Why do many businesses use a provision for doubtful debts?
2. ldenti'y two accounting ccncepts that are applied when
setting up a provision tor doubtful debts.
3. What does the expression 'true and fair' mean in regard to
financial statements?
4. What is the double entry required to create a provision for
doubtful debts?
More about provisions
for doubtful debts
Reviewing a provision for doubtful debts
LEARNING OUTCOMES
Once a business has created a provision for doubtful debts, It is
necessary to review the figure at the end of each financial year to
bring it in line with the latest figure for accounts receivable.
In this unit you will learn about:
Increasing a provision for doubtful debts
If the total of accounts receivable has Increased, it will be necessary
to Increase the provision tor doubtful debts.
I
" ILLUSTRATION 1 increasing a provision for doubtful debts
At the end of Year 2 the business (see Illustration 1 in the
previous unit) has 1otal accounts receivable of $50 000, so the
owner makes entries to increase the provision to $2 500 (i.e. 5%
of S50 000). This represents an Increase of S300 since Year 1.
Journal entry to record the Increase In the provision for doubtful
debts:
JOURNAL
Date
Year 1
Dec 31
Details
Income statement
Provision for doubtful debts
Entries to increase lhe provision
for doubtful debts
Dr
Cr
$
300
$
300
The following entries are made In the general ledger:
Provision for doubtful debts
Year 2
s Year 1
Dec 31 Balancec/d 2500 Dec 31 Income
sta1ement
Year 2
Dec 31 Income
sta1ement
2 200
2500
2 500
Dr
Year 3
Jan 1
Balanceb/d
Cr
$
300
2 500
~
(Continued)
• the reasons for changing a
provision for doubtful debts
• the entries reouired to
Increase a provision
• the entries required to
decrease a provision.
/
ILLUSTRATION 1
EXAM TIP
A COV><V><.Oi,\, V><.istt1~e is
to Ye_c~n;I t~e wnole of tne
This Is how the Increase In provision is shown in the Income
statement:
pYov,s,o"" '"" tne i"'-coV><.e
St t1tt..M"'-t i.., ti i:jttlY
w11,.., tne provisiovs is
bei~
, , i~,..et1sect o""ce ti
7'YoV1.s,o"" l1t1s bee.,, cYet1teof
?"'Li:J ti-le &1V><.ou""1: of A""i:J
i"'-CYtt1se or o!ecre&1se is
~flow"" i"" subseq "''""t
'""°omt ste1teV><.e""ts.
Increasing a provision tor doubtful debts
(Continued)
Income statement (extract) for the year
ended 31 December Year 2
$
$
Gross profit
Less: expenses
Increase irl provision for
doubtful debts
XXX
)()()(
300
XXX
Profit fer the year
XXX
These are the entries in the statement of financial position
(balance sheet):
Statement of financial position (balance sheet)
(extract) at 31 December Year 2
Accounts receivable
Less provision for doubtful debis
$
50000
2500
s
47 500
Decreasing a provision for doubtful debts
tf the total of accounts receivable decreases, the provision for
doubtful debts should be reduced.
/ ILLUSTRATION 2 Decreasing a provision for doubtful debts
At the end of Year 3 the business has total accounts receivable
of $40 000, so the owner makes entries to decrease the
provision to $2 ooo (i.e. 5% of $40 000). (See Illustration 1.) This
represents a decrease of $500 since Year 2.
Journal entry to record the decrease In the provision for doubtful
debts:
JOURNAL
Date
Details
Year 2
Dec
31
Provision for doubtful debts
Income statement
Entries to decrease the provision
for doubtful debts
Dr
Cr
s
s
500
500
'
(Continued)
/
ILLUSTRATION 2
Decreasing a provision for doubtful debts
(Continued)
The following entries are made In the general ledger:
Dr
GENERAL LEDGER
Provision for doubtful debts
Cr
$
Year2
Dec 31 Balancec/d
$
Year 1
2500 Cec 31 Income
statement
Year 2
Dec 31 Income
statement
2500
Year3
Dec 31 Income
statement
31 Balancec/d
2 200
300
2500
Year3
Jan 1
Balance bid 2500
500
2000
2500
2 500
Year4
Jan 1
Balance bid
Income statement (extract) for the year
ended 31 D ecember Vear 3
$
Gross profit
Add: decrease In provision for doubtful
deb'is
Olher income
Adjusted gross profit
Less:expenses
Profit for the year
2000
$
XXX
SUMMARY QUESTIONS
500
300
1. When would it be necessary
to Increase a provision for
doubtful debts?
XXX
XXX
XXX
2. What Is the double entry for
Increasing a provision for
doubtful debts?
$
3. \/\/hen would it be necessary
to decrease a prov,sion for
doubtful debts?
38000
4. What is the double entry for
decreasing a provislcn for
doubtful debts?
Statement of financial position (balance sheet) (Extract)
at 31 December Year 3
Accounls receivable
Less provision for doubtful cfebls
$
40000
2000
.
Depreciation
LEARNING OUTCOMES
What is depreciation?
In 1his unit you will learn about:
Depreciation Is the term used for the loss in the value of the non-
• the nature of depreciation
• how to calculate depreciation
charges
• how to record depreciation.
current assets of a business over their working life, due to wear and tear.
Calculating depreciation
Depreciation is usually calculated using one of the following two
methods:
Straight-line method: where the non-current asset is depreciated
KEY TERMS
Depreciation: the loss in value
equally over its useful life. The calculation often takes account of the
asset's estimated residual value Q.e. the scrap or disposal value of
the asset at the end of Its life).
of a non-current asset over its
useful life.
ILLUSTRATION
Depreciation could also be
caused by:
A business has purchased some new machinery costing
$38 000. The owner believes the machinery will have a useful
life of 4 years and have a residual value of $2 000. The annual
depreciation charge is $9 000 calculated as follows:
• Technological change:
some non-current assets
can become out of date very
quickly and so cease to meet
the needs of a business
(high-tech eculpment such
as computers, mobile
phones are good examples).
• Time factor: the life of some
non-current assets Is llmtted
legally; ;,t the end of the
;,sset's life the asset will have
no v;,lue. For example, some
business premises are held
on ., lease, where there is an
agreement to pay rent for,
say 5 years.
• Inadequacy: some noncurrent assets lose their
value when they cease
to meet the needs of the
business. For example. an
office photocopier could
become inadequate if the
volume of business grows
unexpectedly.
1
Calcula11ng depreciation using the straight-line
method
Cost ($38 000) tess residual value ($2 000)
useful life (4 years)
Note: This method 1s sometimes called the fixed or equal
lnstalmen1method of depreciation.
Sometimes the straight-line method of depreciation Is calculated
by using a fixed percentage rate applied to the cost price of the
non-current asset.
Reducing-balance method: where the non-current asset is
depreciated by an agreed percentage based on the asset's net book
value al the beginning of the year. Net book value means the original
cost less all the depreciation to date (accumulated depreciation).
,...I LLUSTRATION
2 Calculatlng depreciation using the reducingbalance method
A business has purchased a delivery van coS1ing $24 000. It
has been decided to depreciate this asset by 25% per annum.
The first year's depreciation c11arge will be:
25% x cost S24 ooo = $6 ooo.
The second year's depreciation charge will be 25% of net
book value ($24 000 less depreciation to date S6 000, i.e.
S18 000}, $4 500.
Note: This method Is sometimes re'erred 10 as the diminishing
balance method of deprecialion.
Recording depreciation
KEY TERMS
Depreciation is regarded as an expense. In accordance with the
accruals concept It is Important to take account of this expense
every year when preparing financial statements.
ILLUSTRATION 3 Recording depreciation
Here are the entries required to record the depreciation of the
delivery van (see Illustration 2) In Year 2 of that asset's life.
JOURNAL
Date
Year2
Dec 31
the depreciation charge Is
based Ofl the cost of the asset
and allocates an equal amount
of the asset's cost to each
accounting period in the asset's
use'ul life.
Reducing-balance method:
Details
Dr
Cr
$
$
lnccme statemenl
Provision for depreciation (venicle)
Entrles to depreciate delivery vehicle
4 500
Dr
Delivery vehicle
Year 1
Jan 1
Bank
Or
Provision for depreciation (vehicles)
24~0
Straight-line method: where
4500
where the annual depreciation
charge is based on a fixed rate,
like the straight-line method,
but is calculated not on the cost
of the asset but rather on its net
book value at the beginning of
each year.
~
Cr
Year 2
$
Year 1
Dec 31 Balance c/d 1O500 Dec 31 Income
$
statemem
6 000
Dec 31 Income
s1atemem
4 500
Year 2
10500
10 500
---i Year3
IJan 1 Ba'ance bid 10 500
Note: The cost of the non-current asset is recordeo separately to
the record of depreciation, which accumulates year by year.
Income statement (extract) for the year ended
31 December Year 2
s
Gross prom
Less: Other expenses
Depreciation of delivery vehicle
1. Give two reasons ,.,,,hy noncurrent assets lose value.
s
XXX
XXX
4 500
XXX
XXX
Profit for 1he year
Statement of financial position (balance sheet) (extract)
at 31 December Year 2
$
$
$
NON-CURRENT ASSETS
Cost
Delivery vehicle
24000
Total
depreciation
10 500
SUMMARY QUESTIONS
Net
13 500
Note: The income statemen1 records depreciation expense
for that year only. However, the statement of financial position
(balance sheet) shows detail of the total depreciation to date.
2 . Explain the difference in
calculating depreciation
using the straight-line and
reducing-balance methods.
3. Why does an income
statement Include an
amount for depreciation?
4. Why does a statement of
financial position (balance
sheet) show the total
depreciation to date on
non-current assets?
Worked example:
adjustments
The question
Zamran owns a furniture store called Bridgeford Stores. On
30 September 2019 the following trial balance was extracteo:
Accounts payable
Accounts receivable
Bad debt expense
Capital
Cash a'. bank
Discounts allowed
Discounts received
Drawings
Electricity charges
Furniture and equipment:
Cost
Provision for deprecialion at 1 October 2018
Insurance
Inventory 1 October 2018
Purchases
Provision for doubtful debts 1 October 2018
Rent received
Revenue
Shop premises:
Ccst
Provision fer deprecialion al 1 October 2018
Wages
Dr
Cr
$
$
8 410
12 400
420
168 430
4 870
510
730
31 300
5980
20000
7200
2050
11 420
131 800
530
4300
214 900
150 000
6000
39 750
410 500
410 500
Additional information at 30 September 2019
Inventory was valued at $13 700
Wages were accrued $720
Insurance was prepaid S390
Rent received was due $250
Depreciation should be provioed as follows:
• Furniture and equipment 20% per annum using the reducingbalance method
• Shop premises 2% per annum using the straight-line methoo
The provision tor doubtful debts should be maintaineo at 5% of
accounts receivable
Prepare:
• an income statement ior the year ended 30 September 2019
• a statement of financial position (balance sheet) at 30 September
2019.
Getting started
EXAM TIP
Stage 1
The first task is to look through the trial balance, the additional
information and the tasks to be completed. At this point you are just
beginning to familiarise yourself vvith the information you are going to
be using.
Stage 2
Now focus on the trial balance and think about how each item will be
treated.
• Which Hems will be required tor the first part of the income
statement?
• Which Hems will be selected to appear in the second part of the
income statement?
M a ~ i<p 1:1°"'-rtriat
batai,\,Ot
yoK ""-&11::J Likt to ""-&1 y~ IA.)'
t11e t.-iaL b&1L&1v..ee to show
loiow each ite""- wiLL be KSeoi .
50""-e e&1v..oii&l&1tes Li~e
to write is (foy '""COl¾t
state""-t..,,t) a..,,i;1 SOFP (foy
stt1tel¾eV1.t of fi.""a vceiaL
, ,
postho111,/bal&l111,ee shett)
besicle itel¾S, foy ex:a""-pLe.
• What items remain to be recorded In the statement of financial
position (balance sheet)?
Stage 3
It is Important now to start working out how to deal with the
ao'dltional Information.
Take each item in turn and consider how It will be used In your
answer. For example:
• Note 1 gives details of the cl-0sing inventory - you should be
making a mental note that you will neeo this Information for the
first part of the Income statement, but also to record this asset In
the current assets section of the statement of financial position
(balance sheet).
• Note 2 gives details of an accrual concerning wages: you should
be setting out some workings to shov,, how to deal with this ttem.
You need to remember to add the accrual to the wages figure in
the trial balance to find the figure to be included in the income
statement. You also need to remember that the accrual must be
shown as a current liability in the statement of financial position
{balance sheet).
Stage 4
Prepare workings where there are calculations and/or adjustments to
be made. These are an Important part of your answer. There can be
many marks tor this part of your answer, because you may well be
showing you understand some of the more diffieult elements in the
question.
Here are the \0/0rkings based on the additional information. The
letters A, B, C, etc. have been used to show where the resutts are
used In the final answer.
EXAM TIP
M a ~ 6'I.Otes Oto\. ~t triat
bAtai,\,Ot
yo... IM.LIl::J Likt to IM.LIkt
so""-e b.-ief v..otes bl::J
YeLevaVl.t itel¾S ivc the tYiaL
batal'\,(le to snow wnetheY
t)O"'- vceecl to al¾tv..cl the
fi.~uve a~ liow 1:jOK a.-e
goia,cg to <'.l lM.evccl it. SOl¾t
eav..cliclates wouLcl WYite
+;r::i.o beside tlie wages
fi.guYe, fo.- C:X:Lll¾ple, to
sliow liow thi-s ite,,,._ wiLL be
eheia,cge&/.
A
Rent received: $4 300 + due $250 = S4 550
EXAM TIP
B
Insurance: S2 050 - prepayment 8390 = $1 660
lmpottll--« of s llowi."'!3
c Wages: S39 750 + accrual $720 = $40 470
ljOK Y WO ~
D
Increase In provision for doubtful debts: provision becomes 5% x
$12 400. i.e. $620, less existing provision of $530 = S90 increase
E
Depreciation of furniture and equipment: 20% x net book value
{$20 000 - S7 200, I.e. $12 800) = S2 560
F
Depreciation of shop premises: 2% x cost S150 ooo = $3 ooo
It is importaw; to s"1ow
tlie perso"" YlA.a,,-ki"'-0 1::1ou,,wo~ I-low )::JOU treate&f "'""cl
calcul.ite&f the a&fju.stecl
elt>¾e.,,ts '"" the a~we,:
111 .it wa l:::f, eve"" if )::JOU
"'-t'!ke ;-0me >¾istakes, !'.JOU
ca"" StLll ea,-"" SO>¾f of
th e YlA.aYks. If /:JOU &lo "'-Ot
s"1ow !:JOUY worki""9s, a.,,,&(
id~" "'-Q ke mistakes id ou
W<ll ea,-"" .,,,0 marks fo,,the fi.=l fi.g1.<,,-es ljOu <-<.se.
"fhe,-efo,,-e, .ilwaf:JS show
f:JO'-<Y wo,-ki""9s.
The answ er
Step 1
You are now ready to start to prepare the income statement.
Remember that it is important to present your answer well, so
remember to include the name of the business and the correct
heading for the Income statement. Show properly drawn subtotal
and total lines where appropriate, and make correct use of the
columns. Do not forget to label the key subtotals such as cost ot
sales, gross profit for the year. Here is the income statement:
Bridgeford Stores
Income statement for the year ended 30 September 2019
s
$
EXAM TIP
Alte~ l::IOKY ,h1.swer
It ma id be ""ecess Q Ylj
to alter l::JO"'-Y A"'-Swe,:
111is is "'-Ot "'-""'-<S1.<al
uvc&fe,,- t"1e pressure of a""
e.x:ami""i1tio"'-. M.ike a""!'.!
cl-1.i"'-ges as ""eatllj as
i:JOW. CQV\,. Avoicl WYiti"'-g
"'-tW fi.g'-<Yes over w,-0""9
fi.gu,,-es, as f:JOur fi."'-Ql
"'""swe,,- cow.ld be ittegible.
)~teacl cross out '"'-CoYYect
Ltems vceatlf:J, Q vcd w,,-ite
the vcew versio"" above t"1e
Col V\,Celliltiovc.
Revenue
Less: cost of sales
Opening Inventory
Purchases
Less closing inventory
Cost of sales
Gross profit
Add: Discounts received
Rent received ($4 300 + $250)
214 900
11 <120
131 800
143 220
(13 700)
(129 520)
85380
730
4 550
see A
5 280
90660
Less: Bad debts
Discounts allowed
Electricity charges
Insurance ($2 050 - $390)
Wages ($39 750 + $720)
Increase in provision for doubtful c!ebts
(5% X $12 400 = $620 - $530)
Depreciation:
Furnhure and equipmen1
(20% x net book val1.1e =
20% X /$20 000 - $7 200 = $12 800))
420
510
5980
1 660
40470
sees
seeC
90
seeD
see E
2560
Shop premises (2% " cost
$150 000)
see F
3000
Profrt for the year
EXAM TIP
(54 690)
Whe..., t1°w.r ,11,.swer does
35970
""Dtwomow.t
wni:it olo 110<-< olo if 110<-<Y
Step2
You can now move on to produce the statement of financial position
(balance sheet).
Bridgeford Stores Statement of financial position
(balance sheet) at 30 September 2019
$
NON-CURRENT
ASSETS
Shop premises
Furntture and
equipment
CURRENT ASSETS
Inventory
Accoun1s receivable
Less provision for
doubtful debts
$
$
$
Cost
Total
depreciation
Net book
value
150000
9000
141 000
20000
170000
9 760
18 760
10 240
151 240
13 700
12 400
(620)
11 780
Income due: rent
Prepayments:
Insurance
Cash at bank
250
390
4870
30990
Less CURRENT
LIABILITIES
Acccun1s payable
8410
Accrual: wages
720
(9 130)
WORKING CAPITAU
NET CURRENT
ASSETS
21 860
Capttal employed
CAPITAL
173100
Balance, 1 Oc1ober
2018
168 430
Add profi1 for the
year
35970
Less drawings
(31 300)
173100
st&1te""'-t"-t of fi,"-t:l "-CLA L
positi.o"' (bala =e sl1eet)
t~tals olo ""ot agree?
FLYSt of t:lll, _olo "-Ot WOYtJ:1
Kl'\.l'\,ecesst:iyLl!:J, l'.JOK will
'.""'t be Alo"'-t! Do"-'t forget
Lt _wo<.<lol tA ke o"-Ll:J O"-t
sl•p-<-<p to CA<-<Se 1'.fOKY tot&lls
to ~gYee, possibll:J
loSL"'9jKSt O"-t "'-Ark, Ovclt,.
Y0<-< "-teol to tvii"-k e1bout
no"'. "'-<-<en ti""'-t t,ou viave
CIVALlAble to go back ovey
l:'.JO<-<Y A"-Swe;; but still
complete alt the A"-Swevs
"-ecessarl:J to complete tvie
~"'- papey f.<.LL1:1 , if time is
LV\, s~oyt S<-<ppt1:1, CO"-StoieY
leav,""0 tvie A"-Swer c.ti-u:il
towa~ol,; t~e ,.,,,:,1 of tlie
exa"'-•"-Aho"" peYlool A"'"'
the"' goi"-9 bAck to see lf
l:J~<-< CA"' spot A"'tJ obviow.s
"'-LStAkes.
"'°~
Practice exam questions
Paper1
1 Al the end of a financial year a business owes
$220 'or water cnarges. How w,11 che adjustment
for '.his aftec: the financial statements of the
b.isiness?
A ®crease exper,ses and Increase current
assets
B ®crease experses and Increase current
llabiltties
C Increase expenses and inc,-ease current
assets
D increase expenses and ine<ease current
liabillties
2 A1 :he end of a ~nancial period. a business
is owed rem 'rom one of its 1enants. How
will 1he adjustment for this af'ect ,he financial
statements 1Me buslr,ess?
A decrease income and Increase cvrrent asse:s
B decrease income and Increase =rent llabiltties
C increase tncome and increase c 1,,rrent assets
D Increase income and increase current liabilities
3 A busin,ss has decided to introduce a provision
for doubtful debts. The e'fect of introducing a
provision for doubtful debts will be
A decrease profits, decrease accoun1s
recewable
B decrease prcfits, increase accounts receivable
C Increase prcfits, decrease accounts receivable
D Increase profits, Increase accounts receivable
4 A business maintai"S a provision for doubtful
debts at 5% of accourts receivable. At
31 December 2018 accounts receivable totalled
$10 000; a1 31 Decerr1ber 2019 aoccunts
receivable totalled $12 000. The entry In the
Income statement for 1he year ended
31 December 2019 will nave tne following e'fect:
decrease pro'rts S100
B decrease prcfrts S600
A
C Increase profi1s $1 00
o Increase profits $600
5 A business owns eqviprnent that was purchased
at the beginning of Year 1 'or $32 000. The
equipment is expected to nave a residual value
of $2 000. Eq~lpment is deprecla1ed by 25% per
an<'um using the straight-line methOd. What is the
total prevision fO< depreciation at the end of Year 2?
A $7 500
B S8000
C $15000
D S16000
Paper2
1 Recording depreciation
b ,he fellowing ledger accoums recording the
information avallable fer 2018 and 2019:
• Motor vehicles at cost
Bryan's Taxis opened for b->Siness on 1 January
2018 with 1he following ncn-curre'1t assets:
• Motor vehicles at cost $120 000
• Motor vehicles provision for deprecia,lon
• Office equipment at cost S16 000
• Office equipment at cost
The owner decided that motor vehicles should
be depreciated by 25% per annum using the
reducing-balance method, and 1hat office
eq:.,iprnent should be depreciated by 15% per
annum using the siraight-fine method.
Prepare:
• Office equipment provision for depreciation
a calculations of the depreciation charge for
2018 and 2019 for:
i Motor vehicles
ii Office equipment
c
an extract from the statemen1 of financial
pcsition (bala~ce sheet) of the business at
31 December 2019 showing lhe non-current
assets.
2 Reviewing a provision for doubtful debts
Tne owner of Cassimi 1/1/holesalers reviews the provision for doubtful debts at 1he end of each financial year.
On 31 August 2017 the provision for doubtful debls was $2 780. On 31 August 2018 accounts receivable
totalled $62 300; on 31 August 2019 accounts receivable totalled $52 800. The owner has decided to
maintain tne provisiori for doubtful debts at 5% of accounts receivable on each of these dates.
Prepare:
a tne provision for doub1ful debts account In 1he general ledger starcing wltn the original provision a1
31 August 2017 and showing entries 10 revise the provision on 31 August 2018 and 31 August 2019
b extracts from 1he income sta1ernents for each of tne years ended 31 August 2018 and 31 August 2019
showing how 1he changes In the provision for doubtful debts should be recorded
c
extracts from the statements of financial posttion (balance sheets) at 31 August 2018 and 31 August
2019 showing now accounts receivable should be recorded.
3 Preparing end of year financial statements
Thefollowlng trial bsilance 'Nas extracted from the books of Malabar s:ores on 31 December 20H~.
Dr
$
Accounts payable
Acoo,mls receivable
Bad debts written off
Capita!
Cr
$
11 250
14 400
86 0
456 100
Addhioral Information:
Inventory a; 31 December 2018 was val~ed
at $28 450
Insurance $420 was prepaid at
31 December 2018
Cash at bank
2890
Drawings
329&0
Wages and salaries due but unpaic;I flt
31 December 2018, $830
Electricity charges
Insurance
11 270
6310
Rent received paid in advance at
31 December 2018, $370
Inventory 1 January 2018
Office expe~ses
32470
18430
Premises should be deprecia1ed by 2.5%
per <3'1nurn using the straight-line metncd
Premises
cost
provision for dE)preciation
1 January 2018
Prevision for doubtful deb1s.
1 January 2018
Purchases
Rent received
Returns
Revenue
Shop furniture and flt1ings
at oost
provision for depreciation
1 January 2018
Wages and salaries
4&0000
22000
630
173 220
7350
1 840
920
298 440
Shep furntture and fittings should be
depreciated by 20% per annum using the
reducing-balance method
The provision 'or doubtful debts should be
maintained at 5% of accounts receivable at
31 December 2018.
Prepare:
a an i0 come s!atement for the year ended
31 Deoernber 2018
b
a st1;1tement of financial position
(balance sheet) a1 31 December 2018.
32000
11 520
41 600
808 210
808 210
Introduction
Why have control systems?
LEARNING OUTCOMES
In this unit you will learn about:
• the uses of control systems
• the three most commonly
used control systems
• the difference between errors
that affect and errors that do
not affect the trial balance.
Accounting records are used by many indMduals and groups to make:
• judgements about the pertormance of a business
• decisions about the future of the organisation.
It is Important, therefore, that accounting records are accurate,
otherv, ise those who use the accounting records will lose confidence
In the Information they are using, and, even worse, might be led to
make inappropriate decisions, which could further harm the business.
Control systems are concerned with:
• confirming compliance with accounting policies and procedures,
• securing the organisation's assets
• producing reliable and timely financial reports.
The control systems covered in this section will help ensure that
accounting records are accurate, and so provide users with reliable
Information.
M ain control systems
The following table shows the control systems that \"lill be covered here.
Control system
Purpose
Trial balance
To check the arithmetical accuracy of the double-entry records
Suspense account
To record any difference in the totals of a trial balance and part of the double
entry recording corrections of the errors that caused the totals to disagree
Control acoounts
To check the artthmetical accuracy of the sales and purchases ledger accounts
Bank reconciliation statement To ensure the bank oolumns in the cash book are up 10 date and agree whh tre
bank's record of the current account of the business
These techniques have the additional benefrt that they can help
reduce the risk of fraud. This Is because they ensure that accounting
records are continually being monitored for errors.
However, the techniques are not pertect. They help reduce errors
and fraud, but they do not eliminate the risk of errors and fraud
altogether.
Errors not revea led by a trial balance
The trial balance was Introduced in Section 4, Unit 4.5. Trial balances
are very useful because they provide:
• a concise list of all the account balances In the accounting system
which can then be used when preparing financial statements
• a check on the arithmetical accuracy of the double-entry system,
because the total of debit entries is compared to the total of credit
entries to ensure that these totals agree.
Trial balance totals will not a gree whenever a transaction has been
wrongly recorded such that the debit and credit entries do not match.
However, the trial balance Is not unquestionable proof of the
accuracy of the ledger accoun·ts. It is proof only of the artthmetlcal
correctness of the postings. The total of debits may be equal to the
total of credits yet still there may be errors in the trial balance.
The trial balance totals will agree when any of the following types of
error are made:
Commission: where the double entry has been made for the correct
amount: the mistake is that either the debit or credit entry 1,as been
made in the wrong account within a particular ledger.
Omission: where an entire tra.nsaction has been overlooked, i.e. a
transaction goes completely unrecorded in both aspects, perhaps
because a source document has gone missing, or a transaction,
after being recorded in the books of original entry, Is not then posted
in the ledger.
Principle: where the double entry has been made for the correct
amount, but either the debit or credit entry ls in the wrong type
of account. For example, a purchase of furniture is debited to the
purchase account instead of the furniture account.
Original entry: where the double entry has been made in the correct
accounts, but the wrong amount has been recorded throughou1 the
accounting system, often because the amount shown on a source
document has been misread. For example, If an Invoice for $3 289 Is
entered In the sales book as $3 829, the trial balance will come out
correctly, since the debit and credit have been recorded as $3 829.
The arithmetical accuracy is th ere, but in fact there is an error.
Complete reversal: where the double entry has been made In the
correct accounts and for the correct amount, but the debit and credit
entries have been swttched round. For example, a cash payment of
$678 to Mr Jude was entered on the receipt side of the cash book in
error and credited to Mr Jude's account.
Compensating: where two (or more) unconnected errors happen to
cancel each other out.
In each of these situations, although there has been an error
of some kind, there have always been matching amounts of
differences between the debit and credit entries in each case.
For example, one account In the ledger Is debited with $200 less
and another account In the ledger Is credited $200 less - these
errors cancel themselves. That Is, one error Is neutralized by a
similar error on the opposite side.
EXAM TIP
'.'-1""''!:J SttA.tltV1.tS p.~
it 11elpftA.L to rel¾tV>t.ber
tl1e s•x t1::1pes of ewor
"'-Ot revealed bi::I II t.-•al
baw ""ce b1::1 ""'"k.i.""0 tA.J>
a p11rase biised 0 .,., t11e
LVI.Ltliit Letters of tl1ese
t1::1pes of er.-o,; Le. c o
P O C c . For exii""'pte,
Cc!ro~ o.-de.-ed f'"""'"PPLe
Ov., c>rLsp1::I c>ereiits.
/ ILLUSTRATION 1 Examples of errors not revealed by a trial balance
Here are some examples of errors that are not revealed by a trial balance.
Error
Type
1 A credit customer, L Pulchan, settled her account with a cheque for $380.
However, R Pulchan's accoum was credited with this amount
Commission
2 An invoice from a supplier, BT S!ores, for $1 200 was overlooked
Omission
3
The purcl1ase of some new equipment for $800 was debtted to the purchases
account
Principle
4
A cheque counterfoil for S356 for electricity charges was entered In the accounts as Original entry
$365
5
Cash drawings of $50 was deb tted In the cash account and credited to the
drawings account
Complete reversal
6
A payment for general expenses of $35 was entered correctly in the cash book bUl
no entry was made in the general expenses account; meanwhile, the total of the
rerJmS outwards book was understated by $35
Compensating
SUMMARY QUESTIONS
1. Explain one reason tor making use of control systems.
2 . Describe how control systems help rec;Juce the risk ot fr,11,.1 c;1 .
3. Identify the six types of error that are not revealed by a trial
balance.
4 . Explain \"lhy these six types of error are not revealed by a Irial
balance.
-
108
More about errors and
the trial balance
Correcting errors not revealed by a trial balance
Errors not revealed by a trial balance should be corrected by means
of entries In the general journal.
/
ILLUSTRATION 1
Correcting errors not revealed by a
trial balance
Using the information in Illustration 1 In 7.1, the entries to correct
each of the errors 1-6 are as follows. (It has been assumed the
errors were corrected on 31 October 2019.)
2079
1
2
3
4
5
6
Details
In this unit you will learn about:
• preparing journal entries to
correct errors
• the need for a suspense
account
• how to construct a suspense
account.
KEY TERMS
GENERAL JOURNAL
Error Date
LEARNING OUTCOMES
Or
$
Cr
s
Oct 31 Account receivable: R Pulchan
380
Account receivable: L Pulchan
380
Error of commission now oorrecied
31 Purchases
1200
Account payable: BT Stores
1200
Errcr of omission now corrected
31 Equipment
800
Purchases
600
Errcr of orl nciole now correcied
31 Bank
9
Eleciriclty charges
9
Error of oriolnal entrv now corrected
31 Drawings
100
Cash
100
Error of comple,e reversal now
corrected
31 General expenses
35
Returns outwards
35
Com□e'lSaJlnn error now corrected
Correcting errors that are revealed by a trial balance
A suspense account is opened whenever the totals of a trial
balance do not agree.
• An extra entry is made In the trial balance on whichever side, debit
or credit, that will enable the totals to agree.
• The suspense account ln the general ledger records the difference
between the trial balance totals.
• The entry In the ledger account Is made on the same side as the
extra entry In the trial balance.
Suspense account: a
temporary account useo
to make the totals of a trial
balance agree.
Errors that are revealed by a
trial balance should also be
corrected by means of entries
In the general journal. Each
correction will require:
• an entry in whichever
account Is affected by the
error - the entry will be made
on the debit or credit side as
appropriate
• a matching corresponding
entry 1n the suspense
account to complete the
double entry.
EXAM TIP
COYYtcti"'-g CIV\. eYYoy of
•·eve.-sci~ Y~KiYes especi&1t
ccire. This is becci=e tl,e
e"'-tYie,; l¾K5t be foy cioubLt
t lie Al¾ou""t of tlie orlgi=L
eYYOY Cl$ it is ~=Cl '1:1 to
both, cC!""cet tlie orlgi=t
ev.,tyie,; Cl ...,i;1 tl-1e"" recorci the
COYYect e"'-tY~.
EXAM TIP
if l::JO<-< t'1L.,,~ a.,,
error affects. 0.,._,tl::J
Ovce CICCO<-<"'-t tntv. ti-le
olot.tbte ev.tY):! to coyyect
ti-le tYYor ""-t.tst ,vcvotve
ti-le 5t.<Sj>t"'-Se accot.tv.t.
H-oweve,:; if a"" error Ls.
0 "'-' of ti-le s.ix vca ""-tol
tl::Jp~ "'-Ot reveateol bl::)
a trie1t balciv.oe, ti-le
~t.<Sj>t"'-St CI CCO<-<"'-t is. V.Ot
•v.clt.toleol '"" tne ev.tries.
to correct t i1e erro,~
• When all errors are corrected the total of the o'ebit side and creoit
side of the suspense account will agree and the account can be
closed.
/
ILLUSTRATION 2
Correcting errors that have caused the trial
balance totals to oisagree
On 31 December 2018, the totals of the trial balance of a
business failed to agree and a suspense account was opened
to record the difference. The trial balance totals were debit
$108 400, credit $107920.
The following errors \Vere discovered:
• The payment of insurance $700 had been correctly entered
in the cash boo!<, bu1 the entry had not been posted to the
insurance account.
• The total of the purchases book had been miscalculated.
The correct total was $11 200, but the total posted to the
purchases account was $12 100.
• The total of the discounts received column in the cash book.
$280, had not been posted to the general ledger.
GENERAL JOURNAL
Date
· SUMMARY QUESTIONS
1. Explain how correcting an
error of reversal Is different
from correcting other types
of error.
2. Describe the circumstances
under which a trial balance
will reveal that there are
errors in the accounting
records.
3. State which side of a
suspense account should
record the difference in the
totals of a trial balance.
Details
Dec 31 Insurance
Suspense
31 Payment of insurance not posted from
cash book now correCled
31 Suspense
Purchases
Mis-posting of total purchases now
corrected
31 Suspense
Discounts received
Discounts received total not posted
from cash book now corrected
Dr
$
Cr
s
700
700
900
900
280
280
I
/ ILLUSTRATION 3 Constructing a suspense account
Here Is the suspense account based on the entries In
Illustration 2.
Dr
Dec 31 Purchases
Discounts
received
Suspense
Cr
$
900 Dec 31 Difference In
trial balance
280
31 Insurance
$
480
700
1 180
1180
;
Correcting profits
If there is a delay in tracing errors In the accounting records. it
is possible that the end of year financial statements will contain
inaccuracies. As a result, the draft profit (or loss) for the year may
need correction.
ILLUSTRATION 1 Correcting a draft profit figure
LEARNING OUTCOMES
In this unit you will learn about:
• constructing a statement of
revised profit following the
correction of errors.
The draft Income statement of a business for the year ended
31 December 2019 shows a profit of $56 700. However, the
following errors have been discovered:
• the total of the sates book for December 2019, $1300, had
not been posted to the sa.les account
• Insurance prepaid of $300 was overlooked
• drawings were mistotalled at $18 900 instead oi $19 800
• oiscounts allowed of $600 were treated as discounts received
in the income statement.
Here is a statement detailing a correction of the draft profit.
Correction of draft profit for the year ended
3 1 December 2019
s
Draft profit for 1he year
Add sales n01 posted from sales book
Add insurance prepaid overaooked
Less discoums allowed
Corrected profit for the year
56 700
1 300
300
(1 200)
57 100
Notes:
1. The answer ls best set out in the form of a statement.
2. Only errors affecting the income statement are relevant, so the
error in the drawings account has been Ignored.
3. Correcting the error concerning discounts requires double the
amount (as Is usual where an entry Is made on the wrong side
of an account).
A statement of financial posttion may also need to be corrected.
For example, based on Illustration 1 above It would be necessary to
make the following changes:
• Draft profit of $56 700 becomes a corrected profit of $57 100
• Drawings will need to be increaseo by $900 from S18 900 to
$19 800
• Prepaid insurance of $300 'NIii need to be included In the current
assets
SUMMARY QUESTIONS
1. Give one example of
an error that. when a
correction Is made, would
cause a draft profit to be:
a
Increased
b
decreaseo.
2. Give three examples of
an error that would cause
changes to a statement of
financial position.
Worked example:
correcting errors
The question
The following trial balance was extrac1ed from the books of St Michael's Stores on 31 August 2019.
Dr
Cr
The following errors have been discovered.
$
$
1. The purchase of goods on credtt, $7 40, frcm
Ambers Ltd has been overtooked.
Accoun1s payable
Accoun1s receivable
4390
5680
Capttal
41 000
Cash at bank
3 210
Drawings
18 970
General expenses
4 780
Inventory
8200
3. General expenses of $230 had been creoited to the
cash book, but had not been posted to the general
ledger.
4. The sale of goods on credit, $440, to A Black was
correctly entered in the sales book, but posted to the
accounts of both A Black and A Bat ford.
Non-current assets
Cost
44 800
Provision for
depreciation
Purchases
2. Owner's drawings by cheque of $450 had been
correctly entered in the casl, book but debited to tlie
drawings account as S540.
11 200
5. The purchase of a non-current asset by cheque,
S500, had been entered in the books as $550.
Prepare:
69950
Sales
98700
Suspense
300
155 590
155 590
• Journal entries necessary to correct each of these
errors (narratives are not requirec)
• the suspense account recording the opening entry
and relevant entries !rem the journal (the account
shoulo be closed)
• a corrected trial balance.
Getting started
In this question there are two types of error listed:
• those that are revealed by a trial balance and so affect the
suspense account
• those that are not revealed by a trial balance so do not affect the
suspense account.
So, the 1irst step Is to consider each error carefully and decide which
of these two types of error applies:
Error Category
Reason
1
Not affecting suspense acoount Error of omission, so correction affects two 'routine' accounts
2
Affects suspense account
'One-sided ' error, I.e. only one 'routine' account affec1ed, drawings
3
Affects suspe'lse aoccunt
'One-sided' error, i.e. only one 'routirie' account alteeted, general expenses
4
Affects suspe'lse aoccunt
'Or.e-sided' error, i.e. only one 'routine' account affected, A Batford
5
Not affecting suspense acoount Error of original entry, so correction affects two 'routine' acoounts
The answer
Preparing t he journal entries
It Is now possible to start preparing the Journal entries.
GENERAL JOURNAL
Dat e
Details
2019
Aug 31
Purchases
Dr
Cr
$
s
740
Account payable: Ambers Ltd
37 Suspense
740
90
Drawings
90
37 General expenses
230
Suspense
230
3 1 Suspense
440
440
Account receivable: A Batford
3 1 Bank
50
Non-current asset
50
Note: the ques1ion asks that narratives are not shown.
Preparing the suspense account
The suspense account is shown below. Remember that the opening
balance matches the location of the figure In the trial balance. So, in this
case the suspense account Is shown In the credit column In the trial
balance, and so is shown as a credit entry in the suspense account.
Sus ense account
Dr
2019
Aug 31 Drawings
31 A Balford
s
2019
90 Aug 31 Difference in trial
balance
440
31 General expenses
530
Cr
$
300
230
530
Preparing a revised trial balance
Before preparing the new trial balance, it may be helpful to make
notes on the original trial balance of each of the changes you vvish
to make. For example, the correction of the first error means that
the purchases figure increased by $740 (so neatly pencil in +740 by
purchases) and accounts payable also increases (so neatly pencil
in +740 by accounts payable). Apply this process to each of the
remaining error corrections. Your notes will make it easier to work out
the new figures to record in the revised trial balance.
Here is the original trial balance again showing these notes.
Dr
Cr
s
$
Accounts payable
Notes
4 390 Increased by $740 - error 1
Accounts receivable
5680
Decreased by $440- error 4
,q 000
Capttal
Cash at bank
3 210
Increased by $50 - error 5
Drawings
18970
Decreased by $90 - em;r 2
General expenses
4 780
Increased by $230- error 3
Inventory
8 200
Non-current assets
Cost
Decreased by $50 - em;r 5
44800
Provision for depreciation
11 200
Purchases
Increased by $740 - error 1
69950
Sales
98 700
Suspense
300 Eliminated - errors corrected
155 590
155 590
And here ls the revised trial balance based on these notes.
Trial balance at 31 August 2019 (corrected)
Dr
Cr
$
s
Accounts payable
Accounts receivable
5 130
5 240
Capital
41 000
Cash at bank
3260
Drawings
18 880
General expenses
5 010
Inventory
8200
Non-current assets
Cost
44 750
Provision for depreciation
Purchases
11 200
70690
Sales
98 700
156 030
-
,112
.
156 030
Control accounts
It is possible to check the arlth metical accuracy of the sales ledger
and purchases ledger by using control accounts. Control accounts
summarise the entries in the sales and purchases ledgers. The totals
of the sales and purchases general ledger accounts should equal
the totals of the balances of the lnoividual accounts in the sales and
purchases ledgers.
LEARNING OUTCOMES
In this unit you will learn about:
• the purposes of control
accounts
• now they are prepared
• the sources of in•orma11on tor
control accounts
• the construction o• accounts
receivable and accounts
payable control accounts
• the significance of balances
on control counts.
Control accounts are also used as an easily accessible source of
details about total accounts receivable and total accounts payable
when preparing trial balances, statements of financial position, etc.
They can help reduce the risk of fraud since the work of purchases
ledger and sales ledger clerks is checked by a more senior employee
at regular intervals.
Control accounts are prepared from totals taken from the relevant
books of original entry. Control accounts ere not (normally} part of
the double-entry system. They resemble a credit supplier's account
(accounts payable control account) or a credtt customer's account
(accounts receivable control account) in terms of how entries are
debited and credited within the accounts
However, rather like trial balances, control accounts cannot reveal all
the errors that could be made In these two ledgers. If a balance of a
control account agreed with the total of balances In its corresponding
ledger, there could still be errors of commission, omission and
original entry.
KEY TERMS
Control account: a process
for checking entries In the
purchases ledger (accounts
payable control account)
and sales ledger (accounts
receivable control account).
Note:
• accounts payable control ac~ounts are sometimes called
purchases ledger control accounts
• accounts receivable control accounts are sometimes called sales
ledger control accounts,
The fcilowing table shows the source of Information for many of the
entries shown In these two control accounts.
Accounts receivable control account
Accounts payable control account
Source of
Source of
Transaction
Information
Transaction
Information
Total credit sales
Sales book
Total credit purchases
Purchases book
Total receipts from accounts
receivable
Cash book
Total payments to accounts
payable
Cash book
Total discounts allowed
Cash book
Total discounts receNed
Cash book
Total returns inwards
Returns inwards
book
Total returns outwards
Returns outwards book
Total of bad debts written off
General journal
The opening balances of the control accounts are brought down
from the previous period.
Some less common transactions are as follows:
Transaction
Source of
Information
Dishonoured cheques received from a credit
Cash book
KEY TERMS
Dishonoured cheque: a
cheque that 1he payee's bank
will not accept for payment
because the payer (person
writing the cheque) does not
have sufficient funds to cover
the amount being paid. (This
Is sometimes referred to as a
·returned cheque' .)
customer
Interest charged on credit cus!omers' overdue
balances
General
journal
Interest charged by cred~ suppliers on overdue
balances
General
Jo.imal
Contra entries (set off) between a sales ledger
General
journal
account and a purctiases ledger account (or vice
versa). Contra entries occur when an individual or
business Is both a customer and a supplier, and the
balance of the two accounts are set off against each
other.
Contra entry (set off): {relating
to control accounts) a transfer
between an Individual account
payable and an account
receivable arising from the
tact that the supplier Is also a
customer. to establish a net
amount to be paid or to be
received.
Sometimes the account of a credit customer (an account receivable)
will have a credit balance. This can arise tt the customer has
overpaid. Similarly, the account of a credit supplier (an account
payable) will have a debit balance if the supplier has been overpaid.
These balances must be reflected when preparing the relevant
control accounts.
/ ILLUSTRATION 1 Format for the two control accounts
Accounts payable control account
Dr
2019
May
June
$
31
31
31
31
31
31
1
Ba'ance bid
Bani<
Discounts received
Returns outwards
Cont<a with sales ledger
Ba'ance Cid
Ba'ance bid
2019
450 May
17 270
540
1 210
380
18500
38350
270 June
Cr
$
31
31
31
31
1
Ba'ance bid
Cred t purchases
Interest charges
Ba'ance Cid
18 400
19 550
130
270
Ba'ance bid
38 350
18 500
This control account shows that, at 1 June, credit suppliers are ovved $18 500 and there is a credit
supplier's account that has been overpaid by S270. These figures should agree with those shown by
totalling the balances ot accounts in the purchases ledger.
(Continued}
.114
.
,. ILLUSTRATION 1 Format for the tv;o control accounts {Continued)
Dr
2019
May
Accounts receivable control account
Cr
2019
s
$
31
31
31
31
31
Balance bid
Cred1 sa•es
Interest charges
Dishonoured cheque
Balance c/d
14 320 May
31
17 240
31
90
31
410
31
280
31
31
31
Balance bid
Bank
Discounts a lowed
Returns inwards
Contras with pu•chases
ledger
Bad debts written oil
Ba~nce c/d
32 340
June
1
Balance bi d
15 060 June
140
14820
770
6 10
380
560
15060
32340
1
Ba'ance bid
280
This control account shows that at 1 June credit customers owe $15 060 and that there is a credit
customer's account that has been overpaid by $280. These figures should agree with those shown by
totalling 1he balances of accounts in 1he sates ledger.
SUMMARY QUESTIONS
1. Describe three benefits oi preparing control accounts.
2. List three items that should be recorded in an accounts
payable control accoun1 and state the source o' Information
tor each ot these entries.
3. List three items that should be recorded in an accounts
receivable control account and state the source o f
information for each of these entries.
4. Explain the term 'contra entry' when used in connection wtth
control accounts.
EXAM TIP
Rt!M.l1M.ber ti1&1t if t11ere
ii re COll\.trt:1 e""tries,
tl1e1::1 &1ppe&1r i"" botl1 tl1e
t1 cco...,""ts 'f>&l 1::1 Cl bLe co111.troL
ti cco.... ""t &I ""a tl1e &lcco...,111.ts
receivtibte co...troL &1cco"'-"'-t.
Worked example: control
accounts
The question
On 31 December 2019 Alvin must prepare control accounts to
check the accuracy of his sales and purchases ledgers. He has the
following information. (Note that for the purposes of this worked
example, every item of information has been given a reference letter
to help you identify how the item has been used in the answer.}
$
Control account balances, 1 December 201 9
EXAM TIP
~tnet¼,ht~
ii C.0""'-""'-0 "" ""'-istiilu is
~o t'1::1 to LV\.e,L<,<."e ALL H1e
'""fol'1M.tl1:io"" give,,.,, ivc
~ne c-oi'\trol (;lccou""ts. rt is
'""'-)>Ort&r"'-l: to setect ol-\Ll::J
tne ,te""'-S tkat relcrt:e to
tne t:1c-cou,,.,,ts receivi:ibt.e
~l'\.d &ICCOIA.V\.ts }'Cll::JC!ll(.e,
,.e. tnose c-o=er,,.,,£"'-0 the
""'-&lk.i"'-0 i:tl'\.d settle""'-tvct
of oredit tr&rl'\.6i:tctiovcs.
Ht"'-Ce, cash sates i:tl'\.d
M&h p1.<rcnases t:1re
ig=vui '"" &rl'\.6wel'i"'0
tl-,is qKtstLOV\..
Sales ledger control acoount debit balance
Sales ledger comrol acoount credtt balance
6520 A
290 B
Purchases ledger control account credit balance
Purcnases ledger control account debit balance
8480 C
310 D
Cash book totals
Receipts from credit customers
Payments to credit suppliers
Discounts allowed
Discounts receNed
Dishonoured cheques (from credit customers}
Cash purchases
Cash sales
Totals from books of original entry
Sales book
5990 E
8630 F
240 G
450 H
180 I
3920 J
15 870 K
7 440 L
Purchases bock
Returns inwards bock
9300 M
510 N
Returns outwards book
General journal totals
450 0
Bad debts written off
Contra entry betv.reen sales ledger and purchases
ledger accounts
Balances Shown in the sales ledger at 31 December 2019
270 p
Total of debit balances
Total of credit balances
Balances shown in the purchases ledger at 31 December 2019
Total of debit balances
Total of credit balances
880 Q
6350
390 R
520
7 270
• Prepare the sales ledger control account and purchases ledger
control account tor December 2019.
• Explain what the balances of the control accounts at 3 1 December
2019 tell Alvin about his sales and purchases ledger records.
s
Getting started
Read through the details carefully. You need to begin to think about
where you will record this information. \/I/hat Items will need to be
selected to be shown In the accounts receivable control account?
What items will need to be selected to be shown in the accounts
payable control account?
The answer
Preparing the control accounts
When you have selected the Items to be shown in each control
account, the next step is to think carefully about on which side of the
control account to record each item.
Explaining the balances
EXAM TIP
"8414!~ the 00>\tn>L
llOOOw....ts: olo.,,'t forget
to baui=e ijO"<Y co....tr-oL
acco"'""t.s a.,,o1 b,.-£""9 the
bALa ...ce olow.... yo"'" ow"'
bA4l"'ces O"'- tke co""tr-oL
acco"'""ts ca.,, tne"" be
check,eol agail'l<St t'1e
total M ur-es prod"'ced
btJ tke sales Leolger a.,,ol
J'"<Yc'1Ases Leolger cle,-!,es
to see if t'1etJ agr-ee.
The sales ledger account debit balance of $6 350 agrees with the
total balances shown In the sales ledger, so it appears that the total
of the sales ledger balances Is arithmetically correct. The control
account confirms the business Is owed $6 350.
However, the credit balance of the purchases ledger control
account, $7 580, does not agree with the total of the balances in the
purchases ledger, so there are errors in the accounting system. This
discrepancy must be resolved in order for the business to have valid
information about how much is owed to credit suppliers.
Dr
Accounts receivable control account for December 2019
Cr
s
$
Dec
Jan
Dr
1 Balance
31 Credit sales
31 D shonoured cheque
31 Balance
1 Balance
bid
A
L
Cid
R
6 520 Dec 1 Balance
old
7 440
31 Returns Inwards
180
31 Bank (rece.p1s)
390
31 Disoounts allowed
31 Bad debts written off
31 Contra entry wth purchases
14530
6350 Jan
bid
B
N
E
G
p
ledger
31 Balance
c/d
1 Balance
bid R
Q
Jan
880
6350
14530
390
Accounts payable control account for December 2019
Cr
$
Dec
290
510
5990
240
270
1 Balance
31 Returns outwards
bid
D
0
3 1 Bank (payments)
F
31 D scounts rece.ved
H
31 CoPtra emry with
sales ledger
3 1 Balance
Q
1 Balance
Cid
bid
$
310
450
8 630
450
$
Dec
880
7 580
18300
520 Jan
1 Balance
31 Credit purchases
31 Balance
1 Balance
bid
C
M
$
cld
8480
9300
520
18300
7 580
bid
.
117
Bank reconciliation
statements
LEARNING OUTCOMES
In this unit yov will learn about:
• Items that cause Cfifferences
between cash book ano
bank statement balances
• how to update the cash
book
• how 10 construct a bank
reconciliation statement.
EXAM TIP
Do""' t foyget to bala.,,,ce
t vie casl-l book: a "'-Of 1,y("'-0
t vie bcita"'-Ce clowV\, wne""
Kpciat,""0 a casl-l boo~.
The balance of cash at bank as shown by the cash book of a
business on a particular date rarely coincides •..vlth the balance shown
on the bank statement for the same date. The usual reasons for this
are shown below, but it is Important for a check to be made to ensure
that there are no errors In the cash book or in the bank statement. To
do this a bank reconciliation statement must be drawn up.
Usually the difference in the two balances is accounteo for by:
• Timing differences: it takes time for transactions involving a bank
account to progress through the banking system. For example, a
business coulo:
• make a payment by cheque and record this transaction in the
cash book, but it may take days or even weeks for the cheque
to be paid in to a bank account by the payee/recipient and then
be processed by the bank (often re'erreo to as an ·unpresented
cheque', 'outstanding cheque· or a 'late lodgment')
• pay cash, cheques, etc. into the bank and record the transaction
in the cash book, but the transaction could take a few days to
appear on the bank statement of the business (referred to as
outstanding deposits, or deposits in transit).
• Omission of transactions: many transactions are now carried
out au1omatlcally by banks and so may be overlooked when
preparing the cash book. Examples Include:
• the payment of various expenses by direct debit or standing
KEY TERMS
Direct debit: where authority is
given to a bank by a customer
to make payments on the
customer's behalf to another
organisation. The amount
paid is that reouested by that
organisation up to a specifieo
limit.
Standing order: where
a bank's customer gives
Instructions for the automatic
payment to another
organisation of a fixed amount
at regular intervals.
Credit transfer: the aU1omatic
transfer of funds into the bank
account of a business by one of
its customers.
order
• the deduction of bank charges
• the cancellation of a cheque paid Into the account because the
payer had no funds (a returned or dishonoured cheque)
• the receipt of money from a customer using a credit transfer
facility or similar process.
• Errors: occasionally an error may have been made in preparing the
cash book, and sometimes errors come to light in the bank's own
records. The bank reconciliation process helps detect these errors.
The bank reconciliation process is usually carried ou1 at least once a
month and involves:
Step 1: Checking every entry In the cash book against the entries In
the relevant bank statement. It Is usual to tick entries that appear In
both documents. Any entry that is not ticked must, therefore, help
account for the differences in the two balances.
Step 2: Updating the cash book with any entries that have been
omitted, such as bank charges , or direct debit payments that were
overlooked.
' ILLUSTRATION 1 Updating a cash book
On 3 1 January 2019, the cash book of a business sho\,ved a balance of cash at bank of $2 740.
However, the bank statement at this date showed a balance of only S820. After comparing the two
documents. the following items were found to have been omitted from the cash book: direct debit
payment for water charges of $430; bank charges of $80; credit transfer of S11O - one of the customers
of the business, PQ Ltd, had transferred S110 directly into its bank account.
Here is an extract from the cash book of the business updating the balance of $2 740. For convenience,
only the bank columns are shown.
Cash Book (bank columns)
Dr
2019
Jan
Balance bid
31 PO Ltd
31
$
2019
2 740
Jan
110
2850
Feb
1 Ba'ance bid
2 340
Cr
$
Water charges
31 Bank charges
31 Balance c/d
31
430
80
2340
2850
I
Step 3: Preparing a bank reconciliation statem ent that takes
account of those transactions 1hat have not yet been processed by
the bank. This final stage should result in agreement between the
updated cash book balance and the bank statement balance. If this
agreement (or reconciliation) Is not achieved, then errors must have
occurred reciuii'ing further checks.
/'
ILLUSTRATION 2 Preparing a bank reconciliation statement
KEY TERMS
Bank reconciliation
statement: a document
prepared by businesses at
regular intervals to check that
their bank records agree with
those provided by the bank.
The following liming differences were discovered: a cheoue for $670
In payment of a supplier had not yet been presented for payment
cash takings o' $2 190 were paid into the bank on 30 January, but
this transaction had not yet been recorded by the bank.
Here Is the bank reconciliation statement using information from
Illustration 1 and the details above.
Bank reconciliation statement at 31 January 2019
s
Balance as per bank statement
Add: amount not yet credited
Less: unpresented cheques
Balance as per cash book
820
2190
3 010
670
2340
Notes:
1. When the timing dlfferenc,es are taken into account, the I\IVO
balances do agree. It can be assumed, there'ore, that the
cash book and the bank statement are free of error.
2. In the format shown, the thinking process is: 'What would the
bank statement balance have been had the bank reccroeo
the missing transactions?·
SUMMARY QUESTIONS
1. Describe the reasons why
a cash book and bank
statement for the same
period will not always
record exactly the same
Information.
2. Define the term
'unpresented cheque'.
3. Describe how amounts not
yet credited will be recorded
In a bank reconciliation
statement it the statement
begins with the upoated
cash book balance.
Worked example:
preparing a bank
reconciliation statement
The question
Michael Lee owns a retail business. The cash book of his business
showed a balance at bank of $850 on 31 July 2019. However, on
this date his bank statement showed an overdrawn balance of $190.
Michael has compared his cash book and bank statements and has
noted the following differences:
1. A cheque paid tor the purchase of some computer equipment,
$1 759, had not yet been entered on the bank statement.
2. Bank charges not yet entered In the cash book amounted to
$105.
3. A cheque paid to a supplier, Tangle Ltd, for $1 983 had been
entered in the cash book as $1 389.
4. A cheque received from P Joseph tor $850 had been recore1eo in
the cash book. This cheque has been dishonoured.
5 . A standing order payment for rent, $710, had been omitted from
the cash book.
6. Bank deposits not yet credited by the bank totalled $540
Prepare:
• an updateo cash book at 31 July 2019
• a bank reconciliation statement at 31 July 2019.
Getting started
It is, of course, important to read through the question details
carefully. On the first read-through you should notice that the bank
statement is overdrawn (rather than positive), and that the list of
items to be processed is in no particular order and includes a
mixture of items affecting the cash book and items affecting the bank
statement. Some of the Items are more unusual (for example, the
error mentioned In Item 3).
The first task is to sort the Items into the two categories before
producing the updated cash book:
• those affecting the cash book
• those affecting the bank statement.
Here is a table showing how to do this.
Item
,.computer
equipment
2. Bank charges
Affects ..•
Bank
statement
Cash book
Treatment
This is an unpresented cheque. II will make tne current bank statement
overdraft figure even higher Vlihen ii is presented for payment.
This will reduoe the currem cash book balance when added to the cash book.
3. Error recording
cheque
Cash book
This will reduoe the current cash book balance, since the correct figure for
this payment was higher than the one actually recorded .
.G.. Dishonoured
Cash book
This will reduce the ct..rrent cash book balance, since it is necessary to cancel
the receipt as the cheque was dishonoured.
5. Standing order
for rent
Cash book
This will reduce the cvrrent cash book balance as this payment has not ye1
been recorded.
6. Bank depostts
Bank
statement
This item will red.;ce the current bank overdraft balance as this is a receipt
missing from the bank statement.
cheque
The answer
Preparing an updated cash book
Selecting the relevant items, it is now possible to update the cash
book.
Cash Book (bank columns only)
Dr
Cr
$
July
31
31
Ba'ance bid
Ba11;1,nce c/t;I
850
EXAM TIP
$
July
1 409
Bank charges
31 T.ing1e I.to
31 PJoseph
31 Rem
105
31
2 259
594
850
710
t>owt forget to bata..,,ce
H1e cctsl1 book. a...,cf bti....g
tl-ie bctL&!"-C-e clow"'" wl-Je"'"
UJ>clttt•....g Cl Cctsl1 book. .
2 259
Aug
1 Balance
btd 1 409
It is Important to note that the cash book now has an overdrawn
balance at bank.
Preparing t he bank reconc iliation statement
Using the other items, It is no,v possible to prepare the bank
reconciliation statement.
Bank reconciliation statement at 31 July 2019
s
Balance as per bank statement
(190)
Add: amount not yet crediteo
540
Less: unpresented cheque
Balance as per cash book (overdrawn)
(350)
1 759
(1 409)
Note: the negative {overdrawn} figures are shown in brackets.
EXAM TIP
It is ,.,,,_portC! i,,,t to tC! ke
e.i:tt-&! CC!Yt wl-Je"'" 1vork.i....g
w,tl-J Cl"'" overclr-C!ft
fi.gure. i t is eC1si::, to
get c,o"'-fuseix witl1 tl-ie
&! tit11.,,,_etic becci '-<St Cl '"'-1:1
overclr-C!f\:
-{1.c.ur-es Clre
,
'"'-egC1t,ve.
~
Practice exam questions
Paper1
1 A bookkeeper posted a credrt sale to the debit
of \"lalter Owen's account Instead o1 to 1he
debrt of Wayne Owen's account Tnis mistake is
known as:
A an error of commission
B an error of orlginal entry
4 A retailer's cash book shewed a balance of $400
(credit). \"lhen ;he bank statemem was received,
additional entries were made In tne cash book
for: standing order omrtted $100, interest
received $200. The updated cash book balance
will be:
A $100 credit
C an error of pnnciple
D an error of complete reversal
2 The trial balance totals of a business were
Dr$47 200 and Cr $47 400. Wnici'lof 1he
following errors could have caused t/iis
d1sagreerrie:,t?
A a reh.irns inwards o' $200 had rot been
posted to '.he customer's aoco unt
B a sale o1 gocds. $200, rad been omitted
from the books of account
C 1he total of discounts received, $200, had
not been posted 'rom the cash book
D 1he total of1he stationery colunnn, $200, had
no1 been posted from the petty cash book
C $500 credit
B S300 etedlt
D S700 credit
5 Which one o' the following shoJld be entered in
a sales ledger control account?
A
cash sales
C purchases
B discounts received
D returns inwards
6 IA/hich one of toe following shovld be entered In
a p1,1rchases ledger control account?
A cash purchases
B discounts received
C imereSl charged on overdue acco-.1nts
receivable
D re1urns Inwards
3 An Income stater1ent showed a draft profrt for
the year of $36 800. However. .,i.n error was
made when a sale of goods, $500, was treated
as a purchase of goods. When this miS!al<e Is
corrected the profit for the year wil I be:
A $35 800
C $37 300
B $36 300
D S37 800
Paper2
1 Correcting errors that are revealed by a
trial balance
Gloria's trial balance totals did no1 agree. The
totals of the columns were: debit $186 300:
credit $1 85 110. Gloria has discovered the
following errors in her books of account.
• The total of the petty cash analysis column for
travel expenses. $80, had not been posted to
the general ledger.
• An aoco<.1n1payable, Hostens Flowers, had been
paid $1 180 by c,ieque. The transaction had been
entered correctly in ,he cash book, but had been
posted to Hos1ens Flowers' aocount as $1 810.
• The dlscoun1s received column iotalled $320.
This amount tiad been posted In error 10 the
debit of the d1scoun1s received account.
Prepare: a lhe entries in the general journal
required to correct these errors: b 1he s.,spense
acoovnt showing en1ries arising from ;his
Information.
2 Preparing a bank reconciliation statement
Keith's cash book showed a deb rt balance ol
$8 750 on 30 Sep1ember 2019. This did no1
agree with me balance o1 $8 294 shown on ,he
bank S1atement of his business at this date.
A comparison o' 1l7e cash book and bank
S1atemen1has revealed tne following differences:
• A standing order payment of S980 for rent nad
been overlooked when preparln9 l he casn book.
• Cash and cheques totalling $643 paid Into
the bank had no1 yet appeared on lhe bank
statemenl .
• Bank charges of $112 tiad not yet been entered
in the cash book.
• Tnere were two vnpresePted cheques: Seeriath
Seafoods Ltd $382; Radiant Tours Ltd $515.
• Tne bank sta1ement included a credtt 1ranster of
S382 from a credit cuS1omer, L Nelson, which
had no1 yet been included In 1he cash book.
Update Keith's cash book on 30 September
2019 ar d prepare a bank reoonciliation
S1atemen1a1 l his date.
3 Preparing control accounts
On 30 Sep1ember 2019, Michelle totalled the
balances of her sales and purchases ledger
accounts. The tolals were as follows: sales
ledger$16 395: purchases ledger $10 292.
Michelle prepares comrol accounts m check 1he
accuracy of these figures.
Tile following lnformal ion is available for the
month of September 2019:
$
Control account balances at
1 Sep1ember 2019
Purchases book
33808
Returns inwards book
1 626
Relurns outwards book
727
Sales book
47 782
Prepare the accounts receivable and accounts
payable oon!rol accounts for Sep,ember 2019.
State wha11ne closirig balances of the con1rol
accounts reveal.
4 Identifying errors not revealed by a trial
balance
The following errors have been found in the
accounting records of the grocery store owned
by Jagmonan. In each case identify 1he type of
error that nas occurred .
a Goods were returned to a credit supplier,
Gee1a Traders, value $370. However, a debit
en1ry was made in 1he account of Gee1a
Suppliers ra1her lhan Geeta Traders.
b Some new office eqviprnent w,;s pvrcha~eo
by cheque $2 200, The entries made were: Dr
Purchases Cr Bank $2 200.
c An lnvoice was received from TrinBay Ud for
$2 320. The entry in the purchases book was
for $2 230.
d Jagmonan vvtthdrew cash for private use
$240. The entries made were: Dr Cash Cr
Drawings $240.
e The total of 1he discounts allowed column
Sales ledger
16 493
Purchases ledger
12 204
$450 was l ransferred to the debit of the
discounts allowed account as $540; 1he
pi;1ymen1 of general expenses $90 by cheque
was not posted from tne cash book,
Discoun1s allowed
8L17
Discoums received
668
f A paying-in slip counterfoil for cash and
cheques relating ;o casn sales totalling $650
had been overlooked and had not been
en1ered In the books of account.
Totals from book of original entry:
Cash book
Payments to accoun1s payable 34 224
Receipts from accounts
receivable
General journal - bad debts
written off
45 183
224
5 Correcting errors not revealed by a trial
balance
Prepare entries In Jagmohan's general journal
10 correct each of the errors listed in QueS11on 4
above.
••
Introduction
LEARNING OUTCOMES
Features of a partnership
In this unit you will learn about:
• A partnership is a form of business ownership where two or more
Individuals work together with the intention of a making a profit.
• how a partnership business
is defined
• the features of a partnership
• the reasons for establishing
partnerships
• 11,e essential components of
a partnership agreement
• sharing pro'its and tosses.
KEY TERMS
Partnership: a fom, of
business ownership where
two or more lndiviouals work
together with the intention of
making a profit.
Limited partnerships: one or
more partners has limited liability
for the debts o' the business,
meaning they can onty lose the
amount they invested in the
business shoulo it fall. Limited
partners cannot 1ake part In the
oay-to-day decision making of
the partnership.
Unlimited liability: where
the owne~s} of a business are
responsible for all the debts o'
the business and miiy lose all
their investment In the business.
and private possessions as
well, in order to pay off the
debts of the business.
Voluntary association:
a group of individuals who
Join together on the basis of
common objectives.
• Unless it is a limited partnership, each partner will have
unlimited liability for the debts of the business. This is exactly the
same disadvantage that is experienced by a sole trader.
• A partnership is a voluntary association, I.e. a business Vlt here
a group of Individuals join together on the basis of common
objectives.
• All the partners are jointly responsible for the oebts of the
partnership, even if an individual partner played no direct part in
incurring the debt.
• This is one example of mutual agency, whereby each partner has
the power to make contracts on behalf of the partnership and is
bound by the other partners' actions in the normal running of the
partnership.
Why partnerships are formed
Partnerships enjoy some important advantages that do not apply to
the sole trader form oi ownership, such as:
• raising more capital because several owners can contribute
• sharing ideas and expertise
• sharing the workload involved In running a business.
There are, however, some drawbacks that are faced by partnerships,
in addition to unlimited liability for the debts of the business:
• Decision making can be more difficult because every partner must
agree to important proposals about how to run the business.
• Each partner must follow any agreements made by the partners.
• Each partner is jointly responsible tor the debts of the partnership.
• Partnership businesses can be short-lived, because they may have
to close on the retirement or oeath of a partner.
• There is always the risk that partners will disagree and that
relationships may break down, possibly bringing the partnership to
an end.
Partnership agreements
The deed of partnership
Partners usually make a formal agreement when the partnership is
established. The agreement may be merely spoken or may be written
down In the form of a deed of partnership.
Agreements often Include:
• how much capital is to be contributed by each partner
KEY TERMS
Mutual agency: each partner
has the power to mal<e
contracts on behalf of the
partnership ano Is bound by
the other partners' actions
In the normal running of the
partnership.
• the responsibilities of each partner in running the business
• a llmtt on each partner's drav,ings
• how profits and losses are to be shared.
EXAM TIP
Note: where partners do not have a formal agreement about sharing
pro'its and losses, the law requires proms and losses to be shared
equaJly.
ALwa tfS. b~ a wave of
Sharing profits and losses
t he J'YOVLSLO"'-S """ t he
]>llrt"'-tYsh•J> agr-eeV>1.el'\.t.
The agreement about sharing proms and tosses can be very simple:
partners could agree to share all pro'its and losses equally. for
example. However, more elaborate arrangements can be made:
• Each partner may receive a share o' profits based on his/her
capital contribution. This is referred to as Interest on capital. A rate
of Interest per annum will be agreed.
• One or some oi the partners may receive a ·partnership salary', a
share of profits awarded for taking special responsibility for some
aspect of managing the business. This benefits partners who are
more active than others in running the business.
• Proms (or losses) remaining after these awards have been allocated
may be shared equally, or in some other ratio.
• Some agreements may also provide for 'interest on drawings', a
penaJly based on the amount of a partner's drawings.
SUMMARY QUESTIONS
1. Give two reasons why a sole trader might choose to form a
part nershlp.
2. Give tv,o reasons why a sole trader might prefer to stay as a
sole trader rather than !orm a partnership.
3. What oetalls might be included in a deed of partnership?
There ls an example of how profile are shared in Unit 8.5.
LINK
There Is more on interest on
drawings In Unit 8.3.
%
The accounts of
partners
Partners' capital accounts
LEARNING OUTCOMES
In this unit yov will learn about:
• preparing partners' capital
accounts
• how lo prepare an
appropriation account
• how to prepare partners'
current accounts
• the significance of the
brought down balances of
partners' current accounts.
In many cases, partners agree to contribute a fixed amount of
capital that cannot be changed except by agreement of all the
partners. Where this is the case. separate accounts called current
accounts are maintained to record day-to-day changes in lhe
partners' investment In the partnership. Alternatively, in some
partnerships all these records are kept In what are called fluctuating
capital accounts.
Entries to record the capital introduced by partners
When a partnership is established the follo\ving entries will be
required to record the capital introouced by each partner:
JOURNAL ENTRIES
General Journal
DEBIT assets a/cs
brought into the
business
LEDGER ACCOUNTS POSTINGS
Cash Book
General Ledger
DEBIT Casn ale or
Bank ale for monies
brought in
CREDIT the partner's capita! account for the value
oomribuled.
TOTAL DRS muSl equal TOTAL CRS
DEBIT the accounts of asse:s other than cash/bank
contributed by eacn partner.
CREDIT ihe capital aocoum of eaon partner 1,.i1h the total
of their capital contribution.
Capital accounts are often set out in columnar format
because this is less time consuming.
DID YOU KNOW?
" ILLUSTRATION 1 Columnar format for capital accounts
Fluctuating capitals: this form
of capital account combines
all the Information about a
partner's investment In one
account, I.e. In the partnership's
first year it will lncluoe the Initial
capital contnbution, shares of
the year's profit, orawlngs and
a closing balance.
The balance on a partner's
current account can be:
• a debit: where the partner's
drawings have exceeded lhe
share of profits, I.e. the partner
is In debt to the partnership
• a credit: where !he partner's
share of pro'its has exceeded
drawings, I.e. the partnership
is in debt to lhe partner.
Ryan and Sonya agreed lo form a partnership on 1 January
2018. Ryan contributed capital of $50 000 in cash and Sonya
contributed S60 ooo ln cash. Here are the partners' capital
accounts in columnar formal.
GENERAL LEDGER
Dr
Ryan
$
Capital accounts
Cr
Sonya
Ryan
Sonya
$
2018
s
s
Jan 1 Bank 50000 60000
,I
The partnership appropriation account
A partnership's financial statemen!s will include an appropriation
account to show how profits (or losses) have been shared In
accordance with the partnership agreement.
"ILLUSTRATION 2 Preparing an appropriation account
Ryan and Sonya
Appropriation account for the year ended 31 December 2018
$
Profit for the year
Less interest on capitals
Ryan
Sonya
48000
1. Ryan and Sonya share profits
and losses equally after
allowing 10% per annum
interest on capitals and a
salary of $ 11 000 per annum
for Ryan.
(11 000)
37 000
p1 000)
26000
2. Entries would be made in the
general journal to transfer the
profit lo the income statement
and to transfer information to
the partners' current accounts.
$
5000
6000
Less sa'ary (Ryan)
Shares of residual profits
Rya'l
Notes:
13 000
13000
Sonya
26000
..
Partners' current accounts
'Nhen partners' maintain fixed capital accounts, other transactions
affecting the partners are recording In current accounts, for example:
• drawings (transferred from separate drawings accoun ts
maintained for each partner during a financial year)
• shares ot profit (Including interest on capital, salaries, residual
pro'it shares)
2. What does a debit
balance on a partner's
current account mean?
• shares of losses.
/
1. What in'ormation would
you expect to see recorded
on the debit side of a
partner's current account?
ILLUSTRATION 3 Preparing partners' current accounts
I
GENERAL LEDGER
Dr
Current accounts
2018
Dec
31 Drawings
31 Balance c/d
Ryan
Sonya '
$
27000
5 700
$
28000
32 700
Jan
1 Balance b/d
Cr
Ryan
$
Sonya
$
1 Balances bi d
31 Interest on capltal
31 Salary
3 700
5000
11 000
6200
6000
Share of residual
31 profit
31 Balance c/d
13000
13 000
2800
28000
2018
Jan
Dec
28000 I
2 800 ' Jan
1 Balance b/d
32 700
5 700
I
More about partnerships
LEARNING OUTCOMES
In this unit you will learn more
about sharing profits and
losses, in particular:
• interest on drawings and
how this Is recorded
• what action to take If
partners cannot agree, on
how to share profits and
losses.
Interest on drawings
Some proilt-sharing agreements Include a penalty, In the form of an
interest charge, for each partner, based on the amount of orawings
taken out during a year. Interest on drawings helps deter a partner
from making excessive drawings, which would adversely affect the
liquidity of the business.
The entries for interest on drawings are:
Debit the current account of each partner (this reduces the amount
ovved to the partner by the partnership).
Credit the appropriation account (i.e. increase the amount of profit
that can be distributed to the partners).
To calculate Interest on orawings, it is necessary to take account of:
• the Interest rate, vvhich is usually expresseo as x% per annum
• the period of time for which the partnership has been deprived of
the funds.
,.,ILLUSTRATION 1 Calculating and recording Interest on drawings
Louis and Monique are in partnership, sharing
profits and losses equally. Their partnership
agreement provides for interest to be charged
on drawings at 10% per annum. During the
year ended 31 December 2018. Louis withdrew
$15 000 on 1 May and Monique wit hdrew
$18 000 on 1 September. In the same year,
the partnership made a profit of $60 000.
Calculation of interest on drawings
Louis
10% X $15 000 X 8/12
(i.e. for the 8 months
1 May to 31 December)
10% X $18 000 X 4/12
(i.e. for the 4 months
Monique
1 September to
31 December)
= S 1 000
Recording Interest on drawings
Appropriation account for the year ended
31 December 2018
$
$
Profit for the year
Add imerest on dra,,v.ngs
Louis
Moniq~e
1 000
600
1 600
61 600
Snares of residual profits
Louis
Monique
= $600
60000
30800
30800
61 600
(Continued)
" ILLUSTRATION 1 Calculating and recording Interest on drawings (Continued)
GENERAL LEDGER
Dr
Current accounts
Louise
15 000
Monique
$
18 000
1 000
14 800
30800
600
12 200
30800
s
Dec 31 Drawings
31 lnteres! on
drawings
31 Balances c/d
Cr
Dec 31 s·nares of residual
profits
Jan
1 Balances b/d
Louise Monique
$
$
30800
30800
30800
14 800
30800
12 200
Notes:
1. Without the penalty oi interest on drawings, these partners would have shared the prom equally:
$30 ooo each.
2. With the interest on drawings the net effect for the partners Is that Louis receives 829 800 and
Monique $30 200, i.e. the total profit of $60 000 is allocated slightly to Monique's aovantage because
her drawings deprived the business of resources for a much shorter time than Louis's drawings.
Sharing profits and losses where there is
no agreement
EXAMTIP
Where there is no written agreement and partners are in dispute
about how to share profits, tt Is necessary to apply the terms of the
Partnership Act of 1890 as follows:
rt i.s " co""'-"'M>"'- l¾ist&i ke
• profits and tosses rue to be shared equally between partners
• there will be no provision for a partnership salary. interest on their
capitals or interest on drawings.
The Act also provides that a partner viho has made a loan to a
partnership should receive interest of 5% per annum where there is
no agreement to the contrary.
Interest on a partner's loan should be charged as an expense to the
income statement and credited to the partner's current account.
SUMMARY QUESTIONS
1. What is the double entry for lnlerest on drawings?
2. Calculate the Interest on drawings that should be charged at
31 December in a year ,..,hen a partner withdrew $20 000 on
1 May. Assume the Interest rate Is 12% per annum.
3. What are the key provisio ns of the Partnership Act tha1apply
when partners cannot agree about sharing profits or losses?
to Yeco,a iw:eyest 0 "" "
part"'-tY·s Lo&i"" i,.,, Hie
"'f''f'YO-pn.atlo"" ciceouw:
(it sl-iouloi appe&1 y as "'""
expe.,,s;e i."" ti-le i.,,c0 " " '
stcite1M.e.,,t). A""ot'1ev
COl¾l¾0111, l¾LSt&I Ju
is to foy9et to credit
Cl p&lrtl'\.ty's CUYYew:
~ccou""t wltn "'""l:1
Ll'\.tevest o"' ci lo&1.,,
Partnership statements
of financial position
LEARNING OUTCOMES
In this unit yov will learn about:
• how to prepare a partnership
statement of ' lnanclal
position showing the details
of the partners' current
accounts
• how to prepare a partnership
statement of 'inancial
position vvhere summarised
lntormation is given about the
partners' current accounts.
Preparing a partnership statement
of f inancial position
tn many 'Nays a partnership's statement of financial position will
closely resemble that of a sole trader. However, the capital section
will be different, because it will need to reflect the fact that there
is more than one owner, and that, in many cases, the owners'
investment is divided into two different aspects: fixed capital
accounts and current account balances.
There are two ways of setting out the capital section:
• Detailed capital section: showing the capital account balances
at the year end and all the detailed Information recorded In each
partner's current account
• Summarised capital section: showing only the final balances on
each partner's capital and current accounts.
ILLUSTRATION 1 Preparing a partnership statement of financial position
This Illustration shows the two
ways of preparing a partnership
slatemenl of financial position.
For convenience, only subtotals
are shown for non-current
assets, current assets and
current liabilities.
First, here Is the statement of financial posttion \ivith a detailed capital
section:
Tamara and Urban
Statement of financial position at 31 December 2018
$
NON-CURRENT ASSETS
CURRENT ASSETS
Less CURRENT LIABILITIES
Working capital/Net current assets
Capital employed
Less NON-CURRENT LIABILITY
Loan from Urban
CAPITAL ACCOUNTS
CURRENT ACCOUNTS
Opening balances
Interest on capital
Share of residual profits
Less: interest on drawings
drawings
$
$
420000
32600
(14 600)
18 000
438 000
(10 000)
428 000
Tamara
Urban
220 000
190 000
Tamara
Urban
3400
4 000
22 000
19000
14 000 14 000
39 400 37000
(800)
(1 000)
(17 400) (39 200)
21 200
{3 200)
410 000
18000
428000
(Continued)
" ILLUSTRATION 1 Preparing a partnership statement of financial position (Continueo)
Here is an extract from the s~atement of financial position With a summa,ised capital section:
N otes:
Tamara and Urban
Statement of financial position at 31 December 2018
(extract: capital section only)
CAPITAL ACOOUNTS
CURRENT ACCOUNTS
Tamara
Utban
$
$
220 000
190 000
Tamara
Urban
21 200
(3 200)
$
41 0 000
18000
428 000
1. The more detaJled capital section
provides more information for
anyone using this financial
statement.
2. The summarised version o• the
capltal section takes less time
to prepare, but It Is necessary to
have access to the detailed current
accounts In o,der to quote the final
balances.
The following ratio should be used to calculate the return on capital
employed:
Profit for the year
Total of partners' capital and current account balances
- - - - - - - - - - - - - - ' ' - - - - - - - - X 100
The partners' capital and current account balances could be those at
the beginning or end of the year, or an average of these figures.
EXAM TIP
rt L-S i""'-pol't.i ""t to
keep tlie fi.gunis fo y
tlie e.ipit.il .iecou~s
"""°'
C<.<YYe"'-t Clecou~s
quite sep.iy.ite
Cl
0 .,._,
'ILLUSTRATION 2 Calculating the return on capital employed
In the case of the partnership of Tamara and Urban, their return
on capital employed for the year ended 31 December 2018 Is
calculated below. The information In the statement of tinanclal
position shown in Illustration 1 has been used.
pci >t""eYS '1 ip st.iteV1<.e~
~f fi.""~=•cil pos,tio...., cis
""" tlie •Lt=tYcitio"-.
The profit for the year was $67 200 (found by adding together
Interest on capital, shares of residual profits and deducting the
Interest on drawings).
In this example the opening balances of the capital and current
accounts have been used.
These are: capital $41o ooo (capital accounts) + $7 400 (current
accounts), I.e. $417 400
The calculation is:
=
Profit for the year
X 100
Total of partners' capital and current account balances
$67 200
$417 400
= -----xlOO
= 16.09%
SUMMARY QUESTIONS
1. How does a partnership's
statement of financial
position differ from that of a
sole trader?
2. How should the return
on capital employed be
calculated In 1he case of a
partnership?
131·
Worked example:
partnerships
The question
Stephen and Tricia are in partnership sharing profits and losses
equally. On 31 December 2018 the follo\lvlng trial balance was
extracted from the books of accounts of the business after the
income statement for the year ended on that date had been
prepared.
Bank overdraft
Capital
Stephen
Tricia
Current accounts at 1 January 2018
Stephen
Tricia
Drawings
Stephen
Tricia
Insurance prepaid
Inventory at 31 December 2018
Loan from Tricia (repayable 2027)
Non-current assets
Cost
Provision for depreciation al
31 December 2018
Profi1 for the year
Trade payables
Trade receivables
Wages accrued
Dr
Cr
$
$
1 290
200000
150000
820
2300
36000
30000
'140
30610
20000
648 000
297 000
64 440
19 800
9590
755 '160
630
755 460
Additional Information at 31 December 2018:
1. The partners have realised that no entries have been made for
interest on Tricia's loan. Tricia is entitled to receive a full year's
Interest on her loan at 10% per annum.
2. The partners have agreed to the following arrangements for
sharing profits and losses:
• Interest is to be allowed on capital at 10% per annum.
• Interest is to be charged on drawings at 12% per annum.
Stephen's drawings were all taken on 1 April 2018; Tricia's
drawings were all taken on 1 June 2018.
• Residual profits v<1ill be shared equally.
Prepare:
• an appropriation account for the year ended 31 December 2018
• the partners' current accourits for the year ended 31 December
2018 .
The answer
Appropriation account
Before preparing the appropriation account it is necessary to alter the
draft profit for the year oi $64 '140 because Tricia's loan Interest was
overlooked. Tricia should receive interest of $2 000 (10% of the loan
$20 000). This reduces the profit for the year to $62 440. A partner's
loan Interest is credited to that partner's current account.
Stephen and Tricia
Appropriation account for the year ended 31 December 2018
$
62 1140
Profi1 for the year (amended see note above)
Add Interest o n drawings
Stephen (12% x S36 000 x 9/12 months)
3 240
Tricia (12% x $30 000 x 7/1 2 months)
2 100
5340
67 780
Less interest on capital
Stephen (10% x $200 000)
20000
Tricia (10% x $150 000)
15 000
(35 000)
32 780
Shares of residual profit
Stephen
16 390
Tricia
16 390
32 780
s
Partners' current accounts
Dr
Stephen
s
Jan
Dec
Jan
1 Balance bid
31 Drawings
31 Interest on drawings
31 Balancec/d
1 Balance bid
820
36000
3240
40060
3 670
Current accounts
Cr
Tricia
Stephen Tricia
$
$
Jan
1 Balance bid
2300
30000 Dec
31 Interest on capital
20000 15000
2 100
31 Snare of residual profits
16390 16390
31 Loan interest
2000
3590
31 Balancec/d
3670
35690
110060 35 690
Jan
1 Balance bid
3590
s
Practice exam questions
Paper1
1 Which Of the following sn0vld not be entered In
,m appropriation account?
A drawings
B interest on capital
C Interest on drawings
D partners' salaries
2 Nerissa ,md Ortando are in partnership sharing
profits and losses In tne ratio 2:1. This year rne
pannership made a loss o' $60 000. Which entry
should be made in Nerissa's current account?
A credn $20 000
B credr: $.40 000
C debit $20 000
D debit $40 000
3 Bill arn:I Csirmen are In partnership soaring profits
and losses equally. Bill is entitled to a partnership
salary of S20 000. This year tt,e partr ership
made a profit of $70 000. Bill's total share of
profits is:
$25000
B $35000
C $45000
D $55000
A
5 Ravi and Suzette are l'l partnership and :his year
made a profit of Sa5 000. They soare profi'.s
and losses equally aiter charging Interest on
drawings. Tnis year interest on drawings was
Ravi $1 000 and Suzette $2 000. Ravi's net
share of profits Is:
A $20 000
C $24000
B S22 000
D $25000
6 Wesley's cvrrent accoun: includes tne follovvlng
entries: opening debit balance $1 000, drawings
$12 000, interest on drawings $3 000, residual
profit S15000. Theclosirg balance on his
current account is:
credit $7 000
C debit $1 000
A
B credit S1 000
D debit $7 000
4 Listra and Micah are in partnership wltn capitals
of $200 000 end $100 000 respec:tlvely. The
par'.ners share profits and losses equally and
are receMng Interest on capital of 10% per
annum, This year 1he partnership made a prof'rt
of $80 000, Listra's total share of the profit is:
A $35 COO
B $40 000
C $45000
D SSOOOO
Paper2
1 Preparing the accounts of partners
Natasha and Oliver are In partners,.,ip wnh fixed
capital of $160 000 (Natasha) and $120 000
(Olive~. The following informal!on is available for
tile year ended 31 December 2018:
$
Current accounts at 1 January 2018
Natasha
4 400
0 ,lver
900
Drawings
Natasha
25 700
0 Iver
19 600
Profit tor the year
72 300
The partnership agreement includes the
following terms:
Current accounls at
1 January 2018
s
• Partners are to share profits in the ratio Na1asha
3/~. Oliver ~IG.
Drawngs
s
T
Gross Income
Inventory,
31 December 2018
Non-current assets
Cost
Prov sion for
depreciation at
1 January 2018
Operating expenses
Trade payab'es
Trade receivables
• Oliver is to ,eceive a partnership salary of
$14 000.
Prepare:
• an appropria1ion accoum for the year ended
31 December 2018
• the capital accounts of the partners
• 1he curren1 accounts of the partners.
b
2500
T
• ln1erest is to be allowed on caprtals at 10% per
annum.
a
400
Describe two advantages of forming a
partnership rather than operating as a sole
trader.
14300
17 100
12& 600
14500
360000
144 000
32900
7 4 00
11100
458500
458500
c Explain the meaning of a credit balance on a
partner's curren1 account.
Additional in'orma11on:
are in dispute
• Operating expenses $700 were prepaid at
31 December 2018.
E and F are in partnership but 1hey have no
agreement about the sharing of profits and losses
F ten: toe partnership S24 000 on 1 January 2018.
• Non-curren1 assets should be deprecia'.ed
by 20% per annum using the straighl-line
melhod.
During the year ended 31 December 2018 the
partnership made a profit before charging any
interes1on F's loan of $142 000. The partners
cannot agree on interest to be charged on F's
loan or how to share tne profit for the year.
• The partners have agreed the following:
2 Sharing profits and losses where partners
a
• inlerest to be allowed on capital at 10% per
annum
• T to receive a partnership salary of $8 000
per annum
Calculate 1'1e profit to be given 10 E 'or 1ne
year ended 31 December 2018.
• inlerest on drawings to be charged as
follows: S $600, T $900
b Give a brief explana1ion as regards your
proflt-sharir,g ratio for E.
3 Preparing end of year financial statements
from a trial balance
The following trial balance was ex1rac1ed from
the accoun1s of Sand Tat 31 December 2018.
Dr
Cr
s
$
Capital
s
T
Cash at bank
100000
80000
8200
• pR:>fits and losses 10 be shared equally.
Prepare:
a an lncome statemenl for the year ended
31 December 2018 staning wtth the gross
Income
b 1he appropriation account for tre year
ended 31 December 2018
c
lhe partners' currem accounts, balanced at
31 December 2018
d 1he statemem of 'inancial position at
31 December 2018 (showing summarised
Information aboU11he partners' capttal and
current accounts).
•
Introduction
LEARNING OUTCOMES
In this unit you will learn about:
• the essential features of
llmiteo liability companies
• the advantages and
disadvantages of limited
liability companies
• the essential features of
co-operatives
• the essential features of
ncn-proftt organisations.
KEY TERMS
Shareholders: the owners of
the stlare capital of a limited
company, sometimes called
'members'.
Essential features of limited liability companies
A limited company is a form of business organisation whose capi1al is
divided into units calleo shares. Those \/\/hOinvest in a company own
shares and are referred to as shareholders.
The most Important feature of ownership in a limited company is that
each shareholder's responsibility for the debts of the organisation
is limited to the amount they have invested in the company. This
means that, should the organisation run into serious difficulties and
face closure, shareholders cannot be asked to make any further
contributions so that the company can pay its debts. This is in
contrast to a sole trader or a partner who would have to use private
funds if their businesses were to face this sttuation.
The correct term for this special privilege enjoyed by shareholders is
'limited liability', hence the term limited liability company. Individuals
are tar more likely to be inclined to Invest il'I a compMy as a result
of limited liability, because there is a clear limit to the risk they are
taking. As a result, companies can be very large organisations wtth
many shareholders. almost all of whom do not play any part in the
day-to-day running of the organisation. The shareholders elect
directors to manage the running of the company.
Limited liability companies are also known as corporations.
Advantages and disadvantages of limited
liability companies
As well as the advantage of limited liability, companies can:
• raise large amounts of finance because there is the potential to
have many shareholders
• call upon the expertise of a wider group of Individuals to help
manage and develop the company
• continue to operate, despite changes In the indivlduals who own
shares.
Since shares in a company are freely transferable, subject to certain
conditions, no shareholder is permanently or necessarily wedded
to a company. Therefore, the shareholders of a company may keep
on changing from time to time, but that does not affect life of the
company. Neither does the Insolvency or death of a member affect
the existence of the company itsett.
However, companies are:
• subject to many legal reouirements (for example, they are required
to follow strict procedures when they are set up, and they must
follow detailed and ccmplex rules when preparing their annual
accounts tor publication)
• subject to changes in control, if, for example, an lnoividual or
a particular group of shareholders acquires sufficient shares to
control more than 50% of the voting rights.
Principles of co-operative societies
Co-operative societies are based on some important principles:
Open membership: membership is open to anyone regaroless of
their social, political, religious or racial background.
Democratic control : each member has an equal say in the running
of a co-operative society, because each member has Just one vote,
irrespective of the number of shares held.
Limited return on share capital: the key objective Is always
to provide a service for members, so dividends as a reward for
membership are likely to be small (ano in some years non-existent).
Patronage refund: all surpluses {profits) made by a co-operative
belong to the members. but it is a legal requirement that 20%
of any surpluses are set aside in a statutory reserve fund.
Remaining surpluses can be used for the further development of the
co-operative, and can be distributed to members. The distribution
to members Is based on the amount of custom they have provided
(I.e. the extent to which they have patronised the co-operative) rather
than the number of shares owned.
DID YOU KNOW?
The main features of
co-operaHve societies are
as follows :
• they are formed for the
benefit of their members and
local communities
• they provide goods and
services
• making a profit is not their
main priority
• they are owneo by their
members who each buy a
share in the business
• members are both the
owners ano the customers
• they are subject to various
regulations and laws
• their financial statements
comply with accounting
principles and concepts.
Continuous education: co-operative societies have a duty to
provide continuous education tor their members to ensure that
they are in a position to participate effectively In the control and
management of their society. Co-operative societies are required to
transfer a percentage of their surplus to an education fund for the
financing of educational provision.
Co -operation among co- operatives: co-operative societies are
SUMMARY QUESTIONS
1. Explain what is meant by
the term 'limited flablllty'.
expected to work together locally, nationally and Internationally, to
share ideas and experience for the mutual benefit of all.
2. Descrlbe two benefits of
Non-profit organisations
3. Explain how one Individual
forming a limited !!ability
company,
• Non-profit organisations exist for the benefit of their members or
for society in general.
could control a llmlteo
!!ability company.
• Unlike businesses. they are not formed vvith the aim of making a
pro'it.
4. Identify three important
principles on wh1ch cooperatives are based.
• They are often funded through membership subscriptions,
charitable donations and grants, and they may also trade.
• They are usually run by some of the members. who form a
committee that includes a Chair, Treasurer and Secretary.
5. Identify three ways in which
a sports club could be
financed.
Types of limited liability
company, co-operative and
non-profit organisation
LEARNING OUTCOMES
In this unit yov will learn about:
• the types of limited company,
co-operative and non-profit
organisation.
Private limited companies
• A private limited company is one where the ownership of shares
is restricted to members of a family, their friends and possibly
employees.
• They are generally small organisations with few shareholders.
• Members of the general public cannot invest in a private limited
company.
• Shares in a private limited company are bought and sold priva1ely
and only with the consent of all the existing shareholders.
• A private limited company could have Just one shareholder.
• The abbreviation 'Ltd' appears In the title of a private limited
company.
Public limited companies
• A public limited company is one in which the general public can
Invest.
• Shares In a public limited company are traded on stock exchanges.
• They are large organisations with hundreds or even thousands of
shareholders.
• The abbreviation 'pie' appears In the title of a public limited
company.
Although shareholders are the
owners of a limited company,
most of them will no1 lake part
in the day-to-day running of the
company. Instead, shareholoers
appoint directors to manage the
company. Tl1e directors report
to the shareholders at the
annual general meeting (AGM).
The shareholders also use the
AGM 10 appoint olrectors if they
so desire.
In some countries, for example
the USA. the abbreviation
'Inc' is used Instead of pie. nc
means Incorporated.
Co-operatives
I
ILLUSTRATION 1 Types of co-operative
Here are some examples of co-operative societies:
The Openport Fishing Co-operative was formed in 2007
by a group of fishermen who share the use of equipment
purchased by the co-operative. The funds raised by the purchase
of shares by the members have been used to buy some
specialist equipment that is hired out to individual members. The
equipment would have been beyond the means of Individual
members.
The Wide Horizon Retail Co-operative is a co-operative
society formed by a group of villagers to buy groceries in
bulk from suppliers and sell products at favourable prices to
members.
,
(Continued)
,, ILLUSTRATION 1 Types of co-operative (Continued)
The Outoftown Transport Co-operative was formed by a
group of individuals who live in the more remote areas on one of
the Caribbean islands, but who all work in the largest town on
the island. The co-operative has purchased two minibuses that
are used to take members to and from work each day.
The North Island Credit Union provides members with
opportunities to save regularly and to borrow at low interest
rates. The co-operative provides members wtth guidance and
support In making personal financial decisions as part of its
continuous education programme.
Note: co-operative societies also exist in other spheres
such as manufacturing, the provision of housing, marl<etlng,
entertainment, etc.
Non-profit organisations
The main aim of many non-profit organisations is to provide facilities
for their members to use and enjoy. In the case of clubs and societies
these facilities are acquired to provide social, sporting, recreational or
leisure activities. Examples Include gott, yachting, football and netball
clubs. In other cases, the organisation will have been established to
provide some form of charity tor those in need, or to benefit society
In general, for example the Rotary and Lions clubs.
SUMMARY QUESTIONS
1. What are the main differences between private limiteo
companies and public llmtted companies?
2. Identify five different types of co-operative based on the type
of activity, traoe or service they cover.
3. In what areas/activities 'NOuld you expect to find non-profit
organisations?
DID YOU KNOW?
Larger co-operatives are likely
to need to call upon a wider
range of expertise and skills,
and so 1hey tend to employ
professional staff to manage the
organisations. The wages and
salaries of all employees are
treated as an expense in the
financial statements.
How capital is raised by
limited liability companies
and co-operatives
LEARNING OUTCOMES
In this unit you will learn about:
• the various methods of
raising capital available to
limlteo liability companies
and co-operatives
• the various types o' share
and the rights of the owners
of each type of share
• debentures.
The capital of a limited company
When a limited company is formed a decision has to be made as
to the maximum amount of capital that can be raised. This amount
is known as the authorised share capital. It is not necessary to
actually raise this amount immeoialely because inilially the company
will nol require resources of lhat value. A company can. at any lime,
issue new shares up to the full amount oi authorised share capital.
The tolal of a company's shares that are halo by shareholders Is
called Issued share capital. The capital of a company is divided
into shares. Shares can be of two types.
Ordinary shares
All companies have ordinary shares, which are also called equity
shares.
KEY TERMS
Authorised share capital:
:he maximum amount of share
capital thal a llmltecl company
may Issue.
Issued share capital : the
amount of share capital that
has actually been issueo by a
limited company.
Dividend; the reward paid to
shareholders out of the pro'its
of a limited company.
Directors: inoividuals who are
appo1nteo by shareholders to
manage the company on their
behal'.
AGM (annual general
meeting): a yearly meeting of
shareholders where directors
report on the performance of
the company.
• Ordinary shares have a face value or nominal value. Many ordinary
shares have a nominal value of S1 , but it is possible for shares to
have a face value of say 50c, $2, etc.
• The ovvner of an ordinary share would expect to be rewarded for
Investing in the company by receiving an annual payment called a
dividend. The amount of !he annual dividend will depend partly on
how much profit the company makes and partly on how much the
directors feel the company can afford to pay.
• Ordinary shares have voting rights, which can be used at the
AGM (annual general meeting). tor example in the appointment
of directors.
Preferenc-e shares
Some companies also issue preference shares.
• Preference shares also have a nominal value (for example $ 1) and
preference shareholders also expect to receive a dividend.
• However, the amount of dividend that can be paid to a preference
shareholder is a fixed percentage of the amount Invested.
Preference shareholders are entitled to receive their fixed divideno
as long as the company has made a profit.
• Preference shareholders are allocated their oivldend before the
allocation of a dividend to ordinary shareholders. and woulo have
their investment returned before ordinary shareholders should the
company be wound up - hence the term 'preference· share.
• However, pre'erence shareholders do not normally have any
voting rights.
The capital of a co-operative
When a co-operative is formed the capital is provided by members
who purchase shares in the organisation.
Co-operatives may also have access to other sources of finance
such as government grants.
Debentures
A debenture is one of the most common forms of long-term loan
that a company can take. It is a loan that should be repaid on a
specttic date. The oebenture certificate issued by a company is an
acknowledgment that the company has borrowed an amount of
money which it promises to repay at a future date. Debenture holders
are, therefore, creditors of the company. Debentures have a fixed rate
of interest, and this amount of interest Is payable yearly or half-yearly.
Debenture Interest is charged to the income statement.
..
,
-
. - ~-
- .'
EXAM TIP
A COl¾l¾O"'- ""'-t..StQ)u is
to tl-li.v.k?. ti'lt1t olebe.,,tuyes
t!Ye pa•t of tl-ie ct1pitaL
vof tv.e co""'-pt!v.l::J
t1lo"'-g witl'l t i'l e s i'lt1Yes.
t>ebev.tuYes t!Ye "'-Dt
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ct1p•tt1l; tl-iel::J aye
Ytgt1Yoieol as t1 "'-D"'-c1<.n·e""t Lit1 bititl::J.
.-
· SUMMARY
QUESTIONS
.
1. What Is meant by the term authorised capital?
2, Identify two differences between preference shares and
oroinary shares.
3 . A company has Issued 400 000 6% preference shares of S1
each and 1,6 million ordinary shares of soc each. How much
cash shoulo this share issue raise?
4. Explain two ways In v,h,ch debentures differ from ordinary
shares.
EXAM TIP
It i.s "'-Ot "'-"'-COl¾l¾O"'for tYYOYS to OCCl,f,y
~ne"': wYitiv.g fi.guyes
•v. l¾•LLio.,,s. A wnole
"""'-""'-ber
. of, l¾ilti.0.,,s
requ~res six v.ou.ciliits
foY ei<t11¾pLe, s ""'-ZLtiov.
•s 5 ooo ooo. It follows
tl1t1t, St!l::J, 3 .G l¾illiov.
wo1<.Lol t1ppea1• t1s
3 GOO 000, etc.
Journal entries for the
issue of shares and
debentures; dividend
calculations
LEARNING OUTCOMES
In this unit you will learn about:
• recording the issue of shares
and debentures In the
general Journal
• the calculation o' share
olvldends.
KEY TERM
Share premium: the difference
between the nominal value of
shares ano the price at which
they are issued.
Recording the issue of shares
~Vhen a company Issues shares. the amount of money received will
depend upon the following factors:
• the number of shares issued
• the face value of the shares (sometimes called the 'nominal' or
·par' value}
• whether the company is able to issue the shares at a value above
the face value.
If the company issues the shares for a price above the face value,
the additional amount received is called the share premium. In the
accounting records, It is essential to keep a separate record of the
face value of shares and the share premium.
,,ILLUSTRATION 1 Journal entries for the issue of shares
On 1 January 2019 a company issued 500 000 ordinary shares
with a face value of $ 1 each and 100 000 6% preference shares
of $1 each, The ordinary shares were Issued at a market price of
$1.50 per share.
The amounts that will be received from this share Issue are as
follows:
Ordinary shares: a total of $750 ooo made up of $500 000
(face value, i.e. 500 000 x $1} and $250 000 (share premium,
Le. 500 ooo x S0.50)
Preference shares: S100 000.
The Journal entries to record the Issue are:
GENERAL JOURNAL
Date
Details
2019
Jan
1 Bank
Dr
Cr
$
$
850000
Ordinary share capital
(500 QQQ X $1)
500 000
Preference share capital
(100 000 x S1)
100 000
Share premium
{500 000 x SO.SO)
250 000
Issue of ordinary shares at a
premium and preference shares
at face value
,
ILLUSTRATIO N 2 Issuing oebentures
A company Issued $140 000 of 7% debentures {2028) on
1 March 2019.
The journal entry required to record 1he Issue is as follows:
GENERAL JOURNAL
Date
Deta/1s
2019
March
1 Bank
Dr
Cr
s
$
140000
7% Debentures (2028)
140 000
Issue of 7% detentures
Note: {2028) in the title of this non-current liability is a reference
to the year In which the debentures must be repaid.
Calculating dividends
SUMMARY QUESTIONS
Where there are distributable profits, directors must pay preference
shareholders their fixed dividend; they then have to decide the
amount of dividend to be paid to ordinary shareholders. Their
decision will be Influenced by:
1. A company issued 400 000
• the desire to reward the owners of the company
• the amount of profit available for dividend
• the amount of liquid funds the company will have available •,vhen
the time comes to pay the dividend
• alternative priorities for expendtture, 1or example replacing or
improving non-current assets.
.,..ILLUSTRATIO N
31Calculating dividends
Company A has 200 000 8% preference sliares 01 $1 each.
The preference share dividend will amount to 8% of
(20QQQQ X $1), i.e. 8% X $2QQ0Q0 : $160QQ
Company B has 400 000 ordinary shares of $1 each and the
directors have announced a 25% dividend.
The ordinary share dividend •Nill amount to 25% of
(400 ooo x $1), Le. 25% x $400 ooo = s 100 ooo
Company C has 1 000 000 ordinary shares of 50c each and the
directors 1,ave announced a 15% divldeno.
The ordinary share dividend •NIii amount to 15% of
(1 ooo ooo x soc), i.e. 15% x S500 ooo = $75 000
ordinary shares of $1 each
at S1.50 per share. The
share issue was successful
and all the icimo1.1nts 01.1e
were received. State the
double entry required to
record the share issue.
2. A company issued $300 000
of 7% debentures (2025).
a. State the double entry
required to record the
debenture issue.
b. State what Is meant by
2025 In lhe title of the
debentures.
3 . The directors of a company
have proposed the
payment of a preference
share oividend and a 20%
ordinary share dividend.
The company has 400 000
8% S1 pre:erence shares
and 900 000 $1 ordinary
shares. What is the total of
the proposed dividends?
The appropriation account;
the limited company's
income statement
LEARNING OUTCOMES
In this unit you will learn about:
• the appropriation of profit
between dividends and
reserves
• the financial accounts of
llmlteo liability companies.
The appropriation account
The financial statements of a limtted company Include an
appropriation account that shows the decisions made by the
directors about the profits of the company. The account includes:
• the profit (or loss) for the year, transferred from the income
statement
• any profits mace in the past that were not distributed (sometimes
called the opening balance or 'retained profits brought forward')
• proposed dividends
KEY TERMS
Proposed dividends: the
amount of oivideno suggested
to shareholders by the board
of directors (BOD} 'or approval
at the annual general meeting
(AGM).
General reserve: the retained
earnings or a company that are
set aside out of the company's
profits to meet rut ure (known or
unknown} obligations. General
reserves are unlikely to be used
to finance divioends.
• the transfer of some of the profits to a g eneral reserve or any
other reserve
• the closing balance of profits that have not been distributed
{sometimes called 'retained profits carried forward').
,, ILLUSTRATION 1 Preparing an appropriation account
Here Is a company's appropriation account.
Appropriation account for the year ended
30 September 2019
$
Profit for the year
Less: transfer to general reserve
Proposed dividends:
Preference shares (7% x $100 000)
Ordinary shares (15% x $800 000)
Relained proftt for the year
Add: retained profrts brought 'orward
Retained profits to carry forward
$
205 000
44 000
7000
120 000
{171 000)
34 000
57 000
91 000
,
The income statement
A limited company's Income statement will include all the usual
information. but may also record the following items:
Directors' remuneration: this is the expression used to cover
payments made to directors, such as salaries and fees; the item is an
expense to the company.
Debenture interest: this is an expense, and the appropriate amount
should be shown in the income statement in accordance with the
accruals concept - in other words any debenture interest due should
be included and should also be shown as a current liability in the
statement of financial position (balance sheet}.
Auditors' rem uneration: all but the smallest limited companies are
required to have their accounts audited; the amounts paid to the
auditors are an expense to the company.
ILLUSTRATION 2
Preparing a limited company's Income
statement
Here is an example of a limited company's Income statement
that includes the three categ cries of expense described on the
previous page.
Note: limited company 1inanciaJ statements often show 1igures ln
thousands or even millions of dollars; where this is the case the
money columns should be clearly headed $000 or Sm.
Income statement for the year ended 30 June 2019
sooo
Revenue
Less cost of sales:
Opening inventory
Purchases
Closing inven1ory
Cost of sales
Gross proftt
Auditors' remuneration
Administration expenses
Debenture interest
Depreciation o1 non-current assets
Directors' remuneration
Distribution costs
Wages and salaries
$000
1 972
72
996
1068
(88)
Auditors: tliose responsible
for auditing the accounts 01
a business. Auoiting is an
Independent check o' the
accounting information used to
prepare a financial statement.
Auditors are appointed by the
shareholders o1 the company.
EXAM TIP
~ COl¾l¾O"'- Yl<-~tt:lk,e
cs to si1ow olebe""1:uve
i"'-terest '"" ti1e
appropriati.o"" ciccot.tV\.t.
t>ebe"'-t«ve i""tevest ~
ve0avole~ ~s a"" ex-peV\.Se
a""ol so ct l-S s i1owv. t.V\.
ti1e
statel¾eY\.t.
•=ol¾e
(980)
992
38
69
50
115
162
39
256
Profit for 1he year
KEY TERM
(729)
263
SUMMARY QUESTIONS
1. What Is the purpose of an appropriation account tor a limited
liability company?
2. identify two ways in which the income statement of a limited
liability company could difi'er trom that of a sole tracer or
partnership.
3. ~Vhat Is meant by the term 'auditors· remuneration'?
4. Why is debenture Interest included in the income statement
rather than the appropriation account?
Company statements
of financial position
(balance sheets}
LEARNING OUTCOMES
In this unit you will learn how to:
• prepare a limited company's
statement of financial
position (balance, shoot)
• analyse performance and
position using ratios for a
limited company.
The statement of 1inancial position (balance sheet) of a limited
company is different to that of a sole trader or partnership because
its capital S1ructure is different. consisting 01 issued capital and
reserves. So the second part of the statement of financial position
(balance sheet) Is set out to show the following:
• main heading: EQUITY
• authorised capital: set ou1 as a note on the statement of financial
position {balance sheet) because the figures for au1horised capital
do not affeC1 the statement of financial position (balance shoot)
totals
I
' ILLUSTRATION 1 The statement of financial position (balance sheet) 01 a limited llablllty company
Here is a statement of financial
posttion (balance sheet) of a llmtted
liability company:
Notes:
1. A company's statement of
financial position {balance sheet)
will often include the tollowlng
current liabilities: debenture
interest due but unpaid; proposed
dividends.
2. Proposed dividends are a current
liability because they represent
amounts due to be paid to the
shareholders.
3. Dividends are proposed by
the directors and voted on by
shareholders at the AGM.
4. Debentures are a non-current
liability of the company until the
year In which they are due to be
repaid, when they become a
current liability.
5. It is usual to set out detailed
inlormation about the authorised
and issued share capital: number
of shares, their face value. e1c.
6. The authorised capital can
alternatively be set out as a note
to follow the statement of financial
position {balance sheet).
Statement of financial position (balance sheet) at 31 October 2019
NON-CURRENT ASSETS
Land and buildings
Motor vehlc'es
CURRENT ASSETS
lnvemory
Accounts receivab e
Cash at bank
$
$
$
Cost
960000
58000
1018000
Total
depreciation
48 000
29000
77000
Net
912 000
29000
941 000
84000
22 000
17 000
123000
Less CURRENT LIABILITIES
Accounts payable
Debenture Interest due
Proposed dividends
17 000
5000
82 000
(104 000)
NET CURRENT ASSETS
Capltal employed
NON-CURRENT LIABILITIES
10% Debemures (2024)
EQUITY
Authorised share capital
800 000 ordinary snares ol $1 each
200 000 6% preierern;e shares of S1 each
Issued share cap.taJ
500 000 ordinary snares o! $1 each
100 000 6% preference snares of $1 each
Share premium
General reseNe
Reta·ned profits
19000
960000
(200 000)
760000
800000
200000
500000
100000
50000
45000
65000
760000
• issued capital: giving details of the ordinary shares and
preference shares currently issued by the company - ordinary
shares should precede preference shares
• reserves: starting with the share premium, If any, followed by
the general reserve. It any, and finally the retained profit (i.e. the
balance of the appropriation account}.
Analysing the performance of a limited company
All the ratios covered In Section 5, Units 5.7 and 5.8. can be applied
to the financial statements of a limited company In order to analyse
performance. However, it is important to note that the return on
capital employed can be found by:
_______P_ro_ffl
_ fo_r_t_
he____,_
ye_a_r_ _ _ _ _ _ x
100
Capital invested (total of issued shares and reserves}
/ ILLUSTRATION 2 Calculating a company's return on
capital employed
Referring to the statement of financial position (balance sheet) In
Illustration 1 above, and assuming the company made a profit tor
the year of $121 000. the company's return on capttal employee
is as follows:
$121 000
$760000
,
- - - - X 100, l,e.1 5.92%
In other words, the company made 15.92 cents of profit for every
$1 invested by the shareholders in the company.
SUMMARY QUESTIONS
1. ~Vhy is the authorised capital of a company shown as a note
on the statement of financial position (balance sheet}?
2. Explain v1hy proposed dividends should be shown as a
current liability.
3. What is the correct order to record reserves on a company's
statement of financial position (balance sheet)?
4. a. A company has lssueo capital of S800 000, share
premium S70 000 ano retained profits o• S11 O000.
What Is the ccmpany's total capital?
b. This company made a profit for the year of $-'9 000.
What is this company's return on capital employed?
DID YOU KNOW?
A number of different versions
of the ratio tor return on capital
employed can be useo when
analysing the statement of
financial position (balance
slieetJ of a limited company.
You are recommended to use
the ratio described above
during your studies.
Worked example:
•
preparing company
financial statements
The question
The following balances were taken from the books of Soufriere
Packaging Ltd on 30 November 2019 after the company's gross
pro!it had been calculated:
$
10% Debentures
Accounts payable
Accounts receivable
Administration expenses
Auditcrs' fees
Cash at bank
Debenture interest
Directors' remuneration
Gross pro'tt
Inventory at 30 November 2019
lss1;ed share capltal
· DID YOU KNOW? ·
The following Important points
should be noted:
• The gross profit has already
been calculated, so the
Income statement will consist
of the second part only.
• The preference shares have
a face value of $5 each, not
the more usual $ 1 each.
• Tl1e list of balances includes
a number of items that are
particularly Important In
limited company financial
statements, for example:
10% debentures, auditors'
fees, debenture Interest,
olrectors' remuneration,
oetails of Issued share
capital, retained profi1 at the
beginning of the year and
share premium.
• There are very few
adjustments to make: utllitY
charges will be lncreaseo by
the accrual, and non-current
assets are 10 be depreciatea.
• It will be necessary to
calcu1a1e the dividends
that have been paid and
proposed.
• The tasks Include the
expected items, but note that
only part o' the statement
of financial position (balance
sheet) Is required Oust the
capital and reserves section).
400 000 ordinary shares
40 000 8% pre'.erence snares
Non-current assets
Cost
Provision for depreciaticn 1 December 2018
Retained profit 1 December 2018
Share premium
Selling expenses
Utility charges
80000
17 000
32000
14 000
9000
19 000
8000
82000
331 000
62000
400000
200000
900000
90000
75000
50000
8000
12 000
The company's authorised capital consists of:
• 500 000 ordinary shares of $1 each
• 40 000 8% preference shares of $5 each
Additional information:
• At 30 November 2019, utility charges due but unpaid totalled $2 000.
• Non-current assets are to be depreciated by $90 000.
• During tne year the directors had proposed and paid the preference
share dividend and a divideno of 20% on ordinary shares.
Prepare:
a.
an Income statement tor the year endeo 30 November 2019
starting with the figure for gross profit
b. an appropriation account for the year ended 30 November 2019
c. an extract from the statement of financial position (balance sheet}
at 30 November 2019 to show only the capital and reserves of
the company.
Getting started
As always it is Important to read through the question carefully and
to begin to think about how you will approach producing an answer
before rushing into the first tas~.
Selecting the right informaNon at the right moment
This question will really test your understanding of how to treat
each item in preparing a range of financial statements. You may,
therefore, find It helpful to spend a few moments marking off each
Item as to where in the answer it will be used: perhaps writing I for
income statement, A for appropriation account and S for statement
of financial position (balance sheet) extract where appropriate. Don't
forget to mark off the additional information as well.
Calculations and workings
There are relatively few calculations required in this question, but it
might be sensible to do these b eiore preparing the formal answer.
Utility charges: paid $ 12 000 l)ut ado accrual $2 000, so $14 000
should be shown In the Income statement.
Dividends
• p reference shares: the preference shareholders receive a fixed
cl!videno ot 8%, anc;t this rate of c;iiVic;teno shOl,,!lc;t be based on the
issued capital figure of $200 000, to give a dividend of $16 000
• ordinary shares: the ordinary share dividend is 20% and this
should be based on the Issued capttal figure o' $400 000, to give a
dividend of S80 000.
These workings should form part of your answer, so that you
demonstrate your understanding of the techniques Involved.
The answer
The income statement
SOUFRIER E PACKAGING LTD
Income statement for th e year ended 30 November 2019
$
Gross profit
Less: administration expenses
Auditors' fees
Debenture interest
Directors' remuneration
Depreciation
Selling expenses
Utility charges
Profit for the year
s
331 000
EXAM TIP
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A
l¾iStAJu
. COl¾l¾O""
,
is to l¾LSc&1lcut11te
clivicle.,,c/s, foy
O:&ll¾ple btJ biisi"'0
ti1e ctilcuLAti.0.,, 0 .,.,
ti1e A«ti1oYisecl c11pit&1t.
Y/lti1eY
ti1&1.,, ti1e iss«ec:I
,
cC1pit&1L. R.tl¾e ...... beYti111t
clivicle.,,,cls A,e II YtWl! yc/
to si111Yenolcle,s o"" the
fAot vcit.«e of wi1&1t the):j
~11ve &1ct«ALl1::J """vested
:"" th e c-o"""P"""tJ, i .e. tne
'Ui,w,I C-llj)LtAl.
14000
9000
8000
82000
90000
Notes:
8000
14 000
(225 000)
106 000
1. The formal answer should start
with the name of the company.
2. Abbreviations of any kind have
been avoided in the 11eading.
SOUFRIERE PACKAGING LTD
Appropriation account for the year ended 30 November 2019
s
EXAM TIP
Heaal~
Whe"" 'f>YtpaYL"'-g
-fiv,,civcc[aL stt1te~111,ts
foy Cl ""ti bv.sLv.ess, lt Ls
atwci tJS coi,,.,sideYu:I good
'f>Y&!cttce t o stciyt wltl.1 t"1e
v.ame of the bt.<Siv.ess
a s sviowv. heYe.
'
Profit for the year
Less dividends paid:
Preference shares
Ordinary shares
$
106 000
16000
80000
Relained profit for the year
Add relained profits broughl foP1✓ard
Relained proflls to carry forward
96000
10000
75000
85000
The appropriation account
Note: the dividend calculations (here shown on the previous page
under the heading 'calculations and workings') should be Included
with the appropriation account; they are a valuable part of your
answer in an examination.
T he statement of financial position (balance sheet) extract
SOUFRIERE PACKAGING LTD
Statement of financial positton (balance sheet) (extract} at
30 November 2019
$
EQUITY
Authorised share capital
500 000 ordinary shares c f S1 eacn
.10 000 8% preference shares of $5 each
Issued share capital
400 000 ordinary shares cf $1 each
.10 000 8% preference shares of $5 each
Share premium
Retained earnings
500000
200000
400000
200000
50000
85000
735 000
N ote: It is good practice to lncluoe the word 'extract' In the litle of
an incomplete stalement such as this statement of financial position
(balance sheet).
Final accounts
of co-operatives
The accounting records of all co-operatives follow the same
principles, concepts and procedures as any other form of business
organisation. Smaller societies are likely to have more basic
records kept by one of the members who has some knowledge of
bookkeeping and accounting. Larger societies will maintain a full
accounting system.
LEARNING OUTCOME
In this unit you will learn about:
• how to prepare the final
accounts of a co-operative.
Income and expenditure account
This account Is similar to an income statement and is designed to
show the surplus (profit) or de'icit (loss} for the year. The Income and
expenditure may be supported by separate accounts designed to
shovv the gross profit or loss made on specific activities.
f ILLUSTRATION 1
A co-operatlve's Income and expenditure account
INideHorlzons Retail Co-operative Society was formed several years ago to provide members with good
quality fruit and vegetables a t favourable prices.
Notes:
WIDEHORIZONS RETAIL CO-OPERATIVE SOCIETY
1. This retail co-operative's main
Inc ome and expenditu re account for the year ended
31 December 2018
s
INCOME
Gross profit on 1rading activities
{see Note 1)
ln!erest received on investments
Members' annual fees
source of Income is from t1ading
$
81 700
7 500
18300
107 500
EXPENDITURE
Administration expenses
Depreciation of non-current assets
Transport costs
V~ages and salaries
8400
22000
4 700
19900
(55000}
52500
Surpl.;s fer year
Note 1:
Income statement for t he year ended 31 December 2018
Revef'ue
Less cost of sales:
Opening Inventory
Purchases
Closing inventory
Cost of sales
Gross profit on trading operations
s
s
186 000
6200
105 400
11 1600
(7 300)
{104 300}
81 700
in fruit and vegetables. The
gross profit on this activity Is
shown separately in the income
statement (see Note 1}.
2. The co-operative also receives
income in the form of Interest on
investments. Many co-operatives
use any surplus cash funds to
purchase Investments (an asset)
on \l'thich Interest Is received
annually.
3. The other source of income is
from membership fees. Members
are required to pay an annual fee
to entitle them lo use the benefits
provlded by the co-operative.
4. The co-operative's expenses
are typical of any business
organisation.
Appropriation account
This account is designed to show how the surplus for the year Is
to be oistrlbuted. It will Include entries for any honorarium paid to a
member and transfers to statutory reserves. including an education
reserve.
ILLUSTRATION 2 A co-operatlve 's appropriation account
Here is the WideHorizons
Co-operative Society's appropriation
account. It includes the figure for the
surplus shown In Illustration 1.
WIDEHORIZONS RETAIL CO-OPERATIVE SOCIETY
Appropriation account
for the year ended 31 December 2018
$
N otes:
$
1. The Co-operative is required to
transfer 20% of its surplus to the
statutory reserve; II must also
transfer a specttied percentage
{depending on which state's
regulations should be applied here 10%) to the education fund.
Surplus for the year
Less: transfer to staMory reserve
Honoraria
Transfer to education reserve
Proposed dividend
2. The honorarla are the token
payments made to particular
members who have made a
significant contribution to the
successful working of the
Co-operative.
Undistributed surplus for the year
22850
Add: ur dis'.ributed surplus brought fcrvvard
Undistributed surplus to carry forward
48650
71 500
52500
10500
4 600
5 250
9300
(29 650)
3. The proposed dividend could be based on the value of shares owned by members Oust as diVldends
are calculated in the case of a limited liability company) but they could also be based on 1he amount
of business (patronage) provided by each member {i.e. the sales of fruit and vegetables). Here the
dividend has been based on 5% of sales (revenue), which was S186 ooo. As the dividend is
proposed and not yet paid, ii will be shown as a current liability on the statement offinanclal position
(balance sheet).
4. The undistributed surplus for the year Is added to any undistributed surplus from previous years. This
ttem will be shown as one of the reserves on the statement of financial position (balance sheet}.
SUMMARY QUESTIONS
1. Explain the purpose of a co-operative
society's
a. Income and expenditure account
b. appropriation account.
2, List four items that are likely to be recorded
In a co-operative society's appropriation
account.
3. Which items make up the capita! and reserves
section of a co-operative society's statement of
financial position (balance sheet}?
Statement of f inancial position
(balance sheet)
A co-operative society's statement of financial
position (balance sheet} recoros assets and
liabilities In the same way as an other business
organisations. The assets could include
Investments owneo by the co-operative.
Investments should be shown unoer the heading
non-current assets (or under the heading current
assets if they are likely to be cashed in during the
next linancial period). The capital and reserves
section will show share capital, the statutory
reserve, other reserves (such as the education
reserve) and any undistributed surplus Income.
Worked example:
co-operatives
The question
The St Martin's Village Co-operative Society runs a village store
serving the everyday needs of its members, who live in St Martin and
nearby communities.
On 31 December 2018 the foll owing trial balance was extracted from
the Society's books of account:
Dr
Cr
$
$
Accoun1s payable
Administraticn costs
4530
Cash in hand and at bank
3650
Dividends paid
4000
Education fund at 1 January 2018
General expenses
8 210
l~teresl received on Investments
Inventory at 1 January 2018
6 590
Investments in otner retail co-operatives
8 200
Membership fees
Non-wrrent assets:
Cosl
95000
Provision for depredation at 1 January 2018
Purchases
33940
Revenue
Secretary's honorarium
650
Share capital
StatVtory reserve a1 1 January 2018
Undistributed surplus at 1 January 2018
164 770
1 940
6200
670
4 280
19000
80000
40000
8400
4 280
164 770
Additional Information at 31 December 2018:
• Inventory of unsold goods was valued at $4 280.
• General expenses S280 were due.
• Interest due on investments 1otalled $490.
• Some members had paid fees of $570 ln advance for 2019.
• Non-current assets should be depreciated by 20% per annum
using the straight-line method.
• 20% of the surplus for the year should be transferred to the
statutory reserve.
• 10% of the surplus for the year should be transferred to the
education fund.
• All the investments are long term.
Prepare:
a. an income and expenditure account for the year ended
31 December 2018
b. an appropriation account tor the year ended 31 December 2018
c . a statement of financial position {balance sheet) at
31 December 2018.
Note: The list of tasks required in this question is probably more
extensive than is likely to be required In an examination situation.
These tasks are included here to provide a comprehensive
example of hovv to prepare an answer to a question on the financial
statements of co-operative societies.
Getting started
This question requires three different financial statements to be
prepared. so it is very Important to ensure that the right information
is selected for use in each statement. It is, therefore, worth spending
a short time reading through the list of items in the trial balance ano
deciding where each ttem will be used, perhaps pencilling in I Qncome
and expenditure account), A (appropriation account) and S (statement
of financial position (balance sheet)) to help you as you prepare the
formal answer. It Is also important to spend a few moments working
out the effect of the additional information on the items in the trial
balance and deciding which statement will be affected.
Here is the trial balance again, but with some notes adoed based on
this aovice.
Aooounts payable
Administration costs
Cash In hand and at bank
Dividends paid
Education fund at 1 January 2018
General expenses
Interest received on investments
Inventory at 1 January 2018
Investments in other relall co-operatives
Membership fees
Non-current assets:
Cost
Provision for depreciation at 1 January 2018
Purchases
Revenue
Secre,ary's honorarium
Share capna1
Statutory reserJe at 1 January 2018
Undistributed surplus at 1 January 2018
Dr
Cr
$
$
4 530
3650
4 000
Notes based on additional information
1 940 s
I
s
A
6200 S
8 210
670 I
I
6590
8200
s
4 280
Add10% of surplus (A and S)
Add $280 due (I and SJ
Add $490 due (I and S)
Closing inventory $4 280 ~ and SJ
Record as a non-current asset
less $570 (I and SJ
s
95000
19 000 S
Add $19 000 /I and S)
33940
80000 I
650
A
40000 S
8400 S
4 280 A
164 770 164 770
Add 20% of surplus /A and$)
The answer
EXAM TIP
Preparing t he income and expenditure account
As this is a retail co-operative society, the first step is to calculate the
gross profit made on trading by preparing an Income statement.
Once the gross profit has been calculated, it will be possible to prepare
the Society's income and expenditure account, which will show:
• sources of Income, Including the gross profit calculated in the
income statement
It L.s &t COl¾l¾O"" l¾[St&t ~e
to ;econ:;( &11>1.1:j i,, 0 ""DYGIYi«""'
J>il•cl to" l¾tl¾btY 'ls"""
expe1>1.se i,.,_ ti1e i"'-COJ¾t
sti1tel¾e~. 1t i.s; i.mportt:l~
to Ytl¾tl¾btY tl1i1t
fiO"'-OYGIYi.CI G!Yt Ytgt:ly,:;le,:;l C!S
• expenses of running the society
""" ."J>J>YOJ>Yir;itio"" of the
soc.etl:J's s«YJ>L«s fo ,• tl1e
• surplus {or deficit) for the year.
1:Jtilt,: so &iye Ytcoyclecl ;,.,_ tne
ST MARTIN'S VILLAGE CO-OPERATIVE SOCIETY
Income statement for the year ended 31 December 2018
$
Revenue
Less cost of sales:
Opening Inventory
Purchases
Closing Inventory
Cost of sales
Gross profit
$
80000
6590
33940
40530
(4 280)
(36 250)
43750
ST MARTIN'S VILLAGE CO-OPERATIVE SOCIETY
Income and expenditure account
for the year ended 31 December 201 B
$
Gross profit
Add: Interest on investments
Membership fees
$
43 750
1 160
3 710
4 870
48620
Less: Administration cosis
General expenses
Depreciation of non-current assets
Surplus for year
4 530
8490
19 000
(32 020)
16 600
Preparing t he appropriation account
The appropriation account must provide members with information
about the society's surpluses and how these are being used. It shows:
• the surplus for the year
• transfers to reserves
• dividends paid to members
• undistributed surpluses.
&lj>j>YOJ>Yi&tti.o.,_ G!CCOt<l'\.t.
ST MARTIN'S VILLAGE CO-OPERATIVE SOCIETY
Appropriation account for the year ended
31 Dec,e mber 2018
$
Surplus for year
Less: Trans'er to staM ory reserve
Transfer to education fund
Secretary's honorarium
Dividends paid lo members
Notes:
1. The transler to the statutory
reserve was calculated as 20%
of the current surplus,
I.e. 20% X $16 600 = $3 320
2. The transfer to the education
reserve was calculated as 10%
of the current surplus,
i.e. 10% X $16 600 = $1 660
Statement of financial posltiom (balance sheet) at
31 December 2018
$
Cost
NON-CURRENT ASSETS
Investments in other retail
co-operatives
CURRENT ASSETS
Inventory
lnves!men1 imerest due
Cash in hand and at bank
95000
$
Total
Depreciation
38000
$
Net
57 000
8 200
65 200
4 280
'1190
3 65-0
(9 630)
6970
4280
11 250
Preparing the statement
of financial position
(balance sheet)
The co-operative society's statement of
financial position (balance sheet) will show
the business assets, liabilities and capital. It
is set out in a style similar to that of a limited
company's statement of financial position
(balance sheet) (see Unit 9.6). Some special
points to note are:
• Non-current assets should
include investments in other
co-operative societies as they
are said to be long-term investments.
• Current liabiltties should include the
general expenses due and also the
membership fees received in aovance.
1 940
280
570
(2 790)
NET CURRENT ASSETS
Capital employed
CAPITAL AND RESERVES
Share capital
Statutory reserve
Education fund
Undistributed surplus
3320
1 660
650
4000
• Current assets should lncluoe
the investment interest due as it
Is income yet to be received.
8420
Less CURRENT LIABILITIES
Accounts payable
General expenses due
Membership fees received
in advance
16 600
Undistributed surplus for the year
Add: undistributed surplus brought forward
Undistributed surplus to carry forward
ST MARTIN'S VILLAGE CO-OPERATIVE SOCIETY
$
5 630
70830
40000
11 720
7 860
11 250
70830
• The capital and reserves
section shows the capital
(shares) and the three reserves
in the trial balance: statutory
reserve, education fund and
the undistributed profits at the year end.
Non-profit organisations
Revenue and capital expenditure
All organisations have to make a careful distinction between capital
and revenue expenditure when preparing financial statements. This
is important because otherwise the financial statements will provide
misleading information, which could result in poor decision making
by owners, managers and others.
Capital expenditure
Capital expenditure Is money spent on non-current assets. It is
expenditure that is of long-term (i.e. more than one year) benefit.
Capital expenditure covers not Just the basic cost of non-current
assets (for example, a new clubhouse or sports equipment) but also
the following:
• Money spent on improving non-current assets. For example, If a
club installed air-conditioning in Its clubhouse, the money spent
would be regarded as capital expenoiture and added to the value
of the clubhouse, because the benefit from the expenditure is
Intended to last for several years.
• Some Items that seem to be•routine expenses, but that in fact will
benefit the organisation for a longer period. For example, wages
paid to install some new sports fittings should be treated as capital
expenditure and added to the cost of the sports fittings. The
'capitalisation' of the wages Is correct, because the view is taken
that the benefit from the payment for wages will last as long as the
club is using the sports fittings.
Revenue expenditure
Revenue expendit ure is money spent on everyday running costs.
It is expencliture that Is of short-term (I.e. less than a year) benefit
to the organisation. A feature of most revenue expenditure is that
It is recurring, i.e. has to be paid for again and again. So expense
payments such as rent, electricity costs, water charges, wages,
salaries, and repairs, maintenance and servicing costs qualify as
revenue expenditure.
Receipts and payments account
Clubs may receive money from a variety of sources. Here are some
typical examples:
LEARNING OUTCOMES
n this unit you will learn about:
• the difference betvveen
revenue and capital
expenditure
• how to prepare a receipts
and payments account for a
non-profit organisation.
KEY TERM
Capital expenditure: amounts
spent on non-current assets
that are shown on a statement
of financial position (balance
sheet).
DID YOU KNOW?
The rules about capital and
revenue expenditure should
be applied to the financial
statements of businesses as
•Nell as non-profit organisations.
KEY TERM
Revenue expenditure:
amounts spent on everyday
running costs that are taken
Into account when calculating
an organisation's annual profit
(or loss).
• members: in the form of an annual subscription
• money-raising activities
• loans
• donations.
•
The club treasurer will be responsible for making the following
payments:
EXAM TIP
• running costs
~e.,,,ue GKJ>e""olituYe
• expenses of money-raising activities
is Yecoroleol ;,.,,, the
•
iV\.OOIM.e Sti:lte""'-eV\.t
of
• purchase of non-current assets
11 busi""ess, wheYe&1s
c&1pi.ti:1 L GKJ>e""ol itu ve i.s
i:lccou""teol foy '"" the
stA:e~e""t of fi-"'-&1 "'-Cit:1 L
pos,tio.,,, (bt:1LA.,,,ce sheet) .
• repayment of loans.
All these transactions will be recorded in a cash book, which is
summarised at the end of each financial year In the form of a
receipts and payments account.
/ ILLUSTRATION 1 A receipts and payments account
Here is a typical receipts and payments account, which will be shol'm to members and which will help
them understand why the club's cash funds have decreased during the year by $455.
Notes:
THE RIVERFORD COMMUNITY CLU B
Receipts and p ayments account
for t he year ended 3 1 December 2018
RECEIPTS
Opening balance of cash in
hand and cash at bank
Members' subscriptions
Sales of refreshments
Donation from local
business
Loan from member
PAYMENTS
$
1 420
Hire of ccmmunity hall
880
2 750
445
Refreshment cosis
332
Guest speakers' fees
660
Interest on loan from
member
36
Purchase of equipment
2 200
Club secretary·s expenses
142
Closing balances of cash
in hand and cash at bank
965
5 215
$
200
400
5 215
1. The account is set out
using a very simple
format so that members
can easily understand
the contents.
2. Some treasurers may
prefer to use a vertical
style of presentation.
3. The opening and closing
balances shown In a
receipts and payments
account are the
combined balances of
cash in hand and at
bank as recorded In the
treasurer's cash book tor
the period.
KEY TERM
Receipts and payments
account: a summary of a
club's cash book. It Is designed
to help members understand
how and why the club's cash
resources have changed ourlng
a financial period.
, SUMMARY QUESTIONS
1. What is the difference between capital expenditure and
revenue expenditure?
2. What is the purpose of a receipts and payments account?
3. identify three typical receipts for a social club.
Practice exam questions
Paper1
1 Which of the following should be shown In the
income statement of a limited liability company?
A
debemure Interest
C general reserve
B dividends
lhe income aPd expenditure account of a
cc-operative .society?
D share premium
A annual general meeting costs
2 \1\/hiC'l of the fellowing should be shown in the
appropriation account of a Ilmlted company?
A auditors' remunerallcn
B debenture interest
B dividends paid
C secretary's honorarium
D 1ransfer to an education fund
6 \/Vhich o' the following Items should be treated
C diree10rs' remunera1ion
D proposed dividends
3 A limited company r as an authorised capital of
500 000 ordlnc1ry snares of 50c each, of wnich
400 000 have been issued. The directors are
proposing 1o pay a 20% dMdend. The 1o1al
proposed dividend is:
A $40 000
B $50 000
C $80000
5 \1\/hich o' tne 'ollowlng shovld be Included In
as oaprtal expendih,re in the accounts of a
spcnsclob?
A coach nire for away matches
B purchase of sports equipment
C re" t of clubhouse
D secretary's admlnis:ratlon expenses
D $100000
4 Tne excess of income over expenditure in 1ne
accounts o' a cc-operative is called:
a deficit
C a proftt
A
B a less
D a surplus
Paper2
1 Preparing an income stat ement and an
appropriation account
On 31 December 2019 the following Information
was extracted from the books o'. Glenroy Ud:
Administration expenses
Aud tors' remuneration
Cost o' sales
Debenture interest
Depreciahon of non-current assets
Directors' fees and salaries
Proposed dividends ior 2019:
Ordinary shares
Preference st>ares
Retained profits at 1 January 2019
$000
32
21
979
25
112
84
215
60
258
Revenue
Se I ng a~d distribution expenses
Transfer to be made 10 general reseNe
1 717
44
100
Prepare:
a an income statement for the year ended
31 December 2019
b an appropriation accqunt for tne year ended
31 December 2019.
2 Preparing financial st atements
for a co-operative
The Verve\ Retail Co-operative Society's financial
year ended on 31 August 2019. On that date the
following trial balance was extracted from the
society's books.
Accounts payable
Accounts rece vab!e
Cash at bank
Delivery vell,cle:
Dr
Cr
$
$
4 320
830
9 480
19 500
CoSl
Provis on for depreciation
1 September 2018
Education <eserve
General expenses
Honoraria paid
Insurance
Inventory at 1 September
2018
Investment nterest
Investments (long-term)
Members' annual fees
Purchases
3 900
8 450
3 470
• Deprecia1icn should be provided on tne delivery
vehicle at 20% per annum using the reducingbalance melr od, and 10% per a,,num on shop
furniture and fittings using the slralght-li0e
me1hod,
• 20% of the surplus ior the year should be
1ransferred to the ste1utory reserve.
• 10% of the surplus for the year should be
1ransferred to the education reserve.
• It has been agreed to pay members a dividend
5000
1 190
of 5% of 1he amount invested in sl"ares. The
dividend will be paid in December 2018.
Prepare:
6 280
1 600
a an income and expenditure account for the
6 730
b an appropriation account for 1he year ended
45000
31 240
Revenue
89 580
Share capr.al
25000
Shop nrnnure and equipment:
Cost
14 500
Provision for depreciation
1 September 2018
2 900
Shop rent
8800
Statutory reserve
16 900
Undlstnbuted surplus at
1 Seoternber 2018
5 440
U1ilities
2 230
Wages
17 300
164 820 164 820
Addttional information at 31 Aug1,st 2019:
• The inventory of unsold goods was valued at
$8 350.
• Wages due but unpaid totalled $450.
• Members' annual fees received in advance
totalled $320.
year ended 31 August 2019
31 August 2019
e a statement of financlal position (balance
snee1) at 31 August 2019.
3 Preparing a non-profit organisation's
receipts and payments account
The treasurer o' the CapeView Sports Club has
provided the following details about the club's
receipts and payments for the year ended
30 September 2019.
The club had a balance of cash at bark of
$3 120 on 1 October 2018. During the year
ended 30 September 2019 subscriptions
received from members totalled $22 450,
cornpetttion recelpls totalled $4 190 and a
donation of $5 000 was received from a local
business. The treasurer paid administra11on
expenses of $6 400, rent of the club's sports
ground $8 300, purchase of new sports
equipment $14 500 and wages of grounds staff
$6 650.
Prepare the receipts and payments acoount for
1he year ended 30 Sep:ember 2019 to show the
closing balatJce a1 bank.
•
Accounts of manufacturers
Introduction
Manufacturers proouce goods for resale rather than purchasing
them. It is important, therefore, to calculate how much is spent on
the manufacturing process. In order to do this an additional financial
statement called a manufacturing account is prepared.
The following costs are relevant when calculating production costs:
LEARNING OUTCOMES
n this unit you wlll learn about:
• direct and lnoirect cos1s
• preparing a manufacturing
account
• Raw materials
• Labour costs, i.e. payments to those who are engaged in making
the product, perhaps using tools, machinery or other Items of
equipment to do so
• Factory cost/manufacturing overhead, i.e. the cost of operating
a workshop. proouctlon area or perhaps a factory building, that
would include:
• electricity (to provide light and power for the machinery and
equipment)
• insurance (e.g. for the machinery)
• depreciation of the machinery and equipment
• rent of the production area {assuming it is not owned by the
business).
All these costs added together make it possible to calculate total
production costs or total manufacturing costs.
Direct and indirect cos\ts
A manufacturing account Is used to show the total cost of producing
goods during a financial year. The account lists the costs that can be
associated with the production area, which could be anything from a
small workshop to a large factory. In a simple manufacturing account
the costs are organiseo Into two groups:
• Direct costs: These are the costs incurred In manufacturing that
can be associated with an individual product: raw materials and
wages paid. These two Cirect costs are the first to be shown In
the manufacturing account and are subtotalled to show a figure
called the prime cost. The term 'direct' Is used because it ls
known exactly how much should be spent on making one unit of
production. The direct cost of materials is based on purchases
of raw materials, with adjustments made for opening and closing
inventories of raw materials, to give a figure called the cost of raw
materials consumed.
KEY TERMS
Direct costs: manutactunng
costs that are attributable to
a single product, particularly
olrect materials and direct
labour.
Prime cost: the total of direct
costs.
Cost of raw materials
consumed: the direct cost of
raw materials used curing a
financial year.
Indirect costs: manutacturing
costs that cannot be attributed
to one product. lnoirect
manufacturing costs are also
referred to as manufacturing
overheact, factory overhead,
factory burden or burden.
EXAM TIP
1"'-oli.,-ect costs snoulol
0 "'-L/::1 i.""cluole costs
that Cl Ye to olo witl-1
'."'Cl "'-"'-f&1ctuYi"'9. It i.s
'""''P0 rta""t tl1t1t ti-le costs
of Cloimi~tyati,0 .,,
di.s~Yibuti"'-0 goool~,
seU,"'0 goools Cl V\-ol
&1""1::J fi-"';ii=iaL cnayges
&!Ye "'-Ot ' ""Cludeol '"'-
tnis c iiteg 0 ,-1::1 · No""v,,ca.,,ufiictuyi.,_g costs
snoulol co.,,ti""ue to
appea Y i."" tne •=o""-t
stiite""-t""t.
• Indirect costs: These are the other costs linked to the
manufacturing process. i.e. the costs of operating the production
area, which may be a workshop or factory. Indirect costs include
all the costs arising from having machinery and equipment, as
well as electricity, insurance, rent, etc. regardless of the quantity
of goods produced. Also included In this category would be
wages or salaries (indirect labour) paid to staff who are not directly
involved in production, e.g. supeNisors and factory managers. The
term 'indirect' Is used because It would not be possible to know
exactly how much of any of these costs could be identified with
the production of one unit. Indirect costs are shown as the second
section in a manufacturing account, and the costs are subtotalled
to give a figure for total indirect costs.
I
/ ILLUSTRATION 1 Preparing a manU:acturing account
Decibels Lto manufacture steel drums. Here is the company's
manufacturing account for the year ended 30 September 2019.
DECIBELS LTD
Manufacturing account for the year ended
30 September 2019
$
EXAM TIP
Raw materials:
Opening inventory
Add purchases
MA~otk~
A()O()l,(...,t,
.stet:io"-&
It is iv,,cporta~ to
cLeii YLt, snow'"" tne
"""'-f
"'-Cl
Cl cturi"'-0
CICCO<A.""t:
• cost of YClW miite,-iaLs
COV1,S<A.V><.e&(
• pYime cost
· facto,-1::1 ove,-1,,eaols
• cost of pYooluctio""·
Less closing inventory
Cost of raw materials consumed
Direct wages
Prime cost
Factcry overheads:
Depreciation of machinery
Electricity
Insurance
Indirect wages and salaries
Rent
Repairs to machinery
$
36400
342 000
378 400
!31 200)
347 200
202 000
549 200
30000
17 800
6400
47 800
25000
1 800
Cost of production
128 800
678 000
SUMMARY QUESTIONS
1. What is the purpose of a manufacturing account?
2. Explain the difference between a oirecl cost and an Indirect
cost. Give two examples 01 each type of cost relevant to the
manufacturer of sportswear.
3. A manufacturer's costs for a year include raw materials
$70 000, direct labour $90 000 and indirect manufacturing
costs of $50 000. Calculate the prime cost for the year ano
the total cost of production.
More about manufacturing
accounts
Work in progress
LEARNING OUTCOMES
It is very unlikely that all products will be finished at the moment when
the end of year financial statements are prepared. On the production
line there will be some items at different stages of production, some
nearly finished. others In the early stages of production. The cost 01
unfinished goods is called work in progress.
An opening inventory of wor1< I!, progress should be added to the
cost of production, as these items will have been completed ouring
the year under review.
The closing inventory of work In progress is deducted from the
cost of production for the year; ensuring that the cost of production
represents only amounts spentt on goods actually finished during that
year.
Adju stments and the end of year financial
statements
It will be necessary to make adjustments for prepayments, accruals.
etc., when preparing a manufacturer's end of year financial
slatements. II will also be necessary to share certain costs between
the different sections of the business. For example, a manufacturer
could pay rent for all the premises (factory and offices) occupied
by the business. It would then be necessary to charge part of the
total rent to the factory and part to the offices of the business. As
a result an appropriate amount of rent would be charged to the
manufacturing account and the remainder to the Income statement.
Calculating the cost of a unit of production
In order to calculate the cost of producing one unit, it is necessary
to divide the total cost of production by the number of units
manufactured during the financial year, I.e.
Cost of production
Number of units manufactured
This information Is 01 great importance In assessing the pertormance
of the business and in helping with decision-making. For example,
the cost of making one unit will Influence the selling price of the
product.
In this unit you wlll leam about:
• worK in progress and
how it is recorded In a
manufacturing account
• how to make adjustments,
Including the sharing o' costs
between different sections o'
a manufacturing business
• how to calculate the cost of
producing one unit.
EXAM TIP
f l::fO« Qre trl::Ji"-0 to
1
;el¾elMbev now to tYecit
u,..,ve11.torif!; &f work """
progyess, betlr iv. ...,i""d
t ncit t het:J ci re tvecited ;,.,,, t he
~Q"1,\,e WCI!::' CIS Ci""l::J otlotey
•v..ve""tones. '"" otviev woyds
~he ope.,,,£"'-0 '"'-Vevstor1::1
•s cidded to the costs Qi,cd
the ctosi"'-0 iv..ve.,,,tor1:1 is
deducted fro1M the costs.
" ILLUSTRATION 1 Recording work in progress, making adjustments. and calculating unit cost
Whitewater Ltd manufactures surf coards of one type.
On 30 June 2019, the following information was available:
$
Cost of raw materials consumed
Depreciation of machinery
Direct wages
Indirect wages and salaries
Insurance of factory
Rent
Work in progress:
1 July 2018
30June 2019
156000
20000
110000
32500
8500
12 000
5100
7600
Additional Information at 30 June 2019:
• Direct wages due but unpaid totalled S9 000.
• Rent is to be shared: three-fifths to the factory,
two-fifths to administration.
• Insurance $1 700 was prepaid.
The company made 600 surfboards during the year.
Here is the manufacturing account based on this information:
WHITEWATER LTD
M anufacturing account f or the year
ended 30 June 2019
$
Cost of raw materials consumed
Direct wages ($100 000 + S9 000 due)
Primeco:.t
$
156000
119000
275 000
Factory overneads:
Deprecia11on of machinety
20000
Indirect wages and salaries
32500
Insurance ($8 500 - $1 700 prepaid) 6800
Rent (~ x $12 000)
7200
Add opening work in progress
Less closing work in progress
Cost of production
The cost of making one surfboard was:
Cost of production
Number of surfboards manufactured
66500
341 500
5 100
346600
(7 600)
339 000
I.e.
$339 300
= $565 per surfboard
600
Note: Rent of S4 800 (~ of $12 000)
should be charged to the company's
Income statement.
SUMMARY QUESTIONS
1. A business has total manufacturing costs of $750 000, an opening Inventory ot work in progress of
$1o ooo and a closing inventory of work in progress of $25 000. What ls its cost of production?
2. A business has paid $24 000 for Insurance tor the year 2018. Two-thirds of the insurance relates to
the factory and one-thlro' relates to administration. How much insurance should be charged to the
manuiacturlng account and how much should be charged to the Income statement?
3. A manufacturer of a favourite b rand of confectionery made 30 000 bars of a particular proCiuct
during one year. The cost of producing this product was $22 500, How much did it cost to produce
one bar?
The income statement
and statement of financial
position (balance sheet}
Income statement of a manufacturing company
Just like any other business, a manufacturer's income statement
Is designed to show the gross profit on selling goods (i.e. finished
goods) and the profit or loss for the year.
ILLUSTRATION 1 Preparing a manufacturer's income statement
Here Is an Income statement for Whitewater Ltd
(see also Illustration 1 In Unit 10.2):
LEARNING OUTCOMES
rn this unit you will learn about:
• preparing 'inal accounts for
a manufacturing concern:
Income statement and
statement o1 ' inancial
position.
WHIT'EWATER LTD
Income statement for the year ended 30 June 2019
$
Revenue
Less cost ol sales of finished goods:
Opening inventory of finished goods
Add cost of production
625000
17 200
339 000
356 200
Less closing lnvertory of finished goods (14 400)
Cost of sales of finished goods
Gross profit
Less expenses:
Depreciation o' office equipment
5 500
Flnance charges
3 200
Office wages
32900
4800
Insurance (1/s of $12 000)
Selling expenses
11 400
Profit for the year
$
(341 800)
283 200
(57 800)
225 400
Notes:
1. The first part of the income statement will include the cost of
production and this will replace the item ·purchases'. All the
Information In this section of the income statement will be
about finished gooo·s.
2. The second part of a manufacturer's income statement will
show the deduction of non-factory costs from the gross profit,
I.e. aominlstratlon, distribution, finance and selling costs.
Statement of financ ial position (balance sheet)
of a manufacturing company
The statement of financial position {balance sheet} of a manufacturer
closely resembles those for other types of business. There Is Just
one major point of difference: a manufacturer's statement of financial
position (balance sheet} is likely to show three figures for inventories:
raw materials, work ln progress and finished goods.
1. State the key difference In
the way a manufacturer's
gross profit is calculated
compared to that 01 a retail
organisation.
2. How does a manu'acturer's
current assets differ from
that of a retail organisation?
Worked example:
manufacturing accounts
The question
Island Desks Ltd is a small manufaC1uring company that makes one
type of office desk. At the end of the accounting year, 31 March
2019, the following information was available:
$
Administrative experises
Carriage on raw materials
Direct factory wages
Factory machinery at cos1
Factory malnlenance costs
Fac1ory power
Indirect factory wages and salaries
lnsurar1oe
Inventories, 1 April 2018:
Finished goods
Raw materials
Work In progress
Inventories, 31 March 2019:
Finished goods
Raw materials
Work in progress
Purchases of raw ma1eriats
Rent
Relurns outwards
Revenue
Selling expenses
Additional information:
11 200
4 100
85 400
250000
6800
14 300
63500
17 100
• Machinery should be depreciated by 20% per
annum on cost.
13 300
6900
• During the year 1 481 office desks were
completeo.
1 700
Prepare:
11 200
7 400
1 300
186 000
30000
1 400
724 000
4 900
• Direct factory wages in arrears $3 100 at
31 lvlarch 2019.
• Rent is oivlded in the ratio 2:1 between the factory
and the office.
• Insurance is divided in the ratio 3: 1 between the
factory and the office. Insurance was prepaid by
$300 at 31 March 2019.
• A manufaC1uring account for the year ended
31 lvlarch 2019, showing clearly the following:
(i) the cost of raw materials consumed, (ii) prime
cost, (ill) total factory overheads, (iv) cost of
production.
• An income statement for the year ended
31 March 2019.
• A calculation of the cost of producing one office
desk.
Getting started
One of the main tests in questions on manufacturing businesses
Is being able to select the right information for each element of
the financial statements required . So it is wise to start by working
through the information supplied and Identifying how each Item will
be used - perhaps pencilling in 'M' for manufacturing, 'I' for income
statement. You might wish to go even further and, for the items
marked lv1. indicate whether the item will appear in the direct costs
section {MD), or the indirect costs section {Ml). (In this case work In
progress can just be left marked up as M).
Of course, the value of the machinery will be shown in the statement
of financlal position {balance sheet), the figure is given in the question
to enable you to calculate the depreciation charge for the year.
For Income statement Items, it could be useful to mark up those
appearing in the first section {leading to the gross profit) as IF (where
F stands for first) and those appearing in the second section (leading
to the profit or loss for year) as IS (where S stands for second
section).
These indications are shown below - of course, you can use any
abbreviations you like. In this question there is more Information than
usual aboul raw materials. Did you notice that there was carriage on
raw materials and returns outwards as well as the inventories ano
purchases?
$
Identifying which
financial statement
Simple
version
More detailed
version
EXAM TIP
'."""""M.'fcl~ AOCOl,t~
~tt-
lt i.s iv,,:porti:r >'Ct
to Yt"'-tmbeY ti1At
i.te1M.S sl-iow,,._, i,,._, tne
""-A "'-Uf .r Ct«. n"'-0 ACC OU >'Ct
m1<.st be to do witi,, t'1e
l¾AV1,uf.rct1,<n"'0 J'YOC!SS,
so tne1:1 .rye ci Lwi:r us
fcictoyi:'.J costs. A"'-1:1 item
t~At is "'-Ot Afi:rctori:, cost
WLLL cippe.ry i.,, tn e otney
fi. v,,i:r "'-Ci Cl L s ti:rte V\,\,el'l.ts .
Administrative expenses
11 200
I
IS
Carriage on raw materials
4 100
M
MD
Direct factory wages
85 '1.00
M
MD
Factory machinery at cost
250000
Factory maintenance costs
6800
M
Ml
1111.00t'Kl ~~ £tt-
Factory power
14 300
M
Ml
Indirect factory wages and
salaries
63500
M
Ml
Insurance
17 100
MIi
Ml and IS
Finished goods
13 300
I
IF
Raw materials
6900
M
MD
Work in progress
1 700
M
M
Finished goods
11 200
I
IF
Raw materials
7 .6.00
M
MD
\l\lork in progress
1 300
M
M
Purchases of raw materials
186000
M
MD
Rent
30000
MIi
Ml and IS
Returns outwards
1 400
M
MD
724 000
I
IF
:,ne fi,Yst pci rt of tl-ie
LV\.COV\,\,e StAte"1,tV\,t is
cov,,ceY,,,,ed wit'1 fi.v,,di..,,g
tl-ie g YOSS J>Yofi.t OV\, seLLi"'-0
goods . It is LV\,\,porti:r.,,t to
; emeV\,\,bey tl-ii:rt 1::JO"- ""eed to
Lv.clude Q ""1:1 i"'-fDYv>A.CltioV\,
i:r bo1<.t fi.,,._,isl-ied goods
1-ieYe (i..e. '""ve"'-tones,
cost of J>Yod'<ctio"" Clv,,d
Yevev.1<.e) . The secov,,d pcirt
?f t'1e ,.,,come sti:rtev,,cev,,t
LS CO"'-CeY"'-!d wi.tn
decl«.cti"'-0 i:r""!j otney
""D"'--fA;-toYtJ expevsses of
t'1e b:,<5.'"'-'SS: ti:,pice1LL!j
Q d l¾L>'\.LStYAtLOV\./offi.ce
costs, fi.,v,,.r"'-ce cl-ii:r yges,
""'-&IY~th "'-0 i:r .,,_c4 seLLi"'-0
costs.
4900
I
IS
EXAM TIP
Inventories. 1 April 2018:
Inventories, 31 March 2019:
Revenue
Selling expenses
It is also necessary to calculate the effect of the adjustments shovvn
as additional information in the question. Here are the workings:
• Machinery depreciation (a factory indirect cost) is 20% >< machinery
costs $250 000 = S50 000.
EXAM TIP
II\.VeMO~
[.,(.~e,, J>Yessure i.t i.s
tCiSl:J to l¾tX IA.j> DJ>t"-i"'-g
~ "'-i;;( closi.a,cg -fi,gures foy
OY1,\/tV\.tori.es, so &1LWC11:JS
cneck tn&1t 1:Jou ni:ive
selectei;;! the coyyect i.te""" &It
ti,,e COYYect l¾Ol¾tl'\.t
• Direct factory wages (a factory direct cost) are given as $85 400,
but it is necessary to add the accrual of S3 100 "' $88 500.
• Rent of $30 000 Is to be shared between the factory and the office
In the ratio 2: 1 - so rent $20 ooo should be charged to the factory
(manufacturing indirect cost) and $1O 000 to the office (income
statement).
• Insurance of $17 1oo Is also to be shared betv1een the factory
and the offiee In the ratio 3: 1, bu1 first It Is necessary to deduct
the prepayment of $300. Insurance $16 800 {$17 100 - $300)
is therefore to be shared $12 600 to the factory (manufacturing
lnCirect cost) and $4 200 to the office (Income statement).
The answer
Preparing the manufacturing account
EXAM TIP
Having worked 01.11 which items are required and the adjustments to
certain items, it is possible to proouce the manufacturing account.
It Is Important to remember that labels for various subtotals are
required and should always be shown In a manufacturing account as
part of producing a well-presented answer.
Rletot'}j O\ler+leads
A co""'-..,,.,o"'- ..,,.,i.sta ke
is to dei;;luct fi:ictor-1:J
?VtYne&1ds fr-o""" pri...,,.,e cost
""" tl-ie V\,\,&1V1.1<fiicturL"'-tl
i:iccou.,,.,t. I:>o ""Dt for-get
tncit, ;,.,,_, ge"'-tY&1L, ti,,e
ISLAND DESKS LTD
M anufacturing account for the year ended 31 March 2019
$
Opening invemory of raw materials
Add: purchases
Carriage on raw materials
f
'.""&I "-'." Cl Ct L< Yi "'-g Cl CCOIA. l'\.t
•s " lLSt of fcictor-1:J costs
&1Ll of wni.cn "'-ttd to be
&1di:;led togetneY.
Returns outwards
Less closing inventory of raw
materials
Cost of raw materials consumed
Direct wages
Prime cost
Factory overheads:
Maintenance costs
Power
Indirect wages and salaries
Insurance
Rent
Depreciai ion of machinery
Adjustment for work in progress:
Add opening Inventory
Less closing inventory
Cost of production
s
$
6900
186 000
4 100
190 100
(1 "00)
188 700
195 600
(7 400)
188 200
88500
276 700
6800
14 300
63500
12 600
20000
50000
1 700
(1 300)
167 200
443900
400
444 300
Preparing the income statement
ISLAND DESKS LTD
Income statement for the year ended 31 March 2019
$
Revenue
Le&> cost of sales:
s
724 000
Opening Inventory of finished goods
Cost of production
13300
444 300
Closing inventory of finished goods
457 600
(11 200)
Cost of sales
Gross profit
(446400)
277 600
Less: administrative expenses
Insurance
Rent
Selling expenses
11 200
4 200
10000
4 900
(30300)
247 300
Profi1 for the year
Cost of production of one office desk
The total cost of production Is $444 300 and 1 481 office desks were
produced. So the cost of one oftice desk Is:
$444 300 = $300
1 481
Basic costing procedures
LEARNING OUTCOMES
In this unit you will learn about:
• the basic costing principles
o: cost-plus (mark-up) pricing
and absorption costing.
Cost-plus pri cing
Deciding on the right selling price for a product is Important to the
success of any business. The selling price must:
• ensure that costs are covered
• provide the business with a good return on investment
• ensure that the business remains competitive.
The selling price can be based on the cost of making one product
(see Unit 10 .2) plus a percentage of the cost. This is referred to as
cost-plus pricing or mark-up pricing.
r ILLUSTRATION 1 Calculating the selling prlce of a single product
Miguel manufacturers a computer keyboard. The cost of making
one unit Is as follows:
$
Direct materials
Direct l1;1bour
Indirect costs/factory overhead
Total cost
24
33
11
68
Miguel uses cost-plus pricing and adds 50% of the cost to
calculate a selling price. The selling price will be:
$
Cost of one unit
Profit (50% of cost
= 50% X $68)
Selling price
68
34
102
Absorption costing
Some manufacturers use a technique called absorption costing to
calculate the lnoirect cost of maklng a product. The technique is
useful where the manufacturing process Is quite complicated, with
several different processes required, carried out in a number oi
departments (sometimes callee cost centres}.
The technique requires a number of steps. In the following example.
assume the costs given are for a year.
Example
Machining
department
Finishing
department
$
$
38000
32000
Examples:
Rent $33 000 divided on the basis of ffoor area in the ratio 2: 1
22000
11 000
Depreciation of machinery $32 000 divided on the basis of the cost
of machines in each department in the ratio 3:1
24 000
8000
Step 4
Total all the indirect oosts
84 000
51 000
Step s
Calculate the absorption rate
Step 1
Step2
Set up a table with a oolumn for each department
Allocate costs
Record any indirect costs that can be easily attributed to a particular
department (e.g. the depariment manager's salary).
Step3
Apportion oosts
Divide any indirect costs that apply to the business as a whole on
some rational basis between the departments.
Divide the total indirect costs by the number of labour hours or
machine hours available in the department. The choice depends on
which is the more dominant factor in tne department.
Example:
The machining d epartment is machine Intensive and has 21 000
machine hours available each year,
$4 per
machine
hour
The finisning department is labour inlensive and has 17 000 labour
hours available each year.
/
ILLUSTRATION 2
Calculating a selling price using absorption
costing
The following iniormation is available for the product of a business:
Materials
Direct labour:
Machining departmem
Finishing department
Machine hours:
Machining departmem
Finishing department
$3 per
labour hour
KEY TERMS
Cost centre: part of a
business to wnich costs can be
allocated and apportiored.
4 kg at $3 per kg
Allocated: where an entire
3 hrs at $9 per hour
4 hrs at $9 per hour
cost is charged to a cost
centre.
Apportioned: where indirect
5 hours
1 hour
oos,s are divided between cost
cen1res in a ratjcnal manner.
The business uses cost-plus pricing. The selling price of a product
Is based on cost + 25% mark-up.
Using the absorption rates arrived at In Step 5 of the previous
example, the calculation of the selling price is as follows:
(Continued)
ILLUSTRATION 2
Calculating a selling price using absorption
costing (Continued)
s
Materials
Direct labour:
Machining department
Finishing department
Indirect costs:
Machining department
Finishing department
4 kg at S3 per kg
12.00
3 hrs at S9 per hour
4 nrs at $9 per nour
27.00
36.00
5 hours >< S4 per machine
hour
4 hours >< S3 per labour
hour
Total COS!
Add profit (25% x cost =25% x $107)
Selling price
2000
12.00
107.00
2675
133.75
Note:
The calculation of indirect costs needs special care. In the
Illustration the machining department hours are used because
this department absorbs costs using an absorption rate per
machine hour: the finishing department labour hours are used
because this department absorbs costs using an absorption rate
per labour hour.
.,
SUMMARY QUESTIONS
1. What method is used to establish the selling price if a
business uses cost-plus pricing?
2. What Is the difference between allocating an inoirect cost and
apportioning an indirect cost?
3. How is an Indirect cost absorption rate calculateo?
Worked example:
costing procedures
The question
Sherry owns a business which makes cakes for celebrations.
She uses absorption costing. The business has two cost centres:
preparation department and baking department. Some indirect costs
have been allocated to each department as follows:
Monthly indirect cost
Preparation
department
s
Baking
department
$
800
2 200
3000
2500
Depreciation o' eqvloment
Supervisor's salary
Some other indirect costs apply to the business as a whole and are
to be apportioned:
M onthlv indirect cost
$
Annortionment basis
Insurance of equipment
Rent of premises
Electricity charges
450
2 700
700
Cost of equipment (S)
Floor soace (sn ml
Power (kilowatt hours)
The following data has been provided abou1the business:
Equipment cost
Rent of premises
Power (kilowatt hours)
Preparation
denartment
Baking
deoartment
$10000
800sa m
500
$140000
400 sn m
3000
(a) Prepare a table to show total inoirec t costs allocated and
apportioned to each of the departments.
(b) The following data Is available abou1 labour hours and machine
hours:
Prenaration deoanment
Bakina department
Labour hours
per month
M achine hours
per month
600
400
300
1 500
Calculate absorption rates tor each department.
(c) n July 2020 Sherry received an order from a local chain of shops
for celebration cakes. The following details are available about
this order:
Direct materials
Direct labour
Machine hours
Ingredients for cakes
12 nO\Jrs in preparation department
5 hours in baking department
3 hours in preparation department
11 hours in baking department
$950
Labour is paid $16 per hour
Sherry's policy is to apply a mark-up of 50% to all orders
Calculate the charge tor the Job.
Getting started
There is a lot of detail here to understand, so, as always, do take
your time to read through all the information. Fortunately, the ouestion
as a whole is made a little easier as it is broken up into stages. Do
highlight any points you think are particularly important. There Is a lot
ot calculating to do, so do double-check each calculation as you go
along to ensure you are using accurate information In the final stages
of the question.
The answer
Step 1
Answering task (a) requires a table to be set up to show each of the
indirect costs and details of the apportionment of Insurance. rent and
electricity charges.
Here is a suitable table before the figures have been Included:
Apportionment method
Preparation department
Baking department
$
$
Allocated costs:
Depreciation of equipment
Supervisor's salary
Apportioned costs:
Insurance of equipment
Rent of premises
Elec!ricity charges
Equipment cosl
Floor area
Kilowatt nours
Total Indirect costs
And here is the completed table:
Apportionment method
Preparation department
Baking department
$
$
800
2 200
3000
2500
30
1 800
100
4930
420
900
600
7 420
Allocated costs:
Depreciation of equipment
Supervisor's salary
Apportioned costs:
Insurance of equipment
Rent of premises
Electricity charges
Total Indirect costs
Equipment cost
Floor area
Kilowatt hours
Calculation details (ior the apportionment of costs):
Ratio to be used
Preparation department
Baking department
Rent of premises Total floor space
$2 700
800 + 400 = 1 200sq m
10 000/150 000
i.e. 1/ 15 x $450 = S30
800/1 200
i.e. 2/3 X $2 700 = $1 800
Electricity
charges S700
500/3 500
i.e. 1/7 X $700 = $100
140 000/150 000
i.e. 14/15 X $450 = $420
400/ 1 200
i.e 1/3 x S2 700 = S900
3 000/3 500
i.e. 6n x s100 = $600
Equipment
Insurance $450
Total ccst of equipment
$10 000 + $140 000 = $150 000
Total kilowatt hours
500 + 3000 = 3 500
Step 2
Answering task (b) requires the calculation of absorption rates.
The process involves deciding the most Important factor in each
department: labour hours or machine hours. It is important to
correctly label each absorption rate and it is usual to work to two
decimal places (unless you are told to do otherwise).
Preparation department: labour hours Is the most important factor.
DID YOU KNOW?
It Is always advisable to show
detailed calculations so that
at least some marks can be
scoreo for the process even if
the final result is Incorrect.
Absorption rate is: total Indirect costs/labour hours, i.e. $4 930/600 =
$8.22 per labour hour.
Baking department: machine hours is the most Important factor.
Absorption rate is: total Indirect costs/machine hours, i.e.
$7 420/ 1 500 = S4 .95 per machine hour.
Step 3
It Is now possible to move on to the final task (c}. This is the most
Interesting part of the question because it requires you to use all your
calculations and work out how much to charge a customer. All the
hard work will mean that the business will be able to ensure that the
customer pays tor the materials and labour involved in the order, plus
pay a fair share of all the Indirect costs of running the business. plus
make a profit for Sherry.
The calculation should be set out in detail as follows:
$
Direct materials: ingredients for cakes
Direct labour: 17 nours x S16 per hour
Overheads/indirect costs:
Preparation department: 12 hours x absorption rate
S8.22 per labour hour
Baking department: 11 hours x absorption rate $4.95
per machine hour
Total cost of order
Mark-up: 50% of cost (50% x $1 375.09)
950.00
272.00
54.45
1 375.09
687.55
Total charge to customer
2 062.64
9664
DID YOU KNOW?
tt Is best to set out a 'ormal
statement to show the price to
be charged for an order. Marks
will be available for each step In
the calculation, so avoid cutting
corners.
Inventory valuation
LEARNING OUTCOMES
n this unit you will learn about:
• methods of inventory
valuation
• how to calculate the value of
closing inventory using either
FIFO, uFO or AVCO.
There can be a problem valuing inventories when the unit price of
Items has changed during the financial period under review due to
inflation or deflation. To resolve this problem assumptions are made
about the Items In stock as in Illustration 1.
Note: Because one period's closing inventory becomes the next
period's opening inventory, the effect on profit of these different
valuations Is evened out over several financial periods.
I
ILLUSTRATION 1 Using the three methods of inventory valuation
The FIFO (first in fir st out) and LI FO (last in first out) methods
Date
May
Inventory IN
Inventory OUT
FIFO Unsold Inventory
LIFO Unsold Inventory
10@$15
3@$15
3@$15
10@ $17
6@$17
10@$15
3@$15
3@$15
10@$17
3@$15
3@$17
= $96
10@$15
5
7@$24
11
17
10@$17
7 @$24
24
= $102
• FIFO valuation is based on the most recent prices and gives a l1igher valuation of Inventory (when
prices are Increasing).
• LIFO valuation tenCis to value inventory on older prlces and this gives a lower valuation {when prices
are increasing).
The AVCO (weighted average cost) method
Inventory IN
Date
May
Inventory OUT Unsold Inventory Calculation of
average cost
10@$15
5
7@$24
11
17
10@$17
10@$15
3@$15
3@$15
10@$17
$15
$15
3@$15 = $45
10@ $17 = $170
So average cost ls
$215 + 13 = $16.54
7@$24
24
6@$16.54
Value of inventory
$150
$45
$215
$99.24
• The AVCO method is more complicated to use because II is necessary to recalculate the average
cost after each movement of Inventory. {Calculations have been made to two decimal places.)
SUMMARY QUESTIONS
1. How does the FIFO method of inventory valuation differ from the LIFO method of inventory valuation?
2. A business had 50 unsold units, which cost S1 o each, and it has Just purchased 30 units at $11
each. What Is 1he (weighted) average cost of one unit {wor1<1ng to two decimal places)?
.
·,.178
.
I
.
Practice exam questions
Paper1
1 Which of the following Is required v.,t,en
calculati'lg prime cost?
4 A rnanufactvring account lnoli,cJes direct costs
of $70 000 and factory ovel'l'eads of $20 000.
During 1he year work in prqgress Increased
In valve by S10 000. The number of Items
completed during the year was 1O000. The
cos, of producing or,e Item was:
A depreciation of factory macninery
B factory rent
C raw materials purchased
D work ln progress
2 Which of the fOllowing 'actory costs would not
be affected by tne number of products made?
A carriage lrwards on raw materials
B manager's salary
C power to rvn machinery
D wages of machine operators
3 A manufacturer's costs lnck,de the following:
direct wages $50 000. machinery repairs
$30 000, o,ice satanes $20 000, factory rent
S"-0 000. Faciory overheads total:
$140000
C $90 000
A
B $110000
A $4
B $6
C $8
D $10
5 The owner of a business values inventory using
the FIFO method. At 1he beginrir,g of a period,
the lnve11tory consisted of five lter1s valued at
$9 each. During 1he period nine items were
purchased for S10 each and seven rtems were
sold for $18 each. What was the value of the
inventory at the er d cf ,he period usii,g tne FIFO
me1hod of valua!ion?
A $27
C $63
B $30
D $70
D $70 000
Paper2
1 Preparing financial statements
Island Productions ltd manufactvres sets of
o..rtdoor rurni:ure. The following information is
available for the yP..ar ended 31 December 2018:
s
Carriage Inwards on raw ma1erlals
Deprec·at;on of faetory machinery
for 2018
Deprec;at on of office equipment tor
2018
Facto,y Insurance
Factory maintenance
Inventories 1 January 2018:
Finished goods
Raw materials
VVork ,n progress
Inventories 31 December 2018:
Finished goods
1 100
30000
6000
3 400
800
14 900
11 200
1 700
11 300
Raw rnaterla's
Work in progress
Purchases of raw materia s
Rent
Returns Inwards
Revenue
Se I ng expenses
Utilit es
Wages and salaries:
Direct factory wages
Factory supervisor's salary
Office wages and sa'aries
12800
2400
145000
22000
2200
425000
7900
14800
57300
26500
29400
Additional lnforma11on:
• Factory Insurance $300 Is prepaid at
31 December 2018.
• Rent should be shared: factory 75%, office
25%.
• Utilities is In arrears $200 at 31 December
2018. Utilities Should be shared factory 80%,
office 20%.
Overhead
S
• D.iring the year ended 31 December
2018, 580 sels of outdoor furn~ure were
manufac!I.Jred.
Prepare:
Power
charges
a a marufac1urlng account for 1he year ended
Depreciation
of machinery
31 December 2018
b an income s1atement for the year ended
31 Decembef 2018
c a calculation of the cost of production of one
set of outdoor furnrture.
Annual t otal
j.
33 000
CUtling depattmem
} finish ng
LIFO
c
AVCO.
Inventory In Inventory Out
Sept a
10@$22
12
14
21
department
&
Department
Labour
hours
available
per year
M achine
hours
available
per year
Cuttlng department
Finishing departmem
20000
40000
10000
30000
a
Calculate the tolal Indirect costs ft>r e.ich
department.
b
Calwlate the overhead absorption rate for
each department.
0'> 1 September there were five items in the
stockroom tnat had cost $20 each.
Date
¼
Addttlonal Information:
a FIFO
b
CUtllng department
finish ng
department
48 ooo
2 Calculating the value of inventory
From the Information below, calculate 1he value
of inventory at 30 September 2019 using ihe
following methods o' valJalion (working to two
decimal places rt necessary):
Apportionment
rat io
10@$24
3 Calculating price using absorption costing
QX Ltd man:tactures a variety of products. Tre
company uses absorption costing. The following
information has been provided about annual
indirect costs:
Cutting
Finishing
department department
Depa~ment
marager's sala<Y
$
$
35 000
29000
There are tv,10 other indirect costs ihat snovld be
apportioned using the ratio provided.
An order from a customer will cos1 S1 800
In direct materials, $3 100 in direct labour.
It will take 400 machine ho.irs in the cutting
departmen, and 200 labour hours in the finisning
departm~•. The company's policy Is to caloulate
selling price by adding 50% to tne cost of an
order.
c Calculate the price to be charged to the
customer for this order.
Payroll accounting
Methods of payment
The following methods can be used to pay employees and suppliers
of goods and services:
• Cheques
• Standing orders
• Cash
• Electronic fund transfers.
In addition, suppliers can often be paid via oirect debit or electronic
funds transfer at point of sale (EFTPOS).
Payroll: introduction
Payroll is the term used for the document that summarises details
LEARNING OUTCOMES
n this unit you will learn about:
• methods of payment
• voluntary and statutory
oeductlons
• the source oocuments for
payroll
• spreadsheets to arrive at net
pay amounts and deouctions
• the main accounting
software used for payroll
• calculating employees'
earnings using fixed rates.
of each employee's pay on a weekly or monthly basis. The payroll will
show the following details for an individual:
• Gross pay: pay before any deductions
KEY TERMS
• Statutory deductions: amoun ts that are legally required to be
subtracted from gross pay, tor example, income tax and national
Insurance (social security) contributions
Payroll: the O'ocument that
• Voluntary deductions: amounts that the indMdual has requested the
employer to deduct from gross pay, for example, contributions to a
trade union or contributions to credtt unions or savings schemes.
summarises details of each
employee's pay on a vveekly or
monthly basis.
Contract: legal document
setting out terms of an
employment.
Source documents for payroll
Clock card : a document that
• For fixed amount salaries/wages the employee's contract will
provide details of pay rates and voluntary deductions to which the
employee has agreed.
gives oetails of the number of
hours an employee has worked,
obtaineo by using a special
clocking in/out machine or time
recorder.
• For time rates (see details below) records of when an employee
signs in and out for work are used. sometimes In the form of a
clock card .
• Where an employee works away from the business premises a
time sheet \/o/111 provide details of the work done and the time
taken.
• A piecework ticket is used to provide details of the number of
products an employee has made. This document is used where
pay is based on the amount of work done.
Time sheet: a document that
records the hours worked by an
employee who works off site.
Piecework ticket: a document
that recoros the number of
prooucts an employee has
maoe.
Spreadsheets and software used for payroll
A payroll summarises for each employee all the key facts for the
calculation of net pay. This can be kept manually but is otten
maintained using a spreao'sheet. Here is a typical layou1 for a payroll
spreadsheet.
Employee Hourly Normal
rate
hours
Overtime
hours
Normal Overtime Gross
pay
pay
pay
Income
tax
National
Health
Net
Insurance scheme pay
X
y
%
LINK
There is more on the different
payment methods in Section 3.
Unit 3.5 (the cash book) and
Section 7, Unit 7.7 (bank
reconciliation).
Alternatively, there are soft\,vare programs that can be used for
maintaining payroll records; these lnclude Gusto. OnPay, Xero,
Sage intact, etc. These are often found to be worth the initial outlay
because they provide some very desirable advantages, such as:
• speed and accuracy
• automatic generation of payslips
• calculations of bonuses, holiday pay, etc.
• application of current tax regulations
• forecast of future staffing costs .
1. loentify three ways a
business may use 10 pay
On the other hand, like any IT system, payroll software programs can
have certain weak points, with potential for problems around such
issues as data security, loss or theft.
an employee.
2. Explain the difference
between a statutory
deduction and a voluntary
oeduction.
3, Identify tvvo sources of
Information for calculating
an emp!oyee·s pay.
4. Stale:
a. three benefits of using
a software program for
payroll
b. one disao'vantage.
5. An employee's contract
states that their annual
gross pay is $45 000. What
is this employee's monthly
salary?
Payroll calculations: fixed rates
Salaries, and some wages, are often an agreed amount for a year
with the possibility of a pay rise. Details of an Individual's salary will be
found in their personnel records, which are based on the individual's
employment contract.
I
/ ILLUSTRATION 1 Calculating gross pay using a fixed rate
Carissa is the manager of a branch oi an insurance company.
Her salary for the year ended 31 December 2018 was $44 400.
For the year ended 31 December 2019 she received a pay rise
of5%.
Carissa ·s gross monthly pay for the year ended 31 December
2018 was $44 400 .;. 12 = $3 700.
Her salary for the year ended 31 December 2019 was:
S44 400 + (5% x $44 400)
=$44 400 + S2 220 =$46 620.
Her gross monthly pay was: $46 620.;. 12 = S3 885.
More about payroll
Time rate
LEARNING OUTCOMES
Time rate is the expression used when 1/\tages are based on the
hours worked and according to an hourly rate agreed with the
employer.
In this unit you will learn about:
• calcula11ng employees'
earnings using time rates
and piece rates
• calcula11ng nel pay.
• Usually an agreed number ot hours is 1/\tOrked per week.
• 'Nhen employees work more than the agreed hours, the extra
hours worked are referred to as overtime.
• Overtime hours are paid at a higher rate than normal working
hours. The higher rate paid varies. If an employee is paid 1.5 times
the normal rate this is usually expressed as 'time and a half': if the
rate is 1.25 times the normal rate, this is expressed as 'time and
a quarter', If the rate is twice the normal rate, this is expressed as
'double time·, and so on.
/ ILLUSTRATION 1 Calculating gross pay based on time rates
Zachary works In the assembly department of a business that manufactures children's toys. Zachary Is
expected to work an eight-hour day and Is paid $24 per hour. Overtime is paid at time and a hatt.
During the week ended 6 July 2019, Zachary's time card was as follows:
MORNING
AFTERNOON
EVENING
HOURS WORKED
IN
OUT
IN
OUT
IN
OUT
Normal
Overtime
Monday
830
13.00
1330
4.30
Tuesday
830
13.00
1330
4.34
9.30
8
8
3
Wednesday
8.30
13.00
13.30
4.32
Thursday
8.30
13.00
13.30
5.30
Friday
8.30
13.00
13.30
4.30
6.30
8
8
8
1
Note:
it is usual for an employee's lunch time to be considered part of the normal working hours.
Zachary's wages for the week are calculated as follol/\1s:
• Total hours normal working: 5 x 8 = 40 hours
• Total overtime hours: 3 + 1 = 4 hours
• Pay based on normal working: 40 hours x $24 per hour = $960
• Overtime pay 4 hours x {$24 x 1.5) per hour 4 x $36 $144
=
Total gross pay: $1 104
=
=
Piece rate
Piece rate is the term used where pay is based on the amount of
work done. i.e. the number of products made or operations carried
out. The rate of pay will be per product/operation. The employee who
works faster will, therefore. be paio more than the slower worker.
Sometimes employees vvho are paid in this way are subject to:
• minimum wage agreements: where a minimum weekly gross pay is
agreed for full-time employees and Is applied where the amount of
work done is less than normally expected
• quality checks: to discourage careless work, piece rates are only
applied to work that passes a quality check.
I
,..ILLUSTRATION 2 Calculating gross pay using piece rates
Lydia works full-time In a factory. She is paid $1.20 for
each product that is accepted. She has a minimum wage
agreement, so that her gross pay must be at least $840
per week. Lydia's piecework ticket for the week ended
23 November 2019 was as follows:
Number
produced
Number
rejected
Number
accepted
Monday
130
6
124
Tuesday
144
9
135
Wednesday
158
4
154
Thursday
145
3
142
Friday
133
128
Totals
710
5
27
683
Lydia's gross pay wmbe based on the number of accepted
items. i.e. 683 x $1.20 per item = $819.60.
However, this figure Is below the minimum agreed level of
gross pay, so Lydia will be paid S840 for the week ended
23 November 2019.
SUMMARY QUESTIONS
1. Kia is paid $32 per hour for a 40-hour week. Overtime Is paid
at time and a quarter. Calculate Kla's gross pay for a week In
which she worked for 46 hours.
2. Issa is paid a piece rate of $5 per Item. During a recent week
he produced 175 Items: 11owever, 14 of these Items were not
accepted. Calculate lssa's gross pay for the week.
Calculating net pay
Statutory deductions
Note: Each Caribbean state has its own regulations regarding
statutory deductions and these are subject to change from year to
year, so the information given in the examples that follow should be
treated as a guide only.
LEARNING OUTCOMES
In this unit you will learn about:
• calcula11ng employees'
net pay.
Income tax
Most indlviouals pay income tax on their earnings. Income tax is
an example of a statutory o'eduction, which means that it is a legal
requirement. There are often complex rules about how income tax
should be calculated, but the following are key features of most
Income tax systems:
• Personal allowance: each individual is entitled to receive at least
some pay that Is free of tax. For example, the first $8 000 of
earnings could be tax tree.
• Tax deductible items: these are also deducted from gross pay
before applying the income tax rate. Examples Include national
Insurance, pension contributions and professional subscriptions
and expenses. The employer may be required to deduct these
from gross pay using rates set by the tax authority in order to arrive
at taxable pay. Alternatively, the employee will claim back the tax
on some of these Items later via their own tax return.
• Taxable pay: gross pay less the personal allowance and other
allowable items gives what is called taxable pay. Income tax will
be baseo on an individual's taxable pay; it will be calculated at a
particular rate, for example 20% of taxable pay.
' ILLUSTRATION 1 A simple income tax calculation
Nerissa's gross pay is $45 000 per annum. Nerissa Is entitled to a
personal allowance of $9 000.
Income tax Is charged at a rate of 20% on taxable pay.
Step 1: Calculate taxable pay
Taxable pay is gross pay $45 ooo less personal allowance
$9 000, I.e. $36 ooo.
Step 2: Calculate Income tax
Income tax is 20% of taxable pay, i.e. 20% x $36 ooo = $7 200.
So, Nerissa will pay a iotat of $7 200 In Income tax during one
year; this will amount to $600 per month.
DID YOU KNOW?
Many individuals also have
to pay:
• National Insurance (social
security) contributions: this
deduction is made to provide
the funds to pay state
retirement pensions, disablllty
benefits, unemployment
benefits, etc. This deduction
coulo be a percentage of
gross pay.
• Pension plan contributions:
some employees v,111 be
required to contribute to a
scheme that will provide a
pension from their employer
upon retirement. This
deduction could also be a
percentage of gross pay.
DID YOU KNOW?
Voluntary deductions could
include:
• membership o• the
organisation's sports club
• membership of the
organisation's social club
• donations to charities
• membership of a trade union
• con1ribution 10 a private
health scheme
• life insurance contributions
• conltlbutions 10 credit unions
or savings schemes
• loan repayment instalments
to banks or credit unions.
Voluntary deductions
In some organisations, an Individual can request that deductions
are made from their pay to meet their particular needs and
circumstances. Where the deduction is optional ano· requested by an
employee it is referred to as a voluntary deduction.
.,..ILLUSTRATION 2 Calculating an individual's annual net pay
taking account of statutory deductions
Sepaul's annual gross pay is $52 000. He Is entitled to a personal
allowance of S8 000. Income 1ax is charged at 22% of taxable pay.
In addition, Sepaul is required 10 make national Insurance (social
security) contributions of 5% of gross pay and a pension plan
contribution of 4% of gross pay. Calculate Sepaul's annual net pay.
(Assume national insurance and pension plan contributions are
allowable deductions when calculating taxable pay.)
Sepaul
Calculation of Inc ome tax:
s
Gross pay
$
52000
Less:
Personal allowance
8 000
National insurance
(5% x Gross P<IY $52 000)
2 600
Pension plan
(4% x Gross pay $52 000)
2 080
Total allowable deductions
SUMMARY QUESTIONS
1. Michelle's annual salary is
S82 ooo. She is entitled to
a personal allowance of
s 12 000. She is charged
income tax at 20% on
taxable pay. How much
Income tax should Michelle
pay in one year?
2. Harry's weekly gross pay Is
S900. He pays 20% income
tax on all weekly earnings
above $200. He asked his
employer to make voluntary
deductions of $80 per
week from his pay. 1/Vhat is
Harry's weekly take home
pay?
(12 680)
Taxable pay
(Gross pay less Total
allowable deductions)
39 320
Calculation of net pay:
$
Gross pay
s
52 000.00
Less:
lncome1ax
8 650.40
National insurance
2 600.00
Pension plan
2 080.00
(13 330.40)
Annual net pay
Income tax
38 66960
=22% x Taxable pay $39 320 =$8 650.40
.I
Budgets and simple
business plans
Cash flow projections
LEARNING OUTCOMES
An Important part of managing a business is forward planning to
ensure that resources are used efficiently. One aspect of forward
planning is forecasting cash flows, which helps owners and
managers to be prepared for times when there could be a shortage
of cash funds, requiring an overdraft to be arranged. or when there is
a surplus oi cash, which could be used more effectively.
In this unit you will learn about:
• preparing cash flow
projecttons within a
six-month period
• preparing sates and
production budgets for a
three-month period
• using accounting knowledge
and skills to prepare a simple
business plan.
A cash flow projection requires forecasts to be made oi:
Cash Inflows
Cash outflows
Cash sales
Cash P'Jrchases
Receipts from credit customers
Payments to suppliers
Capital introduced by the owner
Expense payments
Grants
Owner's drawings
Format
Month 1
Month 2
Month 3
Month 4
Month 5
Month 6
$
$
$
s
$
$
2 400
2600
2800
2 500
2600
Cash inflows
Cash sales
2000
Grant
Total inflows
4 000
2000
2 400
2600
2800
6 500
2600
Purchases
1 100
1 600
1 800
2 100
2300
1 700
Expenses
800
900
1100
1 400
1 200
Total outflows
1 900
2900
3500
3 500
800
2 500
(300)
(700)
3000
100
800
500
500
(200)
(200)
2 800
2800
2900
Cash outflows
Net Inflow/outflow
100
2 500
(100)
Cash balances
Opening
Closing
800
900
900
800
Notes:
• There are various ways of setting out cash flow projections. The format shown is just one example.
• Negative figures are shown in brackets. (The closing balance is negative in Month 4 and this leads to a
negative opening balance in Month 5 .)
Sales and production budgets
A sales budget is used to forecast the number of units that will be
sold each month and the value of those sales.
" ILLUSTRATION 1
IAsales budget
Sales budget for each of the three months ending
31 August 2020
Sales u,iits
Sales value
June
1 200
S7200
July
1 300
$7 800
AJ.Jqust
1 400
$8400
A production budget is used to forecast the number of units that
will need to be made each month in order to meet o·emand. A
production budget takes account of levels oi inventory of finished
goods. It is Important to note that the budget shows details In units
rather than $.
/ ILLUSTRATION 2 A production budget
Production budget for each of the three months ending
31 M ay 2020
Sales
Less opening Inventory
Add closing inventory
Production
March
untts
900
(100)
200
1 000
Aonl
untts
1 000
(200)
300
1 100
Mav
untts
1 200
(300)
200
1 100
/
1. Owen has prepared a cash
flow projection that shows
cash Inflows for June will be
SB 400 and cash outfl0\11/S
S9 100; in July cash inffows
will be S9 300 and cash
outflows $9 500. The
balance of cash funds on
1 June ls preoicted to be
S200. Calculate the closing
balance of cash funds for
the end of:
a. June
b. July.
2. What Information should be
recorded In:
a. a sales budget
b. a production budget.
3. Identify three key sections
of a simple business plan.
Simple business plans
When planning to set up In business. it Is Important that ideas about
the venture are carefully thought through. A business plan should
make it clear what the business will do and how It will be successful.
The key elements in a business plan are:
• Executive summary: a concise statement about the key features
of the venture. i.e. what the business will do. how It will make
money, how it will attract customers and the amount of finance
required
• Company background: who are the owners and other key
personnel. their skills, experience and qualifications
• M arketing plan: answering questions about who will be the
customers for the goods or services being offered and whether this
target group wlll lncrease ln the future
• M arketing analysis: identifying the likely competitors and how
the venture will ensure that customers are attracted away from the
competttion
• Financial plan: Including detailed statements about the capital
required to set up and run the business, a forecast of profits based
on details about revenues. expenses, etc., cash flo\111 projections
and other budgets.
Worked example:
preparing budgets and
cash flow forecasts
The question
Bill is planning to open his own business in October 2020. He is
going to make a high-quality garden chair of his own design. He has
been preparing a business plan and he has been told that he should
include a sales budget, production budget and a cash flow forecast.
He has provided the following details:
The chair will sell at S240 each. All sales are for cash. He believes he
can sell the following chairs in the first months of trading:
October
100
November
120
December
160
He will produce sufficient chairs each month to meet sales demand.
He also plans to hold an Inventory sufficient to provide 20% of the
following month·s sales. Sales for January 2021 are forecast to be
1tlO chairs.
The following Information is available about cash inflows and cash
outflows:
A
In October 2020 Bill will in~roduce $22 000 as capital tor his
business.
B
He will purchase machinery and equipment for $18 000. Half
of this amount will be paid In October 2020 and the balance in
December 2020.
c
Each month he will purchase materials to make the chairs
shown in the production budget. Materials will cost S100 per
chair. All purchases of materials will be paid for in the month of
production.
D Wages will be S80 per chair and will be paid in the month of
production.
E
Bill Is entitled to a grant of $5 000 for setting up his business.
This amount will be received In November 2020.
F
Bill Intends to wtthdraw S2 000 per month from the business as
drawings.
G General expenses of $8 000 will be paid each month.
Prepare to r each of the months October, November and
December 2020:
• a sales budget In untts and value
• a production budget
• a cash flow forecast.
Getting started
Stage 1
It is important to read the details of the story of Bill's business
carefully so that you give yourself the opportunity to understand what
Is happening.
The answer
Step 1
Focus on producing the sales budget. Notice that you must provide
details both In units ano· sales values. As always take care with the
presentation of your answer because budgets are produced tor
owners and managers of businesses and they would expect details
to be recorded carefully.
Bill
Sales budget for each of the
three months ending December 2020
Sales untts
Sales value ($240 per unit)
October
November
December
100
120
160
$24 000
$28 800
$38 400
Step 2
Focus on producing the production budget. It is important to
remember that production budgets are in units not $. The information
shown •..viii be important for calculating the value of monthly
purchases and monthly wages in the cash ilow forecast.
BIii
Production budget for each of the
three months ending December 2020
Sales
October
November
December
100
120
160
(24)
(32)
Less opening inventory•
EXAM TIP
A co""'-""'-O"'- l¾ista koe is
to iittempt to J'YOol1<.ce ii
)'YOol uctio,,,, b1<.ciget i,,,, -1
YAtf!ey tflA,,,_ i,,,_ t.<i,,,[ts.
Add closing Inventory'"
24
32
28
Production
124
128
156
• There was no opening inventory for October because that was the
month the business started.
·• Closing Inventory is to be 20% of the following month's sales. So
the calculations of closing inventory are:
October
20% x 120 = 24 untts
November
20% x 160 = 32 untts
December
20% x 140 = 28 untts
Step 3
Finally, the cash flow forecast can be prepared. There are some
calculations to be made (purchases figures and wages figures) and
these shoulo form part of your answer. The cash sales figures are
transferred from the sales budget. Remember to show negative
figures In brackets. (There are alternative presentations of a cash flow
forecast which you could use.)
i:.DID YOU KNOW?
BIii
Cash flow forecast for each of the
three months ending December 2020
It Is worth noting the correct
October
November
December
$
$
s
Receipts:
Capital (A)
title for the cash ilow forecast
and the use of 1he word
'enaing' (because tt is about
the future) rather than 'ended'
(which woulo relate to the past).
22 000
Grant (£)
5 000
Sales (from safes budget)
To1aI receip,s
Payments:
24 000
28 800
38 400
-46
-000
---- - - -38-400
-33 800
-------------
Machinery (BJ
9000
Purchases of materials'
12 400
12 800
9000
15 600
1Nages·
9920
10 240
12 480
Drawings (F)
2000
2000
2000
General expenses (G)
8000
8000
8000
Total payments
41 320
33040
47080
4 680
5440
Opening balance (closing
balance of previous month)
EXAM TIP
rt [s wortl,i cneck.i""g t htit
Net inflow/outflow
4 680
760
(8 680)
"'""!:1 "'-'lgtitive fi,g"'res ntive
Closing balance
4 680
5 440
(3 240)
bee"" si1ow"" """ brtlck?.ets .
• Calculations:
Purchases of materials
(Production x S100) (C}
Wages
(Production x $80) (OJ
$
$
October
124 X 100 ; 12 400
124 X 80 ; 9920
November
128x 100 ; 12800
128 X 80 ; 10 240
December
156 X 100 ; 15 600
156x 80 ; 12480
Practice exam questions
Paper1
1 An employee is paid $20 per hour 1or a 40-hour
week. Overtime is paid at time anci a half. What
is the employee's gross pay In a week when 44
no.irs are worked?
A $800
C $900
B $880
D $920
2 An employee is paid $5 for eaci, completed
product that passes a quality check. Tre
employee is entttled to a minimum weekly wage
of $1 000. During one week the err,ployee
oompleted 21 Oitems, of wnicr 20 failed to pass
the quality check. The employee's pay for the
week Is:
A $950
B $1000
C $1050
4 1Nhich of the following ls not a volun1ary
deduction from pay?
A Donations to charities
B Membership ~ee for social cll.,b
C Trade union membersnlp
D Social security contribl.lllons
S Which of t1'e following should not be included In
a cash flow projl)C:ion?
A Owner's drawings
B Payments to suppliers
C Credit sales
D Gran;s
D $1150
3 Zachary's anrual salary Is $45 000. He nas a
personal allowance of $5 000. Income tax Is
charged at 20% of taxable pay. Zachary's net
pay Is:
A $45000
C $37000
8 $40000
D $32000
Paper2
1 Calculating gross monthly pay
Maseo ls the manager o' a retail store. His gross
annual salary for 2018 was $42 000. In 2019 his
gross annual salary was Increased by 5% on 1he
figure for 2018. Calculate Maseo's gross monthly
salary for
a 2018
.
b 2019
2 Calculating gross pay based on time rates
Giselle works on the production line in a local
factory. Glselle is expeoled 10 work an e1ght-tiour
day and Is paid $28 per hour. Overtime ls paid
at time and a quarter. The lunch hour is Included
In normal working hours. For the week ended
18 October 2019, Giselle's l ime card was
as follows:
MORNING
AFTERNOON
EVENING
IN
our
IN
OUT
IN
Monday
8.00
'2.30
"3.30
4.00
6.00 7.30
Tuesday
8.00
12.30
'3.30
4.03
Wednesday 8.00
12.30
'3.30
4.04
Thu,sday
8.00
12.30 13.30
4.01
Fndav
6.00
12.30
4.00
' 3.30
our
6.00 8.30
Calculate Giselle's gross pay for 1he week ended
12 October 2019.
3 Calculating gross pay based on piece rates
Vernon wori<s full-1ime In a fac1ory. He Is paid
$1 .40 for each product that is accepted. lre
business operates a minimum wage agreement.
For Vernon this means he must be paid at least
$800 per week. During tne ,,,eek ended
18 Oc1ober 2019 V61'non's p iecework ticket
showed that he had 662 products ljCCepted.
During tne week ended 25 October 2019 his
piecework ticket was as follows:
Number
accepted
Calcula;e:
a Celiria 's taxable pay
b income tax charged on Celina·s annual salary
c Celina's annual net pay
d Celina's monthly net pay.
5 Forward planning
Yasmin Is planning to open a bl>Siness In
January 2020. She will be selling a produCi 1hat
will have a selling price of $20 per unit. All sales
will be on a cash basis.
Number
produced
Number
rejected
Monday
128
6
Tuesday
122
8
Wednesday
121
3
2020
Units
Thursday
119
5
January
500
Friday
121
7
February
600
Totals
710
27
March
650
C.ilcul.ite:
a Vernon's pay for the week ended
18 October 2019
She nas prepared a forecast of likely sales for
tne first three months of trading:
She has also prepared forecasts of cash
receipts and payments for each of the three
months ending 31 March 2020.
January
b the 1otal number of nems accepted during the
week ended 25 Oc1ober 2019
c Vetnon's pay for the week ended
25 October 2019.
4 Calculating net pay after statutory
deductions
Celina's annual gross pay Is $66 000. She Is
entiiled to a personal allowance of S9 000.
Income tax is charged at 18% of t(l)(able pay.
In addition, Celina Is required to pay national
insurance (social security} ccntributicns of
5% of gross pay and io make a pension platJ
oor,tribu1ion of 4% of gross pay (assume these
are allowable deductions before calculating
income 1(1)().
s
February March
$
s
Capital
Introduced
43000
Grant
2000
Purchases of
non-current
assets
37 000
Payments to
credit suppliers
7 000
9000
9000
Expenses
1 200
1300
1 100
Drawings
900
1000
1 200
8000
a Prepare a sales budge; for each of the three
months ending 31 March 2020.
b Prepare a cash flow projection for each o: tne
three months ending 31 March 2020.
c Describe ,he main details you would expecl
to find In tne marketing analysis S6Cllon of
Yasmin's bushess plan.
absorption cowng 17C-1
accosntlng 5-8
accounting concepts 84-5
accountlngcycie 10
acco1,.nts payable and accounts receiv,3ble 1.a
acc,ua :s concept 84
acd 1esrratio 77, 79
adjustmems 84, 98-101
adjJstmer,ts to expenses 86,89
aoJ-stmems to Income 86-8. 89
manJfa::tu ng accounts 163
AGr./,s (anncal general meetlr9s) i40
allocat,on of costs , 71
apportionment of costs 171
appropr,atlon accoum 126-7 1¥ . 152
assets, l}lpes of 16
auolro,s 145
autho<lsed share caprtal 140, 1"6
balance sheet 12, 14-19,69. 77, 78-9, 146-7,
152 165
balancing accounts <6-7
Interpreting entries and oalances 50
bank reconcl'latlon statements I I 8-2 1
books of o!lglnal entry 22-3, 37, 43-5. 52-9
bJogets 185-9
bJslness organlsatons 10-11
bJslness olans 186
capl•al 140--1
capital accoJrt 68, 126
capital expenoltue 157
can age Inwards ar.d ouv,•ards 65
cash and cred,t transactions 18, 22
casr, at bark and cash n i'and 1•
cash books 30-3
balanci~g cash oook1 36-7
cash discounts 25
cash flow projections 185, 187-9
cash flow statemert 12
cheques, dishonoured I I<
clock cards 179
closing accoJnts ~-9
co-operatives 11, 138-9. 153.5
accourm 151-2
capital 1< I
prlr,cloles of co-operat,ve societies 137
statement o• financial oosltlon 152
consistency con.;ept 84-5
contra entry 30. 31 . 11 4
contracts 179
control accoJnts 113-17
control systems 104
errors 104-<i
corporations 11
COSl•plJS pr clrg 170
costing procedures 17C-5
costs 161-2. 171
calcJlatlng the cost of a un,t of production
163-4
cost cenrres 170. 171
cost of raw matetlals conswmed 161
-cred;t control 13
cred t not~ 28
-credit transfers 118
currer,c acco1.Jnts 126, 127
current rat,o 77, 78-9
debentcres 141, 1<4-5
deb ,1 not~ 28-9
debts. bad 90
debts.doubtfJI 91-5
dep,ec atlon 96-7
direct costs 161 -2
dlfect deb~s 118
directors 1<0, 144
discounts 25. 26-7
cllscoJnt>a'lowed ard 1e,celve-d 25
dlv,dends 1•0, 143
proposed d"icer,ds 1'4
cocble-entry pr1nc,ple •0-1, 52-9, 64-5
efficiency 79
errors 104-8, 110-12, 118
correcting pro~ts 109
etMcal prlncl~ es of a"ountlng 6
ex~enses e6. 89
linar,clal statements 12. 62
company nnancla 1statements 148-50
manufactJrlng acco.r.ts 163
so!e traders 62-3, 70-3
fluctuatlr-g capitals 126
folio refe,er,::.es 43
general Jocrnal 34•5
Income statement 66-7
Issue of shares 142
genefal reserve 1.44
gross and net prolit {or Income) 62, 63
gross prolit percentage 75. 78
mores, 32
nco,ne 86-8, 89
,ncorne and expenditure a::.coJrt )2. 151
ncomestatement 12
bao debts 90
carrege cr.arges 65
do Joieentr; for ln·,emor; 6<-5
joJrnal entries 65-7
lmhed llab llty companies 144--5
manufactJrlng accoJnts 165
ratios 74-5. 78
service businesses 68
so'e traders 63
trad ng section 65
upoa:ing the capital account 66
ncome tax 183
nd rect costs 161-2
nventory 13, 64-5
Inventory vah.•ai:lon , 75
rate of Inventory tJrno,er 75. 78
ss.ed si'arecap,tal 140, 1<7
edger ac<.01,nts 4C-2
debit and credit side 41, 42
labliltles. l}lpes of 16, t 24
lmlted 'labl!I~; companies 11. 136. 136,
148-50
advantages and dlsaovar,tages 136-7
anal,slng performance 147
appropr!a~IO" account J.tt
caoltal 140
lncone statenem 1.£4-5
pubhc and prl•,ate 138
Statement of linar.clal position 146-7
lmlted oartnersh ps 124
IQcldll}I 79
manJfacturlng accounts 161, 163-<, 166-9
directand ndrectcosts 161-2
Income statement 165
statementoflinanclal position 165
mark-up ~ercentage 75. 78
matchlr.g concept 84
mutcal agenc, 12<, 125
net prolit percentage 75. 78
non•prolit organisat ons i t. 137, 139, 157-8
order of IIQuloll}I 15, t 7
order of pem>anence 16
partnerships 11, t 24-5, t 32-3
merest on c,awlngs 128-9
oartnersh,p accocrts 126-7
partnersh p agreemems 125, 129
statement of financial oos,t;on 130- t
payroll 13, 179-80
plecerate 182
statutory deductions t 83
time rate 181
volunta1ydeduc1 ons :a,.
penc I footings 47
performance. repo1tlng on 75. 77. 79-81. 147
pe:ty cash 32-3
oetty cash •,oJcrers 32
p,e.;e rates t 82
p:ecewo11<t,ckets 179
prime cost 161
profit for the year 62
prolitaol llty 74-5. 79
prudence concept 84
pJrchases boo, 26-7
ratos 74-7
linarr.lal position 76-7
receipts an-d P•Y'nentsaccount 157-8
re::l ...clng~balarx:e method 96. 97
reserves lt.4, 147
reti..m on l:westmen.t 77
ren.ms nv11afdS and Ol.twards 65
returrs Inwards and ourNards tooks 26.
29
revenue expendl:ore 157
1
sales and prodJCt•on buoge1s 185-{i
sales book 26-7
serlice business~ 68
sh.1reholoers 135
shares 140, 142
share premlt,.im 1£2
sole traders 11, 62-3. 70-3
sosrce documents 22-3,26-7. 32. 34
orepallng source doccmems 24-5
source docJmems for payroll 179
standing orders 118
statement of linanc,al position (balance
sheet) 12, 14-15
classlfieo staternen1 16-17, 69
co•operatlv~ 152
gsldanceon preparing 15
lrr,l:ed 'lablltycompanes 1<6- 7
manJfacturlng acco"nts t 65
partnersh,ps 130-1
ratios 76-7, 78-9
trarsact•ons 18-19
stralgnt-llne r-netrod 96. 97
sJspense accocrt 107
technology and accounting t2-t3
three-colJmn cash book 30-1
time rates 181
time sheets 179
trade disco.nts 25. 26-7
transactions IS-'9. 22. 32
posting fron tr,e booksof orlgloal en11y
<3-5
transact,on descrlotons 25
mu•,sact,ons and the oouo!e•entry
prlnclp'e <0-1
trial balance 50-1, 104-8
true and fair pr·nc pie 85
unamlteo 'laol lty t 2<
voluntary associations 124
Study Guide
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VN IVERSITY PR.ESS
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ISBN 978•0· 19·843731-4
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