INTERNATIONAL
ACCA
1.1 PREPARING
FINANCIAL STATEMENT
Study System
Volume 1
ACCA
PAPER 1.1
PREPARING FINANCIAL STATEMENTS
(INTERNATIONAL STREAM)
STUDY SYSTEM
VOLUME 1
 Accountancy Tuition Centre (International Holdings) Ltd 2003
(i)
No responsibility for loss occasioned to any person acting or refraining from action as a result of
any material in this publication can be accepted by the author, editor or publisher.
This training material has been published and prepared by Accountancy Tuition Centre Limited
16 Elmtree Road
Teddington
TW11 8ST
United Kingdom.
Editorial material Copyright  Accountancy Tuition Centre (International Holdings) Limited, 2003.
All rights reserved. No part of this training material may be translated, reprinted or reproduced
or utilised in any form either in whole or in part or by any electronic, mechanical or other
means, now known or hereafter invented, including photocopying and recording, or in any
information storage and retrieval system, without permission in writing from the Accountancy
Tuition Centre Limited.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
(ii)
INTRODUCTION
Introduction
This Study System, which is presented in two volumes, has been specifically written for The
Association of Chartered Certified Accountants Part 1, Paper 1.1 Preparing Financial Statements.
Volume 1 covers the International Bookkeeping (IBK) aspects of Paper 1.1.
Volume 2 covers the accounting aspects including certain International Accounting
Standards (IASs).
It provides comprehensive coverage of the core syllabus areas and is designed to be used
both as a reference text and interactively with the ATC Learning System to provide you
with the knowledge, skill and confidence to succeed in your ACCA studies.
SYLLABUS
Aim
To develop knowledge and understanding of the techniques used to prepare year-end
financial statements, including necessary underlying records, and the interpretation of
financial statements for incorporated enterprises, partnerships and sole traders.
Objectives
On completion of this paper students should be able to:
!
describe the role and function of external financial reports and identify their
users;
!
explain the accounting concepts and conventions present in generally
accepted accounting principles;
!
record and summarise accounting data;
!
maintain records relating to non-current asset acquisition and disposal;
!
prepare basic financial statements for sole traders, partnerships, incorporated
enterprises and simple groups;
!
appraise financial performance and the position of an organisation through
the calculation and review of basic ratios;
!
demonstrate the skills expected in Part 1.
Position of the paper in the overall syllabus
No prior knowledge is required before commencing study for Paper 1.1. There is some
connection with Paper 1.2 Financial Information for Management in the areas of
performance management and data recording. There are no links with Paper 1.3 I
Managing People.
The basic financial accounting in Paper 1.1 is developed in Paper 2,5 Financial
Reporting and Paper 3,6 Advanced Corporate Reporting. Knowledge from Paper 1.2
provides the financial accounting background to Paper 2.6 Audit and Internal Review.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
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INTRODUCTION
3.6 Advanced Corporate Reporting
3.1 Audit and Assurance Services
2.5 Financial Reporting
2.6 Audit and Internal Review
1.1 Preparing Financial Statements
Syllabus overview
Introduction to accounting
Balance sheet and income statement
The IASB
GENERAL
FRAMEWORK
BOOKKEEPING &
ACCOUNTING
SYSTEMS
ACCOUNTING
CONCEPTS AND
PRINCIPLES
Conceptual
framework
Accounting
conventions
ACCOUNTING
TREATMENTS
PREPARATION &
INTERPRETATION
OF FINANCIAL
STATEMENTS
 Accountancy Tuition Centre (International Holdings) Ltd 2003
Intangible assets
Tangible assets
Inventories
Post balance sheet events
and contingencies
IAS 1
Incomplete records
Partnership accounting
Incorporated enterprises
Consolidated accounts
Cash flow statements
Ratio analysis
(iv)
Double entry bookkeeping
Correcting mechanisms
Computerised accounting
systems
INTRODUCTION
Syllabus content
1
2
General framework
a
Types of business entity – incorporated entities, partnerships and
sole traders.
b
Forms of capital and capital structures in incorporated entities.
c
The role of the International Accounting Standards Board1 (IASB).
d
Application of International Accounting Standards (IASs) to the
preparation and presentation of financial statements.
e
The IASC’s Framework for the Preparation and Presentation of
Financial Statements (paragraphs 1 to 46 only).
Accounting concepts and principles
a
Basic accounting concepts and principles as stated in the IASC’s
Framework for the Preparation and Presentation of Financial
Statements and IAS 1 Presentation of Financial Statements.
b
Other accounting concepts
i
ii
iii
iv
v
3
historical cost
money measurement
entity
dual aspect
time interval.
Double-entry bookkeeping and accounting systems
a
Double-entry bookkeeping and accounting systems
i
ii
iii
iv
v
vi
vii
viii
ix
b
form and content of accounting records (manual and computerised)
books of original entry, including journals
sales and purchase ledgers
cash book
general ledger
trial balance
accruals, prepayments and adjustments
asset registers
petty cash.
Confirming and correcting mechanisms
i
ii
iii
control accounts
bank reconciliations
suspense accounts and the correction of errors.
c
General principles of the operation of a sales tax.
d
Computerised accounting systems.
1 The International Accounting Standards Committee (1973-2001) was the predecessor body of the IASB
 Accountancy Tuition Centre (International Holdings) Ltd 2003
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INTRODUCTION
4
Accounting treatments
a
b
Non-current assets, tangible and intangible
i
distinction between capital and revenue expenditure
ii
accounting for acquisitions and disposals
iii
depreciation – definition, reasons for and methods,
including straight line, reducing balance and sum of digits
iv
research and development
v
elementary treatment of goodwill.
Current assets
i
ii
iii
5
inventory
accounts receivable, including accounting for bad and doubtful debts
cash.
c
Current liabilities and accruals.
d
Shareholders’ equity.
e
Events after the balance sheet date.
f
Contingencies.
Financial statements
a
Objectives of financial statements.
b
Users and their information needs.
c
Key features of financial statements
i
ii
iii
iv
balance sheet
income statement
cash flow statement
notes to the financial statements (examined to a limited
extent – see d (iii) below).
 Accountancy Tuition Centre (International Holdings) Ltd 2003
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INTRODUCTION
d
Preparation of financial statements for:
i
sole traders, including incomplete records techniques
ii
partnerships
iii
limited liability companies, including income statements
and balance sheets for internal purposes and for external
purposes in accordance with IAS 1 Presentation of
Financial Statements and preparation of basic cash flow
statements in accordance with IAS 7 for limited liability
companies (excluding group cash flow statements). The
following notes to the financial statements will be
examinable and no others:
−
−
−
−
−
−
iv
6
Statement of changes in equity
Non-current assets
Unusual and extraordinary items
Events after the balance sheet date
Contingent liabilities and contingent assets
Research and development expenditure
groups of companies – preparation of a basic consolidated
balance sheet for a company with one subsidiary.
Interpretation
a
Ratio analysis of accounting information and basic interpretation.
Excluded topics
The syllabus content outlines the area for assessment. No questions will be asked on:
!
!
clubs and societies;
partnerships other than the preparation of financial statements for partnerships.
Key areas of the syllabus
The objective of Paper 1.1 Preparing Financial Statements, is to ensure that candidates
have the necessary basic accounting knowledge and skill to progress to the more
advanced work of Paper 2.5 Financial Reporting. The two main skills required are:
!
the ability to prepare basic financial statements and the underlying accounting
records on which they are based; and
!
an understanding of the principles on which accounting is based.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
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INTRODUCTION
The key topic areas are as follows:
!
preparation of financial statements for:
#
limited liability companies for internal purposes or for publication
#
partnerships and sole traders (including incomplete records)
!
basic group accounts – consolidated balance sheet for a company with one subsidiary
!
basic bookkeeping and accounting procedures
!
accounting conventions and concepts
!
interpretation of financial statements
!
cash flow statements
!
accounting standards (see next).
IAS
1
2
7
8
10
16
18
27
35
37
38
Title
Presentation of Financial Statements (Revised)
Inventories
Cash Flow Statements (excluding group and foreign currency)
Net Profit of Loss for the period, Fundamental Errors and
Changes in Accounting Policies
Events Occurring after the Balance Sheet Date (Revised)
Property, Plant and Equipment (Revised)
Revenue
Consolidated Financial Statements and Accounting for
Investments in Subsidiaries
Discontinuing operations (Note 1)
Provisions, contingent assets and contingent liabilities (Note 2)
Intangible assets (Note 3)
Volume 2 Study Session
in which covered
3
7
14
Notes
1
The following paragraphs of IAS 35 are examinable: 27, 31, 41 (provisions
relating to discontinuance previously in IAS 8).
2
The following paragraphs of IAS 37 are examinable in so far as they relate to
contingent liabilities and contingent assets: 10, 27 – 35, 85 – 92, Appendices
A and B.
3
The following paragraphs of IAS 38 are examinable in so far as they relate to
research and development: 7, 39 – 47, 55, 79, 88, 107, 115.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
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13
8
6
4
12
13
8
5
INTRODUCTION
Approach to examining the syllabus
ACCA external examination
The paper based examination is a three hour paper constructed in two sections. Both
sections will draw from all parts of the syllabus and will contain both computational
and discursive elements.
Section A:
Section B:
25 compulsory multiple choice questions
(2 marks each)
5 compulsory short form questions (8-12 marks each)
Number of marks
50
50
___
100
___
Paper 1.1 can also be taken as a three hour computer based examination with the ACCA.
ATC internally assessed examination
Number of marks
Section A: 2 compulsory questions (mainly computational)
Section B: 3 (out of 4) questions of 20 marks each
40
60
_____
100
_____
Time allowed: 3 hours
The overall balance of the paper will be approximately 60% computational and 40% non-computational.
Additional information
Candidates need to be aware that questions involving knowledge of new examinable
regulations will not be set until at least 6 months after the last day of the month in
which the regulation was issued.
Students are advised to read the “Exam Notes”, published in the Student Accountant as
these contain details of examinable legislation, the list of examinable document,
changes in the syllabuses and other useful information. This publication has a
technical section and a noticeboard which are particularly relevant.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
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EXAMINATION TECHNIQUE
EXAMINATION TECHNIQUE
General
!
Divide your time in proportion to the marks on offer. To allocate your time
multiply the marks for each question by 1.8 minutes.
eg 20 mark questions should take you 20 × 1.8 = 36 minutes
!
Keep to this time allocation. The first marks are the easiest to gain in each
question, so don’t be tempted to overstep the time allocation on one question
to tidy up a complicated answer, start the next question instead.
!
Answer the required number of questions (only). For example, for ATC’s
Internally Assessed Paper 1.1 = 2 compulsory + 3 from 4.
!
Write in blue, black or blue/black, NEVER red or green.
!
Use headings and subheadings and underline them with a ruler.
!
DO NOT underline what you think are the “key words” in your answer points.
!
Show all your workings and cross-reference (W1 etc) them to the face of your answer.
!
Do not use tipp-ex or other liquid paper.
Computational questions
Questions requiring large-scale recording of routine trading transactions will not be set, but
double entry skills will be tested by questions on the following topics, among others
!
!
!
!
correction of errors
journal entries
ledger control accounts
bank reconciliations.
The examination will contain a question requiring the preparation of an income
statement and balance sheet for at least one of the three types of entity – sole trader,
partnership and incorporated enterprise.
!
Before starting a computation, picture your route. Do this by jotting down
the steps you are going to take and imagining the layout of your answer.
!
Set up a pro-forma structure to your answer before working the numbers –
but don’t write out every possible caption! (A blank proforma is worth, at
most, a presentation mark.)
!
Use a columnar layout. This helps to avoid mistakes and is easier for the
marker to follow.
!
Include all your workings and cross-reference them to the face of your answer.
!
A clear approach and workings will help earn marks even if you make an
arithmetic mistake.
!
If you do spot a mistake in your answer, often it is not worthwhile spending
time amending the consequent effects of it.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
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EXAMINATION TECHNIQUE
!
NEVER “finish” or “tidy up” a balance sheet or income statement at the
expense of getting on with the next question.
!
Don’t ignore marks for written recommendations or comments based upon
your computation. These are easy marks to gain.
Non-computational questions
In ATC’s Internally Assessed Paper 1.1, Section B Questions 5 and 6 may be wholly written!
!
Do not write an essay! The examiner wants concise and structured comment.
!
Read the requirements carefully at least twice and highlight what you are
being asked to address.
!
Jot down relevant ideas on an answer plan.
!
Use subheadings to focus your answer on what is being asked for.
!
Remember bullet points are easier to mark than continuous narrative.
!
Work to 1 mark per relevant point clearly made.
!
If a question starts “Explain …”
#
#
#
Give justification
Define terms
Use illustrations or examples.
Presentation
!
Use headings, subheadings, indentation and bullet points to give your answer
structure and to make it more digestible for the marker.
!
Use a short sentence to convey each point that you are making.
!
Separate paragraphs by leaving at least one line of space between each one.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
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CONTENTS
Session
Page
1
Introduction to accounting
0101
2
Balance sheet and income statement
0201
3
Introduction to double entry bookkeeping
0301
4
Ledger accounting
0401
5
Credit transactions
0501
6
Trial balance
0601
7
Accounting conventions
0701
8
Accruals and prepayments
0801
9
Depreciation and disposal of non-current assets
0901
10
Bad and doubtful debts
1001
11
Inventory
1101
12
Books of prime entry and control accounts
1201
13
Control account reconciliations
1301
14
Bank reconciliations
1401
15
Journal entries and extended trial balance
1501
16
Suspense accounts and adjustments to profit
1601
17
Computerised accounting systems
1701
18
Appendix 1 – Data sources and records
1801
 Accountancy Tuition Centre (International Holdings) Ltd 2003
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CONTENTS
SESSION 00
Introduction
Syllabus
Aim
Objectives
Position of the paper in the overall syllabus
Syllabus overview
Syllabus content
Excluded topics
Key areas of the syllabus
Approach to examining the syllabus
Additional information
Examination technique
General
Computational questions
Non-computational questions
Presentation
iii
iii
iii
iii
iii
iv
v
vii
vii
ix
ix
x
x
x
xi
xi
SESSION 01
Introduction to accounting
1
Enterprises
1.1 Types
2 Financial accounting
2.1 Meaning
3 Financial statements
3.1 Meaning
3.2 Purpose
3.3 Inter-relationship
3.4 Capital expenditure v revenue expenditure
4 Information
4.1 Users and their information needs
4.2 Qualities
Example solution
0102
0102
0102
0102
0102
0102
0103
0103
0104
0105
0105
0106
0106
SESSION 02
Balance sheet and income statement
1
2
Balance sheet
1.1 A definition
1.2 Description
1.3 Presentation
1.4 Proforma
1.5 Assets
1.6 Liabilities
Income statement
2.1 A definition
2.2 Description
2.3 Proforma
2.4 Trading account
 Accountancy Tuition Centre (International Holdings) Ltd 2003
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0205
0206
0206
0206
0206
0208
(xiii)
CONTENTS
SESSION 03
Introduction to double entry bookkeeping
1
Accounting conventions
1.1 Basic principles
2 Business entity concept
2.1 The concept
2.2 Importance
3 Duality
3.1 The concept
4 The accounting equation
4.1 The principle
4.2 Equity
4.3 The balance sheet equation
Example solutions
0302
0302
0302
0302
0302
0302
0302
0303
0303
0304
0304
0309
SESSION 04
Ledger accounting
1
Double entry
1.1 Bookkeeping
1.2 “Rules”
2 Ledger accounts
2.1 Presentation
2.2 Convention
2.3 Recording transactions
3 Balancing accounts
3.1 Meaning
3.2 Procedure
3.3 Practical points
4 Extracting a list of balances (“Trial balance”)
4.1 Purpose
4.2 Extraction
4.3 Proforma
5 Closing the books
5.1 Explanation
6 Drafting accounts
Example solutions
0402
0402
0402
0402
0402
0402
0403
0407
0407
0407
0409
0409
0409
0409
0410
0412
0412
0413
0416
SESSION 05
Credit transactions
1
2
Credit transactions
1.1 Sales and settlement
1.2 Purchases and settlement
Settlement discounts
2.1 Settlement v trade
2.2 Discounts allowed – to customers
2.3 Discounts received – from suppliers
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(xiv)
CONTENTS
3
Returns
3.1 Sales returns (Returns In)
3.2 Purchases returns (Returns Out)
Example solutions
0504
0504
0504
0504
SESSION 06
Trial balance
1
2
3
Trial balance
1.1 Nature
1.2 Purpose
Error detection
2.1 Types of error
2.2 Errors identified by TB
2.3 Errors not identified by TB
Financial accounts preparation
3.1 Extending the TB
3.2 Period-end adjustments
0602
0602
0602
0602
0602
0603
0604
0604
0604
0604
SESSION 07
Accounting conventions
1
2
3
Accounting perspective
Methods of accounting/valuation
2.1 Historical cost
2.2 Other
Underlying assumptions
3.1 Going concern
3.2 Accrual basis
0702
0702
0702
0703
0703
0703
0704
SESSION 08
Accruals and prepayments
1
2
Accrual basis
Prepayments
2.1 Bookkeeping
3 Accrued expenses
4 Accrued and deferred income
4.1 Accrued income
4.2 Deferred income
5 Summary of accounting entries
6 Practicalities
Example solutions
 Accountancy Tuition Centre (International Holdings) Ltd 2003
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0802
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0807
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0810
0811
0812
0812
0815
(xv)
CONTENTS
SESSION 09
Depreciation and disposal of non-current assets
1
Non-current assets
1.1 Definition
1.2 Examples
2 Property, plant and equipment
2.1 IAS 16
3 Depreciation
3.1 Introduction to concept
3.2 Definitions (simplified)
3.3 Methods
3.4 Straight line method
3.5 Reducing balance method
3.6 Sum of the digits
3.7 Comparison of methods
3.8 Changes in estimated life and/or residual value
4 Disposals
4.1 Ledger accounting
4.2 Part exchange or “trade-in”
5 Revaluation
5.1 Appreciating assets
6 Practical points
6.1 Depreciation methods
6.2 Ledger accounts
6.3 Short-cut calculations
6.4 Fixed asset register
Example solutions
0902
0902
0902
0902
0902
0902
0902
0903
0903
0903
0906
0907
0907
0911
0911
0911
0913
0914
0914
0914
0914
0915
0915
0916
0918
SESSION 10
Bad and doubtful debts
1
Trade accounts receivable
1.1 Definition
1.2 Accounting entries
1.3 Indicators of bad and doubtful debts
2 Bad debts
2.1 “Write-off”
2.2 Double entry
3 Doubtful debts
3.1 Provision
3.2 Accounting entries
3.3 Calculating the provision
3.4 Doubtful debts which go bad
3.5 Recovery of doubtful debts
3.6 Summary
4 Subsequent recovery of bad debts
4.1 Recognised when cash received
4.2 Not recognised immediately on receipt
Example solutions
 Accountancy Tuition Centre (International Holdings) Ltd 2003
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1002
1002
1002
1002
1002
1002
1003
1003
1003
1004
1009
1011
1011
1011
1011
1011
1013
(xvi)
CONTENTS
SESSION 11
Inventory
1
Inventory
1.1 Categories
1.2 Inventory records
2 Measurement
2.1 IAS 2 Inventories
3 Accounting entries
3.1 Introduction
3.2 Closing inventory
3.3 Opening and closing inventory
Example solution
1102
1102
1102
1103
1103
1103
1103
1103
1106
1108
SESSION 12
Books of prime entry and control accounts
1
2
3
4
5
6
7
8
9
Books of prime entry
1.1 Need for
1.2 “Day books”
1.3 Ledgers
Sales day book
2.1 Double entries of totals
2.2 Double entries of individual amounts
2.3 Comparison of methods
Purchases day book
3.1 Description
3.2 Double entries of totals
3.3 Double entries of individual accounts
Cash book
4.1 Description
4.2 Cash book receipts
4.3 Cash book payments
Petty cash book
5.1 Description
5.2 Imprest system
The journal
6.1 Purpose
6.2 Layout
Sales tax
7.1 General principles
7.2 Operation
Control accounts
8.1 Description
8.2 Importance
8.3 Discrepancies
Summary
9.1 Manual system (typical)
9.2 Computerised system (typical)
 Accountancy Tuition Centre (International Holdings) Ltd 2003
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1207
1207
1207
1207
1209
1210
1210
1210
1212
1212
1212
1213
1213
1213
1214
1214
1214
1214
1215
1215
1215
1215
1217
1217
1218
(xvii)
CONTENTS
SESSION 13
Control account reconciliations
1
Control accounts
1.1 Relationship with double entry - recap
1.2 Purpose of control a/cs
1.3 Procedure for agreeing
1.4 Reasons for difference
1.5 Agreement
2 Trade receivables
2.1 Proforma
2.2 Reconciliation
3 Trade payables
3.1 Proforma
Example solutions
1302
1302
1303
1304
1304
1304
1305
1305
1306
1309
1309
1310
SESSION 14
Bank reconciliations
1
Bank reconciliations
1.1 Purpose
1.2 Bank statement balance
1.3 Differences
1.4 Reconciliation procedure
1.5 Proforma
Example solution
1402
1402
1402
1402
1404
1404
1412
SESSION 15
Journal entries and extended trial balance
1
Journal entries
1.1 Description
2 Extended trial balance
2.1 The trial balance
2.2 Post trial balance adjustments
2.3 ETB “worksheet” proforma
Example solutions
1502
1502
1506
1506
1506
1507
1510
SESSION 16
Suspense accounts and adjustments to profit
1
2
3
Errors
1.1 Errors detected by the trial balance
1.2 Errors not detected by the trial balance
1.3 Importance of ledger control a/cs
Journal entries
Suspense accounts
3.1 Purpose
3.2 Correcting errors
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1606
(xviii)
CONTENTS
4
Adjustment to profit
4.1 When needed
4.2 Proforma
Example solutions
1609
1609
1610
1613
SESSION 17
Computerised accounting systems
1
2
3
4
Computerised accounting systems
1.1 Typical manual system
1.2 Computerised accounting systems
1.3 Advantages (over manual systems)
1.4 Disadvantages
Elements
2.1 Inputs
2.2 Types of processing
2.3 Batch processing
2.4 Real-time processing
2.5 Outputs
Software packages
3.1 Spreadsheets
3.2 Database
3.3 Integrated accounting packages
Computers in business
4.1 Types
4.2 Business applications
1702
1702
1702
1702
1703
1703
1703
1705
1705
1707
1707
1708
1708
1708
1709
1710
1710
1711
SESSION 18
Appendix 1 – Data sources and records
1
2
3
4
5
Sales
Purchases/expenses
Cash
Inventory
Tangible non-current assets
1802
1803
1804
1805
1806
INDEX
 Accountancy Tuition Centre (International Holdings) Ltd 2003
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CONTENTS
 Accountancy Tuition Centre (International Holdings) Ltd 2003
(xx)
INTRODUCTION TO ACCOUNTING
OVERVIEW
Objective
To introduce users of financial accounting information.
ENTERPRISES
Types
FINANCIAL
ACCOUNTING
Meaning
Bookkeeping
Summarise
FINANCIAL
STATEMENTS
INFORMATION
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0101
Meaning
Purpose
Inter-relationship
Capital v revenue
Users
Qualities
INTRODUCTION TO ACCOUNTING
1
ENTERPRISES
1.1
Types
Simple
Complex
Sole trader
An enterprise owned and run by the same single
person.
Partnership
An enterprise owned and run by more than one
person with a common view to making profit.
Incorporated
(“Company”)
A separate legal entity owned by shareholders who
appoint directors (managers) to run it. Is subject to
statutory regulation (eg Companies Acts).
2
FINANCIAL ACCOUNTING
2.1
Meaning
Classification and recording of actual transactions in monetary terms
(“bookkeeping”).
Presentation of the results of transactions and financial position in accordance
with established concepts, principles, accounting standards and statutory
requirements (“accounting”).
3
FINANCIAL STATEMENTS
3.1
Meaning
3.1.1
Components
Balance sheet (BS) – a statement of assets and liabilities
Income statement (IS) (or income and expenditure account or profit
and loss account) – a summary of transactions and events
A statement of changes in equity
Cash flow statement (CFS) – a classification of cash flows
Accounting policies and explanatory notes.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
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INTRODUCTION TO ACCOUNTING
3.1.2
Non-financial statements
Financial review (by management)
Chairman’s statement
Directors’ report
Employee reports
Five-year financial record
Analysis of commercial properties
Environmental reports
Value-added statements.
3.2
Purpose
To provide information about
Financial position (eg solvency) ⇒ BS
Financial performance (eg profitability) ⇒ IS
Most
relevant
to IBK
Cash flows ⇒ CFS.
Financial statements also show the results of management’s stewardship (ie
management’s accountability for the resources entrusted to it).
To meet this objective financial statements provide information about
assets
liabilities
equity
income and expenses
cash flows.
3.3
Inter-relationship
OPENING
BALANCE SHEET
+
INCOME
STATEMENT
+
Trading and income
and expenditure a/c
(I&E a/c)
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0103
CHANGES IN
EQUITY
Transactions with
investors
=
CLOSING
BALANCE SHEET
INTRODUCTION TO ACCOUNTING
3.4
Capital expenditure v revenue expenditure
BALANCE
SHEET
Incurred in
INCOME
STATEMENT
Incurred in daily running of business, eg
acquiring property and plant
intended for long-term use (benefits
future accounting periods)
increasing revenue-earning capacity
of existing non-current asset (by
increasing efficiency or useful life).
in buying or manufacturing goods and
providing services
selling and distributing goods
administration
repairing long-term assets.
Example 1
Classify the following items of expenditure as capital or revenue:
(i)
(ii)
(iii)
(iv)
(v)
$27,000 on a new car
$1,800 road tax incorporated in the purchase price of (i)
$10,000 on a second hand delivery van
$12,000 on refurbishing (iii)
$1,000 monthly rental of a vehicle.
Solution
(i)
(ii)
(iii)
(iv)
(v)
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0104
INTRODUCTION TO ACCOUNTING
4
INFORMATION
4.1
Users and their information needs
Users
Investors (owners) and their
advisers
Information needs
Providers of capital are concerned with
the risk and return of their investment.
They need information
−
for decision-making (buy, hold or
sell?)
−
to assess the enterprise’s ability to
pay dividends
Employees and their
representatives
Stability and profitability of employers
Lenders (eg banks)
Whether loans and interest will be paid
when due
Suppliers and other trade
creditors
Whether amounts owing will be paid
when due
Customers
Continuance – important for long-term
involvement with, or dependence on, the
enterprise
Governments and their
agencies (eg tax authorities)
Allocation of resources and, therefore,
activities of enterprises
Ability to provide remuneration,
retirement benefits and employment
opportunities
Information to regulate activities,
determine taxation policies and as the
basis for national income and similar
statistics
Public
Contribution to local economy including
number of employees and patronage of
local suppliers
Trends and recent developments in
prosperity and range of activities
Management
To plan, make decisions and control
operational activities.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0105
INTRODUCTION TO ACCOUNTING
4.2
Qualities
Relevant – otherwise it is useless
Reliable – ie complete, accurate and objective (see below)
Complete – for the purpose(s) for which it is intended
Accurate – so that users have confidence in it
Objective – without bias
Comparable – essential for making comparisons
Cost effective – cost of preparation should be less than value obtained from it
User-friendly – understandable and clear
Concise – discriminating and ignoring trivia
Timely.
FOCUS
You should now be able to:
define accounting – recording, analysing and summarising transaction data;
explain types of business entity – sole trader, partnership, limited liability
company;
identify the main components of financial statements;
outline the purpose of the main financial statements
and identify non-financial statements;
identify users of financial statements and their information needs;
state and explain the desirable qualities of accounting information;
explain the difference between capital and revenue items.
EXAMPLE SOLUTION
Solution 1 – Capital v revenue
(i)
Capital
(ii)
Revenue – road tax is an annual running cost
(iii)
Capital – that the asset acquired is second hand is irrelevant
(iv)
Capital – “refurbish” means renovate which suggests that the useful life of
the existing asset is increased. In this case the expenditure may be incurred
to bring the asset to use in the business (certainly capital).
(v)
Revenue – a rented asset is not owned.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0106
BALANCE SHEET AND INCOME STATEMENT
OVERVIEW
Objective
To present and explain the balance sheet and income statement in vertical format.
“Accounts”
BALANCE
SHEET
INCOME
STATEMENT
A definition
Description
Presentation
Proforma
Assets
Liabilities
 Accountancy Tuition Centre (International Holdings) Ltd 2003
A definition
Description
Proforma
Trading a/c
0201
BALANCE SHEET AND INCOME STATEMENT
1
BALANCE SHEET
1.1
A definition
A statement of the financial position of the enterprise as at a stated date.
1.2
Description
Shows what the enterprise controls (assets) and owes (liabilities).
Usually presented in vertical format
The balance sheet always balances – what it owns (total assets) equals what it
owes (to its suppliers, lenders and owners).
All items recorded have a monetary value attributed to them.
1.3
Presentation
To facilitate meaningful analysis, assets and liabilities are grouped according
to classifications which are generally accepted (or legally required).
IAS 1 Presentation of Financial Statements sets out minimum requirements
for all general purpose financial statements presented in accordance with
IASs.
The proforma which follows is suitable for a sole trader.
1.4
Proforma
Points to note
It is dated at the point in time at which it is stated.
Items are classified in order of liquidity (ie relative ease of
conversion into cash). Non-current assets are placed first, working
down to cash balances.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0202
BALANCE SHEET AND INCOME STATEMENT
BALANCE SHEET AS AT . . . .
$
ASSETS
Non-current assets
Non-current assets
For continuing use over more than
one year – not for resale
Property
Plant and equipment
Current assets
Assets that will be realised in the
near future
$
$
Cost Depreciation
Current assets
Inventories
Trade and other receivables
Prepayments
Cash
x
x
__
x
x
__
x
x
__
x
__
x
__
x
x
x
x
x
__
Total assets
x
__
x
__
Capital
Represents the owners interest and
equals “net assets”
(ie total assets – total liabilities).
Includes owner’s contributions
(eg cash) and retained profit
CAPITAL AND LIABILITIES
Capital and reserves
Capital b/fwd
x
Profit/(loss)
x
Drawings
Profit/(loss)
Per the income statement
(x)
__
Non-current liabilities
Capital c/fwd
x
Obligations due for settlement after
more than 12 months
Non-current liabilities
Interest bearing borrowings
x
Current liabilities
Obligations expected to be settled
in near future
Current liabilities
Trade and other payables
Accrued expenses
Operating overdrafts
x
x
x
__
Total capital and liabilities
 Accountancy Tuition Centre (International Holdings) Ltd 2003
x
__
x
__
0203
Drawings
Amounts (cash and goods) withdrawn
by proprietor during year
BALANCE SHEET AND INCOME STATEMENT
1.5
Assets
Resources having a monetary value.
1.5.1
Non-current assets
May be
tangible (physical objects eg buildings, equipment, vehicles) or
intangible (without physical substance but possessing rights to
monetary values eg trademarks).
Initially recorded in the accounts at their monetary purchase price (“cost”).
With notable exceptions (eg land) assets become less valuable. Wearing out of
a tangible asset is called depreciation (≡ amortisation for an intangible asset).
1.5.2
Investments
Usually shares in, or loans to, other entities.
May be classified as non-current (if held on a continuing basis) or current.
Listed investments are those quoted on a recognised stock exchange.
1.5.3
Current assets
Acquired for conversion into cash in the ordinary course of business.
Cash
Receivables
Inventory
Listed in order of ease with which the asset can be turned into cash
inventory takes the longest time
receivable are fairly liquid
cash is cash.
1.5.4
Inventory
Examples
Retailer
Goods for resale
Manufacturer
Raw materials
Work in progress (WIP) – eg half finished cars on a
production line
Finished goods – eg cars completed but not yet
distributed to garage outlets
Service industry
(eg accountancy)
WIP – eg labour and overheads for accounting
services not yet charged out to clients.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0204
BALANCE SHEET AND INCOME STATEMENT
Inventory should be measured at the lower of
Cost (its purchase price or manufacturing cost) and
Net realisable value (estimated selling price less any further
costs incurred).
1.5.5
Receivables
A general term for persons or entities who owe the enterprise money.
Balance sheet amount is after deducting the provision or allowance for
doubtful debts (representing the amount which may not be received).
1.5.6
Prepayments
Amounts paid on or before the balance sheet date which relate to a period
after the balance sheet date.
1.5.7
Cash
Cash on hand (cheques, notes and coins) and demand deposits with a bank.
If a bank account is overdrawn it is not an asset but a liability.
1.6
Liabilities
Financial obligations of an enterprise.
Imply legal responsibilities to other parties.
Comprise external liabilities (eg to suppliers of goods) and internal liabilities
(to owners, whether shareholders, partners or the proprietor).
Categorised by time.
1.6.1
Non-current liabilities
Enterprises are frequently financed by credit obtained from sources other than
the owners eg interest-bearing loans. A loan due to be repaid in 2005 will be
a non-current liability in the 2003 balance sheet.
1.6.2
Current liabilities
Amounts owed by the business falling due for payment within one year of the
balance sheet date.
1.6.3
Accrued expenses
Amounts which have not been invoiced to the business at the balance sheet
date, but which are known to be due.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0205
BALANCE SHEET AND INCOME STATEMENT
2
INCOME STATEMENT
2.1
A definition
A statement of the financial performance of the enterprise over a period of time.
2.2
Description
The income statement comprises
A trading account summarising trading transactions
(Revenue – Cost of sales = Gross profit)
An income and expenditure account (all other items of I&E
legitimately earned as a result of business activities).
2.3
Proforma
Points to note – For a manufacturing enterprise, the cost of goods sold will be
manufacturing cost (ie including production labour and overheads), not just
raw material purchase cost.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0206
BALANCE SHEET AND INCOME STATEMENT
INCOME STATEMENT
FOR THE YEAR ENDED. . . .
$
Revenue
Income is derived from the main
trading activities
Revenue
Less
Cost of sales
Cost of sales
Opening inventory
Add Purchases
x
x
__
Less Closing inventory
(x)
__
Other operating income
(x)
__
The cost of goods ie actually sold
The cost of goods available for sale
during the period (ie opening
inventory and purchases) less the cost
of goods not sold (closing inventory)
$
Gross profit
x
Other operating income
x
Less
Expenses
Distribution costs
Administrative expenses
 Accountancy Tuition Centre (International Holdings) Ltd 2003
x
x
__
x
__
0207
Expenses
Costs incurred incidental to the
direct costs of goods sold (may be
classified by function)
(x)
__
Net profit
Income other than that derived
from trading activities eg
interest/dividends/discounts/
rent receivable
BALANCE SHEET AND INCOME STATEMENT
2.4
Trading account
2.4.1
Revenue
Revenue reflects all sales made to customers in the year, regardless of
whether or not they have been paid for.
A sale is usually recognised as taking place when goods are despatched (or
services provided) to a customer. The balance sheet reflects, as trade receivables,
the extent to which credit sales made to customers have not been settled for cash.
2.4.2
Cost of sales
This is the cost of goods actually sold.
Costs incurred are “matched” with revenues earned.
2.4.3
Gross profit
This is the difference between revenue and cost of goods sold.
“Gross profit margin”, a common measure of a company’s profitability, is
calculated as:
Gross profit
× 100
Revenue
Illustration 1
Gilda starts a business selling shoes. During the first accounting period she
(i) buys 100 pairs from a supplier for $30 each
(ii) sells 20 pairs for $62 each.
Solution
Profit has been realised to the extent that sales have been made, ie on 20 pairs of shoes.
This could be calculated as
Turnover (20 × $62) =
Less Cost (20 × $30) =
$
1,240
(600)
_____
Gross profit
640
_____
(ie 20 × [62 – 30])
However, this presentation only gives limited information about trading performance.
The trading account is more informative in showing
total purchases (100 × 30 = $3,000); and
goods that remain unsold (ie inventory 80 × 30 = $2,400).
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0208
BALANCE SHEET AND INCOME STATEMENT
Trading activities are presented as
$
$
1,240
Revenue (20 pairs)
3,000
2,400
_____
Purchases (100 pairs)
Less Closing inventory (80 pairs)
Cost of sales (ie cost of goods sold)
600
___
Gross profit
640
___
Illustration 2
During the next accounting period Gilda
(i) buys 20 pairs of shoes at $30 each
(ii) sells 90 pairs at $62 each.
Solution
Part of the current period’s revenue will come from opening inventory.
$
Revenue (90 × $62)
Opening inventory (80 pairs Illustration 1)
Purchases (20 × $30)
2,400
600
Available for sale
Less Closing inventory (10 pairs)
3,000
(300)
____
_____
2,700
_____
Cost of goods (actually) sold (90 pairs)
2,880
_____
Gross profit (check 90 × $[62– 30])
 Accountancy Tuition Centre (International Holdings) Ltd 2003
$
5,580
0209
BALANCE SHEET AND INCOME STATEMENT
KEY POINTS SUMMARY
Balance sheet
Elements include assets, liabilities and equity (capital).
It provides information on the resource structure of an enterprise (ie the major classes
and amounts of assets). It assists users to have items grouped into classes.
Assets are presented to help users assess the liquidity of available resources. Assets
held on a continuing basis for use are shown separately from assets held for sale.
The balance sheet is a static statement.
It does not purport to show the value of a business.
Income statement
The trading account shows gross profit for the accounting period.
Gross profit is sales (revenue) less cost of goods sold.
Revenue is recognised even though cash may have yet to be received.
Cost of goods sold is calculated as
Opening inventory
X
Purchases
–
Closing inventory
X
+
Goods available for sale
(X)
Goods unsold
An incorporated enterprise does not present this calculation although
cost of goods sold is determined in this way.
FOCUS
You should now be able to:
define assets and liabilities;
distinguish between current and non-current assets and liabilities;
explain how and why assets are disclosed in the balance sheet;
explain the application of the matching concept to costs and revenues;
explain how and why revenues and expenses are disclosed in the income statement;
draft a simple balance sheet and income statement in vertical format;
understand “gross profit” and “gross profit margin”.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0210
INTRODUCTION TO DOUBLE-ENTRY BOOKKEEPING
OVERVIEW
Objective
To introduce bookkeeping principles.
ACCOUNTING
CONVENTIONS
3 basic principles
BUSINESS
ENTITY
"DUALITY"
The concept
The concept
Importance
THE
ACCOUNTING
EQUATION
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0301
The principle
Equity
BS equation
INTRODUCTION TO DOUBLE-ENTRY BOOKKEEPING
1
ACCOUNTING CONVENTIONS
1.1
Basic principles
Three principles underlie double entry bookkeeping
the business entity concept
“duality”
the accounting equation.
2
BUSINESS ENTITY CONCEPT
2.1
The concept
Business entities are regarded as separate from their owners.
An entity may be legally separated from its owners (eg an incorporated
enterprise).
Businesses which are not legally distinguishable (sole traders and
partnerships) are distinct from their proprietors for accounting purposes.
2.2
Importance
Transactions between a business entity and its owners are separately
identified and accounted for from the entity’s perspective.
3
DUALITY
3.1
The concept
Every transaction has two effects.
The second effect is equal and “opposite” to the first.
Illustration 1
(a) A borrows $20,000 from a bank
(b) A buys a motor vehicle for $8,000 cash
(c) A sells goods for $600 on credit.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0302
INTRODUCTION TO DOUBLE-ENTRY BOOKKEEPING
Solution
(a)
Effect 1: A has $20,000 more cash
A owes the bank $20,000
(b)
Effect 1: A has $8,000 less cash
A owns a motor vehicle costing $8,000
(c)
Effect 1: A has $600 more sales revenue
A is owed $600
Effects are considered from A’s perspective
Example 1
M is a sole trader. What are the two effects of each of the following
transactions?
(i) Introduces $10,000 capital
(ii) Buys a car for $5,000 cash
(iii) Borrows $5,000 from the bank
Solution
(i)
1:
2:
(ii)
1:
2:
(iii)
1:
2:
4
THE ACCOUNTING EQUATION
4.1
The principle
At any point in time
Net assets (ie Assets – Liabilities) = Equity
Consequently, the movement (ie change) in net assets over a specified period
must equal the movement in equity for the same period ie
Closing
–
net assets
Opening
net assets
= Capital introduced +
in period
–
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0303
Profit
Loss
–
Appropriations
INTRODUCTION TO DOUBLE-ENTRY BOOKKEEPING
4.2
Equity
The residual interest in assets after deducting all liabilities.
Components include
Capital – representing investment by the owner(s)
Accumulated profits – profits less losses earned and retained.
Profits retained are after setting apart (ie “appropriating”)
amounts due to owners. Eg
−
−
−
4.3
distributions (“dividends”) to shareholders
salaries and profit shares to partners
drawings by sole traders.
The balance sheet equation
The accounting equation is also known as the balance sheet equation because,
re-arranged, it underlies the presentation of the balance sheet.
Assets = Equity + Liabilities
Example 2
Show the balance sheet equation at the end of each transaction set out in Example 1.
(i)
(ii)
(iii)
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0304
INTRODUCTION TO DOUBLE-ENTRY BOOKKEEPING
The following illustration shows the dual effect and how the accounting equation holds
for the preparation of the balance sheet.
Illustration 2
Day 1
Open a new business bank account with the $5,000 proceeds of an issue of
5,000 $1 shares.
Day 2
Purchase 100 books at $20 each for cash.
Day 3
Purchase 300 books at $5 each on 14 days credit (ie the supplier gives 14
days in which to pay).
Day 4
Sell all inventory for $4,500 cash.
Day 5
Pay $50 cash to deliver inventory to the customer.
Day 6
Pay a dividend of 10 cents per share.
Day 1
$5,000 more cash
$5,000 is owed to the shareholders
1
2
ASSET
=
EQUITY
$
5,000
_____
Cash
Share capital
$
5,000
_____
Day 2
1
2
$2,000 less cash
$2,000 worth of books are owned
The books are an asset, inventory.
ASSETS
Cash
Inventory
=
$
3,000
2,000
_____
5,000
_____
EQUITY
Share capital
 Accountancy Tuition Centre (International Holdings) Ltd 2003
$
5,000
_____
5,000
_____
0305
INTRODUCTION TO DOUBLE-ENTRY BOOKKEEPING
Day 3
1
2
$1,500 more inventory
$1,500 is owed to the supplier
The obligation to the supplier is a liability (the “opposite” of an asset) called
a trade payable (or account payable).
ASSETS
Cash
Inventory
=
$
3,000
3,500
_____
EQUITY +
LIABILITIES
Share capital
Trade payable
6,500
_____
$
5,000
1,500
_____
6,500
_____
Day 4
1
$4,500 more cash
2
$3,500 less inventory
Difference . . . $1,000 is profit.
Profit is made by a business for the benefit of its owners and is
therefore owed to them.
ASSETS
Cash
=
$
7,500
_____
EQUITY +
LIABILITIES
Share capital
Profit
Trade payable
7,500
_____
 Accountancy Tuition Centre (International Holdings) Ltd 2003
$
5,000
1,000
1,500
_____
7,500
_____
0306
INTRODUCTION TO DOUBLE-ENTRY BOOKKEEPING
Day 5
1
2
$50 less cash
$50 less profit
The delivery charge is an expense or a cost.
ASSETS
=
$
7,450
Cash
EQUITY +
LIABILITIES
Share capital
Profit
Trade payable
_____
7,450
_____
$
5,000
950
1,500
_____
7,450
_____
Day 6
1
2
$500 less cash
$500 less profit
Dividends are a distribution of profit.
ASSETS
Cash
=
$
6,950
_____
EQUITY +
LIABILITIES
Share capital
Accumulated (retained)
profit
Trade payable
6,950
_____
 Accountancy Tuition Centre (International Holdings) Ltd 2003
$
5,000
450
1,500
_____
6,950
_____
0307
INTRODUCTION TO DOUBLE-ENTRY BOOKKEEPING
Summary of accumulated profit
$
Nil
950
(500)
___
Balance Day 1
Net profit for the period
Dividends
– per income statement (below)
450
___
Balance Day 6
Income statement
$
Revenue
Cost of goods sold
4,500
3,500
_____
Gross profit
Expense
1,000
50
_____
Net profit
950
_____
FOCUS
You should now be able to:
outline and illustrate the application of the conventions of business entity and duality;
explain how the business entity convention and the balance sheet equation
underlie the balance sheet.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0308
INTRODUCTION TO DOUBLE-ENTRY BOOKKEEPING
EXAMPLE SOLUTIONS
Solution 1 – Dual effect
(i)
1:
2:
Cash increases by $10,000
Capital increases by $10,000
(ii)
1:
2:
Cash decreases by $5,000
Car increases by $5,000
(iii)
1:
2:
Cash increases by $5,000
Bank loan increases by $5,000
Solution 2 – Balance sheet equation
(i)
Cash $10,000 = Capital $10,000
(ii)
Car
Cash
$
5,000
5,000
______
10,000
______
= Capital $10,000
(iii)
Car
Cash
$
5,000
10,000
––––––
15,000
––––––
$
10,000
5,000
––––––
15,000
––––––
Capital
Loan
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0309
INTRODUCTION TO DOUBLE-ENTRY BOOKKEEPING
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0310
LEDGER ACCOUNTING
OVERVIEW
Objective
To explain how individual transactions are recorded and periodically totalled
for the preparation of financial statements.
DOUBLE
ENTRY
LEDGER
ACCOUNTING
Bookkeeping
"Rules"
Presentation
Convention
Recording transactions
BALANCING
ACCOUNTS
LIST OF
BALANCES
Meaning
Procedure
Practical points
CLOSING THE
BOOKS
Explanation
DRAFTING
ACCOUNTS
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0401
Purpose
Extraction
Proforma
LEDGER ACCOUNTING
1
DOUBLE ENTRY
1.1
Bookkeeping
Each transaction has two financial effects therefore recording is in two
separate places.
1.2
“Rules”
One entry is called the “debit” and the other the “credit”.
Every debit has a matching credit (and vice versa).
2
LEDGER ACCOUNTS
2.1
Presentation
A series of separate accounts in a ledger (historically huge bound books).
One account is used for each type of transaction.
Each account is divided into a left-hand side and a right-hand side.
Depicted as “T” accounts
Account name
$
2.2
$
Convention
Debits (abbreviated Dr) are on the left
Credits (abbreviated Cr) are on the right
a/c
Debit
$
Credit
$
Consistency is essential to ensuring that transactions can be easily
summarised. For example, all increases in cash must be recorded on the
same side of the cash a/c and all decreases on the opposite side.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0402
LEDGER ACCOUNTING
Which side, is purely convention.
Balance sheet a/c
A DEBIT entry represents
A CREDIT entry represents
1
1
An INCREASE in an ASSET
or
An INCREASE in a LIABILITY
or
2
A DECREASE in a LIABILITY
2
A DECREASE in an ASSET
Income and expenditure a/c
A DEBIT entry represents
A CREDIT entry represents
1
1
An INCREASE in EXPENSE
or
or
2
2.3
An INCREASE in INCOME
A DECREASE in INCOME
2
A DECREASE in EXPENSE
Recording transactions
Illustration 1
Transactions
$
1
2
3
4
5
6
7
Shareholders invest in 10,000 $1 shares
Buy a car for
Buy goods for
Sell goods for
Pay wages of
Sell goods on credit
Buy goods on credit
10,000
5,000
3,000
4,000
500
3,500
2,800
Required:
Present each transaction in the form
Dr
Cr
Name of a/c
Name of a/c
$X
 Accountancy Tuition Centre (International Holdings) Ltd 2003
$X
0403
LEDGER ACCOUNTING
Solution
1
2
3
Dr
Dr
Dr
Cash (increase an asset)
Cr
Share capital
(liability to owner/equity)
$10,000
Car (increase an asset)
Cr
Cash (decrease an asset)
$5,000
Purchases (an expense)
Cr
Cash (decrease an asset)
$3,000
$10,000
$5,000
$3,000
Note: Purchases of inventory are recorded as purchases (expenses). There is
a separate adjustment for unsold inventory later.
4
Dr
Cash (increase an asset)
Cr
Revenue (income)
$4,000
$4,000
Note: Profit is not computed on each transaction.
5
6
7
Dr
Dr
Dr
Wages (an expense)
Cr
Cash (decrease an asset)
$500
$500
Trade receivable (increase an asset)
Cr
Revenue (income)
$3,500
Purchases (expense)
Cr
Trade payable (a liability)
$2,800
$3,500
$2,800
Illustration 2
Write up the “T” a/cs to reflect the double entries in respect of Illustration 1.
Solution
Note: The narrative is the “other side” of the entry.
Cash a/c
$
(1)
(4)
Share capital
Revenue
10,000
4,000
$
(2)
(3)
(5)
Car purchase
Purchases (goods)
Wages
5,000
3,000
500
Share capital a/c
$
$
(1)
Cash
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0404
10,000
LEDGER ACCOUNTING
Wages a/c
$
(5)
Cash
$
500
Non-current asset (Car) a/c
$
(2)
Cash
$
5,000
Purchases a/c
$
(3)
(7)
Cash
Trade payable
$
3,000
2,800
Revenue a/c
$
$
(4)
(6)
Cash
Trade receivable
4,000
3,500
Trade receivables a/c
$
(6)
Revenue
$
3,500
Trade payables a/c
$
$
(7)
 Accountancy Tuition Centre (International Holdings) Ltd 2003
Purchases
0405
2,800
LEDGER ACCOUNTING
Example 1
M is a sole trader of sports equipment. Write up the following transactions in “T” a/cs
(i) Introduces $10,000 capital
(ii) Buys a computer for $5,000 cash
(iii) Borrows $5,000 from the bank
(iv) Buys a printer for $3,000 cash
(v) Repays loan to bank
(vi) Purchases track suits for resale for $1,000 cash
(vii) Pays rent $1,000
(viii) Sells all the track suits for $5,000 cash.
Solution
Cash a/c
$
Capital a/c
$
$
Computer equipment a/c
$
Loan a/c
$
$
Purchase a/c
$
Rent a/c
$
$
$
Revenue a/c
$
$
$
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0406
$
LEDGER ACCOUNTING
3
BALANCING ACCOUNTS
3.1
Meaning
To balance an account means to put in a balancing figure (“strike a balance”).
3.2
Procedure
(1)
Cast (ie sum) the debit side and note the total (in pencil).
Cast the credit side and note the total (in pencil).
(2)
Whichever is the larger will be the total on both sides – write this in.
(3)
Insert the balancing figure so that both sides are equal this is called the
balance “carried forward” (c/fwd) or the balance “carried down” (c/d).
(4)
If the sum of the debits exceeds the sum of the credits (ie ΣDrs > ΣCrs)
the balancing figure is a debit balance. This is “brought forward”
(b/fwd) or “brought down” (b/d) on the debit side of the account.
If the sum of the credits exceeds the sum of the debits (ie ΣCrs > ΣDrs)
the balancing figure is a credit balance. This is “brought forward”
(b/fwd) or “brought down” (b/d) on the credit side of the account.
Illustration 3
Balancing the cash account from Illustration 2.
Cash a/c
$
$
Share capital
Revenue
10,000
4,000
______
Car purchase
Purchases (goods)
Wages
Balance c/fwd
14,000
______
14,000
______
Balance b/fwd
5,500
Note: Step 1 Debits total $14,000 and credits total $8,500.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
5,000
3,000
500
5,500
______
0407
LEDGER ACCOUNTING
Illustration 3 – Continued
Balance all the accounts in Illustration 2.
Solution
Share capital a/c
$
Balance c/fwd
10,000
______
$
(1)
Cash
10,000
______
10,000
______
10,000
______
Balance b/fwd
10,000
Wages a/c
$
(5)
Cash
500
___
$
Balance c/fwd
500
___
Balance b/fwd
500
___
500
___
500
Non-current asset (Car) a/c
$
(2)
Cash
5,000
_____
$
Balance c/fwd
5,000
_____
Balance b/fwd
5,000
_____
5,000
_____
5,000
Revenue a/c
$
Balance c/fwd
7,500
_____
$
(4)
(6)
Cash
Trade receivable
7,500
_____
4,000
3,500
_____
7,500
_____
Balance b/fwd
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0408
7,500
LEDGER ACCOUNTING
Trade receivables a/c
$
(6)
Revenue
3,500
_____
$
Balance c/fwd
3,500
_____
Balance b/fwd
3,500
_____
3,500
_____
3,500
Purchases a/c
$
(3)
(7)
Cash
Trade payable
3,000
2,800
_____
$
Balance c/fwd
_____
5,800
_____
Balance b/fwd
5,800
5,800
_____
5,800
Trade payables a/c
$
Balance c/fwd
2,800
_____
$
(7)
Purchases
2,800
_____
2,800
_____
Balance b/fwd
3.3
2,800
_____
2,800
Practical points
Although this procedure appears trivial when there is only one transaction on
the account, it is important to apply it systematically to every account.
Accounts can be balanced at any time, normally at every month end. It is
usual, therefore, to assign a date to the carrying down of balances, for
example, “Bal c/d @ 31.3.03 . . .” and “Bal b/d @ 1.4.03 . . .”
4
EXTRACTING A LIST OF BALANCES (“TRIAL BALANCE”)
4.1
Purpose
A list of balances provides a link between the ledger accounts and the
financial statements.
4.2
Extraction
Ledger balances can be extracted (ie listed) at any time (eg at month ends)
and are always extracted at the accounting year end for the preparation of the
balance sheet and income statement.
It is simply a list of all the debit and credit balances on the individual ledger
accounts.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0409
LEDGER ACCOUNTING
4.3
Proforma
List of balances as at . . . .
Dr
$
Capital
Accumulated profit (at beginning of period)
Freehold property
Plant and equipment – cost
Plant and equipment – depreciation (see Session 9)
Opening inventory (see Session 11)
Purchases
Revenue
Rent and rates
Wages
Sundry expenses
Cash in hand
Bank overdraft
Trade receivables
Provision for bad & doubtful debts (see Session 10)
Trade payables
Cr
$
x
x
x
x
x
x
x
x
x
x
x
x
x
x
__
x
x
__
x
__
x
__
Illustration 4
Extract a list of balances from Illustration 3.
Solution
Dr
$
Cash
Share capital
Wages
Car
Revenue
Trade receivables
Purchases
Trade payables
5,500
10,000
500
5,000
7,500
3,500
5,800
Note: Debit balances represent assets and expenses
Credit balances represent liabilities and income.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
Cr
$
0410
______
2,800
______
20,300
______
20,300
______
LEDGER ACCOUNTING
Example 2 – Example 1 Revisited
Balance the accounts of M and extract a list of balances.
Solution
Cash a/c
$
$
$
(i) Capital 10,000
(iii) Loan
5,000
(viii) Revenue 5,000
Capital a/c
(ii) Computer
(iv) Printer
(v) Loan
(vi) Purchases
(vii) Rent
5,000
3,000
5,000
1,000
1,000
______
______
Computer equipment a/c
$
10,000
______
______
Loan a/c
$
$
(v) Cash
5,000
3,000
_____
_____
$
5,000
(iii) Cash
5,000
______
______
Purchase a/c
(vi) Cash
(i) Cash
______
______
______
______
(ii) Cash
(iv) Cash
$
$
1,000
Rent a/c
$
$
(vii) Cash
Revenue a/c
$
$
(viii) Cash
5,000
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0411
1,000
$
LEDGER ACCOUNTING
Cash
Capital
Computer equipment
Loan
Purchases
Revenue
Rent
5
CLOSING THE BOOKS
5.1
Explanation
Dr
$
Cr
$
______
______
______
______
There are two types of account
income and expense accounts – these are “closed off” to the
trading and income and expenditure account (“I&E a/c”)
asset and liability accounts which are left to be represented in the
balance sheet. Closing balances are simply brought down (or
forward) as the opening balances for the next accounting period.
Illustration 5
(a)
Close off the income and expense accounts in Illustration 3 by transferring
their balances to a “T” a/c headed “I&E a/c”.
(b)
Balance the I&E account.
Solution
Wages a/c
$
$
Balance b/d
500
___
Transfer I&E a/c
500
___
Revenue a/c
$
$
Transfer I&E a/c
7,500
_____
Balance b/d
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0412
7,500
_____
LEDGER ACCOUNTING
Purchases a/c
$
$
Balance b/d
5,800
_____
Transfer I&E a/c
5,800
_____
I&E a/c
$
$
Purchases
Wages
Transfer accumulated profit
5,800 Revenue
500
1,200*
_____
7,500
_____
7,500
_____
7,500
_____
* The balancing figure represents profit (Cr Accumulated profit)
or loss (Dr accumulated profit).
6
DRAFTING ACCOUNTS
This is simply presenting the I&E a/c and balances in the prescribed formats
(ie suitable for presentation as financial statements).
Example 3 – Example 2 Revisited
(a) Close the income and expenditure accounts to an I&E a/c.
(b) Draft the income statement and balance sheet.
Solution
Purchase a/c
$
(vi) Cash
Rent a/c
$
$
1,000
 Accountancy Tuition Centre (International Holdings) Ltd 2003
(vii) Cash
0413
1,000
$
LEDGER ACCOUNTING
Revenue a/c
$
I&E a/c
$
$
$
–––––
–––––
–––––
–––––
Income Statement for the period ended .....
$
Revenue
Less: Cost of sales
_____
Gross profit
Less: Expenses
_____
Net profit
_____
Balance sheet as at .....
$
ASSETS
Non-current assets
Current assets
Cash
______
______
EQUITY
Capital
Profit
______
______
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0414
LEDGER ACCOUNTING
FOCUS
You should now be able to:
explain debit and credit and how double-entry bookkeeping relies upon the
convention of duality and the balance sheet equation;
distinguish between assets, liability, revenue and expense accounts and
illustrate how the income statement and balance sheet are inter-related;
record individual transactions in a set of general ledger (“T” a/cs);
balance the accounts and explain the meaning of the balance on each type of
account;
extract a trial balance;
close the books;
draft simple financial statements.
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0415
LEDGER ACCOUNTING
EXAMPLE SOLUTIONS
Solution 1 – Ledger entries
Cash a/c
Capital a/c
$
$
(i)
Capital 10,000
(iii) Loan
5,000
(viii) Revenue 5,000
(ii)
(iv)
(v)
(vi)
(vii)
Computer
Printer
Loan
Purchases
Rent
$
5,000
3,000
5,000
1,000
1,000
(i) Cash
Computer equipment a/c
$
(ii) Cash
(iv) Cash
$
$
(v) Cash
5,000
3,000
5,000
(iii) Cash
5,000
$
$
Trf I&E a/c
$
Rent a/c
$
1,000
10,000
Loan a/c
Purchase a/c
(vi) Cash
$
1,000
(vii) Cash
1,000
$
Trf I&E a/c
1,000
Revenue a/c
$
Trf I&E a/c
5,000
$
(viii) Cash
5,000
Solution 2 – Balancing ledger accounts
Cash a/c
$
$
______
(ii) Computer 5,000
(iv) Printer
3,000
(v) Loan
5,000
(vi) Purchases 1,000
(vii) Rent
1,000
Bal c/d
5,000
______
20,000
______
20,000
______
(i)
Capital 10,000
(iii) Loan
5,000
(viii) Revenue 5,000
Bal b/d
Capital a/c
$
(i) Cash
Bal c/d
0416
10,000
10,000
______
______
10,000
______
10,000
______
Bal b/d
5,000
 Accountancy Tuition Centre (International Holdings) Ltd 2003
$
10,000
LEDGER ACCOUNTING
Computer equipment a/c
$
$
(ii) Cash
(iv) Cash
5,000
3,000
_____
$
(v) Cash
Bal c/d
8,000
_____
Bal b/d
Loan a/c
5,000
_____
8,000
_____
(iii) Cash
5,000
_____
8,000
_____
8,000
Purchase a/c
(vi) Cash
$
$
1,000
Rent a/c
$
$
(vii) Cash
$
1,000
Revenue a/c
$
$
(viii) Cash
5,000
List of balances
Dr
$
5,000
Cash
Capital
Computer equipment
Loan
Purchases
Revenue
Rent
Cr
$
10,000
8,000
–
1,000
–
5,000
1,000
______
______
15,000
______
15,000
______
Solution 3 – Closing books
(a)
Purchase a/c
$
(vi) Cash
1,000
_____
Rent a/c
$
Trf I&E a/c
1,000
_____
 Accountancy Tuition Centre (International Holdings) Ltd 2003
$
(vii) Cash
0417
1,000
_____
$
Trf I&E a/c
1,000
_____
LEDGER ACCOUNTING
Revenue a/c
I&E a/c
$
TrfI&E a/c
5,000
–––––
(viii) Cash
$
$
5,000
–––––
Purchases
1,000
Rent
1,000
Trf Accumulated
profit
3,000
–––––
5,000
–––––
$
Revenue
–––––
5,000
–––––
(b)
Income Statement for the period ended .....
$
Revenue
Less: Cost of sales
5,000
(1,000)
_____
Gross profit
Less: Expenses
4,000
(1,000)
_____
Net profit
3,000
_____
Balance sheet as at .....
$
ASSETS
Non-current assets
Current assets
Cash
8,000
5,000
______
13,000
______
EQUITY
Capital
Profit
10,000
3,000
______
13,000
______
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0418
5,000
CREDIT TRANSACTIONS
OVERVIEW
Objective
To describe how credit transactions are recorded in ledger accounts.
CREDIT
TRANSACTIONS
Cash
settlement
transactions
Receipt
Payment
SETTLEMENT
DISCOUNTS
Settlement v trade
Allowed
Received
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0501
Sales
Purchases
RETURNS
Sales
Purchases
CREDIT TRANSACTIONS
1
CREDIT TRANSACTIONS
1.1
Sales
and settlement
Cash sale
D/E
Credit sale
Dr
Cash
Cr Sales
When sale made
D/E
Dr
Trade receivable
Cr Sales
When cash received
D/E
1.2
Purchases
Dr
Cash
Cr Trade receivable
and settlement
Cash purchase
D/E
Dr
Credit purchase
Purchases
Cr Cash
When purchase made
D/E
Dr
Purchases
Cr Trade payable
When cash paid
D/E
2
SETTLEMENT DISCOUNTS
2.1
Settlement v trade
Offered if invoice is paid within a
specified period. Full price is recorded
when original sale takes place.
Therefore need to account for reduced
amount of cash received. Also called
“prompt payment” discounts.
2.2
Dr
Trade payable
Cr Cash
Price reductions given to businesses
in the same trade. Sale or purchase
is recorded at net figure when
transactions entered into.
Discounts allowed – to customers
To allow a discount is to forego cash receivable – therefore an expense.
D/E
Dr
Discount allowed (I&E) a/c
Cr Trade receivable
 Accountancy Tuition Centre (International Holdings) Ltd 2003
0502
$x
$x
CREDIT TRANSACTIONS
Illustration
Si sells Art $500 of goods on credit offering him a 5% discount for early settlement.
Art takes advantage of the discount offered.
Step 1 – Record sale at full price
Dr
Trade receivable a/c (Art)
Cr Revenue a/c
$500
$500
Step 2 – (i) Record receipt of cash
Dr
Cash a/c
Cr Trade receivable a/c (Art)
$475
$475
(ii) Record discount allowed
Dr
2.3
Discounts allowed a/c (I&E)
Cr Trade receivable a/c (Art)
$25
$25
Discounts received – from suppliers
To be entitled to a discount means paying less for goods already received – ie
a reduction in expense.
D/E
Dr
Trade payables a/c
Cr Discounts received (I&E) a/c
$x
$x
Example 1
Yin buys goods from Xen for $100 on credit, and Xen offers Yin a 5% discount for
early settlement. Yin decides to take advantage of the discount offered.
Solution
Step 1 – Record purchase at full price
Dr
$
Cr
$
Step 2 –
(i) Record cash paid
Dr
$
Cr
$
(ii) Record discount received
Dr
$
Cr
 Accountancy Tuition Centre (International Holdings) Ltd 2003
$
0503
CREDIT TRANSACTIONS
3
RETURNS
3.1
Sales returns (Returns In)
The accounting entry depends on whether or not cash has been received.
If cash not yet received
D/E
Dr
Sales returns (or Revenue)
Cr Trade receivables
If cash has been received (and is therefore refunded)
D/E
3.2
Dr
Sales returns (or Revenue)
Cr Cash
Purchases returns (Returns Out)
If cash not yet paid
D/E
Dr
Trade payables
Cr Purchase returns (or Purchases)
If cash has been paid
D/E
Dr
Cash
Cr Purchase returns (or Purchases)
FOCUS
You should now be able to record:
credit sale and purchase transactions in a set of ledger accounts;
sale and purchase returns transactions in a set of ledger accounts.
EXAMPLE SOLUTIONS
Solution 1 – Discount received
Step 1 – Record purchase at full price
Dr
Purchases a/c
Cr
Trade payable a/c (Xen)
$100
$100
Step 2
(i) Record cash paid
Dr
Trade payable a/c (Xen)
Cr
Cash a/c
$95
$95
(ii) Record discount received
Dr
Trade payable a/c (Xen)
Cr
Discounts received a/c
 Accountancy Tuition Centre (International Holdings) Ltd 2003
$5
$5
0504