Revision Notes 0452 Accounting PDF

REVISION NOTES 0452 ACCOUNTING  1.1 The purpose of accounting Book-keeping Purposes of measuring business profit and loss ❖ Book-keeping is the detailed recording of ❖ To know whether the owner is receiving a all the financial transactions of a busine...

REVISION NOTES 0452 ACCOUNTING  1.1 The purpose of accounting Book-keeping Purposes of measuring business profit and loss ❖ Book-keeping is the detailed recording of ❖ To know whether the owner is receiving a all the financial transactions of a business return on his investment Accounting ❖ To check funds are available for expanding or improving the business ❖ Accounting is using book-keeping records to prepare financial statements and to ❖ Whether to close down the business if the assist in decision making owner is not receiving any return on his investment Role of accounting ❖ To check whether funds are not available ❖ To provide financial information for for running the business decision making purposes  1.2 The accounting equation Assets Accounting equation ❖ Assets are resources owned or controlled Assets = equity (capital) + Liabilities by the business to carry out its activities Capital = Assets – Liabilities Liabilities Liabilities = Assets - Capital ❖ Liabilities are the amounts owed by the business to other businesses or individuals Notes Owner’s equity Anything provided for a business by ❖ Owner’s equity is the amount contributed the owner represents capital. This is by the owner and profit made by the not necessarily in the form of money business  2.1 The double entry system of book-keeping Advantages of maintaining Double entry system of book-keeping ALICE Matrix double entry records Step 4: Step 2: Step 4: ❖ Double entry system of book- Choose Classify Choose ❖ The possibility of fraud is keeping is the process of making a “Dr or Cr” the “Dr or Cr” reduced debit entry and a credit entry for accounts ❖ Easy to prepare financial each transaction DR Accounting CR statements elements Steps to record double entry ❖ Full details are available transactions + Assets - about the assets, liabilities, A - Assets revenues and expenses of L - Liabilities - Liabilities + the business 1. Identify two accounts I - Income 2. Classify the accounts according to C - Capital - Income + ❖ Detailed records are “ALICE” E - Expense 3. Determine which accounts go to - Capital (equity) + available for reference purposes “+” and which accounts go to “-” + Expense - 4. Determine which accounts go to ❖ Information required by “Dr” and which accounts go to “Cr” bank/lender is readily Step3: Accounts “+” or “-” available  2.1 The double entry system of book-keeping Important double entry transactions for easy Important double entry transactions for easy Important double entry transactions for easy recall recall recall ❖ Goods sold on credit (invoice ❖ Goods purchased on credit (invoice ❖ When money is withdrawn by the owner issued/sales invoice) received/purchases invoice) for personal use DR Trade receivables (selling price) DR Purchases DR Drawings CR Sales (selling price) CR Trade payables CR Cash/Bank ❖ Goods sold for cash or cheque ❖ Goods purchased for cash or cheque ❖ When a non-current asset is withdrawn by the owner for personal use DR Cash/Bank DR Purchases CR Sales CR Cash/Bank DR Drawings CR Non-current assets ❖ Sales returns of goods sold on credit ❖ Purchase returns of goods bought on (customer returns/credit note issued) credit (business returns/credit note ❖ When inventory (goods) are withdrawn received) by the owner for personal use DR Sales returns CR Trade receivables DR Trade payables DR Drawings CR Purchase returns CR Purchases Trade receivables: the people or organizations who owes to the Drawings: Whenever the owner of a business takes value from the business business for his/her own use Trade payables: the people or organizations to whom money is owed Inventory: is the goods a business has available for resale by the business  2.1 The double entry system of book-keeping Interpreting ledger accounts and their balances Ledger accounts Example: The following account appears in the Post transactions to the ledger accounts ledger of Ajay. ❖All accounts are kept in a book Ajay The steps for recording transactions are: called the ledger Xavier Traders account 1. Determine the names of the account Date Details $ Date Details $ ❖There are two ways of presenting 2. Identify the types of the account 2019 Balance 122 2019 Cash 122 accounts: 3. Identify the effects on the accounts - Mar 1 b/d Mar 9 apply rules of double entry ✓ T account format 8 Sales 650 15 Returns 98 ✓ Three column running balance Balancing the ledger accounts accounts ❖When balancing an account, add up Explain the following entries in the above account and ❖Division of the ledger each side of the account and find the state where the double entry for each item will be found difference between them before ✓ Sales ledger – trade receivables Mar 1: Xavier trader owe Ajay $122 for goods supplied drawing total lines and before writing account on credit in previous months the word “balance” Double entry: Xavier traders account for Feb Credit side ✓ Purchases ledger - trade payables Mar 8: Ajay sold goods on credit to Xavier Trader, $650 account Double entry: Sales account credit side ✓ Nominal (general) ledger - any Mar 9: Ajay received cash, $122 from Xavier Trader account apart from trade payables Double entry: Cash account debit and trade receivables  2.2 Business documents Business documents/Source documents Types of source documents and its uses… ❖ Business rely on source documents to record ❖ Statement of account: it is a document issued business transactions by the seller of goods on credit to summarize the transactions for the month ❖Source documents serve as evidence to prove (statement of account is never entered in the that a business transaction have taken place and accounting records) it also provide details of transactions ❖ Cheque: is a written order to a bank to pay a Types of source documents and its uses stated sum of money to the person or business named on the order ❖ Invoice: request for payment from the seller ✓ Cheque counterfoil: shows payment made by (used for credit transactions on sales and cheque purchases) ✓ Pay-in-slip: evidence for payment to a third party ❖ Debit note: is a document issued by a buyer of goods on credit to request a reduction in the ❖ Receipt: is a written acknowledgement of invoice received. (debit notes are never money received and acts as a proof of entered in the accounting records) payment ❖ Bank statement: is a copy of customers ❖ Credit note: is a document issued by a seller of account in the books of the bank which is sent goods on credit to notify of a reduction in an to the customer at regular intervals invoice previously issued  2.3 Books of prime entry Dual function of the cash book Types of books of prime entry/books of original entry Book of prime entry It is a book of prime entry Books pf prime Purpose because it is written up ❖ A book of prime entry is one in which entry from the documents transactions are recorded before being entered in the ledger Cash book Record all money transactions It is a part of the double including cash, cheques and entry system as it acts as a Advantages of using journals electronic bank transfers ledger accounts for cash ❖ Prevents overcrowding of the general Petty Cash To record low-value cash payments and bank journals book Advantages of Cash book Sales journal Records credit transactions relating ❖ Allows different staff to work on each to selling of inventory journal to improve efficiency The cash book reduces Purchases Records credit transactions relating number of entries in the ❖ Useful when preparing control accounts journal to the buying of inventory ledger Sales returns Records the returns of inventory Difference between journals and ledgers One person can be put in journal (previously sold on credit) from customers charge of the book, thus ❖ A journal records the transactions in increasing the efficiency chronological order by date. A ledger Purchases Records the returns of inventory and accountability records the transactions by each returns journal (previously bought on credit) to individual account and shows the suppliers Contra entry remaining balance amount in the General journal Records all other transactions not Contra entry is one which accounts recorded in the above journals and appear on both sides of cash book the cash book  2.3 Books of prime entry Advantages of Petty Cash book Trade discounts and cash discounts Reduces number of entries in the main cash book Cash discounts Trade discounts Provide valuable training for junior member of staff Given to encourage Given to encourage Allows chief cashier to concentrate on prompt payment bulk purchases more important tasks Given at the point of Given at the point of Imprest system payment purchase or sale The imprest system of petty cash is where Discount allowed No record of trade the amount spent each period is restored recorded as an expense discount in the ledger so that the petty cashier starts each period and discount received and it is not part of the with the same amount recorded as an income double entry in the ledger Advantages of imprest system Petty cash expenditure can be controlled Under this system the chief cashier is aware of exactly how much petty cash has been spent in each period Prevention of fraud  3.1 The trial balance Trial balance Errors which are not shown by a trial balance A trial balance is a list of the balances on Name of error Description Example the accounts in the ledger at a certain date When a transaction is entered using the correct amount and on the correct side, Cash received from Malini Commission but in the wrong account of the same credited to Malika’s account Purpose class Checks the arithmetical accuracy of When the correct amount is entered in the double entry Complete the correct accounts, but the entry has Cash drawings debited to the Is useful in preparing financial cash account and credited to reversal been made on the wrong side of each the drawings account statements account When a transaction has been completely Limitations Omission omitted from the books. Neither a debit Payment of wages not entered in books It does not imply that the double entry entry nor a credit entry has been made is error-free When an incorrect figure is used when a The trial balance will still balance if any Goods, $100, bought on credit Original entry transaction is first entered in the but recorded as $1000 of the following errors are made accounting records Commission When a transaction is entered using the Omission Motor expenses debited to Principle correct amount and on the correct side, motor vehicles account Compensating but in the wrong class of account Reversal Original entry Purchases account under Compensating These occur when two or more errors added by $100 and sales returns Principle error cancel each other out account over added by $100  3.1 The trial balance The trial balance and the errors The preparation of trial balance There are some errors that are not revealed by the trial Classify the accounting balance (though the trial balance would still balance) elements according to the DEA CLIC when preparing The trial balance will still balance if any of the following the trial balance errors are made D- debit C- credit Transactions which are entered in the wrong C Commission account of same class E- expenses L- liabilities A- assets I- income O Omission Transactions are not recorded at all C- capital Compensating When two or more errors cancel each other C errors out Other items which appear in the trial balance are: An account that should be debited is credited An Account that should be credited is Debit Credit R Reversal debited (During the correction of errors, the amount Sales returns Purchases returns should be doubled to reverse the effects) Drawings Accumulated depreciation Transactions are recorded in the correct O Original Entry account but the amount is wrong when Provision for doubtful debts transaction is first entered in the books Transactions which are entered in the wrong Retained earning P Principle account and wrong class  3.2 Correction of errors Errors which affect a trial balance Adjusting profit after correction of errors If the trial balance fails to balance, It’s obvious that an error has made Profit are affected if income and somewhere. expense items are adjusted during The effect of correction of errors on correction of errors on the journal and a statement of financial position This may be: ledgers ✓ An error of addition within the trial If errors are discovered and All debit adjustments of expense or balance income reduce profit corrected after the preparation ✓ An error of addition within one of the of financial statements, the ledger accounts Dr Expense Profit reduces ✓ Entering different figure on the credit statement of financial position to that entered on the debit when may have to be amended Dr Income Profit reduces making a double entry in the ledger ✓ Making a single entry for a transaction If the profit for the year has rather than a double entry been corrected this will affect All credit adjustments of expense or Use of suspense account income increase profit the capital section of the It is a temporary account opened in statement of financial position, order to make the totals of a trial Dr Expense Profit reduces but the ither items may also balance agree Dr Income Profit reduces need to be amended When all the errors have been found and corrected, the suspense account will close automatically. 3.3 Bank reconciliation Statements Differences between cash book and bank statement Reasons why the bank account and the bank statement may differ Entries in the cash book not Entries on the bank found in the bank statement not found on the Timing difference in the recording of transactions statement (the bank is cash book (the business is Error in recording by one party unaware or has not unaware and has not recorded) recorded Purpose of preparing bank reconciliation statement To reconcile the difference between the cash Debit entries in the Credit entries in ✓ Standing orders ✓ Credit transfers book balance and its bank records to assure that cash book the cash book Eg: Insurance (receiving the difference in values are due to legitimate Cheques deposited Cheques paid to premium payment by the business but trade/other ✓ Bank charges electronically) reasons not yet recorded by payables but not ✓ Interest charged Dividends the bank eg: due to yet presented at ✓ Dishonored deposited To deter internal staff from commuting fraud public holidays. the bank cheque directly into (uncredited (unpresented bank account To identify any errors in the bank statement or the deposits) cheques) ✓ Interest cash at the bank account during the received reconciliation process Recorded in the bank reconciliation Record in the Record in the statement to tally with updated credit column (-) debit column (+) balance from the cash book of the cash of the cash book book  3.3 Bank reconciliation Statements Bank charges Format of a bank reconciliation statement Monthly service charges at the bank Bank reconciliation statement as on …. account Dishonored cheque $ $ Notes Cheques which are returned unpaid Balance as per updated cash book X because of insufficient fund or post- Credit balance in the bank = debit balance Add: Unpresented cheques x dated in the cash book X ✓ This is because the bank and business take Credit transfer an opposite point of view Less: uncredited cheques (X) ✓ When the business deposits money into the Trade receivables pay directly into the bank, bank owes to the business. Hence the Balance as per bank statement X bank bank treats the business as a liability (credit balance) Standing order The ending balance in the bank Business instruct bank to make payment reconciliation statement should tally with on its behalf the debit balance in the cash at bank account Interest received Interest earned on deposits Interest charged Interest charged on overdraft  3.4 Control accounts Types of control accounts Sources of information for control account Sales ledger control account (total trade Item Source of information Notes receivables account) Purchase ledger control account (total trade Credit sales Sales journal Source of information is payables account) not source documents Credit purchases Purchase journal Purposes of purchases ledger and sales ledger The accounts in the sales control accounts Sales returns Sales returns journal ledger and purchases ledger are not used to They can assist in locating errors when the trial Purchases returns Purchase returns journal provide information for balance fails to balance preparing control account They are proof of the arithmetical accuracy of Cheques paid to Trade Cash book otherwise errors in the the ledgers they control Payables ledgers would not be It helps to prepare the income statement and revealed Cheques received from Cash book statement of financial position Trade receivables Dishonored cheque Cash book Discount allowed Cash book Discount received Cash book Contra/transfer/set off General journal Interest charged on General journal overdue accounts Irrecoverable debts General journal 3.4 Control accounts Format of Sales ledger Control Account Format of Purchases ledger Control Account Sales ledger control account Purchases ledger control account (Total Trade Receivables Account) (Total Trade payables Account) Dat Details $ Date Details $ Dat Details $ Date Details $ e e Balance b/d X Discount allowed X Discount received X Balance b/d X Interest charged X Sales returns X Purchase returns X Interest charged X (refunds) Bank/Cash X Transfer/Contra X Transfer/contra X (refunds) X Bank/Cash (dishonored cheque) X Bank/Cash X bank Bank/Cash X Credit purchases X Credit sales X Irrecoverable debts X Balance c/d X Balance c/d X x x x x Balance b/d x Balance b/d x Reasons for debit balance in the Reasons for credit balance in the sales purchases ledger control account ledger control account An overpayment to the trade An overpayment by the customer payables The customer paying in advance for Paying the supplier in advance for the the goods goods The customer returning goods after Returning goods to the supplier after paying the account paying the account 4.1 Capital and revenue expenditure and receipt Effect on profit and asset Capital and revenue expenditure If capital expenditure is treated as a Capital expenditure Revenue expenditure revenue expenditure Capital expenditure is This is money spent Non-current assets Decreases money spent on on running a business purchasing non-currents, on a day-to-day Expenses Increases improving or extending basis existing non-current assets Profit Decreases These costs will appear as These costs will Equity Decrease non-current assets in the appear in the statement of financial income statement position of a business If revenue expenditure is treated as a capital expenditure Capital and revenue receipt Capital receipt Revenue receipt Non-current assets Increases A capital receipt occurs A revenue receipt is when money is received money received Expenses Decreases other than from normal from normal trading trading activities activities Profit Increase Recorded as capital or Recorded in income Equity Increase liabilities in statement of statement as financial position revenue 4.2 Accounting for depreciation and disposal of non-current assets Methods of calculating depreciation Depreciation It is an estimate of the loss in value of non-current assets over its expected Straight-line method Reducing balance Revaluation method working life (fixed instalment method) method (Diminishing balance method) Reasons for depreciation Physical deterioration ❖ Same amount of ❖ The depreciation charged ❖ NCA is revalued at a Economic reasons depreciation is each year decreases as it is given date to Passage of time charged each year calculated on the NBV rather determine the Depletion ❖ Suitable for NCA that than cost depreciation has constant usage ❖ Suitable for NCA that has ❖ Suitable for small Journal entries for the provision of Eg: furniture higher usage at initial years equipment used in depreciation and lesser usage at the later offices and years laboratories, loose tools Debit Income statement Eg: Machinery, Motor Vehicle (cost-residual value) ÷ Credit Provision for depreciation (no.of useful years) Cost price x % Value at the beginning + Net Book Value x % new purchase – value at NBV = Cost – total the end depreciation to date 4.2 Accounting for depreciation and disposal of non-current assets Accounting concepts for depreciation Journal entries for Disposal of non-current assets Matching concept states that expenses incurred (depreciation expenses) must be matched against Dr Dispose; of NCA Remove and transfer NCA Cr NCA, e.g. motor vehicles income earned (income is earned through use of the NCA) to determine the profit or loss for a given financial period Dr Accumulated depreciation Remove accumulated Cr Disposal of NCA depreciation Prudence concept stated that a business should not overstate its assets and profits. Hence it requires Dr cash at bank/other receivables business to record depreciation expenses (decrease Record payment received Cr Disposal of NCA profit) and accumulated depreciation (to reduce asset value) Profit on disposal of NCA Disposal of non-current assets DR disposal of NCA Record gain or loss from Cr income statement When a NCA is sold it is a capital receipt and it is the disposal of NCA and recorded in a special account known as disposal of lose the account Loss on disposal of NCA NCA rather than in the sales account Dr income statement Cr Disposal of NCA 4.3 Other payables and other receivables Accrued and prepaid expenses At the start of the year (these items At the end of the year (these items will Accounting concept for other are brought over from previous year) be brought forward to the next year) payables and other receivables Add(+) to this year’s expense Minus (-) from this year’s expense Expenses are recognized the Explanation Explanation moment they are incurred, income recognized the moment ❖Prepaid expense The prepaid Expense is derived from The prepaid expenses at the end of the they are earned regardless of (expenses paid the previous year. Additional year is additional amount paid in the whether full payment is made in advance) amount paid in the previous year current year and would only be utilized would be utilized (“spend”) in the (“spend”) in the next year. current year Hence it should not be added to this Matching concept: expense are year’s expenses to be matched with the income earned in the same period to Minus (-) from this year’s expense Add(+) to this year’s expense derive the correct profit. Income Explanation Explanation earned and expenses incurred before or after the financial The accrued expense is derived The accrued expenses are derived from ❖Accrued period should not be included from the previous year. The amount the current year. The amount that is expense that is owing was incurred (“spend”) owing is incurred (“spend”) this year and (expense owing) last year and belongs to the belongs to this year’s expenses. Hence it previous year’s expense. should be added to this year’s expenses Hence it should not be added to this year’s expenses 4.3 Other payables and other receivables Accrued and prepaid income At the start of the year (these items At the end of the year (these items will be are brought over from previous year) brought forward to the next year) Add(+) to this year’s expense Minus (-) from this year’s expense Explanation Explanation ❖Prepaid income (income received The prepaid income is received in the The prepaid income is received in advance in advance/ previous year. Goods and services in the current year. Goods and services unearned income would only be earned in the current would only be provided in the next year. year. Hence the income would only Hence the income would only be earned in be earned in the current year the next year Minus (-) from this year’s expense Add(+) to this year’s expense ❖Accrued income Explanation Explanation (income The accrued income is earned in the The accrued income is earned in the receivables/ previous year as goods and services current year as goods and services were income earned were provided in the previous year. provided in the current year but payment but not year Hence it should not be added to this has not been received. Hence it should be received year’s income added to this year’s income 4.3 Other payables and other receivables Format of expense account Expense account Date Details $ Date Details $ How to record other payables and other receivables in the statement of financial position Balance b/d X Balance b/d X Bank/Cash X Income X Balance c/d X statement X P - Prepaid A – Asset (other receivables) Balance c/d Expenses A - Accrued L – Liabilities (other payables) P - Prepaid L – Liabilities (other payables) Format of income account Incomes Income account A - Accrued A – Asset (other receivables) Date Details $ Date Details $ Balance b/d X Balance b/d X Income X Bank/Cash X statement X Balance c/d X Balance c/d  4.4 Irrecoverable debts and provision for doubtful Irrecoverable debts Reasons for irrecoverable debt It is an amount owing to a business which will Trade receivable is unable to pay not be paid by the credit customer Trade receivable has died or has become bankrupt Journal entries for irrecoverable debt Trade receivable cannot be traced Dr irrecoverable debts When debt is written off Cr credit Customer’s account Ways to reduce the possibility of irrecoverable debt Dr Income statement Reduce credit sales/sell on a cash basis At the year end Cr irrecoverable debts Obtain references from new credit customers Accounting concept for irrecoverable debts Fix a credit limit for each customer Improve credit control issue invoices and monthly Writing of irrecoverable debts is an example of the statements promptly application of prudence Refuse further supplies until outstanding balance is If the Irrecoverable debts are not deducted from trade paid receivables then the assets will be over-stated Allow cash discount for payment The amount of irrecoverable debt is a loss to the business, so if it is not included in the income statement then the Charge interest on overdue accounts profit will be overstated  4.4 Irrecoverable debts and provision for doubtful Debts recovered Accounting Concepts for PFDD Journal entries for PFDD A debt written off may be recovered if a credit Prudence- profit for the year is not customer pays some, or all of the amount owed, Creating PFDD overstated and the amount of trade Dr income statement after the amount was written off and increasing receivables in the statement of financial the PFDD Cr PFDD position is shown at a realistic value Journal entries for debt recovered Matching- the amount of sales for Dr PFDD Decreasing the which the business is unlikely to be paid PFDD Cr income statement is regarded as an expense of the year Dr cash/bank in which those sales are made When the amount is received Cr debts recovered account Ways to determine the amount of *Notes Dr Debts recovered PFDD are: At the year-end account When a PFDD is created, the total Looking at each individual credit amount is entered in the income Cr income statement customer’s account and estimating statement. In later years, only the which ones will not be paid amount by which the PFDD Provision for doubtful debts (PFDD) Estimating on the basis of past increases or decreases Is entered experience in the income statement It is an estimate of the amount which a business will lose in a financial year Considering the length of time debts have been outstanding by means of because of irrecoverable debts an ageing schedule 4.5 Valuation of inventory How over-valuing the closing inventory will affect financial statements (Gross Profit, Inventory valuation Profit for the year, capital and Assets) E.g. : After the preparation of financial statement for the year ended 31 December 2018, it Inventory is always valued at the was discovered that the closing inventory was over-valued by $50 lower of cost or net realizable value Overstated Understated No effect Accounting concept for Inventory ❖ Gross profit for the year ended 31 December 2018 P valuation ❖ Profit for the year ended 31 December 2018 P Prudence – overvaluing the ❖ Capital at 31 December 2018 P inventory causes both the profit ❖ Assets at 31 December 2018 P and the assets to be overvalued ❖ Gross profit for the year ended 31 December 2019 P Cost of the inventory ❖ Profit for the year ended 31 December 2019 P It is the actual purchase price plus ❖ Capital at 31 December 2019 P any additional costs (such a ❖ Assets at 31 December 2019 P carriage inwards) incurred in bringing the inventory to its present If closing inventory is over-valued then Closing inventory of 31 Dec 2018 would be the position and condition opening inventory of the next year the cost of sales will be under-stated If the opening inventory is over-valued then the cost and as a result both gross profit and Net realizable value of sales will be overstated and as a result both gross profit for the year will be over-stated. profit and profit for the year will be understated It is the estimated receipts from the Over-stating the profit for the year Under-stating the profit for the year means the means that the balance of the balance of the capital account on 31 Dec 2018 will sale of the inventory, less any costs of capital account on 31 Dec will also have been corrected at 31 Dec 2019 completing the goods or costs of be over-stated. Opening inventory is not recorded in the statement selling the goods of financial position. So no effect to the total assets Total current assets will be over-stated if the closing inventory is overvalued at 31 dec 2019  5.1 Sole trader Income statement It shows the financial performance of a Statement of financial position It is a statement of the assets and liabilities of the business on a certain business for a given financial period Sole trader date An income statement which consists of It shows the financial position of the two sections: A sole trader manages and has full control over running of business at that point in time ✓ A trading section in which the gross the business profit of the business is calculated ✓ A profit and loss section in which the Service business profit for the year of the business is calculated A service business is one which does not buy and sell goods, such as accountant, insurance company, a travel Business transactions agent, a hair dresser and so on A trading business A trading business is one which buys and sells goods Assets Liabilities Owner’s equity Income/Revenue Expenses Advantages and disadvantages of sole trader Advantages Disadvantages Easier and less Responsible for any expensive to set up losses the business Statement of financial position Income statement and maintain the makes Assets = Equity + Liabilities Profit= income - expenses business There is no one to Owner earns entire with whom to share profit decision making or Business decisions the workload can be made more The capital of the quickly, as business will be consultation is not restricted to what necessary the trader is able to invest  5.1 Sole trader Format of the Balance sheet Name of the Business Balance sheet as at… Format of the income statement $ $ $ Notes NCA are assets which are obtained for use NON-CURRENT ASSETS Cost Depreciation Bank and not for sale, To date Value The income Name of the Business which help business Premises XXX (XXX) XXX statement of Income statement for the year-ended… to earn revenue Office Equipment XXX (XXX) XXX service Motor Vehicles XXX (XXX) XXX business does $ $ $ not have a XXX (XXX) XXX Sales xxx trading Less Sales returns (xxx) xxx account CA are short-term assets CURRENT ASSETS Trading section whose amounts are Closing Inventory XXX + section constantly changing LESS COST OF SALES Trade Receivables XXX Intangible Opening Inventory xxx - Bank XXX assets is Add: Purchases xxx Cash XXX something Less: Purchases returns (xx) Other Receivables XXX XXX owned by a Add carriage inwards xxx Total Assets XXX business which Less closing inventory (xxx) (xxx) cannot be GROSS PROFIT xxx CAPITAL & LIABILITIES touched Capital XXX ADD OTHER INCOMES + Add: Profit for the year XXX Commission received xxx NCL are amount owed Less: Drawings (Cash (XXX) XXX Rent Received drawings + goods drawings) Profit & xxx which are not due for Discount Received Loss xxx Xxx repayment within next Non-current Liabilities section xxx 12 months Loan XXX LESS EXPENSES Current Liabilities Wages and salaries xxx CL are amounts owed Trade payables XXX Depreciation of motor xxx which are due for Bank overdraft XXX vehicles xxx (xxx) repayment within next Other payables XXX XXX Finance cost 12 months Total capital & liabilities XXX PROFIT OR LOSS FOR THE xxx YEAR  5.2 Partnership Advantages and disadvantages of partnership Appropriation account of a partnership A partnership appropriation account shows the Partnership Advantages Disadvantages division of the profit or loss between the partners A partnership is a business in which two or more people work together as owners with a view to Additional finance is Profits have to Format of appropriation account of partnership make profit available be shared Additional knowledge, among the $ $ $ Partnership agreement experience and skill are partners A partnership agreement includes the following available Disagreement Profit for the year Xxx The risks are shared s can occur Add: Interest on ✓ Amount of capital invested by each partner Decisions may drawings Xx + ✓ How profits and losses are to be shared take longer to Partner A xx ✓ If interest on partners’ capital is to be paid, and put into effect Partner B xx if so, at what rate Xx ✓ If partners’ salaries are to be paid and if so, what Less: Interest on capital amount Partner A xx ✓ If an upper limit is to be placed on partners’ Partner B Xx Xx drawings, and if so, what amount - ✓ If interest on partners’ drawings is to be charged, Less: Partner’s salary and if so, at what rate Partner A xx ✓ If interest on partner’s loans is to be paid and if The residual profit is the profit Partner B xx Xx (xx) so, at what rate remaining after adjusting the profit for Residual profit Xx the year for interest on drawings, interest on capital and partner’s Share of profit salaries. It is divided between partners in Partner A Xx the agreed profit sharing ratio Partner B xx xx  5.2 Partnership Loans from partners Format of current account When a loan is obtained from a partner Date Partner A Partner B Date Partner A Partner B Debit: Bank account $ $ $ $ Credit: Loan from Partner X account Balance b/d Xxx Balance b/d Xx When a loan is repaid to a partner Drawings xx Xx Interest on capital xx Xx Debit: loan from partner X account Credit: Bank account Interest on xx Xx Partner’s salary xx Xx drawings Interest on loan due but not paid Balance c/d xx Share of profit xx Xx Debit: Interest on loan account Credit: loan from partner X current account Balance c/d xx xxx xxx xxx xxx Balance b/d xx Balance b/d xx Format of statement of financial position It is same as that of sole trader with the exception of the capital section A credit balance represents the $ $ $ amount owed to the Capital partner Partner A Xx Partner B Xx Any debit xxx balance in the A debit balance current represents the account must amount owed by Current account be deducted the partner to the Partner A (xx) from the business Partner B Xx Xx capital figureb  5.3 Limited Companies Types of Shares Limited company Preference Shares Ordinary shares It is a legal entity which has a separate identity from its shareholders, whose liability for the company's debts is limited These shares get preference These are known as equity over the ordinary shares shares Advantages and disadvantages of limited company They received fixed rate of Dividends vary according to dividend the profits of the company Advantages Disadvantages Are not usually entitled to vote Are usually entitled to vote at at shareholder’s meetings shareholder’s meetings Company can issue shares to More complicated raise funds and it is easier to and expensive to set borrow money from the bank up and maintain Easier to transfer ownership business Redeemable Preference Shares through stock exchange where Shareholders receive shares are traded only a proportion of The dividend is included as a profits as dividends finance cost of the income statement (with any accrued Non- redeemable Preference dividend appearing in the Shares Share capital current liabilities in the statement of financial position) The dividend paid is included in Shown as a non-current liability the statement of changes in Issued share capital It is the amount of capital issued to the equity in the statement of financial shareholders It is included in the equity and position Called up capital It is the part of the issued share capital reserve section of the for which payment has been statement of financial position requested from shareholders Income statement of a Limited company Paid up capital It is the part of the called up capital It is exactly the same way as it is prepared for sole for which the company has received trader or partnership business payment from shareholders The only difference is that in the finance cost there may be debenture interest and dividend on redeemable preference shares  5.3 Limited Companies Format of statement of financial position Notes $ $ $ Statement of changes in equity In the statement of It shows how the profit for the year is used Equity and liabilities Equity financial position of It summarizes the changes in during the year to the a limited company ordinary share capital, non-redeemable preference the assets section share capital, retained earning and general reserve Ordinary share capital Xxx General reserve Xxx and current liabilities Retained earnings Xxx section are the same Format of statement of changes in equity as sole trader Shareholders fund Xxx Non-current liabilities + Equity is the total Ordinary General Retained Total funds provided by Debentures Xxx share reserve earning the shareholders of Capital employed xxx capital the company Balance at … (opening date) xxx xxx xxx Xxx Debenture is a long- Share issue Xxx Xxx term loan which has fixed rate of interest, Profit for the year xxx Xxx payable irrespective of the profit of the Dividend paid (interim) (xx) (xx) company Dividend paid (final) (xx) (xx) Debenture interest appear in the income statement Transfer to general reserve xx (xx) - under finance cost Balance at … (closing date) xxx xxx xxx xxx 5.4 Clubs and societies Difference between receipts and payments account and income and expenditure account Introduction Receipts and payments Receipts and payment Income and expenditure It is an organization formed to provide facilities account is a summary of the account account and services for members and they are not cash book which is prepared annually No adjustments are Adjustments are made for formed with the aim of making profit made for accruals and accruals and prepayments prepayments Terms used by a business and those used by a club Income and expenditure or society Non-monetary items Non-monetary items such account compares the such as depreciation as depreciation are gains and the expenses to Business Club or society are not included included calculate surplus or deficit Includes both capital Includes only revenue Cash book Receipts and payments account and revenue items items A surplus arises when the Income statement Income and expenditure account gains of a club and society exceed the expenses Profit for the year Surplus Loss for the year Deficit A deficit arises when the expenses of a club and Capital Accumulated fund society exceed the gains The accumulated fund consist of the surpluses (less any deficits) which have accumulated over the life of the organization Accumulated fund = Assets - Liabilities 5.5 Manufacturing accounts Prime cost Introduction Direct material It is the cost of the essentials necessary for production Costs of the materials Formula: Direct expenses + Direct Labor + Direct A manufacturing account is part of used during the period. material the annual financial statements and Include the purchase is used to calculate the cost of price of raw materials goods produced and the acquisition cost Cost of production related to the purchase It is the total cost of manufacturing the Eg: Purchase of raw goods completed THE ELEMENTS OF COST materials, carriage Formula: Prime cost + Factory overhead inwards/ freight charge on raw materials Factory overheads Work in progress These are sometimes It is the goods which are partly completed referred to as indirect Direct expenses at the end of the financial year factory expenses. They These are any other include all the costs expenses which a involved in operating the manufacturer can Calculation of unit cost Direct labor factory which cannot directly link with the Wages paid to the Formula: Cost of Production directly linked with the product being people who are No.of units produced product being manufactured directly involved in manufactured Eg: Royalty: a fee paid the manufacturing Eg: factory rent and rates, by the manufacturer for process depreciation of factory every item produced to Eg: Direct labour, machinery, indirect factory the person who Direct wages, wages originally invented the Factory wages, product Production wages or manufacturing wages 5.5 Manufacturing accounts… Format of Manufacturing Account Format of income statement (trading account) Format of statement of $ $ of a manufacturing concern financial position DIRECT MATERIALS XXX $ $ $ $ $ Opening inventory of raw materials Add: Purchases of raw materials XXX Revenue of finished goods XXX Current Assets + Carriage inwards of raw materials XXX Inventories : (XXX) XXX - Returns outwards (purchase returns) of raw materials Less: sales returns (XX) Raw material XXX XXX (XXX) XXX Work in Progress XXX Less: Closing inventory of raw materials XXX Less: cost of sales Finished Goods XXX XXX (XXX) Opening inventory of finished goods XXX Less: Sale of scrap of raw materials XXX Add: Cost of containers and packing materials Cost of production XXX (opening inventory + purchases – closing inventory) XXX XXX Add: Purchases of finished goods XXX *Notes Cost of raw materials consumed DIRECT LABOUR Less: Finished goods drawings by the (XX) XXX The Statement of Financial Manufacturing wages/Production wages XXX owner position of a manufacturing DIRECT EXPENSES account is similar to that XX Less: Closing Inventory of finished (XXX) Factory direct expenses / Royalties XXX goods prepared by a wholesale or Prime Cost (XX) retail business. There is only FACTORY OVERHEADS Gross profit or Gross loss XXX one main deference which is Indirect wages XXX that a manufacturer may Indirect Expenses XXX have three different Factory rent and rates XXX Dep. On factory paint and equipment XXX inventories-raw material, work XXX in progress and finished goods. Add: Opening Inventory of work – in – progress XX Less: Closing inventory of work – in – progress (XX) (XX) COST OF PRODUCTION XXX 5.6 Incomplete records Four basic techniques used for incomplete records What are incomplete records? Incomplete records refer to cases where a full set of double entry books are not kept or when there are missing information due to lapse in recording Capital comparison Construction of a cash Via control accounts Use of mark-up, margin & method or bank summary rate of inventory turn over When a list of assets and Prepare statement of Use to calculate Use to calculate credit Use to calculate liabilities is prepared affairs bank figure, sales, credit purchases, sales, purchases, without the use of a set of incomes/expenses amount received from gross profit, and cost double entry records it is figure, amount trade payables, amount of sales (refer 6.1) known as a Statement of received from trade paid to trade payables or Affairs rather than a Calculate profit/loss using receivables and any other missing figure in balance sheet CADLON amount paid to the control accounts $ trade payables Closing capital x (refer 3.4) Mark-up: Gross profit x 100 Add: Drawings x Profit/loss can also COS Less: Opening capital (x) be calculated via New capital (x) capital account Gross profit margin: Gross profit x 100 Profit/loss xx Sales Rate of inventory turnover = cost of sales Average inventory  6.1 Calculation and understanding of accounting ratios Accounting ratios Profitability ratios Liquidity ratios Current ratio Current assets Satisfactory Gross profit margin Gross profit/sales x 100 (working capital ratio) current liabilities level: 2:1 Profit Margin Profit/sales x 100 Liquid (quick) ratio Current assets-inventory Satisfactory (Acid test ratio) current liabilities level: 1:1 Return on capital Profit before employed (ROCE) interest/capital Rate of inventory turn Cost of sales employed x 100 over Average inventory Trade receivables turn Trade receivables X 365 over credit sales Capital Employed: Trade payables turn Trade payables X 365 = Owner’s capital +NCL over credit sales Or = Issued Shares + Reserves Importance of profitability ratio Importance of Liquidity ratio + Non-Current Liabilities (LTD) Business needs to know its A Business needs to have adequate operating efficiency and cash flow to operate efficiently. Average Inventory: identify arear to increase