Accounting Short Notes PDF

SHORT NOTES Unit 01 – Accounting & it’s importance MAIN OBJECTIVES OF ACCOUNTING Financial - To provide general purpose financial statements to stakeholders for decision making (specially for existing and potential investors, lenders and other creditors) Management - To provide...

SHORT NOTES Unit 01 – Accounting & it’s importance MAIN OBJECTIVES OF ACCOUNTING Financial - To provide general purpose financial statements to stakeholders for decision making (specially for existing and potential investors, lenders and other creditors) Management - To provide Specific purpose managerial information to managers for decision making SEQUENTIAL ORDER OF ACCOUNTING Transactions take place Source Documents are prepared Prime entry books are prepared Posted to Ledger Accounts Preparation of Trial Balance Financial Statements Differences between Financial Accounting and Management Accounting Financial Management Purpose General purpose  specific purpose Users Internal & External Internal only Legal requirement compulsory  not compulsory Reporting frequency  Annually On demand Nature of information Historical Present and forecasted Legal Technological Technical & Professional Environmental factors of Accounting  Social & Cultural Political & Economic Lakshitha Rathnayake Page 1 Accounting Elements - Assets, Liabilities, Equity Expense, Income, Main Elements Sub Elements Components of financial statements Statement of profit or loss - Net profit SOFP – financial position Cash flow statement – Changes in financial position Statement of Changes in equity Accounting notes Measurement basis of Accounting Element 1) Historical cost 2) Current Cost a) Fair Value (the present market value) b) value in use and fulfillment value (Value in use - The use you gain without selling the asset) c) Current cost Qualitative Characteristics Fundamental Enhancing/improvable Relevance - Predictive value Timelines Confirmatory value Verifiability Materiality Understandability Comparability Faithful representation - Completeness Neutral Free from errors Main Underlying Assumption Going concern New trends of accounting Computerized Accounting Human Resource Accounting Environmental Accounting Inflationary Accounting Social Responsibility Accounting Lakshitha Rathnayake Page 2  Unit 02 - Accounting equation A (Final Accounting = equation) E + L Basic Accounting equation (+) (-) Add Capital/ Income Drawings/ Expenses A + E = Eq + I + L Final Accounting equation Profit equation/ Net asset approach Profit/Loss = NA1 - NAo + D - AC Profit/Loss = Increase in net assets + D - AC Increase in net assets = Increase in Assets – Increase in Liability Equity Capital = Net Assets Capital Retained How to record VAT under accounting equation  only add. Earning Ex-; Credit purchases Rs.230,000 (including 15% VAT) capital Drawings A = E + L Income +200,000 (stocks) +230,000(creditors) Expenses +30,000 (VAT receivable) Ex-; Credit sales Rs.230,000 (including 15% VAT) cost of these goods 180,000 A = E + L -180,000 (stocks) +20,000(profit) +30,000 (VAT payable) +230,000 (debtors) How to record EPF under accounting equation A = E + L ( - ) Net salary (-) employee related total (+) EPF (employer + employee) expense Mark up (profit on cost) and Margin (profit on Selling price) Ex-: Selling price 240,000 (profit 20% on cost) Cost + profit = Selling price Meaning of 20% on cost is 100 + 20 = 120 To find cost = 240,000 x 100 To find profit = 240,000 x 20 120 120 Ex-: Cost 160,000 (profit 20% on selling price) Cost + profit = Selling price Meaning of 20% on selling price is 80 + 20 = 100 To find selling price = 160,000 x 100 To find profit = 160,000 x 20 80 80 Lakshitha Rathnayake Page 3 Unit 03 Double entry system A + E = C + I + L Increase Debit Increase Credit Decrease Credit Decrease Debit Type of account Provision for depreciation and provision for doubtful debts - Asset Account Sales return - Income account Purchase return – Expense account Retained earnings –equity Accrued expense - Liability VAT account - Asset /Liability Prepaid expense - Asset Provision for warranty – Liability Provision for gratuity - Liability Income received in advance- Liability Subscription - Income account Income receivable - Asset Life membership- Equity Accumulated fund - Equity Drawing - Equity Double entries which use frequently  credit sales - Debtors control Dr Sales Cr Credit purchases – Purchases Dr Creditors control Cr  Sales Return - Sales Return Dr Debtors control Cr Purchase Return - Creditors control Dr Purchase Return Cr  Discount Received - Creditors control Dr Discount Received Cr  Discount Allowed - Discount Allowed Dr Debtors control Cr  Bad debts - Bad debts Dr Debtors control Cr  Doubtful debts - Doubtful debts Dr Provision for Doubtful debts Cr  Depreciation - Depreciation Dr Provision for Depreciation Cr  Closing stock - Closing stock Dr Cost of sales Cr Goods drawings - Drawings Dr Purchases Cr Lakshitha Rathnayake Page 4 Unit 04 – Prime entry books (Chronological book of Accounts) SR Transaction Source document Prime Entry Book NO 1 Cash Receipts Receipt Cash Receipt Journal 2 Cash payments Payment Voucher Cash Payment Journal 3 Credit sales - (Goods ) Sales Invoice Sales Journal 4 Credit Purchase – (Goods) Purchase Invoice Purchase Journal 5 Sales returns Credit Note Sales return Journal 6 Purchase returns Debit Note Purchase return Journal 7 Petty cash transactions Petty Cash Voucher Petty Cash journal 8 All other transactions Journal Voucher General Journal Opening entries (A & L) Closing entries (I & E) Rectification of errors Purchase of NCA on credit Sale of NCA on credit Dishonored cheques List Price = 8 000 (Trade discount 10%) Invoice Price = 7 200 should be recorded in purchase journal (Always after deducting trade discount) If cash discount of 10% is received when settlement by cheque, double entry Creditor Dr 7200 Cash Cr 6480 Discount received Cr 720 If this cheque is returned by the bank Cash control Dr 6480 Discount received Dr 720 Creditor Cr 7200 If cheque issued for payment an expense returned by the bank Cash control Dr xx Accrued expense Cr xx Credit purchases with VAT Purchase Dr xxx (excluding vat) Income statement Vat control Dr xxx (vat amount) asset Creditors control Cr xxx (including vat) Credit Sales with VAT Debtors control Dr xxx (including vat) Vat control Cr xxx (vat amount) Liability Sales Cr xxx (excluding vat) Income statement Lakshitha Rathnayake Page 5 Petty cash imprest/Float – total amount given to petty cashier Reimbursement - Amount given by the main cashier to refill petty cash imprest Format of a Cash Receipt Journal Date Receipt No Description Discount Amount Analysis Columns VAT Allowed Sales Debtors Income Other xxxxx xxxxx xxxxxx xxxxxx xxxx xxxx Discount Allowed Dr. Exp. Debtors Control Cr. Assets (Asset ) Cash Control Account Dr (Income ) Sales Cr. (Asset ) Debtors control Cr. (Income ) Income Cr. ( Liability ) VAT control Cr. Format of a Cash Payment Journal Date Payment Description Discount Amount Analysis Columns VAT No Received Purchases Creditors Expenses Other xxxxx xxxxx xxxxxx xxxxxx Xxxx xxxxx Creditors Control Dr. Discount Received Cr. (Expense ) Purchase Dr. (Liability ) Creditors Dr. (Exp. ) Other Exp. Dr. (Asset ) VATCcontrol Dr (Asset ) Cash Control Cr. Format of a Petty Cash Journal Date Voucher Descripti Ledger Amount Analysis Columns No on Folio Postage Stationery Cleaning Other Ledger (Creditors) xxxxx xxxxxx xxxxxx xxxxx xxxxxx Petty Cash Imprest is given by the main Cashier: Stationery Dr. xxxx Postage Dr. xxxx Petty Cash Control Dr. xxxx Cleaning Dr. xxxx Cash Control Cr. xxxx Other Dr. xxxx Ledger (Creditors) Dr. xxxx Petty Cash Control Cr. Xxxx Lakshitha Rathnayake Page 6 Format of a Purchase Journal Date Invoice No Suppliers Name Excluding VAT VAT(15%) Including VAT 1/20 001 Nimal 200 30 230 200 30 230 Purchase Dr. Creditors Control Dr. Credit Purchase of Goods VAT Dr. (Assets) (Including VAT) (Expense ) ) ( Format of a Purchase Return Journal Date Debit Note No Customers Name Excluding VAT VAT(15%) Including VAT 1/25 002 Nimal 50 7.5 57.5 50 7.5 57.5 Purchase Return Cr. (E) VAT Cr. (Assets ) Creditors Dr. (L ) Format of a Sales Journal VAT Column is needed only if the Business is a PLC or VAT registered only Date Invoice No Customers Name Excluding VAT VAT(15%) Including VAT Amal 300 45 345 300 45 345 Sales Journal Credit Sales of Goods Sales Cr.(I) VAT Cr.(L) Debtors Control Dr (Asset) Format of a Sales Return Journal Date Credit Note No Customers Name Excluding VAT VAT(15%) Including VAT Amal 100 15 115 100 15 115 Return Dr Sales Cr. VAT Dr.(c) Debtors Cr.(A) Lakshitha Rathnayake Page 7 General Jouurnal BANK RECONCILIATION Causes for differences Errors of Omission (standing order, bank charges, direct deposit) Arithmetic Errors Errors of Timing differences (Un-presented &unrealized) Bank Balance 50 000 Bank Balance 30 000 Bank Statement Balance 30 000 Bank Statement 50 000 Reasons Reasons Deposited dishonored cheques Issued dishonored cheque Unrealized cheques Unpresented cheques Bank charges Direct remittance Standing orders Lakshitha Rathnayake Page 8 Error correction Trial Balance - The Statement which shows mathematical accuracy of the accounting process  if same amount has debited and credited to two accounts it is not affected to the trial balance Error types - Omission Under casting Over casting Principle (Different category different account) Duplication not affected to trial Compensation balance Commission (Same category different Account) General Ledger – The record which include all the type of ledger accounts (except debtors and creditors personal accounts) Profit Correction statement When preparing Net profit correction statement If Income or expense account Cr, it should be added (+) to the NET PROFIT If Income or expense account Dr, it should be Deducted (-) from the NET PROFIT When Income account Cr Income Increase Profit Increase When Income account Dr Income Decrease Profit Decrease When Expense account Dr Expense Increase Profit Decrease When Expense account Cr Expense Decrease Profit Increase Lakshitha Rathnayake Page 9 Control Accounts Transactions and Events In Total Daily Source documents To the General Ledgers in To subsidiary ledgers in the double entry system the single entry system Prime Entry Books Debtors Control A/c xx Debtors Ledger Creditors Ledger A P Creditors Control A/c xx B Q All other accounts C R Sales List of Debtors Balances List of Creditors Balances Purchases A x Px B x Qx C x Rx x x Comparing list of balances Trial Balance Financial Statements Lakshitha Rathnayake Page 10  Debtors Sub Ledger and debtors Control Account Original documents Transactions and Events related to Debtors Books of Prime Entry Double Entry in the Debtors Ledger General Ledger Sales Journal Debtors a/c - Debit Debtors Control A/c - Debit Returns Inwards Journal Debtors a/c - Credit Sales A/c - Credit Cash Receipts Journal Debtors a/c - Credit General Journal Debtors a/c - Credit Returns Inwards A/c - Debit Debtors Control A/c - Credit Cash Control A/c - Debit Debtors Control A/c - Credit Discount allowed A/c - Debit Debtors Control A/c - Credit Debtors Control A/c - Debit Creditors Control A/c - Credit Bad Debts A/c - Debit Debtors Control A/c - Credit Debtors Control A/c Balance Comparison List of balances of Debtors Debtors Balances Reconciliation Statement Lakshitha Rathnayake Page 11 Unit 05 – Accounting concepts ASSETS Results of a past transaction Controlled by the business Present economic resource (Right that has the potential to produce economic benefits) LIABILITY Result of a past transaction Present obligation Transfer an economic resource Equity Equity is the residual interest in the assets the entity after deducting all its liabilities. Similarity and difference between Liability and Equity Similarity - As a result of a past transaction or an event Difference – Equity represent obligation to the owner, Liability represent obligation to external parties Income Increases in assets or decreases in liabilities that result in increases in equity, other than those relating to contributions from holders of equity claims. Expenses Decreases in assets or increases in liabilities that result in decreases in equity, other than those relating to distributions to holders of equity claims. RECOGNITION CRITERIAS (Accounting Elements)  Relevant information about the asset or the liability and about any income, expense or changes in equity A faithful representation of the asset or the liability and of any income, expenses or changes in equity It should comply with the definition BUSINESS ENTITY Business Name Drawings (deducting from equity) Capital in liability side GOING CONCERN Assets and liabilities classified as current & non-current Basis for depreciation PERIODIC CONCEPT Mentioning Accounting period  I/S for the year ended  SOFP as at MONEY MEASUREMENT Under this concept, business transactions which can be measured using the currency unit are recorded Lakshitha Rathnayake Page 12  Eg: ‘RS’ Non recognition of Employee Competency in Finance Statement ACCRUAL CONCEPT – Paid or not the relevant amount for the period should be recorded Accrued expenses Receivable income Received in advance Debtors, Creditors Pre-payments SUBSTANCE OVER FORM consider Economic substance rather than legal aspect Leasing Lease faithful representation (relevant qualitative feature) MATCHING CONCEPT Income should be matched with relevant expense portion Recognition of cost of goods sold as an expense and yearend inventory as an asset deduct cost of Sales from sales to compute gross profit preparing income statement (all expenses recorded in I/S) *Cost- Monetary value of resource used to production (production cost) * Expense- Cost of goods used to earning revenues PRUDENCE CONCEPT All the provisions are made based on this concept.  Stock valued at lower of cost or NRV. (Historical cost concept is violated due to this principle) CONSISTENCY CONCEPT Maintaining same accounting policies Eg: Use FIFO method to issue inventory each year Maintaining same accounting policies comparability (relevant qualitative feature) MATERIALITY CONCEPT The materiality mans the importance of an item recorded separately in the financial statements Eg: Stapler Machine, loose tools HISTORICAL COST CONCEPT Assets should always be valued at historical cost (due to this relevance feature is violated). Revaluation Inventory Valuation at lower of cost or NRV violated historical cost concept Realization Concepts  Recognize credit sales as an income Sales in advance recognize as a liability Disclosure Concepts All accounting practices used must be disclosed. Eg; Inventory issuing method Lakshitha Rathnayake Page 13 Unit 06 – Sole trader Adjustments  Accrued Expenses - Relevant Expense Dr Accrued Expense Cr  Prepaid Expenses - Prepaid Expense Dr Relevant Expense Cr  Income Receivable - Income Receivable Dr Relevant Income Cr  Income Received in Advance - Relevant Income Dr Income Received in Advance Cr  Goods in Transit - Closing stock Dr Cost of sales Cr  Closing stock adjustment - Closing stock Dr (lower of cost or NRV) Stock written off Dr (difference between cost and NRV) Cost of sales Cr (Always Cost)  Stock damages with an insurance claim - Insurance Receivable Dr Stock loss Dr Purchases Cr Stock sent on Sale or Return basis Eliminate sales entry from the books (when recorded as sales but not sold) Sales Dr Debtors control Cr Added to closing stock Closing stock Dr Cost of sales Cr  Stock sold but not collected - Cost of sales Dr Closing stock Cr  Advances on Sales - Sales Dr Sales in Advance Cr Lakshitha Rathnayake Page 14 Unit 07 – Manufacturing Accounts  DM + DL + DO = PRIME COST  DM + DL + DO + POH = Manufacturing cost/ product cost /production cost  DM + DL + DO + POH + Non production overheads = TOTAL COST  DL + DO + POH = Conversion cost  production overhead + non production overheads = Total overheads  DM + Conversion cost + non production overheads = Total cost  Prime cost + Total overheads = Total cost  Total Direct cost + Total indirect cost = Total cost  Prime cost + Total overheads – Non manufacturing cost = manufacturing cost Prime cost + variable production overhead + fixed production overhead = manufacturing Cost Cost of Sales = DM + DL + DO + POH + Finished goods How to adjust Increase or Decrease in Stocks Increase in Inventories Raw material Work in progress (-) manufacturing Account Finished goods Decrease in Inventories Raw material Work in progress (+) manufacturing Account Finished goods Lakshitha Rathnayake Page 15 Unit 08 –Nonprofit Organizations Differences Receipts & Payments I&E Basis Cash basis Accrual Basis Purpose To find the cash balance To find surplus or deficit ACCOUNTING FOR LIFE MEMBERSHIP Treat it as an income in the year in which life membership were received Treat it as a liability and a transfer agreed amount to income and expenditure account Treat it as a direct increase in accumulated fund Closing accumulated fund AF closing = Closing Assets - Closing liabilities AF closing = AF opening + Surplus Surplus = AF1 - AF0 Special fund R&P Dr xx Building fund Cr xx When it is used for construction  Building Dr xx R&P Cr xx  Building fund Dr xx Accumulated fund Cr xx Subscription Account Opening Arrears xxxx Opening advance xxxx Income and Expenditure xxxx Receipts and Payments xxxx Subscription w/off xxxx Closing advance xxxx Closing Arrears xxxx xxxx xxxx Lakshitha Rathnayake Page 16 Unit 10 - PARTNERSHIP Section 24 Profits equally No salaries No interest on capital 5% interest on additional loan Section 42 – 5% interest on retired partners loan GOODWILL CALCULATION Expense incurred by a partner on Behalf of the partnership 1.Admission of a partner  Expense Dr 2.Retirement of a partner partners current a/c Cr 3. When partnership agreement change when Reimburse  partners current a/c Dr New profit sharing ratio Cash Cr A B C Old 2 1 3 3 New 4 X 2 4 X 1 1 5 3 5 3 5 8 4 3 15 15 15 8 : 4 : 3 Goodwill Double entry Capital a/c Dr (new profit sharing ratio) Capital a/c Cr (old profit sharing ratio) Equity of a Partnership = Capital Balances + Current Balances + Other Reserves if Available Increase in Equity = Closing Equity – opening Equity Closing Equity = Opening Equity + Net profit + Additional capital + other entitlement for partners (Loan interest, Rent) - Drawings Special profit calculation method for partnership Profit = Salaries + Interest on Capital + Profit shares Total profit distributed to a partner = Salary + interest on capital + profit share Total Income distributed to a partner = Salary + interest on capital + profit share + Loan interest and other entitlements Lakshitha Rathnayake Page 17 Unit 11 – Accounting standards In preparing and presenting financial statements of specified Business enterprise should follow Sri Lanka Accounting Standards recommended by Sri Lanka Accounting and Auditing Standards Act No. 15 of 1995.  Two statutory bodies that have been established under the Sri Lanka Accounting and Auditing standards act No. 15 of 1995 1) Sri Lanka Accounting Standards Committee 2) Sri Lanka Auditing Standards Committee Incorporation of Sri Lanka Accounting Standards Committee according to Sri Lanka Accounting and Auditing Standards Act No. 15 of 1995. The Sri Lanka Accounting and Auditing Standards Monitoring Board has the power to examine whether the Sri Lanka Accounting Standards have been adhered to in preparation of accounting statements of a specified business enterprises, and to take necessary action if the standards have not been adhered to. Functions of Institute of Charted Accountants of Sri Lanka. Organizing exams in order to provide related qualification and relevant educational courses Controlling and supervising of student education and training. Conceptual framework A set of rules which helps to make functions and limitations of financial accounting and financial statements are known as conceptual framework. Objectives of financial Statements The objectives of general purpose financial statements to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources of the entity Accounting Standards Various professional Institutes provide rules to be followed by organizations in preparing financial statements are known by Accounting Standards or required rules to be followed in recognizing, measuring and presenting transactions. The Institute of Chartered Accountants of Sri Lanka is the authorized institute in Sri Lanka. Lakshitha Rathnayake Page 18  LKAS 02 - inventory INVENTORIES Held for sale in the ordinary cause of business (Finish goods) In the process of production for such sale (work in progress) or In the form of materials or supplies to be consumed in the production process (raw materials) COMPONENTS OF COST OF INVENTORY Purchase cost Conversion cost (Direct labor, direct other, production overhead) Other cost (incurred in bringing the inventories to their present location and condition) Excluded cost from inventory valuation (2019A/L) overhead selling costs abnormal amounts of wasted material, labor and other production cost general administrative overheads Storage costs NRV = Estimated selling price – (Estimated cost of completion + Estimated selling expenses) ACCEPTED COST FORMULAS UNDER LKAS -02 FIFO WAC METHODS OF DETERMINATION Net Realizable Value Item by item basis group basis Recognition of inventory as an expense At the time of selling inventories If there is a stock loss (when NRV of inventory is lower than it’s cost) DISCLOSURES OF INVENTORY ( included in notes)  NRV determination method (Item by item basis, group basis)  Cost formula (FIFO, WAC) Inventories kept as securities stock losses Lakshitha Rathnayake Page 19  LKAS 07 – Cashflow Cash and cash equivalents - Cash Bank Treasury Bills and short term investments less than 3 months Working capital relationship Current assets negative Cashflow Current Liability positive Cashflow Following items have to be adjust twice when preparing indirect method cashflow statement Interest expense Interest income Dividend income Rent income Disposal proceed and gain/loss Format of a Retained Earnings account Retained Earnings Dividend paid xx BBF xxx Transfer to G/R xx Profit for the year xxx Bonus issue using R/E xx BCD xx xx xx Format of a Property plant and equipment account (at cost) Property plant and equipment account (at cost) BBF (Cost) xxx Disposal(cost) xx Revaluation Gain xx Dep. on revaluation xxx Aquisitions xx BCD (Cost) xx xx xx Format of a provision for Property plant and equipment account Provision for Property plant and equipment account (at cost) Dep.on revaluation xxx BBF xxx Disposal xx Annual Depreciation xxx BCD xx xx xx Format of a Property plant and equipment account (at NBV) Property plant and equipment account (at NBV) BBF (NBV) xxx Disposal (NBV) xx Revaluation Gain xx Depreciation xxx Aquisitions xx BCD (NBV) xx xx xx Lakshitha Rathnayake Page 20  LKAS 08 Accounting Policies Accounting policies are the specific principles, bases, conventions, rules and practices adopted by an enterprise in preparing and presenting financial statements. Selecting Accounting Policies There are two ways of selecting an accounting policy. If an accounting standard is clearly applied to a transaction or an event. The accounting policy should adhere to the standard. Eg -: FIFO or WAC as per LKAS 02 In the absence a recommended accounting policy. (The management of the entity should develop an appropriate accounting policy. What is change of accounting policies? Change in recognition, measurement and presentation. Why accounting estimate? Inherent uncertainties in business activities. Many items in the financial statements are to be estimated since they can’t be measured with accuracy. Changes in accounting estimates It is an adjustment of the carrying amount of an asset or a liability or the amount of the periodic consumption of an asset. That results from the assessment of the present status and expected future benefits and obligations associates with assets and liabilities. Errors Errors in financial statements can arise on account of incorrect recognition, measurement, presentation or disclosure of items in financial statements. (Mainly focus on prior period errors) LKAS - 08 Accounting Accounting Fundamental Estimates Policies Errors Eg: Residual Value Eg: inventory policy (FIFO/WAC) Income tax Item by Item/Grouping method Eg: last year closing Depreciation% using cost model or revaluation stock under stated Depreciation method model for subsequent measurement Adjust Useful life opening balance R/E A/c Doubtful Debts (Retained earnings) N.R.V Change due to (Retrospective Restatement) Change due to - if Required by LKAS(Prospective) New environment changes - For more reliable presentation (Retrospective) New information or experience Adjust Past, Present & Future, Financial Statement Adjust (Retrospective or prospective Application) Present & Future Period Financial Statement (prospective Application) Lakshitha Rathnayake Page 21 Example with workings The following balances of Isuru PLC are given: Provision for product warranty as at 01.04.2018 - Rs. 12 000 Sales for the year ended 31.03.2019 - Rs. 900 000 The company offers one year product warranty. Amount equal to 10% of current year sales are expected to incur as repairing expenses for the faculty products sold during the year under warranty. Repair cost incurred during the year Rs. 40 000 for current year sales. Previous year warranty has expired. Required: i. State the accounting treatment for previous year balance of the warranty provision with reference to the LKASs. ii. Show the financial statement extract for the year ended 31.03.2019 Answer i) Previous year balance should be excluded from distribution expenses. (as it has already been expired) ii) I/S extract Distribution expense Last year over provision (12,000) Current year provision 90,000 SOFP extract Current liability Provision for warranty 50,000 Lakshitha Rathnayake Page 22  LKAS 10 Events after reporting period “Are those events, favorable and unfavorable that occur between the end of the reporting period and the date when the financial statements are authorized for issue adjusting events Those that provide evidence of conditions that existed at the balance sheet date (b)Those Non adjusting events that is indicative of conditions that arose after the balance sheet date 25.05.2023 01.04.2022 31.03.2023 Directors authorized date Events occurring after the balance sheet date Adjusting Events Non-adjusting events Accounting treatment Accounting treatment Should be adjusted in current year financial statement Should be Disclosed as a note Eg-: Eg-: Bankruptcy of a debtor who owed substantial Discontinued operations amount at the balance sheet date Proposed dividend for O/S Sale of inventory lower than cost at 31.03.2023 Assets destroyed due to fire Decision of a court case delivered on 30.04.2023 Declining market value of confirming employee compensation. (court case Investments should be filed before balance sheet date) Actual value of an asset purchased during the  A part of a building taken over by accounting period was decided after the reporting period. the government after reporting period Disclosure requirement Date of authorization for issue The person who authorizes Discloses the situation as at the end of the period Nature of non adjusting events Lakshitha Rathnayake Page 23  LKAS 16 PPE Are held for use in the production or supply of goods or services or for rental to others or for Administrative purpose Are expected to be used during more than one period Cost Cost is the amount of cash or cash equivalents paid or the fair value of other consideration given to acquire an asset at the time of its acquisition or construction or, where applicable, the amount attributed to that asset when initially recognized in accordance with the specific requirements. Depreciation Depreciable amount is the cost of an asset or other amount substituted for cost, less its residual value. Carrying amount Carrying amount is the amount at which an asset is recognized after deducting any accumulated depreciation and accumulated impairments losses. Fair value Fair value is the amount for which an asset could be exchanged between knowledgable, willing parties in an arm’s length transaction. Residual value The residual value of an asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, in the condition expected at the end of its useful life. Useful life Useful life is the period over which an asset is expected to be available for use by an entity or the number of production or similar units expected to be obtained from the asset by an entity. Except land other assets Depreciable asset Disclosures Depreciation Method used Useful life Dep. Rate Property kept as a security Cost components Initial Purchase Price (+) Installation (+) Initial Testing (except trial production unit cost) (+) Legal Fees (+) VAT (+) Cost of removing unwanted constructions Lakshitha Rathnayake Page 24 (-) Trade discount (-) Subsidies (-) Income from removing unwanted constructions PLC VAT REGISTERED COMPANY Initial purchasing price - VAT should not be included if it is a VAT Registered Company If company is not registered for VAT – VAT should be added to the cost Examples of excluded cost  cost of opening a new facility or business (opening ceremony)  Costs of introducing a new product or service (including cost of advertising and promotional activities) 2019A/L costs of conducting business in a new location or with a new class of customer (including cost of staff training) Administration and other general overhead costs The disposal of an asset/Exchange of Fixed Assets 1 Eliminate the cost value of the disposed asset Asset disposal account Dr. Asset account Cr. 2. Eliminate the provision for depreciation of the disposed asset Provision for depreciation account Dr. Asset disposal account Cr. 3. Any cost on asset disposal Asset disposal account Dr. Cash Cr. 4. Cash received on disposal Cash Dr. Asset disposal account Cr Finaly the balance in the asset disposal account will be transferred to the profit and Loss account. Change in useful life, residual value, depreciation method or cost of an asset Steps 1) find net book value 2) Add new cost 3) Deduct residual value 4) divide by new or remaining useful life Lakshitha Rathnayake Page 25  SLFRS 16 – Leases Right to Control the use of an Asset LESSOR LESSEE Rentals Lessor - The party who transfers right to control the use of an asset in a lease contract Lessee - The party who obtains the right to control the use of an asset in a lease contract Accounting for Leases in the Books of Lessee  SLFRS 16 Do not apply for: a) Short-term leases (a lease that, at the commencement date, has a lease term of 12 months or less) b) Leases for which the underlying asset is of low value. Accounting treatment for above two situations: Lease Rental Dr Cash Cr Initial Recognition - Right of use Asset  Measure the right of use asset at cost at the commencement date  The cost of the right or use asset comprises: the amount of the initial measurement of the lease liability any lease payments made at or before the commencement date, less any lease incentives received. Any initial direct costs incurred by the lessee An estimate of costs to be incurred by the lessee in dismantling and removing the underlying asset, restoring the site on which it is located or restoring the underlying asset to the condition required by the terms and conditions of the lease, unless those costs are incurred to produce inventories. Initial Recognition – Lease Liability  Measure the lease liability at the present value of the lease payments that are not paid at the commencement date.  The lease payments are discounted using the interest rate implicit in the lease (If readily determinable)  Lease payments included: Fixed payments less any lease incentives receivable Variable lease payments that depend on an index or a rate. Amounts expected to be payable by the lessee under residual value guarantees. The exercise price of a purchase option of the lessee is reasonably certain to exercise that option. Payments of penalties for terminating the lease, if the lease term reflects the lessee exercising an option to terminate the lease. Lakshitha Rathnayake Page 26 Depreciation (finance Lease) If Ownership is transferred at the end of lease period Using useful life If Ownership is not transferred at the end of lease period lease period The accounting for the lease in the books of the lessee. Initial deposit value / Down payment Right of use asset Dr xxx Cash account Cr xxx Present value of minimum lease payment Right of use asset Dr xxx Lease Liability account Cr xxx Interest on lease at the end of the period Interest on lease account Dr xxx Lease Liability account Cr xxx Payment of installment Lease Liability account Dr xxx Cash account Cr xxx Classify Final Lease Liability as current and non current Current Liability = Installment – Next year Interest Final Lease Liability Non Current Liability = Final lease liability – Current portion Format of a Lease Liability account Lease Liability initial lease liability xxx Installment xxx Interest xxx BCD xxx xxx xxx Final Lease Liability Example with workings Supun PLC acquired a machine on lease basis on 01.04.2019. The following information is provided.  Initial payment on 01.04.2019 - Rs. 500 000  Annual installment - Rs. 200 000 (starting from 01.04.2019)  Lease term - 4 years  Initial direct cost incurred on 01.04.2019 by the lessee - Rs. 10 000  The interest rate implicit the lease - 10%  Discounting factors at 10% rate.  Residual value - Rs. 143 800  Useful life of the machine - 5 years  The ownership of the machine will be transferred to Supun PLC at the end of 5th year. Lakshitha Rathnayake Page 27  Year : 1 2 3 4 Discount factor : 0.909 0.826 0.751 0.683 Useful life of the machine - 5 years Residual value - 50 000 The ownership of the machine will be transferred to Supun PLC at the end of the lease term. Required to Calculate: 1. The amount of the lease liability 2. The amount to be recognized as right of use asset 3. Prepare lease liability account for the year ended 31.03.2020 4. Prepare financial statement extracts for the year ended 31.03.2020 Answer 1. Year : 1 2 3 4 Discount factor : 0.909 0.826 0.751 0.683 Lease installment : 200,000 200,000 200,000 200,000 Present value : 181,800 165,200 150,200 136,600 Initial lease liability : 633,800 2. Right of use asset Initial payment 500,000 (+) present value 633,800 (+) Initial Direct cost 10,000 1,143,800 3. Lease Liability initial lease liability 633,800 Installment 200,000 Interest 63,380 BCD 497,180 697180 697180 Final Lease Liability 4. I/S extract Distribution expense Right of use asset depreciation 200,000 Finance expense Interest 63,380 SOFP extract Non Current Assets Right of use asset 943,800 Non Current liability Lease Liability 346,898 Current liability Lease Liability 150,282 Current Liability = Installment – Next year Interest 150,282 = 200,000 - 49,718 Final Lease Liability Non Current Liability = Final lease liability – Current portion 346,898 = 497,180 - 150,282 Lakshitha Rathnayake Page 28  SLFRS 15 – Revenue from Contracts with Customers Main Features of SLFRS 15  Introduces a Five Steps Revenue Model (COPAR)  Five Steps Revenue Model STEP 1 STEP 2 STEP 3 STEP 4 STEP 5 Identify the Identify the Determine Allocate the Recognize Contract(s) Performance the transaction Revenue With the Obligations transaction Price When a Customer In the price Between performane Contracts Performances obligation Obligations is satisfied Five Steps Revenue Model Eg-: ABC PLC signed a contract to sell a machine to XYZ PLC and provide one year service contract for 30 million on 01.01.2019. The machine was delivered on 01.04.2019 and service started on 30.09.2019. The machine is usually sold without the service for 24 million and service is separately performed for 6 million. Full contract price was received on 01.04.2019. Accounting year ends on 31.03.2020 STEP 1 Identify the Contract - is a written, oral or implied agreement between 2 or more parties which create Contract(s) rights and obligations and it should be a legally enforceable. With the Eg- ABC PLC came to an agreement to deliver a machine and provide service. Customer STEP 2 Performance Obligations - A promise to transfer a good/service Eg- There are two performance obligations in this example 1. Supply of machine 2. Provide one year service STEP 3 Transaction price – The amount of consideration which an entity expects to receive from a customer in exchange for transferring promised goods or service. Eg- 30 million STEP 4 Allocate - Transaction price should be allocated based on standalone selling prices of each obligation. Eg- Performance obligation Standalone selling price Allocated price 1. Supply of machine 24 million 24 million 2. Provide one year service 6 million 6 million Total 30 million 30 million (in this example there is no discount, therefore standalone selling price and allocated price between two performance obligations are equal.) Lakshitha Rathnayake Page 29 STEP 5 Recognize Revenue - An entity recognizes revenue when it satisfies the performance obligation by transferring promised goods or service to a customer. Eg- Recognize 24 million sales revenue on 01.04.2019 (when the machine is delivered) Recognize 3 million service revenue on 31.03.2020 (for the services already provided – 6million x 6/12) Exercise 01 PQR PLC signed a contract to sell a machine to XYZ PLC and provide one year service contract for 25 million on 01.01.2019. The machine was delivered on 01.04.2019 and service started on 30.09.2019. The machine is usually sold without the service for 24 million and service is separately performed for 6 million. Full contract price was received on 01.04.2019. Required 1. Performance obligations to be recognized? 2. Transaction price? 3. Total Discount amount? 4. Allocate the transaction price among performance obligations? 5. Journal entries Answers 1) i) There are two performance obligations 1. Supply of machine 2. Provide one year service 2) 25 million 3) Standalone selling price - Transaction price = Total discount amount 30 million - 25 million = 5 million 4) Performance obligation Standalone selling price Allocated price 1. Supply of machine 24 million 25 x (4/5) = 20 million 2. Provide one year service 6 million 25 x (1/5) = 5 million Total 30 million 25 million 5) Journal entries i) when transaction price is received Cash Dr 25 million Unearned revenue Cr 25 million ii) when machine is delivered Unearned revenue Dr 20 million Sales revenue Cr 20 million iii) Services already provided as at 31.03.2020 Unearned revenue Dr 2.5 million Service revenue Cr 2.5 million Lakshitha Rathnayake Page 30  LKAS 37 Provision (Adjusted in financial statements) Eg: Provision for warranty Only liability provisions Provision for compensation Are considered in LKAS 37 Provision is a liability of uncertain timing or amount. Legal or constructive obligation. Characteristics: Present obligation (Legal or constructive obligation). Reliable estimate Probable outflow Legal obligations may arise due to  Operations of contractual law  Operations of provisions in parliaments acts or  Operations of other law constructive obligation may arise due to  established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities and,  as a result, a valid expectation created by entity on the part of those other parties that it will discharge those responsibilities. Contingent liability (Disclose as a note) A possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or nonoccurrence of one or more uncertain future events not wholly within the control of the entity. Characteristics: possible obligation Cannot estimate reliably Future Liability probable possible Remote make a Provision Contingent Liability (disclose) no need to disclose Contingent Assets Possible asset that arises from past events whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity. Contingent Assets Could not be recognized as an asset in the statement of financial position. Disclose only if there is a probability of an inflow of economic benefit. Lakshitha Rathnayake Page 31 Unit 12 – Limited company Differences Bonus issue/capitalization or reserves Right issue Impact on cash No change Cash increase Impact on Equity No change Equity increase Bonus issue Reserve Account Dr. xx Share Capital Cr. Xx Share issue 1) Receipts of cash with applications Cash Dr Share issue Cr 2) Rejection of applications or excess money Share issue Dr Cash Cr 3) Allotment of shares or capitalization of shares Share issue Dr Share capital Cr 4) Share issue expenses Share Capital Dr (Deducted from SOCE) Cash Cr Total income Total Expense  Sales Cost of sales  Other income  Other expenses  Revaluation gain  Revaluation loss Total = profit for the year + Other Comprehensive income Comprehensive income Total Comprehensive income = Total income - Total expense First time revaluation gain and subsequent revaluation loss Cost first time revalued Subsequent revalued amount amount 1000 1500 800 Asset Dr 500 Revaluation reserve Dr 500 Revaluation reserve Cr 500 P&L Dr 200 Asset Cr 700 First time revaluation gain and subsequent revaluation loss Cost first time revalued Subsequent revalued amount amount 1000 700 1,500 P & L (other expense) Dr 300 Asset Dr 800 Asset Cr 300 P&L Cr 300 Revaluation reserve Cr 500 Lakshitha Rathnayake Page 32 Unit 13 – Accounting ratios Profitability Ratios Gross Profit Ratio = Gross profit X 100 Sales To GP ratio S.P COS Change in Inventory valuation policy (FIFO is more suitable) In an inflationary Situation FIFO Closing Stock C.O.S G.P (Current Revenue is compared with the historical cost) Net Profit Ratio = Net profit after tax X 100 Sales Return on Equity = Net profit after tax X 100 Equity Return on Assets = Net profit after tax + Interest X 100 Total assets Liquidity Ratios Current assets Current ratio = Current liabilities Liquid assets Quick ratio = Current liabilities Liquid assets = Total current assets - (closing inventory + Pre-payments) Leverage ratios Debt Ratio = Debt capital x 100 Total capital Debt capital = Long term loans with fixed interest rate Total capital = Ordinary share capital + Reserves + Long term loans Equity Ratio = Equity capital x 100 Total capital Equity capital = Ordinary share capital + reserves Lakshitha Rathnayake Page 33  Debt to Equity Ratio = Debt capital: Equity capital or Debt to Equity ratio = Debt Equity Profit before tax + interest Interest Coverage Ratio = Interest Efficiency ratios Inventory Turnover Ratio = Cost of sales Average Inventory Inventory residence period = Average Inventory x 365 days Cost of sales Debtors Turnover Ratio = Credit sales Average Debtors Debtors Collection period = Average Debtors x 365 days Credit sales Assets turnover Ratio = Total sales Total assets Relationship between turnover ratio and residence/collection period inventory turnover inventory residence period favorable situation debtors turnover Debtors collection period favorable situation Investors' ratios Profit for the year Earnings per share = Number of Ordinary Shares Dividends for ordinary shares for the year Dividend per share = Number of Ordinary Shares Cash cycle = Inventory residence + Debtors collection - Creditors payment Period period period Lakshitha Rathnayake Page 34 Unit 14- Cost Accounting Cost unit - Any activity for which a separate measurement of cost is required is known as cost unit/cost object VC Fixed Cost & AFC AVC TC or Semi variable cost Material purchasing process Productio Stores Purchase n Dept. DEPT MRN/SRN Dept. PRN PRN MIN GRN (copy) GRN GRN (copy) Delivery note PO Accounti ng Dept. PV/Invoice/ Cheque counterfoil SUPPLIER Lakshitha Rathnayake Page 35 EOQ Assumptions -Annual demand constant -Holding cost per unit constant -Cost per order is constant Annual ordering Cost = cost per order X No of order Annual Holding Cost = Average inventory X Holding cost per unit EOQ X 50% EOQ = 2DCo Ch Re –order level = maximum consumption X maximum lead time Minimum stock level = Re order level – (Average consumption x average lead time) Maximum stock level = ROL – (Minimum consumption x Minimum lead time) +EOQ Average stock level = Minimum stock level + Economic order Quantity 2 Or Average stock level = Minimum stock level + Maximum stock level 2 Differences Bin Card Stores Ledger Quantity Only Value and Quantity Maintain the stores Maintain in the accounts department Labour records Active Time Retaining Time Job ticket Attendance Register Job cost sheet Cards with bar codes Daily time sheet Finger printer machine Documents required to prepare Pay sheet Appointment letter Time sheet Attendance register Lakshitha Rathnayake Page 36 Journal entries relevant for Labour costing 1) Recording of Gross salary Salaries and wages Dr Salaries and wages control Cr 2) Deduction from salaries / wages Salaries and wages control Dr Relevant deduction account Cr 3) Payment of net salary Salaries and wages control Dr Cash Cr 4) Employer’s contribution for the EPF (Employees Provident Fund) EPF expense Dr EPF payable Cr 5) Employer’s contribution for the ETF (Employees Trust Fund) ETF expense Dr ETF payable Cr Employee related total Expense = Gross salary + EPF by employer + ETF by employer Direct Wages = Production employee related total Expense – (bonus based on Company Profit) OAR = Total budgeted Overhead of the relevant production department Total Budgeted basis Absorbed Overhead = OAR X Actual Hours (Budgeted will be taken if actual is not given) Under or (over) absorption = Actual overhead – Absorbed overhead Different Overhead absorption rates OAR = Total budgeted Overhead of the relevant production department x 100 (as a % of DM cost) Total Direct material cost OAR = Total budgeted Overhead of the relevant production department x 100 (as a % of DL cost) Total Direct Labour cost OAR = Total budgeted Overhead of the relevant production department x 100 (as a % of Prime cost) Total Prime cost Lakshitha Rathnayake Page 37 Unit 15 – Marginal costing BEP Assumptions Selling price is constant Technology constant All cost are divided as variable and fixed FC does not vary with quantity VC vary with quantity, VC per unit is constant at BEP Cost and income behavior as linear function At BEP TR = TC Profit = O Total contribution = TFC Contribution Per Unit = AFC.  Total contribution = TR – VC Total contribution = TFC + Profit Total contribution = Contribution per unit x no of units  Contribution per unit = selling price – variable cost per unit Contribution per unit = AFC + profit per unit Contribution per unit = Total contribution No of units Contribution per unit = Change in contribution Change in quantity Contribution per unit = Change in profit Change in quantity  Contribution sales ratio = Total contribution x 100 Total sales Contribution sales ratio = contribution per unit x 100 Selling price Change in total cost  Unit variable cost = Change in quantity  Breakeven point (Q) = Total Fixed cost contribution per unit  Breakeven point (RS) = BEP (Q) x selling price Breakeven point (RS) = Total Fixed cost Contribution to sales ratio  Margin of safety (Q) = Expected (Q) – BEP (Q) Margin of safety (RS) = Margin of safety (Q) x selling price Margin of safety (RS) = Net profit Contribution to sales ratio Lakshitha Rathnayake Page 38   Profit = TR-TC Profit = Total Contribution - Total Fixed cost Profit = Margin of safety (Q) x contribution per unit  Required/ Expected (Q) = Total Fixed cost + Expected profit contribution per unit If C/S ratio 40%, VC ratio should be 60% Break even chart Profit volume chart Lakshitha Rathnayake Page 39  Unit 16 - Investment Appraisal Money has a time value due It can generate returns when it is invested Average net profit after tax Average rate of return = x 100 Average investment Average net profit after tax = Total net profit after tax ÷ Number of years Average Investment = (initial investment + scrap value) ÷ 2 Payback period months = deficit amount x 12 Next year net cashflow Assumptions used in investment appraisal Initial investment cost should be incurred at the beginning of the investment (in the year zero). Annual cash flows are occurred at the end of each year. If there is any cash flow at the beginning of any year, it is occurred at the end of previous year. Disadvantages of payback period It fails to take into account the cash flows earned after the payback period. It ignores the Time Value of Money (TVM) Advantages of NPV Consider time value of money Consider all the cash flow of investment Helps to select the investment which increase the owners wealth Irrelevant Cost Depreciation (Non cash item) Market survey (feasibility study) sunk cost) Interest expense  Existing working capital Reasons for increasing NPV Cash inflows Cash outflows Discounting factor Cost of capital rate/Discount rate (money dep. Rate) Payback period Net cash flow = Net Profit + Dep ARR Net Profit = Net Cash flow - Dep NPV Net Cash flow = Net profit + Dep Lakshitha Rathnayake Page 40