Contents

BASIC ACCOUNTING ...................................................................................................................................... 3

BOOKS OF ORIGINAL ENTRY / PRIME ENTRY .............................................................................................. 10
ADJUSTMENTS TO FINAL ACCOUNTS.......................................................................................................... 11
ACCOUNTING CONCEPTS ............................................................................................................................ 13
DEPRECIATION ............................................................................................................................................ 15
BAD DEBTS .................................................................................................................................................. 24
FINAL ACCOUNTS ........................................................................................................................................ 32
DEPARTMENTAL ACCOUNTING .................................................................................................................. 35
BANK RECONCILIATION STATEMENT .......................................................................................................... 36
CONTROL ACCOUNTS .................................................................................................................................. 40
ERRORS AFFECTING AND NOT AFFECTING TRIAL BALANCE ....................................................................... 43
MANUFACTURING ACCOUNTS.................................................................................................................... 47
NON-PROFIT ORGANISATIONS (NPO) ......................................................................................................... 53
INVENTORY VALUATION ............................................................................................................................. 59
SINGLE ENTRY ............................................................................................................................................. 61
INCOMPLETE RECORDS ............................................................................................................................... 63
RATIO ANALYSIS .......................................................................................................................................... 64
PARTNERSHIP .............................................................................................................................................. 69
LIMITED COMPANIES .................................................................................................................................. 79
PAYROLL ACCOUNTING ............................................................................................................................... 91
 Page 3

BASIC ACCOUNTING
ACCOUNTING is an art of
1. Classifying
2. Recording
3. Summarizing Business Transactions
4. Interpreting
5. Communicating

Transactions are day to day activities of the business which involves monetary value.
Business is an entity that transforms resources to perform activities to achieve business
objectives.

CLASSIFICATION OF ACCOUNTS

5 PILLARS OF ACCOUNTING:
1) ASSETS
2) LIABILITIES
3) CAPITAL ALCER
4) EXPENSES
5) REVENUES

ASSETS:
The resources of business whether owned or owed. They are the possessions of the business.
They are divided into 2 categories:
➢ Non-Current Assets
➢ Current Assets

Non-Current Assets are those assets which are used in the course of the business for more than
an accounting period. They comprise of machines, motor vehicles, factories and so on. Also
known as Fixed Assets.
Accounting period usually comprises of 12 months but in some cases, it can be extended up to
18 months.
Current Assets are those assets which are used in the course of the business for less than an
accounting period. Example: Inventory, Receivables, Cash and Cash Equivalents. They change
their form continuously.

Page 3
 Page 4

Inventory are the stock of goods. The goods which were bought or produced with an intention
of resale but are yet unsold are called Inventory.
Goods are all those things in which a business trades.
Receivables are those people or business to whom we have given credit or to whom we have
sold goods on credit. They are divided into
➢ General Receivables
➢ Trade Receivables
Trade Receivables are all those people to whom we have sold goods on credit. Also known as
Debtors.
General Receivables are all those people to whom we have lent money or have sold a non-
current asset on credit.
Cash and Cash Equivalents means cash or bank.

Cash and
Cash
Equivalents

Trade Inventory
Receivables

LIABILITIES:
The resources owed by the business. They are the obligations of the business. They are divided
into 2 categories:
➢ Non-Current Liabilities
➢ Current Liabilities
Non-Current Liabilities are also known as Long-term liabilities and they are owed by the
business for more than an accounting period. Examples: Long-term loans from banks and
financial institutions, and debentures. They are subject to fixed rate of interest which is charged
on per annum basis.

Page 4
 Page 5

Debentures are the I Owe You Certificates indicating the amount borrowed, the repayment
date, and the rate of interest. They are usually secured against mortgage.
Mortgage is a collateral agreement indicating that in case of non-payment, the amount of loan
will be recovered by selling off the asset which has been kept as a security.
Current Liabilities are those liabilities which have to be repaid within an accounting period and
hence comprise of payables (creditors), bank overdraft and short-term loans.
Payables are all those people or business from whom we had borrowed money or those from
whom we have bought non-current assets on credit or those from whom we have bought
goods on credit. They are divided into 2 categories:
➢ General Payables
➢ Trade Payables
Trade Payables are those from we have bought goods on credit.
Bank Overdraft is the facility provided by the bank to its loyal customers that if they want to
withdraw more amount from the bank than is present in the bank, then bank will allow to do so
but will charge interest on overdraft on daily basis.
CAPITAL:
The resources owned by the business. They are the investment of the owner and hence
determine the ownership of the business.

BASIC ACCOUNTING EQUATION: CAPITAL = ASSETS - LIABILITIES

ASSETS
(All resources of the business)

Owned Owed
CAPITAL LIABILITIES

Page 5
 Page 6

Expenses are the day-to day running costs of the business without which it is practically
impossible to run the business. Example: Rent, Utility Bills, Wages and Salaries etc.
In accounting, expenditures are divided into 2 categories:
➢ Capital Expenditures
➢ Revenue Expenditures
Capital Expenditures are all expenditures associated to purchase of non-current assets. All
expenses incurred in bringing the non-current asset to its present location and condition is part
of Capital Expenditures. All those expenses which increases the life of the fixed asset or
improve the performance of fixed assets are Capital Expenditures. All expenses incurred till the
asset is available for use for the very first time is part of Capital Expenditure. Any major
expenses without which running of a non-current asset becomes impossible is part of Capital
Expenditure. If an asset is bought for the business purpose, then printing the logo of company
on that asset is also part of Capital Expenditure.
Other Examples of Capital Expenditures include:
➢ Patents
➢ Copyright
➢ Royalty
➢ Trademark
➢ Franchise
➢ License
Revenue Expenditures are the day-to-day running costs of the business and hence are the
Expense part of ALCER. Example: Utility bills, rent, wages and salaries, re-painting, re-
decoration, repair and maintenance. The fuel filled in asset ‘after the first time’ is also Revenue
Expenditure. If an expenditure incurred on an asset does not qualify to be a major expenditure,
then it is also Revenue Expenditure.
Revenues are earnings or incomes of the business. It is very important to realize that there is a
difference between revenues and profits. Profits are obtained after deducting all expenses
from revenues.
Profit = Revenues – Expenses
When a business makes sales, it generates Revenue. Similarly, if business earns commission, it
earns Revenue. When business gives its property on rent, it results in Revenue.
Incomes are also divided into 2 categories:
➢ Capital Income
➢ Revenue Income

Page 6
 Page 7

Capital Income are the income generated through sale of non-current asset or when the owner
introduces additional capital into the business.
Revenue Incomes are the normal earnings of the business which are part of Revenue category
of ALCER. Example: sales of goods, commission or rent earned, profit from sale of non-current
asset, etc.

Page 7
 Page 8

RECORDING OF TRANSACTIONS
Transactions are recorded on the basis of double-entry system in the ledgers. Ledgers are also
known as T-accounts. This is because of the shape of the ledger. On the T-accounts, there is a
title indicating which T-account is it. A T-account has 2 sides; the left-hand side is called the
Debit Side and the right-hand side is called the Credit Side. When the transactions are
recorded, we have to follow the double-entry system based on dual-aspect concept which
states that every debit will be followed by an equal ‘amount’ of credit.

TITLE OF T-ACCOUNT

DEBIT SIDE (DR) CREDIT SIDE (CR)

RULES OF DEBIT AND CREDIT

DEBIT: Anything that comes into the business is Debited.

CREDIT: Anything that goes out of the business is Credited.

ASSETS
DEBIT SIDE (DR) CREDIT SIDE (CR) Increases on Debit Side

+ - Decreases on Credit Side

LIABILITIES
DEBIT SIDE (DR) CREDIT SIDE (CR) Increases on Credit Side

- + Decreases on Debit Side

CAPITAL
DEBIT SIDE (DR) CREDIT SIDE (CR) Increases on Credit Side

- + Decreases on Debit Side

EXPENSES
DEBIT SIDE (DR) CREDIT SIDE (CR) Increases on Debit Side

+ - Decreases on Credit Side

Page 8
 Page 9

REVENUES
DEBIT SIDE (DR) CREDIT SIDE (CR) Increases on Credit Side

- + Decreases on Debit Side

SUMMARISING OF TRANSACTIONS
In order to summarize the transaction, we need to balance off the T-account and the extract a
Trial Balance. The Trial Balance is a list of balances extracted from the ledger to check the
arithmetical accuracy of the ledgers. After making the trial balance, in order to summarize the
performance of the business, we should prepare the final accounts. Final accounts comprise of
Income Statement and Statement of Financial Position. Income Statement shows the
profitability position of the business whereas while the Statement of Financial Position shows
the details of assets, liabilities and capital on a certain date.

INTERPRETATION/ANALYSIS OF TRANSACTIONS
Once the transactions are summarized, they need to be interpreted and analyzed whether the
performance of the business has improved, deteriorated or remained constant in comparison
to last year’s performance or competitor’s performance. If the performance of the business has
improved, what caused it and if the performance of the business has deteriorated, what went
wrong. The tool used to interpret the business performance is called Ratio Analysis.

COMMUNICATION
Once the performance of the business has been analyzed, it is extremely important to
communicate the findings to all the relevant stakeholders. Stakeholders are those people who
are directly or indirectly associated to the business e.g. owners, investors, government
authorities, banks, customers, suppliers, prospective buyers, etc.

x ----- x ----- x ----- x

Once all transactions and entries are recorded in the ledgers, the T-accounts needs to be
balanced off. To balance off a T-account, the T-account will act like a weighing machine which
has to be balanced off. The balance will be put on the smaller side and will be called Balance
Carried Down. Balance Carried Down is always recorded on the last day of the accounting
period. The balance which is carried down is also Brought Down on the first day of the next
period.
Whenever the accounts are balanced off, we have to extract a Trial Balance. A Trial Balance is a
list of balances extracted from the ledgers to check the arithmetical accuracy of the ledger.

Page 9
 Page 10

BOOKS OF ORIGINAL ENTRY / PRIME ENTRY

Before the transactions are recorded in the ledger or the T-accounts, they have to be posted in
the books of Prime entry. There are 6 books of prime entry which are as follows:
Cash Book: All transactions that involves cash or bank will pass through the Cash Book. Cash
Book is not only a book of original entry, it is also a ledger and hence transactions once
recorded in the Cash Book, indicates that one part of double entry is complete.
Sales Day Book: All transactions that involves ‘credit sales’ of goods are passed through this
book. Also called Sales Journal.
Purchases Day Book: All transactions that involves ‘credit purchases’ of goods are passed
through this book. Also called Purchases Journal.
Sales Returns Journal: Also known as Returns Inwards Day Book. When our customers return us
goods which we had previously sold them on credit is part of this book.
Purchases Returns Journal: Also known as Returns Outwards Day Book. When we return goods
to our suppliers which we had previously bought on credit, it will pass through this book.
General Journal: All those transactions which do not come in any of the above 5 books are to
be passed through this book. In other words, all those transactions that does not involve cash,
bank, cheque or goods are passed through this book. Hence, credit purchases of non-current
assets, credit sales of non-current assets or return of non-current asset on credit will pass
through this book. Any amendment or correction of error will also pass through this book.
Opening and closing entries will also pass through this book.
ACCOUNTING TERMINOLOGIES
Sales/Revenue are the goods sold which were previously bought with an intention of re-sale.
Purchases are goods bought with an intention of re-sale.

Sales Returns are the goods retuned to us by our customers which we have previously sold to
them.
Purchases Returns is when we return goods to our suppliers which we have previously bought.

Goods are all those things that we trade in.

Inventory (previously known as Stock of Goods) are the goods bought or produced with an
intention of resale yet unsold.

Drawings: Whenever owner withdraws anything from the business, be it cash, goods or non-
current assets for personal use, it is called Drawings.

What is Contra? If an item does not fall in any category of ALCER but has opposite features of
some categories, then it is called Contra.

Page 10
 Page 11

ADJUSTMENTS TO FINAL ACCOUNTS

Final Accounts are divided into 2 categories,

➢ Income Statement
➢ Statement of Financial Position

Income Statement:
It indicates profitability position of the business and indicates the earning capacity of the
business. It helps us in finding how much revenue is generated and through what sources and
how much expenses are incurred and by what means. It used to be called Trading and Profit
and Loss Account.

Statement of Financial Position:

It shows the details of assets, liabilities and capital on a certain date. It was known as Balance
Sheet.

FINAL ACCOUNTS are prepared when the accounting year ends but it is published after 3
months. Any changes occurring during these 3 months which impacts the figures of the
previous year are called Adjustments and hence they must be taken into consideration before
the final accounts are published so that the financial statements reflect a true and fair view of
the business performance and are reliable. Some adjustments that need to be incorporated are
as follows:

Prepayments: Also known as Prepaid Expenses or Expenses paid in advance. These are the
expenses paid but not yet incurred and hence are the current assets of the business. Example,
School fees.

Accruals: They are the expenses incurred but not yet paid. They are the expenses due but
unpaid and are also known as Accrued Expenses, Outstanding Expenses and Owings. Example,
Utility bills. Hence, accruals are the current liabilities of the business.

Accrued Income: They are the incomes earned but yet not received. They are also known as
Arrears and are current assets for the business. Example, Commission of a commission agent

Pre-received Income / Unearned Income: They are the incomes received (in advance) but yet
not ‘earned’ and hence are the current liabilities of the business. Example, school fees for the
school.

NOTE: At the end of the accounting period, all expenses and all revenues are transferred to the
income statement or profit and loss account.

Page 11
 Page 12

EXPENSES
Prepayments b/d xxx Accruals b/d xxx
Cash/Bank xxx Income Statement xxx
Accruals c/d xxx Prepayments c/d xxx
xxx xxx
PAAP

REVENUES
Accrued Income b/d xxx Pre-received Income b/d xxx
Income Statement xxx Cash/Bank xxx
Pre-received Income c/d xxx Accrued Income c/d xxx
xxx xxx
APPA

Page 12
 Page 13

ACCOUNTING CONCEPTS
Accounting Concepts are the guidelines and the principles based on which the whole
accounting system lies and which needs to be followed when passing accounting entries. The
accounting concepts are as follows:

1. Dual Aspect Concept: This concept states that accounting is based on double-entry system
which means that every debit will be followed by an ‘equal amount’ of credit.
E.g. Cash 5000
Bank 10000
Capital 15000

Cash 500
Bank 200
Commission received 700

Rent Expense 2500

Cash 500
Bank 2000

2. Money Measurement Concept: This concept states that only those transactions are recorded
in the books of accounts that have a monetary value (otherwise it will not be a transaction).
3. Business Entity Concept: This concept states that business is a separate legal entity different
from its owners which has a legal status, has its own name, bank account in its personal name,
which can sue and it can be sued.
(The concept of “Drawings” exist because of this concept)
4. Going Concern Concept: This concept states that a business will continue its course of
operations in the foreseeable future. Foreseeable future for different business varies. For a
normal business, foreseeable future is at least an accounting period but for a high-tech industry
or oil-rigging company, foreseeable future can be as long as 10 years.
If the business plans to shut down, it must disclose it to all its relevant stakeholders that the
going concern concept has been hampered.
5. Materiality Concept: This concept states that an item which is an asset for a small business,
the same item might be an expense for a much larger business.

Page 13
 Page 14

6. Consistency Concept: This concept states that accounting policies and procedures should not
vary from one accounting period to another. Only if the business feels that the current policy or
procedure is not reflecting the true and fair value of the business, then it is allowed to change
the policy once. But once the policy is changed, the business cannot revert back to old policy
and it must disclose why the policy has been changed.
7. Historical Cost Concept: This concept states that ‘non-current’ assets should be recorded in
the books of accounts at their original cost including all capital expenditures, despite any loss in
the value of non-current assets until and unless the asset is revalued or disposed off.
8. Prudence Concept: This concept states that expected losses are to be recorded in the books
of accounts as soon as they are expected whereas expected profits are not to be recorded until
and unless they are actually realized.
9. Accrual Concept: This concept states that expenses should be recorded as soon as they are
incurred irrespective of the fact whether they are paid or not. Similarly, profits will be recorded
as soon as they are ‘earned’ irrespective of whether they are received or not.
10. Matching Concept: This concept states that expenses of one year are to be matched with
the revenues of that year.
11. Substance over form: If an asset is bought on hire purchase or lease then despite the fact
that the asset is not yet owned by the business, it will still be treated as the non-current asset
and the amount not yet paid will be treated as liability of the business. Also known as
‘Commercial Reality Concept’.

Page 14
 Page 15

DEPRECIATION
Depreciation is the loss in the value of fixed (non-current) assets over their useful life. It is
charged so that the cost of the asset could be distributed amongst the number of years it will
be used as per “Prudence and Matching Concept”.
Why does asset lose its value?
1. Time factor
2. Technological changes
3. Obsolescence
4. Wear and tear
5. Depletion
6. Inadequacy
7. Damage
8. Usage
Methods of charging Depreciation:
There are 7 methods of charging depreciation:
1. Straight line method
2. Reducing balance method
3. Revaluation method
4. Usage method
5. Mileage method
6. Depletion method
7. Sum of year digit method
Straight Line Method:
This school of thought suggests that same amount of depreciation is charged each year
throughout the life of the asset. The formula to calculate depreciation is
Depreciation = Cost – Scrap Value
Estimated Useful Life
Cost Price =Purchase Price + All capital expenditures
Scrap Value is the value generated from the asset once it is no more in the usable condition.
(Also known as Residual Value and Salvage Value)
Estimated useful life is an assumption as to how long will the asset be used in the business.
In order to find the “rate of depreciation”, we apply the following formula:
Depreciation Rate = Depreciation x 100
Cost

Page 15
 Page 16

Straight line method of depreciation is also called “Depreciation on Cost”.

DEPRECIATION REPAIR AND MAINTENANCE TOTAL

YEAR 1 9000 0 9000
YEAR 2 9000 2000 11000
YEAR 3 9000 2500 11500
YEAR 4 9000 3500 12500
YEAR 5 9000 5000 14000

Example:
Given that the cost of an asset is $50000 which is expected to be sold for $5000 after being
used for 5 years. Find depreciation per year and the rate of depreciation.
Cost = 50000
Salvage Value = 5000
Life = 5 years
Depreciation = 50000-5000 = $9000/year
5
Depreciation Rate = 9000 x 100 = 18%
50000
Cost 50000
Less: Year 1 Depreciation (9000)
Net Book Value/Reduced Cost 41000 (Also known as Written-down value)
Less: Year 2 Depreciation (9000)
Net Book Value/Reduced Cost 32000
Less: Year 3 Depreciation (9000)
Net Book Value/Reduced Cost 23000
Less: Year 4 Depreciation (9000)
Net Book Value/Reduced Cost 14000
Less: Year 5 Depreciation (9000)
Salvage Value 5000
Reducing Balance Method:
This school of thought suggests that more depreciation to be charged in the initial years than in
the later years. This is because when the asset is new, it has little or no maintenance cost but as
asset gets older, the burden of ‘repair and maintenance’ starts increasing, therefore in order to
equalize the burden of asset, it is very important that initially more depreciation should be
charged and in later years, less depreciation to be charged.

Page 16
 Page 17

Reducing balance method of depreciation is also known as “Depreciation on written-down

value”
Net Book Value/Reduced Cost/Written-down value = Cost – Depreciation

DEPRECIATION REPAIR AND MAINTENANCE TOTAL

YEAR 1 12000 0 12000
YEAR 2 10000 2000 12000
YEAR 3 9000 2500 11500
YEAR 4 8000 3500 11500
YEAR 5 6000 5000 11000

Example:
Given that the cost of an asset is $50000 and it is to be depreciated using reducing-balance
method at the rate of 20% per annum. Find depreciation charges each year.
Cost 50000
Less: Year 1 Depreciation (10000)
Net Book Value/Reduced Cost 40000
Less: Year 2 Depreciation 20% of 40000 (8000)
Net Book Value/Reduced Cost 32000
Less: Year 3 Depreciation 20% of 32000 (6400)
Net Book Value/Reduced Cost 25600
Less: Year 4 Depreciation 20% of 25600 (5120)
Net Book Value/Reduced Cost 20480
Less: Year 5 Depreciation 20% of 20480 (4096)
Scrap Value 16384
Formula to find the rate of depreciation using reducing balance method:
Rate = 1 - n√(R/C)
Where, R is the residual value
C is the cost
n is the estimated life in years

Page 17
 Page 18

Example:
Given that the cost of an asset is $50000, it will be used for 5 years and has a residual value of
$10000. Find the rate of depreciation to be charged using reducing-balance method and also
find the depreciation charge each year.
R= 10000
C= 50000
n= 5 years
Rate = 1 – 5√10000/50000 = 27.5%
Cost 50000
Less: Year 1 Depreciation 27.5% (13750)
Net Book Value/Reduced Cost 36250
Less: Year 2 Depreciation 27.5% (9969)
Net Book Value/Reduced Cost 26281
Less: Year 3 Depreciation 27.5% (7227)
Net Book Value/Reduced Cost 19054
Less: Year 4 Depreciation 27.5% (5240)
Net Book Value/Reduced Cost 13814
Less: Year 5 Depreciation 27.5% (3799)
Scrap Value 10015

STRAIGHT-LINE METHOD (DEPRECIATION PER YEAR)

10000
9000
8000
DEPRECIATION

7000
6000
5000
4000
3000
2000
1000
0
Year 1 9000
Year 2 9000
Year 3 9000
YEAR

Page 18
 Page 19

Revaluation Method:
This school of thought suggests that more depreciation should be based on market value of
asset and specifically applied to loose tools and land whose value changes ae per the change in
market value.
Opening value of asset xxx
Add: Purchase of asset xxx
Less: Sale of Asset (at NBV) (xxx)
Less: Closing value of asset (xxx)
Depreciation for the year xxx
Usage Method:
This school of thought suggests that depreciation on an asset should be charged as per their
usage. The more the asset will be used, the higher the depreciation will be charged. This
method of depreciation is suitable for those assets which have a fixed life, either in terms of
number of hours or in terms of number of units produced. Hence, the formula to calculate
depreciation is:
Depreciation = Units Produced x (Cost – Scrap Value)
Total Life In Units
Depreciation = Hours Consumed x (Cost – Scrap Value)
Total Life In Hours
Example: Printer
Year 1: 15000 pages Depreciation= 15000 x (79000-4000) = 22500
50000
Year 2: 10000 pages Depreciation= 10000 x (79000 - 4000) = 15000
50000
Year 3: 5000 pages Depreciation=5000 x (79000 - 4000) = 7500
50000
Year 4: 12000 pages Depreciation= 12000 x (79000 - 4000) = 18000
50000
Year 5: 8000 pages Depreciation=8000 x (79000 - 4000) = 12000
50000 pages 50000

Page 19
 Page 20

Mileage Method:
This method is applied on vehicles, ships and aero planes. All vehicles have a life in terms of the
distance that they will travel and hence it is extremely important to depreciate them using
mileage method in accordance with the distance travelled.
Depreciation = Distance Travelled x (Cost – Scrap Value)
Total Life In Miles
Example: Given that a vehicle has a life of 3 years during which it can travel a maximum of
80000 miles. The expected mileage for the three years are; Year 1: 20000; Year 2: 25000, Year
3: 35000. The cost of the vehicle is $175000 and it will be sold after 3 years for $1500.Year 1:
Depreciation=20000 x (175000 - 1500) = 40000
80000
Year 2: Depreciation=25000 x (175000 - 1500) = 50000
80000
Year 3: Depreciation=35000 x (175000 - 1500) = 70000
80000
Depletion Method:
This method is applicable on natural resources such as oil wells, coal mines and gas resources.
Depreciation = Natural resources extracted x Cost
Total natural resources available
Sum of years Digit method:
This school of thought suggests that depreciation should be charged on the basis of the life of
the asset. The more the life is left, the higher the depreciation is charged.
Example:
Cost: 32000
S.V: 2000
Life:5 years
1+2+3+4+5 = 15
Year 1: Depreciation= 5 x (32000 - 2000) = 10000
15
Year 2: Depreciation= 4 x (32000 - 2000) = 8000
15
Year 3: Depreciation= 3 x (32000 - 2000) = 6000
15
Year 4: Depreciation= 2 x (32000 - 2000) = 4000
15

Page 20
 Page 21

Year 5: Depreciation= 1 x (32000 - 2000) = 2000

15

Q - Apply all the depreciation methods on the given data:

Cost: 30000
R.V: 3000
Life: 3 years
How to record Depreciation?
✓ Depreciation Expense for the year
✓ Provision for Depreciation Accumulated Depreciation (Contra Asset)
Double Entries to record Depreciation:
Income Statement DR xxx
Provision for Depreciation CR xxx
Disposal of an asset:
Net Book Value/Reduced Cost/Written-down value = Cost – Accumulated Depreciation
Case 1:
Cost 50000
Less: Accumulated Depreciation (42000)
Net Book Value 8000
Less: Sales Proceeds (5000)
Loss on Disposal 3000
Case 2:
Cost 50000
Less: Accumulated Depreciation (42000)
Net Book Value 8000
Less: Sales Proceeds (10000)
Gain on Disposal (2000)
Case 3:
Cost 50000
Less: Accumulated Depreciation (42000)
Net Book Value 8000
Less: Sales Proceeds (8000)
No Gain / No Loss 0

Page 21
 Page 22

1. If NBV > Sales Proceeds Loss on Disposal

2. If NBV < Sales Proceeds Gain on Disposal
3. If NBV = Sales Proceeds No Gain / No Loss
Question 1:
A company buys 2 machines worth $10000 each on 1st Jan 2010. The company’s policy is to
depreciate all its non-current assets at the end of each year at the rate of 20% per annum using
reducing balance method. At the end of the second year after allowing the second year’s
depreciation, the company decided to dispose off one of the assets for $5000. On the same
day, a new machine worth $1300 was bought. You are required to prepare showing all workings
clearly:
1) Machinery A/C 2) Provision for Depreciation A/C
3) Income Statement Extract 4) Disposal A/C
Question 2:
A company bought 2 machines worth $7000 each paying by cheque on 1st Jan 2012. The
company’s policy is to charge depreciation at the rate of 30% per annum using straight line
method. After allowing the 2 year’s depreciation, one of the assets is sold for $3000. On the
same date, another asset worth $10000 is bought by cheque. You are required to prepare
showing all workings clearly:
1) Machinery A/C 2) Provision for Depreciation A/C
3) Income Statement Extract 4) Disposal A/C

Page 22
 Page 23

Schedule of Non-Current Assets

It shows the details of the cost of the asset, purchase of asset during the year, sale of asset
during the year and the closing balance of asset. Moreover, it shows details of depreciation as
in opening balance of depreciation, depreciation charge during the year, depreciation on
disposal of asset, and closing balance of depreciation. The schedule of asset also shows the
closing net book value obtained by deducting closing value of asset by closing depreciation.
Cost Vehicles Plant & Machinery Equipment Total
Opening balance xxx xxx xxx xxx
Purchase of asset xxx xxx xxx xxx
Sale of Asset (Cost) (xxx) (xxx) (xxx) (xxx)
Closing Balance xxx xxx xxx xxx
Depreciation
Opening balance xxx xxx xxx xxx
Charge for the year xxx xxx xxx xxx
Depreciation charged on Disposed assets(xxx) (xxx) (xxx) (xxx)
Closing Balance xxx xxx xxx xxx
Net Book Value xxx xxx xxx xxx
There are 3 policies with regards to charging of depreciation:
1. Full year’s depreciation in the year of purchase and no depreciation in the year of sale.
This means that whatever date we buy the asset, whether beginning of the year or at
the end of the year or during the year, we will charge full year’s depreciation. And
whatever date we sell the asset, no depreciation will be charged.
2. Full year’s depreciation in the year of sale and no depreciation in the year of purchase.
3. When the question is silent and does not mention any policy, then it means that
depreciation will be charged on Pro-Rata basis, i.e. monthly basis.
What is a Part-Exchange Allowance?
Part-exchange allowance is also known as Trade-in-Allowance. When an old asset is exchanged
with a new asset, then we do not have to pay the complete amount of asset, instead we only
have to pay the difference between the cost of the new asset and the exchange value of old
asset. Hence, the amount which is not paid is the ‘trade-in allowance’.
NOTE: There is a difference between accounting year and calendar year. Calendar year begins
in January and ends at December whereas Accounting year will be a duration of 12 months
starting from any date. Depreciation is charged at the end of the accounting year (not at the
end of the calendar year).

Page 23
 Page 24

BAD DEBTS

If the customer who owes us money refuses to pay back the amount he owes is called ‘bad
debt’. Bad Debt is an actual loss and hence is an expense for the business. The double-entries
to record bad debt is:
Bad Debt Expense DR xxx
Trade Receivables CR xxx
Income Statement DR xxx
Bad Debt Expense CR xxx
Reasons why a receivable become bad debt:
✓ He becomes bankrupt
✓ Receivable becomes mentally retarded
✓ The receivable dies ☹
✓ Debtor runs away
✓ Refuses to pay

Provision for Bad Debts

Provision for bad debts is an expected loss. If we expect that the receivables will not pay us
back the amount that they owe, then they will be considered as expected losses and as per
Prudence Concept, expected losses are to be recorded as expenses as soon as they are
expected.
Provision for bad debt is always charged on the ‘net debtor’ figure, i.e. receivables – bad debts
Double Entries to record Provision for Bad Debts:
Income Statement DR xxx
Provision for Bad Debts CR xxx
What are the factors to be considered in deciding the rate of provision for bad debts?
✓ Past Experience
✓ Economic Conditions
✓ Credit worthiness of receivables
✓ Age of debts
✓ Industry averages

Page 24
 Page 25

NOTE: Since provision for B/D is Contra-asset therefore,

Increase in provision:
Income Statement DR xxx
Provision for Bad Debts CR xxx
Decrease in provision:
Provision for Bad Debts I DR xxx
Income Statement CR xxx

Bad Debts Recovered

The person who has previously been recorded as Bad Debt suddenly comes back and pays you
back the amount he owes. Such a person is known as ‘Bad Debts Recovered’. Bad Debts
Recovered is the Revenue for the business and hence the double-entries to record bad debts
recovered are as follows:
Trade Receivables DR xxx
Bad Debt Recovered CR xxx
Bank DR xxx
Trade Receivables CR xxx
Bad Debt Recovered DR xxx
Income Statement CR xxx
NOTE: If a debtor becomes bad debt and is recovered the same year, it is neither bad debt nor
bad debt recovered. Instead, it will be considered as normal treatment of debtor paying us
back.
Example:
At the end of December 2011, receivables amounted to $12500 of which receivables worth
$1500 proved to be bad. It is the company’s policy to charge provision for bad debts at the rate
of 2% per annum. At the end of 31st December 2012, receivables amounted to $17500 of which
receivables worth $2500 proved to be bad. On 31st December 2013, receivables amounted to
$10500 of which receivables worth $500 proved to be bad. You are required to prepare,
showing all workings clearly, the following accounts:
1) Bad Debts A/C 2) Provision for Bad Debts A/C
3) Income Statement Extract

Page 25
 Page 26

Provision for Discount Allowed

When our customers pay us within time, we allow them a discount for prompt payment which
is expense for the business, therefore if the business expects that some of its customers will
pay the business back on time to avail discounts, it has to prepare a provision for discount
allowed, which is an expected loss. The accounting treatment of provision for discount allowed
is exactly the same as provision for bad debt. Therefore, the double-entries to record provision
for discount allowed is as follows:
Income Statement DR xxx
Provision for Discount Allowed CR xxx

Page 26
 Page 27

MISCELLANEOUS NOTES:
1) Closing Inventory is always ‘counted’ at the end of the accounting period. We do not
prepare the account of closing inventory instead closing inventory is counted by techniques of
inventory valuation. The amount of closing inventory is always part of income statement and the
statement of financial position.

2) If the adjustments to final accounts involve both opening and closing accruals and
prepayments, then in order to find the figure for expenses and revenues, we have to apply
PAAP(expenses) and APPA(revenues).

3) If adjustments to final accounts only involve closing prepayments, then closing

prepayments will be deducted from the expenses figure given in the trial balance. The amount
hence obtained will go to income statement as expenses and the amount of prepayment will go to
statement of financial position as current assets.

4) If only closing accruals are given in adjustments to final accounts, then in order to find
the expenses figure, we will add accruals to the expense figure given in the trial balance. The
amount hence obtained will go to income statement as expenses and the amount of accruals will
go to statement of financial position as liability.

5) If the adjustment states that a certain percentage of depreciation is to be charged on the

non-current asset and no previous depreciation is given in the trial balance, then the rate of
depreciation will directly be charged on the cost of the asset and the amount hence obtained will
go to income statement as expenses and will be deducted from the cost of the asset in the
statement of financial position.

If the question states that depreciation is to be charged on cost, it indicates that straight-
line depreciation is to be charged. In order to do so, the rate of depreciation will be charged on
the cost of the asset. The amount hence obtained is depreciation for the year and hence will be
charged to the income statement as expense. Accumulated depreciation (i.e. current year’s
depreciation just found and the previous year’s depreciation given in the trial balance) will be
transferred to the statement of financial position as a deduction from non-current assets.

If the adjustment states that depreciation is to be charged on the reduced cost or the net-
book value or written down value, it indicates that reducing balance method is to be charged. In
order to do so, we will first deduct the depreciation given in the trial balance from the cost of the
asset, the amount hence obtained is the net-book value and is subject to the rate of depreciation.
When this rate of depreciation will be charged on the net-book value, the amount obtained will
be depreciation for the year and will go to the income statement as an expense. The accumulated
depreciation will go to the statement of financial position.

Page 27
 Page 28

6) Whenever the owner withdraws anything from the business for his own use, it is Drawings. Of
the owner withdraws cash, it is known as Cash Drawings and the double-entries to record cash
drawings is
Drawings DR
Cash CR
When the owner withdraws non-current assets, the double-entries to record this is
Drawings DR
Non-Current Assets CR
If the owner withdraws goods from the business for his own use, it is called Stock Drawings and
the double-entries to record stock drawings is
Drawings DR
Purchases CR
7) If the bad debt figure is given in the trial balance, it indicates that the debtor figure in the trial
balance is the net debtor figure and hence the percentage of provision will directly be charged on
this figure.
If the bad debt figure is given in the adjustments to final accounts, it means that the
debtor figure in trial balance is not the net debtor figure therefore in order to achieve the net
debtor figure, bad debt should be deducted from the debtor figure given in the trial balance. The
amount hence obtained will be subject to provision for bad debts.
Provision for bad debts will be charged on the amount of net debtors. The amount hence
obtained will go to statement of financial position as deduction from debtors. If there is no
provision for bad debts given in the trial balance, the same amount will also go the income
statement as an expense.
If previous provisions for bad debts is given in the trial balance, then the current year’s
estimate will be deducted from it.
If there is increase in provision, it will be treated as an expense and if there is decrease in
provision, it will be treated as a revenue.
If it is stated that provision for bad debt is to be ‘created’, it means that there will be no
previous estimate, hence the same amount will be charged in income statement as an expense
and statement of financial position as deduction from debtors.
Whether bad debts are given in trial balance or adjustments to final accounts, they will
always be treated as an expense.

8) If provision for discount allowed is given in adjustments, then the accounting treatment of
provision for discount allowed is exactly the same as provision for bad debt.

9) If a new business is commenced or started, then there will be no opening inventory.

10) If premises are sub-let, it means that they have been given on rent and hence income from such
premises are the revenues of the business.

Page 28
 Page 29

11) Whenever the question involves preparation of financial statements for the half-year ended, all
things remain intact except for depreciation. In questions involving half-year, depreciation is to
be halved.

12) If you are required to prepare income statement for the quarter ended, then all other things will
remain intact except for depreciation, which has to be divided by 4.

13) If you are required to prepare income statement for a month, then all other things will remain
intact except for depreciation which needs to be divided by 12.

14) Expenses are divided into 2 categories; Expenses associated to Purchases and expenses
associated to sales.
Expenses which are associated to Purchases should be part of Cost of Goods Sold and
hence must be included in the trading account section of income statement.
Expenses which are associated to Sales should be part of Profit and Loss account of
Income Statement and hence must be deducted from the gross profit as expenses.

EXPENSES

Associated to Purchases Associated to Sales

Added to Cost of Goods

Added to Expenses
Sold

Part of Profit and Loss

Part of Trading Account
Account

15) Whenever goods are damaged, destroyed, lost or robbed and no insurance claim is accepted
against it, the double entries are

Income Statement DR
Purchases CR

If goods are damaged, destroyed, lost or robbed and insurance claim is accepted but yet not
received, then the accepted claim of the insurance claim of the insurance company will be treated
as current assets and the double entries will be

Insurance claim DR
Purchases CR

Page 29
 Page 30

If partial claim is accepted but yet not received, then the amount accepted will be treated as
current assets and the amount not accepted will be treated as loss, and hence the double entries
will be

Income Statement DR
Insurance claim DR
Purchases CR

16) If the rate of interest is given in adjustments to final accounts, it will be charged on the amount of
loan and the amount hence obtained is the interest expense for the year, which will be charged to
income statement as an expense. The amount of interest given in the trial balance is the interest
paid and the difference between interest incurred and the interest paid are the accrued interest
which will go to the balance sheet as current liabilities.

Page 30
 Page 31

ACCOUNTING SOURCE DOCUMENTS

11) Receipt
9) Statement of Account
8) Credit Note
6) Statement of Account
4) Sales Invoice
2) Quotation

BUYER SELLER
1) Request for Quotation
3) Purchase order
5) Goods Received Note
7) Debit Note
10) Cheque Counterfoil

Debit Note Issued: Returns Outwards

Debit Note Received: Returns Inwards
Credit Note Issued: Returns Inwards
Credit Note Received: Returns Outwards

Page 31
 Page 32

FINAL ACCOUNTS

RAJ INDUSTRIES
INCOME STATEMENT FOR THE YEAR ENDED 31 DEC 2013
$ $ $
Sales xxx
Less: Sales Returns (xx) xxx
Less: Cost of Goods Sold
Opening Inventory xxx
Purchases xxx
Less: Purchases Returns (xx) xxx
Carriage Inwards xxx
Cost of Goods Available for sale xxx
Less: Closing Inventory (xx) (xxx)

Gross Profit xxx

Add: Other Incomes

Discount Received xx
Gain on Disposal xx
Bad Debts Recovered xx
Decrease in provision xx
Commission Received xx
Rent Received xx xxx
xxx
Less: Expenses
Rent xx
Utility xx
Depreciation xx
Discount Allowed xx
Loss on Disposal xx
Increase in provision xx
Carriage outwards xx
Wages and Salaries xx
Interest xx (xxx)
Profit / (Loss) for the year xxx

Page 32
 Page 33

RAJ INDUSTRIES
STATEMENT OF FINANCIAL POSITION AS AT 31 DEC 2013
$ $ $
Intangible Non-Current Assets
Goodwill xxx
Patent xxx xxx
Tangible Non-Current Assets
Equipment xxx
Less: Provision for depreciation (xx) xxx

Land and Building xxx

Less: Provision for depreciation (xx) xxx xxx

Total Non-Current Assets xxx

Current Assets
Inventory xxx
Receivables (Net) xxx
Less: Provision for bad debts (x)
Less: Provision for discount allowed (x) xx
Prepayments xx
Bank xx
Cash xx xxx

Total Assets xxx

Current Liabilities
Payables xxx
Accruals xxx
Bank Overdraft xxx

Total Current Liabilities xxx

Non-Current Liabilities
Debentures xxx
Loan from XYZ xxx

Total Non-Current Liabilities xxx

Total Liabilities xxx

Equity
Opening Capital xxx
Add: Net Profit xxx xxx
Less: Drawings (xx)
Closing Capital xxx

Total Liabilities and Equity xxx

Page 33
 Page 34

WHAT IS AN INTANGIBLE ASSET?

Intangible Non-Current Assets are those assets which involve good reputation of the business
such as goodwill or some worthy asset such as patents.
(This is the most basic definition. We will go into further details later)
NOTE:
Current Assets must always be written in the reverse order of liquidity (ability of asset to turn
into cash) i.e.
Inventory
Receivables
Prepayments
Bank
Cash

Page 34
 Page 35

DEPARTMENTAL ACCOUNTING

Some businesses operate more than one department and hence it is very important to identify
how much profit has each department made so that it could be justified whether the
department should continue to exist or should shut down. Moreover, expenses of each
department should be identified in isolation so that it should be analyzed which department
has how much share of expenses.
In order to make income statement of departmental accounts, we have to make a Columnar
Income Statement.
When doing departmental accounting, although income statement is made in Columnar form,
statement of financial position would be made normal.

VALENTINE GIFT SHOP

DEPARTMENTAL INCOME STATEMENT FOR THE YEAR ENDED ______

Fresh Flowers Cards Chocolates Total

Sales xx xx xx xx
Less: Cost of Goods Sold
Opening Inventory xx xx xx
Purchases x x x
Costs Associated to Purchases x x x
Cost of Goods Available for sale xx xx xx
Less: Closing Inventory (xx) (xx) (xx) (xx) (xx) (xx) (xx)
Gross Profit xxx xxx xxx xxx
Add: Other Incomes
Discount Received x x - x
Gain on Disposal x x x x
xxx xxx xxx xxx
Less: Expenses
Rent xx xx xx
Wages and Salaries xx xx xx
Utility bills xx xx xx
Depreciation of Refrigerator - - xx
All other expenses to be distributed xx xx xx
as per department xx (xx) xx (xx) xx (xx) (xx)
Profit for the year xxx xxx xxx xxx

Page 35
 Page 36

BANK RECONCILIATION STATEMENT

Every month the business receives bank statement from the bank which is compared by the
business with the cash book that the business prepares. Officially the balance of the bank
statement at the end of the month should be equal to the balance of the cash book at the end
of the month but unfortunately this is not the case and there is a need to reconcile the cash
book with the bank statement so that the causes of the discrepancies could be identified and
removed. The causes of the discrepancies between the cash book and the bank statement are
as follows:
STANDING ORDER:
When the business instructs the bank to transfer a fixed amount of money on a fixed date to a
fixed person’s account, it Is called Standing Order. It is immediately recorded in the bank but
will be recorded in the cash book once the bank statement is received. It is also known as
Banker’s Order.
DIRECT DEBIT:
If a certain amount of money is transferred from the business bank account to some person’s
account on a particular date, it is known as Direct Debit. It is immediately taken into
consideration by the bank but will be recorded in the cash book once the bank statement will
be received.
CREDIT TRANSFER:
When someone transfers a certain amount of money directly into the business bank account, it
is known as Credit Transfer, and it will be immediately recorded by the bank but will be
recorded by the business when the bank statement will be received. It is also known as Bank
Giro.
BANK CHARGES:
Bank charges service charges for providing services to the business. These charges vary each
month depending on the services of the bank utilized and hence are not known by the business
till the bank statement is received, but are immediately taken into consideration by the bank.
INTEREST ON OVERDRAFT:
If bank overdraft facilities are availed by the business, the bank charges interest to the business
against the overdraft facilities. Interest on overdraft is an expense for the business which is
immediately taken into consideration by the bank, but will pass through business accounts once
the bank statement will be received.
INTEREST ON DEPOSIT:
When business deposits a certain amount of money into the bank, it receives interest on it
which is an income for the business. Interest on deposit will be immediately taken into

Page 36
 Page 37

consideration by the bank, but will be recorded in the business books once the bank statement
will be received.
DISHONOURED CHEQUES:
Dishonored Cheques are the cheques which are returned unpaid. These are the Bounced
Cheques which are immediately taken into consideration by the bank but will pass through the
business books once the business is informed by the bank or when the bank statement is
received.
Why is a cheque dishonored?
Cheque is dishonored because of the following reasons:
➢ Insufficient funds in the account of the business/person who has issued the cheque.
➢ Amount in the words and amount in figures are different
➢ The signature on the cheque is of wrong specification
➢ The cheque is stale (if the cheque is more than 6 months old, it becomes stale)
➢ The cheque is mutilated/damaged
➢ The person who has issued the cheque dies
➢ The person who has issued the cheque becomes mentally retarded
All the above-mentioned causes of the discrepancies are those which are present in the bank
statement but are not there in the cash book and hence will impact the adjusted cash book. The
following are the causes of discrepancies which impact the bank statement and are already part
of cash book.
UNPRESENTED CHEQUES:
When the cheques are issued by the business, they are immediately taken into consideration by
the business and are recorded in the cash book but they will only be taken into consideration by
the bank once the cheque is presented to the bank.
UNCREDITED DEPOSITS:
When a certain amount of money is deposited into the bank by means of cheque, it passes
through the process of clearing which takes 2-3 days. For this period of 2-3 days, the amount
will be shown in the cash book but will not appear in the bank statement. It is also known as
Bank Lodgments.
NOTE: Any error made or corrected by the bank might also cause difference in the amount of
cash book and the bank statement.
HOW TO RECONCILE THE CASH BOOK AND THE BANK STATEMENT
There are 2 varieties of questions involved when reconciling the cash book with the bank
statement. In the first variety, you are provided with the cash book and the bank statement
which are not balancing with each other, thus creating a need to reconcile the cash book with
the bank statement.

Page 37
 Page 38

In order to do so, we will open up adjusted cash book showing the bank column only, starting
with the incorrect balance given in the question. We need to remember that when we deposit
into the bank, it is an asset for the business but at the same time, it is liability for the bank,
hence when reconciling, we match the debit side of the cash book with the credit side of the
bank statement, and we match the credit side of the cash book with the debit side of the bank
statement.
When matching the debit side of the cash book with the credit side of the bank statement, all
those things that are common on both sides will be ignored. All those things that are present on
the credit side of the bank statement, but are not there on the debit side of the cash book will
be recorded on the debit side of the adjusted cash book. All those things that are present on
the debit side of the cash book, but are not there on the credit side of the bank statement will
be recorded in the bank reconciliation statement as Uncredited Deposits.
Then we will match the credit side of the cash book with the debit side of the bank statement,
all those things that are common on both sides, i.e. the credit side of the cash book and the
debit side of the bank statement will be ignored. All those things that are present on the debit
side of the bank statement, but are not there on the credit side of the cash book will be
recorded on the credit side of the adjusted cash book. All those things that are present on the
credit side of the cash book but are not there on the debit side of the bank statement will be
recorded on the bank reconciliation statement as Unpresented Cheques.

Finally, the adjusted cash book balance will match with the bank reconciliation statement. 😊

NOTE: When reconciling the cash book with the bank statement, any error made or corrected
by the bank will be ignored.
If the cheque number in the bank statement is older than the cheque number in the
cash book, all such entries are to be ignored.

In the 2nd variety of questions involving bank reconciliation statement, you will be
provided with the cash book balance and the bank statement balance (not complete cash book
and bank statement). The balances provided will obviously be different and hence there will be
a need to reconcile the cash book with the bank statement. The question will also provide the
causes of differences between the two, we will read those differences and identify whether
they are affecting the cash book or the bank statement. If they are affecting the cash book, the
entry will pass through the adjusted cash book. But if they are affecting the bank statement, we
have to realize whether they are Unpresented cheques or Uncredited Deposits, and hence they
will be incorporated in the bank reconciliation statement. Ideally, the adjusted cash book and
the bank reconciliation statement are made as follows:

Page 38
 Page 39

ADJUSTED CASH BOOK

Balance b/d xxx Balance b/d xxx

Credit Transfer xxx Standing Order xxx
Interest on Deposits xxx Direct Debit xxx
Dividends xxx Bank Charges xxx
Dishonored Cheques xxx
Interest on Overdraft xxx
Balance c/d xxx Balance c/d xxx
xxx xxx
Balance b/d xxx Balance b/d xxx

AQ INDUSTRIES
BANK RECONCILIATION STATEMENT AS AT 31st DEC 2016
Balance as per Bank Statement xxx
Add: Uncredited Deposits xxx
Less: Unpresented Cheques (xxx)
Balance as per Adjusted Cash Book xxx
OR
Balance as per Adjusted Cash Book xxx
Add: Unpresented Cheques xxx
Less: Uncredited Deposits (xxx)
Balance as per Bank Statement xxx

Page 39
 Page 40

CONTROL ACCOUNTS

WHAT ARE CONTROL ACCOUNTS AND WHY ARE THEY PREPARED?

Control Accounts are divided into 2 categories:
Sales Ledger Control Account / Receivables Control Account because it is the account of total
receivables. It is made in such a manner that whatever is recorded in than individual receivable
account will also be recorded in the total receivable account, i.e. sales ledger control account.
Purchases Ledger Control Account / Payables Control Account because whatever is recorded in
than individual receivable account will also be recorded in the total receivable account, i.e.
sales ledger control account.
The purpose of preparing the control accounts are:
➢ To identify the errors
➢ To detect frauds
➢ To find the values of total receivables and total payables
➢ To find the figures of credit sales and credit purchases
➢ To reconcile the control accounts with the individual accounts
HOW TO MAKE CONTROL ACCOUNTS:
In order to make control accounts, it must be kept in mind that whatever happens to an
individual receivables and payables account also impacts the control accounts. The only
difference is while individual accounts are affected by daily transactions, whereas control
accounts are prepared from books of original entries so the accuracy of control accounts is
dependent upon accuracy of books of original entries. Control A/Cs are made as follows:

SALES LEDGER CONTROL A/C (TOTAL RECEIVABLES A/C)

Balance b/d xxx Minor balance b/d xxx

Credit Sales xxx Sales returns xxx
Dishonored cheques xxx Bank xxx
Bad Debts Recovered xxx Bad Debts xxx
Interest on overdue account xxx Discount Allowed xxx
Cash refund xxx Bad Debts Recovered(bank) xxx
Contra set-off xxx
Minor balance c/d xxx Balance c/d xxx
xxx xxx
Balance b/d xxx Minor balance b/d xxx

Page 40
 Page 41

PURCHASE LEDGER CONTROL A/C (TOTAL PAYABLES A/C)

Minor balance b/d xxx Balance b/d xxx

Purchases returns xxx Credit Purchases xxx
Discount Received xxx Interest on overdue account xxx
Bank xxx Dishonored cheques xxx
Contra set-off xxx
Balance c/d xxx Minor balance c/d xxx
xxx xxx
Minor balance b/d xxx Balance b/d xxx

CONTRA-SET OFF is always made with the MINOR of the two balances and will impact both
Sales Ledger Control Account and Purchase Ledger Control Account.
MINOR BALANCE: When the receivables overpays and does not adjust his account, he becomes
the payable for a very short period of time. (Overpaid, returned goods, invoice overcharged by
error)

Page 41
 Page 42

HOW TO RECONCILE CONTROL ACCOUNTS WITH INDIVIDUAL ACCOUNTS

Since control accounts are total receivables and total payables account, therefore at the end of
every month, the sum of all individual receivables account must be equal to the total receivable
account, i.e. sales ledger control account and sum of all individual payables account must be
equal to total payables account i.e. purchase ledger control account but unfortunately this is
not the case and hence there is a need to reconcile the control accounts with the individual
accounts.
The questions involving reconciliation of control accounts will provide the control account
balances as well as the individual account balances, which obviously will be different indicating
the need to reconcile and identify whether they are affecting the control accounts, the
individual accounts or both the control accounts as well as the individual accounts.
If an error will affect the books of original entry, then it is an indication that it will affect the
control accounts. Similarly, if the error affects total of anything, it will once again affect the
control accounts.
On the other hand, if an error affects a particular receivable or a particular payable or list of
receivables or list of payables or if an error affects schedule of receivable or schedule of
payable or if an error affects sales ledger or purchases ledger, it is an indication that it will
affect the individual accounts.
If an item is entirely omitted, then it will affect both individual accounts as well as control
accounts. Similarly, if there is an error in invoice, then it will affect both individual accounts as
well as control accounts.
All those things which will affect individual accounts will be recorded in the reconciliation
statement and all those things that will affect control accounts will be recorded in the adjusted
control account. Finally, the adjusted control account balance must be equal to reconciliation
statement balance.
NOTE:
➢ When correcting accounts, if an entry is Understated, it will be corrected by making the
entry on the same side by the amount of understatement.
➢ When correcting accounts, if an entry is Overstated, it will be corrected by making the
entry on the opposite side by the amount of overstatement.
➢ When correcting accounts, if an entry is made on the wrong side, then it will be
corrected by making an entry on the correct side by the double amount.

Page 42
 Page 43

ERRORS AFFECTING AND NOT AFFECTING TRIAL BALANCE

Trial Balance is a list of balances, extracted from the ledgers to check the arithmetical accuracy
of the ledgers. If it does not balance, it has errors that affects trial balance. If it balances, it
might be correct or it might have balanced by the wrong amount. If it has balanced by the
wrong amount, it has errors not affecting trial balance.
ERRORS
Not affecting Trial Balance Affecting Trial Balance
Whether errors affect or do not affect trial balance, they need to be corrected.

ERRORS NOT AFFECTING TRIAL BALANCE

➢ Error of Commission: If the double entry is complete with correct amounts being involved but
the entry has been made in the wrong person’s account, it is called Error of Commission. For
example, goods sold on credit to Ayesha worth $200 has been posted to Aisha’s Account.

➢ Error of Principle: If the double entry is complete with correct amounts being involved but the
entry has been made in the wrong type of account, it is called Error of Principle. For example,
furniture purchased paying by cash worth $500 have been posted to purchases account.

➢ Error of Omission: If the double entry is entirely omitted, it is referred to as Error of Omission,
because neither the debit entry nor the credit entry has been passed. For example, cash sales
$200 has been entirely omitted.

➢ Error of Original Entry: If the double entry is complete with correct accounts being involved but
the entry has been made by the wrong amount, it is referred to as Error of Original Entry. For
example, cash sales of $500 has been recorded as $5000.

➢ Transposition Error: If the double entry is complete with correct accounts being involved but
the entry has been made by the wrong amount in such a manner that the digits have been
interchanged, then it is referred to as Transposition Error. For example, cash sales of $360 has
been recorded as $630.

➢ Casting Error: If the double entry is complete with correct accounts being involved but the
entry has been made by the wrong amount because of the totaling error in the invoice, it is
referred to as Casting Error.

➢ Error of Complete Reversal: If the double entry is complete with correct accounts and correct
amounts being involved but the entries have been made on the wrong side of accounts, then
the error is referred to as Error of Complete Reversal. For example, cash purchases $250 has
been posted on debit side of cash Account and credit side of purchases account.

Page 43
 Page 44

➢ Compensating Error: If two errors that have no relationship with each other offsets each
other’s mistakes are referred to as Compensating Errors. For example, cash sales $200 recorded
as $20 in cash account, i.e.
Cash DR 20
Sales CR 200
And furniture bought on cash worth $200 recorded as $20 in cash account, i.e.
Furniture DR 200
Cash CR 20
Hence, overall both error’s effect is nil.

COPCROCT

Page 44
 Page 45

ERRORS AFFECTING TRIAL BALANCE

Whenever an error affects the trial balance, it needs to be corrected with the help of Suspense
Account. A Suspense Account is a temporary account which is opened when the errors are
found and closed when the errors are corrected. Until and unless the balance on the suspense
account is not nullified, it means that all errors are not yet found and the trial balance will still
not balance. If the final accounts are prepared before the correction of all errors, then the debit
balance in the suspense account will be treated as Current Assets and the credit balance in the
suspense account will be treated as Current Liabilities till all the errors are found and corrected.
Errors affecting trial balance can be broken down into 2 categories:
1) Errors to be corrected by double-entries
2) Errors to be corrected by just a single entry in the suspense account
Errors to be corrected by Double-Entries are:
1) When the double-entry is not complete, i.e. either the debit entry or credit entry is
made, but not both.
2) The double-entries are made with different amounts
3) Both the double-entries are made on the same side.
Errors to be corrected by Just Single Entry in Suspense Account:
If the error is such that there is no mistake in the ledger but instead the error is in the trial
balance or listing of some figures, then in order to correct these, only a single entry in the
suspense account will be required because when there is no error in the ledger, then no
correction in the ledger should be made.
1) Wrong amount is posted in the trial balance.
2) An item is omitted from the trial balance.
3) An item is recorded on the wrong side of the trial balance.
4) Something included in the trial balance should not be included, e.g. trade discount,
closing inventory
HOW TO INVLOVE QUESTIONS INVOLVING SUSPENSE ACCOUNT
In order to solve questions involving suspense account, the question will provide us with wither
an incorrect trial balance or the trial balance with different balances. The question will also
provide us with the errors that might have or might not have affected the trial balance. We will
read those errors and apply the following rules of correction:
1) What should have been done
2) What has been done
3) Identify the error
4) Correct the error

Page 45
 Page 46

HOW TO CORRECT THE NET PROFIT WHEN ERRORS ARE INVOLVED

If an item affecting income statement, when corrected, is being debited, it will decrease the
profit, whereas if an item affecting income statement is being credited, it will increase the
profit.
HOW TO CORRECT THE WORKING CAPITAL
If an item affecting working capital i.e. either current assets or current liabilities is debited, it
will increase working capital, whereas if an item affecting working capital i.e. either current
assets or current liabilities is credited, it will decrease the working capital.

Page 46
 Page 47

MANUFACTURING ACCOUNTS

Some businesses do not involve just in trading activities but instead they manufacture their
own products. Such businesses are called Manufacturing businesses. For such businesses in
order to calculate profitability, we have to calculate the cost of production. Thus, it is very
important to understand the cost structure of the business, which comprises of the following:
1) FIXED COSTS: Fixed Costs are those costs which do not vary as output varies. Whether
output is zero or in large quantities, the fixed costs remain same. They are also known as
‘Indirect Costs’ or ‘Factory Overheads’. For example, rent, supervisor salary, depreciation and
so on.

It is very important to realize that as output increases, the ‘fixed cost per unit’ keeps on falling
(spreads over the output).
2) VARIABLE COSTS: Variable Costs are those costs which varies as output varies. When
output is zero, variable costs do not exist. But as output starts rising, variable costs starts
increasing. They are also known as ‘Direct Costs’ or ‘Prime Cost’. For example, cost of material,
wages of labor, etc.

The ‘variable cost per unit’ is always fixed.

Page 47
 Page 48

3) SEMI-VARIABLE COSTS: Semi-Variable Costs are those costs which have a certain
element of variable cost and some portion of fixed cost. For example, Utility Bills in which line
rent is fixed and other cost depends on the units consumed. There are 3 situations in which
semi-variable costs can be applied:

Utility Bills Call packages Rent a car

4) STEPPED COSTS: Step Costs are those costs which are fixed over a range of output and
then fixed again over another range of output. Thus, the cost increases in the form of steps. For
example, Warehousing cost.

5) SUNK COSTS: Sunk Costs are those costs which are irrelevant from the decision-making
perspective, and hence are not drawn as a graph. For example, Market research cost which is
irrelevant to cost of production, and when making manufacturing account, our only concern is
the cost of production.

6) TOTAL COST: is the sum of fixed costs and variable costs. When output is zero, total cost
is equals to the fixed costs because at the instant, variable cost does not exist. But as output
starts increasing, total costs start increasing because of increase in variable costs.
The increase in total cost is because of the variable cost and thus total cost and variable costs
graphs are always parallel and the vertical distance between these two graphs is the fixed cost.

Page 48
 Page 49

WHY IS THERE A NEED TO MANUFACTURE GOODS?

➢ To earn higher profits
➢ To produce high-quality products
➢ To maintain brand image
➢ To remove dependency from suppliers
➢ Availability of raw materials (If raw material is available, then instead of buying finished
products, the business tries to convert those raw materials into finished goods itself)
NOTE:
When making manufacturing account, we try to identify what is the cost of production and
whether it is feasible to manufacture goods or to buy it from an outside vendor. If it is cheaper
to produce than to buy a product, then manufacturing should be done and the difference
between the manufacturing cost and the purchase price is manufacturing profit.
It is extremely important that manufacturing profit and trading profit should be
calculated separately, so that the performance of the manufacturing department and the
trading department could be identified individually. This is also important because of the fact
that the performance of each department manager is judged by the performance of his
department.

Page 49
 Page 50

AQ INDUSTRIES
MANUFACTRING ACCOUNT FOR THE YEAR ENDED 31 DEC 2016
$ $ $
Cost of Raw Materials Consumed
Opening Inventory of Raw Materials xxx
Purchases of Raw Materials xxx
Less: Purchases Returns of Raw Materials (xx) xxx
Carriage Inwards of Raw Materials xx
Cost of Raw Materials Available for sale xxx
Less: Closing Inventory of Raw Materials (xx) xxx
Add: Other Direct Costs
Direct Labor xx
Variable Overheads xx
Royalties xx xxx
Prime Cost xxx
Add: Indirect Costs/ Factory Overheads
Depreciation xx
Rent and Rates xx
Supervisor Salary xx
Indirect Material xx
Indirect Labor xx xxx
Manufacturing Cost xxx
Add: Opening Inventory of Work-in-Process xx
Less: Closing Inventory of Work-in-Process (xx) xx
Cost of Production xxx

Page 50
 Page 51

AQ INDUSTRIES
INCOME STATEMENT FOR THE YEAR ENDED 31 DEC 2016
$ $ $
Sales xxx
Less: Sales Returns (xx) xxx
Less: Cost of Goods Sold
Opening Inventory of Finished Goods xxx
Transfer from Manufacturing Account xxx
Purchases of Finished Goods xxx
Less: Purchases Returns of Finished Goods (xx) xxx
Cost of Goods Available for sale xxx
Less: Closing Inventory of Finished Goods (xx) (xxx)

Gross Profit xxx

Add: Other Incomes

Discount Received xx
Rent Received xx xxx
xxx
Less: Expenses
All expenses associated to trading department xx
for sale of goods xx
Bad Debts xx
Office expenses xx
Office salaries xx (xx)
Net Profit xxx

Page 51
 Page 52

AQ INDUSTRIES
STATEMENT OF FINANCIAL POSITION AS AT 31 DEC 2016
$ $ $
Non-Current Assets
Machinery xxx
Less: Provision for depreciation (xx) xxx
Premises xxx xxx
Current Assets
Closing Inventory (RM + WIP + FG) xxx
Less: Provision for unrealized profit (x) xxx
Receivables (Net) xx
Less: Provision for bad debts (x)
Less: Provision for discount allowed (x) xx
Prepayments xx
Bank xx
Cash xx xxx
Total Assets xxx
Current Liabilities
Payables xxx
Accruals xxx
Total Current Liabilities xxx
Non-Current Liabilities
Loan from XYZ xxx
Total Liabilities xxx
Equity
Opening Capital xxx
Add: Net Profit xxx xxx
Less: Drawings (xx)
Closing Capital xxx
Total Liabilities and Equity xxx

NOTE:
Manufacturing Royalties Direct Cost (Manufacturing Account)
Selling Royalties Expenses (Income Statement)

Page 52
 Page 53

NON-PROFIT ORGANISATIONS (NPO)

Some organizations come into existence not to make profits but to provide facilities to their
members. Such organizations do not have owners. They have members who choose one of the
members who is made responsible for running the NPO. Since there are no owners, there is no
concept of capital, drawings or profits. Such organizations exist in the form of clubs, or housing
societies and thus NPOs are also referred to as Club Accounting.

Since in clubs, there is no concept of Capital, therefore instead of capital Account, we make
‘Accumulated Funds Account’. Moreover, instead of Bank Account, we make ‘Receipts and
Payments Account’, and since there is no concept of profit and loss account, we make ‘Income
and Expenditure Account’ to find out whether the club has more incomes or expenses.

The major source of Income for the club is Subscriptions. Subscriptions are payments made by
the members to the NPO in order to avail the facilities of the club. Sometimes, club also involve
in trading activities and once again the motive is not profit making but instead facility of
member.

The accounting treatment of a NPO comprise of the following steps. If the requirement of the
question is to prepare Income and Expenditure Account and Statement of Financial Position, all
the following steps must be applied:

1) Preparation of Accumulated Funds

Accumulated Funds are similar to Capital Account and is achieved when opening liabilities are
deducted from opening assets.

ACCUMULATED FUNDS
Assets xxx Liabilities xxx
xxx xxx
xxx xxx
xxx xxx
xxx
Accumulated Funds xxx

Page 53
 Page 54

2) Preparation of Receipts and Payments Account

Receipts and Payments Account is similar to Bank Account and is based on cash concept. When
cash comes into the business, it is recorded as Receipts and when cash goes out of the business,
it is recorded as Payments. The Receipts and Payments Account can either have debit balance
or a credit balance. Debit balance of Receipts and Payments Account is Current Assets and
credit balance of Receipts and Payments Account is Current Liabilities. Receipts and Payments
Account is made as follows:

RECEIPTS AND PAYMENTS ACCOUNT

Receipts Payments
Balance b/d xxx Balance b/d xxx
xxx xxx
xxx xxx
xxx xxx
Balance c/d xxx Balance c/d xxx

3) Preparation of Trading Account

If clubs involve into trading activities, then we need to prepare Trading account. If receivables
and payables are given in the question, then we must prepare SLCA and PLCA to find out sales
and purchases. The terminology used for sales in questions involving NPO is ‘Takings’. The
trading account is made as follows:

TRADING ACCOUNT FOR THE YEAR ENDED 31 DEC 2013

$ $ $
Sales xxx
Less: Cost of Goods Sold
Opening Inventory xxx
Purchases xxx
Cost of Goods Available for sale xxx
Less: Closing Inventory (xx) (xxx)

Gross Profit xxx

Less: Expenses associated to Trading only

Wages xx
Other Expenses xx (xxx)
Profit / (Loss) from trading xxx

Page 54
 Page 55

4) Preparation of Subscription Account

Subscriptions are weekly, monthly or annual payments made by the members to the NPO in
order to avail the facilities of the club.

Subscriptions in Arrears:
Subscriptions in arrears means subscriptions earned but yet not received. They are accrued
subscriptions which are accrued incomes and hence current assets for the club.
Subscriptions in Advance:
Subscriptions in advance are the subscriptions received but yet not earned. They are unearned
income or pre-received income and hence current liabilities for the club.
The subscription account is made as follows:

SUBSCRIPTIONS ACCOUNT
Accrued b/d xxx Advance b/d xxx
Cash Refund xxx Receipts and Payments Account xxx
Income and Expenditure Account xxx Bad Debts xxx
Advance c/d xxx Accrued c/d xxx
xxx xxx

5) Adjustment of Expenses and Revenues

The revenues and expenses can be adjusted through PAAP and APPA. If the question is silent
regarding depreciation of NCA in questions involving NOP, then it does not mean that no
depreciation will be charges. Instead, it is an indication that revaluation method of depreciation
is to be applied, as follows:

Opening value of asset xxx

Add: Purchase of asset xxx
Less: Sale of Asset (xxx)
Less: Closing value of asset (xxx)
Depreciation for the year xxx
6) Preparation of Income and Expenditure Account
Income and Expenditure Account takes into consideration the earning capacity of the club as to
how much income is generated and through what sources and how much expenses are made
and by what means. If gift/donation/legacy received by the club is without any purpose, then it
is to be treated as an Income. The life membership which is capitalized during the accounting
period is also to be treated as an Income. Thus, Income and Expenditure Account is made as
follows:

Page 55
 Page 56

INCOME AND EXPENDITURE ACCOUNT FOR THE YEAR ENDED 31st DEC 2016

Incomes $ $
Subscription xxx
Profit from Trading xxx
Gift/Donation/Legacy (Not for specific purposes) xxx
Gain on Disposal xxx
Entrance fees xxx xxx

Less: Expenses
Rent xxx
Loss from Trading xxx
Depreciation xxx
Loss on Disposal xxx
Wages xxx
Utility Bills xxx
Any other expense associated to club xxx (xxx)
SURPLUS / (DEFICIT) OF INCOME OVER EXPENDITURE xxx

7) Preparation of Statement of Financial Position

Statement of Financial Position will be made normally. The only important thing is to take into
consideration the ‘Capital Receipts’. The life membership which has not been capitalized and
gift/donation/legacy for specific purposes are examples of Capital Receipts, and hence are not
to be included in Income and Expenditure Account; instead are to be part of Financed By
section of Statement of Financial Position. Statement of Financial Position is to be made as
follows:

Page 56
 Page 57

STATEMENT OF FINANCIAL POSITION AS AT 31 DEC 2016

$ $ $
Non-Current Assets
Motor Vehicle xxx
Less: Provision for depreciation (xx) xxx

Fixtures and Fittings xxx

Less: Provision for depreciation (xx) xxx xxx

Total Non-Current Assets xxx

Current Assets
Inventory xx
Receivables xx
Prepayments xx
Arrears (Subscriptions) xx
Receipts and Payments Account xx xxx

Total Assets xxx

Current Liabilities
Payables xx
Advance (Subscriptions) xx
Accruals xx
Receipts and Payments Account (Overdraft) xx

Total Current Liabilities xxx

Non-Current Liabilities
Loan from XYZ xxx

Total Liabilities xxx

Financed By:
Accumulated Funds xxx
Add: Surplus / (Deficit) xxx
Add: Life Membership xxx
Add: Gift/Donation/Legacy (for specific purposes) xxx xxx

Total Liabilities and Accumulated Funds xxx

Page 57
 Page 58

GIFT/DONATION/LEGACY:
If gift/donation/legacy is not for specific purpose, it will be treated as Income, and will be
recorded in the Income and Expenditure Account. But if gift/donation/legacy is for a specific
purpose, then it will be recorded in the Financed By section of the Balance Sheet.

HOW TO CAPITALISE LIFE MEMBERSHIP?

Some clubs provide the facility of life membership in which the members do not have to pay
monthly or annually. Instead they pay a lump sum amount at the time of joining the club. The
question will always tell over how many years this amount will spread over. The spreading of
life membership over its life is called Capitalization of Life Membership. Each year, the amount
of life membership is Capitalized and transferred to the Income Statement, and the amount not
Capitalized remains in the Financed By section of the Balance Sheet.
Example: Life membership of $20000 paid which will expire over next 10 years.

Income and Balance Sheet

Expenditure Account
1st Year 2000 18000
2nd Year 2000 16000
3rd Year 2000 14000

COMMON ERRORS MADE BY STUDENTS IN QUESTIONS INVOLVING NPO:

1. Students forget to write opening bank balance figure in accumulated funds, because it is
usually written separately.
2. Students consider bank balance as always debit balance whereas the bank balance can
also be a credit balance.
3. Students forget to make Control Accounts for calculation of sales and purchases.
4. Students do not calculate depreciation when question is silent regarding depreciation.
5. Students do not adjust other expenses and revenues for accruals and prepayments.
6. Students do not take into consideration the appropriate treatment of life membership.
7. Gift/Donation/Legacy is not properly accounted for.

Page 58
 Page 59

INVENTORY VALUATION

Inventory is valued at Lower of Cost or Net Realizable Value (NRV) as per Prudence Concept.
What is Inventory? Inventory are the stock of goods. These are those goods which are bought
or manufactured with an intention of resale, yet unsold.
How to value Inventory?
Inventory must be valued at lower of cost or NRV, as per Prudence Concept, using three cost-
flow assumptions of valuing inventory and each cost-flow assumption can be used using 2
methods. The 3 cash-flow assumptions are:
1) FIFO (First In First Out): FIFO means inventory which is bought first will be sold first
2) LIFO (Last In First Out): Inventory which is bought at the end will be sold first. As per
International Accounting Standards (IAS 2), LIFO method is no more applicable and
hence must not be used.
3) AVCO (Average Weighted Cost): The average cost of inventory is calculated after every
transaction.
Each of the above-mentioned cost-flow assumptions is applied either through
1) Perpetual Method
2) Periodic Method
Perpetual method means inventory will be valued after every transaction. This is a lengthy and
time-consuming process of inventory valuation, but is very accurate.
Periodic Method of Inventory valuation is although less time-consuming but is not so accurate.
Periodic Method means inventory is valued at the end of each period and not on regular basis.

The valuation of inventory must always be done on the last day of the accounting period
because when preparing the Income Statement and the Statement of Financial Position, the
value of inventory required is that of last day of accounting period without which it is practically
impossible to prepare Income Statement and the Statement of Financial Position.
If inventory is valued before or after the last day of the financial year, then in order to arrive at
the inventory figure that was in existence on the last day of the accounting period, we have to
do inventory valuation forwards or backwards.
25th December 31st December 20th January
Inventory Valuation Forwards Inventory Valuation Backwards

Page 59
 Page 60

WHAT IS COST OF INVENTORY?

Cost of Inventory comprises of purchase price of goods add all costs associated to purchases.
Cost = Purchase Price + all costs associated to purchases
WHAT IS NET REALIZABLE VALUE (NRV) OF INVENTORY?
NRV of Inventory is the selling price ‘less’ all cost associated to sale without which it is
practically impossible to sell the goods. Usually, this term appears in case of those goods which
are damaged and on which repair and maintenance cost is to be incurred.
NRV = Selling Price – All costs associated to sales
MARKUP MARGIN
Gross Profit as a percentage of Cost Gross Profit as a percentage of Sales
In markup, cost is always 100% In margin, sales is always 100%

Whether markup or margin,

Selling Price = Cost Price + Profit
Cost Price = Selling Price - Profit
Example, Given that
Mark-up = 20%
Cost = 100% ?
S.P = 120% 2400
Unknown Value = Unknown % x Known Value
Known %
Cost = 100 x 2400 = 2000
120
Example, Given that
Margin = 20%
S.P = 100% 2400
Cost = 80% ?
Cost = 80 x 2400 = 1920
100

Page 60
 Page 61

SINGLE ENTRY

When a business does not maintain any book of original entry, no accounting records are kept
and it is practically impossible to find each item of Income Statement such as sales, purchases
and expenses, then the question falls under the category of Single Entry.
In questions involving Single Entry, we cannot prepare full set of financial statements because
of unavailability of all financial information, thus we cannot make Income Statement at all,
therefore in order to find the profit that the business made, we will make ‘Statement of Profit
or Loss’ as follows:
STATEMENT OF PROFIT OR LOSS
$
Closing Capital xx
Add: Drawings xx
Less: Additional Capital (xx)
Less: Opening Capital (xx)
Net Profit/ (Net Loss) xx
Any business that does not keep any books of original entry or no accounting records is still in
the position to provide 4 details:
1) Closing Capital
2) Opening Capital
3) Additional Capital
4) Drawings
Opening Capital = Opening Assets – Opening Liabilities
Closing Capital = Closing Assets (with adjustments) – Closing Liabilities (with adjustments)
DRAWINGS

Cash Drawings Stock Drawings Fixed Asset Drawings

Weekly (52 weeks in a year)

DRAWINGS Monthly (12 months)
Quarterly (4 Quarters each year; Each quarter has 3 months)
Daily (365 days)

Page 61
 Page 62

Cash
ADDITIONAL CAPITAL Goods
Assets
Once Statement of Profit or Loss is made, it is a possibility to prepare properly the Statement of
Financial Position.
Statement of Affairs is another way of calculating opening and closing capital.

STATEMENT OF AFFAIRS (OPENING)

Assets xxx Liabilities xxx
xxx xxx
xxx xxx
xxx xxx
xxx
Opening Capital xxx

STATEMENT OF AFFAIRS (CLOSING)

Assets (with adjustment xxx Liabilities (with adjustments) xxx
xxx xxx
xxx xxx
xxx xxx
xxx
Closing Capital xxx

Page 62
 Page 63

INCOMPLETE RECORDS

In questions involving Incomplete Records, the business keeps at least one book of original
entry, usually the cash book. Accounting records are maintained but in scattered form. We have
to accumulate all possible information so that we can prepare the Income Statement and the
Statement of Financial Position properly and completely and thus in order to do so, we will
prepare the following accounts:
➢ Opening Capital
➢ Sales Ledger Control Account
➢ Expenses (PAAP)
➢ Revenues (APPA)
➢ Fixed Assets
➢ Current Assets
➢ Current Liabilities
➢ Long Term Liabilities
➢ Depreciation
➢ Markup, Margin
➢ Other Expenses (Bad Debts, Provision for Bad Debts etc.)
➢ Drawings
➢ Additional Capital
NOTE:
Whenever we are left with a debit balance while preparing cash account, it means that balance
is cash sales or receipts from debtors. If we are left with credit balance, it means it is Drawings.
If depreciation is not mentioned in the question, it does not mean depreciation will not be
charged; it means we will apply the Revaluation method of depreciation.

Page 63
 Page 64

RATIO ANALYSIS
Once the income statement and statement of financial position are prepared, it is extremely
important to analyze the business performance so that it could be found whether the
performance of the business has improved, deteriorated or remained constant. Not only this,
the ratios also help in analyzing that what caused the changes in business performance. If the
performance improved, what caused the improvement. If the performance deteriorated, what
went wrong. And if the performance remained constant, why was there no improvement.
Moreover, with the help of ratios, it can also be analyzed as to what measures can be taken to
further improve the performance and what steps should be followed to avoid deterioration.
For the purpose of analysis, the rations are divided into the following categories:
➢ Profitability Ratios
➢ Resource Utilization Ratios (Not part of OL syllabus)
➢ Liquidity Ratios
➢ Investment Ratios (Not part of OL syllabus)
➢ Cash Flow Ratios (Not part of OL syllabus)
Profitability Ratios
Profitability ratios identifies the earning capacity of the business, as to how much profit is
earned and through what sources, and how can expenses be controlled to earn more profits.
Thus, the profitability ratios are as follows:
Net Sales/ Turnover = Sales – Sales Returns
Cost of Goods Sold = Opening Inventory + Net Purchases – Closing Inventory
Owner’s Capital = Total Assets – Total Liabilities
= Capital Employed – Non-Current Liabilities
Capital Employed = Net Assets
= Fixed Assets + Current Assets – Current Liabilities
= Fixed Assets + Working Capital
= Total Assets – Current Liabilities
= Owner’s Capital + Non-Current Liabilities
= Opening Capital + Net Profit – Drawings + Additional Capital + Non-Current Liabilities
Sales – COGS = Gross Profit
Gross Profit – Expenses = Net Profit
Gross Profit Markup: Gross profit as a percentage of Cost
= Gross Profit x 100
Cost

Page 64
 Page 65

Gross Profit Margin: Gross profit as a percentage of Sales

= Gross Profit x 100
Sales
Net Profit Margin: Gross profit as a percentage of Sales
= Net Profit x 100
Sales
Expenses to Sales ratio: Gross profit as a percentage of Sales
= Expenses x 100
Sales
Expenses to Sales ratio = Gross Profit Margin - Net Profit Margin
Return on Capital Employed (ROCE) = Net Profit before Interest and Tax x 100
Capital Employed
Return on Net Assets (RONA) = Net Profit before Interest and Tax x 100
Net Assets
Return on Total Assets (ROTA) = Net Profit before Interest and Tax x 100
Total Assets
Return on Investment (ROI) = Net Profit before Interest and Tax x 100
Investment
Return on Current Assets (ROCA) = Net Profit before Interest and Tax x 100
Current Assets
Return on Equity (ROE) = Net Profit after Interest and Tax x 100
Equity
Return on Shareholder’s Fund (ROSHF) = Net Profit after Interest and Tax x 100
Shareholder’s Fund
Equity = Owner’s Capital
Equity = Ordinary Share Capital + All Reserves
Shareholder’s Fund = Ordinary Share Capital + Preference Share Capital + All Reserves
Shareholder’s Fund = Equity + Preference Share Capital
An increase in all above ratios except for expenses to sales ratio depicts an improvement in
business performance and vice versa.
An increase in expense to sales ratio depicts deterioration as expenses have increased and
business is unable to control them.

Page 65
 Page 66

Liquidity Ratios
Liquidity Ratios identifies how much cash is available within the business. It helps in identifying
whether the business has enough assets to pay off its debts and meet its obligations. It is the
ability of the business to convert its assets into cash. It must always be kept in mind that there
is a difference between profitability and liquidity of the business. If the business is earning good
profits, it does not necessarily mean that that it is also generating good cash because when
calculating profits, we also take into consideration some cash and non-cash expenses whereas
when considering liquidity, we are only interested in cash inflows and outflows. Some non-cash
expenses and revenues taken into consideration are credit sales, credit purchases, discount
allowed, discount received, gain or loss on disposal, bad debts, depreciation and so on.
It is extremely important to realize that it is never the lack of profit which causes the company
to shut down. It is always the lack of liquidity or shortage of cash and inability to meet their
obligations and pay off the debts which causes the company to become bankrupt or to go into
liquidation. Thus, having a good liquidity is extremely essential for the survival or the going
concern of the business. Liquidity ratios are as follows:
Working Capital = Current Assets – Current Liabilities
Working Capital should always be positive at any period in time because if working capital is
negative, it indicates that the business is unable to meet its obligations and is on the verge of
the bankruptcy.
Positive Working Capital is known as Net Current Assets.
Negative Working Capital is known as Net Current Liabilities.
Current Ratio = Current Assets Ideal Ratio = 1.5:1 – 2:1
Current Liabilities
Quick Ratio = Current Assets – Closing Inventory Ideal Ratio = 1:1
Current Liabilities
The current and quick ratio must be close to or equal to the ideal ratio because if they are less
than ideal ratio, it is an indication that the company is suffering from financial crunch and
liquidity crisis. Similarly, if the current and quick ratio are above the ideal ratio, it indicates that
the business is not utilizing resources appropriately and is in-efficient. The amount which
should be invested elsewhere is stuck into the business.
Average Inventory = Opening Inventory + Closing Inventory
2
Rate of Inventory Turnover = Cost of Goods Sold
Average Inventory

Page 66
 Page 67

It indicates the number of times the business is able to sell its stock completely. The higher the
rate of inventory turnover, the better the performance is. It helps in finding the rapidity with
which inventory is sold.
Inventory Turnover (Days): This indicates how many days does the business takes to
completely sell the inventory.
= Average Inventory x 365
Cost of Goods Sold
= 1 x 365
Rate of Inventory Turnover
Unless otherwise states, we have to give answer in ‘days’.
Receivables Collection Period (Days) = Receivables x 365
Credit Sales
It indicates how long do the receivables take to pay back the amount that they owe.
Payables PaymentPeriod (Days) = Payables x 365
Credit Purchases
It indicates how long does the business take to pay back the amount that is owed by them.

Working Capital Cycle

= Inventory Turnover (Days) + Receivables Collection Period (Days) - Payables Payment Period (Days)

Working Capital cycles indicates the number of days the business takes to recover the working capital.
The shorter the working capital cycle is, the better the liquidity of the business is. If we delay payments
to our creditors, then although working capital cycle will improve but at the expense of adverse
relationship with the payables and the discount which will have to be forgone on early payments.

Page 67
 Page 68

Commenting on Ratios
Whenever we have to comment on ratios, we will never do so in a haphazard manner instead
whatever the sequence in which we calculated ratios, we will first comment on all profitability
ratios, then on all resource utilization ratios, then on liquidity ratios and finally we will give the
conclusion. Not only this, it is extremely important to realize that we are not supposed to tell
whether the ratio has increased or decreased, instead we have to identify whether the
performance of the business has improved or deteriorated and what caused the improvement
or deterioration. We also need to suggest what steps should be taken to further improve the
performance. When some ratios increase, they show improved performance. When some ratios
decrease, it shows improved performance.

Sample Comment:
The gross profit margin of Najim has deteriorated by 3%. This could be because of the fact that
either his selling price has fallen or his cost of goods sold has increased. Despite fall in the GP
margin, the NP margin has improved by more than 2% which is quite commendable. This is
because of the fact that Najim has been able to control his expenses in an amazing manner and
his expenses to sales ratio fell from 22.5% to 17.4% which is worth appreciating. This, in turn,
has caused the ROCE to increase by more than 2%. Overall, his profitability has improved.

The current and quick ratio of Najim are almost equal to the ideal ratios, with slight
deterioration in current ratio and slight improvement in quick ratio. The inventory turnover
days has improved by 3 days indicating that Najim is able to sell his inventory earlier and much
easily. This could be supported by the fact that he might have reduced his selling price in order
to attract sales which might have caused his GP margin to fall. Najim is facing difficulty in
collecting money from his receivables and they are paying 6 days late compared to last year. In
turn, Najim is paying his suppliers 6 days late which is not a good strategy. By paying 6 days
late, he is deteriorating his relationship with the suppliers and might be forgoing the discounts
which he would have otherwise achieved if he would have paid on time. Overall, his working
capital cycle has improved by 3 days indicating an improved liquidity in comparison to last year.

Overall, there is an improvement in Najim’s performance when comparing 2011 with 2010 as
far as profitability and liquidity ratios are concerned.

Page 68
 Page 69

PARTNERSHIP

Partnership is an agreement between two to twenty people who join together with an
intention of sharing profits and bearing losses. When the partnership is formed, a partnership
agreement is made in which it is decided how much will be the interest on capital, interest on
drawings, salary to partners, bonus or commissions and whether any partner will be a dormant
partner or not. And if the partner has provided loan how much will be the interest.
In absence of partnership agreement, partnership Act 1890 will come under consideration and
the contents of Partnership Act 1890 are:
i. No interest on capital
ii. No interest on drawings
iii. No salary to partners
iv. No bonus to partners
v. No commission to partners
vi. No partner to be treated as dormant partner
vii. Interest on loan by the partner at the rate of 5%
viii. Residual profits to be distributed amongst partners equally.

INTEREST ON CAPITAL: It is given to the partner as an incentive to invest more into partnership.
Usually this interest rate is equal to the market rate of interest so as to attract the partners so
that by joining the partnership not only will they earn the normal interest but they will also
reap benefits of partnership.
INTEREST ON DRAWINGS: It is charged to the partners as a restriction to withdraw
unnecessarily, otherwise the partners will withdraw huge amounts causing liquidity crisis of
partnership.
SALARY TO PARTNERS: It is given to the partner against the services provided by them.
BONUS/COMMISSION TO PARTNERS: It is given against their performance or the performance
of the business.
INTEREST ON LOAN BY THE PARTNERS: When the partners provide loans to the partnership,
they are not considered to be the partner for that amount of loan. Instead, they are a liability of
the partnership and hence interest on loan is not the distribution of profit, instead it is an
expense of the business.
RESIDUAL PROFITS: Once the profits are distributed in the forms of interest, salary, bonus,
commission. The remaining profits are called residual profits which are to be distributed
amongst the partners in their predetermined rates decided in the partnership agreement.

Page 69
 Page 70

DORMANT PARTNER: It is also known as 'Sleeping Partner'', such a partner is not actively
involved in the running of the partnership. His role is restricted to investing in the partnership
but is not part of decision making process. Since the dormant partner is not actively involved his
liability is limited.
LIMITED LIABILITY: it means that incase of bankruptcy or insolvency, the maximum amount
that can be snatched from a partner is his investment. His personal belongings will not be
affected.
In a partnership, all partners cannot be sleeping partners there has to be at least one active
partner who will be responsible for the running of the business. The liability of the active
partner is unlimited. Unlimited liability means that incase of bankruptcy or insolvency, the
personal belongings of the partner will be at stake.
The accounting treatment of partnership involves preparation of:
I. Income statement
II. Profit and Loss Appropriation account
III. Partners' Current account
IV. Partners' Capital account
V. Statement of Financial Position

INCOME STATEMENT is made as normally like any other business. The only thing to be taken
into consideration is Interest on Loan by partners will be treated as an expense and hence is not
the distribution of profits.

PROFIT AND LOSS APPROPRIATION ACCOUNT shows the distribution of profits amongst the
partners in the form of interest, salary, bonus and commission. It also identifies the figure of
residual profits and the way it is distributed amongst the partners.

CURRENT ACCOUNTS are also known as Fluctuating Capital Account and shows movement in
Capital because of distribution of profits and drawings. The current account can have both a
credit or a debit balance. If the distribution of profits is more than drawings, the current
account will have a credit balance whereas if the drawings are more than the distribution of
profits, the current account will have debit balance. The credit balance in the current account
will have a positive balance and the debit balance in the current account will have a negative
balance.

Page 70
 Page 71

PARTNERS’ CAPITAL ACCOUNT is also known as Fixed Capital Account because it usually does
not change and the changes in the capital account only occurs when:
➢ The partner introduces additional capital
➢ When no separate current accounts are maintained (in this case, all entries regarding
current account are passes through the capital account)
➢ When there is a partnership change (in case of a partnership change, we have to
prepare and adjust Goodwill account and Revaluation accounts into the capital
accounts)

At AS Level, the partnership change can only occur because of the following reasons:
i. Admission of a partner
ii. Retirement of a partner
iii. Change in the profit and loss sharing ratio

STATEMENT OF FINANCIAL POSITION is made as normally except for the Financed By section in
which we have to take into consideration the closing capital and current account balances.
Moreover, if there is any goodwill maintained in the books, it has to be incorporated in the
Statement of Financial Position as Intangible Non-Current Asset.

Page 71
 Page 72

SIMON, RAJ AND KULJEET

INCOME STATEMENT FOR THE YEAR ENDED 31 DEC 2016
$ $ $
Sales xxx
Less: Sales Returns (xx) xxx
Less: Cost of Goods Sold
Opening Inventory xxx
Purchases xxx
Less: Purchases Returns (xx) xxx
Costs Associated to Purchases xxx
Cost of Goods Available for sale xxx
Less: Closing Inventory (xx) (xxx)
Gross Profit xxx
Add: Other Incomes
Discount Received xx
Gain on Disposal xx
Bad Debts Recovered xx
Decrease in provision xx
Commission Received xx
Rent Received xx xxx
xxx
Less: Expenses
Rent xx
Utility xx
Depreciation xx
Discount Allowed xx
Loss on Disposal xx
Increase in provision xx
Carriage outwards xx
All Expenses associated to partnership xx
Interest on loan by partner xx (xxx)
Profit / (Loss) for the year xxx

Page 72
 Page 73

PROFIT AND LOSS APPROPRIATION ACCOUNT

$ $ $
Profit / (Loss) for the year xxx
Add: Interest on Drawings
Simon xx
Raj xx
Kuljeet xx xx xxx
Less: Interest on Capital
Simon xx
Raj xx
Kuljeet xx (xx)
Less: Salary
Simon xx
Raj xx (xx)
Less: Commission
Kuljeet (xx) (xx)
RESIDUAL PROFIT xx
Less: Share of Profit
Simon xx
Raj xx
Kuljeet xx (xx)
-

Page 73
 Page 74

CURRENT ACCOUNT

SIMON RAJ KULJEET SIMON RAJ KULJEET

Balance b/d - - x Balance b/d x x -
Share of Loss x x x Interest on x x x
Capital
Drawings x x x Salary x x x
Interest on x x x Bonus/Com x x -
Drawings mission
Share of - - x
Profit
Interest on x x x
Loan *
Balance c/d x x - Balance c/d - - x
xxx xxx xxx xxx xxx xxx

*If interest on loan by the partner is already paid to the partner, then it will not be included in the
current account. If it is not paid, it will be part of current account but not part of Accruals in the
Statement of Financial Position. Whatsoever, it will be always part of Income Statement as an
expense.
CAPITAL ACCOUNT

SIMON RAJ KULJEET SIMON RAJ KULJEET

Goodwill x x x Balance b/d x x x
Cash - x -
Goodwill x x x
Balance c/d x x x Revaluation x x x
xxx xxx xxx xxx xxx xxx

Page 74
 Page 75

SIMON, RAJ AND KULJEET

STATEMENT OF FINANCIAL POSITION AS AT 31 DEC 2016

$ $ $

Intangible Non-Current Assets

Goodwill xxx
Tangible Non-Current Assets
Motor Vehicle xxx
Less: Provision for depreciation (xx) xxx

Plant and Machinery xxx

Less: Provision for depreciation (xx) xxx xxx

Total Non-Current Assets xxx

Current Assets
Inventory xxx
Receivables (Net) xxx
Less: Provision for bad debts (x)
Less: Provision for discount allowed (x) xx
Prepayments xx
Bank xx
Cash xx xxx

Total Assets xxx

Current Liabilities
Payables xxx
Accruals xxx
Bank Overdraft xxx

Total Current Liabilities xxx

Non-Current Liabilities
Debentures xxx
Loan from Simon xxx

Total Non-Current Liabilities xxx

Total Liabilities xxx

FINANCED BY:
Capital Accounts:
Simon xx
Raj xx
Kuljeet xx xx

Current Accounts:
Simon xx
Raj xx
Kuljeet (x) xx xxx

Total Liabilities and Equity xxx

Page 75
 Page 76

GOODWILL
Goodwill is the good reputation of the business. It is the worth of the business over and above
the fair value of its net assets and hence it is an Intangible Non-Current Asset.

Goodwill = Purchase Price – Fair Value of Net Assets Acquired

When there is a partnership change, it is a compulsion to value Goodwill so that the existing
partners can realize the true worth of the business and receive their due share. What at the
time of partnership change, goodwill is recorded, it is recorded amongst the old partners in
their old profit and loss sharing ratio, and hence the double-entries to record Goodwill are

Goodwill DR
Partners’ Capital Account CR:
A
B Amongst old partners in
C old profit and loss sharing ratio

If the question states that the Goodwill is to be maintained in the books, then it will be kept in
the books as Intangible Non-Current Assets, and each year we will have to check whether this
Goodwill is having any fall in its value. Fall in the value of Goodwill occurs either because of
Amortization (Depreciation of Goodwill) or Impairment (Sudden fall in the value of Goodwill)
and the fall in the value of Goodwill will be treated as an expense in the Income Statement, and
the double –entries are

Income Statement DR
Goodwill CR

If at the time of partnership change, the question indicates that Goodwill is not be maintained
in the books, or Goodwill is to be written off, or Goodwill is not to be recorded, it all indicates
that Goodwill will be written off after recording it, and will not come in Statement of Financial
Position. Goodwill is written off amongst new partners in their new Profit and Loss sharing
ratio, and hence the double-entries are:

Partners’ Capital Account DR:

A
B Amongst new partners in their
C new profit and loss sharing ratio
Goodwill Account CR

Page 76
 Page 77

Example: A, B and C are partners sharing Profit and Loss equally. C retires and D is admitted and
now partners are sharing profit and loss in the ratio 3:2:1.
If goodwill which is not be maintained in the books is valued at $18000, pass double-entries and
make goodwill account.

Recording of GW:
Goodwill DR 18000
A CR 6000
B CR 6000
C CR 6000

GOODWILL ACCOUNT
A 6000 A
B 6000 B
C 6000 D
18000

Page 77
 Page 78

ADMISSION OF A PARTNER
When a new partner is admitted to the partnership, he brings with him either cash or assets. At
the time of admission, the accounting treatment comprises of preparation of
➢ Goodwill Account
➢ Revaluation Account
➢ Partners’ Capital Account
➢ Statement of Financial Position after the admission
NOTE: At the time of admission of partners, the current account balances are NOT transferred
to the capital account.
RETIREMENT OF A PARTNER
When a partner retires, he takes with him his due share from the partnership and hence at the
time of retirement, the current account balances of the retiring partner only are transferred to
the capital account. The balance then remaining on the retiring partners’ capital account will
either be taken by the partner in the form of cash or any other asset. The retiring partner can
also leave loan to the partnership and this loan will not be considered as a loan from partner
because retiring partner is no more a partner.
FORMATION OF PARTNERSHIP
When two sole traders merge together to form a partnership, we will take all those assets and
liabilities which the partnership is taking over at the amount valued by the partnership. Hence,
at the time of formation, revaluation account will NOT be made.

Page 78
 Page 79

LIMITED COMPANIES

Limited companies are incorporated businesses. They are owned by the shareholders and
controlled by the directors, appointed by the shareholders at the meeting. When the company
comes into existence, it has to be registered through the registrar of the company which if
accepted will be incorporated into Limited Liability Company. When the company comes into
existence it has to prepare two documents:
➢ Memorandum of association.
➢ Articles of association.
Memorandum of Association is the relation of the company to the outside world and the
contents of memorandum of association are as follows:
1) Name Clause: Name of the company ending either PLC or Ltd.
2) Liability Clause: A statement that the liability of the company is Ltd.
3) Capital Clause: The amount of Authorized Share Capital.
4) Address Clause: The address of registered office
5) Activity Clause: The activities that the company will involve in.
Articles of association are the internal rules governing the rights of the members and the
running of the company. The contents are as follows:
1) It defines rights and the duties of the shareholders.
2) It defines rights and the duties of the directors.
3) It contains the regulations as to how the meetings may be called.
4) It defines the rules regarding the voting rights.
5) It contains rules regarding the members who fail to pay the amount due upon them.
6) The minimum qualification to be a director.
7) The minimum number of share that a director must hold.
A company is divided into two categories:
➢ Public Limited companies.
➢ Private Limited companies.
Private Limited Companies are usually family owned business. They can't have Authorized
Share Capital of more than $ 50,000. They can't issue share to the general public, nor are their
shares traded in the stock exchange. Private Limited companies always have Ltd attached to its
name.
Public Limited Companies can issue their share to the general public and their shares can be
traded in the stock exchange. Their Authorized Share Capital has to be more than $ 50,000.
They work under the policy of IAS and Companies Act 1985. They usually have the word PLC
attached to its name.

Page 79
 Page 80

The capital structure of a company comprises of Ordinary Share Capital, Preference Share
Capital, Debentures, Convertible Loan Stocks and Reserves.
Ordinary Shareholders are the real owners of the company and have a voting right with which
they take active part in the running of the business, by appointing the directors and hence they
are the risk bearers. At the time of distribution of dividends, the ordinary shareholders are
given the last priority and even in the case of insolvency they rank last after the payments have
been made to the creditors, long term liabilities and preference shareholders. The amount of
dividends that they receive is not fixed and varies as per the profitability of the company. In
years of low or no profit, they are not given any dividends at all.
The priorities in which the company distributes its assets in case of insolvency are as follows:
i) Short-term debts (creditors, accruals, bank overdraft)
ii) Secured Long-term debts
iii) Unsecured Long-term debts
iv) Preference Share Capital
v) Ordinary Share Capital
Preference Shareholders are given preference over ordinary shareholders both at the time of
distribution of dividends and incase of insolvency. They usually don’t have a voting right and
they receive a fixed rate of dividends and are divided into four categories:
➢ Cumulative Preference Shares.
➢ Non-cumulative Preference Shares.
➢ Participating Preference Shares.
➢ Non-participating Preference Shares
Cumulative Preference Shares are those shares who will receive the dividends whether the
company is making good profits or not. In case the company is not able to pay dividends in one
year because of low profitability, then the amount that is not paid is to be compensated in the
next year, and until it is compensated, it is treated as Current Liability.
Non-cumulative Preference Shares are those which will receive a fixed rate of dividends only in
the year when the company is making good profits. In years of low profits, they will only receive
the dividends which the company will be able to pay and the right over the remaining dividends
will be lapsed and will not be compensated in the future years.
Participating Preference Shares are those preference shares which have a voting right and they
take part in running of the business by choosing the directors at the Annual General Meetings
(AGM). Amongst the Preference Shares they rank last both at the time of distribution of
dividends and in case of insolvency.

Page 80
 Page 81

Non-participating Preference Shares are those preference shares who neither have voting
rights nor are cumulative.
Besides the above-mentioned 4 categories, preference shares are broadly classified as
Redeemable and Non-Redeemable.
Debentures are the (I owe You's) of the company, they are the long-term liabilities on which a
fixed rate of interest is given and the amount owed by the company is to be returned on
maturity. The interest on debentures are not the distribution of profits, instead are the expense
of the company.
Convertible Loan Stocks are the long-term liability of the company on which a fixed rate of
interest is to be given. On maturity, the convertible loan stock holders are given an option to
convert the loan into shares. Thus, the convertible loan stock holder becomes the shareholders
from the creditors of the company. The rate of conversion, the maturity date and the option to
convert are all pre-decided at the time when the convertible loan stocks are issued.
If the conversion is equal to the number of shares issued then the double entry is as follows:
Convertible Loan Stock DR
Ordinary Share Capital CR
If more amount of shares are issued compared to the amount of convertible loan stocks then
the double entry are as follows:
Convertible Loan Stock DR
Share Premium DR
Ordinary Share Capital CR
If less amount of shares are issued compared to the amount of convertible loan stocks, then it
indicates that the shares are issued at higher price or in other words shares are issued at
premium. The double entries are as follows:
Convertible Loan Stock DR
Share Premium CR
Ordinary Share Capital CR
RESERVES
There are two types of reserves,
➢ Revenue Reserves
➢ Capital Reserves

Revenue Reserves are the amounts set aside by the company from the trading activities of the
business, i.e. from the profits for the future prospects of the company. The revenue reserves of
the company comprise of:

Page 81
 Page 82

1. General Reserves
2. Asset Replacement Reserves
3. Retained Profits

General Reserves are the amounts that the company set aside for the purpose of expansion or
to combat a problem that might arise in future.
Asset Replacement Reserves is the amount set aside by the company so that it has sufficient
funds to buy a new asset when the old one is disposed off.
Retained Profits is the left-over profits which are ploughed back into the company to finance
the running of the company in an effective manner.
Capital Reserves are those which are generated through non-trading activities and they
comprise of:
➢ Share Premium
➢ Revaluation Reserves
➢ Capital Redemption Reserves
➢ Debenture Redemption Reserve Fund
Share Premium is the amount that is generated by selling a share at higher price than its face
value.
Revaluation Reserves is the amount that is generated when the assets are revalued over and
above its Net Book Value.
Capital Redemption Reserves (Not part of syllabus) are the reserves which might be created
when the shares are redeemed.
Debentures Redemption Reserve Funds (Not part of syllabus) are the reserves which might be
created when the debentures are redeemed.
Limited companies are also called Limited Liability companies because the liability of the
shareholders is limited, i.e. they are not personally liable for the debts of the company in case
of insolvency or bankruptcy. In case of insolvency the maximum amount that can be snatched
from them is limited to their investment.
Authorized Share Capital is the maximum amount of shares that the company is allowed to
issue.
Issued Share Capital is the part of authorized share capital which the company has already
issued to the general public.
Called-up Share Capital is the part of issued share capital that the company has asked to pay.
Uncalled-up Share Capital is that part of issued share capital that the company has yet not
asked to pay.

Page 82
 Page 83

Paid-up Share Capital is that part of called-us share capital which has already been paid.
Unpaid Share Capital comprises of Uncalled Share Capital and the unpaid part of Called up
Share Capital.
Face Value is also known as nominal or par value. It is that amount of share which is written on
the face of the shares.
Issue Price is the amount of shares at which the shares are offered to the general public.
Share Premium is the difference between issue price and the face value of the share.
Formula: Share Premium = Issued Price – Face Value
Market Value is the price at which the share is being traded at the stock exchange.
Dividends are the distribution of profits which is paid to the shareholders if the dividends are
paid during the year, they are called Interim Dividends and if dividends are paid at the end of
the year then they are called Final Dividends.

Authorized Share Capital ($100000)

Issued Share Capital ($70000)

Called Up Share Capital Uncalled Share Capital

$0.6 $0.4

Paid up Share Capital $0.15

$0.45 Unpaid Share Capital

DIVIDENDS
If dividends are paid during the year, they are known as Interim Dividends, and if the dividends
are paid at the end of the year, they are known as Final Dividends. If the dividends are declared
but yet not paid, they are known as Proposed Dividends.
Proposed Preference Dividends are Current Liabilities of the business whereas Proposed
Ordinary Dividends are neither part of income Statement nor Statement of Financial Position.

Page 83
 Page 84

Preference Shares are always subject to fixed rate of dividends whereas ordinary shares can
receive varying amount of dividends each year either in the form of dividend per share or a rate
of dividend.
DIVIDENDS

Dividends per share (DPS) Rate of Dividends

DPS are applied on the ‘Number of Shares’ Rate of Dividends are applied on the ‘Amount
of Shares’
Example: If a company has 100000 Ordinary
shares of $0.5 each and it decided to pay a Amount = Number of Shares x Face Value
dividend of $0.05 per share, then the
dividends will be Example: If a company has 100000 Ordinary
shares of $0.5 each and it decided to pay a
100000 x 0.05 = $5000 dividend of 10%, then

100000 x 0.5 = 50000

Rate 10% of 50000 = $5000

Amount of Shares = Number of Shares x Face value

100000 Ordinary Shares of $0.5 each = $50000
80000 12% Preference Shares of $0.6 each = $48000

Number Fixed Rate Type of Share Face Value Amount of Shares

of Shares of Dividend
Preference Dividends are only subject to Rate of Dividends because they receive fixed rate of
dividends which is applicable to the Amount of Shares.

Page 84
 Page 85

Example: If a company has 80000 12% Preference Shares of $0.6 each, then the total dividends
applicable is
80000*0.6=48000
Rate of 12% = 12% of 48000 = $5760
Since preference shares receive fixed rate of dividend, if some amount is paid as Interim
Dividends them only the remaining amount is paid as Final.

INTERIM FINAL TOTAL

2000 3760 5760
2880 2880 5760
5000 760 5760
0 5760 5760
5760 0 5760

This is not applicable for ordinary shares because they are the real owners of the business and
can receive as much interim and as much final dividend as possible.

INTERIM FINAL TOTAL

5000 10000 15000
8000 12000 20000
0 0 0
0 8000 8000
7000 2000 9000

The accounting treatment of questions involving companies comprise of preparation of:

I. Income statement
II. Statement of Changes in Equity
III. Statement of Financial Position
IV. Notes to Accounts

Income Statement is made as normally and shows the profitability position of the business. In
companies, it is compulsory to divide expenses into 3 categories:

1. Selling and Distribution Expenses: These includes all those expenses which are
associated to promotes sales. Example; Discount allowed, advertising, bad debts,
provision for bad debts, depreciation of delivery van, carriage outwards and so on.
2. Administrative Expenses: These includes expenses which are incurred in managing the
business such as wages and salaries, rent, depreciation of property/plant/equipment
and utility bills
3. Financial Expenses: are those expenses which are associated to Interest.

Page 85
 Page 86

Together Selling and Distribution expenses and Administrative expenses are called Operating
Expenses.

Statement of Changes in Equity is similar to Appropriation account and shows the distribution
of profits in the form of dividends and transfers to reserves.

Statement of Financial Position is made as normally except for the fact that there is no
Financed By section in companies. Instead, there is a ‘Share Capital and Reserves Section’.
Notes to Accounts are the supplementary documents attached to financial statements in order
to make financial statements understandable in a better way.
TYPES OF SHARES

Ordinary Shares Preference Shares

➢ are part of Shareholder’s Fund ➢ are part of Shareholder’s Fund

➢ Their dividends are part of distribution of ➢ Their dividends are part of distribution of
profits profits
➢ Ordinary dividends paid only are part of ➢ Preference dividends paid and proposed
Statement of Changes in Equity are part of Statement of Changes in Equity
➢ Proposed Ordinary dividends are neither ➢ Proposed Preference Dividends are
part of Statement of Changes in Equity, nor Current Liabilities of the company.
are part of Current Liabilities
➢ Proposed Ordinary dividends are mentioned
in the Notes to Accounts

Page 86
 Page 87

AQ LTD.
INCOME STATEMENT FOR THE YEAR ENDED 31 DEC 2016

$ $ $

Sales xxx
Less: Sales Returns (xx) xxx

Less: Cost of Goods Sold

Opening Inventory xxx
Purchases xxx
Less: Purchases Returns (xx) xxx
Carriage Inwards xxx
Cost of Goods Available for sale xxx
Less: Closing Inventory (xx) (xxx)

Gross Profit xxx

Add: Other Incomes xx

Less: Selling and Distribution Expenses

Advertising xx
Bad Debts xx
Provision for Bad Debts xx
Discount Allowed xx
Commission xx
Depreciation of Delivery van xx
Carriage outwards xx xx

Less: Administrative Expenses

Wages and Salaries xx

Rent xx
Utility Bills xx
Depreciation xx
Loss on Disposal xx xx

Operating Expenses (xx)

Operating Profit/Profit before Interest and Tax xxx

Less: Financial Expenses

Interest xx
Dividends on Redeemable Preference Shares xx (xx)
Profit After Interest and Tax xxx

Less: Corporation Tax (xx)

Distributable Profits xxx

Page 87
 Page 88

Ordinary Preference Revaluation Share General Asset Retained Total

Share Share Reserve Premium Reserve Replacement Profit
Capital Capital Reserve
Opening x x x x x x x xx
Balance
Distributable - - - - - - xx xx
Profits
Transfer to - - - - xx xx (xx) -
any reserve
Issue of xx xx - x - - - xx
shares at
premium
Preference - - - - - - (xx) (xx)
Dividends
(Paid +
Proposed)
Ordinary - - - - - - (xx) (xx)
Dividends
(Paid only)
Closing xx xx xx xx xx xx xx xxx
Balance

AQLTD.
STATEMENT OF FINANCIAL POSITION AS AT 31 DEC 2016
$ $ $
Intangible Non-Current Assets
Goodwill xxx
Tangible Non-Current Assets
Property, Plant and Equipment xxx
Less: Provision for depreciation (xx) xxx
Motor Vehicle xxx
Less: Provision for depreciation (xx) xxx xxx
Total Non-Current Assets xxx
Current Assets
Inventory xxx
Receivables (Net) xxx
Less: Provision for bad debts (x) xx
Prepayments xx
Cash and Cash Equivalents xx xxx
Total Assets xxx

Page 88
 Page 89

Current Liabilities
Payables xxx
Accruals xxx
Proposed Taxation xxx
Proposed Preference Dividends xxx
Total Current Liabilities xxx
Non-Current Liabilities
Debentures xxx
Redeemable Preference Shares xxx
Convertible Loan Stock xxx
Total Non-Current Liabilities xxx
Total Liabilities xxx
Share Capital and Reserves
Ordinary Share Capital xxx
Preference Share Capital xxx
Revaluation Reserve xxx
Share Premium xxx
General Reserve xxx
Asset Replacement Reserve xxx
Retained Profits xxx xxx
Total Liabilities and Equity xxx

NOTES TO ACCOUNTS
The company proposed ordinary dividends of $0.05 each amounting to $12000.

Page 89
 Page 90

ISSUE OF SHARES
When the company issue shares, it offers it to general public either at par value or at premium,
and hence cash is received against issue of shares. Thus, the double-entries to record issue of
shares are:
Bank DR
Ordinary Share Capital CR If issued at a premium
Share Premium CR
Bank DR
Ordinary Share Capital CR If issued at Par
RIGHTS ISSUE
The existing shareholders have a pre-emptive right that whenever shares are issued, they
should be offered to the existing shareholders first before offering it to general public because
if this is not done, then the shareholding of the existing shareholders will be diluted.
So, in order to avoid dilution of shares, this pre-emptive right is given to existing shareholders.
The rights issue is usually made at a premium but they can also be issued at par. But the issue
price should always be less than the market value and hence the double-entries to record rights
issue are:
Bank DR
Ordinary Share Capital CR If issued at a premium
Share Premium CR
Bank DR
Ordinary Share Capital CR If issued at Par

Page 90
 Page 91

PAYROLL ACCOUNTING

Payroll Accounting is all about employees and their wages and salaries. All employees of a
company must be on the company’s payroll and the amount that they receive against their
services is called wages and salaries. There are certain terminologies that need to be
understood when discussing payrolls:
1) Gross Pay: It is the amount earned by an employee by providing services for a day, week,
month or a year. There are different methods of calculating Gross Pay:
Basic Pay: It is a fixed amount of salary paid to an employee irrespective of the number of
hours he worked, number of units he made or the task he performed.
Commission Only: Some employees receive commission against their work, the more sales they
make the higher gross pay they receive.
Basic Pay + Commission: Some employees receive a fixed basic pay and over and above that
they also get commission so if they make low sales, they are still entitled to a certain amount of
salary but with higher sales, their overall salary improves. (Performance Related Pay-PRR)
Hourly Pay: Such employees receive salary on the basis of number of hours they work. The
greater the number of hours they work, the higher the salary they are entitled to. If such
employees work over-time (means working more than specified number of hours), they are
compensated accordingly and usually the hourly pay rate is higher than the normal pay rate.
Piece Meal: Such employees receive salary on the basis of number of units produced; the more
units they produce, the higher the salary they receive.
2) Deductions: When the employee earns gross pay, some deductions are made from it.
Deduction are divided into 2 categories; Statutory Deduction and Voluntary Deduction

Statutory Deductions: They are the deductions which are mandatory by law and they comprise
of Income Tax and National Insurance Contribution/Social Security Tax.
Income Tax: When an employee earns more than a specified amount, he has to pay tax against
their earnings. The more they earn, the higher the Income Tax. The tax rate changes as per the
change in Income bracket.
National Insurance Contribution: It is deducted from all employees’ pay as a security that if in
future, the employee becomes unemployed or retired or dies, then the government pays him
or his family from the amount saved as NIC. Moreover, whatever deduction is made from the
employees’ salary, the same amount is matched by the employer and deposited with the
government so that the double amount us saved on behalf of the employee.

Page 91
 Page 92

Voluntary Deductions: It comprises of pension contribution, trade union subscription, and

charitable donation.
Pension Contribution: Some organizations have their own private pension scheme, which is
deducted from employees’ pay if the employee agrees so that when he retires or dies, his
family gets compensation. The amount saved as pension contribution can also be withdrawn in
time of need by the employee.
Trade Union Subscription: They are workers association which works for the rights of employee
so that employees could get some benefit. Any employee who wishes to be a pay of trade
union must pay trade union dues.
Charitable Donations: If an employee wish to pay charity to the specific charitable organization,
they can do so and hence also receive some tax exemptions.

3) Net Pay: It is also referred to as ‘Take-home salary’. It is the amount which is actually received
by the employee after all deductions have been made from the Gross Pay.

4) Benefits: They are the advantages received by the employee for doing the job they are also
known as Perks such as paid leaves, house allowance, fuel allowance, cell phones and other
benefits that might be given from the company they work in.

Total Cost of Employing: The total cost that the employer incurs comprise of gross pay +
employers share of NIC

Double entries to record payroll:

Cost of Employing DR
Deductions CR (Employers’ share + Employees’ deductions)

Net Pay DR Payment to an employee

Bank CR

Deduction DR Payment to relevant authorities

Bank CR

Some basic Payroll terminologies:

Clock Card is used to note the time that an employee spent on a certain task. It is a time
recorder which is used to assist in tracking the hours work by an employee of the company.
Time Sheet is a method for recording the amount of a workers’ time spent on each job.

Page 92
 Page 93

Pay slip is given to the employees at the end of each month to ensure that employees have
received the correct amount of pay. The pay slip contains details as to the number of hours
worked, the benefits received, gross pay, deductions, and net pay of the employee.
Payroll register is a document that records all details about employee’s pay during a period. It
provides details of the hours spent on each job, rate of pay, gross pay, deduction, net pay. It
also contains details of employee’s personal information.
Wages sheet is also known as Payroll sheet and it is a comprehensive list of all the workers,
their pay, rate of pay, deduction, benefits, and so on. The employee record should be kept
updated so any change in rate of pay or deduction could be incorporated in wage sheet.

Page 93