Financial Reporting and Financial Statements

11.1 Types of Business Entities

• Businesses exist to make profit by producing and selling goods and services.

• Profit = Income earned − Expenses incurred.

• Businesses vary significantly in size, financing, and legal structure.

• These variations affect how businesses report in their financial statements.

• Types of business entities:

o Sole Trader

o Partnership

o Limited Liability Company

Exam advice: Be able to recognize the key features of each business type.

1.2 Sole Traders

Definition

• A sole trader is an individual who owns, controls, and operates a business alone.

• May employ others.

1.2.1 Key Features of Sole Traders

 • Change in Business Ownership:
The sole trader sells the business to a new owner directly, without needing agreement from others.

• Business Continuation:
The business cannot continue if the sole trader exits unless sold to another individual.

• Taxation:
The sole trader is personally taxed on business profits; the business itself is not separately taxed.

• Ownership of Business Property:

No legal distinction between the owner and the business; the owner owns all business assets.

• Legal Action:
The sole trader is personally liable for any legal penalties or fines arising from business disputes.

1.2.2 Advantages of Sole Traders

• Control: Complete control over business decisions and full entitlement to profits.

• Ease of Set-up: Simple to establish with no company legislation compliance.

• Financial Statements: No obligation to publish financial statements; may prepare them for tax or lenders.

• Flexibility: Owner can decide how and when to operate the business.

1.2.3 Disadvantages of Sole Traders

• Liability: Unlimited personal liability; personal assets may be used to settle business debts.

• Raising Finance: Limited to owner’s capital and short-term bank finance like overdrafts.

• Business Continuity: Business ends if the owner retires or dies unless sold/transferred.

1.3 Partnerships
Definition

• A partnership is a business owned and operated by two or more people aiming to make profit.

1.3.1 Key Features of Partnerships

• Change in Business Ownership:

All partners must agree to admit a new partner. The new partner usually buys in with a financial contribution.

• Business Continuation:
Partnership ends automatically if a partner leaves unless agreement allows continuation by remaining partners.

• Tax on Personal Income:

Individual partners pay tax on their share of partnership profits; partnership itself is not taxed.

• Ownership of Business Property:

No legal separation between the partnership and the partners.

• Legal Action:
Partners are personally liable for any legal penalties or court judgements against the partnership.

1.3.2 Advantages of Partnerships

• Defined Structure and Profit Sharing:

Governed by a partnership agreement covering operations, admission and exit of partners, and profit distribution.

• Raising Finance:
New partners bring financial contributions, increasing capital.

• Financial Statements:
No obligation to publish financial statements but must prepare them for profit sharing and tax/lenders.

• Skills and Knowledge:

Partners bring diverse skills, enhancing business performance.
 • Risk Sharing:
Risks and losses spread among multiple partners, reducing impact on individuals.

1.3.3 Disadvantages of Partnerships

• Costs:
Drafting a legally binding partnership agreement incurs costs.

• Decision Making:
May be slow if partners disagree, affecting business development.

• Profit Sharing:
Profit divided among partners, potentially reducing individual incentives.

• Business Continuity:
Partnership may dissolve if a partner leaves unless new partners are admitted.

• Liability:
Partners are personally liable for business debts, risking personal bankruptcy.

• Disputes:
Serious disputes can cause deadlocks or end the partnership.

1.4 Limited Liability Companies (LLCs)

Definition

• LLC is a separate legal person distinct from its owners (shareholders).

• Shareholders own shares in the company.

• Shareholders seek returns via dividends or share value increase.

• Directors may be appointed to run the company.

 • Shareholders’ liability limited to their investment.

Types of Companies

• Private Limited Company: Smaller shareholders; may restrict share transfers.

• Public Limited Company: Larger; shares listed on stock exchanges, available to public.

1.4.1 Key Features of Limited Liability Companies

• Change in Business Ownership:

Shares can be freely bought and sold, except in small companies which may restrict transfers.

• Business Continuation:
Company continues despite changes in shareholders.

• Taxation:
Company pays corporate income tax on profits; shareholders pay tax on dividends.

• Ownership of Business Property:

Property owned by company, not individual shareholders.

• Legal Action:
Company liable for debts and legal issues; shareholders only liable to extent of share value.

1.4.2 Advantages of Limited Liability Companies

• Limited Liability:
Protects shareholders’ personal assets.

• Raising Finance:
Easier access via share issues; public companies can raise from general public.

• Business Continuity:
Ownership changes don’t affect company existence.
1.4.3 Disadvantages of Limited Liability Companies

• Costs:
High initial setup, legal fees, registration, ongoing administration, and mandatory meetings.

• Tax:
Company profits taxed; shareholders/directors also taxed individually.

• Publication:
Required to file annual financial statements for public inspection.

2.1 Financial Reporting

Definition

• Financial reporting involves recording, analyzing, and summarizing financial data to present the business’s financial
performance and position.

Recording

• Bookkeepers record all transactions promptly with sufficient detail.

• Examples: sales, purchases.

• Computerized systems automate some recording (e.g., barcode scanning).

Analyzing

• Transactions are classified into appropriate categories (e.g., expenses, income).

• Helps managers identify key financial data.

Summarizing

• Detailed records are condensed into annual financial statements.

 • Enables users to get a clear overview without wading through raw data.

Analysis of Financial Statements

• Users compare statements over years and use financial ratios.

• Helps assess trends, investment decisions, and business health.

2.2 Nature, Principles and Scope of Financial Statements

Main Financial Statements:

1. Statement of Financial Position (Balance Sheet)

Shows assets, liabilities, and equity at a specific date.

2. Statement of Profit or Loss and Other Comprehensive Income

Shows profitability over a period.

3. Statement of Cash Flows (Companies only)

Details cash inflows/outflows.

4. Statement of Changes in Equity (Companies only)

Shows changes in equity during the year.

Non-Financial Reports (Usually in Annual Report):

• Financial review by management

• Chairman’s statement

• Directors’ report

• Employee reports

• Sustainability disclosures (IFRS S1, S2)

 • Value-added statements

2.3 Statement of Financial Position

Definition

• Snapshot of business financial position at a point in time.

• Shows net worth = Assets − Liabilities.

Components:

• Non-Current Assets: Long-term assets used >12 months (e.g., property, equipment).

• Current Assets: Cash/convertible to cash within 12 months (e.g., inventory, receivables).

• Capital/Equity: Owner’s investment plus retained profits minus withdrawals.

• Non-Current Liabilities: Debts payable after 12 months (e.g., long-term loans).

• Current Liabilities: Debts payable within 12 months (e.g., payables, overdrafts).

Example:

• Assets and liabilities are balanced.

• Current assets ordered by liquidity (cash most liquid).

2.4 Statement of Profit or Loss and Other Comprehensive Income

2.4.1 Statement of Profit or Loss

• Shows income and expenses for a period.

 • Trading summary: Sales - cost of sales = Gross profit.

• Includes other income and expenses.

• Profit or loss calculated after deducting all expenses including interest and tax.

2.4.2 Other Comprehensive Income

• Income/expenses not shown in profit or loss.

• Common example: revaluation surplus on property.

• Companies must show OCI; sole traders/partnerships may do so optionally.

2.5 Statement of Cash Flows

Definition

• Details cash inflows and outflows during the period.

• Shows opening and closing cash balances.

• Required for companies only.

Cash Flows Categories:

1. Operating Activities:
Cash from business operations, including taxes paid.

2. Investing Activities:
Purchases and sales of assets, dividends and interest received.

3. Financing Activities:
Share capital issues, loans received/repaid, dividends paid, interest paid.
2.6 Statement of Changes in Equity

• Reconciles equity at start and end of the year.

• Includes:

o Profit or loss

o Share issues

o Dividends

o Revaluation gains/losses

3.1 Stakeholders

Definition

• Individuals or groups affected by or affecting the business.

3.1.1 Internal Stakeholders

Stakeholder Information Needs

Owners/Investors Profitability, safety of investment, decision to buy/sell shares

Management Detailed info for planning, decision-making, control

Employees Job security, company stability, remuneration prospects

3.1.2 External Stakeholders

Stakeholder Information Needs

Prospective Investors Financial returns, risks, growth prospects

Customers Supply reliability, company financial health

Suppliers Payment ability, financial security

Government/Tax Authorities Compliance, profit for tax calculation, economic data

Lenders Ability to repay loans and interest

Auditors Accuracy and reliability of financial statements

Public Economic contribution, environmental impact

Summary

• Understand differences in business entity features, including ownership, liability, taxation, and continuity.

• Know the content and purpose of the four main financial statements and additional reports.

• Recognize stakeholder groups and their information needs.

• Memorize advantages and disadvantages of each business entity.

• Understand legal and financial implications for owners/partners/shareholders.

Elements of Financial Statements and Double Entry
Bookkeeping
1. Statement of Financial Position (SOFP)

Purpose

The Statement of Financial Position provides a snapshot of an organization’s financial standing on a specific date. It shows the
balances of:

• Assets

• Liabilities

• Capital (Equity)

1.1 Elements of the Statement of Financial Position

1.1.1 Assets

Definition (IFRS Conceptual Framework):

An asset is a present economic resource controlled by the entity as a result of past events.

An economic resource is a right that has the potential to produce economic benefits.
 Asset Categories

Assets are classified into Current and Non-Current.

Current Assets

As per IFRS 18, an asset is classified as current when:

1. It is expected to be realized, sold, or consumed during the normal operating cycle.

2. It is held primarily for trading.

3. It is expected to be realized within 12 months after the reporting date.

4. It is cash or a cash equivalent (as per IAS 7).

Examples:

• Cash at bank

• Trade receivables

• Inventory (goods for resale)

Non-Current Assets

Assets that do not meet the criteria of current assets. These are used long-term.

Subcategories:

Type Definition Examples

 Tangible Physical form – can be touched Machinery, equipment, fixtures

Intangible No physical form – provides future economic benefit Software licenses used for over 12 months

Note: Assets must be clearly split into current and non-current in the SOFP.

1.1.2 Liabilities

Definition (IFRS Conceptual Framework):

A liability is a present obligation of the entity to transfer an economic resource because of past events.

Liabilities usually represent amounts owed by the business.

Liability Categories

Liabilities are classified into Current and Non-Current.

Current Liabilities

As per IFRS 18, a liability is current if:

1. It is expected to be settled in the normal operating cycle.

2. It is held for the purpose of trading.

3. It is expected to be settled within 12 months of the reporting date.

4. The business does not have the right to defer payment for at least 12 months.

Examples:

• Trade payables (amounts owed to suppliers)

 • Short-term loans

Non-Current Liabilities

These are obligations payable beyond 12 months from the reporting date.

Examples:

• Long-term loans

• Lease obligations

Example:
A 5-year loan taken in 20X5:

• Appears as non-current in 20X5 to 20X8.

• In 20X9, the remaining amount becomes current.

1.1.3 Capital / Equity

Definition:

Equity is the residual interest in the entity's assets after deducting liabilities.

Equity = Total Assets – Total Liabilities

Also referred to as:

• Shareholders’ funds

• Owner’s capital
 • Net worth

Represents:
The owner’s total investment, including:

• Capital introduced

• Retained profits

• Less: Drawings

1.2 Statement of Profit or Loss (P&L)

Purpose

The Statement of Profit or Loss shows the financial performance of an organisation during a specific accounting period.

Structure of P&L:

1. Gross Profit = Sales – Cost of Goods Sold (COGS)

2. Profit = Gross Profit – Operating Expenses + Other Income

In companies, a more detailed version is known as:

Statement of Profit or Loss and Other Comprehensive Income

1.2.1 Income

Definition (IFRS Conceptual Framework):

Income is:

• An increase in assets or

• A decrease in liabilities
That leads to an increase in equity
(excluding contributions from equity holders)

Important Notes:

• Includes both cash and credit sales

• Income is recorded when goods/services are delivered, not necessarily when paid

• Cash received from shareholders is not income

Example:
Sales made on credit → recorded as income
→ Balance appears under trade receivables on SOFP.

1.2.2 Expenses

Definition (IFRS Conceptual Framework):

Expenses are:

• A decrease in assets or

• An increase in liabilities
That leads to a decrease in equity
(excluding distributions to equity holders like dividends)

Important Concepts:
 • Expenses are related to daily operations

• Dividends are not expenses

• Expenses must be matched to income in the same period (Matching Principle)

Examples:

• Rent, electricity, wages

• Cost of sales

• Repairs and administration costs

1.3 Asset Expenditure vs Expenses

When a cost is incurred, it must be classified as:

1.3.1 Asset (Capitalized) Expenditure

This is spent on non-current assets which provide long-term benefit.

Examples:

• Purchase of equipment

• Cost of extending asset life or efficiency

Initially recorded as an asset, then written off through depreciation.

1.3.2 Expenses

These are operating costs incurred in the day-to-day running of the business.
Examples:

• Buying goods for resale

• Salaries, rent

• Repairs to existing assets

These are charged immediately to the profit or loss account.

Ethics Alert:

Misclassifying expenses as assets:

• Understates expenses

• Overstates profit

• Misleads stakeholders and users of financial statements

2. Accounting Fundamentals

2.1 Duality Concept

• Every transaction affects two accounts.

• For every debit, there is a corresponding credit.

• This is the basis of double-entry bookkeeping.

 2.2 The Accounting Equation

Capital = Assets – Liabilities

or

Assets – Liabilities = Capital

Also referred to as Net Assets.

Expanded Equation (with all elements):

Assets – Liabilities = Capital Introduced – Drawings + Income – Expenses

Rearranged Format:

Assets + Drawings + Expenses = Capital + Liabilities + Income

Closing Capital Formula:

Closing Capital = Opening Capital + Capital Introduced – Drawings + Profit

2.2.1 Double Entry & Accounting Equation

Each transaction affects the equation but keeps it balanced.

Account Type Debit Effect Credit Effect

Asset Increases asset Decreases asset

 Liability Decreases liability Increases liability

Income Decreases income Increases income

Expense Increases expense Decreases expense

Capital Decreases capital Increases capital

Drawings Increases drawings Decreases drawings

Example:

Transaction: Paying wages from the bank

• Wages (Expense): Debit → Expense increases

• Bank (Asset): Credit → Asset decreases

Final Revision Summary:

Element Key Details

Asset Resource controlled by entity; current if <12 months

Liability Obligation to pay others; current if <12 months

Capital / Equity Owner’s residual interest (Assets – Liabilities)

Income Increases in equity (not owner contributions)

Expenses Decreases in equity (not owner distributions)

 Duality Every transaction has 2 effects: Dr & Cr

Equation A = L + C or A – L = Capital

The Regulatory and Conceptual Framework

1. Regulatory Framework of Financial Reporting

1.1 Purpose of Financial Statements

• Financial statements provide relevant information to internal/external users.

• This info helps stakeholders make decisions about a business’s future.

1.2 Need for Regulation

• Regulations standardize preparation to ensure reliability and fairness.

• IFRS and guidance come from IASB, governed by the IFRS Foundation.

Structure of IFRS Standard Setting

Three-Tier Framework:

1. Independent Standard-Setting

• IASB: Develops IFRS standards.

 • ISSB: Develops sustainability disclosure standards.

2. Governance and Oversight

• IFRS Trustees oversee IASB & ISSB.

• IFRS Advisory Council (IFRSAC) gives input.

3. Public Accountability

• Trustees are accountable to the IFRS Monitoring Board.

➡ Note: These bodies cannot enforce compliance. Adoption is up to national regulators.

1.2 IFRS Foundation – Trustees

• Independent body; oversee IASB & ISSB.

• Accountable to the Monitoring Board.

• Not involved in technical standards.

• Focus on emerging economies, SMEs, profit & non-profit organizations.

• Trustees must understand international issues.

1.3 IASB (International Accounting Standards Board)

Key Roles:

• Independent experts: standard-setting, reporting, auditing, education.

• Develop and publish IFRS Accounting Standards.

 • Provide transparency, comparability & global adoption.

Objective of Financial Reports:

• Provide useful info to investors & creditors.

Constitution:

• 14 members appointed by Trustees.

• Board has full control over:

o Standards

o Exposure Drafts

o Technical agenda

• Supermajority required for publishing.

1.4 ISSB (International Sustainability Standards Board)

Why Formed:

• Respond to global need for sustainability disclosures (climate, ESG).

Key Objectives:

1. Develop global baseline standards.

2. Serve investors’ needs.

3. Enable full sustainability disclosure.

4. Ensure interoperability with local standards.

First Standards Released (June 2023):

• IFRS S1: General sustainability disclosures.

• IFRS S2: Climate-related disclosures.

1.5 IFRS Advisory Council (IFRSAC)

• Advises Trustees, IASB, ISSB.

• Members: investors, auditors, academics, regulators.

• Consulted on:

o Agenda setting

o Work priorities

o Implementation issues

1.6 IFRS Interpretations Committee (IFRS IC)

• Interpretative body of IASB.

• 14 voting members + 1 non-voting chair.

• Responsibilities:

o Interpret IFRS standards

o Resolve application issues

o Provide guidance on unclear areas

 • Publishes draft interpretations for public comment.

2. IFRS Global Accounting Standards

IFRS Covers:

• All IAS and SIC interpretations remain unless replaced.

• IASB develops each IFRS standard for specific topics.

Mission:

• Provide transparency, accountability, efficiency.

• Serve public interest → trust, stability, informed decisions.

2.3 Development Process of IFRS Standards

Due Process:

1. Set Agenda – based on investor relevance and guidance availability.

2. Plan Project – consult Advisory Council.

3. Discussion Paper – overview & approach (Board majority needed).

4. Exposure Draft – public comment (supermajority needed).

5. Publish Final IFRS Standard – after considering all input.

6. Post-Issue Review – adapt based on new issues or changes.

 2.4 Application Scope

• Applies to commercial/industrial businesses (public/private).

• Covers both separate and consolidated statements.

• Doesn’t apply to:

o Non-business public sector entities.

o Private sector not-for-profit entities.

2.5 Advantages vs. Disadvantages of IFRS

Advantages:

• Easier international comparison.

• Trust from foreign investors.

• Shared basis for multinational firms.

• Ready-to-adopt for national bodies.

• Helps global firms & accountants.

Disadvantages:

• Costly to adopt initially.

• May lacks rigor vs. national rules.

• May conflict with local law.

3. Corporate Governance
Definition:

• System by which companies are directed and controlled (OECD, ASX).

Purpose:

• Protect shareholders’ interests, promote transparency, manage risk, ensure accountability.

Components:

1. Risk Management – disclose & manage risks.

2. Information Quality – reliable, timely, true & fair.

3. Stewardship – open communication of performance and strategy.

3.2 Governance & Financial Statements (UK Code)

Responsibilities of Board:

• Present fair and balanced financial statements.

• Maintain internal control systems.

Audit Committee Duties:

• Review internal/external audits.

• Monitor financial statement integrity.

• Oversee risk management.

3.2.1 Directors’ Duties (Fiduciary Duties)

 • Responsible for:

o Preparing fair financial statements.

o Ensuring proper records and systems.

o Preventing fraud.

o Cooperating with auditors.

• Must approve statements only if true and fair.

• File statements as per legal requirements.

3.4 Ethics in Governance (ACCA Code)

5 Ethical Principles:

1. Integrity – honest, balanced reporting.

2. Objectivity – unbiased, independent.

3. Professional Competence – knowledge & care.

4. Professional Behaviors – law-abiding, uphold reputation.

5. Confidentiality – respect for sensitive information.

4. Conceptual Framework

Purpose:

• Guide for:
 o IASB in setting standards

o Preparers in policy decisions

o Users in interpretation

Not a standard – cannot override IFRS.

4.2 Qualitative Characteristics of Useful Information

Fundamental:

1. Relevance

2. Faithful Representation (complete, neutral, free from error)

Enhancing:

3. Comparability

4. Verifiability

5. Timeliness

6. Understandability

5. Accounting Principles

5.1 Key Principles

Principle Description
Materiality Info is material if omission affects decisions

Offsetting Assets/Liabilities/Income/Expenses should not offset unless allowed

Consistency Use consistent accounting unless justified change

Prudence Avoid over/understatement; apply caution

Duality Every transaction affects two accounts (double entry)

Historical Cost Record at original cost

Current Value Use fair value, value-in-use, or current cost

Substance Over Form Record based on commercial reality, not just legal form

5.2 Basis of Financial Statement Preparation

1. Going Concern – Business will continue for at least 12 months.

2. Accruals Basis – Transactions recorded when they occur, not when cash is paid/received.

3. Business Entity – Entity is separate from owners.

Comprehensive Accounting Notes for Memorization

Recording Financial Accounting Information
1.1 Flow of Accounting Information

Objective of Accounting

The aim of accounting is to present fairly and accurately all financial transactions in the financial statements. This is crucial for
internal decision-making and external reporting.

Accounting Information Process (Step-by-Step)

1. Business Transactions Occur

o All financial activity starts with business transactions that have monetary value.

o These include sales, purchases, payments, and receipts.

2. Recording Transactions

o Transactions are recorded using information from financial/source documents.

o This data is then posted into relevant ledger accounts using computerized systems or journals.

3. Classification into Ledgers

o Transactions are classified and recorded in their respective general ledger accounts (assets, liabilities, income,
expenses, capital).
4. Trial Balance Preparation

o At the end of the year, the closing balances of each account are extracted into the trial balance.

o This ensures debits equal credits and is used as the foundation for preparing financial statements.

5. Financial Statements Creation

o The trial balance leads to preparation of:

▪ Statement of Financial Position (Balance Sheet)

▪ Statement of Profit or Loss (Income Statement)

6. Conclusion:

o Accounting systems serve as the bridge through which transaction data flows into final financial reports.

FA/FFA Exam Key Advice

• Computerized systems are assumed throughout.

• Sales & Purchase modules are integrated:

o Sales invoices → auto-recorded in customer account, trade receivables, and sales account.

o Purchase invoices → auto-recorded in supplier account, trade payables, and relevant expense or inventory account.

• Manual journal entries are required for:

o Non-current assets (acquisition or disposal)

o Cash and bank transactions (cash sales, purchases, payments, receipts)

o Payroll (wages/salaries recorded manually)

 o Inventory transfer to cost of sales

• Inventory Systems:

o Manual or integrated.

o In both systems, journal entries are needed for:

▪ Opening/closing inventory

▪ Purchase transfer to cost of sales

• Electronic filing of records is standard.

2.1 Business Transactions

Definition

Business transactions are daily financial activities of a business that are measurable in money. These activities are recorded in
the accounting system to reflect the operational performance.

Types of Transactions

Type Description

Sales Selling goods/services for cash or credit. Credit sales are collected later.

Sales Returns Goods returned by customers due to fault or damage. Offset against sales.

Purchases Acquiring goods/services for business operations. Paid in cash or on credit.

Purchase Returns Goods returned to suppliers due to issues. Offset against purchases or relevant expense.

Payments Outflow of money to third parties (e.g. suppliers, wages, taxes).

 Receipts Inflow of money from third parties (e.g. customers).

All financial transactions must be backed by appropriate source documents.

2.2 Financial or Source Documents

Purpose

Source documents validate the existence of financial transactions and provide evidence used in bookkeeping.

Key Source Documents

Document Use Content

Quotation Price estimate to buyer Description, quantity, price

Purchase Order Customer's order request Supplier name, item details, quantity, price

Sales Order Seller’s internal doc after customer order Buyer details, product info

Delivery Note / GDN Proof of goods delivered Goods description, customer sign-off

GRN (Goods Received Note) Confirms goods received by buyer Quantity, item details

Sales Invoice Bill sent to customer for credit sale Seller & buyer details, quantity, price, tax, terms

Purchase Invoice Bill from supplier for purchases Same as sales invoice from supplier's side

Credit Note Reduces a sales invoice Used for returns or pricing issues

Debit Note Request to issue a credit note Initiated by customer

Statement of Account Summary of transactions for reconciliation Outstanding amounts, invoices, credit notes
 Remittance Advice Confirms payment has been made Details of amount paid payment method

Receipt Confirms payment received Amount paid, invoices covered

In computerized systems, these documents may be auto generated, ensuring mandatory control and authorization.

3.1 General Ledger (GL)

Definition

A General Ledger contains all the individual ledger accounts necessary for preparing financial statements. It ensures accurate
classification of transactions using the double-entry system.

Structure

Each GL account is categorized into:

• Assets

• Liabilities

• Capital

• Income

• Expenses

3.1.1 T-Accounts

• A T-account visually represents the ledger:

o Left = Debit
 o Right = Credit

3.2 Main General Ledger Accounts

Statement of Financial Position Accounts

Account Type Debit Entry Credit Entry

Trade Receivables Asset Increases receivables Decreases when customer pays

Bank/Cash Asset Increases with receipts Decreases with payments

Trade Payables Liability Decreases on payment Increases with credit purchases

Asset: Debit ↑ / Credit ↓ | Liability: Debit ↓ / Credit ↑

Statement of Profit or Loss Accounts

Account Type Debit Entry Credit Entry

Sales Income Decreases (returns) Increases with sales

Expenses (e.g., Purchases) Expense Increases with purchases Decreases on return

Income: Debit ↓ / Credit ↑ | Expense: Debit ↑ / Credit ↓

3.3 Balancing Off Ledger Accounts

Why Balance?
 • Ensures accuracy of double-entry records.

• Confirms accounts are ready for the trial balance.

Steps:

1. Total each side of the account.

2. Find the difference → Balance c/d (carried down).

3. Record the balance on the opposite side to balance the account.

4. Bring down (b/d) this figures to the next period.

Application:

• SOFP accounts (Assets, Liabilities, Capital): Balances carried forward.

• P&L accounts (Income, Expenses): Transferred to profit/loss account (no b/d).

4.1 Computerized Accounting Systems

Overview

Modern accounting is done through computerized software rather than manual books.

🛠 System Processes

1. Input – Enter data from source documents.

2. Processing – Data posted to relevant ledger accounts.

3. Output – Reports and financial statements generated.

4.1.1 Features of Computerized Systems

• Integrated Modules: Sales, purchases, inventory, payroll

• Automatic posting: e.g., sales invoice → receivables, inventory, sales accounts

• Backups: Prevent data loss

• Authorization: Passwords, tokens, approvals

• Edit Logs: Track any changes made

• Real-time Reports: e.g., trade receivables aging, purchase analysis

4.1.2 Desktop vs Cloud Systems

Feature Desktop Cloud

Access Local machine Internet required

Users Usually, single user Multiple users remotely

Backups Manual Auto-backup

Installation Required Not required

Security Local-based Encrypted and online

Payment One-time license Subscription-based

4.2 Sources of Accounting Information

 Source Description Example

Manual Entry Human inputs data Clerk enters invoice manually

Computer-Assisted Entry Systems read input Email orders processed automatically

Databases Store large data Customer/supplier master data

Integrated Systems Connect with external systems Auto-order creation from inventory alerts

4.3 Journal Entries

Automatic Transactions

Example:
Sales invoice created in the system

DR Trade Receivables
CR Sales

This journal is generated automatically in integrated systems.

Manual Journal Entries

Used for:

• Bank and cash transactions

• Wages and payroll

• Fixed asset acquisitions/disposals

 • Inventory adjustments

• Accruals and prepayments

Format:

DR Expense A/c (e.g., Wages)

CR Bank A/c
Explanation: “To record payment of wages”

4.4 Accounting System Definition

A system for recording, assembling, and reporting financial information, including internal controls.

A Good System Must:

• Ensure resources are used efficiently

• Comply with organizational policies

• Prevent fraud and errors

• Maintain complete, accurate records

• Enable timely, reliable reporting

4.4.1 Characteristics of Useful Accounting Information

To be useful, accounting information must be:

• Relevant to users’ needs

• Reliable, accurate, and objective

 • Complete for the intended purpose

• Timely, comparable, and understandable

• Cost-effective and concise

4.4.2 Organizational Objectives

Management must ensure:

• Efficient operations

• Protection of assets

• Prevention and detection of errors

• Accurate, timely reports

Internal Controls Must Ensure:

• All transactions are valid, accurate, and complete

• Asset and record access is restricted

• Physical assets match recorded assets

4.5 Policies, Procedures, and Performance

Concept Description

Policies Principles/guidelines to achieve long-term goals

 Procedures Step-by-step actions for routine tasks (e.g., sales recording)

Performance Evaluation of outcomes (e.g., actual vs expected profits)

Recording Business Transactions and Sales Tax

1. Types of Business Transactions

1.1 Overview

• Business transactions have a monetary value.

• Recorded using journal entries (manual or automatic).

• Based on the double-entry principle.

• Entries affect the general ledger accounts.

FA/FFA exams assume businesses use computerized systems with sales/purchase modules integrated with the general ledger.

Transactions Covered

• Cash and Credit Sales

• Sales Returns

• Cash and Credit Purchases

• Purchase Returns
 • Petty Cash Transactions

1.2 Sales Transactions

1.2.1 Cash and Credit Sales

Sale Type Entry Category Explanation

Cash Sale DR Cash/Bank Asset / Income Cash ↑, Sales ↑

CR Sales

Credit Sale DR Trade Receivables Asset / Income Receivables ↑, Sales ↑

CR Sales

Posted automatically in integrated systems.

1.2.2 Sales Returns

Case 1: No “Sales Returns” account used

• DR Sales (Income ↓)

• CR Trade Receivables (Asset ↓)

Case 2: “Sales Returns” account used

• DR Sales Returns (Income ↓)

• CR Trade Receivables (Asset ↓)

If sales return account is not mentioned in the exam, use Sales account for debit.
1.2.3 Receipts from Customers

Manual journal required (bank not integrated).

• DR Bank/Cash (Asset ↑)

• CR Trade Receivables (Asset ↓)

1.3 Purchase Transactions

1.3.1 Cash and Credit Purchases

Purchase Type Entry Category Explanation

Cash Purchase DR Purchases Expense / Asset Purchases ↑, Cash ↓

CR Cash/Bank

Credit Purchase DR Purchases Expense / Liability Purchases ↑, Liabilities ↑

CR Trade Payables

Automatically posted in integrated systems.

1.3.2 Purchase Returns

• DR Trade Payables (Liability ↓)

• CR Purchases/Expense (Expense ↓)

If a purchase returns account is used, it is credited instead of purchases.

1.3.3 Payments to Suppliers

 • DR Trade Payables (Liability ↓)

• CR Bank/Cash (Asset ↓)

1.4 Petty Cash Transactions

Definition

• Small cash fund used for minor expenses (postage, taxis).

• Stored securely in a cash tin.

• Maintained using the Imprest System or Non-imprest System.

1.4.1 Imprest System

• Fixed float maintained.

• Cash + vouchers = imprest balance.

• Reimbursement example:

o Paid: $68 → Cash in tin = $32

o Reimburse $68 to restore to $100

Journal Entry (Replenishment):

• DR Petty Cash (Asset ↑)

• CR Bank (Asset ↓)
1.4.2 Importance of Records

• Supports internal controls and fraud prevention.

• Each payment has a voucher.

• Monthly totals posted to general ledger.

2. Sales Tax

2.1 General Principles

• Sales Tax = Indirect Tax

• Charged on goods/services, not profits.

• Must register to:

o Charge tax on sales (Output Tax)

o Reclaim tax on purchases (Input Tax)

Outcome:

• Output > Input → Liability

• Input > Output → Asset (Refund)

Regular returns must be submitted to tax authorities.

2.2 Sales Tax Calculation

Term Definition

Net Amount Before tax = 100%

Gross Amount Net + Sales tax

2.3 Accounting for Sales Tax

2.3.1 Cash & Credit Sales

• DR Cash/Trade Receivables (Gross)

• CR Sales (Net)

• CR Sales Tax (Liability)

2.3.2 Sales Returns

• DR Sales / Sales Returns

• DR Sales Tax

• CR Trade Receivables (Gross)

2.3.3 Purchases with Sales Tax

• DR Purchases (Net)

• DR Sales Tax (Asset)

• CR Cash / Trade Payables (Gross)

2.3.4 Purchase Returns with Tax

• DR Trade Payables

• CR Sales Tax

• CR Purchase Returns

2.3.5 Tax Payment / Refund

Action Journal Entry

DR Sales Tax
Payment
CR Bank

DR Bank
Refund
CR Sales Tax

2.3.6 Sales Tax T-Account Summary

DR CR

Input Tax Output Tax

Sales Returns Purchase Returns
Cash paid to tax authority Cash received from tax authority

3. Discounts

3.1 Trade Discounts

 • Given for bulk/repeat purchases

• Always excluded from accounting records

• Transactions recorded net of trade discount

3.2 Settlement (Prompt Payment) Discounts

3.2.1 Seller Perspective (IFRS 15)

Scenario Initial Entry If Paid Early If Not Paid Early

Expected to take DR Receivables (Net) DR Cash DR Cash

CR Sales (Net) CR Receivables CR Receivables
CR Sales

Not expected to take DR Receivables (Gross) DR Cash DR Cash

CR Sales (Gross) DR Sales CR Receivables
CR Receivables

3.2.2 Purchaser Perspective

• Always record full amount of invoice at purchase.

• If discount taken on payment:

DR Trade Payables
CR Cash (Net Amount Paid)
CR Discounts Received (Income)
3.2.3 Both Discounts on One Invoice

Settlement discount is calculated after trade discount is deducted.

4. Bank Reconciliation

4.1 Purpose

• Match Bank Statement Balance with Bank Ledger Account

• Ensures accuracy of reported bank balance on financial statements.

4.2 Reasons for Differences

Reason Description

Errors Incorrect postings in ledger or statement

Omissions Missed entries (e.g. bank charges, interest)

Timing Differences Payment/receipt delays

Types of Timing Differences

• Unpresented Cheques – Not yet cashed by payee.

• Outstanding Lodgments – Deposits not yet shown.

• Direct Debits / Credits

• Dishonored Cheques
4.3 Reconciliation Procedure

Steps

1. Compare opening balances.

2. Identify missing or erroneous transactions in ledger.

3. Create bank reconciliation statement.

Format

Bank Statement Balance X

Less Unpresented Cheques (X)
Add Outstanding Lodgments X
± Bank Errors ±X
= Corrected Bank Ledger Balance X

Only corrected ledger balance appears in the financial statements.

Receivables and Payables
1.1 Introduction to Receivables

1.1.1 Definition of Receivables

• Receivables are amounts due to the business from individuals, organizations, or other entities to settle a debt or claim.

1.1.2 Examples of Receivables

• Trade Receivables: Amounts due from customers for credit sales.

• Other Receivables:

o Rent receivable from tenants

o Tax refunds due (e.g., overpaid tax)

o Accrued income (earned but not yet invoiced)

o Loans receivable

o Interest receivable

o Advance payments to suppliers (refundable until delivery)

1.2 Sales on Credit

Key Concepts

• Credit allows customers to buy now, pay later, giving businesses a competitive edge.

• Customers agree to settle within credit terms and are assigned a credit limit.

• A credit controller monitors credit terms and customer balances.

1.2.1 Advantages and Disadvantages of Selling on Credit

Advantages Disadvantages

Increase in revenue Risk of non-payment

Immediate item usage by buyer Legal/admin costs

Convenience for buyer May need borrowing (interest costs)

Supports online selling Possible bad debts

Payment flexibility May require security guarantees

1.2.2 Credit Control

Includes procedures for:

1. Granting credit (e.g., reference checks)

 2. Agreeing credit terms and limits

3. Accurate invoicing

4. Monitoring customer balances

1.2.3 Credit Limits

Definition:

• The maximum amount a business will allow a customer to owe without further review.

Purpose:

• Limit risk exposure

• Improve collections

• Speed up sales process

• Serve as account monitoring tool

1.3 Aged Receivables Analysis

Purpose:

• Lists receivables by customer and by age of outstanding amounts.

Time Categories:

• 0–30 days

• 31–60 days
 • 61–90 days

• Over 90 days

Used for: Prompt reminders, monitoring, and corrective actions if overdue debt increases.

1.4 Irrecoverable Debts (Bad Debts)

1.4.1 Definition:

• Amounts that are not expected to be collected.

Indicators:

• Late payments

• Installments beyond credit terms

• Frequent invoice disputes

• Customer in liquidation/receivership

Write-Off Journal Entry:

• DR: Irrecoverable debts expense

• CR: Trade receivables

1.4.2 Subsequent Recovery of Irrecoverable Debt

Step 1: Reverse Write-off

• DR: Trade receivables

 • CR: Irrecoverable debts expense

Step 2: Record Receipt

• DR: Bank

• CR: Trade receivables

Net Effect:

• DR Bank

• CR Irrecoverable debts expense

1.5 Allowance for Irrecoverable Debts

Key Concepts:

• Based on expected credit losses (forward-looking).

• Offset against gross receivables in the statement of financial position.

Presentation:

Trade receivables X

Less Allowance for irrecoverable debts X

Also known as:

• Allowance for doubtful debts

 • Bad debt provision (not technically a "provision")

1.5.1 Journal Entries for Allowances

1. If Closing Allowance > Opening Allowance:

o DR: Irrecoverable debts expense

o CR: Allowance for irrecoverable debts

2. If Closing Allowance < Opening Allowance:

o DR: Allowance for irrecoverable debts

o CR: Irrecoverable debts expense

Note: Although termed an asset, the allowance is a negative asset.

1.6 Calculating the Allowance

Under IFRS 9:

• Allowance must be made from the sale date.

• Uses expected credit loss model (not examinable in FA/FFA exam).

• Exam questions will provide opening and closing balances.

1.6.1 Write-off When Allowance Exists

Journal Entry:
 • DR: Irrecoverable debts expense

• CR: Trade receivables

The effect is not double counting since the allowance is reduced simultaneously.

2.1 Introduction to Payables

2.1.1 Definition of Payables

• Amounts owed for purchases or obligations not yet paid.

2.1.2 Examples of Payables

• Trade Payables – amounts due for credit purchases

• Bank Overdraft

• Sales Tax Liability

• Income Tax Liability

• Accruals (e.g., rent, utilities)

• Other Payables:

o Deferred income

o Loans + interest

o Group company balances

o Unpaid salaries/dividends
2.1.3 Payables Ledger

• Contains individual supplier accounts (not in general ledger)

• Reconciled with supplier statements

• General ledger’s trade payables balance = total of all individual supplier accounts

2.2 Receivables and Payables Contra

Key Concept:

• If a supplier is also a customer, netting off balances is allowed.

Journal Entry:

• DR: Trade payables

• CR: Trade receivables

Offset limited to the smaller balance.

2.3 Supplier Statements

Purpose:

• Issued monthly like a credit card statement

• Summarizes opening balance, invoices, credit notes, payments

Includes:
 • Supplier & customer details

• Date received stamp

• Debits (invoices), Credits (payments/credit notes)

• Total amount due

• Credit terms and limits

2.4 Supplier Statement Reconciliation

Definition:

• Comparing supplier ledger balance vs. supplier statement

Differences arise due to:

Timing Differences:

• Invoices not yet received

• Payments made/received at different times

Entry Errors:

• Omitted or duplicated entries

• Transposition errors (e.g., $56 vs $65)

• Wrong supplier allocation

• Incorrect discounts

Key Point:
 • No accounting adjustment for timing differences—correct in future period.

• Adjustments for errors only.

Example Reconciliation

Type Description Action

Missing credit note Not recorded in ledger DR Payables, CR Purchases

Supplier error in invoice Overstated invoice Adjust under supplier statement and inform supplier

Final Reconciliation Table:

Reconciliation of Payables (Puja) Amount ($)

Balance per Payables Ledger 615.42

Less: Supplier invoice error (27.00)

Balance per Supplier Statement 588.42

Summary & Memory Triggers

Topic Key Term Trigger/Tip

Receivables Amounts owed to the business Think "Receive = Incoming"

Payables Amounts owed by the business Think "Pay = Outgoing"

Bad Debts Not collectible Customer default

 Allowance Expected credit losses Future risk buffer

Contra Entry Offset receivable/payable Double role (supplier & customer)

Supplier Statement External document Like a monthly bill

Reconciliation Match internal vs. external records Audit check

IAS 37 Provisions, Contingent Liabilities and Contingent

Assets
1. Core Definitions & Context

• Provision (IAS 37):

"A liability of uncertain timing or amount."

• Key Attributes:

o Present obligation from past events (obligating event).

o Settlement requires outflow of economic resources (cash/goods/services).

o Uncertainty distinguishes provisions from other liabilities (e.g., payables).

• Distinction from General Liability:

o IAS 37 liability definition focuses on obligations from past events; IFRS Framework emphasizes present duty to
transfer economic resources.
Common Examples:

• Warranty provisions: Obligation to repair/replace defective products sold.

• Clean-up provisions: Legal/constructive duty to restore land after industrial use.

• Legal dispute provisions: Estimated costs to settle lawsuits (if probable).

2. Recognition Criteria for Provisions

(All 3 Must Be Satisfied)

1. Present Obligation (Legal/Constructive):

o Legal: Enforceable by law (e.g., contracts, legislation).

o Constructive: Implied by entity’s actions (e.g., past practice creating valid expectations).

o Obligating Event: Past incident triggering obligation (e.g., product sale for warranties).

2. Probable Outflow of Economic Resources:

o "Probable" = >50% likelihood ("more likely than not").

o Not "possible" (5–50%) or "remote" (<5%).

3. Reliable Estimate:

o Must be possible even if precise amount is uncertain (e.g., using ranges/probabilities).

o Exception: Rare cases with no reliable basis (e.g., unprecedented lawsuits).

Memory Hook: P.R.O.B.

• Present Obligation
 • Resource Outflow Probable (>50%)

• Best Estimate Reliable

3. Measurement of Provisions

Principle: Best estimate of expenditure to settle obligation at reporting date.

Methods:

Scenario Method Application

Narrow Range Mid-point Example 1: Damages estimated at $250K–$300K → $275K provision.

Single Obligation Most likely outcome Example 2: $120K most likely (not $146K expected value).

Large Population Expected value Example 3: Warranty costs = (Units × Repair probability × Cost per repair).

Time Value of Money Discounted present value Used if material (e.g., long-term environmental provisions).

Critical Nuances:

• Avoid Over-Prudence: Mid-point preferred over range extremes (unless one end is significantly more probable).

• Exclude Reimbursements: Recognize separately (e.g., insurance recoveries) only if virtually certain.

• Post-Reporting Events: Adjust estimates if new evidence arises (e.g., court rulings).

4. Accounting Treatment for Provisions

Journal Entries:

• Increase in Provision:
DR Expense Account (e.g., "Warranty Expense," "Legal Costs")

CR Provisions (Liability)

• Decrease in Provision:

DR Provisions (Liability)

CR Expense Account

Steps for Year-End Adjustment:

1. Calculate closing provision balance (using best estimate).

2. Compare to opening provision balance.

3. Increase needed: Expense ↑, Liability ↑.

4. Decrease needed: Expense ↓ (reversal), Liability ↓.

Example:

• Opening provision: $100K

• New best estimate: $150K

• Adjustment: DR Expense $50K / CR Provisions $50K

5. Contingent Liabilities

• Definition:

o Possible obligation (existence confirmed by future events); OR

 o Present obligation not recognized because:
(a) Outflow not probable (<50%), OR
(b) Amount cannot be estimated reliably.

• Accounting Treatment:

o Never recognized in financial statements.

o Disclosed in notes unless "remote" (<5% chance).

o Disclosure Details: Nature estimated financial impact, uncertainties.

• Recognition Trigger:

o If outflow becomes probable (>50%) → Reclassify as provision.

Examples:

• Pending lawsuit where outcome is uncertain (<50% loss probability).

• Guarantees for third-party loans (if default unlikely).

Memory Hook: C.L.O.W.N.

• Contingent

• Liability

• Outflow uncertain

• Watch notes

• No recognition

6. Contingent Assets
 • Definition:

Possible asset from past events, confirmed by future events.

o E.g., Unsettled insurance claims, potential lawsuit winnings.

• Accounting Treatment:

o Never recognized (risk of unrealized revenue).

o Disclosed in notes if probable (>50% inflow likelihood).

o Recognized as asset only if virtually certain (>95%).

• Disclosure Caution: Avoid over-optimism; emphasize uncertainties.

Example:

• $1M insurance claim pending adjudication (70% success chance) → Note disclosure only.

7. Probability Thresholds: Summary Table

Likelihood Assets Liabilities

Virtually Certain (>95%) Recognized as asset Recognized as liability

Probable (51–95%) Disclosed (contingent asset) Recognized as provision

Possible (5–50%) No disclosure Disclosed (contingent liability)

Remote (<5%) No disclosure No disclosure

Key Clarifications:
 • % ranges are guidelines, not strict boundaries.

• "Probable" for liabilities = recognize; for assets = disclose only.

8. Disclosure Requirements

• Provisions:

o Nature & Timing: Brief description (e.g., "warranties for 2025 sales").

o Uncertainties: Key assumptions (e.g., "clean-up costs depend on regulatory standards").

o Reimbursements: Expected recoveries (e.g., insurance).

o Movement Analysis:

Opening Balance
+ Additions
- Amounts Used
± Reversal/Unused Amounts
= Closing Balance

• Contingencies:

o Nature (e.g., "pending tax dispute").

o Estimated financial effect (if quantifiable).

o Uncertainties (e.g., "outcome depends on court ruling").

Scope of IAS 37: Excludes provisions covered by other standards (e.g., employee benefits [IAS 19], leases [IFRS 16]).
Memory Triggers & Application Tips

• Provisions: "3 R's" →

Recognition (criteria),
Reliability (estimate),
Resource outflow (probable).

• Contingent Liability: "D.N.R." →

Disclose in Notes,
Not Recognized,
Remote = ignore.

• Probability Scale Mnemonic: "Very Proud Penguins Race"

(Virtually certain → Probable → Possible → Remote).

• Exam Focus:

o Always test all 3 recognition criteria.

o Use expected value only for large populations (e.g., warranties).

o Discount long-term provisions to present value.

IAS 2 Inventories
1. Inventory: Definition, Scope, and Classification

Definition (IAS 2.6):

Assets held for sale in the ordinary course of business, in production for such sale, or as materials/supplies to be consumed in
production or rendering services.

Classifications:

Type Description Examples

Finished Goods Completed products ready for sale Retailer’s clothing stock

Work-in-Progress Partially completed goods Unpainted furniture assemblies

Raw Materials Inputs for production Timber for furniture manufacturing

Goods for Resale Merchandise purchased for direct resale Wholesaler’s electronics inventory

Key Principles:

• Asset Recognition: Inventory is a current asset until sold.

• Expense Timing: Costs become expenses (COS) only when inventory is sold.

• Exclusions: Financial instruments, agricultural products, mineral resources.

2. Accruals Accounting & Cost of Sales Mechanics

Core Concept:

• Matching Principle: Link expenses to revenue generation period.

• COS ≠ Purchases: Reflects actual cost of goods sold (not purchased).

COS Formula & Components:

COS = Opening Inventory + Net Purchases − Closing Inventory

Net Purchases = Purchases + Carriage Inwards − Purchase Returns/Discounts

Why Adjust?

• Opening Inventory: Included in COS (consumed for current-year sales).

• Closing Inventory: Excluded from COS (asset for future sales).

Example:

• Opening Inv: $20,000

• Purchases: $100,000

• Closing Inv: $25,000

• COS = $20,000 + $100,000 − $25,000 = $95,000

3. Detailed Accounting Entries & Ledger Impact

Year-End Adjustment Process:

1. Remove Opening Inventory:

o Journal:

DR Cost of Goods Sold (SOPL) $20,000

CR Inventory (SOFP) $20,000

o Effect: Transfers opening inventory to COS.

2. Close Purchases Account:

 o Journal:

DR Cost of Goods Sold (SOPL) $100,000

CR Purchases (Expense) $100,000

o Effect: Adds current-year purchases to COS.

3. Record Closing Inventory:

o Journal:

DR Inventory (SOFP) $25,000

CR Cost of Goods Sold (SOPL) $25,000

o Effect: Excludes unsold goods from expenses; recognizes as asset.

Final Ledger Balances:

DR Inventory Account $25,000 (SOFP Current Account)

CR COS Account $25,000 (SOPL Expense)

4. Inventory Systems: Continuous vs. Periodic

Continuous (Perpetual) System:

• Process: Real-time tracking per item (manual cards/digital ERP).

• Formula:

Closing Qty = Opening Qty + Purchases − Sales

• Advantages: Instant stock visibility; theft detection.

 • Disadvantages: Costly for high-volume items; requires regular reconciliation.

Periodic System:

• Process: Physical count at year-end (no real-time records).

• Formula:

COS = Opening Inv + Purchases − Closing Inv (from count)

• Advantages: Low-cost; simple for small businesses.

• Disadvantages: Stock discrepancies missed; no mid-year data.

Control Procedures:

• Annual Stock take: Mandatory for all systems.

• Test Counting: Spot-checks high-risk items quarterly.

• Reconciliation: Investigate >5% ledger vs. physical variances.

Memory Hook: "C.P.R." = Continuous needs Perpetual updates, Periodic needs Reconciliation.

5. IAS 2: Cost Measurement & NRV

Golden Rule:

Value inventory at lower of Cost or Net Realizable Value (NRV).

5.1 Cost Components:

Cost Element Included? Examples

Purchase Price Yes Invoice price of goods

 Import Duties/Taxes Yes Customs duties on imported materials

Carriage Inwards Yes Freight to bring goods to warehouse

Direct Labor Yes Wages for factory workers

Production Overheads Yes Factory rent, machinery depreciation

Production Royalties Yes License fees for patented processes

Administration Costs No Office electricity, manager salaries

Carriage Outwards No Delivery to customers

Abnormal Waste No Material scrapped due to worker error

5.2 Net Realizable Value (NRV):

NRV = Estimated Selling Price

− Estimated Completion Costs

− Estimated Selling/Distribution Costs

Example:

• Selling Price: $50/unit

• Completion Costs: $10/unit

• Selling Costs: $5/unit

• NRV = $50 − $10 − $5 = $35/unit

NRV Application:

• If Cost = $40 > NRV ($35) → Write down inventory to $35.

 • Write-down journal:

DR Cost of Goods Sold $5

CR Inventory $5

6. Inventory Valuation Methods: Mechanics & Impact

6.1 FIFO (First-In-First-Out):

• Principle: Oldest purchases sold first.

• Closing Inventory: Valued at most recent prices.

• Impact:

o Inflation: Lower COS → Higher profit.

o Deflation: Higher COS → Lower profit.

Example (FIFO):

Transaction Units Cost/Unit Total

Jan 1: Opening 100 $10 $1,000

Mar 1: Purchase 200 $12 $2,400

Nov 1: Sales 250 – –

Closing (FIFO) 50 $12 $600

6.2 Weighted Average Cost (AVCO):

 • Periodic AVCO:

Avg Cost = Total Cost of Goods Available ÷ Total Units Available

• Cumulative AVCO: Recalculate after each purchase.

Example (Periodic AVCO):

• Goods Available: 300 units @ $3,400

• Avg Cost = $3,400 ÷ 300 = $11.33/unit

• Closing Inventory: 50 units × $11.33 = $566.50

Financial Statement Impact:

Method Rising Prices Falling Prices

FIFO Lower COS → Higher Profit Higher COS → Lower Profit

AVCO Moderate COS/Profit Moderate COS/Profit

7. Disclosure Requirements (IAS 2.36-38)

Mandatory Disclosures:

1. Accounting Policies:

o Valuation method (FIFO/AVCO).

o Cost formula (e.g., standard costing).

2. Inventory Classification:

o Raw materials, WIP, finished goods.

 3. Carrying Amounts:

o Total inventory value.

o Amount pledged as security.

4. NRV Details:

o Write-downs recognized (e.g., $5,000).

o Reversals of write-downs.

5. Movement Analysis:

Opening Balance $ XXX

+ Additions $ XXX
- Cost of Sales $ (XXX)
± Write-downs/Reversals $ (XXX) / $ XXX
= Closing Balance $ XXX

Example Disclosure Snippet:

*"Inventories are valued at the lower of cost (FIFO) and net realizable value.
Raw materials: $40,000; Work-in-progress: $25,000; Finished goods: $35,000.
$10,000 write-downs recognized due to obsolescence."*

Memory Triggers & Exam Tactics

Mnemonics:

• "I.N.V.E.N.T.O.R. Y" for Cost Components:

Import duties | Net purchase price | Variable overheads
 Excluded costs (admin) | NRV test | Taxes (inbound)
Outward carriage excluded | Royalties | Yields (direct labor)

• "F.A.R." for Valuation Impact:

FIFO = Assets reflect Reality (current prices)

Exam Warnings:

1. Carriage Inwards vs. Outwards:

o Carriage Inwards → Included in inventory cost.

o Carriage Outwards → OUT to SPL expenses.

2. Abnormal Costs: Always expense immediately → Never capitalize.

3. NRV Write-Downs:

o Irreversible if due to new circumstances (e.g., tech obsolescence).

o Reversible only if original write-down reason reverses (e.g., price recovery).

Common Pitfalls:

• Including storage costs for finished goods (excluded unless necessary for production).

• Forgetting to exclude purchase returns from net purchases.

• Using selling price instead of estimated selling price for NRV.

IAS 16 Property, Plant and Equipment
1. Introduction to IAS 16

IAS 16 prescribes the accounting treatment for Property, Plant, and Equipment (PPE)—tangible non-current assets used in
production, supply, rental, or administration. The standard covers:

• Initial recognition (what costs to capitalize)

• Subsequent measurement (cost or revaluation model)

• Depreciation (allocating asset cost over useful life)

• Derecognition (disposal and impairment)

2. Initial Recognition of PPE

2.1 Definition of PPE

PPE must meet two criteria for recognition:

1. Future economic benefits are probable.

2. Cost can be measured reliably.

2.2 Cost Components

PPE is initially recorded at cost, which includes:

Cost Element Included? Examples

Purchase price (after discounts) Invoice price

 Directly attributable costs Delivery, installation, testing

Dismantling & restoration costs Environmental cleanup obligations

Borrowing costs (if applicable) Interest on construction loans

Administrative costs Office salaries, general overheads

Carriage outwards Delivery to customers

2.3 Directly Attributable Costs

These are essential to bring the asset to working condition:

• Site preparation (demolition, foundations)

• Professional fees (architects, engineers)

• Testing costs (trial runs to ensure functionality)

• Labor costs (directly related to construction)

Excluded costs:

• General admin expenses

• Training staff to use the asset

• Initial operating losses

2.4 Self-Constructed Assets

If a business builds its own PPE (e.g., a factory), costs include:

 • Materials (raw materials, components)

• Labor (direct wages)

• Overheads (allocated if directly related to construction)

3. Subsequent Measurement: Cost vs. Revaluation Model

After initial recognition, IAS 16 allows two models:

3.1 Cost Model

• Carrying amount = Historical cost – Accumulated depreciation – Impairment losses

• Advantage: Simple, consistent

• Disadvantage: May not reflect fair value

3.2 Revaluation Model

• Carrying amount = Fair value at revaluation date – Subsequent depreciation

• Key rules:

o Must be applied to entire classes of assets (e.g., all buildings)

o Revaluations must be regular (not ad-hoc)

o Surplus → Credited to Revaluation Surplus (OCI)

o Deficit → Charged to P/L if beyond prior surplus

Journal Entry (Upward Revaluation):

DR PPE Asset (Cost) Increase to fair value

 DR Accumulated Depreciation Eliminate existing
depreciation
CR Revaluation Surplus Equity

Revised Depreciation:
After revaluation, depreciation is based on:

(Revalued Amount – Residual Value) / Remaining Useful Life

4. Depreciation of PPE

4.1 Key Definitions

• Useful Life: Period asset is expected to be used (years/units produced)

• Residual Value: Estimated salvage value at disposal

• Depreciable Amount: Cost – Residual Value

4.2 Depreciation Methods

Method Formula When to Use

Straight-Line (Cost – RV) / Useful Life Even benefits over time (e.g., buildings)

Diminishing Balance % × Carrying Amount Higher benefits in early years (e.g., vehicles)

Units of Production (Cost – RV) × (Units Produced / Total Capacity) Asset wear depends on usage (e.g., machinery)

4.3 Pro Rata Depreciation

• Full-Year Convention: Full depreciation in year of purchase, none in disposal year.

• Pro Rata Basis: Depreciation calculated per month owned.

Example:

• Asset bought July 1 (6 months usage)

• Annual depreciation = $12,000

• Pro Rata Depreciation = $12,000 × (6/12) = $6,000

5. Derecognition (Disposal of PPE)

When an asset is sold/scrapped, four steps are required:

5.1 Remove Asset Cost

DR Disposal Account
CR PPE Cost Account

5.2 Remove Accumulated Depreciation

DR Accumulated Depreciation
CR Disposal Account

5.3 Record Sale Proceeds

DR Cash/Bank
CR Disposal Account
5.4 Recognize Profit/Loss

• Profit:

DR Disposal Account
CR Profit on Disposal (P/L)
 • Loss:

DR Loss on Disposal (P/L)

CR Disposal Account

Example Calculation:

• Cost = $50,000

• Accumulated Depreciation = $30,000

• Sold for $25,000

• Carrying Amount = $50,000 – $30,000 = $20,000

• Profit = $25,000 – $20,000 = $5,000

6. Disclosure Requirements

IAS 16 mandates detailed disclosures, including:

1. Measurement bases (cost or revaluation)

2. Depreciation methods & rates

3. Gross carrying amount & accumulated depreciation

4. Reconciliation of carrying amounts:

Opening Balance $ XXX

+ Additions $ XXX
- Disposals $ (XXX)
± Revaluation $ XXX / $ (XXX)
- Depreciation $ (XXX)
 = Closing Balance $ XXX

7. Key Takeaways & Memory Aids

7.1 Mnemonics

• "CAPITALIZE" (Costs to include):

Cost, Attributable fees, Prep costs, Installation, Testing, Adjustments (dismantling), Labor, import duties, Zero admin
costs, Exclude carriage out

• "SL vs. DB":

Straight-Line = Steady expense
Diminishing Balance = Declining charge

7.2 Exam Tips

Land is not depreciated (infinite life)

Revaluation increases go to OCI, decreases to P/L
Always compare carrying amount to NRV for impairment

Conclusion

IAS 16 ensures PPE is accurately valued, depreciated, and disclosed in financial statements. Mastering:
✔ Cost vs. revaluation models
✔ Depreciation methods
✔ Disposal accounting
✔ Disclosure rules
—will ensure compliance and accurate financial reporting.
IAS 38 Intangible Assets
1. Introduction to IAS 38

IAS 38 prescribes the accounting treatment for intangible assets - non-monetary assets without physical substance that are
identifiable and controlled by an entity for future economic benefits. The standard covers:

• Recognition criteria

• Measurement (initial and subsequent)

• Amortization requirements

• Disclosure obligations

Key distinction: Unlike tangible assets, intangibles derive value from legal/contractual rights or intellectual property rather than
physical form.

2. Definition and Recognition Criteria

2.1 Definition of Intangible Assets

An intangible asset must meet three essential characteristics:

1. Identifiability

o Separable (can be sold/licensed independently), or

o Arises from contractual/legal rights (e.g., patents, copyrights)

2. Control

o Power to obtain future economic benefits

o Ability to restrict others' access

 3. Future Economic Benefits

o Expected to generate cash flows or cost savings

2.2 Recognition Thresholds

To be recognized, an intangible asset must satisfy both:

• Probability criterion: Future benefits are probable

• Cost reliability: Cost can be measured reliably

Exclusions:

• Internally generated goodwill

• Brands/trademarks developed internally

• Customer lists

• Publishing titles

3. Initial Measurement

3.1 Cost Components

Intangible assets are initially measured at cost, which includes:

• Purchase price (net of discounts)

• Directly attributable costs:

o Legal fees

o Registration charges

o Professional fees (architects, engineers)

 o Testing costs

Excluded costs:

• Administration overheads

• Training expenses

• Initial operating losses

• Relocation/reorganization costs

3.2 Internally Generated Intangibles

General rule: Expense all internally generated intangibles except:

• Development costs meeting capitalization criteria

• Specific website development costs

Research vs. Development:

Phase Accounting Treatment Examples

Research Always expensed - Exploratory market studies

- Testing alternative materials

Development Capitalized if 6 criteria met - Prototype design

- Pilot plant construction

4. Development Cost Capitalization

4.1 Six Capitalization Criteria

Development costs can only be capitalized if all are met:

 1. Technical feasibility of completion

2. Intention to complete and use/sell

3. Ability to use/sell the asset

4. Future economic benefits are probable

5. Adequate resources exist to complete

6. Cost can be measured reliably

4.2 Capitalizable Costs

Cost Type Included? Examples

Direct labour R&D team salaries

Materials Prototype components

Specific overheads Lab utilities

General admin CEO oversight

Selling costs Market testing

Journal Entry (Capitalization):

DR Intangible Asset – Development (SOFP) $ XXX

CR Cash/Bank (SOFP) $ XXX

5. Subsequent Measurement
5.1 Measurement Models

IAS 38 permits two models:

1. Cost Model

o Carrying amount = Cost - Accumulated amortization - Impairment losses

2. Revaluation Model (Rare for intangibles)

o Only allowed if active market exists (e.g., taxi licenses)

o Requires regular revaluations

5.2 Amortization Requirements

Key Concepts:

• Amortizable amount: Cost - Residual value

• Residual value: Typically $0 (unless third-party commitment exists)

• Useful life:

o Finite: Amortized over best estimate

o Indefinite: No amortization (tested annually for impairment)

Amortization Methods:

Method Formula When Used

Straight-line (Cost - RV) ÷ Useful life Default approach

Unit production (Cost - RV) × (Units produced/Total capacity) When benefits linked to output

Journal Entry:
 DR Amortization Expense [P/L] $ XXX
CR Accumulated Amortization [SFP] $ XXX

6. Derecognition

6.1 Disposal of Intangible Assets

4-Step Accounting Process:

1. Remove asset cost:

DR Disposal Account $ XXX

CR Intangible Asset - Cost $ XXX

2. Remove accumulated amortization:

DR Accumulated Amortization $ XXX

CR Disposal Account $ XXX

3. Record sale proceeds:

DR Cash/Bank $ XXX
CR Disposal Account $ XXX
 4. Recognize gain/loss:

o Profit:

DR Disposal Account $ XXX

CR Gain on Disposal [P/L] $ XXX

o Loss:

DR Loss on Disposal [P/L] $ XXX

CR Disposal Account $ XXX

7. Disclosure Requirements

7.1 Mandatory Disclosures

1. For each intangible asset class:

o Useful lives/amortization rates

o Amortization methods

o Gross carrying amount and accumulated amortization

2. Reconciliation:

Opening Carrying Amount $ XXX

+ Additions $ XXX
- Disposal $ (XXX)
- Amortization $ (XXX)
± Impairments/Reversals $ XXX/(XXX)
= Closing Carrying Amount $ XXX
 3. Research & Development:

o Total R&D expense recognized in P/L

4. Assets with indefinite lives:

o Carrying amounts

o Reasons for indefinite life assessment

7.2 Sample Disclosure

Intangible Assets Note:

Patents ($) Software ($) Total ($)

Cost

At 1 Jan 20X8 500,000 200,000 700,000

Additions 50,000 30,000 80,000

At 31 Dec 20X8 550,000 230,000 780,000

Accum. Amort.

At 1 Jan 20X8 (150,000) (80,000) (230,000)

Charge (50,000) (30,000) (80,000)

At 31 Dec 20X8 (200,000) (110,000) (310,000)

Carrying Amount

31 Dec 20X8 350,000 120,000 470,000

8. Practical Applications & Case Studies

8.1 Software Development Costs

Capitalization Criteria:

• Technical feasibility established

• Completion intention confirmed

• Future revenue streams identified

Example:

• A company spends $1M developing inventory management software:

o $600k on preliminary research → Expensed

o $400k on coding/testing after technical feasibility proven → Capitalized

8.2 Pharmaceutical R&D

Clinical Trial Phases:

• Phase I-II: Research → Expense

• Phase III: Development (if success probable) → Potential capitalization

9. Memory Aids & Exam Strategies

9.1 Mnemonics

• "I.C.E." for Recognition:

o Identifiable

o Control
 o Economic benefits

• "S.P.E.C.I.A.L" for Development:

o Sale/Use possible

o Probable benefits

o Existing resources

o Commitment to complete

o Intention to use

o Asset feasible

o Liable cost measurement

9.2 Exam Tips

Research = Always expense

Development = Capitalize only if 6 criteria met
Residual value usually $0
Review useful lives annually

Common Pitfalls:

• Capitalizing research costs

• Forgetting to amortize finite-lived assets

• Overlooking disclosure requirements

10. Conclusion

IAS 38 establishes rigorous standards for intangible asset accounting, emphasizing:

 • Prudent capitalization of development costs

• Systematic amortization

• Comprehensive disclosures

Mastery requires understanding:

✔ Recognition thresholds
✔ Capitalization criteria
✔ Amortization mechanics
✔ Disclosure obligations

Final Reminder: When in doubt, refer to the IAS 38 decision tree for proper treatment of intangible assets.
Accruals, Prepayments, Accrued and Deferred Income
1. Core Principles of Accrual Accounting

Definition: Accrual accounting recognizes revenues and expenses when they are earned or incurred, regardless of cash flow timing.
This aligns with:

• Matching Principle: Expenses matched to related revenues

• Accruals Concept: Transactions recorded in the period they relate to

• Prudence Concept: Avoid overstating income/assets

Key Adjustment Types:

1. Prepaid Expenses (Expenses paid in advance)

2. Accrued Expenses (Expenses incurred but unpaid)

3. Accrued Income (Income earned but not received)

4. Deferred Income (Income received before being earned)

2. Prepaid Expenses (Asset)

Definition & Context

• Occurs when payment is made before expense is incurred

• Represents future economic benefit → Classified as current asset

• Common examples: Insurance premiums, rent, subscriptions

Accounting Process

1. Initial Payment:

DR Expense Account $ XXX

CR Cash/Bank $ XXX

2. Year-End Adjustment:

o Calculate unexpired portion: (Total payment × Months remaining/Total months)

DR Prepayment (Asset) $ XXX

CR Expense Account $ XXX

3. Next Period Reversal:

DR Expense Account $ XXX

CR Prepayment (Asset) $ XXX

Example: Insurance Premium

• Scenario: Paid $1,200 on Dec 1 for 12-month policy. Year-end: Dec 31.

• Calculation:

o 1 month expired (Dec): $100 expense

o 11 months prepaid: $1,100 asset

• Journals:

12/1 Payment:
 DR Insurance $ 1,200
CR Cash $ 1,200

12/31 Adjust:

DR Prepayment $ 1.100
CR Insurance $ 1.100

1/1 Reversal:

DR Insurance $ 1,100
CR Prepayment $ 1,100

Financial Statement Impact

Statement Effect Reason

Income Statement ↓ Current expense → ↑ Profit Unused portion removed from expenses

Balance Sheet ↑ Current assets Prepayment recognized as asset

3. Accrued Expenses (Liability)

Definition & Context

• Expense incurred but not paid/invoiced by period-end

• Obligation to pay → Classified as current liability

• Common examples: Wages, utilities, interest

Accounting Process
 1. Year-End Adjustment:

o Estimate incurred-but-unrecorded expense

DR Expense Account $ XXX

CR Accruals (Liability) $ XXX

2. Next Period Reversal:

DR Accruals (Liability) $ XXX

CR Expense Account $ XXX

3. Actual Payment:

DR Expense Account $ XXX

CR Cash/Bank $ XXX

Example: Electricity Bill

• Scenario: December electricity used: $500. Bill received Jan 10.

• Journals:

12/31 Adjust:

DR Electricity $ 500
CR Accruals $ 500

1/1 Reversal:

DR Accruals $ 500
CR Electricity $ 500
1/10 Payment:

DR Electricity $ 500
CR Cash $ 500

Financial Statement Impact

Statement Effect Reason

Income Statement ↑ Current expense → ↓ Profit Expense recognized when incurred

Balance Sheet ↑ Current liabilities Obligation to pay recorded

4. Accrued Income (Asset)

Definition & Context

• Income earned but not received/invoiced by period-end

• Right to receive payment → Classified as current asset

• Common examples: Rent earned, services completed

Accounting Process

1. Year-End Adjustment:

DR Accrued Income (Asset) $ XXX

CR Income Account $ XXX

2. Next Period Reversal:

 DR Income Account $ XXX
CR Accrued Income (Asset) $ XXX

3. Actual Receipt:

DR Cash/Bank $ XXX
CR Income Account $ XXX

Example: Service Revenue

• Scenario: $3,000 service completed Dec 28. Invoice sent Jan 5.

• Journals:

12/31 Adjust:

DR Accrued Income $ 3,000

CR Service Revenue $ 3,000

1/1 Reversal:

DR Service Revenue $ 3,000

CR Accrued Income $ 3,000

1/5 Receipt:

DR Cash $ 3,000
CR Service Revenue $ 3,000
Financial Statement Impact

Statement Effect Reason

Income Statement ↑ Current income → ↑ Profit Revenue recognized when earned

Balance Sheet ↑ Current assets Receivable right recorded

5. Deferred Income (Liability)

Definition & Context

• Payment received before income is earned

• Obligation to provide service → Classified as current liability

• Common examples: Advance rent, subscription fees

Accounting Process

1. Initial Receipt:

DR Cash/Bank $ XXX
CR Income Account $ XXX

2. Year-End Adjustment:

o Calculate unearned portion: (Total receipt × Months remaining/Total months)

DR Income Account $ XXX

CR Deferred Income (Liability) $ XXX

3. Earning Recognition:
 DR Deferred Income (Liability) $ XXX
CR Income Account $ XXX

Example: Advance Rent

• Scenario: Received $6,000 on Dec 15 for Jan-Mar rent. Year-end: Dec 31.

• Journals:

12/15 Receipt:

DR Cash $ 6,000
CR Rent Income $ 6,000

12/31 Adjust:

DR Rent Income $ 6,000

CR Deferred Income $ 6,000

1/31 Earn:

DR Deferred Income $ 2,000

CR Rent Income $ 2,000

Financial Statement Impact

Statement Effect Reason

Income Statement ↓ Current income → ↓ Profit Unearned portion removed from income

Balance Sheet ↑ Current liabilities Obligation to provide service

6. Comprehensive Adjustment Framework

Decision Tree for Adjustments

Transaction

Cash Before or
After

Payment Before Expense Before Receipt Before Income Before

Expense Payment Payment Receipt

Prepaid Accrued Deferred Accrued

Expense Expense Income Income
Financial Impact Summary

Adjustment Income Statement Balance Sheet Net Effect on Equity

Prepaid Expense ↓ Expenses ↑ Assets ↑ (Profit ↑)

Accrued Expense ↑ Expenses ↑ Liabilities ↓ (Profit ↓)

Accrued Income ↑ Income ↑ Assets ↑ (Profit ↑)

Deferred Income ↓ Income ↑ Liabilities ↓ (Profit ↓)

Timeline Visualization

text

Period 1: Dec 2024 Period 2: Jan 2025

┌───────────────────────┐ ┌───────────────────────┐

│ Prepaid: DR Asset │ Reversal → │ Prepaid: CR Asset │

│ Accrued: DR Expense │ Reversal → │ Accrued: CR Liability │

└───────────────────────┘ └───────────────────────┘

7. Professional Applications & Case Studies

Subscription-Based Business

• Scenario: SaaS company receives $12,000 annually on Jan 1

• Monthly Adjustment:
 DR Deferred Income $ 1,000
CR Subscription Revenue $ 1,000

• Impact: Smooths revenue recognition, avoids profit spikes

Construction Project

• Scenario: $100,000 project completed 60% by year-end

• Adjustment:

DR Accrued Income $ 60,000

CR Project Revenue $ 60,000

• Compliance: Matches revenue to percentage-of-completion

8. Advanced Considerations

Partial Period Calculations

• Daily Rate: (Total amount / Total days) × Days applicable

• Example: $3,600 rent paid quarterly on Dec 20 for Jan-Mar

o Days in Dec: 11 (Dec 21-31)

o Daily rate: $3,600 ÷ 90 days = $40/day

o Prepaid: $40 × 79 days (Jan 1-Mar 31) = $3,160

Multi-Period Adjustments

• Prepaid Expenses >1 Year: Classify as non-current asset

 • Deferred Revenue >1 Year: Split current/non-current liability

Audit Evidence Requirements

• Prepayments: Contracts, payment receipts

• Accruals: Supplier estimates, timesheets

• Deferred Income: Customer agreements, delivery schedules

9. Memory Optimization System

Mnemonic Devices

• "C.A.S.H. Flow":

o Credit Income When Accrued

o Stop Expenses When Held (Prepaid)

• "A.D.P.E." Order:

o Assets (Prepayments/Accrued Income)

o Debits increase assets

o Profit impact

o Equity connection
Visual Matrix

Prepaid Expense Accrued Expense Accrued Income Deferred Income

Balance Sheet Asset ↑ Liability ↑ Asset ↑ Liability ↑

Income Statement Expense ↓ Expense ↑ Income ↑ Income ↓

Cash Timing Paid Early Paid Late Received Late Received Early

Common Pitfall Alerts

• Double Counting: Forgetting reversal entries

• Misclassification: Recording deferred income as asset

• Materiality Errors: Not adjusting small amounts

• Tax Implications: Timing differences in tax reporting

SHORT NOTES
Multi-Modal Study Notes

IAS 16 Property, Plant & Equipment

(Integrated Mind Map + Step-by-Step Guides + Flashcard System)

1. Mind Map: Core Structure of IAS 16

 IAS 16 PPE

Initial Recognition Subsequent Measurement Depreciation Disposal Revaluation Disclosures

Cost Components Cost Model Straight Line Remove Cost Class-Wide Revaluation Measurement Based

Purchase Price Revaluation Model Diminishing Balance Remove Acc. Depreciation Revised Depreciation Reconciliations

Directly Attributable Costs Pro Rata Record Proceeds Revaluation Surplus

Dismantling/Restoration
Profit/Loss
Costs
2. Step-by-Step Breakdowns

2.1 Initial Recognition of PPE

Steps to Capitalize Costs:

1. Purchase Price (net of trade discounts)

2. + Directly Attributable Costs:

o Site prep (e.g., concrete flooring)

o Delivery/installation fees

o Professional fees (legal, architects)

o Testing costs

o Exclude admin/general overheads

3. + Dismantling/Restoration Costs (estimated)

Journal Entry:

DR PPE Asset Account Total Capitalized Cost

CR Cash/Payables/Bank Loan

2.2 Depreciation Calculation

Formula Selection Flowchart:

Start → Is benefit pattern uniform? → Yes → Straight-Line → (Cost - RV) / UL

↓ No

↓ Is higher benefit in early years? → Yes → Diminishing Balance → % × Carrying Amount

Pro Rata Adjustment:

 • Full-Year Policy: Charge full depreciation in purchase year; none in disposal year.

• Pro Rata Policy: Charge depreciation for months used.

Example: Asset bought April 1 (9 months use) → depreciation = (Annual Charge × 9/12)

2.3 Disposal of PPE

4-Step Journal Process*:

1. Remove Cost:

DR Disposal Account
CR PPE Cost Account

2. Remove Acc. Depreciation:

DR Acc. Depreciation
CR Disposal Account

Record Proceeds:

DR Cash
CR Disposal Account

3. Book Profit/Loss:

o Profit:

DR Disposal Account
CR Profit on Disposal SPL

o Loss:
 DR Loss on Disposal (SPL)
CR Disposal Account

2.4 Revaluation Model

Upward Revaluation Process:

1. Reset carrying amount to fair value.

2. Eliminate accumulated depreciation.

3. Credit surplus to Revaluation Reserve (OCI).

4. Revise depreciation: (Revalued Amount − New RV) / Remaining UL.

Excess Depreciation Transfer (Optional):

DR Revaluation Reserve
CR Retained Earnings

(Amount = Revised Deprecation − Original Depreciation)

3. Flashcard-Style Condensed Notes

Card 1: Cost Components

Q: What costs capitalize under IAS 16?
A:

• Purchase price (net)

• Directly attributable costs

 • Dismantling/restoration estimates
Exclusions: Admin costs, carriage outwards.

Card 2: Depreciation Methods

Q: When to use straight-line vs. diminishing balance?
A:

• Straight-Line: Uniform benefits (e.g., office furniture).

• Diminishing Balance: Higher early-year benefits (e.g., machinery).

Formula SL: (Cost − RV) ÷ UL
Formula DB: % × Carrying Amount

Card 3: Disposal Entries

Q: Profit on disposal is $5,000. Show journals.
A:

DR Disposal (Cost Removed)

CR PPE Cost

2.

DR Depreciation
CR Disposal

3.

DR Cash (Proceeds)
CR Disposal

4.
 DR Disposal
CR Profit

Card 4: Revaluation Rules

Q: What are IAS 16 revaluation requirements?
A:

• Revalue entire asset class (e.g., all buildings).

• Update regularly to fair value.

• Surplus → Revaluation Reserve (Equity).

• Deficit → Expense if beyond prior surplus.

Card 5: Key Disclosures

Q: What must be disclosed for PPE?
A:

• Measurement bases (cost/revaluation)

• Depreciation methods/rates

• Reconciliation:

Opening CA
+ Additions
- Disposals
± Revaluation
- Depreciation
= Closing CA
4. Memory Triggers & Visual Anchors

Depreciation Methods:

• SL = "Steady Level" (equal annual charge)

• DB = "Declining Balance" (front-loaded charge)

Cost Capitalization: "BRING" Mnemonic

• Bring to location

• Restoration costs

• Installation fees

• Necessary testing

• Get operational

Revaluation Rules: "C.C.F."

• Class-wide

• Consistent

• Fair value reliable

Disposal Entries: "C.A.P.S." Sequence

• Cost out

• Acc. Depreciation out

• Proceeds in

• Surplus/Loss booked
5. Critical IAS 16 Exceptions

Scenario Treatment Reason

Land No depreciation Indefinite useful life

Revaluation deficit Charge to P/L beyond surplus Prudence concept

Major inspections Capitalize as separate asset Distinct component

IAS 38 Intangible Assets
1. Mind Map: Core Structure of IAS 38
IAS 38
Intangibles

Definition &
Amortization
Recognition

Useful Life
Identifiable Non-Physical Methods
Factors

Contractual Technical
Separable Market Demand Straight-Line Unit Production
Rights Absolenced

Can be Residual Value =

Sold/Licenced 0

Control + Future
Benefits

R&D Accounting Disclosures

Research = Development = Amortization

Reconciliation
Always Expense Capitalize IF Policies

R&D Expense
Feasibilty Intention
Disclosure

Future Benefits Resources

Measurable Cost
2. Step-by-Step Breakdowns

2.1 Recognition Criteria for Intangibles

Decision Tree:

Start → Is asset identifiable? → No → Expense

↓ Yes

↓ Does entity control it? → No → Expense

↓ Yes

↓ Future benefits probable? → No → Expense

↓ Yes

↓ Cost measurable? → No → Expense

↓ Yes → CAPITALIZE

2.2 Development Capitalization Checklist

All 6 criteria must be met:

1. Technical feasibility proven

2. Intention to complete

3. Ability to use/sell

4. Future economic benefits probable

5. Resources available to complete

6. Cost measurable reliably

2.3 Amortization Process
Annual Procedure:

1. Review useful life (consider obsolescence/demand)

2. Confirm residual value (usually $0)

3. Calculate amortizable amount: Cost - Residual Value

4. Apply method:

o Default: Straight-line (Amortizable Amount / Useful Life)

o Alternative: Unit production if pattern discernible

5. Journal entry:

DR Amortization Expense (P/L) $ XXX

CR Accumulated Amortization $ XXX

3. Flashcard-Style Condensed Notes

Card 1: Research vs. Development

Q: How to treat research costs? Development costs?
A:

• RESEARCH: Always expense immediately

DR Research Expense $ XXX

CR Cash $ XXX

• DEVELOPMENT: Capitalize only if 6 criteria met

 DR Intangible Asset $ XXX
CR Cash $ XXX

Card 2: Amortization Residual Value

Q: When can residual value > $0?
A: Only if:

• Third-party commitment to purchase, OR

• Active market exists (rare for intangibles)

Card 3: Development Costs Included

Q: What costs capitalize for development?
A:

• Salaries (direct R&D staff)

• Materials/services (used in development)

• Specific overheads (energy, security for lab)

Excluded: General admin, training, initial operating losses

Card 4: Mandatory Disclosures

Q: What must be disclosed for intangibles?
A:

• Amortization methods/rates

• Gross cost + accumulated amortization

• Reconciliation:
 Opening CA $ XXX
+ Additions $ XXX
- Amortization $ (XXX)
- Disposals $ (XXX)
= Closing AC $ XXX

• Total R&D expensed

4. Long-Form Detailed Notes

4.1 Definition & Recognition

Intangible Asset = Identifiable non-monetary asset without physical substance controlled for future benefits.

• Identifiable if:

o Separable (can be sold/licensed independently), OR

o Arises from contractual/legal rights (e.g., patent)

• Excluded: Internally generated goodwill, brands, customer lists

Recognition Criteria:

• Control: Power to obtain future benefits

• Future Benefits: Probable economic inflow

• Reliable Measurement: Cost can be quantified

Examples:

• Patents, copyrights, trademarks

 • Software licenses

• Development projects (if capitalized)

4.2 Amortization

Key Concepts:

• Useful Life: Period of expected benefit consumption

o Factors: Technical obsolescence, market demand, legal limits

• Residual Value: Typically $0 (no active market)

• Methods:

Method When Used Formula

Straight-Line Default (no clear pattern) (Cost - RV) ÷ Useful Life

Unit Production Benefit linked to output (Cost - RV) × (Units/Total Capacity)

Journal Entries:

• Annual amortization:

DR Amortization Expense (P/L) $ XXX

CR Accumulated Amortization (SFP) $ XXX

• Impairment tested separately under IAS 36

4.3 Research & Development Accounting

Research Phase:

• Always expensed (uncertain future benefits)

• Examples:

o Seeking new knowledge

o Evaluating alternatives

• Journal:

DR Research Expense (P/L) $ XXX

CR Cash $ XXX

Development Phase:

• Capitalize only if 6 criteria met:

1. Technical feasibility of completion

2. Intention to complete/use

3. Ability to use/sell

4. Future economic benefits probable

5. Resources available to complete

6. Cost measurable reliably

• Journal (if criteria met):

 DR Intangible Asset (SFP) $ XXX
CR Cash $ XXX

• Journal (if not met):

DR Development Expense (P/L) $ XXX

CR Cash $ XXX

Costs Included:

• Direct R&D salaries

• Materials/services consumed

• Specific overheads (e.g., lab utilities)

Excluded: General admin, selling costs, training

4.4 Disclosure Requirements

Per IAS 38.118-128:

1. For each intangible class:

o Useful lives/amortization rates

o Amortization methods

o Gross carrying amount + accum. amortization

2. Reconciliation:
 Opening Carrying Amount $ XXX
+ Additions (Internally developed/purchased) $ XXX
- Disposals $ (XXX)
- Amortization $ (XXX)
± Revaluations (if applicable) $ XXX
= Closing Carrying Amount $ XXX

3. R&D Disclosure:

o Total R&D expense recognized in P/L

4. Impairment Details:

o Losses recognized/reversed

Example Disclosure Table:

Intangible Assets Software ($) Patents ($) Total ($)

Cost at Jan 1 50,000 30,000 80,000

Additions 15,000 – 15,000

Cost at Dec 31 65,000 30,000 95,000

Accum. Amort. at Jan 1 (20,000) (10,000) (30,000)

Amort. Charge (8,000) (5,000) (13,000)

Accum. Amort. at Dec 31 (28,000) (15,000) (43,000)

Carrying Amount at Dec 31 37,000 15,000 52,000

5. Memory Aids & Exam Tactics

Mnemonics:

• "S.P.E.C.I.A.L" for Development Criteria:

Sale/Use ability
Probable benefits
Existence of resources
Commitment (intention)
Intention to complete
Asset feasibility
Liable measurement (cost)

• "R.A.D" for R&D Treatment:

Research = Always Deduct (expense)
Development = Depends on criteria

Critical Exceptions:

• Land: Never amortized

• Goodwill: Tested annually for impairment (IAS 36)

• Websites: Treated as intangible assets

Common Pitfalls:

• Capitalizing research costs (always expense!)

• Forgetting to amortize development assets

• Residual value > $0 without justification

 Accruals, Prepayments, Accrued and Deferred Income
1. Mind Map: Core Structure of Accrual Accounting

Accrual
Accounting

Expense Income
Adjustments Adjustments

Accrued Prepaid
Accrued Income Deffered Income
Expenses Expenses

Expense Incured. DR. Expense Expense Paid. DR Asset Income Earned. DR Asset Income Received. DR Income
Not Paid CR. Liabilty Not Incurred CR Expense Not Received CR Income Not Earned CR Liability
2. Step-by-Step Breakdowns

2.1 Accrued Expenses (Liability)

When: Expense incurred but not yet paid/invoiced by year-end.
Process:

1. Year-End Adjustment:

DR Expense (P/L) $ XXX

CR Accruals (SOFP Liability) $ XXX

2. Next Period Reversal:

DR Accruals (SFP Liability) $ XXX

CR Expense (P/L) $ XXX

3. Actual Payment:

DR Expense (P/L) $ XXX

CR Cash (SFP Asset) $ XXX

Example:

• Dec 31 Year-End: $5,000 electricity used but not billed

• Jan 15 Next Year: Bill received and paid

• Journals:

o Dec 31: DR Electricity $5,000 | CR Accruals $5,000

o Jan 1: DR Accruals $5,000 | CR Electricity $5,000 (Reversal)

o Jan 15: DR Electricity $5,000 | CR Cash $5,000

2.2 Prepaid Expenses (Asset)
When: Expense paid in advance for future periods.
Process:

1. Initial Payment:

DR Expense (P/L) $ XXX

CR Cash (SFP Asset) $ XXX

2. Year-End Adjustment:

DR Prepayment (SOFP Asset) $ XXX

CR Expense (P/L) $ XXX

3. Next Period Reversal:

DR Expense (P/L) $ XXX

CR Prepayment (SFP Asset) $ XXX

Example:

• Dec 1: Pay $12,000 for 12-month insurance (Jan-Dec 20X5)

• Dec 31, 20X4 Year-End: 1 month used ($1,000), 11 months prepaid ($11,000)

• Journals:

o Dec 1: DR Insurance $12,000 | CR Cash $12,000

o Dec 31: DR Prepayment $11,000 | CR Insurance $11,000

o Jan 1, 20X5: DR Insurance $11,000 | CR Prepayment $11,000

2.3 Accrued Income (Asset)
When: Income earned but not yet received/invoiced.
Process:

1. Year-End Adjustment:

DR Accrued Income (SOFP Asset) $ XXX

CR Income (P/L) $ XXX

2. Next Period Reversal:

DR Income (P/L) $ XXX

CR Accrued Income (SFP Asset) $ XXX

3. Actual Receipt:

DR Cash (SFP Asset) $ XXX

CR Income (P/L) $ XXX

Example:

• Dec 31: $3,000 rent earned but not yet billed

• Jan 10: Invoice sent and payment received

• Journals:

o Dec 31: DR Accrued Income $3,000 | CR Rent Income $3,000

o Jan 1: DR Rent Income $3,000 | CR Accrued Income $3,000

o Jan 10: DR Cash $3,000 | CR Rent Income $3,000

2.4 Deferred Income (Liability)
When: Income received in advance (not yet earned).
Process:

1. Initial Receipt:

DR Cash (SFP Asset) $ XXX

CR Income (P/L) $ XXX

2. Year-End Adjustment:

DR Income (P/L) $ XXX

CR Deferred Income (SFP Liability) $ XXX

3. Next Period Reversal:

DR Deferred Income (SFP Liability) $ XXX

CR Income (P/L) $ XXX

Example:

• Dec 15: Receive $6,000 for 3-month rental (Jan-Mar 20X5)

• Dec 31, 20X4 Year-End: $6,000 deferred (0% earned)

• Journals:

o Dec 15: DR Cash $6,000 | CR Rent Income $6,000

o Dec 31: DR Rent Income $6,000 | CR Deferred Income $6,000

o Jan 1, 20X5: DR Deferred Income $2,000 | CR Rent Income $2,000 (Monthly recognition)
3. Flashcard-Style Condensed Notes

Card 1: Accrued Expenses

Q: What’s the journal for $2,000 unpaid wages at year-end?
A:

DR Wages Expense $2,000

CR Accruals $2,000
Impact: ↓ Profit, ↑ Liabilities

Card 2: Prepaid Expenses

Q: Paid $1,200 for 12-month insurance. At 3 months, what’s the prepaid amount?
A:

• Used: $300 (3/12 × $1,200)

• Prepaid: $900 (Asset)

Journal:

DR Prepayment $ 900
CR Insurance $ 900

Card 3: Accrued vs. Deferred Income

Q: Compare accrued and deferred income.
A:

• Accrued: Earned, not received (Asset)

DR Accrued Income $ XXX

CR Income $ XXX
 • Deferred: Received, not earned (Liability)

DR Income $ XXX
CR Deferred Income $ XXX

Card 4: Key Definitions

Q: Define "matching concept."
A: Expenses must be recorded in the same period as the revenue they help generate.

4. Memory Aids & Exam Tactics

Mnemonics:

• "A.P.A.D." for Adjustments:

Accruals (Expense)
Prepayments
Accrued Income
Deferred Income

• "E.A.R.N." for Accruals:

Expense
Accrued
Recognized now
Not paid

Exam Warnings:
Accruals increase expenses (↓ profit)
Prepayments decrease expenses (↑ profit)
Reversals always occur in the next period
Deferred income = Unearned revenue
Common Pitfalls:

• Forgetting to reverse prior-year adjustments

• Misclassifying deferred income as an asset

• Overlooking partial-period calculations (e.g., 5 months of prepaid rent)

5. Comprehensive Summary Tables

Adjustment Types:

Type When? SFP Category Impact on Profit

Accrued Expense Incurred, not paid Liability Decreases

Prepaid Expense Paid, not incurred Asset Increases

Accrued Income Earned, not received Asset Increases

Deferred Income Received, not earned Liability Decreases

Journal Entry Cheat Sheet:

Adjustment Initial Entry Reversal Entry

Accrued Expense DR Expense DR Accrual

CR Accrual CR Expense

Prepaid Expense DR Prepayment DR Expense

CR Expense CR Prepayment
Accrued Income DR Accrued Income DR Income
CR Income CR Accrued Income

Deferred Income DR Income DR Def Income

CR Def Income CR Income