115 AS Accounting Theory & Practice Text Book

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AS ACCOUNTING
THEORY & PRACTICE (5th Edition)
As per new (2019-21) syllabus
Article: 115
Muhammad Nauman Malik

MS Accounting (Gold Medalist), FCMA, MBA (Finance), B.Com (Gold Medalist), PIPFA, DCMA
KIMS, Roots FWS, LACAS, GACS
Reviewed By
Sajid Munir
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All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted, in
any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written
permission of the Author.
Cambridge International has not provided these questions or answers and can take no responsibility whatsoever for
their accuracy or suitability for the examinations.
Title AS Accounting - Theory and Practice (5th edition)
Author Muhammad Nauman Malik

Cell: 0300-8414262, 0321-8414262
E-mail: nauman.kims@gmail.com
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Printed by Sadaat Printers Urdu Bazar Lahore
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Edition 2019-21
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PREFACE
Current financial reporting practices have been under major review with the approach of a single market,
moving towards harmonization. Consequently, all global syllabuses, from December 2007 onwards, use
international terminology. The globalized frame work of Cambridge International Advanced Level, in
practice over 125 countries, has led to the introduction of an international format and layout for all its
syllabuses.
This book is intended to cover the accounting content of CIE Advanced Level syllabus comprehensively.
With a thorough discussion of the basic double entry principles for the beginners, it is also useful for those
who have some knowledge.
The strengths and weaknesses of accounting practices are reinforced by a set of Review Questions at the
end of each chapter, enabling the students to put, what is learnt, into practice. These Questions have been
developed by the author and are not taken from past exam papers. The Review Questions have been set
in increasing order of difficulty and each odd number Question is complimented by an even numbered
question with the same difficulty level.
Solutions to odd numbered questions are given in the appendix at the end of the book. In addition
solutions to even numbered questions are available in a separate manual. Teachers using “AS Accounting
- Theory and Practice” as a text book, may get the manual by applying officially on a school letterhead.
Providing the students with a solid foundation in the “Why” as well as the “How” of accounting concepts,
the emphasis is put on understanding rather than mere cramming. A brief list of learning objectives at the
beginning of each chapter will assist the readers to determine the things they should understand while
going through the chapter. Hence, checking back may help them to identify weak areas which still need
thorough review.
I would like to thank numerous people for the contribution they made to the writing of this book. In
particular, I gratefully acknowledge the input that Mr. Sajid Munir made in developing the Review
Questions, text for various chapters and for his constructive criticism throughout the process of developing
the book. In addition, my thanks owe to the Sheraz Siddiq, Waseem Zia, Zafar Hashmi, Rabia Malik for
their continuous support, insightful comments and suggestions during several stages of the book
development.
Constructive criticism and suggestions to make the subsequent editions more useful would be appreciated
and thankfully acknowledged.
Muhammad Nauman Malik

Mobile No: 0300-8414262
0321-8414262
Email: nauman.kims@gmail.com
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Table of Contents
PREFACE 2
CHAPTER 1 BOOKKEEPING AND ACCOUNTING 16
1.1 BRANCHES OF ACCOUNTING ............................................................................................................... 16

1.2 ACCOUNTING EQUATION ................................................................................................................... 16
1.2.1 Assets 17
1.2.2 Liabilities 17
1.2.3 Equity 17
1.2.4 Drawings 17
1.3 TRANSACTION ................................................................................................................................. 17
1.3.1 Cash Transactions 17
1.3.2 Credit Transactions 17
1.4 BALANCE SHEET (STATEMENT OF FINANCIAL POSITION) ........................................................................... 19
1.4 .1 Balance Sheet (Vertical Style) 19
REVIEW QUESTIONS ................................................................................................................................. 21
CHAPTER 2 ACCOUNTING FOR ASSETS, LIABILITIES AND CAPITAL 25
2.1 EVOLUTION OF BOOK KEEPING ........................................................................................................... 25

2.2 RULES OF DEBIT AND CREDIT .............................................................................................................. 25
2.3 LEDGER .......................................................................................................................................... 26
2.4 ACCOUNT ....................................................................................................................................... 26
2.4.1 “T” Account 26
2.5 DOUBLE-ENTRY RELATING TO ASSETS AND LIABILITIES .............................................................................. 27
2.5.1 EXAMPLE 27
2.6 BALANCING OF AN ACCOUNT .............................................................................................................. 28
2.6.1 When should accounts be balanced? 30
2.7 TRIAL BALANCE................................................................................................................................ 31
2.7.1 Uses of a Trial Balance 31
2.7.2 Why is it Necessary for a Trial Balance to ‘Balance’? 31
2.7.3 Trial Balance - An aid to Financial Statements 32
CHAPTER 3 ACCOUNTING FOR INVENTORIES 35
3.1 INVENTORY OF GOODS ...................................................................................................................... 35

3.2 BOOKKEEPING FOR INVENTORY OF GOODS ............................................................................................ 35
3.3 PURCHASES ..................................................................................................................................... 35
3.3.1 Cash Purchases 35
3.3.2 Credit Purchases 36
3.4 SALES............................................................................................................................................. 36
3.4.1 Cash Sales 36
3.4.2 Credit Sales 36
3.5 PURCHASES RETURNS (RETURN OUTWARDS) ......................................................................................... 37
3.6 SALES RETURNS (RETURNS INWARDS) .................................................................................................. 37
3.7 TRADING SECTION OF INCOME STATEMENT ........................................................................................... 38
3.8 CLOSING OF INCOMES AND EXPENSES................................................................................................... 38
3.9 CLOSING INVENTORY ......................................................................................................................... 39
3.10 OPENING INVENTORY ........................................................................................................................ 40
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3.11 CALCULATION OF PROFITS FOR SERVICE BUSINESSES ................................................................................ 40

CHAPTER 4 ACCOUNTING FOR INCOMES AND EXPENSES 44
4.1 INCOMES ........................................................................................................................................ 44

4.2 EXPENSES ....................................................................................................................................... 44
4.3 DOUBLE-ENTRY FOR EXPENSES AND INCOMES (REVENUES) ....................................................................... 44
4.4 BOOKKEEPING FOR INCOMES AND EXPENSES ......................................................................................... 45
4.5 CALCULATION OF PROFIT FOR THE YEAR ................................................................................................ 46
4.6 CLOSING OF INCOMES AND EXPENSES................................................................................................... 46
CHAPTER 5 FINANCIAL STATEMENTS-AN INTRODUCTION 50
5.1 NEED FOR INCOME STATEMENT ........................................................................................................... 50

5.2 USES OF INCOME STATEMENT ............................................................................................................. 50
5.3 CARRIAGE INWARDS ......................................................................................................................... 50
5.4 CARRIAGE OUTWARDS ...................................................................................................................... 50
5.5 INCOME STATEMENT AND BALANCE SHEET-AN IMPORTANT CONSIDERATION ................................................. 51
5.6 ACCOUNTING PERIOD ....................................................................................................................... 51
5.7 DRAWINGS ..................................................................................................................................... 51
5.8 ASSETS ........................................................................................................................................... 51
5.8.1 Non-Current Assets 52
5.8.2 Current Assets 52
5.9 LIABILITIES ...................................................................................................................................... 52
5.9.1 Current Liabilities 52
5.9.2 Non-Current Liabilities 52
CHAPTER 6 BOOKS OF ORIGINAL ENTRY & DIVISION OF LEDGER 61
6.1 ADVANTAGES OF MAINTAINING BOOKS OF ORIGINAL ENTRY .................................................................... 62

6.2 COMPONENTS OF BOOKS OF ORIGINAL ENTRY ....................................................................................... 62
6.3 SALES JOURNAL ............................................................................................................................... 62
6.3.1 Posting from the Sales Journal to the Ledger 63
6.3.2 Trade Discount 63
6.3.3 Sales on Credit Card 64
6.4 PURCHASES JOURNAL ........................................................................................................................ 64
6.4.1 Posting from the Purchases Journal to the Ledger 64
6.5 RETURN INWARDS JOURNAL ............................................................................................................... 65
6.5.1 Posting from the Returns Inwards Journal to the Ledger 65
6.6 RETURN OUTWARDS JOURNAL ............................................................................................................ 66
6.6.1 Posting from the Returns Outwards Journal to the Ledger 66
6.7 GENERAL JOURNAL ........................................................................................................................... 67
6.7.1 Posting from the General Journal to the Ledger 68
6.8 CASH BOOK .................................................................................................................................... 68
6.8.1 Two Column Cash Book 68
6.8.2 Cash Discounts 69
6.8.3 Three Column Cash Book 69
6.8.4 Nature of Discounts Columns 69
6.8.5 Folio Columns 70
6.8.6 Contra Entries 70
6.8.7 Balancing of Cash and Bank Columns 70
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6.8.8 Cash Book in Recent Times 70

6.9 PERSONAL LEDGERS .......................................................................................................................... 71
6.10 CASH BOOK .................................................................................................................................... 71
6.11 GENERAL LEDGER ............................................................................................................................. 72
6.12 PRIVATE LEDGER .............................................................................................................................. 72
CHAPTER 7 BANK RECONCILIATION STATEMENTS 76
7.1 REASONS FOR DIFFERENCE BETWEEN BANK STATEMENT AND CASH BOOK BALANCE....................................... 76
7.1.1 Items in the Bank Statement but not in the Cash Book 76
7.1.2 Items in the Cash Book but not in the Bank Statement 76
7.2 BANK RECONCILIATION STATEMENT ..................................................................................................... 77
7.3 STEPS FOR PREPARING A BANK RECONCILIATION STATEMENT ..................................................................... 77
7.4 USES OF BANK RECONCILIATION STATEMENT.......................................................................................... 80
CHAPTER 8 BAD DEBTS AND PROVISION FOR DOUBTFUL DEBTS 86
8.1 BAD DEBTS ..................................................................................................................................... 86

8.2 DOUBTFUL DEBTS............................................................................................................................. 86
8.3 PROVISION FOR DOUBTFUL DEBTS ....................................................................................................... 86
8.3.1 General Provision for Doubtful Debts 86
8.3.2 Specific Provision for Doubtful Debts 87
8.3.3 Calculation of Provision for Doubtful Debts 87
8.3.4 Treatment of Provision in Financial Statements 87
8.4 AGEING SCHEDULE ........................................................................................................................... 88
8.5 BAD DEBTS RECOVERY ....................................................................................................................... 89
8.6 CASH DISCOUNTS ALLOWED AND PROVISION FOR DISCOUNTS ALLOWED .................................................... 89
8.6.1 Benefits of Offering Cash Discounts 89
8.6.2 Recording of Provision for Discounts Allowed in Journal 90
8.7 WHY PROVISIONS ARE MADE FOR BAD DEBTS AND DISCOUNTS ALLOWED ................................................... 90
8.8 SALIENT POINTS TO NOTE .................................................................................................................. 90
CHAPTER 9 ACCOUNTING FOR NON-CURRENT ASSET 94
9.1 DEPRECIATION ................................................................................................................................. 94

9.2 AMORTISATION AND DEPLETION.......................................................................................................... 94
9.3 EFFECTS ON CASH FLOWS .................................................................................................................. 94
9.4 RELATIONSHIP WITH MARKET VALUE.................................................................................................... 94
9.5 CAUSES FOR DEPRECIATION ................................................................................................................ 94
9.6 FACTORS FOR CALCULATING DEPRECIATION ........................................................................................... 95
9.6.1 The Original Cost of Asset 95
9.6.2 The Estimated Useful Economic Life 95
9.6.3 The Approximate Residual Value 95
9.7 CHARACTERISTICS OF DEPRECIATION .................................................................................................... 95
9.8 WHY DEPRECIATION IS PROVIDED FOR? ................................................................................................. 95
9.9 METHODS FOR CALCULATING DEPRECIATION ......................................................................................... 95
9.9.1 Revaluation Method 96
9.9.2 Straight Line Method or Original Cost Method 96
9.9.3 Reducing Balance Method 97
9.10 ANNUAL DEPRECIATION UNDER REDUCING BALANCE & STRAIGHT LINE METHODS ........................................ 98
9.11 DISTINCTIVE FEATURES OF STRAIGHT LINE AND REDUCING BALANCE METHOD ............................................. 98
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9.12 CHOICE OF A METHOD ...................................................................................................................... 99

9.13 DIFFERENCE BETWEEN DEPRECIATION AND PROVISION FOR DEPRECIATION .................................................. 99
9.14 DEPRECIATION POLICIES..................................................................................................................... 99
9.15 DEPRECIATION ACCOUNTING .............................................................................................................. 99
9.16 DEPRECIATION AND ACCOUNTING CONCEPTS....................................................................................... 101
REVIEW QUESTIONS ............................................................................................................................... 103
CHAPTER 10 ACCOUNTING CONCEPTS AND CONVENTIONS 106
10.1 CONVENTIONS AND CONCEPTS – AN IMPLICATION ................................................................................ 106

10.2 DUAL ASPECT (DUALITY) CONCEPT ................................................................................................... 106
10.3 BUSINESS ENTITY CONCEPT .............................................................................................................. 106
10.4 PRUDENCE CONCEPT ...................................................................................................................... 107
10.5 CONSISTENCY CONCEPT ................................................................................................................... 107
10.6 MATERIALITY CONCEPT ................................................................................................................... 108
10.7 REALISATION CONCEPT ................................................................................................................... 108
10.8 ACCRUAL CONCEPT......................................................................................................................... 108
10.9 MATCHING CONCEPT ...................................................................................................................... 108
10.10 SUBSTANCE OVER FORM .................................................................................................................. 109
10.11 OBJECTIVITY .................................................................................................................................. 109
10.12 MONEY MEASUREMENT CONCEPT .................................................................................................... 109
10.13 HISTORICAL COST CONCEPT ............................................................................................................. 109
10.14 GOING CONCERN CONCEPT.............................................................................................................. 110
10.15 REVALUATION OF ASSETS ................................................................................................................. 110
10.16 A CRITICAL REVIEW OF ACCOUNTING CONVENTIONS ............................................................................. 110
CHAPTER 11 CAPITAL AND REVENUE 113
11.1 TREATMENT OF CAPITAL AND REVENUE ITEMS IN FINANCIAL STATEMENT ................................................... 113
11.2 DISTINCTION BETWEEN CAPITAL AND REVENUE EXPENDITURES................................................................ 113
11.2.1 Expenditures for Acquisition of a Non-current asset 113
11.2.2 Expenditures for Improving Efficiency /Capacity of a Non-current asset 113
11.2.3 Expenditure at the Initiation of Business 114
11.2.4 Expenditure on Extension of Business 114
11.2.5 Expenditures to Increase the Useful Life of an Asset 114
11.2.6 Expenditures of Abnormal Amounts 114
11.3 APPLICATION OF MATERIALITY CONCEPT ............................................................................................. 114
11.4 DIFFERENCE BETWEEN CAPITAL AND REVENUE RECEIPTS ........................................................................ 114
11.4.1 Revenue Receipts 114
11.4.2 Capital Receipts 114
11.5 EFFECTS OF WRONG TREATMENT OF CAPITAL AND REVENUE ITEMS ......................................................... 115
CHAPTER 12 CORRECTION OF ERRORS AND SUSPENSE ACCOUNT 118
12.1 TYPES OF ERRORS ........................................................................................................................... 118

12.1.1 Errors Not Affecting Agreement of Trial Balance 118
12.1.2 Errors Affecting Agreement of Trial Balance 120
12.2 SUSPENSE ACCOUNT ....................................................................................................................... 120
12.3 EFFECT ON PROFIT OF CORRECTING ERRORS ........................................................................................ 122
12.4 EFFECTS ON BALANCE SHEET OF CORRECTING ERRORS........................................................................... 122
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CHAPTER 13 CONTROL ACCOUNTS 128
13.1 CONTROL ACCOUNTS IN CAMBRIDGE A LEVEL SYLLABUS ......................................................................... 128

13.2 THE FORMAT OF SALES LEDGER AND PURCHASE LEDGER CONTROL ACCOUNTS........................................... 128
13.3 HOW CONTROL ACCOUNTS ARE PREPARED? ....................................................................................... 129
13.4 CONTRA ENTRY.............................................................................................................................. 130
13.5 TWO BALANCES OF CONTROL ACCOUNTS............................................................................................ 131
13.5.1 Reasons for Having Two Balances of a Control Account 131
13.5.2 Treatment of Two Balances in the Balance Sheet 131
13.6 CORRECTION OF ERRORS IN CONTROL ACCOUNTS ................................................................................. 133
13.7 ADVANTAGES AND USES OF CONTROL ACCOUNTS ................................................................................. 136
13.8 LIMITATIONS (DISADVANTAGES) OF PREPARING CONTROL ACCOUNTS ....................................................... 136
CHAPTER 14 FINANCIAL STATEMENTS WITH ADJUSTMENTS 142
14.1 CASH AND ACCRUAL BASIS OF ACCOUNTING........................................................................................ 142

14.2 NEED FOR ADJUSTMENTS................................................................................................................. 142
14.3 TYPES OF ADJUSTMENTS .................................................................................................................. 142
14.4 INVENTORY AT YEAR END ................................................................................................................. 143
14.4.1 Closing Inventory in Trial Balance 143
14.5 DRAWINGS OF GOODS FOR OWNER’S PERSONAL USE ........................................................................... 143
14.6 ACCRUED EXPENSES........................................................................................................................ 143
14.7 ACCRUED INCOMES ........................................................................................................................ 144
14.8 PREPAID EXPENSES (OTHER RECEIVABLES) ........................................................................................... 144
14.9 PRE-RECEIVED /DEFERRED INCOMES .................................................................................................. 145
14.10 TREATMENT OF OPENING ACCRUALS OR PREPAYMENTS ......................................................................... 145
14.11 DEPRECIATION ............................................................................................................................... 146
14.11.1 Methods of Depreciation 146
14.11.2 Depreciation Policies 146
14.11.3 Recording of Depreciation 146
14.12 BAD DEBTS ................................................................................................................................... 147
14.12.1 Bad Debts written off (included in the trial balance) 147
14.12.2 Bad Debts to be written off (given as an adjustment) 147
14.13 PROVISION FOR DOUBTFUL DEBTS ..................................................................................................... 147
14.14 ADJUSTING MORE THAN TWO ACCOUNTS........................................................................................... 148
14.15 CALCULATION OF PROFITS FOR SERVICE BUSINESSES .............................................................................. 150
14.16 USERS OF FINANCIAL STATEMENTS ..................................................................................................... 150
14.17 LIMITATIONS OF FINANCIAL STATEMENTS............................................................................................. 150
CHAPTER 15 ACCOUNTS FROM INCOMPLETE RECORDS 160
15.1 THE REASONS FOR INCOMPLETE RECORDS........................................................................................... 160

15.2 NEED FOR PREPARING FINANCIAL STATEMENT FROM INCOMPLETE RECORDS .............................................. 160
15.3 CALCULATING PROFITS AND LOSSES FROM CHANGES IN CAPITAL/NET ASSETS ............................................ 160
15.3.1 Statement of Affairs 161
15.3.2 Statement of Profit or Loss 161
15.4 PREPARATION OF FINANCIAL STATEMENTS FROM INCOMPLETE RECORDS ................................................... 162
15.4.1 Calculation of Opening capital through Statement of Affairs 162
15.4.2 Preparation of Cash/Bank Account 162
15.4.3 Calculation of Total Sales 162
15.4.4 Calculation of Total Purchases 163
15.4.5 Calculation of Incomes/Expenses to be shown in Income Statement 164
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15.4.6 Calculation of Non-Cash Expenses 166

15.5 MARK-UP AND MARGIN ................................................................................................................. 166
15.5.1 Use of Mark up and Margin to calculate Missing Items in Trading Section 167
15.5.2 Conversion of Mark-up into Margin 169
15.5.3 Conversion of Margin into Mark-up 170
15.6 CALCULATION OF GOODS LOST BY THEFT OR FIRE ................................................................................. 170
15.7 PREPARING BALANCE SHEET FROM INCOMPLETE RECORDS ..................................................................... 172
15.8 INVENTORY COUNT AND THE BALANCE SHEET DATE .............................................................................. 172
15.9 DISADVANTAGES OR DEFECTS OF ACCOUNTS PREPARED FROM INCOMPLETE RECORDS ................................. 173
CHAPTER 16 FINANCIAL STATEMENTS OF PARTNERSHIPS 182
16.1 CHARACTERISTICS OF PARTNERSHIP ................................................................................................... 182

16.2 ADVANTAGES AND DISADVANTAGES OF THE PARTNERSHIP ...................................................................... 183
16.3 PARTNERSHIP AGREEMENT .............................................................................................................. 183
16.3.1 Contents of Partnership Deed 183
16.4 PROVISIONS OF PARTNERSHIP ACT 1890 WHEN NO PARTNERSHIP AGREEMENT EXISTS .............................. 184
16.5 FINANCIAL STATEMENTS OF A PARTNERSHIP ........................................................................................ 184
16.5.1 Appropriations of profit 184
16.5.2 Balance Sheet of Partnerships 186
16.6 ACCOUNTING RECORDS FOR PARTNERS .............................................................................................. 186
16.6.1 Partners' Capital Accounts 186
16.6.2 Drawings Accounts 187
16.6.3 Partners’ Loan Account 188
16.7 CALCULATION OF INTEREST ON CAPITAL .............................................................................................. 189
16.8 CALCULATION OF INTEREST ON DRAWINGS .......................................................................................... 189
16.9 PARTNER’S GUARANTEED SHARE IN PROFIT ......................................................................................... 189
CHAPTER 17 CHANGES IN PARTNERSHIPS 199
17.1 ADMISSION OF A NEW PARTNER ...................................................................................................... 199

17.2 RETIREMENT OR DEATH OF AN EXISTING PARTNER .............................................................................. 199
17.2.1 Final Settlement of Retired or Deceased Partner’s Capital 200
17.3 CHANGES IN PROFIT-SHARING ARRANGEMENTS.................................................................................. 200
17.4 APPORTIONMENT OF PROFITS .......................................................................................................... 200
17.5 ADJUSTMENTS FOR GOODWILL ........................................................................................................ 202
17.5.1 Types of Goodwill 202
17.5.2 Factors Affecting Value of Goodwill 202
17.5.3 Valuation of Inherent Goodwill 203
17.5.4 Why Goodwill is accounted for in Partnership? 204
17.5.5 Accounting Treatment of Goodwill 204
17.5.6 Change in Goodwill 206
17.6 REVALUATION ON PARTNERSHIP CHANGE........................................................................................... 206
17.6.1 Opening of a Revaluation Account 207
17.6.2 Profit or Loss on Revaluation 207
17.6.3 Revaluation of Non-Current Assets with Provision for Depreciation 209
17.6.4 Revaluation and the Accounting Conventions 211
17.6.5 Values to Remain Unaltered in Books 211
17.7 CAPITAL IN PROFIT AND LOSS SHARING RATIOS ................................................................................... 215
REVIEW QUESTIONS............................................................................................................................... 216
CHAPTER 18 DISSOLUTION OF PARTNERSHIPS 224

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18.1 REASONS OF DISSOLVING A BUSINESS ............................................................................................... 224

18.2 REALISATION ACCOUNT .................................................................................................................. 224
18.3 ACCOUNTING TREATMENT ON DISSOLUTION....................................................................................... 224
18.3.1 Assets on Dissolution 225
18.3.2 Goodwill on Dissolution 225
18.3.3 Liabilities on Dissolution 225
18.3.4 Expenses on Dissolution 226
18.3.5 Profit (loss) on Realisation Account 226
18.3.6 Partners’ Loans Accounts on Dissolution 226
18.3.7 Current Account Balances on Dissolution 226
18.3.8 Cash or Bank Balance on Dissolution 226
18.3.9 Partners’ Capital Accounts on Dissolution 227
CHAPTER 19 FINANCIAL STATEMENTS OF COMPANIES 232
19.1 THE NEED FOR COMPANIES .............................................................................................................. 232

19.2 CHOICE BETWEEN A PARTNERSHIP AND A LIMITED COMPANY .................................................................. 232
19.3 ADVANTAGES AND DISADVANTAGES OF FORMING A LIMITED COMPANY .................................................... 233
19.3.1 Advantages of a Limited Company 233
19.3.2 Disadvantages of Forming a Limited Company 234
19.4 SOURCES OF FINANCE FOR A COMPANY .............................................................................................. 235
19.5 TYPES OF SHARES ........................................................................................................................... 235
19.5.1 Ordinary Shares 235
19.5.2 Preference Shares 235
19.6 DEBENTURES ................................................................................................................................. 236
19.7 TYPES OF PREFERENCE SHARES ......................................................................................................... 236
19.7.1 Participating Preference Shares 236
19.7.2 Non-Participating Preference Shares 236
19.7.3 Cumulative Preference Shares 236
19.7.4 Non-Cumulative Preference Shares 237
19.8 FORMS OF CAPITAL ......................................................................................................................... 237
19.8.1 Authorised Share Capital 237
19.8.2 Issued Share Capital 237
19.8.3 Called Up Share Capital 238
19.8.4 Paid Up Capital 238
19.9 FINANCIAL STATEMENTS OF LIMITED COMPANIES.................................................................................. 238
19.10 STATEMENT OF CHANGES IN EQUITY .................................................................................................. 239
19.11 EQUITY DIVIDENDS ON ORDINARY SHARES .......................................................................................... 239
19.11.1 IAS rules for Equity Dividends 239
19.11.2 Transfer to General Reserve 239
19.12 SHAREHOLDERS' EQUITY .................................................................................................................. 239
19.13 RESERVES ..................................................................................................................................... 239
19.13.1 Capital Reserves 239
19.13.2 Revenue Reserves 240
19.14 FINANCIAL STATEMENTS IN CIE EXAMS ............................................................................................... 241
19.15 A COMPARISON OF FINANCIAL STATEMENTS OF BUSINESS ORGANISATIONS ................................................ 242
CHAPTER 20 ISSUE OF SHARES & DEBENTURES 248
20.1 PRICES OF A SHARE ........................................................................................................................ 248

20.1.1 Par Value 248
20.1.2 Issue Price 248
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20.1.3 Book Value 248

20.1.4 Market Value 248
20.2 SELLING SHARES TO THE GENERAL PUBLIC .......................................................................................... 248
20.2.1 Issue of Shares at Par 249
20.2.2 Issue of Shares at Premium (at a price more than face value) 249
20.3 RIGHTS ISSUE ................................................................................................................................ 249
20.3.1 Advantages of Rights Issue 250
20.3.2 Disadvantages of Rights Issue 250
20.4 BONUS OR SCRIP ISSUE ................................................................................................................... 250
20.4.1 Reasons for Bonus Issue 250
20.4.2 Effect on Earnings per Share (EPS) 251
20.4.3 Advantages of Bonus Issue 251
20.4.4 Disadvantages of Bonus Issue 252
20.5 DIFFERENCE BETWEEN RIGHTS AND BONUS ISSUE ................................................................................ 252
20.6 ISSUE OF LOANS AND DEBENTURES ................................................................................................... 253
20.6.1 Issue of Debentures at Par 253
20.6.2 Issue of Debentures at Premium (at a Price more than Face Value) 254
20.6.3 Issue of Debentures at Discount (at a Price below Face Value) 254
CHAPTER 21 RATIO ANALYSIS 259
21.1 FINANCIAL RATIOS .......................................................................................................................... 259

21.2 ANALYSIS OF RATIOS ....................................................................................................................... 259
21.2.1 Comparing one Year with Another (Trend or Time Series Analysis) 259
21.2.2 Comparing one Business with another Business (Cross-Sectional Analysis) 260
21.2.3 Rule of Thumb 260
21.3 DEMONSTRATION OF RATIOS ............................................................................................................ 260
21.4 PROFITABILITY RATIOS ..................................................................................................................... 260
21.4.1 Gross Profit Ratio 260
21.4.2 Profit for the year Ratio 261
21.4.3 Operating Expenses Ratio 261
21.4.4 Return on Assets 262
21.4.5 Return on Capital Employed (ROCE) 262
21.4.6 Return on Equity 262
21.5 ACTIVITY RATIOS ............................................................................................................................ 263
21.5.1 Inventory Turnover Ratio 263
21.5.2 Trade Receivables’ Collection Period 263
21.5.3 Trade payables’ Payment Period 264
21.5.4 Non-Current Asset Turnover 264
21.6 LIQUIDITY RATIOS ........................................................................................................................... 265
21.6.1 Current Ratio 265
21.6.2 Liquid Ratio 265
21.7 USES OF RATIO ANALYSIS ................................................................................................................. 266
21.8 LIMITATIONS OF RATIO ANALYSIS ....................................................................................................... 266
21.9 USERS OF FINANCIAL RATIOS............................................................................................................. 266
21.10 PREPARATION OF FINANCIAL STATEMENTS WITH THE HELP OF RATIOS ........................................................ 268
CHAPTER 22 STATEMENT OF CASH FLOWS 276
22.1 CLASSIFICATIONS OF CASH FLOWS - AN EXAMPLE ................................................................................ 276

22.2 CASH AND CASH EQUIVALENTS......................................................................................................... 277
22.2.1 Cash 277
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22.2.2 Cash Equivalents 277

22.2.3 Bank Overdrafts 277
22.3 PREPARATION OF A STATEMENT OF CASH FLOWS .................................................................................. 277
22.4 CASH FLOW FROM OPERATING ACTIVITIES ......................................................................................... 277
22.4.1 Importance of Cash Flow from Operating Activities 277
22.5 CALCULATION OF CASH FLOW FROM OPERATING ACTIVITIES ................................................................. 277
22.5.1 Cash from Operating Activities in Direct Method 277
22.5.2 Cash from Operating Activities in Indirect Method 277
22.6 INVESTING ACTIVITIES..................................................................................................................... 280
22.7 FINANCING ACTIVITIES.................................................................................................................... 280
22.8 CASH FLOW AT A GLANCE ................................................................................................................ 281
22.9 USES OF A STATEMENT OF CASH FLOWS.............................................................................................. 283
CHAPTER 23 COST ACCOUNTING – AN INTRODUCTION 289
23.1 DIFFERENCE BETWEEN COST AND EXPENSE.......................................................................................... 289

23.2 COST CLASSIFICATION BY CHANGES IN ACTIVITY..................................................................................... 290
23.2.1 Fixed Cost 290
23.2.2 Variable Costs 290
23.2.3 Mixed Costs 290
23.2.4 Step Costs 291
23.3 COST CLASSIFICATION BY TRACEABILITY ............................................................................................... 291
23.3.1 Direct Costs Error! Bookmark not defined. 291
23.3.2 Indirect Costs 291
23.3.3 Sunk Costs 291
23.4 DIRECT LABOUR COST ..................................................................................................................... 291
23.5 INDIRECT LABOUR COST .................................................................................................................. 291
23.6 LABOUR COST AND TIMEKEEPING ..................................................................................................... 292
23.6.1 Clock Card (Time Card) 292
23.6.2 Time Sheets 292
23.6.3 Wage Sheet 292
23.7 CALCULATION OF LABOUR COST ........................................................................................................ 292
23.7.1 Piece Work Wage System 292
23.7.2 Time Wage System (Pay on Time Basis) 293
23.8 OVERTIME .................................................................................................................................... 294
23.9 INCENTIVE SCHEMES AND BONUS PLANS ............................................................................................ 294
REVIEW QUESTIONS .............................................................................................................................. 296
CHAPTER 24 INVENTORY VALUATION - FURTHER ISSUES 300
24.1 INVENTORY VALUATION METHODS .................................................................................................... 300

24.1.1 First in First out (FIFO) 300
24.1.2 Last in First out (LIFO) 301
24.1.3 Weighted Average Cost (AVCO) 301
24.2 RELATIONSHIP OF INVENTORY VALUATION METHODS WITH PHYSICAL FLOW OF GOODS ............................... 302
24.3 BASES OF INVENTORY VALUATION ...................................................................................................... 302
24.4 ROLE OF ACCOUNTING CONCEPTS IN INVENTORY VALUATION.................................................................. 302
24.5 SEPARATE VALUATION OF INVENTORY ITEMS ........................................................................................ 303
24.6 CALCULATION OF COST OF WORK IN PROCESS...................................................................................... 303
24.7 EFFECTS OF ERRORS IN VALUING INVENTORY ....................................................................................... 303
24.8 GOODS ON SALE OR RETURN ............................................................................................................ 303
24.8.1 Goods Sent to Customers on Sale or Return (Approval) Basis 303
24.8.2 Goods Received on Sale or Return (Approval) Basis 303
13
24.9 SYSTEMS OF INVENTORY ACCOUNTING ............................................................................................... 304

24.9.1 Periodic Inventory System 304
24.9.2 Perpetual Inventory System 304
CHAPTER 25 ABSORPTION COSTING 309
25.1 ABSORPTION COSTING .................................................................................................................... 309

25.2 CALCULATION OF TOTAL PRODUCTION COST ........................................................................................ 310
25.3 FEATURES OF ABSORPTION COSTING .................................................................................................. 311
25.4 ABSORPTION COSTING IN PRICE SETTING ............................................................................................ 311
25.5 COST CENTER ................................................................................................................................ 312
25.5.1 Production Cost Centers 312
25.5.2 Service Cost Centers 312
25.6 COST UNIT.................................................................................................................................... 312
25.7 ALLOCATION OF PRODUCTION OVERHEADS ......................................................................................... 313
25.8 APPORTIONMENT OF PRODUCTION OVERHEADS................................................................................... 313
25.9 ALLOTMENT OF SERVICE DEPARTMENT COSTS TO PRODUCTION DEPARTMENTS .......................................... 313
25.9.1 Production Cost Centers 313
25.9.2 Service Cost Centers 314
25.9.3 Allotment of Non-Reciprocal Services 314
25.9.4 Allotment of Reciprocal Services 315
25.10 CALCULATION OF OVERHEAD ABSORPTION RATES ................................................................................. 317
25.10.1 Actual Vs Predetermined Absorption Rate 317
25.10.2 Advantages of using Predetermined Overhead Absorption Rates 317
25.10.3 Choosing the Appropriate Absorption Base 319
25.10.4 Single (Factory wide) Overhead Absorption Rate 320
25.10.5 Departmental Overhead Absorption Rate 320
25.11 ABSORPTION OF OVERHEADS............................................................................................................ 320
25.12 OVER/UNDER ABSORBED OVERHEADS ............................................................................................... 320
25.12.1 Over-Absorbed Overheads 321
25.12.2 Under-Absorbed Overheads 321
25.13 COSTING SYSTEMS/METHODS .......................................................................................................... 321
25.13.1 Specific Order Costing 321
25.13.2 Continuous Costing 322
CHAPTER 26 MARGINAL COSTING 329
26.1 MARGINAL COST............................................................................................................................ 329

26.2 MARGINAL COSTING ....................................................................................................................... 330
26.3 THE PRINCIPLES OF MARGINAL COSTING ............................................................................................ 330
26.4 ADVANTAGES AND DISADVANTAGES OF MARGINAL COSTING TECHNIQUE ................................................. 330
26.4.1 Advantages 330
26.4.2 Disadvantages of Marginal Costing Technique 330
26.5 THE USES OF MARGINAL COSTING..................................................................................................... 331
26.6 CONTRIBUTION .............................................................................................................................. 331
26.7 BREAK EVEN ANALYSIS .................................................................................................................... 331
26.7.1 Break-Even Point 331
26.7.2 Break-Even Point in Sales ($) Value 332
26.7.3 Target Profits 332
26.7.4 Break Even Chart 333
26.7.5 Assumptions and Limitations of Break Even Analysis 334
26.7.6 Significance of Break Even Analysis 335
14
26.8 MARGIN OF SAFETY ........................................................................................................................ 335

26.9 PROFIT-VOLUME CHART .................................................................................................................. 336
26.9.1 How to Increase Contribution Ratio 337
26.10 INCOME STATEMENTS UNDER MARGINAL COSTING AND ABSORPTION COSTING ......................................... 337
26.10.1 Profits of Marginal Costing and Absorption Costing 339
26.10.2 Difference between Marginal and Absorption Costing 339
26.11 SHORT TERM DECISION MAKING....................................................................................................... 340
26.12 MAKE OR BUY DECISION ................................................................................................................. 340
26.12.1 Qualitative Factors for Make or Buy Decision 341
26.13 SPECIAL ORDER TO USE UP SPARE CAPACITY ....................................................................................... 342
26.13.1 Acceptance of Order with Negative Contribution 343
26.13.2 Conditions for accepting Order below Normal Price 343
26.13.3 Considerations for accepting order below Normal Price 344
26.13.4 Consequences of Acceptance of Order below Normal Price 344
26.14 ABANDONMENT OF A PRODUCT LINE/DEPARTMENT ............................................................................. 344
26.14.1 Factors to be Considered before Closure of a Department 345
26.15 LIMITING FACTOR........................................................................................................................... 345
26.15.1 Examples of Limiting Factors 345
26.15.2 Reducing the Effects of Limiting Factors 346
26.15.3 Decision- Making Process to Reduce Effects of a Limiting Factor 346
CHAPTER 27 ACCOUNTING & BUSINESS PLANNING 359
27.1 DIFFERENCE BETWEEN BUDGETS AND BUDGETARY CONTROL .................................................................. 359

27.2 PURPOSES OF BUDGET .................................................................................................................... 359
27.3 ADVANTAGES OF BUDGETARY CONTROL SYSTEM .................................................................................. 360
27.4 LIMITATIONS OF BUDGETARY CONTROL SYSTEM ................................................................................... 360
27.5 STAGES IN THE BUDGETARY PLANNING PROCESS .................................................................................. 360
27.6 EFFECTS OF PRINCIPAL BUDGET FACTORS ON THE PREPARATION OF BUDGETS............................................ 361
27.7 BEHAVIOURAL ASPECTS OF BUDGETARY CONTROL SYSTEM..................................................................... 361
SOLUTIONS TO ODD NUMBERED QUESTIONS 363
CHAPTER 1 .............................................................................................................................................. 363

CHAPTER 2 .............................................................................................................................................. 364
CHAPTER 3 .............................................................................................................................................. 366
CHAPTER 4 .............................................................................................................................................. 368
CHAPTER 5 .............................................................................................................................................. 370
CHAPTER 6 .............................................................................................................................................. 372
CHAPTER 7 .............................................................................................................................................. 375
CHAPTER 8 .............................................................................................................................................. 376
CHAPTER 9 .............................................................................................................................................. 377
CHAPTER 10 ............................................................................................................................................ 380
CHAPTER 11 ............................................................................................................................................ 380
CHAPTER 12 ............................................................................................................................................ 381
CHAPTER 13 ............................................................................................................................................ 383
CHAPTER 14 ............................................................................................................................................ 385
CHAPTER 15 ............................................................................................................................................ 389
CHAPTER 16 ............................................................................................................................................ 393
CHAPTER 17............................................................................................................................................ 396
CHAPTER 18............................................................................................................................................ 400
CHAPTER 19 ............................................................................................................................................ 401
CHAPTER 20............................................................................................................................................ 404
15
CHAPTER 21 ............................................................................................................................................ 406

CHAPTER 22 ............................................................................................................................................ 409
CHAPTER 23 ............................................................................................................................................ 410
CHAPTER 24 ............................................................................................................................................ 412
CHAPTER 25 ............................................................................................................................................ 413
CHAPTER 26 ............................................................................................................................................ 416
KEY TO EVEN NUMBERED QUESTIONS 422
INDEX 430
Chapter 1 16 Book Keeping and Accounting
Read & Write Publications
Chapter 1 Bookkeeping and Accounting

Learning Objectives
By the end of this chapter you should be able to
 define and differentiate between bookkeeping and accounting
 identify different branches of accounting
 explain the meanings of the terms assets, liabilities, capital and drawings
 define and differentiate cash and credit transactions
 understand the nature and significance of the accounting equation
 understand the concept of entity & dual aspect & their impact on accounting equation
 define and prepare simple balance sheets in both horizontal and vertical layouts
Accounting has its origins from the earliest times in the history of our society. Accounting is primarily concerned with
providing information for internal and external users. Users of accounting information may well be included
management, lenders, customers, government, tax authorities, prospective investors etc.
Financial information can only be provided if there is a proper system of recording transactions of the organisation.
This process of recording transactions is called book keeping. Initially, the records were hand written in the books
however in recent times much of the work of a book keeper can be accomplished by the use of electronic and
mechanical devices. Nonetheless both ways of recording information work on the same principles.
Accounting measures, summarises and then communicates the information recorded by book keepers in the form of
accounting reports using acknowledged methods and techniques which may ultimately be used for decision making.
The role of accountants is therefore to supervise the bookkeeper.
The importance of accounting cannot be overemphasised as this is as important for a business as fresh air for a
human to exist. In the absence of a proper accounting system healthier survival of an organisation would be at stake.
This should also be remembered that the role of accounting is not only confined to business concerns but it is also
useful for all classes and forms of organisations or individuals.
1.1 Branches of Accounting

Firstly accounting is related to recording of transactions. The process of recording transactions in the books is called
“Book Keeping” as records are kept and stored in the books of accounts.
Secondly accounting is concerned with measuring, summarizing and presenting the data, recorded by book keepers
in monetary terms, to the persons who need this information. This aspect of accounting is called “Financial
Accounting”.
Thirdly it is linked with controlling what is happening within the organisation. This is called “Managerial Accounting”
as this branch of accounting helps the managers to control the ongoing activities and to make better decisions.
1.2 Accounting Equation
The whole system of accounting has developed from the same basic tenet of a single equation. As we know that a
business does not own any thing at its own so whatever resources it owns may come from two sources as shown
below.
Resources of the business = Sources of resources
Initially all the assets may be provided to the business by the owner and some businesses solely rely on owner’s
investment. In that case accounting equation may be expressed as
Assets = Capital
However as it is usual for the businesses to borrow amounts from outsiders in addition to owner’s investment so in
that case the accounting equation may be stated as follows:
Assets = Liabilities + Equity
The equation shows that at any given time the assets of any entity must be equal in monetary terms to the total
amount of its liabilities and capital. This also shows that an entity does not own any asset at its own rather these are
provided by either of its owner or lenders. The lenders have a claim against the assets of the entity until the liabilities
are paid. The owner, therefore, has a claim only on the remaining assets of the entity once lenders are paid off.
Another way of expressing this mathematical relationship involves a simple variation in the equation which shows
that difference between what businesses own and what they owe represent owner’s capital.
Equity = Assets  Liabilities
In order to understand the relationship between assets, liabilities and capital it is important to have some basic
understanding of these accounting terms.
1.2.1 Assets
Assets are monetary or economic resources which are owned by an entity and are expected to benefit it in
future. Moreover they must be quantified and expressed in monetary (dollar) terms.
Some items like company's outstanding reputation, customers’ loyalty, its popular brands and its skilled and
experienced work force etc. though benefit the business but cannot be quantified and expressed in monetary
terms. In the absence of any objective monetary value these items are not reported as assets in the accounting
records.
Examples of assets include land, buildings, equipment, vehicles, investments, inventory, accounts receivable,
cash etc.
1.2.2 Liabilities
Liabilities are obligations of an organisation to pay to other entities including individuals, government, financial
institutions, or other businesses. They represent amounts owed to lenders and suppliers. Liabilities include bank
overdrafts, loans taken out for the business. Liabilities may also include advances from customers for a future
sale or for rendering a service in future.
1.2.3 Equity
This is the investment made by owner in his business including any accumulated profits and reduced by losses
and withdrawals by him. In most cases owner’s capital takes the form of cash or other assets brought by the
owner into the business. However owner may introduce capital by paying a business liability out of his personal
account. Similar to liabilities capital is also an obligation of the business to pay to the owner however business
is not obligated to pay the amount of capital in the normal course of events.
1.2.4 Drawings
Drawings represent the amounts of business cash or other assets withdrawn by the owner for his personal use.
Drawings also occur when business makes payment for owner’s private expenses.
In order to avoid unnecessary detail in the owner’s capital balance, a separate record is kept for drawings to
include all the withdrawals made by the owner during the year. At the end of accounting period, the total amount
in the drawing account is closed and adjusted against the owner's capital to determine the net value of owner’s
investment left within the business after all withdrawals.
1.3 Transaction
Before illustrating accounting equation first we should know that accounting equation is only affected when business
enters into a transaction. The term transaction is defined below:
Transaction is an event or happening that changes financial position and/or earnings. An event is said to be a
transaction when
(i) two or more than two parties are involved
(ii) the transaction is measureable in terms of money
(iii) the transaction involves exchange of goods or services
Transaction is the basic element of accounting that gives rise to entries in accounting records, Transactions may be
categorised as
1.3.1 Cash Transactions

Cash transactions occur when cash is paid or received at the time of transaction.
1.3.2 Credit Transactions

In case of credit transactions payment or receipt of cash is deferred to a future date.
EXAMPLE
Let’s take an example to understand the effects of transactions on the equilibrium of the accounting equation.
Transaction 1
Henry Hodgson starts off with a trading business by putting his $50 000 savings in the business bank account.
Effects
Capital increased as owner’s investment within
Asset of Bank ↑ $50 000 Capital ↑ $50 000
the business has increased
The accounting equation will show this transaction as follows:
Assets = Capital + Liabilities
Bank $50 000 = $50 000 + $0
Transaction 2
Henry Hodgson got an opportunity to have a financing from ABC Bank for purchase of office furniture costing $10
000.
Effects
Asset of Liability to pay As increase is financed by bank (liability) so
↑ $10 000 ↑ $10 000
Furniture to ABC Bank capital amount remains unchanged.
The accounting equation will show these changes as follows:
ASSETS = CAPITAL + LIABILITIES
Bank $50 000 = $50 000 + ABC Bank $10 000
Furniture $10 000 ______ ______
Total $60 000 = $50 000 + $10 000
Transaction 3
Henry Hodgson acquires a suitable business premises for $20 000 paying out of the business bank account.
Effects
There is no change in the total of either side of the
Asset of Asset of equation as only the composition of the assets is
↑ $20 000 ↓ $20 000
Premises Bank changed i.e. ↑ in asset of Premises is compensated by
↓ in the asset of Bank.
The accounting equation equilibrium now shifts to a new level:
Bank $30 000 $50 000 ABC Bank $10 000
Furniture $10 000
Premises $20 000 ______ ______
Total $60 000 = $50 000 + $10 000
Transaction 4
Henry Hodgson brought his personal vehicle costing $4 000 within the business:
Effects
Capital increased as owner’s investment
Asset of Vehicle ↑ $4 000 Capital ↑ $4 000
within the business has increased
The accounting equation will then include

Bank $30 000 $54 000 ABC Bank $10 000
Furniture $10 000
Premises $20 000
Vehicles $4 000 _______ ______
Total $64 000 = $54 000 + $10 000
Transaction 5
Some inventory of goods was purchased on credit from a supplier D. Ingram for $3 000.
Effects
Asset of Liability to pay As purchase is financed by a payable so capital
↑ $3 000 ↑ $3 000
Inventory to D. Ingram amount remains unchanged.
The accounting equation equilibrium now shifts to a new level:
Bank $30 000 $54 000 ABC Bank $10 000
Furniture $10 000 D. Ingram (payable) $3 000
Premises $20 000
Vehicles $4 000
Inventory $3 000 _______ ______
Total $67 000 = $54 000 + $13 000
Transaction 6
Henry Hodgson paid $1 000 to D. Ingram by cheque. This would reduce bank balance (asset) and capital investment
of the owner.
Effects
Asset of Liability to pay As business bank account is used to settle a
↓ $1 000 ↓ $1 000
Bank to D. Ingram liability so capital amount remains unchanged.
The accounting equation will show this transaction as follows:
Bank $29 000 $54 000 ABC Bank $10 000
Furniture $10 000 D. Ingram (payable) $2 000
Premises $20 000
Vehicles $4 000
Inventory $3 000 _______ ______
Total $66 000 = $54 000 + $12 000
1.4 Balance Sheet (Statement of Financial Position)

The balance sheet is a statement (not an account) which shows financial position of an entity at a certain date. It is
one of the most important financial statements prepared by a business. It is a snapshot of what an organization owns
(assets) and owes (liabilities) at a specific date.
1.4 .1 Balance Sheet (Vertical Style)

This is in fact another way of expressing accounting equation. Instead of accounting equation being applied
horizontally across the page, it may be written down the page. The two totals are directly underneath instead of
being side by side. In CIE examinations balance sheet should be prepared in vertical style unless clearly specified.
Balance Sheet (vertical style)
ASSETS $ $
Premises 20 000
Furniture 10 000
Vehicles 4 000
Inventory 3 000
Bank 29 000 66 000
LIABILITIES
ABC Bank 10 000
D. Ingram (payable) 2 000 *(12 000)
CAPITAL 54 000
It is called a balance sheet because its two sides always balance. This makes sense as a business does not own
anything at its own and it has to pay for all of its assets by either getting them from owners (capital/equity) or
borrowing money (liabilities) from outsiders.
*Use of parentheses
An amount in parentheses indicates a negative amount. In this case liabilities which are shown on the other side
of the equation are subtracted from assets to determine amount of capital.
REVIEW QUESTIONS
1.1
State which of the following is an asset, liability or a capital?
Office equipment Motor vehicles
Receivables Inventory of goods
Bank balance Loan from Mr. Y
Payables Investment by owner
1.2
State which of the following is an asset, liability or a capital?
Premises Inventory of goods
Cash balance Loan to Mr. X
Fixtures and fittings Payable to owner
Loan from bank Plant and equipment
1.3
Complete the following table
Assets Liabilities Capital
(i) 50 000 10 000 ?
(ii) 60 000 ? 45 000
(iii) ? 5 000 50 000
(iv) 40 000 ? 40 000
(v) ? 20 000 20 000
(vi) 60 000 4 000 ?
1.4
Complete the following table
Assets Liabilities Capital
(i) 70 000 20 000 ?
(ii) ? 15 000 75 000
(iii) 35 000 ? 30 000
(iv) ? 20 000 20 000
(v) 30 000 ? 30 000
(vi) 55 000 10 000 ?
1.5
Show the effects of each transaction given in the following table
Transactions Assets Liabilities Capital
Owner started business with cash
Bought Furniture for cash
A vehicle bought on credit from XYZ Motors
Cash deposited into bank
Sold furniture on credit to P. Jones
Amount borrowed from bank
Cash paid to XYZ Motors in part payment
Furniture sold for cash
Cash received from P. Jones
Owner withdrew cash for his personal use
1.6
Complete the following table to show the effects of the following transactions.
Transactions Assets Liabilities Capital
Owner started business with cash
Cash deposited into bank
Purchased equipment paying by cheque
A loan received from M. Harry
Purchased furniture on credit from G. Prince
Sold equipment for cash
Repaid part of M Harry loan by cheque
Owner brought his personal vehicle for business use
Cash withdrawn from bank for office use
Cash withdrawn from bank for owner’s personal use
1.7
A sole trader has the following items among its assets, liabilities and capital at the end of January 20X7.
$
Cash 22 000
Inventory 28 000
Receivables 21 000
Machines 20 000
Payables 21 000
Bank loan 10 000
Capital 60 000
The following transactions occurred during the following month.
(i) Purchased inventory for cash $2 000.
(ii) Sold a machine for $3 000 on credit.
(iii) Bought two machines on credit for $5 000.
(iv) Repaid part of bank loan $4 000.
(v) Received $2 000 from a receivable.
(vi) Returned a machine with purchase price of $1 000 and amount was adjusted against the amount owed.
(vii) The owner withdrew $1 000 in cash for his personal use.
REQUIRED
Show the effect of above transactions on assets, liabilities and capital in the form of accounting equation.
1.8
The following balances of assets, liabilities and capital are taken from the books of a sole trader at the end of October
20X9.
$
Cash at bank 18 000
Inventory 31 000
Receivables 19 000
Vehicles 25 000
Payables 13 000
Bank loan 10 000
Capital 70 000
The following transactions occurred during November 20X9.
(i) Owner invested a further sum of $2 000 into the business.
(ii) Sold inventory for cash $3 000.
(iii) Bought a vehicle on credit $4 000.
(iv) Borrowed a further loan of $2 000 from the bank.
(v) Sold a vehicle for $2 000 on credit.
(vi) Paid payables an amount of $3 000.
(vii) The owner brought his personal vehicle costing $4 000 into the business.
REQUIRED
Show the effect of above transactions on assets, liabilities and capital in the form of accounting equation.
1.9
The following transactions relating to a sole trader are summarised below in the form of an equation.
Assets = Liabilities + Capital
Cash + Inventory + Machines + Furniture = Payables + Equity
(i) 20 000 20 000
(ii) 3 000 3 000
(iii) (2 000) 2 000
(iv) 1 500 (1 000) 500
(v) (400) (400)
(vi) 5 000 5 000
(vii) (1 000) (1 000)
18 100 + 2 000 + 5 000 + 2 000 = 7 600 + 19 500
REQUIRED
Write down a separate sentence to explain nature of each transaction.
1.10
The following transactions relating to a sole trader are summarised below in the form of an equation.
Assets = Liabilities + Capital
Cash + Bank + Machines + Vehicles = Bank loan + Payables + Equity
(i) 30 000 30 000
(ii) 2 000 2 000
(iii) 10 000 10 000
(iv) (1 500) 1 500
(v) (3 000) 3 000
(vi) 2 500 2 500
(vii) 1 000 (1 000)
29 500 + 7 500 + 3 000 + 4 500 = 10 000 + 2 000 + 32 500
REQUIRED
Write down a separate sentence to explain nature of each transaction.
1.11
A sole trader Mr. Flint has the following items among its assets, liabilities & capital at 31 December 20X4.
$
Cash 22 000
Inventory 28 000
Receivables 11 000
Machines 25 000
Vehicles 15 000
Payables 21 000
Bank loan 10 000
Capital 70 000
REQUIRED
Prepare a balance sheet as at 31 December 20X4 to show the above assets, liabilities and capital.
1.12
A sole trader Mr. Barry has the following items among its assets, liabilities & capital at 31 December 20X4.
$
Capital 100 000
Premises 50 000
Equipment 17 000
Cash at bank 12 000
Cash in hand 8 000
Loan from Mr. X 10 000
Inventory 18 000
Receivables 14 500
Payables 9 500
REQUIRED
Prepare a balance sheet as at 31 December 20X4 to show the above assets, liabilities and capital.
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1

Muhammad Nauman Malik

Title AS Accounting - Theory and Practice (5th edition)

Author Muhammad Nauman Malik

Published by Read & Write Publications

Printed by Sadaat Printers Urdu Bazar Lahore

Composed by Rashid Mehmood

Title designed by Rashid Mehmood

Legal Advisor Mian Tariq Ahmad (Advocate Supreme Court)

Muhammad Nauman Malik

CHAPTER 1 BOOKKEEPING AND ACCOUNTING 16

1.1 BRANCHES OF ACCOUNTING ............................................................................................................... 16

CHAPTER 2 ACCOUNTING FOR ASSETS, LIABILITIES AND CAPITAL 25

2.1 EVOLUTION OF BOOK KEEPING ........................................................................................................... 25

CHAPTER 3 ACCOUNTING FOR INVENTORIES 35

3.1 INVENTORY OF GOODS ...................................................................................................................... 35

3.11 CALCULATION OF PROFITS FOR SERVICE BUSINESSES ................................................................................ 40

CHAPTER 4 ACCOUNTING FOR INCOMES AND EXPENSES 44

4.1 INCOMES ........................................................................................................................................ 44

CHAPTER 5 FINANCIAL STATEMENTS-AN INTRODUCTION 50

5.1 NEED FOR INCOME STATEMENT ........................................................................................................... 50

CHAPTER 6 BOOKS OF ORIGINAL ENTRY & DIVISION OF LEDGER 61

6.1 ADVANTAGES OF MAINTAINING BOOKS OF ORIGINAL ENTRY .................................................................... 62

6.8.8 Cash Book in Recent Times 70

CHAPTER 7 BANK RECONCILIATION STATEMENTS 76

CHAPTER 8 BAD DEBTS AND PROVISION FOR DOUBTFUL DEBTS 86

8.1 BAD DEBTS ..................................................................................................................................... 86

CHAPTER 9 ACCOUNTING FOR NON-CURRENT ASSET 94

9.1 DEPRECIATION ................................................................................................................................. 94

9.12 CHOICE OF A METHOD ...................................................................................................................... 99

CHAPTER 10 ACCOUNTING CONCEPTS AND CONVENTIONS 106

10.1 CONVENTIONS AND CONCEPTS – AN IMPLICATION ................................................................................ 106

CHAPTER 11 CAPITAL AND REVENUE 113

CHAPTER 12 CORRECTION OF ERRORS AND SUSPENSE ACCOUNT 118

12.1 TYPES OF ERRORS ........................................................................................................................... 118

CHAPTER 13 CONTROL ACCOUNTS 128

13.1 CONTROL ACCOUNTS IN CAMBRIDGE A LEVEL SYLLABUS ......................................................................... 128

CHAPTER 14 FINANCIAL STATEMENTS WITH ADJUSTMENTS 142

14.1 CASH AND ACCRUAL BASIS OF ACCOUNTING........................................................................................ 142

CHAPTER 15 ACCOUNTS FROM INCOMPLETE RECORDS 160

15.1 THE REASONS FOR INCOMPLETE RECORDS........................................................................................... 160

15.4.6 Calculation of Non-Cash Expenses 166

CHAPTER 16 FINANCIAL STATEMENTS OF PARTNERSHIPS 182

16.1 CHARACTERISTICS OF PARTNERSHIP ................................................................................................... 182

CHAPTER 17 CHANGES IN PARTNERSHIPS 199

17.1 ADMISSION OF A NEW PARTNER ...................................................................................................... 199

CHAPTER 18 DISSOLUTION OF PARTNERSHIPS 224

18.1 REASONS OF DISSOLVING A BUSINESS ............................................................................................... 224

CHAPTER 19 FINANCIAL STATEMENTS OF COMPANIES 232

19.1 THE NEED FOR COMPANIES .............................................................................................................. 232

CHAPTER 20 ISSUE OF SHARES & DEBENTURES 248

20.1 PRICES OF A SHARE ........................................................................................................................ 248

20.1.3 Book Value 248

CHAPTER 21 RATIO ANALYSIS 259

21.1 FINANCIAL RATIOS .......................................................................................................................... 259

CHAPTER 22 STATEMENT OF CASH FLOWS 276

22.1 CLASSIFICATIONS OF CASH FLOWS - AN EXAMPLE ................................................................................ 276

22.2.2 Cash Equivalents 277

CHAPTER 23 COST ACCOUNTING – AN INTRODUCTION 289

23.1 DIFFERENCE BETWEEN COST AND EXPENSE.......................................................................................... 289

CHAPTER 24 INVENTORY VALUATION - FURTHER ISSUES 300

24.1 INVENTORY VALUATION METHODS .................................................................................................... 300

24.9 SYSTEMS OF INVENTORY ACCOUNTING ............................................................................................... 304

115 AS Accounting Theory & Practice Text Book

115 AS Accounting Theory & Practice Text Book