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Gaw31009 Bi PDF
Gaw31009 Bi PDF
BBAW2103
Financial Accounting
Answers 265
INTRODUCTION
BBAW2103 Financial Accounting is one of the courses offered by the Faculty of
Business and Management at Open University Malaysia (OUM). This course is
worth three credit hours and should be covered over 15 weeks.
COURSE AUDIENCE
This is a core course for students undergoing the Bachelor of Management,
Bachelor of Business Administration, Bachelor of Tourism Management and
Bachelor of Hospitality Management programmes. For students undergoing
Bachelor of Human Resource Management, this is basic major course.
As an open and distance learner, you should be able to learn independently and
optimise the learning modes and environment available to you. Before you begin
this course, please ensure that you have the right course materials, understand
the course requirements, as well as know how the course is conducted.
STUDY SCHEDULE
It is a standard OUM practice that learners accumulate 40 study hours for every
credit hour. As such, for a three-credit hour course, you are expected to spend
120 study hours. Table 1 gives an estimation of how the 120 study hours could be
accumulated.
STUDY
STUDY ACTIVITIES
HOURS
Online participation 12
Revision 15
LEARNING OUTCOMES
By the end of this course, you should be able to:
1. Discuss the fundamental concepts of accounting and classify types of
financial statements;
2. Describe the meaning of accounting information, its role and importance;
3. Illustrate the process of preparing accounting information and completing
the accounting cycle;
4. Prepare and understand a complete financial statement; and
5. Propose and plan an accounting information.
COURSE SYNOPSIS
This course is divided into 10 topics. The synopsis for each topic is presented
below:
Topic 3 explains the accounting cycle which is basically the steps taken in the
recording process and preparation of financial statements. It includes the journal
entry, transfer of entries to ledger and consequently the preparation of a balance
sheet. A complete example of the whole process is included to provide better
understanding of the accounting cycle.
Topic 4 discusses the types of adjusting entries that affect the accounts in the
income statement and balance sheet. An adjusted trial balance is prepared after
the adjusting entries have been recorded and transferred.
Topic 5 completes the accounting cycle by using information from the adjusted
trial balance in Topic 4 to prepare the four basic components of financial
statements. The closing entries and reversal entries will also be covered in this
topic.
Topic 9 covers cash management principles and internal control mechanisms for
cash. The preparation of bank reconciliation statement is also emphasised in this
chapter.
Learning Outcomes: This section refers to what you should achieve after you
have completely covered a topic. As you go through each topic, you should
frequently refer to these learning outcomes. By doing this, you can continuously
gauge your understanding of the topic.
Summary: You will find this component at the end of each topic. This component
helps you to recap the whole topic. By going through the summary, you should
be able to gauge your knowledge retention level. Should you find points in the
summary that you do not fully understand, it would be a good idea for you to
revisit the details in the module.
Key Terms: This component can be found at the end of each topic. You should go
through this component to remind yourself of important terms or jargon used
throughout the module. Should you find terms here that you are not able to
explain, you should look for the terms in the module.
ASSESSMENT METHOD
Please refer to myINSPIRE.
REFERENCES
Horngren, C. T., Harrison, W. T. Jr. & Bamber, L. S. (2002), Accounting (5th ed.),
Prentice Hall, New Jersey.
Larson Kermit D., Wild John J., & Chiappetta Barbara, (2004) Fundamentals
accounting principles, (17th ed.), McGraw Hill.
Roger, H. H et al. (1997), Accounting: A business perspective, (7th ed.), Irwin US.
Warren, C. S., Reeve, J. M., & Fess, P. E. (2004), Accounting (21st ed.),
International Thompson Publishing, Ohio, USA.
Weygandt Jerry J., Keiso Donald E., & Kimmel Paul D., (2004) Accounting
principles, (7th ed.), John Wiley & Sons, Inc.
INTRODUCTION
Accounting plays an important role in our daily lives without us realising it.
Accounting is a financial information system that helps us make better economic
decisions. It is sometimes referred to as the language of business since it
communicates the financial performance and well being of an organisation.
In this topic, you will be introduced to the basics of financial accounting. Among
them are the definition and branches of accounting, users of accounting
information, professional accounting bodies in Malaysia as well as the
fundamental concepts in accounting.
The other differences between these two groups are summarised in Table 1.1.
Example:
Annual report published
by the company.
Copyright © Open University Malaysia (OUM)
4 TOPIC 1 ACCOUNTING ENVIRONMENT
These branches are not static as they evolve in time and requirement. The two
most important branches taught at foundation level are financial accounting and
management accounting. This financial accounting course will combine two of
the most basic and important accounting branches; that are financial accounting
and management accounting. Even though this course focuses on financial
accounting, it is important for you to know some of the differences between these
two branches. Let us look at Table 1.2.
EXERCISE 1.1
These characteristics are divided into two categories; primary and secondary
qualities. The primary qualities of accounting information are relevant and
reliable. While the secondary qualities are comparability and consistency. In
summary, accounting information is only useful if it has relevance, reliability,
comparability and consistency qualities.
(a) Relevance
In everyday terms, we might describe relevant as important or being
related. In accounting, relevant is described as something that makes a
difference in arriving at a decision. In other words, something is said to be
relevant if it influences or affects the decision being made.
For example, suppose you are an investor and you intend to buy shares of a
public listed company. What kind of information might be relevant to your
needs? You might want to know the profitability and performance of the
said company for the past five years, including new projects or products for
the company that will be profitable in the future. This information is
relevant as it will influence your decision. Suppose the information that
you obtained showed that the company is experiencing continuous losses
for the past five years and it does not have any new projects. Will you still
proceed with the proposal to invest in the company? Probably not.
After knowing the meaning of relevant, you must also know how certain
information are said to be relevant. To become relevant, the information
must have three characteristics, namely feedback value, forecast value and
timeliness.
(i) Feedback Value
Relevant information must be able to assist users in substantiating or
correcting early expectations matters at hand.
(ii) Forecast Value
Relevant information must be able to assist users in forecasting.
(iii) Timeliness
Relevant information must be obtained before it becomes obsolete or
unusable.
(b) Reliability
Reliability means that users can rely or depend on the said information to
make good decisions. This characteristic is important because users might
not have the time or expertise to evaluate some information. Generally,
users simply depend on the information presented by the related entity and
assume it to be true. This information is then used in decision making.
Reliability does not mean that the said information must be precise. This is
because in accounting there are a lot of information that involves estimation
and approximation that might not be precise. What is important is that the
estimation and approximation made must be reliable.
(c) Comparability
Comparability means that the information can be compared whether
among companies, industries or different periods. This will enable users to
identify the similarities or differences that might exist in the said
information. This characteristic is important because information that can
be compared is more useful.
Let us look at an example. Assume that you were told that the net profit of
a business in the year 2011 was RM5 million. Is this information useful?
This information would only be meaningful if you can compare it with the
net profit of the business in the year 2010 or the net profit of other
businesses in the same industry as shown in Figure 1.4. Thus, financial
statements contained in the Annual Report also include information on the
previous year in addition to the current year for comparison purposes.
(d) Consistency
Consistency means that an entity must use the same accounting procedures
in every period. It is for the purpose of enabling comparison to be made
more effectively. In other words, a company cannot change their accounting
procedure every year. This does not mean that the company cannot change
the accounting procedure at all. Changes can still be made, but the
company must make complete disclosure in the financial statement to
explain to the users why they are making the changes and the effect of the
changes towards the financial statements.
SELF-CHECK 1.1
ACTIVITY 1.1
EXERCISE 1.2
Example 1:
Assume that you own a business, your personal economic activities must be
kept separate from the businessÊ economic activities. If you wish to buy
products for personal use, you cannot take the businessÊ money and assume
that as part of the business activities. Instead, you must record it as
drawings. The Drawings Account shows the money or products from the
business taken by the owner for personal use.
Example 2:
Supposing you have just set up a business which offers computer repair
services. As it is a small business and you are the sole proprietor, the
businessÊ cash is deposited into your private account. Assume that on 31
December 2010, the bank balance of your account is RM5,000. Based on
your record, RM1,000 is the money from your business and the balance of
RM4,000 is funds for your studies.
If you did not comply with the assumption of separate entity and assume
RM5,000 is the money from your business, you might make an inaccurate
business decision. You might feel that your business has adequate funds
while in fact only RM1,000 is the businessÊ cash. Although all the money
belongs to you, from the accounting perspective, RM1,000 is for the
business funds and the balance of RM4,000 is the money for your education
purposes.
Assuming that Mr. Ali owns three different businesses, all three are
considered to be separated from accounting perspective. Accounting
records must be maintained separately; assets and liabilities for each
business cannot be mixed together. Segregation would enable the owner to
know the performance for each business.
As a simple example, suppose that Mr. AliÊs businesses show the following
result on 31 December 2010:
If the assumption of separate entity is not complied with and all the entities
are assumed as one, Mr. Ali will have an overall business profit of
RM10,000 [RM6,000 + (-8,000) + RM12,000]. Based on this result, Mr. Ali
might be satisfied and might not take any measures for improvement.
However, by preparing separate accounts, Mr. Ali will know that Business
2 is facing problems as it is suffering a loss of RM8,000, while Business 3 is
performing very well with a profit of RM12,000.
(b) Assumption of Going Concern
According to this assumption, an entity is assumed to continue to exist and
in operation in the future. This assumption is important because it enables
the principle of historical cost to be applied. According to the historical cost
principle, all assets and liabilities must be recorded at the purchase price
(original cost). For most assets, this cost would be depreciated throughout
the life span of the assets to depict its usage. However, asset of property
would not be depreciated as its value would always appreciate.
The assumption also enables users to make decisions without any doubt or
worries. Suppose you are interested to invest in a company that has
consistently achieved high profits in the past few years. However, you were
informed that the company would exist only for another five years. Would
you still continue with your plan to invest in the said company? Generally,
we will only invest when we believe the company will continue to exist in
the future.
(c) Assumption of Monetary Unit
According to this assumption, all economic activities are measured and
valued in currency unit. In Malaysia, the currency unit used is Malaysian
Ringgit (RM). Only transactions that can be stated in currency unit will be
recorded for accounting purposes. Currency unit enables the transactions to
be summarised, reported and compared. Before the existence of currency,
transactions were conducted by way of exchanging goods (barter system).
The non-existence of currency unit had created difficulties in ascertaining
the value of transactions. With a countryÊs standard currency unit, we
would be able to value every product.
The selected accounting period can start from 1 January and ends on 31
December, or starts from 1 July and ends on 30 June the following year, and
so on depending on the operation of the company. For example, if an entity
is established on 1 March, it might choose an accounting period that starts
from 1 March and ends on 28 February of the following year. This
accounting period can be changed if the entity feels that there is a need to
do so.
There are also companies which produce reports within a period of less than a
year, for example monthly, quarterly or half yearly. These reports are known as
interim reports. Interim report is normally produced to fulfill the requirement of
users that might need a more up-to-date report.
ACTIVITY 1.2
There is a company that has obtained high profits consistently for the
past 5 years and would exist for a period of another 10 years. Would
you invest in the company? Explain your decision.
For example, you want to buy a piece of land for your business site. The
seller set the price at RM80,000. You do not agree with the price and ask the
seller to sell it at RM70,000. After negotiation, the seller agreed with the
price of RM72,000. In this case, the land would be recorded at the value of
RM72,000 in your financial statement. Five years later, you wish to revalue
the land. The assessor informed you that the value of the land had
appreciated to RM120,000. Although there is a high appreciation in value,
you must still record it at the value of RM72,000, which is the original cost
of the land during the purchase.
The principle of historical cost is justified by its high reliability. The value
recorded in the financial statement is based on the original cost at the time
of purchase supported by documentation. This advantage is also a
weakness for certain parties. These parties criticised the failure of the
Normally, income is recognised at the point of sale. The point of sale refers
to a situation whereby ownership has been transferred from the seller to the
buyer, notwithstanding whether the cash has been received or not. For an
entity that offers services, the point of sale is when the service has been
provided to the customer.
EXERCISE 1.3
For example, a small amount of expense like a purchase of stamps and fares
are combined into one account known as sundry expenses. Another
example will be the practice of approximation. You can see examples in the
annual report published by companies. Generally, companies would not
record the cents value, but instead will round the figures up to the nearest
ringgit (example: RM471.20 is recorded as RM471). For larger companies, it
might make the approximation to the nearest hundred ringgit (example:
RM525,795 is recorded as RM525,800).
On the other hand, materiality may also be affected by the nature, not the
size, of the transaction. For example, those transactions that might involve
bribery or environmental damage in any form might be relevant to a
personÊs decision making whether to invest or not to invest in a particular
company.
These statements are interconnected with one another. The title for each
statement must contain the reporting entityÊs name, type of statement and the
reporting period covered. In this section, we will see in summary, the format for
each of the four statements based on the transactions for Reen Cyber Service. We
will learn about the preparation of each statement in detail in Topic 5.
Let us take a look at Figure 1.7. Generally, businesses are divided into three
types, which are sole proprietorship, partnership and company. Sole
proprietorship is owned by a single owner while partnership is owned by 2 to 20
owners. Financial statements for these two types of business are not subject to the
standards released by MASB. Therefore, there might be several formats used by
these two types of business.
Companies can be divided into private and public companies. Private companies
can be owned by 2 to 50 owners. However, there are unlimited number of
owners for public companies. To protect the public interest in public companies,
the preparation of their financial statements is subject to the standards released
by MASB, whether in the form of accounting method, disclosure and reporting
format.
In the statement format, the asset, liability and ownerÊs equity are listed
vertically.
Cash flows from operating activities include cash receipts and payments from a
business main activities such as trading and staff salaries. Cash flows from
investing activities involve cash transactions from purchases and sales of non-
current assets. Cash flows from financing activities are long-term cash
borrowings and repayments lenders and cash investments and withdrawals
made by owner.
ACTIVITY 1.3
Discuss the issues that might arise if a business entity did not disclose
the relevant information in its financial statement. Present in your
tutorial.
EXERCISE 1.4
EXERCISE 1.5
1. Below are the assets and liabilities accounts balances for Seri
Consultation Services as at 31 December 2008 including the
revenue and expense incurred throughout the year 2008. On 1
January 2008, the capital of Miss Seri Devi (the owner) is RM22,200.
Throughout the year, she made a cash drawings of RM6,000 but no
records of it has been made.
Required:
Based on the information given, prepare:
(a) Income Statement for the year ended 31 December 2008.
(b) Statement of Changes in Owner Ês Equity for the year ended 31
December 2008.
(c) Balance Sheet as at 31 December 2008.
Required: Prepare a statement of cash flows for Samrah Florist for the
year ended 30 June 2011.
INTRODUCTION
Before anything is recorded in the accounts, we need to identify what events
have occurred that relate to the business entity. These events must have
economic consequences to the business to be considered a transaction. After the
transactions are identified they must be analysed and properly classified before
they actually enter the recording system.
The first two steps will be discussed in this topic while the rest of the steps,
which is the recording process, will be detailed in the next topic.
The accounting cycle starts when you can identify a transaction that affects the
business entity economically. Each transaction must be accompanied by a source
document to verify that the transaction actually occurs. Each source document
will be analysed and used as a basis of recording a transaction. For example,
when a purchase of inventory is made, the firm will either received an ÂinvoiceÊ if
it purchases on credit or a ÂreceiptÊ if it purchases with cash. Either one of this
document will be kept as evidence that the transaction, i.e. purchases of
inventory, has taken place. So, a source document is important to prove that an
economic event has taken place in a business entity. Now we can begin to
analyse the transaction using the rules in accounting equation.
What is asset?
Asset is the resources that can bring economic benefit, owned by the entity.
For each resource, there must be a claim or rights on it. A simple example, if you
own some money, the money belongs to you. If you buy a vehicle with bank
loan, the ownership of the vehicle is claimed by the bank until you have settled
your loan. In other words, the vehicle is not owned by you (but is owned by the
bank) until you have settled your entire loan.
It is the same in business. Every asset owned by the business can be claimed
either by the owner itself, or loan providers. Rights or claims made by the loan
providers are known as liabilities, whereas the rights or claims made by the
owner itself are known as equities.
Loan providers have priority over the rights to the business assets. If the entity is
facing problems, it must first settle its loans. The owner can only claim his rights
if there are assets left. Therefore, liability is put ahead of owner Ês equity in the
accounting equation as shown below:
SELF-CHECK 2.1
We will use the example of a sole proprietor business owned by Reen. Reen, who
is skilled in the computer field, has established her own company on 1 November
2010. For a start, the business (Reen Cyber Service) offers services in computer
consultancy. If successful, Reen intends to expand her business to sell computers.
The following is a list of transactions incurred by Reen Cyber Service throughout
the month of November 2010:
Table 2.1: List of Transactions for Reen Cyber Service, November 2010
All the transactions in Table 2.1 are pertaining to Reen Cyber Service. The
personal transactions of the owner (Reen) will not be taken into account if it does
not involve the business. Now we have to analyse each transaction to see their
effects on the accounting equation.
Figure 2.2 shows the effect of revenue, capital, expenses and drawings on
ownerÊs equity.
Transaction 1:
Reen invested cash of RM30,000 into Reen Cyber Service. Again, it needs to be
emphasised that we are only interested in transactions involving Reen Cyber
Service, and not ReenÊs personal transactions. Therefore, even though the cash
owned by Reen was reduced by RM30,000, the cash owned by Reen Cyber
Service has increased by RM30,000. This capital was contributed by Reen.
Therefore, owner Ês equity will increase by RM30,000.
Transaction 2:
The business entity purchased a piece of land valued at RM20,000, paying
RM5,000 by cash and the balance of RM15,000 being financed by bank loan.
From this transaction, the business will have a new asset (land) valued at
RM20,000. The businessÊ cash is reduced by RM5,000 while a new liability of
RM15,000 is created. Bank loan is always represented by the account Notes
Payable (NP). Note that the equation still holds true. The asset section increased
by RM15,000 and the liability section also increased by RM15,000.
„Balance‰ shows the final balance for each item after every transaction.
OWNERÊS
Transaction ASSET = LIABILITY +
EQUITY
Transaction 3:
Purchased office supplies valued at RM2,700 on credit. The asset will increase by
RM2,700. The purchase by credit will create a new liability, which is Account
Payable (AP).
OWNERÊS
Transaction ASSET = LIABILITY +
EQUITY
Cash + Land + Supplies NP + AP Capital,
Reen
Balance 25,000 + 20,000 = 15,000 + 30,000
3 2,700 = 2,700
Balance 25,000 20,000 2,700 = 15,000 2,700 30,000
Normally, office supplies bought are not only used in the current accounting period.
The purchase of office supplies are prepaid expenses. The usage of office supplies for
the specific period is recorded by using the account Supplies Expenses.
Transaction 4:
Received revenue from consultancy services provided to customer. The customer
paid RM15,000 cash.
OWNERÊS
Transaction ASSET = LIABILITY +
EQUITY
Capital,
Cash + Land + Supplies NP + AP
Reen
Balance 25,000 + 20,000 + 2,700 = 15,000 + 2,700 + 30,000
15,000
4 15,000 = service
revenue
Balance 40,000 20,000 2,700 = 15,000 2,700 45,000
Transaction 5:
Paid salary expense RM4,250; rental expense RM1,600; utility expense RM900
and other expenses RM550.
OWNERÊS
Transaction ASSET = LIABILITY +
EQUITY
Cash + Land + Supplies NP + AP Capital,
Reen
Balance 40,000 + 20,000 + 2,700 = 15,000 + 2,700 + 45,000
5 (-4,250) = (-4,250)
paid salary
(-1,600) = (–1,600)
paid rental
(-900) = (-900)
paid utility
(-550) = (-550)
paid
sundry
Balance 32,700 + 20,000 + 2,700 = 15,000 + 2,700 + 37,700
In this transaction, all the expenses were paid by cash. Therefore, cash will
decrease according to the amount involved. Each expenses item has to be
recorded separately and cannot be combined. As explained in Transaction 4,
expenses will reduce owner Ês equity.
Transaction 6:
Made payment for account payable of RM1,900. When the business paid
RM1,900, cash will decrease by RM1,900 and liability will also decrease by
RM1,900.
OWNERÊS
Transaction ASSET = LIABILITY +
EQUITY
Cash + Land + Supplies NP + AP Capital,
Reen
Balance 32,700 + 20,000 + 2,700 = 15,000 + 2,700 + 37,700
6 (-1,900) = (-1,900)
Balance 30,800 + 20,000 + 2,700 = 15,000 + 800 + 37,700
Transaction 7:
At the end of the month, the unused office supplies were valued at RM1,100. The
office supplies was originally bought for RM2,700. The value of office supplies
used up during the period is RM1,600 (RM2,700 – RM1,100)
OWNERÊS
Transaction ASSET = LIABILITY +
EQUITY
Cash + Land + Supplies NP + AP Capital,
Reen
Balance 30,800 + 20,000 + 2,700 = 15,000 + 800 + 37,700
7 (-1,600) = (-1,600)
Supplies
expenses
Balance 30,800 + 20,000 + 1,100 = 15,000 + 800 + 36,100
Transaction 8:
Reen withdrew money from the business amounting to RM4,000 for her personal
use.
OWNERÊS
Transaction ASSET = LIABILITY +
EQUITY
Table 2.2 is a summary of analysis for all the transactions of Reen Cyber Service.
After all the transactions have been recorded, we will discover that the
accounting equation will still be equal.
Table 2.2: Summary of Analysis of Transaction for Reen Cyber Service, November 2010
OWNER
Transaction ASSET = LIABILITY +
EQUITY
As a result, the accounting system was created to show the increase or decrease
of each item in the financial statement separately. The separate recording of each
item is known as account. As an example, cash account is a separate recording
especially to show the increase or decrease in the cash item. This also applies to
other items like account payable, service revenue and salary expense.
SELF-CHECK 2.2
Now let us look at Figure 2.3 which summarises the concept of ledger and chart
of accounts.
Figure 2.3 explains the chart of accounts clearly. This chart will be used as an
example in this topic. New accounts will be introduced in the following units
when the entity increases its business scope. The chart is created by the entity
itself. Therefore, the chart of accounts between one entity and another entity
might be different.
Table 2.3 shows the chart of accounts for Reen Cyber Service. Its chart of accounts
consists of only two digits. The first digit will show the type of account (example:
1 for asset account, 2 for liability account, 3 for owner Ês equity account, 4 for
revenue account and 5 for expense account). The second digit will show the
account itself. For larger businesses, the chart might consist of three to four digits.
If the entity has a branch at different location, the first digit might be used to
show the branch location.
1 ASSETS 4 REVENUE
11 Cash 41 Service revenue
12 Account receivable
14 Supplies
15 Insurance prepayment
17 Land
18 Office equipment
2 LIABILITIES 5 EXPENSES
21 Account payable 51 Salary expenses
22 Notes Payable 52 Rental expenses
23 Deferred Rental 53 Utility expenses
54 Supplies expenses
3 OWNERÊS EQUITY
55 Sundry expenses
31 Capital, Reen
32 Drawings, Reen
EXERCISE 2.1
Which of these events can be considered as a transaction and must be
recorded? Explain.
(a) The death of a branch manager.
(b) The capital contribution of the owner into the business.
(c) The hiring of new staff.
(d) The inventory taken by owner from business.
The debit and credit section are used to record either the increase or decrease in
the specific account. However, do remember that, debit does not necessarily
show an increase and that credit does not necessarily show a reduction. It
depends on the type of account. This subject will be explained in detail later
under the rule of debit and credit.
Accounts are also known as T-accounts due to their shapes that look like the letter T
(refer Figure 2.4).
Each section of the T-account should have four columns in the debit section and
four columns in the credit section (refer Figure 2.5).
There is another format of account known as the three column account (refer Figure
2.6). Although in fact there are actually six columns in this accountÊs format, the
three columns refer to the debit, credit and balance columns. An advantage of this
format is that it can show the latest account balance at any particular time.
credit and every transaction will affect at least two accounts. For every transaction,
the total debit must be equal to the total credit. This is the basis of the double entry
system. This rule of debit and credit is important to ensure that we make accurate
recording. Table 2.4 shows the rules of debit and credit for each type of accounts.
Table 2.4 shows that when the asset account increases, we will debit the said
account. For example, when the entity receives cash, we will debit cash account.
When the asset account decreases, we will credit the said account. For example,
when the entity made cash payment, we will credit the entityÊs cash account.
Refering to Table 2.4, we will discover that the nature of the asset account is
opposite to that of the liability and ownerÊs equity accounts. To observe this more
clearly, please refer back to the accounting equation we had learnt:
The asset item is on the left side while the liability and ownerÊs equity are on the
right side. Asset is the economic resources owned by the entity while liability and
owner equity are parties claiming ownership on the asset. Therefore, asset is the
opposite of liability and ownerÊs equity.
SELF-CHECK 2.3
Let us take the asset account as an example. When asset increases, the account is
debited. When asset decreases, the account is credited. Therefore, the normal
balance for asset account is debit. This is because the reduction in asset normally
would not exceed the increase that had occurred. As a simple example, if we
have cash of RM1,000 in the bank, normally we cannot withdraw more than the
said value. Table 2.5 shows the rules of debit and credit including the normal
balances for each type of accounts.
Table 2.5: The Rules of Debit and Credit Including Normal Balances
The rule of normal balance is important as it may help you to identify errors. For
example, if the land account has a credit balance, you might have made a mistake
in recording. However, you must also remember that normal balance is the balance
that is ordinarily shown. The cash account that normally has a debit balance can
also have a credit balance. This occurs when a company has withdrawn more cash
than what is available. This might occur if the company has an overdraft
agreement with the bank. When an entity has an overdraft agreement with the
bank, it will be allowed to withdraw more money than what it is available in its
account. The amount that can be withdrawn is subject to agreement.
ACTIVITY 2.1
EXERCISE 2.2
10. If the total assets increased by RM15,000 and the total liabilities
decreased by RM10,000; ownerÊs equity had:
A. Increased by RM5,000.
B. Decreased by RM5,000.
C. Increased by RM25,000.
D. Decreased by RM25,000.
EXERCISE 2.3
2. State the effects of the following transactions on the asset, liability and
ownerÊs equity. An example is shown in transaction (a):
Transaction Effect
(a) Paid debts to supplier. Asset decreased, Liability
decreased.
(b) Purchased office equipment by cash.
(c) Owner took cash from the business
for personal use.
(d) Paid staff salary for the
current period.
(e) Received cash from customer to settle
his account receivable.
(f) Owner contributed office
equipment for business use.
Required:
(a) State the effect of each transaction and the balance after each
transaction using the accounting equation format that you have
learnt.
(b) Create the accounting equation for Mr. Ashwin business after the
last transaction for that month.
The accounting cycle describes all the activities involved in the accounting
process to produce a complete set of financial statements.
The chart and format of accounts used to present the financial report of an
organisation.
The rules of debit and credit are fundamental to the double entry system.
The rules of normal balance for each type of account are used to assist in
identifying errors in recording.
INTRODUCTION
Do you still remember the topics that we have discussed previously? We have
discussed how to analyse transactions, we will now learn about recording
process. Recording is the most important step in accounting for a business entity.
However, before recording, we must identify the event that had occurred. Only
events that occur to the business entity will be recorded in the entityÊs book. Not
all events are transactions, for example, recruitment of staff. Although it will
affect the entity economically, this event is not considered as a transaction.
3.1.1 Journal
Journal is the first book to be used in the recording process. Recording in journals
(journalising) is the first process of recording. Transactions are recorded
chronologically in the journal before been transferred to ledger. There are two
main types of journal, the general journal and special journal.
For example, an entity that have numerous cash transactions might want to
create Cash Receipts Journal and Cash Payment Journal that will be
specially used for cash transactions. All the other transactions can still be
recorded in the General Journal. This segregation will simplify recording
and control. Among the special journals that are commonly used are:
(i) Purchase Journal: Particularly for recording purchases of goods on
credit.
(ii) Sales Journal: Particularly for recording sales of goods on credit.
(iii) Cash Receipt Journal: Particularly for recording all cash received.
(iv) Cash Payment Journal: Particularly for recording all cash payment.
However, this course will only emphasise to the general journal. The format of
general journal is shown in Figure 3.2.
ACTIVITY 3.1
In your opinion, what are the appropriate journals for a book shop in a
school? Discuss.
Transaction 1:
On 1 November, Reen invested RM30,000 as capital for Reen Cyber Service
business. From our analysis in Topic 2, we know that this transaction will
increase the cash and owner Ês equity by RM30,000. According to the rules of
debit and credit, the increase in asset account (cash) will be debited and increase
in ownerÊs equity account (capital) will be credited.
When recording, note that the name of the account to be debited is listed first,
followed by the name of account to be credited. The name of the credited account
will be aligned slightly to the right to differentiate it from the account to be
debited.
Journal entry:
General Journal pg 1
Post to ledger:
Cash
RM
Nov 1 Capital, Reen 30,000
Capital, Reen
RM
Nov 1 Cash 30,000
Ledger 1: Ledger for Transaction 1
Transaction 2:
On 2 November, the business purchased a piece of land valued at RM20,000. A
total of RM5,000 cash had been paid while the balance is financed by bank loan
(notes payable).
Note that even though this transaction involves more than two accounts, the total
amount of debit is still equal to the total amount of credit.
Journal entry:
General Journal pg 1
Post to ledger:
Land
RM
Nov 2 Cash 5,000
Notes Payable 15,000
Cash
RM RM
Nov 1 Capital, Reen 30,000 Nov 2 Land 5,000
Notes Payable
RM
Nov 2 Land 15,000
Transaction 3:
On 4 November, the business bought office supplies valued at RM2,700 on credit.
Journal entry:
General Journal pg 1
Post to ledger:
Supplies
RM
Nov 4 Accounts Payable 2,700
Accounts Payable
RM
Nov 4 Supplies 2,700
Transaction 4:
On 15 November, the business received revenue from consultancy services
provided to a customer. The customer paid cash of RM15,000.
Journal entry:
General Journal pg 1
Post to ledger:
Cash
RM RM
Nov 1 Capital, Reen 30,000 Nov 2 Land 5,000
15 Service revenue 15,000
Service revenue
RM
Nov 15 Cash 15,000
Transaction 5:
On 30 November, the business paid salary expenses (RM4,250), rental expenses
(RM1,600), utility expenses (RM900) and sundry expenses (RM550).
Journal entry:
General Journal pg 1
Post to ledger:
Cash
RM RM
Nov 1 Capital, Reen 30,000 Nov 2 Land 5,000
15 Service revenue 15,000 30 Salary expenses 4,250
Rental expenses 1,600
Utility expenses 900
Sundry expenses 550
RM RM
Nov 30 Cash 4,250 Nov 30 Cash 1,600
RM RM
Nov 30 Cash 900 Nov 30 Cash 550
Transaction 6:
On 30 November, the business paid its debt to the supplier of supplies purchased
on 4 November for RM1,900.
Journal entry:
General Journal pg 1
Post to ledger:
Cash
RM RM
Nov 1 Capital, Reen 30,000 Nov 2 Land 5,000
15 Service revenue 15,000 30 Salary expenses 4,250
Rental expenses 1,600
Utility expenses 900
Sundry expenses 550
30 Accounts payable 1,900
Accounts Payable
RM RM
Nov 30 Cash 1,900 Nov 4 Supplies 2,700
Ledger 6: Ledger for Transaction 6
Transaction 7:
Unused office supplies on 30 November were valued at RM1,100.
Journal entry:
General Journal pg 1
Post to ledger:
Supplies
RM RM
Nov 4 Accounts payable 2,700 Nov 30 Supplies expenses 1,600
Supplies expenses
RM
Nov 30 Supplies 1,600
Ledger 7: Ledger for Transaction 7
Transaction 8:
On 30 November, Reen took RM4,000 cash from the business for her personal use.
Journal entry:
General Journal pg 1
Post to ledger:
Cash
RM RM
Nov 1 Capital, Reen 30,000 Nov 2 Land 5,000
15 Service revenue 15,000 30 Salary expenses 4,250
Rental expenses 1,600
Utility expenses 900
Sundry expenses 550
30 Accounts payable 1,900
30 Drawings, Reen 4,000
Drawings, Reen
RM
Nov 30 Cash 4,000
Ledger 8: Ledger for Transaction 8
How are you doing so far? Can you understand the recording process at this
stage? By using the same transactions, we have prepared the journal entries and
transferred them to ledger. The journalising and posting process that we have
done is a very simple example for you to better understand the basic process,
emphasising only on the date, accounts and amounts involved. In the next
example, we will perform postings in detail involving reference column.
You might feel difficult at this stage to make an analysis or feel there are too
many things to remember. However, with familiarisation and frequent practice,
you will find that these three things can be done simultaneously.
We will now continue with the example of Reen Cyber Service by extending the
transactions to December. In December, we will see more transactions. We will
analyse the transactions one by one with emphasis on the types of transaction
that have not been analysed before. The transactions throughout December are
listed in Table 3.1.
Date
No. Transactions
(Dec 2010)
7 13 Paid salary of temporary staff for RM1,900 for the first two weeks
of December.
13 27 Paid salary of temporary staff for RM2,400 for the last two weeks
of December.
14 31 Paid telephone and electricity bill for the month December for
RM620 and RM450 respectively.
Transaction 1:
Paid insurance premium for 24 months totalling RM4,800.
Have you ever paid insurance premium? If you own a vehicle, you will be
familiar with paying insurance premium. Insurance premium must be paid at the
beginning of the coverage period. Payment made in advance is known as prepaid
expenses and it is an asset. The asset you get is the insurance coverage for 24
months starting from 1 December 2010.
Journal entry:
General Journal pg 2
Post to ledger:
Prepaid Insurance Account No: 15
In this example, we did not use the T-account format. Instead, we used the three
column account format to make you more familiar with the different types of
accounting format available. This format is better as it can show the balance after
each transaction. The balance column is supposed to show final balance after
each transaction including the previous transactions in November. However, in
this section, the column is left blank to avoid confusion. After completing all the
transactions, we will combine all the processes of journal entries and entry post
to ledger. After that, you will be able to understand better the function of the
balance column in this three column account format.
Note that for reference purposes, the account number (refer to the chart of
accounts in Table 2.3 from Topic 2) must be recorded in the Reference column in
the journal, while the page of General journal is recorded in the Reference
column in the accounts.
Transaction 2:
Paid RM1,600 rental for the month of December.
This transaction is prepaid expense as the rental expense was paid at the
beginning of December. However, it is different from transaction 1 in terms of
the coverage period.
In transaction 1, the premium paid was for 24 months. In this transaction, the
rental paid was only for one month. For such a short period, we normally do not
use the prepaid rental account. This is easier as we need not make any
adjustments at the end of the period. The adjustments will be taught in detail in
Topic 4.
Journal entry:
General Journal pg 2
Post to ledger:
ACTIVITY 3.2
Do you still remember the accounting constraints on materiality that
we had studied earlier? Can you relate it to the recording of
Transaction 2? Discuss with your coursemates.
Transaction 3:
Received RM720 from the landÊs tenant for rental of three months.
This is a liability (the business „owes‰ services to the tenant) and the account
created is deferred rental account. The deferred rental will be recognised as
rental revenue at the end of the period when the services have been provided.
Journal entry:
General Journal pg 2
Post to ledger:
Journal entry:
General Journal pg 2
(Purchased office
equipment on credit)
Transaction 5:
Paid RM360 for advertisement in newspaper.
For large businesses that always advertise their products or services. For an
advertisement that involves large sums, a specific account (Advertisement
expenses) will be created for this purpose. However, if the advertisement
expenses seldom occur and immaterial, it is often recorded as sundry expenses.
In the example of Reen Cyber Service, we will use the sundry expenses account
to record this expense.
Journal entry:
General Journal pg 2
(Payment for
advertisement expenses)
Post to ledger:
Journal entry:
General Journal pg 2
(Payment for
advertisement expenses)
Post to ledger:
Transaction 7:
Paid salary of temporary staff for the first two weeks of December totalling
RM1,900.
Journal entry:
General Journal pg 2
Post to ledger:
Transaction 8:
Journal entry:
General Journal pg 2
Post to ledger:
Transaction 9:
Journal entry:
General Journal pg 2
Post to ledger:
Transaction 10:
Payment of RM1,800 to supplier (for transaction on 4 December).
Journal entry:
General Journal pg 3
Post to ledger:
Transaction 11:
Customer paid cash RM1,300 as payment on its accounts receivable.
Journal entry:
General Journal pg 3
Post to ledger:
Transaction 12:
Purchased supplies by cash for RM2,900.
Journal entry:
General Journal pg 3
Post to ledger:
Transaction 13:
Paid salary of temporary staff for the last two weeks of December totalling
RM2,400.
General Journal pg 3
Post to ledger:
Transaction 14:
Made payment for telephone and electricity bill for RM620 and RM450,
respectively.
The payment of bills like electricity, water and telephone are normally grouped
into the utility expenses account. This is because the expenses incurred are
normally immaterial in terms of amount and significance until the entity has to
open a separate account for each type of bill. Therefore, the total utility expenses
paid on this date are RM1,070.
Journal entry:
General Journal pg 3
Post to ledger:
Transaction 15:
Received cash RM5,740 for services provided.
Journal entry:
General Journal pg 3
Post to ledger:
Transaction 16:
Billed customer for RM2,240 for services provided.
Journal entry:
General Journal pg 3
Post to ledger:
Transaction 17:
Owner made cash drawings of RM4,000.
Notes: Although the drawings account is a type of owner equity account, it has
an opposite feature against the ownerÊs equity. Therefore, we will put the word
„contra‰ to show the difference.
Journal entry:
General Journal pg 3
Post to ledger:
After analysing all the transactions one by one, we will now combine all the
journal entries and entries posting involved throughout the month of November
and December 2010.
The following are the general journal entries and postings throughout November
and December 2010.
GENERAL JOURNAL pg 1
GENERAL JOURNAL pg 2
Date Account and Description Reference Debit (RM) Credit (RM)
Dec 1 Prepaid Insurance L15 4,800
Cash L11 4,800
(Paid insurance premium)
1 Rental expenses L52 1,600
Cash L11 1,600
(Paid rental for December)
1 Cash L11 720
Deferred rental L23 720
(Cash received for three
months rental)
4 Office equipment L18 3,600
Accounts payable L21 3,600
(Purchased office equipment on
credit)
6 Sundry expenses L55 360
Cash L11 360
(Payment for advertisement
expenses)
11 Accounts payable L21 800
Cash L11 800
(Payment to accounts payable)
13 Salary expenses L51 1,900
Cash L11 1,900
(Payment for salary of temporary
staff)
16 Cash L11 6,200
Service revenue L41 6,200
(Received cash for services
provided)
16 Accounts receivable L12 3,500
Service revenue L41 3,500
(Billed customer for services
provided)
GENERAL JOURNAL pg 3
Journal 26: General Journal for Reen Cyber Service for the month of November and
December 2010
GENERAL LEDGER
* It was previously explained that the „Balance‰ column will show the updated
balance after each transaction. Can you relate to it now?
The main purpose of preparing the trial balance is to ensure that the total
debit and credit balances are the same. Unequal amount of total balances indicate
that errors had happened in any one of the stages in the recording process,
whether during the journal entry, posting to ledger or the preparation of the trial
balance itself.
However, it must always be kept in mind that a balanced trial balance does not
necessarily mean that there are no errors. Examples of errors that can occur even
though the trial balance is balanced are:
(a) The transaction has not been recorded at all in the journal;
(b) The transaction entry has not been posted to the ledger;
(c) The transaction of entry posted to ledger had been done twice; and
(d) The use of wrong account during journalising or posting.
In the first case, the transaction was not recorded at all. Both the debit and credit
sections were not affected. Therefore, the trial balance will be balanced, only
the total would be less than what it should have been. In the second case, the
transaction had been recorded in the journal without being posted to ledger. The
result is the same as with the first case because the trial balance is prepared based
on the ledger balance.
In the third case, the entry was posted correctly but twice. The trial balance will
be balanced, only the total would be more than what it should have been. In the
final case, the debit and credit amount is equal, only that they have been
recorded on the wrong side of the accounts. The final balance of the trial
balance would be the same as it should be but there will be errors in the last
balance of the individual accounts. For example, when a business purchased
supplies by cash, the correct entry should be to debit the supplies account and to
credit the cash account. However, a mistake was made by debiting cash and
crediting supplies. Although the accounts have been recorded wrongly, the trial
balance will still be balanced. Only the individual balances in the cash account
and supplies account will be incorrect. This error is quite difficult to detect as the
final amount in the trial balance is still equal.
The following is the trial balance for Reen Cyber Service as at 31 December 2010.
The balances of the accounts were derived from the previous general ledger.
EXERCISE 3.1
EXERCISE 3.2
ACCOUNT TITLE RM
Account Payables 10,263
Account Receivables 11,654
Capital 46,381
Cash ?
Drawings 570
Equipment 48,350
Insurance expense 1,800
Loan 32,500
Repair expenses 971
Salaries expenses 4,832
Service revenue 12,310
Utility expenses 1,758
EXERCISE 3.3
a. +5,000 +5,000
Capital,
Cindy
b. +275 +275
c. +3,250 +3,250
Service
revenue
d. -750 -750
Paid rental
expense
e. -125 -125
f. +1,875 +1,875
Service
revenue
g. -577 -390
Paid utility
Expense
-187
Paid sundry
expense
h. -1,250 -1,250
Paid salary
i. -162 -162
Paid
supplies
Required:
(a) Prepare the journal entries for all the above transactions.
(b) Transfer the entries to ledger using the 3 column account format.
(c) Prepare the trial balance as at 30 April 2011.
Date Transactions
Feb 1 Purchased office supplies by cash RM274.
2 Edlin withdrew cash from business totalling RM2,000 for personal
use.
5 Received RM2,740 cash from customer for payment on accounts
receivable.
9 Purchased office equipment valued at RM4,000 on credit. The seller
agreed to give a discount of RM150 from the amount.
15 Made payment to accounts payable for RM1,200.
18 Received cash for services provided for RM580.
25 Paid RM420 to advertise its business in the newspaper.
28 Paid telephone bills (RM75 for Edlin's house and RM135 for business)
and electricity bills (RM42 for Edlin's house and RM80 for business).
All the payments had been made using money from his savings.
Required:
(a) Prepare the journal entries to record all the above transactions by
using the accounts listed in the chart of accounts for Edlin
Enterprise.
(b) Post the entries to ledger by using the three column account format.
(c) Prepare the trial balance as at 28 February 2011.
Transactions are recorded in the journal before being transferred into the
ledger.
The general ledger is used to record all kinds of transactions whereas special
journals are created to avoid confusion due to many entries made in the
general journal.
The main purpose of preparing the trial balance is to ensure that debit and
credit balances are equal.
Copyright © Open University Malaysia (OUM)
TOPIC 3 RECORDING PROCESS 93
Assets Ledger
Chart of Accounts Liabilities
Credit Posting
Debit Revenue
Expenses Trial Balance
Journal
INTRODUCTION
In the previous topic, you came across unadjusted trial balance. In this topic, we
will discuss the preparation of adjusting entries for the purpose of preparing
the adjusted trial balance. The adjusted trial balance is prepared after the
adjusting entries have been recorded and transferred.
Adjusting entries will affect at least one income statement account (revenue or
expense) and one balance sheet account (asset or liability). After the
adjustments, the accounts in the trial balance will show the updated balances,
which will then be used to prepare the financial statements.
Prepaid and accruals are the basis for making adjusting entries. Prepaid refers to
cash received or paid before revenues or expenses are recorded, while accruals
are revenues or expenses which are recorded before cash is received or paid.
Prepaid expenses refer to all expenses that have been paid in advance by cash
but the benefit from the expenses has not been received or obtained.
It is an asset to the business and will be written off after it has been used or when
it expires. Adjusting entries must be made at the end of the accounting period to
recognise assets that have been written off as expenses.
Example 4.1
On 1 April 2010, Encik Zaini rented a house and paid a total of RM900 for the
first three months. The landlord had set the rental at RM300 per month. The
journal entries are as follows:
When the entry is transferred to ledger, the accounts involved will be:
The trial balance on 30 April 2010 before adjustment shows the rental
prepayment account with a normal debit balance of RM900. This amount is
incorrect if used for the purpose of preparing the financial statement.
When the adjusting entry is transferred to the ledger, it would involve one
account from the income statement (rental expenses account) and one account
from the balance sheet (rental prepayment account).
The adjusting entries that had been transferred to ledger are as follows:
The adjusting entries had recognised the rental expenses for a period of one
month in April, which is RM300. The rental prepayment account had been
credited by RM300, causing the balance in the account to decrease by RM300.
Therefore, the rental prepayment account has been updated from RM900 to
RM600.
Depreciation Expenses
Depreciation expenses are provisions against the cost of fixed assets like
plant, equipment and vehicle.
It is an expense throughout the lifespan of the asset. The concept used for asset
and depreciation is the same as with prepaid expenses.
Cash paid by the business to acquire the asset is viewed as a prepaid expense.
In other words, the cash is paid in advance before the asset is used. Adjusting
entries must be recorded as the asset expires or when the asset has been
used by the business. The entry is made at the end of the accounting period and
acknowledges the usage of the asset as expenses.
Example 4.2
On 1 Jan 2011, Mazni Enterprise purchased a vehicle for office usage valued at
RM60,000 by cash. This vehicle is estimated to have a lifespan of 10 years. The
journal entries for this transaction are as follows:
When the entry is transferred to ledger, the accounts involved will be:
*The straight line method was used to calculate the depreciation expenses.
Formula:
Useful Life
The adjusting entry is then transferred to ledger and will involve one account
from income statement (depreciation expenses account) and one account from
balance sheet (accumulated depreciation of vehicle account, which is a contra
account for asset).
The debit entry of RM6,000 in the depreciation expenses account reflects the
businessÊ use of the asset for the one year period, while the credit balance in the
accumulated depreciation account for vehicle shows the total depreciation on the
asset to date. The total accumulated depreciation will be deducted from the total
asset to provide the book value or carrying value of the asset:
RM
VehicleÊs cost as at 1 Jan 2011 60,000
(-) Accumulated depreciation – vehicle (6,000)
VehicleÊs book value as at 31 December 2011 54,000
Example 4.3
When the entry is transferred to the ledger, the accounts involved will be:
The adjusting entry is then transferred to ledger and will involve one account
from income statement (service revenue account) and one account from balance
sheet (unearned revenue account).
Accrued expenses refer to all expenses incurred but have not yet been paid or
recorded because there was no cash outflow from the business entity.
Accrued expenses are a liability as an obligation exists that must be settled by the
business. At the end of the accounting period, the business entity must record/
recognise all expenditure even though no cash outflow occurred. Examples of
accrued expenses are salary payable, rental payable, interest payable and tax
payable.
Example 4.4
Haruman Company has not paid its staff salary for the month of December 2010,
totalling RM4,500 due to financial problems. However, the company promised to
pay the salary in January 2011. On 31 December 2010, the adjusting entry will
be as follows:
Accrued revenue refers to the revenue that had been obtained but there is no
cash inflow into the business entity.
This happens when the goods or services were provided to the customer but the
customer has not paid for it yet.
Accrued revenue is an asset as the benefit in the form of cash will be obtained by
the business entity in the future. Examples of accrued revenue are rental revenue
receivable, service revenue receivable and interest revenue receivable.
Example 4.5
Geelang Company rented out a section of its building at the monthly rate of
RM1,200 which must be paid at the end of the month. However, the tenant failed
to pay the rental for the month of December 2010 but promised to settle the rental
in the month of January 2011. The adjusting entry required for Geelang Company
would be:
The adjusting entry is then transferred to ledger and will involve one account
from income statement (rental revenue account) and one account from balance
sheet (rental receivable or rental revenue accrued account).
At the end of the accounting period, revenue that has been recorded or recognised
totalled RM1,200 even though there is no cash inflow while asset increased by
RM1,200 when rental receivable was debited.
All the adjustments made to the account balances in the trial balance will
produce the Adjusted Trial Balance. The Adjusted Trial Balance will be used as
the basis in the preparation of the financial statements. The Adjusted Trial
Balance will be discussed in the next subtopic.
EXERCISE 4.1
The purpose of preparing the Adjusted Trial Balance is to show the effect of
all financial events that had occurred in the accounting period. The Adjusted
Trial Balance is to verify that the total debit and total credit are equal for all the
accounts in the ledger after the adjustments.
You must refer to the information in the Unadjusted Trial Balance for Reen Cyber
Service in Topic 3 (refer Figure 3.3: Trial Balance) for the preparation of this
Adjusted Trial Balance. For your reading convenience, the unadjusted balance
had been included in Table 4.2.
Debit Credit
Date Description Reference
(RM) (RM)
31 December Supplies expenses 2,480
Supplies 2,480
31 December Insurance expenses 200
Insurance prepayment 200
31 December Unearned rental revenue 240
Rental revenue 240
31 December Salary expenses 500
Salary accrued 500
31 December Accounts receivable 1,000
Interest revenue 1,000
31 December Depreciation expenses 100
Accumulated 100
depreciation for office
equipment
(a) The supplies account shown in the Unadjusted Trial Balance is the
opening balance at 1 January 2010 which is RM4,000. The additional
information stated the current balance, which is the balance at 31 December
2010 totalling RM1,520.
(b) Insurance prepaid account with debit balance totalling RM4,800 showed
insurance prepaid for a period of 24 months starting 1 December 2010.
Therefore, the insurance expenses at 31 December 2010 that must be
recognised total RM4,800 ÷ 24 = RM200.
(c) Unearned rental revenue account has a normal credit balance of RM720
which showed total cash for the rental received in advance for three
months. Therefore, the rental revenue that need to be recognised for the
month of December is 1/3 x RM720 = RM240.
(d) Salary accrued or unpaid for the month of December totalled RM500. The
salary accrued will increase the total expenditure and is a liability to the
business entity. The adjusting entry will recognise this salary expense as an
item in the Income Statement and the salary payable or salary accrued as a
balance sheet item totalling RM500 for the period.
(e) Interest revenue accrued for the business entity but yet to be recognised or
recorded totalled RM1,000. This amount is an asset and will increase the total
revenue of the business entity. The adjusting entry will recognise the interest
revenue as an item in the Income Statement and accounts receivable account
in Balance Sheet will show a total of RM1,000 for the period.
The worksheet as per Table 4.3 is used to prepare the Adjusted Trial Balance
for Reen Cyber Service for two months ending at 31 December 2010.
Adjusted Trial
Trial Balance Adjustment
Balance
Dr. Cr. Dr. Cr. Dr. Cr.
Name of Account
(RM) (RM) (RM) (RM) (RM) (RM)
Cash 19,130 19,130
Accounts receivable 4,440 (5) 1,000 5,440
Supplies 4,000 (1) 2,480 1,520
Insurance prepayment 4,800 (2) 200 4,600
Land 20,000 20,000
Office equipment 3,600 3,600
Accounts payable 1,800 1,800
Unearned rental revenue 720 (3) 240 480
Notes payable 15,000 15,000
Capital, Reen 30,000 30,000
Drawings, Reen 8,000 8,000
Interest revenue 32,680 (5) 1,000 33,680
Salary expenses 8,550 (4) 500 9,050
Rental expenses 3,200 3,200
Utility expenses 1,970 1,970
Supplies expenses 1,600 (1) 2,480 4,080
Sundry expenses 910 910
Insurance expenses (2) 200 200
Rental revenue (3) 240 240
Salary accrued (4) 500 500
Depreciation expenses (6) 100 100
Accumulated depreciation – (6) 100 100
equipment
80,200 80,200 4,520 4,520 81,800 81,800
You can also prepare the Adjusted Trial Balance for Reen Cyber Service
without using the sheet by:
(a) Preparing the adjusting entries.
(b) Updating all the account involved with the adjusting entries
(c) Entering the current balance that had been adjusted into the Adjusted
Trial Balance as shown in Table 4.4.
RM RM
Cash 19,130
Accounts receivable * 5,440
Supplies * 1,520
Insurance prepayment * 4,600
Land 20,000
Office equipment 3,600
Accounts payable 1,800
Unearned revenue * 480
Notes payable 15,000
Capital, Reen 30,000
Drawings, Reen 8,000
Interest revenue * 33,680
Salary expenses * 9,050
Rental expenses 3,200
Utility expenses 1,970
Supplies expenses * 4,080
Sundry expenses 910
Insurance expenses ** 200
Rental revenue ** 240
Salary accrued ** 500
Depreciation expenses ** 100
Accumulated depreciation – equipment ** 100
81,800 81,800
* Updated accounts
** New accounts created after the adjusting entries.
After the adjustments are made, you will find that the ledger accounts in the
Adjusted Trial Balance show the same total debit and total credit. This Adjusted
Trial Balance will be used in the preparation of the financial statements,
which will be discussed in the next topic.
ACTIVITY 4.1
In your opinion, what are the uses of the Adjusted Trial Balance for
small businesses? Discuss.
SELF-CHECK 4.1
When is the right time to prepare the Adjusted Trial Balance? Explain.
EXERCISE 4.2
EXERCISE 4.3
Dapur Rona
Trial Balance as at 30 June 2011
Accounts Debit (RM) Credit (RM)
Cash 36,000
Accounts receivable 67,500
Raw materials supplies 28,500
Prepaid rent 162,000
Furniture and fittings 255,000
Accumulated depreciation – 65,400
furniture and fittings
Unearned revenue 30,000
Capital 153,000
Service revenue 495,000
Wages expense 176,400
Utility expense 18,000
Total 607,500 879,300
Required:
1. Prepare a corrected trial balance as at 30 June 2011.
2. Prepare the adjusting entries as at 30 June 2011.
3. Prepare an adjusted trial balance as at 30 June 2011.
EXERCISE 4.4
Required:
(a) Prepare the appropriate adjusting journal entries.
(b) Prepare an adjusted trial balance as at 31 December 2010 for Asoka
Travel and Tours.
EXERCISE 4.5
The trial balances before and after adjustments for Bamba Management
Consultant at the end of the period are as follows:
Required: Find the adjusting entries that were made and prepare their
journal entries.
INTRODUCTION
Do you still remember how to prepare Adjusted Trial Balance, which we have
learned in the previous topic? Now, you will learn how to prepare financial
statements. These are prepared after all transactions are recorded or journalised,
transferred and summarised in the trial balance. The financial statements are also
known as the accounting report that reports the financial status at the end of the
accounting period.
In this topic, you will also be exposed to closing and reversal entries to complete
the accounting cycle.
It is also known as the summary of revenue and expense for a specific period
whether it is one month, three months, six months or a year. If the business
entityÊs total revenue is more than total expenditure, then the net profit will be
reported in its income statement.
If the total expense exceeds total revenue, the business entity will report a
net loss.
The matching process is used to determine the net profit or net loss. The contents
in the Income Statement comprise five main elements:
(a) Name of business entity
Example: Noora Jaya Company
(b) Title of statement, which is Income Statement
Revenue obtained will increase the total asset and owner equity for a business
entity. For example, the main revenue for a car wash business is revenue from
the car wash services provided. Other examples of revenue are fees, commission,
interest, dividend, royalty and rental.
Expenses are costs to the assets or services used or provided in the process to
generate the revenue.
Expense will reduce the total asset and owner equity. Examples of expense for a
car wash business are water, cleaning materials and staff salary.
The steps involved in preparing the Income Statement for Reen Cyber Service are
as follows:
(a) You must analyse the information reported in the following Adjusted
Trial Balance:
RM RM
Cash 19,130
Accounts receivable 5,440
Supplies 1,520
Insurance prepayment 4,600
Land 20,000
Office equipment 3,600
Accounts payable 1,800
Unearned interest revenue 480
Notes payable 15,000
Capital, Reen 30,000
Drawings, Reen 8,000
Interest revenue 33,680
Salary expenses 9,050
Rental expenses 3,200
Utility expenses 1,970
Supplies expenses 4,080
Sundry expenses 910
Insurance expenses 200
Rental revenue 240
Salary payable 500
Depreciation expenses 100
Accumulated depreciation 100
81,800 81,800
(b) Extract all the revenue and expense items only because these are the
main components in the preparation of an Income Statement.
The following are all the revenue and expense items found in the
Adjusted Trial Balance for Reen Cyber Service.
(c) Calculate the net profit or loss by adding all the revenue items and
deducting all the expense items. If the total revenue exceeds total
expenditure, then net profit is obtained. If total expense exceeds total
revenue then net loss is obtained.
RM
Total revenue 33,920
Total expense (19,510)
Net Profit 14,410
(d) Finally, you must enter all the items involved (revenues, expense and
net profit) into the income statement format.
RM RM
Revenue:
Interest revenue 33,680
Rental revenue 240
33,920
Less expenses:
Salary expenses 9,050
Rental expenses 3,200
Utility expenses 1,970
Supplies expenses 4,080
Sundry expenses 910
Insurance expenses 200
Depreciation expenses 100 (19,510)
Net Profit 14,410
This statement is related to the Income Statement and Balance Sheet (which will
be discussed after this) and is prepared at the end of the accounting period.
Equity is the ownerÊs claim on the total asset. It equals the total assets after
deducting all the liabilities.
Drawings refer to the total cash or goods taken by the business entityÊs owner for
personal use.
* Total opening capital and drawings were taken from the Adjusted Trial Balance.
Normally, this statement is not prepared and is only shown in the notes to the
accounts (which will be discussed at the end of this unit). Items in this statement
will be shown either in the income statement or in the balance sheet. For
example, the yearly retained profit/loss is shown in the income statement while
the total closing capital is shown in the balance sheet.
The statement of changes in equity contains the total net profit taken from the
income statement that had been prepared previously. From the statement of
changes in equity thus prepared, the closing capital is obtained. This total will be
reported in the balance sheet statement. Therefore, the statement of changes in
equity has linked the income statement with the balance sheet.
(a) Asset
Asset is an economic resource owned by a business entity that can bring
benefit to the business entity in the future. Asset exists in a business due to
past occurrences and transactions. Asset is a valuable resource to the
company as it can be used or exchanged to generate products or provide
services.
Asset is recorded in the balance sheet based on historical cost, which is the
original cost of purchase. Three characteristics that enable a resource to be
classified as an asset are:
(i) The resource can help the business entity to generate cash inflow in
the future, whether directly or indirectly.
(ii) The resource must benefit the business entity in the future and the
entity has controlling power on the said resource. Controlling power
means that the entity can prevent other people from using the said
resources.
(iii) Transaction or event that gives the rights to the business entity to
control the said resource had occurred. If the transaction of
purchasing the resource had not occurred then the resource cannot be
considered as an asset to the entity.
Operating cycle refer to the time frame taken by the business entity to process
as well as to sell the inventory, to collect accounts receivable (AR) as well as to
transform the accounts receivable into cash as shown in Figure 5.4.
• Intangible/Non-physical Asset
Goodwill, patent, copyright and trademark are intangible assets
because they lack physical substance. The economic benefits that
can be provided by the intangible assets to the business entity in
the future are difficult to evaluate. Examples of other intangible
assets are franchise, trade names and computer softwareÊs cost.
Generally, intangible assets are amortised in a period of five to 40
years. The intangible asset will be reported in the balance sheet at
book value, which is cost less accumulated amortisation expenses.
Figure 5.5 shows types of long-term assets.
In short, assets are economic resources that can generate benefit for the entity in
the future. Table 5.1 shows a summary on assets.
SELF-CHECK 5.1
(b) Liability
Liability is an obligation or responsibility of a business entity to external
parties like creditors or other business entities that have claims on the said
business. Liability is presented in the balance sheet to help users of financial
statements to measure the extent of the claims of other entities towards the
business entityÊs resources. Liability is divided into two, which are current
liability and long-term liability (non-current liability) as can be seen in
Figure 5.6.
Bank loan exists when a business entity applies for loan from the
bank, which must be settled within a year. Meanwhile, overdraft is a
facility given to current account holders to make withdrawal in excess
of the savings available.
Other items payable are salary payable, rental payable, interest payable,
which are expenses accrued or payable by the business entity. The
service is already received by the business entity but the payment is still
outstanding or there is no cash outflow from the business entity.
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128 TOPIC 5 COMPLETING THE ACCOUNTING CYCLE
The cash received will be the current liability to the business entity as
long as the services have not been provided. Examples of deferred
revenue are unearned fees, unearned revenue and deposit from
customers.
Liabilities
Economic benefit that must be sacrificed by transferring the asset or providing
services/goods to another business entity.
Current Liability Long-term Liability/
Non-current Liability
1. Expected to be paid within a 1. Expected to be settled within the
period of one year period > one year
2. Comprises of: 2. Comprises of:
• Bank loan; • Bonds payable;
• Item payable; • Notes payable;
• Portion of current long-term • Inter-company loans;
liability; and • Secured loan; and
• Deferred revenue. • Contingent liability.
Now you know all the items that need to be reported in the balance sheet,
namely, asset, liability and ownerÊs equity.
The following balance sheet statement reports all items of asset, liability
and ownerÊs equity found in the Adjusted Trial Balance and Statement of
Changes in ownerÊs equity for Reen Cyber Service:
• If the statement of changes in equity has not been prepared, all the
items in that statement would be shown in the balance sheet for the
purpose of reporting the closing capital as at 31 December 2010.
Net assets refer to the difference between net current assets and net current
liabilities. This item must be reported according to the regulation and
standards approved by the Malaysian Accounting Standards Board (MASB)
Financial Reporting Standard 101: Presentation of Financial Statements.
To ensure that you have understood what you have learned, complete the
following exercise.
EXERCISE 5.1
Debit Credit
Cash 56,350
Accounts receivable 41,600
Office supplies 12,300
Rental prepayment 4,400
Insurance prepayment 15,100
Office equipment 99,000
Accumulated depreciation – office equipment 10,725
Statement of cash flows can be classified under three activities (see Figure 5.7),
which are, operating activities, investing activities and financing activities.
Examples of Cash Received and Payments for each of the activities are as follows:
Operating Activities
Investing Activities
Financing Activities
Examples for each activity above are reported in the Cash Flow Statement shown
as follows:
For your information, the Statement of Cash Flow must take into account all cash
related transactions. This means that you must refer to Topic 3, which is the
recording of information related to incoming or outgoing cash flow.
Notes to Solution:
(i) Cash from a customer totalled RM13,960, which is the total cash received
throughout the month of December. You can refer to the journal entry done
in Topic 3 relating to accounts receivable. RM13,960 was total cash received
for 1 December for RM720; 16 December for RM6,200; 21 December for
RM1,300 and 31 December for RM5,740.
(iii) Cash for payment of expenditure was from all transactions related to
expenses and outgoing cash flow. Examples of expenses involved are rental
expenses, insurance expenses, sundry expenses and utility expenses. You
can try by using the same way we had derived the total cash from
customers. You will find that total for all expenses are RM15,030. Therefore,
the net cash flow from the operating activities totalled (RM3,670), which is
(RM13,960 – RM17,630).
(iv) What had happened to the overall cash flow? The cash flow had decreased
by RM7,670 throughout the month of December. This is different from the
one reported in the income statement for the period ended 31 December,
that is the net profit of RM14,410. This is because the entity had used the
accrual basis in recognising the revenue and expenditure, without taking
into account the incoming or outgoing cash.
(v) Total cash balance as at 1 December 2010 which is RM26,800 refers to cash
transaction throughout the month of November 2010.
SELF-CHECK 5.2
Briefly explain the four financial statements which are included in the
preparation of financial reports.
Closing entry refers to the temporary closing of accounts, where all the
accounts in the income statement (revenue and expenses accounts) will be
transferred to the revenue summary account.
The purpose of closing entry is to measure the profit accurately. It is also for the
purpose of making the temporary accounts into zero balance for the next period.
Closing entries for Reen Cyber Services as at 31 December 2010 are as follows:
31 December 2010
Notes to Solutions:
(i) All revenue accounts will be closed by debiting the specific accounts and
creating a revenue summary account. With this all the revenue accounts
will have a zero balance while the revenue summary account will have
RM33,920 credit balance.
(ii) All expenses accounts will be closed by crediting the said accounts. With
this all the expenses accounts for that period will have a zero balance.
Meanwhile, the current balance of revenue summary account will become
RM14,410 after taking into account the expenses transferred over to this
account.
SELF-CHECK 5.3
Reversing entry is a reversal to the adjusting entry from the previous period
but only related to accruals, which are accrued revenue and accrued expenses.
Reversing entry is usually prepared on the first day of the next accounting
period. It is to simplify the accounting process because it separates the expenses
or revenue for the two accounting periods. However, a business entity has a
choice on whether to prepare this reversal entry or not.
Example 5.1
At the end of year 2009, Mas Merah Company has accrued salary expenses of
RM800. The adjusting entry recorded was:
At 31 December, closing entry must be made to close the salary expenses account
as this account is temporary. The entry needed is:
If Mas Merah Company prepares the reversal entry on the first day of the next
accounting period, the reversal entry would be:
After all the journal entries had been transferred to the ledger, the accounts
involved are:
RM
31 Dec 2009 Closing 800
Cash Account
RM
1 Jan 2010 Payment 2,000
As at 15 January 2010, the balance for salary payable account will be 0, that is,
after the reversal entry had been transferred to salary payable ledger. The
revenue summary account will be closed by debiting the capital account while
cash account will be permanently reported in the balance sheet.
EXERCISE 5.2
1. The trial balance for Berkat Enterprise as at 30 June 2011 is as
follows:
Debit (RM) Credit (RM)
Cash 3,425
Accounts receivable 7,000
Supplies 1,270
Insurance prepayment 620
Office equipment 51,650
Accumulated depreciation – 9,700
Office equipment
Salary payable 925
Unearned revenue 1,250
Capital 29,000
Drawings 5,200
Service revenue 59,125
Salary expenses 22,415
Sundry expenses 8,420
Total 100,000 100,000
Adjustment information:
(a) Supplies in hand as at 30 June 2011 totalled RM380.
(b) Insurance premium expired for the year totalled
RM315.
(c) Yearly depreciation for office equipment totalled
RM4,950.
(d) Salary accrued but yet to be paid as at 30 June is
RM440.
(e) Service revenue accrued but yet to be recorded totalled
RM1,000.
(f) Unearned revenue as at 30 June totalled RM750.
• The preparation of closing entries must be done for the purpose of measuring
the profit accurately and to make the temporary accounts into zero balance
for the next accounting period.
• The preparation of reversing entries must be done on the first day of the
next accounting period. This is a reversal to the adjusting entries made in
the previous period and is related only to accruals (accrued revenue and
accrued expenses).
INTRODUCTION
Do you know that business entities are required to report their financial status in
a formal report at the end of each accounting period? This report is also known
as the financial report or annual report. Why is it so? The purpose of the report
is to present the financial status of the business entity for a specific accounting
period.
In this topic, we will discuss the statutory requirements that call for business
entities, especially public companies, to prepare the financial report or annual
report for publication purpose. Later, at the end of this topic, we will discuss the
contents of the financial reports released by business entities which comprise
financial information and non-financial information.
In this type of company, not all owners will be involved in the management of
the company. There must be some kind of legislation on its financial reporting, so
that what is presented to them represents the „true and fair‰ view of the
company they have invested in and that the management is transparent in its
actions.
Financial reports are very useful and important for users of accounting
information such as investors, creditors, government, economic analysts and
other interested users. This is because financial reports help them to conclude on
the performance and financial status of a business entity. Financial reports are
also prepared to fulfil statutory requirements.
Figure 6.1 shows the summary of statutory bodies that require annual reports.
Figure 6.1: Statutory bodies that require annual reports from business entities
Sections 169 (1), (2), (3), (4) and (5) of the Companies Act 1965 require a
newly incorporated business entity registered with the Registrar of
Companies to prepare an annual report not later than 18 months from the
date of its incorporation. For the following years, the annual report
must be prepared at the end of each accounting period. A business entity
will be fined or its registration will be annulled by the Registrar of
Companies if it fails to prepare the annual report.
SELF-CHECK 6.1
EXERCISE 6.1
The contents and presentation format of the annual reports prepared by business
entities are normally different depending on the policy adopted by the
management. There are two main components in financial report/annual report
for a business entity – financial and non-financial information.
SELF-CHECK 6.2
ACTIVITY 6.1
The following are the minimum accounting information required by FRS 101 for
reporting purposes:
(a) Revenue;
(b) Finance costs;
(c) Share of the profit or loss of associates and joint ventures accounted for
using the equity method;
(d) Tax expense;
(e) A single amount comprising the total of:
(i) The post-tax profit or loss of discontinued operations; and
(ii) The post-tax gain or loss recognised on the measurement to fair value
less costs to sell or on the disposal of the assets or disposal group(s)
constituting the discontinued operation;
(f) Profit or loss;
(g) Each component of other comprehensive income classified by nature
(excluding amounts in (h));
(h) Share of the other comprehensive income of associates and joint ventures
accounted for using the equity method; and
(i) Total comprehensive income.
Revenue X
Other income X
Changes in inventories of finished goods and work in X
progress
Raw materials and consumables used X
Employee benefits expense X
Depreciation and amortisation expense X
Other expenses X
Total expenses (X)
Profit before tax X
Revenue X
Cost of sales (X)
Gross profit X
Other income X
Distribution costs (X)
Administrative expenses (X)
Other expenses (X)
Profit before tax X
FRS 101 requires business entities to report the following items, which are the
minimum disclosure in the statement of financial position/balance sheet:
(a) Property, plant and equipment;
(b) Investment property;
(c) Intangible assets;
(d) Financial assets (excluding amounts shown under (e), (h) and (i));
(e) Investments accounted for using the equity method;
(f) Biological assets;
(g) Inventories;
(h) Trade and other receivables;
(i) Cash and cash equivalents;
(j) The total of assets classified as held for sale and assets included in disposal
groups classified as held for sale in accordance with FRS 5 non-current
assets held for sale and discontinued operations;
(k) Trade and other payables;
(l) Provisions;
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154 TOPIC 6 FINANCIAL REPORTING STANDARDS
(m) Financial liabilities (excluding amounts shown under (k) and (l));
(n) Liabilities and assets for current tax, as defined in FRS 112 income taxes;
(o) Deferred tax liabilities and deferred tax assets, as defined in FRS 112;
(p) Liabilities included in disposal groups classified as held for sale in
accordance with FRS 5;
(q) Non-controlling interests, presented within equity; and
(r) Issued capital and reserves attributable to owners of the parent.
However, several of the above items will only be studied in the more advanced
accounting curriculum.
cash was generated and used; and the ability of the business entity to generate
cash in the future.
FRS 107 sets out requirements for the presentation and disclosure of cash flow
information. Basically, it requires business entities to report the net cash flow
from the following activities (which were previously discussed in Topic 1):
(a) Operating activities;
(b) Investing activities; and
(c) Financing activities.
All the statements discussed before must be reported in the annual report by
comparing two accounting periods which is the current period and the previous
period.
For example, among the notes to the accounts reported in the financial report are
in relation to:
(a) Accounting policy;
(b) Debtors Account/Account Receivable;
(c) Inventory Account;
(d) Investment;
(e) Share capital;
(f) Reserves; and
(g) Contingent liabilities.
Copyright © Open University Malaysia (OUM)
156 TOPIC 6 FINANCIAL REPORTING STANDARDS
Accounting policies for a business entity refer to the accounting policies practised
by the entity in preparing and presenting the financial statement. These
accounting policies are subject to the standards released by MASB and the
accounting bodies. They usually include the measurement basis/bases used in
preparing the financial statements and the other accounting policies used that are
relevant to an understanding of the financial statements. Examples of accounting
policies that must be disclosed by a business entity are:
(a) Basis of measurement used (for example, historical cost, current cost, net
realisable value, fair value or recoverable amount);
(b) Basis of consolidation for consolidated accounts;
(c) Meaning of consolidated companies;
(d) Meaning of associated companies; and
(e) Basis of accounting for fixed asset and the methods used for calculation of
depreciation.
EXERCISE 6.2
1. What is the purpose of preparing a financial report?
ACTIVITY 6.2
• FRS 101 lists the financial statements that must be presented in the key
financial statements. These are:
– Statement of Financial Position;
– Statement of Comprehensive Income;
– Statement of Changes in Equity;
– Statement of Cash Flows; and
– Notes to the Accounts and Accounting Policies.
INTRODUCTION
Do you still remember the topics we discussed previously? We have discussed
the accounting environment and recording process as well as the way to
complete the accounting cycle. We have also discussed the types of adjusting
entries that will affect the accounts in the income statement. However, you might
notice that those transactions only focused on service firms rather than
inventories.
Thus, in this topic, let us shift focus to trading firms where inventories are
particularly discussed. We will start by looking at the differences between
trading firms and service firms and then we will identify the important
transactions in trading firms.
between trading firms and service firms can be narrowed down to the revenue
and expense items which appear in the Income Statement as shown in Figure 7.1.
Figure 7.1: Difference in income statement for service firms and trading firms
Service firms generally derive their revenue from services which they provide to
customers. For example, the revenue of accounting firms relate to fees from
conducting audits in organisations. For an income statement of service firms,
revenue from these services is reported as fees earned (or service revenue). Net
operating income for service firms is the difference between the fees earned and
the operating expense involved in offering the services. This can be clearly seen
in the previous Figure 7.1.
However, the situation is different for trading firms, where revenue is generated
from activities of buying and selling goods. In other words, trading firms buy
goods and then resell them to their customers with an intention of making profit.
When goods are sold, the revenue received is reported as sales revenue. It is
important to note that before selling, the trading firms would have, of course,
purchased their goods from suppliers. The cost of buying the merchandise will
also need to be recorded. This expense item is known as cost of goods sold. The
difference between sales revenue and cost of goods sold is known as gross profit.
Gross profit is the profit before deducting the operating expense involved in
buying and selling these goods.
You must be thinking that practically in businesses, not all goods bought can be
sold and wondering what would happen to those unsold goods, right? Generally,
goods which are unsold by the end of the accounting period will be kept as
inventory. This inventory will be reported in the current asset section of the
companyÊs balance sheet. As a note, you have now started to identify the
transactions involved in the income statement (sales, cost of goods sold and gross
profit) and balance sheet (trading goods inventory).
On the other hand, trading transactions are recorded in the accounts using the
rules of debit and credit. Do you still remember the rules of debit and credit that
we have learned in Topic 1 until Topic 6?
Income statements for trading and service firms are different as both involve
different activities. As indicated earlier, trading firms buy goods from suppliers
and then resell the goods in order to generate profit. There are two types of
trading firms:
(a) Retailers
Retailers are trading firms that buy goods from wholesalers and resell it
directly to consumers. Examples of retailers are supermarkets and retail
shops such as those which sell electrical goods and furniture.
(b) Wholesalers
Wholesalers are trading firms that buy goods directly from manufacturers
in large quantities. Wholesalers do not sell the goods directly to consumers;
instead, they sell them to retailers.
(d) Operating expense will be deducted from gross profit to obtain net
operating income; and
(e) Goods or inventory that is not sold by the end of the accounting period will
be treated as closing inventory and will be reported as current asset in
balance sheet.
As trading firms deal with goods, they must have an efficient inventory system
to value the opening inventory and closing inventory effectively. There are two
types of inventory management system, namely, periodic inventory system and
ACTIVITY 7.1
Give two examples of trading companies that are successful and famous
in Malaysia. What are their success factors? Discuss with your class
mates.
EXERCISE 7.1
True False
For cash sales, however, the operating cycle is related only to buying and selling
goods involving cash. This operating cycle will be repeated throughout the
lifetime of the business.
There are five important types of transactions in a trading firm, which are:
(a) Purchases;
(b) Sales;
(c) Discounts;
(d) Returns and allowances; and
(e) Transportation cost.
7.2.1 Purchases
Purchase transactions involve purchasing goods to be resold. Any item bought
for use in the business, such as purchase of property, plant and equipment
(which are fixed asset), is not regarded as a purchase. Purchases can be made via
cash or credit. Credit purchases will be supported by purchase invoices. Copies
of sales invoices from the seller are regarded as purchase invoices. The buyer can
only recognise the purchase or inventory in its business when the ownership of
the goods purchased has been transferred from the seller to the buyer.
7.2.2 Sales
Sales involve the transfer of ownership of goods or inventories from the seller to
the buyer. Based on the principle of income recognition as stated in the Financial
Reporting Standard 118 (FRS 118), sales revenue will be recorded when goods
have changed hands from the seller to the buyer. Similar to purchases, sales can
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164 TOPIC 7 TRADING BUSINESS ENVIRONMENT
also be made either by cash or credit. For credit sales, the duration taken to
transfer the goods from the seller to the buyer depends on the delivery terms
stated. In addition, credit sales may involve cash discounts, depending on the
credit payment period.
7.2.3 Discounts
Discounts are price reductions given by the seller to the buyer.
There are two types of discount:
Example:
If quantity purchased is between:
3000 – 4000 units, then a 10% discount will be given.
4001 – 5000 units, then a 20% discount will be given.
This shows that the more units are purchased, the higher the discount
obtained.
(b) Cash Discount
Cash discounts are offered for credit purchases to encourage prompt
payment.
Cash discounts are price reductions given if payment is made within the
discount period.
If quantity discount is given together with cash discount, the cash discount
will be calculated after deducting the quantity discount amount.
Credit terms are the terms given by the seller to the buyer on the
duration to make payment.
Several credit terms that are commonly used are:
(ii) n/30
No discount is given but the total purchase amount must be settled
within 30 days.
As a result of this discount, the price paid will be less than the price
stated in the purchase invoice. In the periodic system, the purchase
discounts account (with normal credit balance) will be set off (contra)
against the purchases account.
Sales discounts or discounts given are price reductions given to credit sales if
the customer pays up within the discount period.
In this situation, cash payable by the customer or debtor will be less
compared to the original price stated in the invoice. An example of a
transaction involving purchase discount and sales discount is shown
in Figure 7.2:
Figure 7.2: Example of a transaction involving purchase discount and
sales discount of purchase discount
EXERCISE 7.2
Recall the example where Besta Sdn Bhd sold goods to Ali Company, in the
previous Figure 7.2. In that illustration, Besta Sdn Bhd is the seller while Ali
Company is the buyer. Now, let us assume that Ali Company has returned goods
to Besta Sdn Bhd following the misspecifications of the product. In this case, the
goods returned is known as purchase return for Ali Company as they relate to
purchases that occurred earlier. On the other hand, the returned goods received
by Besta Sdn Bhd (seller) will be viewed as sales return as they relate to their
earlier sales.
Further details on purchase returns and allowances, and sales returns and
allowances are explained here:
Alternatively, buyers may choose to keep the goods with them and obtain a
price reduction from the seller. This option will give rise to purchase
allowances. In this case, the buyer needs to send a debit memo to the seller
as a reminder to reduce the buyerÊs account balance. Example of a debit
memo is shown in Figure 7.3.
Figure 7.3: Example of a debit memo
EXERCISE 7.3
The transportation term will decide who will pay for the transportation cost
(either the buyer or the seller) and the point for the goods to be transferred
from the seller to the buyer.
Figure 7.5: FOB shipping point
Figure 7.6: FOB destination
SELF-CHECK 7.1
ACTIVITY 7.2
1. Discuss the purpose of giving discounts. In your opinion, why do
business entities provide discounts to their buyers?
2. Discuss the importance of having return allowances to the buyer
and seller. Post your answer in the forum.
3. In groups, make a comparison between FOB shipping point and
FOB destination. List down the differences. Discuss which FOB
term is suitable for a business selling computers.
EXERCISE 7.4
Income statement for trading and service firms are different due to the
different activities involved. There are two types of trading business which
are retailers and wholesalers.
INTRODUCTION
We know that trading firms buy goods for the purpose of resale. This is what we
have learned in the previous topic. In accounting, these goods are called inventories.
Financial Reporting Standard (FRS 102) describes inventories to include not only
finished goods held for resale (as in the case of trading firms) but also incomplete
goods that need further processing and materials or supplies to be consumed in the
production of the finished goods (for manufacturing firms). It is important to
account for inventory because it affects both the income statement and balance sheet.
As you know, trading firms buy goods for the purpose of resale. The goods
purchased will become inventory for the business entity. There are two methods
of recording inventory: Periodic Inventory System and Perpetual Inventory
System. Let us read about these methods in detail.
In the Periodic Inventory System, companies must calculate the cost of goods
sold at the end of the accounting period. The calculations for cost of goods
purchased and the cost of goods sold are done in the income statement. The
calculation for cost of goods purchased is shown in Figure 8.1:
The opening inventory amount for the current year will be the closing inventory
for the previous year. This closing inventory amount will be determined by
physical calculation.
(d) Sales of Inventory will be recorded at two prices, sales price and cost price.
The sales recorded at selling price will show the total sales revenue, while
the recording at cost price will show the total cost of goods sold and
decrease in inventory account.
In the Perpetual Inventory System, there is no need to calculate the cost of goods
purchased and the cost of goods sold. Companies can know the value of cost of
goods sold directly by checking the balance in the cost of goods sold account.
This is because each time goods or inventories are sold, it will be recorded in the
Cost of Goods Sold Account at cost value.
SELF-CHECK 8.1
Now, let us take a look at Table 8.1 which shows the different journal entries
between the two inventory systems while Table 8.2 shows the journal entries for
the related transactions, from the view of the buyer and seller.
Table 8.1: Differences in Journal Entries for Periodic Inventory System and Perpetual Inventory System
TOPIC 8
ACCOUNTING FOR INVENTORY
EXERCISE 8.1
Date Transaction
December 3 Purchased goods from Firdaus Sdn Bhd for RM4,000, FOB shipping
point terms, 2/10, n/30 with prepayment of carriage for RM120.
December 5 Purchased goods from Kenari Sdn Bhd for RM8,500, with FOB
destination terms 1/10, n/30.
December 6 Sold goods bought on 3 December to Hijrah Sdn Bhd at the price of
RM5,800.
December 8 Purchased office supplies by cash for RM150.
December 10 Returned RM1,300 of goods purchased on 5 December from Kenari
Sdn Bhd
December 13 Paid Firdaus Sdn Bhd for purchases made on 3 December, after
discount.
December 14 Purchased goods by cash of RM10,500.
December 15 Paid Kenari Sdn Bhd for the purchases made on 5 December, after
deducting returns on 10 December and discount.
December 16 Received cash for sales made to Hijrah Sdn Bhd on December 6, after
deducting discount.
December 19 Sold goods, payment made via American Express credit card for
RM2,450. Cost of goods sold is RM980.
December 22 Sold goods to Cerating Sdn Bhd total RM3,480, credit terms 2/10,
n/30. Cost of goods sold is RM1,400.
December 24 Sold goods by cash for RM4,350. Cost of goods sold is RM1,750.
December 25 Received returns from Cerating Sdn Bhd for sales made on 22
December, RM1,480. Cost of goods returned is RM600.
December 31 Received cash from American Express for sales made on 19 December
and the service charges is RM140.
Required:
Prepare journal entries for the transactions in Table 8.3 using perpetual inventory
and periodic inventory system.
Solution:
The journal entries for the transactions in Table 8.3 are shown in Table 8.4.
Table 8.4: Journal Entries for the Transactions of Selasih Sdn Bhd
throughout December 2011
(a) Using Perpetual Inventory System
EXERCISE 8.2
Required:
(a) Prepare journal entries for the above transactions by using the
Perpetual Inventory System.
(b) Prepare ledgers for each of the entries.
(c) Prepare the Income Statement for the month ended 31 May 2011.
Table 8.5: Record of Inventory of Seri Jaya Sdn Bhd for December 2011
Date Explanation
Dec 21 200 units from opening balance on Dec 1
280 units from purchases made on Dec 15
Dec 31 100 units from opening balance on Dec 1
150 units from purchases made on Dec 15
465 units from purchases made on Dec 27
RM9,920
Weighted Average cost per unit
1, 430
RM6.94
Calculation:
1 [(300 RM5) + (620 RM7)] / (300 + 620) = RM6.35 per unit
2 (RM5,842 – RM3,048) / (920 – 480) = RM6.35 per unit
3 (RM2,794 + RM4,080) / (440 + 510) = RM7.24 per unit
4 (RM6,878 – RM5,177) / (950 – 715) = RM7.24 per unit
EXERCISE 8.3
Let us discuss the two types of statement that are normally used – single level
income statement and multiple level income statement.
In the income section, companies would not report the gross sales, sales returns
and allowances and sales discounts individually but will only report overall net
sales. Single Level Income Statement emphasises more on the total revenue and
total expenditure to determine the net profit. The Single Level Income Statement
also does not show directly the information on gross profit and revenue from
operations for analysis purposes.
In the Perpetual Inventory System, the closing balance of cost of goods sold can
be obtained directly from the account. This is because sales or sales returns and
allowances are recorded at sales and cost price. In comparison, information on
cost of goods sold for the Periodic Inventory System can only be obtained
through calculation which must be done physically.
Table 8.19 shows the format for a Multiple Level Income Statement using the
Periodic Inventory System, while Table 8.20 illustrates the format for Multiple
Level Income Statement using the Perpetual Inventory System.
RM RM RM RM
Revenue:
Sales XX
(–) Sales returns and allowances XX
Sales discount XX (XX)
Net sales XX
Less: Cost of goods sold
Opening inventory XX
Purchases XX
(–) Purchases returns and allowances XX
Purchases discount XX (XX)
Net purchases XX
* Cost of goods sold must be calculated according to the calculation explained earlier
Table 8.20: Multiple Level Income Statement – Perpetual Inventory System of Angsana
Berhad for 30 June 2011
RM RM RM
Revenue:
Sales XX
(–) Sales returns and allowances XX
Sales discount XX (XX)
Net sales XX
(–) Cost of goods sold XX
Gross profit XX
Add: Other income
Interest revenue
Rental revenue XX
Less: Operating expenditures XX
Sales expenses XX
Sales salary expenses
Advertisement expenses
Sales maintenance expenses XX
Store depreciation expenses
Total sale expenses XX
Administrative expenses XX
Administrative salary expenses XX
Equipment depreciation expenses
Insurance expenses XX
Rental expenses
Total administrative expenses XX
Total sale and administrative expenses XX
Revenue from operating XX
Total administrative expenses XX
Total sales and administrative expenses (XX)
Revenue from operating XX
Add: Other revenue
Interest revenue XX
Rental revenue XX XX
Less: Other expenditures
Interest expenses (XX) XX
Net profit XX
* Cost of goods sold can be determined by looking at the closing balance of the cost of
goods sold account
The major difference between these two formats is the total cost of goods sold
(COGS). In the Perpetual Inventory System, the cost of goods sold account was
created to record the credit sales or cash sales at cost. It is the same for returns. For
credit sales or cash sales, the returns will be recorded at sales price and cost price.
Therefore, the closing balance for the cost of goods sold can be determined from the
cost of goods sold account balance. On contrary, the accounting method for Periodic
Inventory System only records the credit sales and cash sales at sales price, therefore
numerical calculation must be done to obtain the cost of goods sold.
EXERCISE 8.4
The trial balance for Melati Sdn Bhd involved the following accounts for
the year ended as at 31 December 2011.
Additional information:
1. Depreciation for building is RM10,000 and equipment RM9,000
(both are administrative expenses).
2. Interest payable RM7,000 and notes payable still outstanding as at
31 December 2011.
3. Salary expenses are 80% for sales and 10% for administration.
4. Utility expenses, repair expenses and insurance expenses are 100%
for administration.
5. RM15,000 from the notes payable will mature this year.
6. Maintenance expenses are for sales expenses.
Required:
(a) Prepare the journal for adjusting entries.
(b) Prepare the Income Statement for the year ended 31 December
2011.
(c) Prepare the balance sheet as at 31 December 2011.
(d) Prepare the closing entries.
Similarly, the drawings account will also be closed but transferred to the capital
account. Accounts for assets and liabilities will be maintained and carried
forward to the next accounting period. The format of closing entries for the
Periodic Inventory System is shown in Figure 8.3, while the format of closing
entries for the Perpetual Inventory System is shown in Figure 8.4.
RM RM
Dr Sales XX
Dr Interest revenue XX
Cr Revenue summary XX
RM RM
Dr Revenue summary
Cr Sales returns and allowances XX XX
Cr Sales discount XX
Cr Cost of goods sold XX
Cr Carriage outwards XX
Cr Insurance expenses XX
Cr Salary expenses XX
Cr Other expenses XX
RM RM
Dr Revenue Summary XX
Cr Capital XX
RM RM
Dr Capital XX
Cr Revenue Summary XX
RM RM
Dr Capital XX
Cr Drawings XX
Figure 8.3: Closing entries for trading firms using periodic inventory system
Figure 8.4: Closing entries for trading firms using perpetual inventory system
Example:
Sejahtera Company has just started its retail business on 1 September 2011. Table
8.21 shows the transactions made by Sejahtera Company Sdn Bhd throughout the
month of September 2011:
Date Transaction
Sept 1 Owner of Sejahtera Company, Farid invested cash of RM50,00 into the
business. Purchased and received inventory of RM10,000 bought on credit
from Azlan Company with the terms 2/10, n/30, FOB destination.
Sept 2 Sold inventory for RM8,000 on credit to Indah Company with terms 2/10,
n/30, FOB shipping point. Cost of inventory sold total RM3,200.
Sept 5 Returned RM500 of inventory purchased on 1 September from
Azlan Company as the inventory was found to be damaged.
Sept 9 Received cash from Indah Company for the sales made on 2 September.
Sept 10 Settled all debts to Azlan Company for purchase made on 1 September after
deducting returns on 5 September.
Sept 11 Purchased inventory totalling RM4,800 by cash.
Sept 15 Purchased inventory totalling RM4,000 on credit from Huda Company with
terms 1/10, n/30, FOB shipping point.
Sept 17 Paid carriage expenses of RM300 for purchases on 15 September.
Sept 22 Sold inventory totalling RM12,500 by cash to Cahaya Company. Cost of goods
sold totalled RM6,250.
Sept 25 Received inventory returned of RM200 from Cahaya Company for sales on
22 September. The cost of the inventory is RM100.
Sept 28 Sold inventory for RM3,500 on credit to Umi Company with terms n/30.
Cost of inventory sold is RM1,500.
Sept 30 Paid building rental for the month of September total RM2,000 and salary for
the month of September for RM6,000.
Required:
(a) Prepare the journal entries for the transactions is Table 8.21, assuming
Sejahtera Company adopts the Perpetual Inventory System.
(b) Prepare the Single Level of Income Statement for the month ended
30 September 2011.
(c) Prepare the closing entries for Sejahtera Company.
Answers
(a)
RM RM
Revenue:
Net sales (8,000–160+12,500–200+3,500) 23,640
Less Expenditure
Cost of goods sold (3,200+6,250–100+1,500) 10,850
Salary expenses 2,000
Rental expenses 6,000
Total expenditure (18,850)
Net profit 4,790
(c)
Visit the following websites to obtain additional information on the topics discussed.
EXERCISE 8.5
Prepare the closing journal entries by recording the above items in the
revenue summary.
Prepare the journal entries to record the transactions for Olen Sdn Bhd
using the perpetual inventory system. Assume payment was made on
4 May instead of 15 April.
Required:
Prepare the journal entries to record the transactions for Selasih Sdn
Bhd, using the perpetual inventory system.
Assume that Selasih Sdn Bhd had received the payment from Desaru
Sdn Bhd on 2 January instead of 13 December. Prepare the journal
entries for the payment received on 2 January the following year.
The differences between the Periodic and Perpetual Inventory Systems are in
cash and credit sales, and sales returns and allowances (cash and credit).
Three items that are found in income statements for trading firms but not in
income statements for service firms are sales revenue from trading goods,
cost of goods sold and gross profit.
There are two types of income statement for trading firms – single level
income statement and multiple level income statement.
The closing entries must be made at the end of the accounting period to close
all temporary accounts for trading firms.
INTRODUCTION
Cash is an important asset of a business. It is considered the most liquid asset of
the business and can be easily transferred from one party to another. Thus,
having sufficient cash is crucial for a business to be seen as financially sound,
especially for short-term survival. For instance, without cash, a business may not
be able to pay short-term creditors. Likewise, lack of cash may hinder a business
from acquiring other assets. Because of its liquidity and unidentifiable nature,
cash is seen as a vulnerable asset and always subject to misappropriation. Hence,
this topic will focus on the management and internal control of cash to secure
this business asset from fraudulent acts.
addition, there are companies which report cash and cash equivalent as one item
in their balance sheets. Cash equivalents are defined as highly liquid short-term
investments that can be easily converted into cash. To be considered as cash
equivalents, the investments must meet these two conditions:
(a) They are readily converted into a sum of cash; and
(b) They are very close to maturity date and will not be affected by changes in
interest rates.
Examples of cash equivalents are treasury bills, commercial paper and short-term
notes payable.
SELF-CHECK 9.1
EXERCISE 9.1
In the event of mismatch between the amount of cash in a cash register and
the record of cash receipts, such difference should be recorded. If a cash
register shows record of RM500 but the cash count in the register is RM490,
the entry to record cash sales and its shortage is:
Cash 490
Cash Over and Short 10
Sales 500
On the other hand, if the cash count exceeds the amount of sales recorded
in a cash register, the Cash Over and Short will be credited. To illustrate,
assume the cash register shows a record of RM1,000 but the cash count is
RM1,010. The journal entry will be:
Cash 1,100
Cash Over and Short 100
Sales 1,000
EXERCISE 9.2
Why is it important to have proper internal control of cash?
Some business transactions may involve a small amount of cash. Thus, paying by
cheque may not be practical. In that instance, businesses may use petty cash. To
establish petty cash, businesses should make an estimation of the small expenses
to be made during the month or week. Then, payment will be transferred from
cash to petty cash. A petty cashier, who is responsible for the petty cash, can
make payments from the funds with all records kept intact. The petty cash is
Copyright © Open University Malaysia (OUM)
TOPIC 9 CASH MANAGEMENT AND CONTROL 215
normally reimbursed when it is nearing zero. To illustrate, assume Teja Sdn Bhd
establishes petty cash on October 1 for RM200. The entry for this transaction
would be:
For every payment made out of petty cash, the petty cashier must record them in
Petty Cash Payments Report. To illustrate, assume payments were made in
October for:
(a) Cleaning of RM30;
(b) Postage of RM15; and
(c) Courier service of RM45.
To reimburse the funds, the petty cashier will forward the petty cash payment
report to the companyÊs cashier. As shown in Figure 9.1, since RM90 was paid
from the petty cash, that same amount will be reimbursed by the cashier. After
the petty cashier cashes the cheque, the amount of cash in the petty cash will be
RM200 again.
In theory, the bank statement should reflect exactly the same transactions and
events of the business. Thus, it is expected that the bank statement sent by the
bank should tally with the businessÊ Cash at Bank account. However, in reality, it
is not always the case. There are three situations that lead the two records (Bank
Statement and Cash at Bank account) to be in disagreement:
(a) Items that have been recorded in business account are not yet recorded by
banks, such as unpresented or outstanding cheques drawn by the business
and deposits in transit.
(b) Some items originated by the bank such as bank fees, charges and interest
and dishonoured cheques.
(c) Errors may have been made by either party.
EXERCISE 9.3
On 1 November 2011, Teraju Indah Sdn Bhd set up a petty cash fund for
RM350. On 28 November, the petty cashier requested to reimburse the
fund and submitted the following vouchers and receipts:
(a) Postage of RM15;
(b) Supplies purchased of RM28;
(c) Courier service of RM45; and
(d) Refreshment of RM37.
Prepare the entries to establish the petty cash and to reimburse the fund.
Once all the information is gathered, we may begin preparing the bank
reconciliation by following these procedures:
Assuming Teraju Indah Sdn Bhd had the following Cash at Bank account as
shown in Table 9.1 and Bank Statement as shown in Table 9.2, let us prepare the
bank reconciliation using the above procedures.
Table 9.3 shows the bank reconciliation of Teraju Indah Sdn Bhd.
Balances are equal
Note: Cheque No. 303 amounting to RM210 is not adjusted in the current bank
reconciliation as the cheque was paid in the previous month (and not shown in
Cash at Bank account).
EXERCISE 9.4
Cash includes short-term investment which can be easily converted into cash,
also known as cash equivalents.
Internal control is important for both cash receipts and cash disbursement.
INTRODUCTION
Now, let us read this final topic which explains financial statement analysis in
more detail. Generally, financial statement analysis provides useful information
for both internal and external users for decision-making. In particular, this
financial statement information will be used to evaluate the performance and
financial status of a company.
In this topic, we will take a look at the purpose of financial statement analysis
and the sources of financial information. We will also look at three techniques of
financial analysis.
Internal users are responsible for planning strategies and executing the
companyÊs operations. Thus, the purpose of financial analysis is to provide them
with information in order to improve efficiency and effectiveness in producing
the output or services of the organisation.
Figure 10.2: External users of accounting information
SELF-CHECK 10.1
EXERCISE 10.1
ACTIVITY 10.1
Let us take a look at Figure 10.3 which summarises the analysis techniques
mentioned.
SELF-CHECK 10.2
ACTIVITY 10.2
Horizontal analysis is a technique used to assess the trend of the items in the
financial statement (increasing or decreasing) in terms of the amount or the
percentage of fluctuation.
(a) First, the comparison is made on every item in the financial statement for at
least two accounting period or years. The basis of comparison for these two
years (the current year and the previous year) will be set using the financial
statement of the previous year as the base to determine an increase or
decrease.
(b) Second, the comparison for sequential financial data is normally conducted
for several years, for example for 5 to 10 years or more. This comparison is
also known as trend analysis.
Step 1: Calculate the amount of change for the base year (previous year) and
the following year (current year), for every item in the financial
statement.
Step 2: Divide the amount of change, as calculated above, with the amount in
the base year for every item in the financial statement, to obtain the
percentage of change.
Percentage of change in Cash in the Balance Sheet (Refer Table 10.2) is shown
here:
This shows that there is an increase of 39.9% of change from 2010 to 2011.
The calculation above is then repeated for each item in the balance sheet, income
statement and retained earnings statement.
Table 10.1: Percentage Change for Marketable Securities and Non-current Liability
The calculations show that marketable securities increase by 25% and non-
current liability decreases by 50%.
Now, let us take a look at Table 10.2 which shows the horizontal analysis for the
entire Balance Sheet of Anggerik Sdn Bhd. The format of the balance sheet is as
set out in FRS 101, „Presentation of Financial Statements‰. This comparative
balance sheet consists of balance sheet amounts from two accounting periods
arranged side by side. Next to that, each itemÊs change in both monetary term
and percentage is shown. Such changes will be examined to identify the intensity
of the change as well as whether they are favourable or unfavourable. In Table
10.2 also shows that cash and marketable securities increase substantially in 2011.
This reflects the high liquidity of the company.
Non-current Assets:
Long-term investment 95,000 177,500 (82,500) (46.5)
Building and Equipment (net) 444,500 470,000 (25,500) (5.4)
Intangible assets 50,000 50,000 – –
Total non-current assets 589,500 697,500 (108,000) (15.5)
Current Assets:
Cash 90,500 64,700 25,800 39.9
Marketable securities 75,000 60,000 15,000 25.0
Accounts receivable 115,000 120,000 (5,000) (4.2)
Inventory 264,000 283,000 (19,000) (6.7)
Expenses pre-payment 5,500 5,300 200 3.8
Total current assets 550,000 533,000 17,000 3.2
Current liability:
Accounts payable 210,000 243,000 (33,000) (13.6)
Total net current assets 340,000 290,000 50,000 17.2
929,500 987,500 (58,000) 5.9
Financed by owner and long-term
liability:
Owner Ês equity:
6% Preference shares, RM100 150,000 150,000 – –
Ordinary shares, RM10 500,000 500,000 – –
Retained earnings 179,500 137,500 42,000 30.5
Non-current liability 100,000 200,000 (100,000) (50.0)
Total owner Ês equity and long-term 929,500 987,500 (58,000) 5.9
liability
Table 10.3 shows the horizontal analysis for the Income Statement of Anggerik
Sdn Bhd. Comparative income statement is prepared similarly to comparative
balance sheet. It appears that net sales have increased almost 25 percent in 2011
as compared to the previous year. Also, the ability to obtain a profit of
20.7 percent on revenue growth of 24.8 percent is impressive.
Horizontal analysis for the Retained Earnings Statement of Anggerik Sdn Bhd is
shown in Table 10.4. The analysis indicates an increase of net profit of 19 percent
in 2011 compared to 2010.
Example:
The Net Sales item taken from the Income Statements of Angsana Sdn Bhd for
the years 2007 to 2011, is shown in Table 10.5.
Table 10.5: Angsana Sdn Bhd – Net Sales Data for a Period of 5 Years
By using 2007 as the base year for comparison, calculation of increase or decrease
of the financial data for the following years is calculated as follows:
Example:
Increase in net sales for year 2008:
RM30,518
RM33,110 RM30,518 100
RM30,518
8.5%
Therefore, net sales have increased by 8.5% in 2008 from the base year of 2007.
By using the sales figure for 2007 to 2011, a sequential period analysis is shown as
in Table 10.6.
Table 10.6: Angsana Sdn Bhd – Net Sales Data for a Period of 5 Years
SELF-CHECK 10.3
What can you say about the trend in sales of Angsana Sdn Bhd from
2007 to 2011?
A vertical analysis shows the relationship of every item in the financial statement
in which one item is used as the base. The base item for a balance sheet is Total
Assets, and the base item for an Income Statement is Net Sales.
The vertical analysis can be performed more easily if (Total Assets) and (Total
Liability and OwnerÊs Equity) is shown in the analysis. The basis of comparison
in vertical analysis is based on (Total Assets) or (Total Liability and OwnerÊs
Equity). This can be illustrated based on the accounting equation:
Table 10.7 shows examples of the calculation for Cash and Accounts payable
items for 2011 and 2010.
2007 2006
Cash Percentage:
RM90,500 RM64,700
Cash 100 100
100 RM1,139,500 RM1,230,500
Total assets
7.9% 5.3%
Accounts Payable Percentage:
RM210,000 RM243,000
Accounts Payable 100 100
100 RM1,139,500 RM1,230,500
Total Liability and Owner Equity
18.4% 19.7%
The vertical analysis for the entire Balance Sheet of Anggerik Sdn Bhd as at
31 December 2011 and 2010 is shown in Table 10.8.
The analysis can also be done by comparing the percentage of an item for one
year with its percentage for another year. For example, in 2010, total liabilities
comprise 36% of the total liabilities and ownerÊs equity. The corresponding figure
for 2011 is only 27.2%, implying that the usage of debts in year 2011 had
decreased as compared to 2010 The same approach can be used to analyse other
items.
2011 2010
Sales percentage:
Sales RM1,530,500 RM1,234,000
100 100 100
Net assets RM1,498.00 RM1,200.00
102.2% 102.8%
Administrative expenses percentage:
Administrative expenses RM104,500 RM97,400
100 100 100
Net sales RM1,498.00 RM1,200.00
6.9% 8.1%
The calculation results of vertical analysis for the entire Income Statement are
shown in Table 10.10.
It is possible to identify the reason for the decrease by making the same
comparison for the other items. For example, in 2010, cost of goods sold (as
percentage of net sales) is 68.3%. The corresponding figure in year 2011 had
increased to 69.6%. This increase might be the reason for the decrease in the
percentage of profit after tax.
EXERCISE 10.2
Prepare the horizontal and vertical analysis by using the above data.
(a) Liquidity
Liquidity ratios measure the businessÊ short-term capability to discharge
its obligations or debts upon maturity and to fulfil unforeseen cash
requirements. This ratio is often used by short-term creditors.
(b) Efficiency
Efficiency ratios measure the level of efficiency and capability of the
management to operate its business, especially in the use of assets to
generate sales.
(c) Profitability
Profitability ratios measure the ability of a business to generate profit
within a specific period. It is used as an indicator to analyse the efficiency
and effectiveness of a business in achieving its profit.
ACTIVITY 10.3
EXERCISE 10.3
CURRENT ASSETS RM
Cash 8,241,000
Marketable securities 1,947,000
Accounts receivable 12,545,000
Inventory 14,814,000
Expenses prepayment 5,371,000
TOTAL CURRENT ASSETS 42,918,000
CURRENT LIABILITY:
Total current liability 45,844,000
Calculate the:
(a) Working Capital
(b) Current Ratio
(c) Quick Ratio
The calculation, purpose and description of each of these ratios will be described
in Table 10.12.
Copyright © Open University Malaysia (OUM)
242 TOPIC10 FINANCIAL STATEMENT ANALYSIS
The purposes and descriptions of each ratio will be explained in Table 10.13.
Table 10.13: Classification of Profitability Ratio (continuation)
The purposes and summary to calculate the debt management ratio are shown in
Table 10.14.
ACTIVITY 10.4
EXERCISE 10.4
The average ratios for the plastics industry are as shown in Table 10.17.
Required:
(a) Prepare the vertical analysis for Kenanga Sdn BhdÊs Income Statement.
Compare it with the industry average and explain briefly the result of the
analysis.
(b) Calculate the following financial ratios and compare it with industry
average for 2011 for Kenanga Sdn Bhd. Explain your analysis results.
(i) Current ratio
(ii) Quick ratio
(iii) Accounts receivable turnover
(iv) Average collection period
(v) Inventory turnover
(vi) Asset turnover
(vii) Gross profit margin
(viii) Net profit margin
(ix) Return on asset
(x) Return on ownerÊs equityÊs ordinary shares
(xi) Interest coverage ratio
(xii) Debt ratio
(xiii) Debt equity ratio
Copyright © Open University Malaysia (OUM)
252 TOPIC10 FINANCIAL STATEMENT ANALYSIS
Solution:
Net sales *
(Cash sales RM330,000) 600,000 600/600 100 100
Cost of goods sold 384,000 384/600 64 74.2
Gross profit 216,000 216/600 36 25.8
Sales and administrative 194,000 194/600 32.3 22.5
expenses
Profit from operating 22,000 22/600 3.7 3.3
Other expenses
(Interest expenses RM3,000) (4,000) 4/600 0.7 0.2
Profit before tax 18,000 18/600 3.0 3.1
Income tax expenses (5,000) 5/600 0.8 0.7
Net profit 13,000 13/600 2.2 2.3
Table 10.19: Ratio Analysis for Kenanga Sdn BhdÊs Income Statement
Industry
No Ratio Kenanga Sdn Bhd
Average
(i) Current ratio Current asset 1.8 : 1.0
Current liability
120, 000
60, 000
2.0 : 1.0
Analysis result:
Quick ratio of the company is just enough to pay
the short-term debts quickly. This quick ratio is
less by 0.1 from the industry average.
(iii) Accounts Net credit sales 9.5 times
receivable
Average Net AR
turnover
60, 000 330, 000
(25, 000 35, 000)/ 2
9.0 times
Analysis result:
The AR turnover for year 2001 is 9 times. This
shows that the business is able to collect its debts
quickly. The industry average is 0.5 times more
than the company.
* AR = Account Receivable
(iv) Average 365 days 38 days
collection
*AR turnover
period
365
9
41 days
Analysis result:
The company is able to collect debts within 41
days. The efficiency of the company in debt
collection is late by 3 days compared to industry
average of 38 days.
Analysis result:
The higher the inventory turnover the better.
This shows the business is good in selling its
inventory and reduces the chances of obsolete
inventory. The companyÊs inventory turnover
of 8.1 times is twice as fast as the industry
average of 4.8 times.
(vi) Asset turnover Net sales 2.3 times
Average total asset
RM600,000
(RM140, 000 RM200, 000)/ 2
3.5 times
Analysis result:
The higher the ratio, the better. Asset
turnover for the company is better compared to
industry average of 2.3 times.
(vii) Gross profit Gross profit 25.8%
margin Net sales
RM216,000
RM600, 000
36%
Analysis result:
The higher the gross profit margin the better.
This indicates good purchasing management and
lower purchasing cost. The gross profit margin of
this company is better compared to industry
average. This shows the purchasing management
and cost of the company is 10.2% better than
industry average.
Analysis result:
The lower the sales price, the higher the sales
revenue generated is being used for other
activities. The higher the ratio, the better
as it shows lower expenditure or cost needed to
generate sales.
The percentage of net profit margin for the
company is less than the industry average.
(ix) Return on Net profit 4.0%
asset Average total asset
RM13,000
(RM140, 000 RM200,000/2
7.6%
Analysis result:
This shows that profit return is 7.6% as
relates to management efficiency in using the
asset regardless of resources to finance the asset.
Return on the companyÊs asset is much better
compared to the industry average that only
contributes 4.0%.
(x) Return Net profit Dividend for preference shares 11.4%
on owner Average owner's equity
equityÊs
ordinary RM13,000 0
shares (RM80, 000 RM125,000/2
12.68%
Analysis result:
The higher the ratio the better as it shows the
business is capable of generating higher profit
for the shareholders. The company is able to
give 12.68% profit to the ordinary shareholders.
The return for the companyÊs ordinary
shareholders is 1.28% higher than industry
average, only a slight difference as compared to
the industry average.
Now, let us take a look at Table 10.20 which ssummarises the Financial Ratios.
Table 10.20: Summary of Financial Ratios
Table 10.20: Summary of Financial Ratios (Continuation)
Table 10.20: Summary of Financial Ratios (Continuation)
EXERCISE 10.5
Required:
Calculate the ratios listed below for 2011.
(a) Current ratio;
(b) Quick ratio;
(c) Accounts receivable turnover;
(d) Inventory turnover; and
(e) Return on sales.
EXERCISE 10.6
31 December 31 December
2011 2010
Current asset 125,000 100,000
Equipment (net) 400,000 330,000
Current liability 91,000 70,000
Long-term liability 144,000 95,000
Ordinary shares @ RM1 155,000 115,000
Retained earnings 135,000 150,000
Required:
Prepare the Horizontal Analysis for year 2011 by using year
2010 as the base year.
2011 2010
(RM) (RM)
Net Sales 800,000 720,000
Cost of sales 480,000 40,000
Interest expenses 7,000 5,000
Net revenue 64,000 42,000
Account receivables 120,000 100,000
Inventory 85,000 75,000
Total asset 600,000 500,000
Total owner equity 450,000 310,000
Required:
Calculate the following ratios for year 2011.
(a) profit margin;
(b) asset turnover;
(c) return on asset; and
(d) return on owner equity.
Additional Information:
1. The market values of ordinary shares for Teguh Sdn Bhd are RM4 for
year 2009, RM5 for year 2010 and RM7.95 for year 2011.
2. All dividends were paid by cash.
3. At 1 July 2011, 4,000 units of new ordinary shares were issued.
Required:
Calculate the following ratios for 2011 and 2010.
(a) Profit margin; (b) Asset turnover;
(c) Earnings per share; (d) Price earnings ratio;
(e) Dividend payout ratio; and (f) Debt ratio.
Additional information:
1. Ordinary shares are sold at RM19.50 per share.
Required:
Calculate the following ratios for the year 2011:
Answers
Exercise 1.1
1. Internal users are people who have direct access to the resources of an entity
and are normally involved in the management of the company; an example
being the companyÊs management. These people are involved in planning
and controlling the activities of the company to enable it to achieve
specified objectives. Examples of common decision making are:
(a) does the company require additional capital or not; if the
company requires additional capital, would the company be applying
for loan or issue shares.
(b) does the company require additional asset; if the company requires
additional asset, would the company be buying or renting it.
(c) how much is the companyÊs excess cash, if any, should be utilised.
(d) how the company is going to overcome insufficient cash flow
problems it might be facing.
(e) the companyÊs strategy to expand the market for its products.
External users are people who do not have direct access to the
resources of the company and to not involved in the management of the
company. Examples of external users are investors, loan providers, Inland
Revenue Board, government agencies and the public. The types of decision
made are different according to user groups. For example, investors make
decisions on whether to invest in a company, loan providers make
decisions on whether to approve loans while the Inland Revenue Board
decide on the total tax to be imposed.
Exercise 1.2
1. The characteristics of accounting information can be divided into two
categories, primary characteristics and secondary characteristics. The
primary characteristics are comprised of relevance and reliability, while the
secondary characteristics are comparability and consistency.
Exercise 1.3
1. The purpose of accounting is to provide information to stakeholders about
the economic activities and conditions of a business so that they can make
informed decision. These stakeholders may have direct or indirect interest
in the business. The information provided usually takes in the form of
financial statements and can be analysed using different financial tools to
suit their purpose.
they bring RM2. All these examples show that the currency value has
changed. In other words, the RM1 you have today will not have the
same value as the RM1 you will receive in a couple of monthsÊ time.
The fluctuation in the currency value should have been taken into
account when recording transactions but was ignored.
Exercise 1.4
1. B
2. A
3. D
4. C
5. False
6. False
7. True
8. False
9. False
Exercise 1.5
1. (a) Seri Consultation Services Income Statement For the year ended 31
December 2008.
RM RM
Service Revenue 78,750
(-) Expenses:
Supplies expenses 6,300
Tax expenses 4,200
Salary expenses 18,000
Rental expenses 14,400
Utility expenses 7,350
Sundry expenses 1,265 (51,515)
Net income 27,235
RM
Capital, Seri Dewi – 1 Jan 22,200
(+) Net income 27,235
49,435
(-) Drawings (6,000)
Capital, Seri Dewi – 31 Dec 43,435
RM
ASSETS
Cash (23,300 – 6,000) 17,300
Accounts receivable 18,855
Supplies 8,480
TOTAL ASSETS 44,635
LIABILITIES
Accounts Payable 1,200
OWNERÊS EQUITY
Capital, Seri Dewi 43,435
TOTAL LIABILITIES AND O.EQUITY 44,635
2. Statement of cash flow for Samrah Florist for the year ended 30 June 2011:
Samrah Florist
Statement of Cash Flow
For year ended 30 June 2011
Exercise 2.1
1. (a) It is not a transaction and must not be recorded. This is because it will
not affect the entityÊs financial position (will not affect the asset,
liability or owner equity) and cannot be measured in currency unit.
(b) It is a transaction and must be recorded. This will affect the entityÊs
financial position (increase asset and owner Ês equity) and can be
measured in currency unit.
(c) It is not a transaction and must not be recorded. This is because it will
not affect the entityÊs financial position (will not affect the asset,
liability or owner equity) and cannot be measured in currency unit.
Only after the staff has served the entity would it be obliged to pay his
salary. Only then there will be outflow of/decrease in asset and
ownerÊs equity.
(d) It is a transaction and must be recorded. This will affect the entityÊs
financial position (decrease asset and owner Ês equity) and can be
measured in currency unit.
Exercise 2.2
1. Account is a specific and separate accounting record for each item in the
financial statement. It records the increases and decreases in specific assets,
liabilities and ownerÊs equity items. All transactions that affect the items
will be recorded in the accounts. Chart of accounts is the list of accounts in
the ledger and their identification numbers.
2. T-Account and three column account. T-account is easier but the three
column account enables us to know the last balance after each transaction.
5. Drawings are made by the owner for personal use while expenses are
incurred by the entity for the purpose of generating income. Drawings are
not considered in the calculation of net profit of loss, but are deducted
directly from owner's equity.
6. B
7. C
8. C
9. B
10. C
Exercise 2.3
1. (a) 46,000
(b) 100,000
(c) 75,000
3.
Exercise 3.1
1. Journal is the first book of entry for a transaction before the data is
transferred to the accounts. It discloses the complete effects of every
transaction and provides a chronological record of all transactions. A
ledger is an entire group of accounts maintained by an entity. It provides all
the information about changes in specific account balances.
2. The primary purpose of a trial balance is to prove the equality of debits and
credits after posting. A trial balance may also help to uncover errors in
journalising and posting and is useful in preparing financial statements.
3. (a) Asset
(b) Expense
(c) Asset
(d) Income
(e) Liability
(f) Asset
(g) Expense
(h) Asset
Exercise 3.2
Samurai Laundry Service
Trial Balance as at 30 April 2011
ACCOUNTS RM RM
Account Payables 10,263
Account Receivables 11,654
Capital 46,381
Cash 31,519
Drawings 570
Equipment 48,350
Insurance expense 1,800
Loan 32,500
Repair expenses 971
Salaries expenses 4,832
Service revenue 12,310
Utility expenses 1,758
101,454 101,454
Exercise 3.3
1. (a) Journal entries for all the transactions.
Date Account and Description Reference Debit (RM) Credit (RM)
Apr 2011
a. Cash 5,000
Capital, Cindy 5,000
(Cash investment by Cindy)
b. Supplies 275
Accounts payable 275
(Purchase of supplies on credit)
c. Cash 3,250
Service revenue 3,250
(Cash received for services
provided)
d. Rental expenses 750
Cash 750
(Payment of rental by cash)
e. Accounts payable 125
Cash 125
(Payment to accounts payable)
f. Accounts receivable 1,875
Service revenue 1875
(Customer has not paid for
services provided)
g. Utility expenses 390
Sundry expenses 187
Cash 577
(Payment for expenses by cash)
h. Salary expenses 1,250
Cash 1,250
(Payment for salary by cash)
i. Supplies expenses 162
Supplies 162
(Usage of supplies)
j. Drawings 550
Cash 500
Supplies 50
(Cash and supplies drawings
by owner)
Cash Account
Date Description Reference Debit Credit Balance
(RM) (RM) (RM)
Apr 2011 Capital, Cindy 5,000 5,000
Service revenue 3,250 8,250
Rental expenses 750 7,500
Accounts payable 125 7,375
Utility expenses 390 6,985
Sundry expenses 187 6,798
Salary expenses 1,250 5,548
Drawings, Cindy 500 5,048
Account Receivable
Date Description Reference Debit Credit Balance
(RM) (RM) (RM)
Apr 2011 Service revenue 1,875 1,875
Supplies Account
Date Description Reference Debit Credit Balance
(RM) (RM) (RM)
Apr 2008 Account payable 275 275
Supplies expenses 162 113
Drawings, Cindy 50 63
Accounts Payable
Date Description Reference Debit Credit Balance
(RM) (RM) (RM)
Apr 2008 Supplies 275 275
Cash 125 150
Exercise 4.1
(a) Accrued Revenue
Accrued revenue refers to the revenue that has been obtained but there is
no incoming cash flow into the business entity. This happens when the
goods or services have been supplied to the customer but the customer has
not paid for it yet. Accrued revenue is an asset as the benefit in the form of
cash will be obtained by the business entity in the future. Examples of
accrued revenue are rental revenue receivable, service revenue receivable
and interest receivable.
Exercise 4.2
Adjusted Entries as at 31 December 2010
6. Cash RM5,000
Unearned revenue RM5,000
Exercise 4.3
1. Dapur Rona's Adjusting Entries as at June 30, 2011
Exercise 4.4
1. (a) Appropriate Adjusting Journal Entries.
1. (b) Adjusted Trial Balance as at 31 December 2010 for Asoka Travel and
Tours.
Debit Credit
Cash 10,350
Account receivables 67,500
Revenue receivable 5,325
Supplies 3,600
Motor vehicles 341,100
Accumulated depreciation 12,300
Account payable 15,750
Accrued utilities expenses 1,800
Unearned revenue 9,000
Capital 234,000
Drawings 13,500
Revenue earned 421,575
Depreciation expense 12,300
Salary expense 94,500
Supplies expenses 12,600
Petrol expense 8,100
Rent expense 24,000
Insurance 48,000
Utilities expenses 53,550
694,425 694,425
Exercise 4.5
The adjusting entries that were made and prepare for Bamba Management
Consultant journal entries.
Exercise 5.1
1. Income statement for the period ended 30 June 2010 for KhairunnisaÊ
Consulting Services.
RM RM
Fees Revenue 119,280
Less Expenditure:
Sundry expenses 10,700
Rental expenses 13,800
Utility expenses 4,900
Salary expenses 49,600
Supplies expenses 5,600
Insurance expenses 3,500
Depreciation expenses 825
Total expenditure (88,925)
Net revenue 30,355
RM RM
Current Assets Current Liabilities
Cash 56,350 Accounts Payable 17,600
Accounts Receivable 41,600 Salary Payable 7,100
Office supplies 12,300 Unearned fees 10,980
Rental prepayment 4,400 35,680
Insurance prepayment 15,100
129,750 Non-current Liabilities
Notes Payable 100,000
Total liabilities 135,680
Non-current Assets
Office equipment 99,000 OwnerÊs Equity
Less: Accumulated 10,725 Opening capital, 51,990
Depreciation 0000000 KhairunnisaÊ
Net book value 88,275 Net revenue 30,355
Closing capital,
KhairunnisaÊ 82,345
Total Assets 218,025 Total Liabilities & Equity 218,025
The balance sheet is presented according to the account format. You can also
use the report format as suggested by MASB1. If the report format is used,
the net assets reported are RM94,070. Therefore, the total assets will be
RM182,345. Total non-current liabilities and equity are the same at
RM182,345.
Exercise 5.2
1. (a) Adjusting Entries RM RM
Supplies expenses 890
Supplies 890
Insurance expenses 315
Insurance prepayment 315
Depreciation expenses 4,950
Accumulated depreciation 4,950
Salary Expenses 440
Salary payable 440
1. (b) (i) Income Statement for Berkat Enterprise For the Period Ended
30 June 2011
Berkat Enterprise
Income Statement
For the Period Ended 30 June 2011
RM RM
Service revenue 60,625
Salary expenses 22,855
Sundry expenses 8,420
Supplies expenses 890
Insurance expenses 315
Depreciation expenses 4,950 (37,430)
Net profit (23,195)
1. (b) (ii) Balance Sheet for Berkat Enterprise For the Period Ended
30 June 2011
Berkat Enterprise
Balance Sheet
30 June 2011
RM RM RM
Non-current Asset:
Office equipment 51,650
Accumulated Depreciation (14, 650) 37,000
Curent assets:
Cash 3,425
Account receivable 8,000
Supplies 380
Insurance prepayment 305 12,110
Current liablities:
Salary payable 1,365
Unearned revenue 750 2,115
1. (c) Closing entries for Berkat Enterprise For the Period Ended 30 June
2011
Closing entries RM RM
Service Revenue 60,625
Revenue Summary 60,625
Capital 5,200
Drawings 5,200
Adjusting entries RM RM
Salary expenses 100
Accrued/Payable Salary 100
Closing entry
Revenue summary 100
Salary expenses 100
Reversing entry
Accrued salary 100
Salary expenses 100
Salary expenses
RM RM
31/12/10 Adjusting 100 31/12/10 Closing 100
100 100
01/01/11 Payment 120 01/01/11 Reversing 100
Accrued Salary
RM RM
31/12/10 Balance 100 31/12/10 Adjusting 100
100 100
01/01/11 Reversing 100 01/01/11 Balance 100
Revenue Summary
31/12/10 Closing RM100
Cash
01/01/01 Payment RM120
3. (a) (i)
Moiz Real Estate
Income Statement
for the Period Ended 31 December 2010
RM RM
Revenue:
Service revenue 118,250
Less Expenditure:
Salary expenses 44,830
Depreciation expenses 5,430
Rental expenses 8,400
Sundry expenses 3,010
Total expenditure 61,670
Net revenue 56,580
3. (a) (ii)
Moiz Real Estate
Statement of Changes in Equity
for the Period Ended 31 December 2010
RM
Capital, Moiz, 1 January 2004 58,000
Add: Net revenue 56,580
114,580
Less: Drawings (10,400)
Capital, Moiz, 31 December 2004 104,180
3. (a) (iii)
Moiz Real Estate
Balance Sheet
As at 31 December 2010
RM RM RM
Current Assets Current Liabilities
Cash 6,850 Accounts Payable 1,850
Accounts Receivable 14,000 Unearned revenue 2,500
Supplies 2,540 Total current liabilities 4,350
Insurance prepayment 1,240
Total current assets 24,630 Owner Ês Equity
Capital, Moiz 104,180
Non-current Assets
Equipment 103,300
Acc Dep (19,400)
Net book value 83,900
Total Assets 108,530 Total Liabilities &
108,530
Equity
The above Balance Sheet was reported using the account format. If the
statement format is used, the total net assets would be RM20,280 and the
total assets would be RM104,180. The total equity would also be RM104,180.
Closing Entries
RM RM
Service revenue 118,250
Revenue Summary 118,250
Capital 10,400
Drawings 10,400
Exercise 6.1
1. Regulations that are linked with financial reporting
(i) The Companies Act 1965
(ii) The Securities Commission 1995
(iii) The Financial Reporting Act 1997
(iv) The Income Tax Act 1967
Exercise 6.2
1. The purpose of preparing a financial report is to provide information about
the financial position, performance and changes in the financial position of
a company that is useful in making economic decisions such investments
and lending decisions.
3. Notes to the accounts are prepared for the users of accounting information
to clarify the total of the accounts as reported in the financial statement.
4. (a) True
(b) False
(c) False
(d) True
(e) False
(f) False
(g) True
(h) False
(i) False
(j) False
Exercise 7.1
1. (a) False
(b) False
(c) True
(d) False
Exercise 7.2
1. 2/10, n/30
2% discount will be given if payment is made within 10 days from the
invoice date and the last payment period (without discount) is within 30
days.
2. Sales Discount
Price reduction will be given on credit sales if customer pays within
discount period.
3. Purchase Discount
Price reduction will be given by seller to buyer if buyer pays within
discount period.
Exercise 7.3
1. C
2. Purchase Allowance
Exists when buyer does not return the goods that do not meet specification
and seller agreed to reduce the purchase price.]
Purchase Return
Exists when buyer return the goods that do not meet specification.
3. Sales Allowance
Exists when buyer chooses to keep the damaged goods.
Sales Return
Exists when buyer returns the damaged goods.
Exercise 7.4
The differences between FOB shipping point with FOB destination are as below:
FOB destination defined that the ownership of the goods will be transferred from
the seller to the buyer when the goods reached the buyerÊs destination, which is
the buyerÊs warehouse. The goods purchased will be owned by the buyer or can
be recorded as the buyerÊs inventory only when the buyer has received the
goods. The buyer cannot record the goods in its inventory during purchase but
only upon receiving the goods. The seller will bear the transportation cost and
record it as carriage outwards after it had been paid. Carriage outwards will be
included in the income statement as a part of the operating expenditure.
Exercise 8.1
1. Credit terms of 2/10, n/30 means that the company will receive 2% cash
discount if payment is made within 10 days from the date of invoice.
However, the last payment period is 30 days from date of invoice with the
amount to be paid as stated in the invoice.
RM RM
July 24 Dr Accounts receivable 1,900
(RM2,000 – RM100)
Cr Inventory (RM1,900 2%) 38
Cr Cash (RM1,900 – RM38) 1,862
2. One credit sales was on 10 July totalling RM800 with credit terms 2/10,
n/30. On 12 July, RM100 worth of goods had been returned. Prepare
journal entries on 19 July to record the cash received by customer.
RM RM
July 19 Dr Cash (RM700 – RM14) 686
Dr Sales discount (RM700 2%) 14
Cr Accounts receivable
(RM800 – RM100) 700
Exercise 8.2
(a) Journal
(b) Ledger
Cash
Date Description Debit Credit Balance
May 1 Balance 5,000
9 Accounts receivable 4,410 9,410
10 Accounts payable 5,684 3,726
11 Supplies 900 2,826
12 Inventory 2,400 426
15 Inventory 230 656
19 Inventory 250 406
24 Sales 6,200 6,606
27 Accounts payable 1,862 4,744
29 Sales return and allowances 100 4,644
Accounts receivable
Date Description Debit Credit Balance
May 2 Sales 4,500 4,500
9 Cash 4,410 90
9 Sales discount 90 0
31 Sales 1,600 1,600
Inventory
Date Description Debit Credit Balance
May 1 Accounts payable 6,000 6,000
2 Cost of goods sold 3,000 3,000
5 Accounts payable 200 2,800
10 Accounts payable 116 2,684
12 Cash 2,400 5,084
15 Cash 230 4,854
17 Accounts payable 1,900 6,754
19 Cash 250 7,004
24 Cost of goods sold 4,340 2,664
27 Accounts payable 38 2,626
28 Account payable 1,000 3,626
29 Cost of goods sold 70 3,696
31 Cost of goods sold 1,120 2,576
Supplies
Date Description Debit Credit Balance
Cash 900 900
Accounts payable
Date Description Debit Credit Balance
May 1 Inventory 6,000 6,000
5 Inventory 200 5,800
10 Inventory 116 5,684
10 Cash 5,684 0
17 Inventory 1,900 1,900
27 Inventory 38 1,862
27 Cash 1,862 0
28 Inventory 1,000 1,000
Sales
Date Description Debit Credit Balance
May 2 Accounts receivable 4,500 4,500
24 Cash 6,200 10,700
31 Accounts receivable 1,600 12,300
Sales Discount
Date Description Debit Credit Balance
May 9 Accounts receivable 90 90
RM RM
Sales revenue:
Sales 12,300
Less: Sales return and allowances 100
Sales discount 90 (190)
Net sales 12,110
Cost of goods sold (8,390)
Gross profit 3,720
Exercise 8.4
(a) Adjusting Entries
Entries Debit Credit
1. Depreciation expenses – building 10,000
Accumulated depreciation – building 10,000
2. Depreciation expenses – equipment 9,000
Accumulated depreciation – equipment 9,000
3. Interest expenses 7,000
Interest payable 7,000
RM RM RM
Sales revenue:
Sales 902,100
Less: Sales Discount (4,600)
Net Sales 897,500
Cost of goods sold (709,900)
Gross profit 187,600
Less: Operating expenses
Sales expenses:
Salary expenses (69,800 80%) 55,840
Maintenance expenses 7,200 63,040
Administrative expenses
Salary expenses (69,800 20%) 13,960
Depreciation expenses – building 10,000
Utility expenses 19,400
Depreciation expenses – equipment 9,000
Repair expenses 5,900
Insurance expenses 3,500 61,760
Total operating cost (124,800)
Operating revenue 62,800
Other expenses – interest expenses (7,000)
Net revenue 55,800
Current Assets:
Cash 23,400
Accounts receivable 37,600
Inventory 90,000 151,000
Current Liabilities:
Notes payable (mature in year 2001) 15,000
Accounts payable 37,500
Interest payable 7,000 59,500
Financed by:
Capital (267,800+55,800-10,000) 313,600
Long-term liability 35,000
348,600
Exercise 8.5
1.
Date Description Debit Credit
Mar 2 Accounts receivable 800,000
Sales 800,000
Cost of goods sold 600,000
Inventory 600,000
Mar 6 Sales return and allowance 120,000
Accounts receivable 120,000
Inventory 90,000
Cost of goods sold 90,000
Mar 12 Cash (680,000 – 13,600) 666,400
Sales discount (680,000 2%) 13,600
Accounts receivable 680,000
2.
Description Debit Credit
Sales 180,000
Revenue summary 180,000
Revenue summary 102,000
Cost of goods sold 100,000
Sales discount 2,000
Goods inventory 40,000
Revenue summary 40,000
3. (i)
Date Description Debit Credit
April 5 Inventory 16,000
Accounts payable 16,000
April 6 Inventory 900
Cash 900
April 7 Equipment 26,000
Accounts payable 26,000
April 8 Accounts payable 3,000
Inventory 3,000
April 15 Accounts payable (16,000-3,000) 13,000
Inventory [(16,000-3,000) 2%] 260
Cash (13,000-260) 12,740
(ii)
Date Description Debit Credit
May 4 Accounts payable 13,000
Cash 13,000
4.
Date Description Debit Credit
Sept 6 Inventory (80 RM19) 1,520
Cash 1,520
Sept 9 Inventory 80
Cash 80
Sept 12 Accounts receivable (26 RM30) 780
Sale 780
Cost of goods sold (26 RM20) 520
Inventory 520
Sept 14 Sales return and allowance 30
Accounts receivable 30
Inventory 20
Cost of goods sold 20
Sep 20 Accounts receivable (30 RM30) 900
Sales 900
Cost of goods sold (30 RM20) 600
Inventory 600
5. (a)
Date Description Debit Credit
Dec 3 Accounts receivable 480,000
Sales 480,000
Cost of goods sold 320,000
Inventory 320,000
Dec 8 Sales return and allowance 20,000
Accounts receivable 20,000
Dec 13 Cash (460,000 – 9,200) 450,800
Sales discount [(480,000 – 20,000) 2%] 9,200
Accounts receivable 460,000
(480,000 – 20,000)
(b)
Date Description Debit Credit
Jan 2 Sales 460,000
Accounts receivable 460,000
(RM480,000 – RM20,000)
Exercise 9.1
• Efficient collection policy of accounts receivable
A business should have a reasonable average collection time for receivables
to ensure cash is not tied up. This is important not only to ensure sufficient
cash available but also to avoid the potential of having bad debt.
Exercise 9.2
To safeguard and ensure accuracy of recording cash transactions, as well as
minimising the potential for making errors.
Exercise 9.3
Exercise 9.4
Springfield Enterprise
Bank Reconciliation
31 June 2011
Item RM Item RM
Bank statement balance 1,455.00 Book balance 1,220.00
Add: Add:
Deposit in transit 80.00 Dividend earned 60.00
Interest 95.00
1,535.00 1,375.00
Deduct: Deduct:
Unpresented cheque 175.00 Cheque book 15.00
Exercise 10.1
The bases of comparison for intra-company, inter-company and industry average
can be compared by looking at the financial information aspect.
Exercise 10.2
1. The difference between horizontal analysis with vertical analysis is that
horizontal analysis is used especially for comparison within the company
while vertical analysis can also be used for within the company or between
companies comparison. Ratio analysis is used in all three bases of
comparison, which are within the company, between companies and
industry average.
2. Horizontal Analysis
Change in
Percentage
31 Dec 2010 31 Dec 2011 Amount Calculation
(%)
(RM)
Accounts 500,000 400,000 100,000 100k/500k 20%
receivable
Inventory 840,000 600,000 240,000 240k/840k 28.57%
Total 3,220,000 2,800,000 420,000 420k/3,220k 13.04%
current
assets
Vertical Analysis
31 Dec 2010 31 Dec 2011
Accounts 500,000 15.52% 400,000 14.28%
receivable
Inventory 840,000 26.08% 600,000 21.42%
Total asset 3,220,000 100% 2,800,000 100%
Exercise 10.3
1. The meaning of current ratio and quick ratio, including their formula, are
shown below:
Explanation Formula
Current ratio To measure the adequacy Current asset
of current asset to pay Current liability
current liability
Current asset
(b) Current ratio =
Current liability
42, 918, 000
=
45, 844, 000
= 0.94 : 1
Exercise 10.4
Cost of goods sold
Inventory turnover =
Average inventory
Exercise 10.5
Current Asset
(a) Current ratio =
Current Liability
Quick asset
(b) Quick ratio =
Current Liability
65,000 + 20,000
=
50,000
= 1.7 : 1
Exercise 10.6
1. Desa Sdn. Bhd.
Balance Sheet
as at 31 December 2010 and 2011
2010 Increase (Decrease)
2011
(RM) Amount Percentage
(RM)
Basis Year (RM) (%)
Assets:
Current asset 125,000 100,000 25,000 25.0
Equipment (net) 400,000 330,000 70,000 21.2
Total Assets 525,000 430,000 95,000 22.1
Liabilities:
Current liability 91,000 70,000 21,000 30.0
Long-term liability 144,000 95,000 49,000 51.6
Total Liabilities 235,000 165,000 70,000 42.4
OwnerÊs Equity:
Ordinary shares @ RM1 155,000 115,000 40,000 34.8
Retained earnings 135,000 150,000 (15,000) (10.0)
Total ownerÊs equity 290,000 265,000 25,000 9.4
Total liabilities and ownerÊs equity 525,000 430,000 95,000 22.1
Net profit
2. (a) Profit margin =
Sales (net)
64,000
=
800,000
= 8%
Net sales
(b) Asset turnover =
Average total asset*
800,000
=
550,000
= 1.5 times
Net profit
(c) Return on asset =
Average total asset*
64,000
=
550,000
= 11.6%
Formula 2010
(a) Profit margin Net profit 35,000
Sales (net) 650,000
5.4%
(b) Asset turnover Net sales 650,000
Average total asset* 561,500*
1.2 times
* [Total asset last year +
Total asset current year] *(533k+590k)/2
2 *561,500
Formula 2010
(c) Earnings per Net profit - Dividend 35,000
share for Preference Shares 30,000* unit
Average ordinary shares RM1.17
issued (unit)
*(300,000+300,000)/2
RM10
* 30,000
Current Asset
4. (a) Current ratio =
Current Liability
235,000
=
135,000
= 1.7 : 1
Quick asset
(b) Quick ratio =
Current Liability
41,000 + 18,000 + 92,000
=
135,000
= 1.1 : 1
Gross profit
(e) Gross profit margin =
Sales (net)
235,000
=
650,000
= 36.2%
Net sales
(f) Asset turnover =
Average total asset*
650,000
=
599,000
= 1.1 times
Net profit
(g) Return on asset =
Average total asset*
59,800
=
599,000
= 10%
Net profit
(h) Return on ownerÊs equity =
Average owners equity's ordinary shares*
59,800
=
361,500
= 16.5%
* [Total owner equity last year + Total owner equity current year]
2
350,000 + 373,000
2
361,500
Cash dividend*
(k) Dividend payout ratio =
Net profit
36,800
=
59,800
= 61.5%
Total liability
(l) Debt to equity ratio =
Total owner's equity
265,000
=
373,000
= 71.0%