ACCOUNTING1 Cevdet

FINANCIAL ACCOUNTING, COST ACCOUNTING AND MANAGERIAL ACCOUNTING
CHAPTER 1: FINANCIAL ACCOUNTING
1.1 BOOK-KEEPING AND ACCOUNTING
1.1.1 Book-keeping and Accounting in Business
We can usually observe familiar and similar headlines as well as announcements

while reading newspapers and watching TV. Frequently, the firms involved here
have profits or losses running into many millions of Turkish liras. Far-reaching
decisions are taken on the basis of some results. These decisions are such as
whether a company will raise the prices of goods that all of us buy regularly, or
whether it will build a new factory or close down an old one. In addition to this, an
investor uses these figures to help him or her decide where to put money. As an
example, an investor can put money into a construction company, an insurance firm
or a brewery.
In regards to these decisions, it is very important that the profits and the losses of
the companies and other financial information are reported correctly. The figures
for the profits and the losses are calculated from book-keeping and accounting
records which include the firm’s all transactions during the year. However, it is
clear that such records are designed to fit the needs of the company. For instance,
when Ulker or Eti sold you a bar of chocolate last week, the transaction was
recorded somewhat differently from, say, the sale to a refinery of a tanker's load of
crude oil. Despite that, the principle is the same. Both transactions are included to
the firm's book-keeping and accounting records and both contribute to its profit or
loss for the year.
Book-keeping is the recording of business transactions in books of account and we

must be concerned principally with the system known as double-entry book-
keeping. Using this system, each business transaction is entered twice into the
books of account. In case this is done correctly, it will be possible to show the
books 'balance'. Accounting is generally taking the basic information from the
books of account and using it to explain the financial condition of the business. This
method involves producing accounts at the end of each financial year to show the
profit or loss of the business.
By the way, the words 'book-keeping' and 'accounts' are sometimes used
incorrectly. Because some people usually talk about 'books', 'accounts', 'books of
account' and 'accounting' as if all mean the same thing. On the other hand, we must
always remember that book-keeping is the preparation of the basic accounting
records while accounting is the putting of these records to further use.
1
COST ACCOUNTING Ahmet Kızıl- Cevdet Kızıl
1.1.2 Abilities of Book-keeping / Accounting System
Indeed, a lot of information can be gathered from the book-keeping or accounting

system of a company. We will use the word of “Financial Acoounting” instead
of ‘book-keeping’ and ‘accounting’. As an example, we can learn the following:
(a) the sales,

(b) the purchases,
(c) the expenses, such as wages, heating and phone costs,
(d) the gross and net profits or losses for the year,
(e) the total amount of money owed to the business,
(f) the total amount of money owed by the business,
(g) the amount of cash held by the business, together with the amount of its bank
balance or bank overdraft,
(h) the premises, motor vehicles, machinery and etc… that the firm owns,
(i) the amount invested in the business, in other words its capital,
(j) the amount of money drawn out of the company by the owner.
Moreover, as a student of book-keeping, you will usually need to practice your

new-found skills. The great majority of that practice will be acquired from the use
of handwritten accounts. However, whether handwritten accounts are used or
computer help is obtained, the fundamental book-keeping procedures are always the
same: Remember that you are the one who enable computer miracle.
1.1.3 Business Transactions
In book-keeping and accounts, we record the transactions of a particular company.

We don’t record the transactions of the owner of that specific business acting in
terms of personal capacity. This means that assets owned by him or her personally,
such as a house, TV set or car, do not appear in the books of the firms; nor do
liabilities (debts) owed personally, such as a bank overdraft. But, when dealing
with the accounts of a small business run by one person, it is a common mistake to
confuse the owner's assets and liabilities with those of the business. We must be very
careful at this point and avoid it completely. Because such items must always be
separate and if we remember this rule, it will help our book-keeping and accounting
2
activities seriously. This idea, or in other words this rule states that our accounts
record only the transactions of the business, and not those of the owner carried out
in a personal capacity. This rule is known as the business entity or separate entity
concept. Also, when a person decides to start a business and puts in some of his or
her personal money, we must record this in the business books. The owner's stake
in the company is called capital.
The next critical thing to remember is that we must use money as the unit of
measurement for all business transactions. The reason here is that it is only possible
to include together machinery and motor vehicles if both are measured in terms of
money values. This idea/rule is called the money measurement concept.
1.1.4 Some Accounting Terms
In this chapter, we have learned some accounting terms which you will be much
more familiar in the near future.
(a) Books of account record the business transactions, usually using a system
called double-entry book-keeping.
(a) Book-keeping refers to the keeping of books of account.
(b) Accounting puts the fundamental book-keeping data for further use in
order to explain the financial condition of the business.
(d) Assets mean the things owned.
(e) Liabilities (debts) are the amounts owed.
(f) Capital is the amount invested in a company by the owner.
(e) Business entity concept—to record the transactions of a business, and
not to record the personal transactions of the owner.
(f) Money measurement concept—money amounts are used to measure business
transactions.
1.2 DOUBLE ENTRY AND ACCOUNTS
Business transactions always consist of two aspects:

(g)a gain (profit);
(ii) a loss.
Actually, we experience these two aspects already in our daily lives. Now, let’s
consider a few transactions that you yourself might make. For example, if you go to
a shop and buy bread, you have got bread, but there is also a loss of cash. Let’s
provide another example. If you sell your bike to a friend, you will lose your bike, but
you will also gain cash. Finally, in case you swap your old computer for your friend's
bike, then you have now obtained a bike, but also lost a computer.
3
While each of these transactions has two aspects, we would not record them
formally in books of account because they are personal transactions and not
company transactions. However, it is necessary for a firm to keep accurate records
of all business transactions. Besides, the company must show both the gain and the
loss caused by each.
As a book-keeper, your duty is to record the transactions of a specific business

from the viewpoint of that business. Let’s suppose that you have just been hired as
the book-keeper to a newly founded business. The first few transactions are shown
below.
Cover up the answers and check if you are able to work out the gain and the loss
in each, from the business's point of view.
Date Transaction Gain Loss

20-1
Jan 1. Started business with 2 000 YTL in cash. Cash Capital
Jan 2. Bought a furniture for 750 YTL, paying in cash. Furniture Cash
Jan 3. Put 800 YTL cash into a bank account. Bank Cash
Jan 4. Bought a secondhand car for 1 200 YTL, paying by
check. Car Check
Jan 5. Bought a printer for 150 YTL, paying in cash. Printer Cash
Jan 6. Sold the furniture as being unsuitable for 750 YTL,
a check being received. Check Furniture
Perhaps, the first transaction is the most difficult one since it is tightly related
with the owner's capital. Because, at that particular point, the owner is putting
some money into the business. As book-keepers, we are looking at the transaction
from the point of view of the business just as we mentioned before. So, we can
realize that its gain is 2,000 YTL in cash, and the loss is that it owes this amount of
money to the owner. On the opposite side, the capital is unlikely to be repaid to the
owner because, in that scenario, the business would cease to exist.
The Accounts
A book-keeping system is comprised of a number of separate accounts which, when

put together in a book, stored in a CD or held on a computer disc, are known as a
ledger or a ledger section So, to use and implement the filing cabinet idea, each
separate card or paper file stands for an individual account, each drawer of the filing
cabinet a ledger section, and the whole filing cabinet the ledger.
The book-keeper's responsibility is to enter the transactions of the business into

accounts. The two aspects of each transaction—gain and loss—are entered into
4
two different accounts, indeed this is the main reason we use the term double-
entry book-keeping.
Dr (Name of Account) Cr
. .
Date Details Folio YTL P Date Details Folio YTL P
The figure above shows a ruling for an account together with the headings. Paper
preprinted with such ruling may be purchased from a stationer. You will only
need to ask for a ledger paper.
Rules:
(a) The name of the account is written at the top.
(b) The page is divided into two halves by the central vertical line. Here, the left-
hand half is known as the debit side (Dr. stands for 'debtor'), while the right-hand
half is known as the credit (Cr. stands for credit) side.
(c) Both halves have identical vertical lines. That is to give space for the date,
details and the amount of each transaction.
(d) The folio column is used as a cross-referencing device.
Each business transaction must be entered into two accounts: on the debit side of
one, and on the credit side of another. The debit side of an account has two important
functions. It is used to record gains made by the business and amounts owing to the
business. On the other hand, the credit side records losses and amounts owing by
the business.
Now we will consider how these would be entered into the accounts. Here is the
first transaction:
Jan 1. Started the business with 2,000 YTL in cash.

Before, we had explained that the two sides of this transaction are that the business
gains 1,500 YTL in cash and at the same time owes this amount back to the
owner. Because of this, the transaction will be entered on the debit side of the
Cash Account, and on the credit side of the Capital Account, as shown below:
CASH
20-1 YTL 20-1 YTL
Jan 1 Capital 2 000

5
CAPITAL
20-1 YTL 20-1 YTL
Jan 1 Cash 2 000

Notes:
(a) In the 'details' column of each account, the name of the other
account related to the transaction is written. That rule acts as a method of
cross-referencing.
(b) In practice, indeed each account would be opened on a new page. However, in
exercises, several accounts can be shown on one page.
(c) For making this example easier to understand, all vertical lines on the paper are
not shown.
Here is the second transaction:
Jan 2. Bought a furniture for 750 YTL, paying in cash.
In this step, the business obtains a machine, but loses cash. So, the transaction is
entered on the debit side of the Machinery Account and on the credit side of the
Cash Account. The second transaction takes place below.
FURNITURE AND FIXTURE

20-1 YTL 20-1 YTL
Jan 2 Cash 750

CASH
20-1 YTL 20-1 YTL
Jan 1 Capital 1,500 Jan 2 Furniture and Fix. 750

For this transaction, we have opened a new account for machinery but, as we had
already opened a Cash Account in the first transaction, there is no need to open
another one. The full set of accounts from all the business transactions given in
section 1.2.1 is as follows:
CAPITAL
20-1 YTL 20-1 YTL
Jan 1 Cash 2 000

6
CASH
20-1 YTL 20-1 YTL
Jan 1 Capital 2 000 Jan 2 Furniture and fix. 750
Jan 3 Bank 800
Jan 5 Furniture 150
BANKS
20-1 YTL 20-1 YTL
Jan 3 Cash 800

MOTOR VEHICLES
20-1 YTL 20-1 YTL
Jan 4 Checks Given 1 200

FURNITURE AND FIXTURES

20-1 YTL 20-1 YTL
Jan 2 Cash 750 Jan 6 Check received 750
Jan 5 Cash 150

CHECKS GIVEN
20-1 YTL 20-1 YTL
Jan 4 Motor Vehicles 1 200

CHECKS RECEIVED
20-1 YTL 20-1 YTL
Jan 6 Furniture and fixture 750

As it is easily seen, the new accounts have been opened as required. Here, it is really
important to realize that money in the form of cash has been distinguished from
money in a bank account, and an account has been opened for each. In other
words, these two accounts are completely different from each other. The Bank
Account shown above is the company’s own record of how much money it has put
into or taken out of its bank account. On the opposite side, the bank which is a
7
separate institution from the business also records these transactions from its own
point of view. In this example, on January 3, the bank has gained cash (debit Cash
Account) but owes this amount of money back to the customer (credit customer's
account). So, in our accounts, we record the transaction on the debit side because
we have gained an amount in our Bank Account. However, the bank will show the
transaction as a credit entry, because it owes the money back to us. Finally, in
double-entry book-keeping, debits are always gains, while credits are always losses
from the point of view of the business whose accounts we are considering.
1.3 THE TRANSACTIONS
When we bought or sold items such as machines, printers or vans, we either paid or
received cash or a check immediately. Just have a look at the example below:
9 Mar. 20-1 Bought a machine for 1 400 YTL, paying by check. This is
correctly entered into the accounts as:
MACHINERY AND EQUIPMENTS

20-1 YTL 20-1 YTL
Mar. 9 Checks Given 1 400

CHECKS GIVEN
20-1 YTL 20-1 YTL
Mar. 9 Machinery 1 400

Here, the firm has obtained a machine costing 1,400 YTL and its checks given
balance has grown by the same amount.
The vast majority of the businesses buys or sells items on credit. But payment is
made some time after the item has been supplied. In this context, we must always
keep in mind that the book-keeping logic remains the same. Because, there have
been a gain and a loss. Assume that the transaction reads as follows:
12 Mar.. 20-1 Bought a furniture for 900 YTL, on credit from Enes Olgun Ltd.
Although the company whose accounts we are preparing has gained a furniture, its
bank balance remains unchanged. Instead, the business owes 900 YTL to Enes
Olgun Ltd. The accounts will appear like this:
8
FURNITURE AND FIXTURE

20-1 YTL 20-1 YTL
Mar. 12 Accounts Payable 900
Enes Olgun Ltd.

ACCOUNTS PAYABLE
Enes Olgun Ltd.
20-1 YTL 20-1 YTL
Mar. 12 Furniture 900

The second of these accounts tells us that 'our' business owes 900 YTL to Enes Olgun
Ltd. Here, because the account has a credit balance, we say that Enes Olgun Ltd. is
a creditor of our firm. This means, a creditor is someone to whom we, or the firm
whose accounts we are preparing, owe money.
Now, let’s suppose that a few days later, the furniture is paid for by the check:
Mar 18. 20-1 Paid Enes Olgun Ltd. 900 YTL by check.
Here, the company’s Checks Given Account goes up by 900 YTL. However, the
gain of the business is that it no longer owes a creditor. The accounts will appear
like those:
ACCOUNTS PAYABLE
Enes Olgun Ltd.
20-1 YTL 20-1 YTL
Mar. 18 Checks Given 900 Mar. 12 Furniture 900

CHECKS GIVEN
20-1 YTL 20-1 YTL
Mar 18 Account Payable 900

As it is crystal clear, 'our' organization no longer owes any money to Enes Olgun
Ltd. Their account with us has a zero balance.
When the “Checks Given” had been drawn from the bank accounts:
9
20 Mar. 20-1 Paid Checks Given 900 YTL by banks.
CHECKS GIVEN
20-1 YTL 20-1 YTL
Mar 20 Banks 900 Mar 18 Account Payable 900

BANKS
20-1 YTL 20-1 YTL
xxx Mar 20 Checks Given 900

Here is another transaction:
Feb. 10, 20-1 Sold a printer which was unsuitable for the firm, on credit to Arici
Co. for 150 YTL (the printer had been purchased on January 5, 20-1 for the same
amount and it was paid in cash).
That step is also very important. Because the firm loses a printer but gains a
debtor. Here, the debtor is Arici Co. and it will pay the 150 YTL in the future. As a
result, a debtor is someone who owes money to us or to the firm whose accounts we
are preparing. The accounts should be like that:

20-1 YTL 20-1 YTL
Jan 2 Cash 750 Jan 6 Check received 750
Jan 5 Cash 150 Feb 10 Oth.Var.Receiv. 150

OTHER VARIOUS RECEIVABLES

Arici Co.
20-1 YTL 20-1 YTL
Feb 10 Fur. And Fixtures 150

As we discussed earlier, Arici Co. will pay the amount later in the future. So our
company will earn 150 YTL and will lose a debtor. The account should look like
10
that:
Apr 28. 20-1 Arici Co. pays 150 YTL by check.
OTHER VARIOUS RECEIVABLES

Arici Co.
20-1 YTL 20-1 YTL
Feb 10 Fur. And Fixtures 150 Apr 28 Checks Received 150

CHECKS RECEIVED
20-1 YTL 20-1 YTL
Apr 28 Oth.Var.Receivable 150

Apr 29. 20-1 When the Checks Received 150 YTL had been drawn from the
costumer’s bank accounts:
CHECKS RECEIVED
20-1 YTL 20-1 YTL
Apr 28 Oth.Var.Receivable 150 Apr 29 Cash 150

CASH
20-1 YTL 20-1 YTL
Apr 29 Check Received 150

1.4 PURCHASES, SALES AND RETURNS
The business transactions that are discussed until that point was usually related
with the buying and selling of things like machinery, typewriters, printers vans and
cars. In our double-entry book-keeping, to record the purchase of a typewriter, we
have debited an account in the name of typewriters and credited bank, cash or a
creditor's account. So, when the company has sold it, we have credited the
typewriters account and debited bank, cash or a debtor's account. That is really the
11
right way to follow when a firm buys items with the purpose of keeping them for
reasonable time duration, using them in the company and then selling them when it
can’t use them any more. To give you an example, let’s say a firm bought a van. The
company will use this van for a long time to make deliveries. But at the end, that one
will complete its life and the business will have to sell it. We must emphasize here
that the company didn’t have the purpose of buying the van solely to sell it again
quickly to make profit. Because, the goods in which a business trades are bought for
the main purpose of resale at a higher price. But, we must underline the fact here
that two special accounts are necessary to record such activities.
1.4.1 The Use of Purchases and Sales Accounts
These accounts are used only to record the purchase and sales of the goods in which
a business trades. In this reard, these goods are the ones which a company buys at
one price with the purpose of selling them at a higher price in the near future. We
can also give some lively examples on this matter. For instance, a fashion shop
buys clothes from a producer, holds them in stock, and wishes to sell them to the
consumers as soon as possible, of course by making profit. One other example can
be that a greengrocer buys fruits and vegetables from the wholesale market and
presents them to the consumers in the store. Here, the greengrocer also wants to
make profits by selling the fruits and vegetables at a higher price than he paid to
the wholesaler.
We must also stress that, when a company buys goods to sell them later again
(resale), they are entered into Purchases Account in the accounting records. Also,
when such goods are sold, they are entered into the Sales Account. Be careful to use
these two accounts for 'bought goods' and 'sold goods' respectively. You should
absolutely avoid using a Stock Account or a Stock of Goods Account at this stage.
Because this account is used only at the end of a financial year.
1.4.2 Purchases for Cash or Check
On this subject, the rules that are learned for entering business transactions into the
double-entry book-keeping accounts will still be valid. Below, you can learn from
a good example:
6 May., 20-1 Bought goods for sale which cost 200 YTL, paying in cash.
At this phase, the business has obtained some goods to sell them later. But of
course, to buy these goods, an amount of cash totaling 200 YTL is given. Here,
there are two related accounts which are purchases and cash. Finally, the
transaction will be as follows:
12
MERCHANDISE
20-1 YTL 20-1 YTL
May 6 Cash 200

CASH
20-1 YTL 20-1 YTL
xxx May 6 Marchandise 200

1.4.3 Purchases on Credit
Companies usually purchase and sell the goods in which they trade on credit which
means payment is not made for some time after delivery. It is a good idea to
give another example:
15 Oct. 20-1 Bought goods for sale costing 250 YTL on credit from Saritas
Ltd..
Let’s just use our logic. It is pretty simple that the business will gain goods for sale
but at the same time will owe 250 YTL to Saritas Ltd. Below; you can see how the
accounts will look like:
MERCHANDISE
20-1 YTL 20-1 YTL
May 6 Cash 200
Oct 15 Accounts Payable 250

ACCOUNTS PAYABLE
Saritas Ltd.
20-1 YTL 20-1 YTL
Oct 15 Marchandise 250

Saritas Ltd.'s account easily clearly reflects that our business owes him 250 YTL
which means that Saritas Ltd. is a creditor. In the future, the firm will make
payment to Saritas Ltd. and the accounting entries will be as follows:
13
ACCOUNTS PAYABLE
Saritas Ltd.
20-1 YTL 20-1 YTL
……. Cash, Banks or Oth. 250 Oct 15 Marchandise 250

CASH, BANKS OR OTHERS

20-1 YTL 20-1 YTL
xxx ….. Accounts Payable 250

1.4.4 Sales for Cash or Check
We must still go on to follow the same book-keeping orders. For example:

Feb. 15, 20-1 Sold goods for 180 YTL, a check being received. The business has
gained a check for 180 YTL, but also sells the goods for this amount.
CHECKS RECEIVED
20-1 YTL 20-1 YTL
Feb 15 Domestic Sales 180

DOMESTIC SALES
20-1 YTL 20-1 YTL
Feb 15 Checks Received 180

1.4.5 Sales on Credit
Again, the same book-keeping rules apply. For example:
May 9, 20-1 Sold goods for 245 YTL on credit to Aykut Co.
At that particular point, the company gains a debtor which is Aykut Co. We
believe you have recognized that Aykut Co. will owe 245 YTL to the
company. 245 YTL is the amount which the goods are sold for.
14
COSTOMERS
Aykut Co.
20-1 YTL 20-1 YTL
May 9 Domestic Sales 245

DOMESTIC SALES
20-1 YTL 20-1 YTL
Feb 15 Checks Received 180
May 9 Aykut Co. 245

Aykut Co. will pay for the goods and the entries in the accounts will be
as follows:
CASH, BANKS OR OTHERS

20-1 YTL 20-1 YTL
xxx May 6 Marchandise 200
…… Costomers 245

COSTOMERS
Aykut Co.
20-1 YTL 20-1 YTL
May9 Domestic Sales 245 ….. Cash 245

1.4.6 More About Sales and Purchases Accounts
We had learned that the price paid for the goods purchased is entered to the
debit side of the Marchandise Account. Also, the amount received from the
goods sold is entered to the credit side of the Sales Account. Because of that
reason, there must never be any transactions on the credit side of the
Marchandise Account and on the debit side of the Sales Account. The only
exception to this rule is the entries to balance the accounts. We will talk
about that later in section 1.5. Actually, that rule is really very important
because you can use it to check if your accounts are correct as you make the
book-keeping entries. If you can rule a line through the credit side of the
15
Marchandise Account and the debit side of the Sales Account, that would
make your job much easier. Please recall that, currently we are not
interested in calculating the profit a company makes on the goods it sells.
Marchandise and Sales Accounts are used to record transactions of the

goods in which a business trades. To better illustrate this, we had provided a
fashion shop example. That fashion shop had bought clothes from a
producer to sell them later (resale). The cost of clothes was entered into the
Marchandise Account. Moreover, when these items were sold, the money
amount was entered into the Sales Account. In the situation where the
fashion shop bought a typewriter to use it in the company, then the amount
would be entered on to the debit side of a Furniture and Fixture Account
instead of the Marchandise Account. The reason of that is simple - the
fashion shop does not trade in typewriters. Now, let’s suppose we prepare
the accounts of an office equipment firm. So, in this scenario, which account
should the office equipment firm enter the purchase of a typewriter? Let’s
give the sharp answer - if it was bought for resale, it would be entered into
the Marchandise Account since it is the goods in which the company trades.
However, if the firm bought the typewriter to use in its own office, then it
would be debited to the Furniture and Fixture Account since it was not
bought with the purpose of selling again (resale) immediately. Using the
same logic, when this company sells typewriters (the goods in which it
trades) the money amount will be credited to the Sales Account. On the
other hand, when the company sells its own office typewriter after using for
some time, the Furniture and Fixture Account will be used. If we should give a
parallel example, a car dealer buying vans for resale, debits the Merchandise
Account. However, if a van was purchased to make deliveries of spares, the purchase
cost would be debited to a Motor Vehicles Account.
1.4.7 Returns Accounts

We believe that all of us must have bought some goods previously which were
unsatisfactory. Here, an unsatisfactory good can be damaged, it may have poor
quality or it can be a non-working item. Under this circumstances, we usually
return the item to the shop that sold it. Similarly, a business can also have logical
reasons to return the goods which it has purchased. We call these returns as
returns outwards or purchases return. Because, the goods are sent out or back to the
original supplier here. Also, a business can have goods which are returned by their
customers. We call these returns as returns inwards, or sales returns. Because, the
goods are received again here. Any company needs to record the movements of
16
returned goods with two separate returns accounts. These are the Returns
Outwards and the Returns Inwards Accounts.
1.4.8 Returns Outwards Account

8 Nov . 20-1 Goods for 50 YTL previously bought on credit from Öztürk Co. are
returned to him.
Looking to the issue from the point of view of our firm, the goods for resale fall
since unsatisfactory or unsuitable goods are sent back; furthermore we owe 50 YTL
less to Ozturk Co. You can see the transaction below:
MERCHANDISE
20-1 YTL 20-1 YTL
May 6 Cash 200 Nov 8 Accounts Payable 50

ACCOUNTS PAYABLE
Öztürk Co.
20-1 YTL 20-1 YTL
Nov 8 Merchandise 50 Oct 6 Merchandise 250

Notes:
Returns Outwards Account (Marchandise) always has transactions entered on

the credit side.
1.4.9 Returns Inwards Account

May 15,. 20-1 Aykut Co. returns the goods to our company which were previously
sold to him on credit for 30 YTL.
Here, our firm gains the goods returned to it. On the other hand, our company
also has a loss since a debtor's account is reduced. This means our business is
owed less.
17
SALES RETURNS
20-1 YTL 20-1 YTL
May 15 Costomers 30

COSTOMERS
Aykut Co.
20-1 YTL 20-1 YTL
May 9 Domestic Sales 245 May 15 Sales Returns 30

Notes:
Returns Inwards Account (Sales Returns) always has transactions entered on the
debit side.
1.4.10 Purchases, Sales and Returns Accounts
The following worked example shows the use of Purchases, Sales and Returns
Accounts;
Transactions: 20-1
Jun. 1 Bought goods 150 YTL on credit from Yilmaz Ltd..
Jun. 4 Sold goods 65 YTL on credit to Baykal Co.
Jun. 5 Bought goods 240 YTL on credit from Adem Co.
Jun. 10 Sold goods 100 YTL, cash being received.
Jun. 13 Returned goods which had cost 30 YTL to Yilmaz Ltd.
Jun. 15 Sold goods 85 YTL on credit to Kaya Co.
Jun. 20 Paid the amount owing to Yilmaz Ltd. in cash.
Jun. 22 Kaya Co. returns unsatisfactory goods which had cost 20 YTL.
Jun. 24 Bought goods 100 YTL on credit from Adem Co..
Jun. 29 Baykal Co. pays the amount owing by him in cash.
Accounts:
MERCHANDISE
20-1 YTL 20-1 YTL
Jun 1 Accounts Payable 150 Jun 13 Accounts Payable 30
Jun 5 Accounts Payable 240
18
Jun 24 Accounts Payable 100
DOMESTIC SALES
20-1 YTL 20-1 YTL
Jun 4 Customers 65
Jun 10 Cash 100
Jun 15 Customers 85
SALES RETURNS
20-1 YTL 20-1 YTL
Jun 22 Customers 20

COSTOMERS
Baykal Co.
20-1 YTL 20-1 YTL
Jun 4 Domestic Sales 65 Jun 29 Cash 65

COSTOMERS
Kaya Co.
20-1 YTL 20-1 YTL
Jun 15 Domestic Sales 85 Jun 22 Sales Returns 20

ACCOUNTS PAYABLE
Baykal Ltd.
20-1 YTL 20-1 YTL
Jun 13 Marchandise 30 Jun 1 Marchandise 150
Jun 20 Cash 120

ACCOUNTS PAYABLE
Adem Co.
20-1 YTL 20-1 YTL
Jun 5 Marchandise 240
Jun 24 Marchandise 100

CASH
20-1 YTL 20-1 YTL
Jun 10 Domestic Sales 100 Jun 20 Accounts Payable 100
19
Jun 29 Customers 65

1.5 BALANCING-OFF ACCOUNTS
1.5.1 Why Should We Balance the Accounts?
As you know, when accounts are prepared, transactions are either on the debit
(left-hand) side or on the credit (right-hand) side. Just see the following
example:
BANKS
20-1 YTL 20-1 YTL
Jan 8 Capital 2 000 Jan 14 Checks Given 300
Jan 22 Checks Given 280

This account above tells us that the firm was initiated on January 8 with 2 000
YTL in a bank account. That is the capital and is shown on the account as you
can notice. After that, on January 14, a computer was bought for 300 YTL. That
amount was paid by check, and on January 22 a machine was bought for 280
YTL and was also paid by check. We assume that these “checks given” are
drown from the bank account. However, the bank account does not tell us how
much money is left in the bank after these transactions. This means that we do
not know the balance of the account. On the opposite side, that’s definitely very
easy to solve.
Amount debited : 2 000 YTL

Amounts credited : 580 YTL
Balance : 1 420 YTL
By the way, double-entry book-keeping accounts similar to the ones we have

been preparing are usually balanced at regular intervals. These regular intervals
are absolutely at the end of each month. Balancing the accounts includes two
steps. The first one is calculating the balance and the second one is entering it in
the accounts.
20
1.5.2 The Way to Balance-off the Accounts
The Bank Account indicated in Chapter 5.1 is balanced at the end of January
(here we suppose that no further transactions exist). Below, you can see how the
bank account was balanced:
BANKS
20-1 YTL 20-1 YTL
Jan 8 Capital 2 000 Jan 14 Checks Given 300
Jan 22 Machinery 280
. Jan 31 Balance c/d 1 420
2 000 2 000
Below, you can have some idea about balancing the accounts:
(a) Each side of the account is added up, and then the sum of each is written
down if required.
(b) The lesser amount is taken away from the larger amount, and the difference
is written on the side of the lesser amount on the next available line.
(c) In this step, we should add up both sides and enter the sum for each in a
'totals box' on the same line on both debit and credit sides
(d) On the lesser side and against the balance, the date is written which shows
that the account is balanced. This is usually at the end of the month. Also, in
the details column, the words 'balance c/d' are written to show that the
balance is carried to the next month.
(e) Moreover, to complete double-entry book-keeping, the same amount of
money must be entered on the opposite side of the account to 'balance c/d'.
However, that should be on the next line below the 'totals box'. That is
described as the ‘balance b/d’ in the details column. By the way, the date of
this entry will be the first day of the next month when accounts are being
balanced at the end of the month. Here, we should emphasize the fact that
this 'balance b/d' is not underlined.
BANKS
20-1 YTL 20-1 YTL
Feb 1 Balance b/d 1 420

.
1.5.3 Account Balancing Examples
21
Unfortunately, for some students, balancing the accountings correctly is tough.

On the other hand, if they will study the following examples, their job will be
much easier. Besides, after some adequate practice, they should find that they
have mastered it.
ACCOUNTS PAYABLE
E.Acikgoz Co.
20-1 YTL 20-1 YTL
Feb 12 Marchandise 60 Feb 1 Marchandise 130
Feb 18 Cash 70 Feb 15 Marchandise 200
Feb 20 Checks Given 200 Feb 21 Marchandise 80
Feb 23 Banks 50 Feb 24 Marchandise 120
Feb 28 Balance c/d 150
530 530
ACCOUNTS PAYABLE
E.Acikgoz Co.
20-1 YTL 20-1 YTL
Mar 1 Balance b/d 150
1.6 THE TRIAL BALANCE
1.6.1 Getting to Know the Trial Balance
To provide a brief definition, a trial balance is a list of the balances of accounts

contained in the double-entry book-keeping system. Generally, it is very good to
prove the arithmetical accuracy of the accounts. The list of balances is divided
into two. The first one is between those accounts with balances brought down on
the debit (left-hand) side of the ledger and the second one is those with balances
brought down on the credit (right-hand) side. It is wise to know that a trial
balance is usually prepared just after the accounts have been balanced. Below,
you can see how it is formed:
Trial balance of (business x) at (date y)
Account: Totals Balance
22
Dr Cr Dr Cr
Capital 2 500 2 500
Banks 1 200 800 400
Cash 1 500 1 140 360
Machinery 650 650
Checks Receivable 2 400 1 800 600
Account Payable 1 000 1 460 460
Costomers 1 930 1 800 130
Marchandise 1 500 30 1 470
Domestic Sales 650 650
Total 10 180 10 180 3 610 3 610
1.6.2 The Extraction of a Trial Balance
In the beginning, all the accounts included to the book-keeping system are
balanced. After that, the balances are listed under the heading of Dr. (debit) or
Cr. (credit) using the 'balance b/d' on each account. Next, the debit and credit
sides of the trial balance are totaled and in case the book-keeping is
arithmetically correct, it must balance. In another expression, the two figures
should be equal.
Notes:
(a) Where accounts are balanced at the end of month, the balances used are
those recorded on each account at the first day of the new month. These are
the balances brought down.
(b) The heading of the trial balance is the date of the last day of the month.
(c) Every account’s balance must be included. The ones that have a zero balance
are no exception. For these, a 'dash' is entered on both of the money
columns.
It is necessary to underline the fact that a trial balance is not a component (part)
of the double-entry book-keeping system. Generally speaking, it is a list of
balances that can be used to check the arithmetical truth of the book-keeping
records. Mostly, it is drawn on a separate sheet of paper ruled with two money
columns on the right-hand side. By the way, in business accounting systems,
trial balances are commonly prepared more than once a month and are kept as
proof to show that the accounts were balanced at the date of the trial balance.
1.6.3 Locating the Errors Indicated by a Trial Balance
23
If there is a mistake with the trial balance, the error(s) must be located and
corrected. Here is how to determine the errors:
(a) Check the addition of the trial balance.

(b) Check to see if the balances were entered correctly from the accounts.
(c) Check the calculation of each balance in the accounts.
(d) Calculate the number of accounts in the book-keeping system and compare
the result with the number of accounts listed in the trial balance. That
clearly explains why accounts with zero balances are included.
(e) Go through the accounts for an amount which matches the trial balance
difference. If you can find one, then check to make sure that the double-
entry book-keeping was carried out correctly.
(f) Divide the trial balance difference by two and search a transaction for that
amount. In case you can find that amount, control to see if the book-keeping
was carried out correctly.
(g) In case all of these don’t work, then it will be a must to check the book-
keeping transactions from source documents. That must be carried out from
the date of the previous trial balance by 'ticking back' each entry in the
accounts.
If a trial balance is correct, then it means that a set of accounts have arithmetical
accuracy. Despite that, other errors may still exist. As an example, a transaction
can be entered on the correct side but it might have a wrong-named account.
Another example may be that a payment in cash can be credited to the Bank
Account.
1.6.4 Preparing a Trial Balance from a List of Balances
It is relatively easy to prepare a set of accounts, and then to extract a trial

balance. Sometimes students find it harder to prepare a trial balance from a list
of balances such as the following:
Accounts YTL
Capital 1 000
Machinery 700
Furnitures and Fixtures 360
Domestic Sales 980
Merchandise 720
Sales Returns 80
Bank Loans 160
Cash 70
24
Accounts Receivable 300

Accounts Payable 90
Here, the balances must be categorized based on whether they are debit or credit.
Know that the Capital Account always has a credit balance since the company in
effect owes this amount back to the owner of the company. If you can recall, that
topic was also discussed earlier. Machinery Account, Furnitures Account and
other similar accounts always have debit balances, because they record items
gained or owned by the business. Cash Account always has a debit balance too.
Then, Bank Loans Account could have a credit balance when the account (in our
records) shows a credit balance which indicates an overdraft. Marchandise
Account always has a debit balance because the business gains when it buys
goods for resale. Domestic (or Export) Sales Account always has a credit
balance—the business loses goods when they are sold. On the contrary, Sales
Returns Account always has a debit balance. The personal accounts of debtors
(Accounts Receivable) and creditors (Accounts Payable) should cause no
problems when preparing a trial balance.
We can put the balances in this example in the form of a trial balance:
Trial balance of Company X as at Date Y.
Accounts: Dr. Cr.

YTL YTL
Capital 1 000
Machinery 700
Domestic Sales 980
Marchandise 720
Sales Returns 80
Bank Loans 160
Cash 70
Accounts Receivable 300
Accounts Payable 90
2 230 2 230
1.7 EXPENSES AND INCOME; DRAWINGS
25
Until now, we studied on the accounts for the following types of business
transaction:
- Introduction of capital into the company.

- The purchase and the sale of assets to be used in the firm. These assets are the
machinery, vans or typewriters.
- The purchase and the sale of goods which the company trades.
- Returns inwards and returns outwards.
- Cash and bank receipts and payments.
But, among our examples, the expenses of running a business such as rent and
rates, wages and salaries, the costs of heating, lighting and the phone, and
vehicle running expenses were not paid. These expenses are recorded in
separate accounts, instead of opening one account in the name of ‘expenses’.
By the way, just like its expenses, a company may also have some certain
income components. These are sometimes called as the revenue like rent or
commission received. The revenue must also be recorded in separate accounts.
1.7.1 Accounts for Expenses
Consider a simple example:
Sep. 10, 20-1 Paid a rent 150 YTL by check.
Parallel to the other double-entry book-keeping transactions, there is a gain to

the business, and also a loss. The gain is that the business has had the use of
premises for an agreed time; the loss is that the checks given account is
increased by 150 YTL. This transaction will be entered into the accounts as:
GENERAL ADMINISTRATIVE EXPENSES

20-1 YTL 20-1 YTL
Sep 10 Checks Given 150
CHECKS GIVEN
20-1 YTL 20-1 YTL
Sep 10 Gen. Adm. Exp. 150
26
And another example:
Oct. 14, 20-4 Paid the phone bill 60 YTL in cash.

Here, the gain of the company is that it can use the phone for a certain period of
time; On the other hand, the firm’s loss is that the amount of cash has been
reduced.

20-1 YTL 20-1 YTL
Sep 10 Checks Given 150
Oct 14 Cash 60
CASH
20-1 YTL 20-1 YTL
xxx Oct 14 Gen. Adm. Exp. 60
Notes:
Expenses accounts always have the transactions entered on the debit side.
1.7.2 Accounts for Income
Jul. 12, 20-6 A Rent of 200 YTL is receieved in cash.
At this step, the company earned cash, but lost the use of a part of its premises
for an agreed time.
OTHER VARIOUS INCOME FROM OPERATIONS

20-1 YTL 20-1 YTL
Jul 12 Cash 200
CASH
20-1 YTL 20-1 YTL
Jul 12 Other Various 200
27
Income
10 May, 20-1 A Commission of 120 YTL is received by check.
Checks Receivable Account has gained 120 YTL; the 'loss' is the time taken to
earn the commission.
CHECKS RECEIVED
20-1 YTL 20-1 YTL
May 10 Commission Income 120

COMMISSION INCOME
20-1 YTL 20-1 YTL
May 10 Checks Received 120
Notes:
Income accounts always have transactions entered on the credit side.
1.7.3 The Use of Drawings (Withdrawals) Account
Sometimes, the owner of the company may wish to draw money from the firm.
As emphasized earlier, the business is a separate entity from its owner. As a
result, even though the owner may draw the money to satisfy his/her personal
needs and to meet his or her living expenses, such amounts must be entered in a
Drawings (Withdrawals) Account.
Aug. 12, 20-1 Owner withdrew 160 YTL from the bank for own use.
The book-keeping entries are shown below:
BANKS
20-1 YTL 20-1 YTL
xxx Aug 12 Rec. From S.hold. 160
28

.
.
RECEIVABLE FROM SHAREHOLDERS

20-1 YTL 20-1 YTL
Aug 12 Banks 160

.
.
Drawings (Receivable From Shareholders) Account’s function is to keep the

sum (total) of owner's drawings for a year . In regards to the gains and losses,
drawings decrease the firm's Bank or Cash Account. That seems to be the dark
side. On the other hand, the advantage to the firm is that a receivable account is
increased.
Plus, the Drawings Account is also used when the owner takes goods from the
company for his or her own personal use. The good and ideal book-keeping
entries are to debit the Drawings Account and to credit the Domestic Sales
Account with the selling price of the goods taken.
Jan. 10, 20-1 Goods taken for own use by owner of business 40 YTL.

20-1 YTL 20-1 YTL
Jan 10 Marchandise 40

.
.
DOMESTIC SALES
20-1 YTL 20-1 YTL
Jan 10 Rec. From S.holders 40
1.8 TRADING ACCOUNT; PROFIT AND LOSS ACCOUNT
29
One advantage of the book-keeping system is that it helps us to find the profit or
loss made by a company. Under normal circumstances, the profit or the loss is
calculated once a year. That is the end of a company's financial year. However,
please know that the company’s financial year should not be the same as a
calendar year. The best way to calculate the profit or the loss for a financial year
is to gather and use the cumulative information during that year. Definitely, the
data here must also be presented in a certain way.
(a) The gross profit or the gross loss for the year.
(c) The net profit or the net loss for the year.
The calculation of the Gross Profit and the Profit and Loss Account are parts of
the double-entry book-keeping system.
1.8.1 The Gross Profit or Loss
To speak for the gross profit, it is the difference between the price a company
pays for the goods for sale and the price at which it sells them. Below, there is an
example about the transactions of a stationery shop:
Pen purchased from manufacturer for 40YTL

Sold to customer for 55 YTL
Gross profit 15 YTL
It is true that a company can calculate the gross profit every time when it sells an
item such as a pen. However, it is also obvious that this action would be very
exhausting and time consuming. Actually, the gross profit is formally calculated
once a year. On the other hand, several companies do so more frequently. For
instance, calculating the gross profit monthly is very common. The main purpose
here is to control if the company is operating profitably.
Following that, to find the gross profit for a year, we must know the total
purchases and the total sales through the year. This information should be kept
during the year in the Merchandise Account and the Sales Account. Because of
that reason, at the end of the year, Merchandise Account’s information must be
transferred to the Cost of Merchandise Sold Account, and then these two
accounts must be transferred to a Profit or Loss for the Period Account.
Here is an example of a Purchases and Sales Account for Paksoy Co. which have
been balanced on January 31.
MERCHANDISE
30
20-1 YTL 20-1 YTL

….. ………….. 1 340 ….. ………….. 60
Jan 31 Balance c/d 1 280
We assumed that we have merchandise valued 350 YTL at the end of January.
MERCHANDISE
20-1 YTL 20-1 YTL

….. ………….. 1 340 ….. ………….. 60
Jan 31 Cost of Merch. Sold 930
Jan 31 Balance c/d 350
1 340 1 340
We can calculate the cost of merchandise sold as it is shown below:
Balance of Merchandise Account at the end of January 1 280 YTL

Merchandise value at the end of January (-) 350 YTL
Cost of Merchandise Sold 930 YTL
MERCHANDISE
20-1 YTL 20-1 YTL

….. ………….. 1 340 ….. ………….. 60
Jan 31 Cost of Merch. Sold 930
COST OF MERCHANDİSE SOLD
20-1 YTL 20-1 YTL

Jan 31 Merchandise 930
DOMESTIC SALES
20-1 YTL 20-1 YTL
Jan 5 Account Receivable 680
Jan 14 Checks Receivable 540

YTL
Total Sales 1 220
31
Cost of Merchandise Sold 930

Gross Profit 290
Cost of Merchandise Sold Account and the Sales Account, during the year, will
have stored up the money amounts of cost of merchandise sold and the sales.
The amounts contained in each account are now transferred to a Profit or Loss
For The Period Account, as follows:
20-1 YTL 20-1 YTL

Profit or Loss For The
Jan 31 Merchandise 930 Jan 31 Period 930
DOMESTIC SALES
20-1 YTL 20-1 YTL
Profit or Loss For The
Jan 31 Period 1 220 Jan 5 Account Receivable 680
Jan 14 Checks Receivable 540

These transactions leave Cost of Merchandise Sold and the Sales Accounts with
zero balances, and the corresponding double-entry book-keeping entries appear
in the Profit or Loss For the Period Account as follows:
PROFIT OR LOSS FOR THE PERIOD
20-1 YTL 20-1 YTL

Jan 31 Cost of Merch. Sold 930 Jan 31 Domestic Sales 1 220
The gross profit is the difference between Cost of Merchandise Sold and the
Sales. The amount of gross profit will be calculated on the Profit or Loss For the
Period Account.
1.8.2 The Profit and Loss Account
32
Previously, we had said in section 1.8.1 that gross profit is the difference
between the buying and the selling prices. Also, it was mentioned that the gross
profit is calculated before subtracting the running expenses of the company. The
Profit and the Loss Accounts begin with the gross profit and then subtracts from
it the running expenses of the firm for the accounting period. That provides the
net profit or the net loss. The net profit or the net loss belongs to the
owner/owners of the company.
Formerly, we had learned how the money amounts for expenses are kept in
various expenses accounts during the financial year. As you can recall, that was
the same way the money amounts for purchases and sales were kept in their
respective accounts. Additionally, when the company’s financial year ends, the
amounts included to the expenses accounts and income accounts were
transferred to the Profit and the Loss Accounts, just as the amounts for the
purchases and the sales were transferred.
Below, you can see the expense accounts of Paksoy Co. which company has a
financial year which ends on December 31. The accounts of Paksoy Company
have been balanced on the last day of the year and present the following
balances:

20-1 YTL 20-1 YTL
…… ……….. 1 760

Rent Paid
20-1 YTL 20-1 YTL
…… ……….. 150
…… ……….. 160

Salaries
20-1 YTL 20-1 YTL
…… ……….. 640
…… ……….. 380
33
Heating and Lighting

20-1 YTL 20-1 YTL
…… ……….. 80
…… ……….. 20

Phone
20-1 YTL 20-1 YTL
…… ……….. 50
…… ……….. 40
FINANCIAL EXPENSES
Interest Expenses
20-1 YTL 20-1 YTL
…… ……….. 40
MARKETING, SALES AND DISTRIBUTION EXPENSES

Marketing Expenses
20-1 YTL 20-1 YTL
…… ……….. 200
…… ……….. 180
DOMESTIC SALES
20-1 YTL 20-1 YTL
…… ………… 2 340
…… ………… 2 150

Each account is now closed off by the transfer to Profit and Loss Account.
COST OF MERCHANDISE SOLD

20-1 YTL 20-1 YTL
…… ……….. 1 760 Dec 31 Profit or Loss Acc. 1 760

Rent Paid
34
20-1 YTL 20-1 YTL

…… ……….. 150
…… ……….. 160 Dec 31 Profit or Loss Acc. 310

Salaries
20-1 YTL 20-1 YTL
…… ……….. 640
…… ……….. 380 31 Dec Profit or Loss Acc. 1 020

Heating and Lighting
20-1 YTL 20-1 YTL
…… ……….. 80

Phone
20-1 YTL 20-1 YTL
…… ……….. 50
FINANCIAL EXPENSES
Interest Expenses
20-1 YTL 20-1 YTL

Marketing Expenses
20-1 YTL 20-1 YTL
…… ……….. 200
DOMESTIC SALES
20-1 YTL 20-1 YTL
35
…… ………… 2 340
Dec 31 Profit or Loss Acc. 4 490 …… ………… 2 150

The Profit and Loss Account is completed as follows:

20-1 YTL 20-1 YTL
Dec 31 Cost of Merch. Sold 1 760 Dec 31 Domestic Sales 4 490
Dec 31 Gen. Ad.Exp. Rent 310
Gen. Ad.Exp.
Dec 31 Salaries 1 020
Gen. Ad.Exp.
Dec 31 Heating 100
Gen. Ad.Exp.
Dec 31 Phone 90
Finan.Exp.
Dec 31 Interests 40
Marketing Exp.
Dec 31 Market 380
Net profit is calculated by totalling all the expenses and then deducting total
expenses from revenues (including any items of income). For a business that has
made a net profit when expenses are less than the revenues. On the other hand,
when expenses are greater than the revenues, the business has made a net loss.
A net profit is entered on the debit side of the Profit and Loss Account, while a
net loss would be shown on the credit side. For example:

20-1 YTL 20-1 YTL
36
Dec 31 Gen. Ad.Exp. Rent 310

Gen. Ad.Exp.
Dec 31 Salaries 1 020
Gen. Ad.Exp.
Dec 31 Heating 100
Gen. Ad.Exp.
Dec 31 Phone 90
Finan.Exp.
Dec 31 Interests 40
Marketing Exp.
Dec 31 Market 380
Balance c/d (net
Dec 31 profit) 790
4 490 4 490
A net profit (or net loss) is transferred to the Net Profit or Loss Account for the
year by completing the double-entry book-keeping. A net profit increases the
shareholders' equity; for example:

20-1 YTL 20-1 YTL
Dec 31 ………… 3 700 Dec 31 …………… 4 490
Dec 31 Net Profit or Loss 790
4 490 4 490
NET PROFIT OR LOSS FOR THE YEAR
20-1 YTL 20-1 YTL

Dec 31 Profit or Loss 790
On the other hand, a net loss reduces the shareholders' equity; for example:
20-1 YTL 20-1 YTL

Dec 31 ………… 5 200 Dec 31 …………… 4 260
Dec 31 Net Profit or Loss 940
5 200 5 200
NET PROFIT OR LOSS FOR THE YEAR
20-1 YTL 20-1 YTL
37
Dec 31 Profit or Loss 940
1.9 THE BALANCE SHEET
1.9.1 Definitions of the Balance Sheet
In regards to the worldwide common definition, a balance sheet is a statement of

the assets and liabilities of a business at a particular time. It has three main parts:
(a) assets
(b) liabilities
(c) capital
Assets are the things owned by the company like the motor vehicles, machinery,
the money owed to it by debtors or its balance at the bank. On the other hand,
Liabilities are the amounts owed (e.g. money owed to the creditors or its bank
overdraft). By the way, capital is also a liability. However it is not like the others
since it represents a liability to the owner of the firm, rather than a liability to the
external group such as the creditors or the bank. Below, you can see one of the
formulas that is used to calculate the capital:
Assets — Liabilities = Capital
So, in case we know the money amount for any two of the three parts of a
balance sheet, we can easily calculate the other one:
Capital + Liabilities = Assets Assets — Capital = Liabilities

There is one common sentence which says that a balance sheet is a 'snapshot' of
a business. Because it shows the assets and liabilities at a particular moment
through time and things can not be the same next day. That clearly explains the
reason for the balance sheet to have the heading 'Balance sheet of... as at...', in
contrast to the headings of Profit or Loss for the Period Account which usually
covers the business activity for a year.
Here is an example of a balance sheet:
Balance sheet of... as at December 31, 20-1
38
Assets: YTL Liabilities: YTL

Cash 750 Bank Loans 3 000
Customers 6 350 Suppliers 5 400
Inventories 7 000 Taxes Payables 2 200
Machinery 8 000 Capital 14 000
Rights 2 500
24 600 24 600
1.9.2 The Effect of Transactions on a Balance Sheet
Actually, it is possible to prepare a new balance sheet after each business

transaction. However, such an action is never practical and that would be very
tiring and time consuming. For example, a large business simply does not have
the adequate time to do so. Instead of that, firms use the book-keeping system to
record transactions and they prepare a Profit or Loss for the Period Account, and
a balance sheet at frequent intervals. Despite these factors, you must know how
transactions affect a balance sheet. Now, we will study some transactions and
learn how the balance sheet appears after each.
Day 1 Started the business with a cash of 5 000 YTL.
The balance sheet shows an asset of cash 5 000 YTL with a liability of capital
for the same amount:
BALANCE SHEET
at end of Day 1

Cash 5 000 Capital 5 000
Day 2 Bought a machine for 2 000 YTL payment made by cash.
Here the Cash falls by 2 000 YTL, but the business gains a machine.
BALANCE SHEET
at end of Day 2
39

Machinery 2 000
Total 5 000 Total 5 000
Day 3 A stock (inventory) of goods valued 1 000 YTL is bought for resale, on
credit from Torcan Ltd.
The company has bought some goods and they will have an asset of stock until
the goods are sold. At the same time, because the goods have not yet been paid
for, the firm owes the amount to Torcan Ltd.
BALANCE SHEET
at end of Day 3

Cash 3 000 Suppliers 1 000
Inventories 1 000 Capital 5 000
Machinery 2 000
Day 4 Goods which had cost 600 YTL are sold for 900 YTL, cash being
received.
At this step, the inventory (stock) of goods decreases by the cost price and the
cash amount goes up by 600 YTL. As a result, the company makes a profit of
300 YTL (900 YTL – 600 YTL) and adds that amount to its capital.
BALANCE SHEET
at end of Day 4

Inventories 400 Capital 5 000
Machinery 2 000 Net Profit 300
Day 5 Goods which had cost 200 YTL are sold for 350 YTL on credit to
M.Hazret Co.
The stock falls by 200 YTL, a profit of 150 YTL is made, and M.Hazret Co.
owes us 350 YTL.
BALANCE SHEET
at end of Day 5
40

Customers 350 Capital 5 000
Inventories 200 Net Profit 450
Machinery 2 000
Day 6 Paid Torcan Ltd. the amount owing in cash.
Cash falls by 1 000 YTL and Torcan Ltd. is no longer a liability.
BALANCE SHEET
at end of Day 6

Customers 350 Net Profit 450
Inventories 200
Machinery 2 000
When you need to prepare a balance sheet, you will often start from a trial
balance or other accounting information. Yet, after you study these examples,
you will be able learn how a balance sheet is affected by an individual
transaction.
1.9.3 A Business Balance Sheet
A company prepares its balance sheet by taking the figures for assets and
liabilities from the accounts which remain with balances on them after the
Trading and Profit and Loss Accounts have been prepared.
As an example, the following accounts on the Trial Balance of Parsan Co. do

belong to December 31, 20-1:
Trial Balance:
41
Accounts: Dr. Cr. Dr. Cr.Balanc

Balance e
YTL YTL YTL YTL
Cash 2 900 2 350 550
Banks 1 500 700 800
Checks Receivable 2 000 1 600 400
Customers 3 000 2 720 280
Accounts Receivable 540 500 40
Merchandise 8 400 6 210 2 190
Machinery 6 000 0 6 000
Furnitures and Fixtures 800 0 800
Bank Loans 1 900 1 900
Suppliers 720 2 200 1 480
Accounts Payable 140 300 160
Paid in Capital 0 5 000 5 000
Domestic Sales 0 12 400 12 400
Cost of Merchandise Sold 6 100 0 6 100
General Administrative Exp. 2 750 2 750
Marketing Expenses 600 600
Interest Income 0 120 0 120
Financial Expenses 550 0 550 0
Total 36 000 36 000 21 060 21 060
Income Statement:
GROSS SALES 12 400

COST OF GOODS SOLD (-) 6 100
Cost of Goods Sold 6 100
GROSS PROFIT OR LOSS 6 300
OPERATING EXPENSES (-) 3 350
Marketing, Selling and Dist.Exp. 600
General Administration Exp. 2 750
OPERATING PROFIT OR LOSS 2 950
INCOME AND PROFIT FROM OTHER
OPERATION 120
Interest Income 120
FINANCIAL EXPENSES (-) 550
Financial Expenses 550
PROFIT OR LOSS FOR THE PERIOD 2 520
BALANCE SHEET
December 31, 20-1
42

Banks 800 Suppliers 1 480
Checks Receivable 400 Accounts Payable 160
Customers 280 Paid in Capital 5 000
Accounts Receivable 40 Net Profit 2 520
Merchandise 2 190
Machinery 6 000
The balance of Profit and Loss Account at the end of the year has been
transferred to the Shareholders’ Equity. On the balance sheet, however, it is
usual to show the owner's capital at the start of the year and then to add net profit
(or deduct net loss), and deduct drawings. This is preferable to showing only the
closing balance of Capital Account, because the balance sheet then sets out
clearly the net profit made by the business and the amount of owner's drawings.
As you can easily recognize, to prepare the balance sheet, all the balances
remaining on the accounts after the completion of the Trading and Profit and
Loss Accounts are listed, rather as in a trial balance. Actually, a balance sheet
looks like a special type of trial balance. Additionally, just as it was mentioned
before, a trial balance is not a part of the double-entry book-keeping system.
1.9.4 Format of the Balance Sheets
(a) Layout
Until now, the balance sheets provided showed the assets on the left and
liabilities on the right. However, another format is also used and is called as the
'vertical presentation'.
Finally, these different presentations should not mix your mind. You must just
keep in mind that the same information is true for each. One layout instead of
another can better fit to the preparer of the balance sheet.
(b) Listing the Assets
First of all, on a balance sheet, the assets are usually listed in the 'decreasing
order of liquidity' (Liquidity refers the ease with which things can be turned into
cash. For instance, checks have lesser liquidity compared to the cash). As a
43
result, the list of assets begins with the one that would take the nearest to turn
into cash. That is usually for the current assets; the cash, checks, banks, accounts
receivable, inventories. Then it is followed by the fixed assets; the fixtures and
fittings, machinery and plant, and motor vehicles. However, the order for these
other items may not be so correct. Because, we can not be completely sure that,
the machinery is more difficult to turn into cash than motor vehicles. By the
way, all of these assets are called as the fixed assets since the company needs
them on a semi-permanent basis. All firms have the purpose to continue their
lives and the fixed assets help the companies on this issue. As an example,
without any premises, companies would absolutely find it so hard to trade.
The remaining assets are listed under the heading of current assets. The nature
of current assets items changes continuously. The current assets, and fixed
assets are also listed in the 'decreasing order of liquidity'. Moreover, current
assets are also called as the circulating assets. That term refers the way in which
the make-up of these assets changes as a company trades. To explain everything
again briefly, the assets side of a balance sheet is usually prepared as follows:
Current assets:
Cash
Bank
Debtors
Stock (Inventory)
Other current assets
Fixed assets:
Premises
Plant and machinery
Motor vehicles
Fixtures and fittings
This order is known as the 'decreasing order of liquidity' as well as the

'increasing order of permanence'.
(c) Listing the Liabilities
The liabilities side of a balance sheet is also customarily prepared in the

'decreasing order of liquidity'. It begins with the short term liabilities and is
followed by the long-term liabilities and permanent capital of the company. For
instance, loans or a mortgage can be provided as examples. In normal
conditions, a current liability is any amount repayable in less than twelve
44
months, and a long-term liability is thought to be any amount repayable in more

than twelve months from the balance-sheet date. If we should summarize, the
liabilities side of the balance sheet is prepared as follows:
Current liabilities: Creditors Bank Overdraft

Long-term liabilities: e.g. Loans, Mortgage
Capital
1.9.5 Goodwill
After the business is established, it starts to improve the operations and achieves
several successes. These successes build up a reputation and then the firm gains
regular customers who trust on its services. Certainly, this reputation and the
loyal customers are very important for the company. So, that’s what we call the
goodwill. As a result, it is so logical to assume that in case the company is sold,
the purchaser would pay an amount for the goodwill as well as for the
machinery, buildings and etc… which it acquires.
Example:
A company is bought at a price of 150 000 YTL. The assets acquired are
premises valued 80 000 YTL, machinery valued 30 000 YTL and stock
(inventory) valued 20 000 YTL. As you can see, the total assets acquired are 130
000 YTL. So, the difference between this amount (20 000 YTL) and the paid
price of 150 000 YTL represents the goodwill. This is equivalent to 20 000 YTL.
( 150 000 YTL – 130 000 YTL = 20 000 YTL.)
Goodwill is recorded to the balance sheet as an intangible asset “Goodwill”.

Here, 'intangible' refers to the assets which can not be seen or touched. On the
other hand, tangible assets can be seen and touched. Machinery can be an
example for that one. Another important point is that the Goodwill is only
entered to the accounts when it has been paid for.
1.10 THE ASSET OF STOCK
1.10.1 Introduction
The word stock means the goods in which a company trades. As we have learned
before, the Purchases Account is used to record the money amount of goods
bought by the business for resale. To speak for the Sales Account, it is used to
record the money amount of goods sold. Most firms always have the stocks of
45
the goods in which they trade. As an example, the computer stores always have a
stock of CDs, and the stationery shops always have a stock of pencils. So, at
regular intervals, and certainly at the end of a financial year, a company should
assign a value on the stock it holds. Besides, if you saw notices on store
windows which say 'closed for stocktaking', then this means that the stock is
being listed and valued.
1.10.2 Stock Valuation
Stock is valued at the amount it costs to the business. However if it is sold at a

price below its cost, then this lower price is thought to be its value. In the
accounting science, this valuation method is called as net realizable value.
Now, let’s give an example. Think about a textile store which buys a stock of
winter coats for 60 YTL each in autumn. But in spring, a few of these coats still
remain because they were not sold. So the owner of the store thinks these coats
can only be sold at a sale price of 30 YTL each. Because of that reason, the coats
have a cost of 60 YTL to the company, but a net realizable value of 30 YTL. As
a result, they will be valued at the lower of the two numbers, 30 YTL.
1.10.3 Closing Stock and the calculation of Gross Profit
Inventory is always valued at the end of a financial year; additionally the

valuation should be brought into that year's Trading Account.
Now, let’s give an example. Say Mrs. Ozturk started selling earrings on January
1, 20-1. On that date, definitely, she had no inventory of goods for resale, but her
accounting records show that during that time of the year to December 31, 20-1
she bought goods for resale totaling 30 000 YTL. At the same time, Mrs.
Ozturk’s Sales Account shows that total sales for the year were 50 000 YTL.
Also, on December 31, Mrs. Ozturk values the stock in the shop at 8 000 TL. So,
of the purchases which equals to 30 000 YTL during the year, goods valued at
8,000 YTL remain unsold at the end of the year. As a result, when preparing her
Trading Account, we should subtract 8 000 YTL from the purchases as you can
see below:
Calculation of Gross Profit of Mrs Öztürk for the year ended on Dec. 31, 20-1
YTL YTL
Purchases 30 000 Sales 50 000
Less Closing stock 8 000
22 000
Gross profit c/d 28 000
50 000 50 000
46
As we discussed before, since the Profit or Loss For the Period Account is a
component of double-entry bookkeeping, opposite entries should be entered in
the Cost of Marchandise Sold Account and the Sales Account. An opposite entry
in the accounts is also required to close the stock, and for this purpose a Stock
Account is used. Since the closing stock of the company on December 31, 20-1
is an asset of the firm, the entry in Stock Account is made as follows:
MERCHANDISE
20-1 YTL 20-1 YTL
….. Purchases 30 000 Dec31 Cost of Merc.Sold 22 000
Dec 31 Balance 8 000

20-1 YTL 20-1 YTL
Dec 31 Merchandise 22 000 Dec 31 Profit or Loss Acc. 22 000
Income Statement:
GROSS SALES 50 000

Profit or Loss for the Period Account of Mrs Öztürk for the year ended on December 31, 20-1

20-1 YTL 20-1 YTL
Dec 31 Cost of Merc. Sold 22 000 Dec 31 Sales 50 000
The cost of goods sold figure tells us the cost price of the goods which Mrs
Öztürk sold during the year for 22 000 YTL.
1.10.4 Opening Stock and Closing Stock
Mrs Öztürk had a closing stock valuation of 8 000 YTL on December 31, 20-1
after her first year of trading. This closing stock for the first year will form the
opening stock for her second year of trading in 20-2. During the second year,
47
Mrs Öztürk will record the money amounts of purchases and sales of her
fashions in the accounts. On December 31, 20-2 she again values her stock.
Suppose that the figures for the year are:
Opening stock on January 1, 20-2 8 000 YTL

Purchases 6 000 YTL
Sales 80 000 YTL
Closing stock on December 31, 20-2 5 000 YTL
For this, in terms of the second year and all the following years, we must take
into account the opening stock, as well as the closing stock, when we will
prepare the Gross Profit Account, as follows:
Calculation of Gross Profit of Mrs Öztürk for the year ended on Dec. 31, 20-2
YTL YTL
Opening Stock 8 000 Sales 80 000
Purchases 56 000
59 000
80 000 80 000
We already know that, as the Gross Profit Account is part of double-entry book-
keeping, opposite entries must be entered in Purchases Account (Merchandise).
An opposite entry in the accounts is also needed for the Cost of Goods Sold
Account. As the closing stock of the business on December 31, 20-2 is an asset
of the business, it will appear as a balance of the Merchandise Account:
MERCHANDISE
20-2 YTL 20-2 YTL
Jan 1 Opening Stock 8 000 Dec 31 Cost of Merc. Sold 59 000
….. Purchases 56 000 Dec 31 Balance 5 000

20-2 YTL 20-2 YTL
48
Income Statement:
GROSS SALES 80 000

What we are saying in the Gross Profit Account is that Mrs Öztürk started the
year with a stock of goods valued at 8 000 YTL. During the year she has added
56 000 YTL worth of goods, making 64 000 YTL. By deducting her closing
stock of 5 000 YTL, however, we see that the cost of the goods which she has
sold for 80 000 YTL amounted to 59 000 YTL. This gives her a gross profit of
21 000 YTL.
You can observe that the opening stock for 20-2 (at the same time the closing
stock for 20-1) is entered on debit side of Merchandise Account on January 1,
20-2. The purchasing amount 56 000 YTL is written to debit side, Merchandise
Account. At the end of 20-2, we enter cost of goods sold (59 000 YTL.) on debit
side of Cost of Goods Sold Account and on credit side of the Merchandise
Account. So, Merchandise Account will show us the closing stock for 20-2 as a
balance. Finally, Cost of Goods Sold Account will be transferred to the Profit or
Loss for the Period Account.
Notes:
As closing stock is an asset of a business at the end of the year, it must be
entered on the balance sheet prepared on that date, just like any other asset.
Stock is listed on the balance sheet as a current asset .
1.10.5 Further with Gross Profit or Loss
a. Returns Inwards and Returns Outwards
Returns Inwards Account (Sales Returns) records the return of goods previously
sold by the business, that is, sales returns. Returns Outwards Account
(Merchandise) , on the other hand, deals with the return of goods previously
bought by the business and then found to be unsuitable, that is, purchases
returns. At the end of a firm's financial year, the information contained in these
two accounts must be taken out and transferred to the Gross Profit Accounts. In
the Trading Account the total of returns outwards is subtracted from purchases,
while the total of returns inwards is subtracted from sales. This then gives us net
figures for both purchases and the sales (the figure for net sales is often called
the turnover of the business).
49
MERCHANDISE
20-1 YTL 20-1 YTL
Jan 1 Opening Stock 200 Jan 11 Purchases Returns 60
…… Purchases 5 400
…… Purchases 2 690
8 290 60
DOMESTIC SALES
20-1 YTL 20-1 YTL
Jan 3 Customers 1 800
……. Cash 2 440
……. Customers 900
5 140
SALES RETURNS
20-1 YTL 20-1 YTL
Jan 16 Customers 150

Calculation of Gross Profit on January 31, 20-1
YTL YTL
Opening Stock 200 Sales 5 140
Purchases 8 090 Less Sales Returns 150
Less Purchases Returns 60 Net Sales 4 990
Net Purchases 8 030
4 990 4 990
The returns accounts, just like purchases and sales, store up money amounts
through the course of the financial year. Cosidering our example, Sales Returns
Account has a debit balance of 150 YTL, that is, goods to this value have been
sent back to the Supplier business. This balance is transferred to the Profit and
Loss Account by crediting Sales Returns Account, and by debiting Profit and
Loss Account—shown as a deduction from sales to give a net sales figure.
Purchases Returns Account (if we use a different account from Merchandise
Account) has a credit balance of 60 YTL, that is, we have returned goods to our
50
suppliers. This balance is transferred by debiting Purchases Returns Account

and crediting Merchandise Account—deducting from the figure for purchases.
b. Carriage Expenses
Carriage is the expense incurred in delivering goods; it is paid to firms that

specialize in providing a delivery service, such as the Post Office and Roadline.
In book-keeping, we need to distinguish between carriage inwards and carriage
outwards.
Carriage in is the charge paid by the buyer to the carrier to deliver goods to the
firm. So, it is the cost of delivering the firm's purchases. As such it is shown in
the Trading Account and added to purchases to show a 'delivered to the door'
price for all purchases. Carriage in is not always paid directly by the buying
firm: Many goods are quoted at a price that includes delivery. Sometimes,
though, a buying price is quoted as being 'ex-works', that is, the price at the
supplying firm's works, and a carriage charge (carriage in) must be paid to
obtain the delivery of the goods. Thus one supplier of goods might quote an 'ex-
works' price of 75 YTL for goods and then charge carriage of 5 YTL, while
another supplier might quote, for identical goods, 80 YTL 'delivered to your
door'. Clearly, where carriage inwards is charged separately it should be added
to the purchases (Merchandise Account) so that all goods purchased are recorded
at 'delivered to the door' prices.
Carriage out is the charge paid by the firm to a carrier to deliver goods that it has
sold to its customers: It is a cost borne by the supplier who is selling to
customers on a 'delivered to the door' basis. It is recorded in the Marketing
Expenses.
To summarize, both carriage in and carriage out are expenses, but carriage in is
charged in the Trading Account, being added to purchases, while carriage out is
charged in the Profit and Loss Account.
c. Other Expenses Charged to Profit or Loss Account
All other expenses incurred in connection with putting the goods in which a
business trades into a saleable condition should be charged to the Profit or Loss
Account. Wages, particularly warehouse wages, are an example of such an
expense and are considered to be a trading cost (contrasting with salaries which
are an administrative expense charged to the Profit and Loss Account).
d. Goods Taken for Own Use
51
We saw that when the owner of a business takes goods for his or her own use
without payment, an accounting entry should be made in the books. This is
carried out by debiting Receivable From Shareholders Account and crediting
Domestic Sales Account with the selling price of the goods.
1.10.6 An Example :
This example shows a number of accounts as they might appear at the end of a
financial year, indicating the ledger transfers to produce a Profit or Loss
Account.
Books of İyigörler
MERCHANDISE
20-1 YTL 20-1 YTL
…… Purchases 29 900 ……. Purchases returns 3 000
…… Carriage in exp. 100 Dec 31 Cost of Merc. Sold 22 000
30 000 30 000
DOMESTIC SALES
20-1 YTL 20-1 YTL
Dec 31 Profit or Loss Acc. 39 200 ……. Customers 35 800
……. Cash 2 500
……. Customers 900
39 200 39 200
SALES RETURNS
20-1 YTL 20-1 YTL
……. Customers 1 600 Dec 31 Profit or Loss Acc. 1 600


20-2 YTL 20-2 YTL

Salaries
52
20-1 YTL 20-1 YTL

…… ……….. 600 Dec 31 Profit or Loss Acc. 1 440
…… ……….. 840
1 440 1 440
FINANCIAL EXPENSES
Interest Expenses
20-1 YTL 20-1 YTL

Marketing Expenses
20-1 YTL 20-1 YTL
…… Carriage out exp. 200 Dec 31 Profit or Loss Acc. 550
…… ……….. 350
550 550

20-1 YTL 20-1 YTL
…… ……….. 1 800 Dec 31 Balance 1 800

20-1 YTL 20-1 YTL
Dec 31 Cost of Merc. Sold 22 000 Dec 31 Domestic Sales 39 200
Dec 31 Sales Returns 1 600
Dec 31 Gen.Adm. Expenses 1 440
Dec 31 Financial Expenses 200
Dec 31 Marketing Expenses 550
Dec 31 Balance (Net Profit) 13 410
39 200 39 200
Calculation of Gross Profit of İyigörler for the year ended on December 31, 20-1
YTL YTL
53
Opening Stock 0 Sales 39 200

Purchases 29 900 Less Sales Returns 1 600
Carriage in expenses 100 Net Sales 37 600
Less Purchases Returns 3 000
Net Purchases 27 000
37 600 37 600
Income Statement:
GROSS SALES 39 200

DISCOUNT OF SALES 1 600
Sales Returns 1 600
NET SALES 37 600
Marketing, Selling and Dist.Exp. 550
OPERATIONS 0
Interest Income 0
1.11 ACCRUALS AND PREPAYMENTS OF EXPENSES AND INCOME;

CAPITAL AND REVENUE EXPENDITURE
The word accruals stands for the amounts that owe and prepayments refer to the
amounts that have been paid in advance. These two terms are often used in
connection with expenses and income. At the end of a financial year, an
expenses account or an income account which has been storing up information
through the year is 'emptied out' via transferring the balance to Profit and Loss
Account. Please look at the example below:

Rents Paid
20-1 YTL 20-1 YTL
54
…… ……….. 600 Dec 31 Profit or Loss Acc. 2 400

…… ……….. 600
…… ……….. 600
…… ……….. 600
2 400 2 400
The system works well provided that expenses and income are respectively paid
or received during the financial year to which they relate. That example may
make you think that the company has rented premises for 2 400 YTL a year,
with the rent payable at the end of each quarter. However, also suppose that the
actual date of the fourth rent payment is January 3, 20-2. If we prepare the Rents
Paid Account as we have learned so far, it will appear as:

Rents Paid
20-1 YTL 20-1 YTL
Mar 31 ……….. 600
Jun 30 ……….. 600
Sep 29 ……….. 600
1 800

Rents Paid
20-2 YTL 20-1 YTL
Jan 3 ……….. 600
There is something incorrect here: Although the business paid 1 800 YTL for
rent through the year, it is clear from the Rents Paid Account that the amount
should have been 1 800 YTL. Because the payment due at the end of December
is 1 800 YTL. That is, on December 31, 20-1, rent of 600 YTL is accrued. To
correct such 'timing differences', we need to make adjustments in the expenses
and income accounts for accruals and prepayments.
1.11.1 Accruals of Expenses
With accruals we are concerned with expenses that are owing by a business at
the end of an accounting period. Suppose that the following account appears in
the books of a business on December 31, 20-1:
Phone
20-1 YTL 20-1 YTL
…… ……….. 90
55
…… ……….. 110
…… ……….. 75
275 275
The owner of the business tells you that he has received another bill for 100
YTL covering his phone expenses up to December 31. He tells you that he has
not yet paid this (he finally does so on January 15, 20-2).
When preparing the Profit and Loss Account for this business, we can not
transfer only the amounts that have been paid during the course of the year, that
is, (90 YTL + 110 YTL + 75 YTL) = 275 YTL. The last bill, even though it has
not been paid within the accounting year, nevertheless forms a part of phone
expenses for 20-1. The transfer to Profit and Loss Account will amount to 375
YTL (275 YTL already paid, plus 100 YTL accrued, and relating to the financial
year). This leaves a balance on the Phone Expenses Account for December 31,
20-1 as follows:

Phone
20-1 YTL 20-1 YTL
…… ……….. 110
…… ……….. 75
…… Accrued Expenses 100
375
ACCRUED EXPENSES
20-1 YTL 20-1 YTL
Dec 31 Phone Exp. 100
The account is now ready to receive payments made in 20-2.
A further point to note concerns the credit balance on Phone Account for
December 31, 20-1. We already know that all accounts with balances remaining
at the end of the year, after making transfers to the Profit and Loss Accounts, are
entered on the balance sheet. By the way, an accruals account is of course the
same since it has a credit balance. Thus, it is entered as a current liability:
Balance sheet (extract) of... on December 31, 20-1
56
Current liabilities: YTL

Bank Loans x
Account Payable x
Accrued Expenses (phone) 100
As a summary:
(a) ) For an expense, the transfer to Profit and Loss Account includes both the
amounts that have been paid, and any amount owing at the end of the year. This
is the amount that the company should have paid, instead of the amount actually
paid.
(b) On the balance sheet, the amount of any expenses accrued is put under the
heading of current liabilities.
1.11.2 Prepayments of Expenses
As we have discussed, prepayments are expenses that are paid beforehand. That
means, despite the fact that they have been paid in one accounting period, the
expense relates to the next.
Now, think of a company which rents its offices for 2 400 YTL for a year,
payable in advance in the first week of each March. If all went according to the
plan, we would expect rent payments to be made by the firm on March 3.
Rents paid
20-1 YTL
March 3 Bank 2 400
This shows us that during the year the business has paid 2 400 YTL for rent. But
we know that rent payable for the year (10 months) is 2 000 YTL, so clearly the
full amount should not be charged to the Profit and Loss Account. Only the
actual rent payable of 2 000 YTL should be charged.
PREPAID EXPENSES
Rents Paid
20-1 YTL 20-1 YTL
Mar 3 Bank 2 400 Mar 31 Gen.Adm. Exp. 200
Apr 30 Gen.Adm. Exp. 200
57
May 31 Gen.Adm. Exp. 200

Jun 30 Gen.Adm. Exp. 200
July 31 Gen.Adm. Exp. 200
Agu 31 Gen.Adm. Exp. 200
Sep 30 Gen.Adm. Exp. 200
Oct 31 Gen.Adm. Exp. 200
Nov 30 Gen.Adm. Exp. 200
Dec 31 Gen.Adm. Exp. 200
Dec 31 Balance c/d 400
2 400 2 400

Rents
20-1 YTL 20-1 YTL
Mar 31 Prepaid Expenses 200 Dec.31 Profit or Loss Acc. 2 000
Apr 30 Prepaid Expenses 200
May 31 Prepaid Expenses 200
Jun 30 Prepaid Expenses 200
July 31 Prepaid Expenses 200
Agu 31 Prepaid Expenses 200
Sep 30 Prepaid Expenses 200
Oct 31 Prepaid Expenses 200
Nov 30 Prepaid Expenses 200
Dec. 31 Prepaid Expenses 200
2 000
On January 1, 20-2, there is a debit balance (400 YTL) on the Prepaid Expenses
account, because the rent payment due on that date was prepaid on March 3, 20-
1. This debit balance (for two months - January and February 20-2) is entered
on the balance sheet on December 31, 20-1 as a current asset:
Balance sheet (extract) of... on December 31, 20-1
Current assets: YTL

Banks x
Customers x
Merchandise x
Prepaid Expenses (rent) 400
The debit balance will be transferred to the Profit and Loss Account at the end of
20-2, together with the further payments due in that year (subject to any
accruals or prepayments!).
To summarize:
58
(a) For prepayment of expenses, the transfer to Profit and Loss Account is the
amount showing on the expense account less the amount of the prepayment,
that is, the amount that should have been paid for the year.
(b) On the balance sheet, prepaid expenses are shown as a current asset.
1.11.3 Accrual of Income
Remember that expenses can be accrued or prepaid. The same also goes for the
income using the same rules. Let’s imagine that Sefa Sevindik gets a
commission to sell double glazing manufactured by another company. When
amounts of commission are received, they are credited to a Commission
Received Account. That account may look like this at the end of a year:
Commission received
20-1 YTL
Apr. 5 Bank 150
Jun. 9 Bank 220
Oct. 27 Bank 130
At the end of Sevindik’s financial year (December 31), he knows that a further
commission payment of 160 YTL is due in respect of double glazing already
sold, and a check for this amount is received on January 6, 20-2. This means that
the amount to be credited to Profit and Loss Account is 660 YTL (500 YTL is
actually received, together with 160 YTL due but not yet received). So, Accrued
Income Account will be balanced at the end of 20-1 in the following way:
COMMISSION INCOME
Commission Received
20-1 YTL 20-1 YTL
Dec. 31 Profit and Loss Acc. 660 Apr 5 Bank 150
Jun 9 Bank 220
Oct 27 Bank 130
Dec 31 Accrued Income 160
660 660
ACCRUED INCOME
Commission Received
20-1 YTL 20-1 YTL
Dec 31 Commission Income 160 Dec 31 Balance c/d 160
59
The debit balance on the account of 160 YTL will feature in Sefa Sevindik's
balance sheet as follows:
Balance sheet (extract) of Sefa Sevindik on December 31, 20-3
Current assets: YTL

Banks x
Customers x
Merchandise x
Accrued Income
(Com. Received) 160
As an alternative way, the amount of commission receivable could be included

with debtors.
When the check for the commission is received on January 6, 20-2, the account
will be cleared and will be ready to receive amounts concerning that financial
year:
ACCRUED INCOME
Commission Received
20-2 YTL 20-2 YTL
Jan 1 Balance 160 Jan 6 Bank 160
Important point:
Many accountants might disagree and say that it is wrong to expect income this
way. Because there is no guarantee that the money will be received. On the other
hand, this depends on conditions and if an examination question emphasizes that
the money definitely will be received or, indeed, already has been received
during the period between the financial year-end and the date of preparation of
the accounts, the amount must be included as an accrual of income.
1.11.4 Prepayment of Income
60
Previously, we have learned that a company which receives money for providing
a service is usually owed amounts at the end of a financial year. Same with this,
income amounts due to the company could be paid beforehand. Assume that a
company rents out part of its premises. This means, it has a rental income which
will be credited to Rent Received Account, and that the rent is 3 000 YTL for
each year, payable in the first week of each April. Thus, if all goes according to
plan, the business ought to receive a rent of 3 000 YTL on April 4 and would
transfer 2 250 YTL to the credit side of Profit and Loss Account. On December
31, 20-1, however, Rent Received Account is as follows:
Rent received
20-1 YTL
April 4 3 000
The transfer to Profit and Loss Account for the year which ended on December
31, 20-1 will be 2 250 YTL (for 9 mounts) , and the additional 750 YTL (for 3
months) will be carried down to 20-2:

Rent Received
20-1 YTL 20-1 YTL
Dec 31 Deferred Income 750 Apr 4 Bank 3 000
Dec 31 Profit and Loss Acc. 2 250
3
000 3 000
DEFERRED INCOME
Rent Received
20-1 YTL 20-1 YTL
Dec 31 Other Var.Income 750
On the balance sheet for December 31, 20-1, the amount of rent received in
advance will appear under the heading 'current liabilities', either added to
creditors or shown as a separate item described as 'rent receivable prepaid'. As
one quarter's rent has been paid in advance, the tenant will need to make only
three payments during 20-2. Therefore, the transfer to Profit and Loss Account
61
at the end of that year will be 2 250 YTL, and the Rent Received Account will
have a zero balance (assuming that there are no amounts paid in advance or
owing by the tenant).
The other way:

When we took the rent, we will write 250 YTL to credit side of the Other
Various Income Account, 2 750 YTL to credit side of the Deferred Income
Account and 3000 YTL to debit side of the Banks Account. At the end of every
month, we will transfer 250 YTL to the Other Various Income Account. Because
at the end of every month, a deferred income of 250 YTL will be accrued.

Rent Received
20-1 YTL 20-1 YTL
Dec 31 Profit and Loss Acc. 2 250 Apr 4 Bank 250
May 30 Deferred Income 250
Jun 30 Deferred Income 250
July 31 Deferred Income 250
Aug 31 Deferred Income 250
Sep 30 Deferred Income 250
Oct 31 Deferred Income 250
Nov 30 Deferred Income 250
Dec 31 Deferred Income 250
2 250 2 250
DEFERRED INCOME
Rent Received
20-1 YTL 20-1 YTL
May 30 Other Var. Income 250 Apr 4 Bank 2 750
Jun 30 Other Var. Income 250
July 31 Other Var. Income 250
Aug 31 Other Var. Income 250
Sep 30 Other Var. Income 250
Oct 31 Other Var. Income 250
Nov 30 Other Var. Income 250
Dec 31 Other Var. Income 250
31 Dec Balance c/d 750
2 750 2 750
1.11.5 Stocks of Office Supplies
In times a company buys items like stationery, postage stamps and so forth, it
generally charges the entire cost to the year's Profit and Loss Account.
Technically, the stock of these items must be valued at the end of the year and
62
the valuation should be passed to the next year's accounts. Because, this
technique will decrease the charge for the expense in the current year's accounts.
In practice, that is done only where the stock of such items is sufficient to affect
the accounts substantially, meaning that the company's accountant will
determine the level at which a carry-down will operate.
Example:
The Stationery Account has the following balance at the end of financial year:
OTHER INVENTORIES
Stationery
20-1 YTL 20-1 YTL
……. Cash 60
……. Cash 150
……. Cash 130
340
On December 31, the stock of stationery is determined to be 110 YTL. It is also

decided to carry this amount down to the next year. The account will appear as:
OTHER INVENTORIES
Stationery
20-1 YTL 20-1 YTL
……. Cash 60 Dec 31 Gen.Adm.Exp. 230
……. Cash 150 Dec 31 Balance 110
……. Cash 130
340 340

Stationery
20-1 YTL 20-1 YTL
Dec 31 Oth.Inventories. 230 Dec 31 Profit and Loss Acc 230
OTHER INVENTORIES
Stationery
20-2 YTL 20-2 YTL
Jan 1 Balance 110
So, 230 YTL is charged to the Profit and Loss Account and it represents the
amount of stationery actually used, while the stock at the end of the year is
transferred to next year. In the balance sheet on December 31, 20-1, the stock of
stationery will be demonstrated as a current asset.
63
1.11.6 Finding the Missing Figures
Probably, there are four different figures forming an expense or an income

account. These are listed below:
(a) amount owing or prepaid at the beginning of the year;

(b) amount paid or received during the course of the year;
(c) amount that is to be transferred to the Profit and Loss Account at the end of
the year.
This is the amount that should have been paid or received.
(d) amount owing or prepaid at the end of the year.
If we know any of these three figures, we can find the fourth 'missing figure' in
all circumstances by creating the expense or income account. For instance,
assume that we are provided the information below about insurance for the year:
(a) prepaid at the beginning of the year - 70 YTL;

(b) amount to be transferred to the Profit and Loss Account – 300 YTL;
(c) amount owing at the end of the year – 40 YTL.
Now, let’s say we were asked to compute the amount paid for insurance through
the year. What we have to do is to prepare an Insurance Account as indicated
below:

Insurance
20-1 YTL 20-1 YTL
Jan 1 Prepaid Expenses 70 Dec 31 Profit and Loss Acc 300
Cash (missing
figure) 190
Dec 31 Balance 40
300 300
By filling in the missing figure which is “Cash” in this example, we can say that
190 YTL was paid through the year.
1.11.7 Private Expenses
Sometimes it is stated that a specific percentage of certain expenses of the

business shall be charged to the owner as private expenses, such as phone or car
64
running expenses. All the particular expenses are then debited to the expense
account during the year in the normal way. At the end of the year, non-
belongings amount of the firm is debited to the owner's Drawings Account, or
Other Extraordinary Expepses Account while the balance is debited to the Profit
and Loss Account in the normal way.
Example
The following is the balance of the Phone Expenses Account at the end of the
financial year:

Phone
20-1 YTL 20-1 YTL
Oth. Extraord.Exp.
or Receivables
…… ……….. 46 Dec 31 From Shareholders 32
…… ……….. 53 Dec 31 Profit and Loss Acc 147
…… ……….. 75
179 179
RECEIVABLES FROM SHAREHOLDERS

Mr. Sezgin
20-1 YTL 20-1 YTL
Dec 31 Gen. Adm. Exp. 32 Dec 31 Balance 32
32 32
Or:
OTHER EXTRAORDINARY EXPENSES AND LOSSES

Phone
20-1 YTL 20-1 YTL
Dec 31 Gen. Adm. Exp. 32 Dec 31 Profit and Loss Acc 32
32 32
1.11.8 Capital Expenditure and the Revenue Expenditure
Capital Expenditure is the money spent by a company on the purchase of fixed

assets for use or sometimes it is the money spent on these assets’ alteration or
65
improvement. Please know that capital expenditure is not the money spent by a
business on the purchase of fixed assets for an immediate resale. Capital
expenditure also includes all the costs of delivering or installing fixed assets,
together with the legal costs of purchasing land and buildings. On the other
hand, Revenue Expenditure is the money spent on the running expenses of a
company. Here, the maintenance of fixed assets, the costs of administering the
company and of selling and distributing items, and the cost of purchase of stock
acquired with the purpose of resale are all included. At this point, let’s present
some examples for a better understanding. For instance, the cost of a new van
should be categorized as capital expenditure. On the other hand, money spent on
gasoline, insurance and repairs should be categorized as revenue expenditure. By
the way, Capital Expenditure is listed on the balance sheet while Revenue
Expenditure is listed on the Profit and Loss Account.
After that, it is really important to categorize expenditures correctly in a book-

keeping system. Because, otherwise the net profit will be demonstrated
incorrectly, or the balance sheet will point out wrong amounts, although it will
still balance. For instance, if the cost price of the van will be debited to the Profit
and Loss Account, then the net profit will be seriously lowered, or will even turn
into a net loss. Simultaneously, the van will not take place in the balance sheet.
However, this is absolutely incorrect since the company owns the van as a fixed
asset.
It is also beneficial to know that the difference between capital and revenue
expenditure is not always so easy to realize. Please, take a glance at these
expenditure items below and try to decide which of them are capital
expenditures and which of them are revenue expenditures:
(a) The cost of building an extension to offices is 12 000 YTL (800 YTL for
repairs to existing office are included).
Here, 800 YTL is written on the Repairs Account and is displayed on the Profit
and Loss Account. It is actually the revenue expenditure. So, what about 11 200
YTL? That’s the additional fixed assets.
(b) Wages (including wages of employees summing up to 1 400 YTL for

working on improvements to the premises) are 16 000 YTL .
For this one, 14 600 YTL is written as an expense and is debited on the Profit
and Loss Account as a revenue expenditure. To speak for 1 400 YTL, it is added
to the fixed asset of premises as capital expenditure.
66
(c) Carriage inwards of 1000 YTL covers 200 YTL carriage on a new
machine.
In regards to that example, 800 YTL is charged to the Profit and Loss Account
as a revenue expenditure and 200 YTL is added to the cost of the machine.
(d) Legal costs of 1 800 YTL covers 600 YTL which is related with the purchase
of some part of land.
The correct answer is to debit 1 200 YTL to the Profit and Loss Account and to
add 600 YTL to the cost of the land as a fixed asset.
As a result, note that the goal of learning the difference between capital
expenditure and revenue expenditure is to allocate costs the right way between
the balance sheet and the Profit and Loss Accounts. If the process will not run
correctly, then the final accounts will not be able to provide us the right feedback
about the condition of the company.
1.11.9 Preparing Final Accounts from a Trial Balance
We may be asked to prepare the final or year-end accounts of a company from

time to time. These can be the Trading & Profit and Loss Accounts in addition to
the balance sheet from a trial balance. In the beginning, you will find the trial
balance to be very short, and there will only be two or three adjustments to be
made. Below, you can study with a typical examination question:
This trial balance was taken from the double-entry book-keeping accounts of
Erkan Iscimen Co. on December 31, 20-1:
Accounts: Dr. Cr. Dr. Cr.

Balance Balance
YTL YTL YTL YTL
Banks 2 000
Accounts Receivable 6 500
Receivables from Shareholders 5 000
67
Merchandise 37 000
Opening Stock 7 000
Purchases 30 000
Furnitures and Fixtures 7 500
Accounts Payable 3 800
Paid in Capital 85 000
General Administrative Exp. 6 400
Rates 1 600
Heating and lighting 1 900
Salaries 1 500
Postage and packing 1 400
Buildings 65 000
Total 129 400 129 400
You are required to take the following into consideration on December

31, 20-1:
(i) Stock 8 000 YTL

(ii) Rates paid in advance 500 YTL
(iii) Salaries owing 300 YTL
Prepare the Trading and Profit & Loss Accounts for the year ended on December
31, 20-1, and also prepare a balance sheet for that date.
When trying to solve such a question, all we have to do is to rearrange the trial
balance and to take the notes into consideration, so that the final accounts are
produced: These should mean more to the owner of the business than a trial
balance can do. The important rules to follow are:
(a) each item from the trial balance appears on the final accounts once only;
(b) each adjustment or note appears—or affects an item—on the final accounts
twice (if this is not done, the balance sheet will not balance!).
It is also definitely a good idea to go through the trial balance and adjustments.
This way, the trial balance figures for stock and purchases can be marked with a
CG' (for Cost of Goods Sold); rates, heating and lighting, salaries, and postage
and packing can be marked with 'P & L' (for Profit and Loss Account); all the
other trial balance figures can be marked 'BS' (for balance sheet). The
adjustments or notes for this question can be marked as follows:
Stock CG and BS
Rates paid in advance P & L and BS
Salaries owing P & L and BS
68
As the final accounts are prepared, each item can be ticked as it is entered. When
the final accounts are completed it is a simple matter to see if each trial balance
item is ticked once, and each adjustment or note is ticked twice. Finally, some
important points about this particular question:
(a) The opening stock is found on the trial balance, while the closing stock
is given as a note—this is often true for questions of this type.
(b) Rates must be adjusted to allow for the prepayment. The trial balance tells
us that 1 600 YTL has been paid for rates but the note explains that 500
YTL has been paid in advance for next year. This means that the Profit and
Loss Account must be charged with 1 100 YTL (amount that must have
been paid) and the prepayment must be shown on the balance sheet as a
current asset.
(c) The trial balance shows that salaries of 1 500 YTL have been paid during the
year, but that 300 YTL is owing at the end of the year. Thus, 1 800 YTL
(amount that must have been paid) must be charged on the Profit and Loss
Account, with 300 YTL showing on the balance sheet as an amount owing
(accrual).
The answer to this question is as follows:
Merchandise and the Cost of Merchandise Sold Accounts of Erkan Isciment Co.
for the year ended on December 31, 20-1
MERCHANDISE
20-1 YTL 20-1 YTL
Jan 1 Opening Stock 7 000 Dec 31 Cost of Merc. Sold 29 000
….. Purchases 30 000 Dec 31 Balance 8 000
37 000 37 000

20-1 YTL 20-1 YTL
Income Statement:
GROSS SALES 40 600

69

Profit and Loss Account of Erkan Iscimen Co. for the year ended on Dec. 31, 20-1
YTL YTL
Rates 1 100 Gross profit b/d 11 600
Heating and lighting 1 900
Salaries 1 800
Postage and packing 1 400
Net profit 5 400
11 600 11 600
Income Statement:
GROSS SALES 40 600

DISCOUNT OF SALES
Sales Returns
NET SALES 40 600
Marketing, Selling and Dist.Exp.
OPERATION 0
Interest Income 0
BALANCE SHEET
December 31, 20-1

Current Assets: Current Liabilities:
70
Banks 2 000 Accounts Payable 3 800

Accounts Receivable 6 500 Accrued Expenses 300
Merchandise 8 000
Prepaid Expenses 500 Capital:
Receivable from Shareholders 5 000 Paid in Capital 85 000
Fixed Assets: Net Profit 5 400
Buildings 65 000
Furnitures and Fixtures 7 500
It is particularly enjoyable when final accounts balance first time and, with care,
they should. You will come across further examples later on in this book, getting
progressively more complex. If you tackle them logically, you too will find them
to be very easy.
1.12 VALUE ADDED TAX (V.A.T.)
1.12.1 Value Added Tax
V.A.T. which stands for Value Added Tax is a well heard form of taxation and is
being used in many countries as a tax on the supply of goods & services. It is
borne by the final consumer at the last step, but is collected at all phases of the
production and distribution chain, wherever 'value' is added.
A wholesaler who purchases items from a manufacturer is charged VAT on

goods bought (on input to the wholesaler) and when the items are sold (on
output) to the retailers, the wholesaler charges VAT that is computed on the
price of goods. After that, the wholesaler pays the difference between tax
charged to the customers and tax paid to the suppliers. Naturally, this difference
is paid to the tax authorities. We can also say that this is the surplus between tax
paid on inputs and tax charged on outputs. (The VAT rate changes from time to
time but a high percentage of examinations consider a rate of 18 percent). Now,
please take a look at the example below:
Wholesaler
Apr.12, 20-1 Buys goods from the manufacturer, Sarkon Ltd.:
800 YTL plus VAT at 18 per cent: value of inputs (excluding VAT) 800 YTL
Value added 144 YTL
Apr. 15, 20-1 Sells goods to the retailer, Serkan Sağlam:
71
1 000 YTL plus VAT at 18 per cent: value of outputs (excluding VAT) 1 000 YTL
Value added 180 YTL
VAT movements:
Paid to the manufacturer by wholesaler 144 YTL
Collected from the retailer by wholesaler 180 YTL
Paid to the tax authorities by wholesaler 36 YTL
1.12.2 The Use of a VAT Account
Let us say that for the example in section 1.12.1, the wholesaler will not send a
check to the tax authorities for all individual transactions. On the other hand, the
VAT settlement is made on a quarterly basis and pending payment amounts are
kept in a VAT Account.
The VAT Account is:

(a) debited with the VAT amount paid on purchases from suppliers.
(b) credited with the VAT amount charged on sales to customers.
Now, it is time to learn how the two transactions focused in section 1.12.1 would
be entered into the double-entry book-keeping accounts. Below, you can see the
two transactions again:
Apr. 12, 20-1 Bought goods of 800 YTL on credit from Sarkon Ltd..
Apr 15,. 20-1 Sold goods of 1000 YTL on credit to Serkan Saglam.
Both transactions are subject to the VAT at 18 per cent.
MERCHANDISE
20-1 YTL 20-1 YTL
Apr. 12 Sarkon Ltd. 800
ACCOUNTS PAYABLE
Sarkon Ltd.
20-1 YTL 20-1 YTL
Apr. 12 Marchandise 944

DOMESTIC SALES
20-1 YTL 20-1 YTL
Apr. 15 Serkan Saglam 1 000
72

COSTOMERS
Sekan Saglam
20-1 YTL 20-1 YTL
Apr. 15 Domestic Sales 1 180

DEDUCTABLE VAT
20-1 YTL 20-1 YTL
Apr. 12 …………. 144
VAT RECEIVED
20-1 YTL 20-1 YTL
Apr. 15 …………… 180
Notes:
(a) Purchases (Merchandise) Account is debited with the amount of VAT

purchases exclusive. Like this one, Sales (Domestic Sales) Account is credited
with the amount of VAT sales exclusive.
(b) Sarkon Ltd.’s (manufacturer) personal account is credited with the amount
of VAT purchases inclusive. Like this one, Serkan Saglam’s account (retailer) is
debited with the amount of VAT sales inclusive.
(c) In case those two were the only transactions for April 20-1, then the
Deductable VAT Account would indicate a 144 YTL debit balance and VAT
Received Account would indicate a 180 YTL credit balance at the end of the
month. We will close both of them at the end of the month. So we are
transferring VAT Accounts to the Taxes Payable Account.
DEDUCTABLE VAT
20-1 YTL 20-1 YTL
Apr. 12 …………. 144 Apr. 30 Taxes Payable 144
73
VAT RECEIVED
20-1 YTL 20-1 YTL
Apr. 30 Taxes Payable 180 Apr.15 …………… 180
TAXES PAYABLE
20-1 YTL 20-1 YTL
Apr. 30 Deductable VAT 144 Apr. 30 VAT Received 180
1.12.3 VAT Calculations
Most goods and services are subject to VAT. Normally, at the time of writing,
rate of VAT is 18 percent. Certain goods carry one or egiht percent rate of VAT.
If the rate of VAT is 18 percent, then we know that goods which cost 100 YTL
excluding the VAT will be 118 YTL when the VAT is included. If we were told
that the VAT-inclusive amount was 118 YTL and if we were asked to calculate
the VAT-exclusive amount, we would carry out the following calculation:
100
118 YTL x —— = 100 YTL
118
Thus, with VAT at 18 percent, multiplying the VAT-inclusive amount by

100/118 will give us the VAT-exclusive amount. The VAT fraction, therefore, at
this rate of tax is 18/118 of the VAT-inclusive amount. At the end, it will be
wise to stress that we need to know both the VAT amount and the VAT-
exclusive amount for further recording in a cash book, a journal and finally a
petty cash book.
1.13 THE LEDGER
Until this point, in double-entry book-keeping, we have opened accounts
74
when they have been required. So, Capital Account can be followed by
the Bank Account, Purchases Account can be followed by a Creditor's
account, Motor Vehicles Account can be followed by the Sales Account
and etc... This means, the ledger which contains all the accounts has no
order. To better explain this concept, let’s say we need information
contained in the Sales Account. What we should do here is to check
through the accounts until we find the specific one. A quick thinking can
help you predict that this will be easy when there are twenty or thirty
accounts and when the firm is a small scaled one. However, what about
the large scaled companies? For sure, as the firm gets bigger and the
ledger contains more accounts, or job will be harder. For example, in the
Uniform Accounting Plan (Chart of Accounts), there are four or five
hundred accounts.
General Ledger
The General Ledger is also known as the nominal ledger. The General Ledger
includes accounts for purchases, sales, expenses and the income. Moreover, it
contains accounts like premises, motor vehicles, machinery and stock for assets.
Furthermore, it contains accounts such as loans and capital for liabilities.
Finally, it contains accounts for drawings, trading, profit and loss. By the way,
these are usually called as the impersonal accounts since they are the accounts of
things instead of people—in contrast to the personal accounts of debtors and
creditors found in general ledger. Another thing to mention is that impersonal
accounts are sometimes further subdivided into real accounts, which are relevant
with assets like premises, motor vehicles and stock, and nominal accounts which
are relevant with revenue and expenses like wages, sales, rent, discount,
purchases and etc..
1.14 THE JOURNALS
Journals are usually known to be day books, as the accounting system gets
bigger. By the way, a journal or a day book is a listing tool that is not a section
of the double-entry book-keeping. It keeps details and money amounts of the
company transactions until they are entered into the accounting system. Journals
are often known as books of original entry because they record the first details of
business transactions, before they are entered into the double-entry book-
keeping system.
This chapter is concerned with the use of basic journals for sales, purchases,
expenses and returns.
75
1.14.1 Uses of the General Journal
We used journals (or day books) for sales, purchases, returns inwards and returns
outwards. Such journals are used where there is a large volume of transactions, and
there are books of original entry which store up information until it is transferred
in the form of a sum to the appropriate general ledger accounts. For irregular
transactions, a general journal is used, again as a book of original entry.
The general journal is used for all items, for example:

(a) the transactions which open the books of a business’ account;
(b) purchases
(c) sales
(d) returns inwards
(e) returns outwards
(f) all other transactions
(g) correction of errors;
(h) other transfers.
We shall look at each of these in turn.

The general journal, which is not a part of the double-entry bookkeeping system,
can be thought of as a place where transactions can be explained in more detail
than it is possible on an account. It provides the accounting entries that are then
passed in respect of certain transactions. Thus, when the accounts are checked,
more information about unusual transactions can be found in the journal. By the
way, a ruled journal page has two columns for money amounts on the right-hand
side. When used for general journal, these two columns represent the debit and
credit respectively.
Journal
Acc.
No Details Folio Dr. Cr.
YTL YTL
1.14.2 The Use of a Journal for Opening Entries

Opening entries relate to the first transactions which open the accounts of a
business. For example, a first business transaction might read:
/ Jan. 20-1 Started the business with YTL 1 500 in cash.

To record this transaction in the accounts, as you know, we must debit the Cash
Account and credit the Capital Account. As this is a non-regular transaction, it
needs to be entered in the journal:
76
Acc.
____________ 01/01/20-1 ____________ YTL YTL
100 Cash 1 500
500 Capital 1 500
Introduction of opening capital
Notes:
(a) The names of the two accounts concerned are given in the 'details'
column.
(b) A few words of explanation, or narrative, are usually included.
(c) Each entry in the journal is complete in itself and should be ruled off so
as not to confuse it with the next entry.
(d) Most journal entries balance, that is, debit amount(s) equal credit
amount(s). Very occasionally a journal entry does not balance; this sometimes
happens, for instance, when correcting certain types of error.
(e) After each journal entry has been made, appropriate entries must be
made in the accounts described in the journal.
Now we look at a further example of opening entries for a firm that starts the
business with several assets and liabilities.
Example:
On January 1, 20-1 Kalyon Co. sets up the business with the following assets and
liabilities: Cash 150 YTL; Banks 300 YTL; Merchandise 800 YTL; Furniture and
Fixtures 700 YTL; Accounts Payable 450 YTL and Capital 1500 YTL.
The opening journal entry will read:
Acc.
____________01/01/20-1 ___________ YTL YTL
1100 Cash 150
102 Banks 300
77
153 Merchandise 800

255 Furniture and Fixtures 700
320 Accounts Payable 450
500 Capital 450
1500
1 950 1 950
Assets and liabilities at the 1950
commencement of business
Here, Capital Account provides the balancing figure: Kalyon Co.'s assets minus its
liabilities equals to its capital. The individual accounts will then need to be
written up.
1.14.3 Purchase or Sale of Fixed Assets

This, too, is a non-regular business transaction, and therefore should be recorded
in the journal.
Example:
Apr. 15, 20-1

Bought a new machine for 2 000 YTL plus VA T at 18 percent, payment made
by check.
The journal entry is:

______________________ 15.04.20-1 ____________________
253 MACHINERY AND EQUIPMENTS 2 000

191 DEDUCTABLE VAT 360
103 CHECKS GIVEN 2 360
Purchase of new machine : purchase
order no 452
______________________ ____________________
Another Example:
May 6, 20-1
Bought a merchandise for 600 YTL plus VA T at 18 percent, on credit
fromDersan Ltd.
The journal entry is:

______________________ 06.05.20-1 ____________________
153 MERCHANDISE 600

320 ACCOUNT PAYABLE 708
78
Purchase of merchandise : purchase

order no 603
______________________ ____________________
1.14.4 Other Transfers
All other company transactions of a non-regular nature must be written down on

the journal. Because, the logic behind this behavior is quite understandable. First
of all, the past events indicate that the complete details of an unorthodox
transaction are usually forgotten in a very short time after the implementation.
So, the journal will show the book-keeping entries made and the reasons behind
them. Plus, the owner or the accountant of a company may have the chance to
observe such transactions in detail by insisting that they are really entered in the
journal. Finally, the category of 'other transfers' contains transactions for:
(a) all transfers to Trading plus the Profit and Loss Accounts.
(b) charging expenses to Owner's Drawings Account.
(c) provision for the bad debts.
(d) bad debts (credits) written off.
(e) depreciation provisions.
(f) fixed assets’ disposal.
Examples
1. Dec. 31, 20-1 The debit balance of Insurance Account isb 300 YTL. Of
this, 260 YTL relates to 20-1, while 40 YTL is a prepayment for 20-2.
______________________ 31.12..20-1 ____________________
180 PREPAID EXPENSES 40

770 GENERAL ADMINISTRATIVE
EXPENSES 40
Transfer to the Prepaid Ezpenses Account
______________________ ____________________
2. Dec. 31, 20-1 Motor Vehicle Expenses Account has a debit balance of
1 450 YTL. Of this, 200 YTL represents the cost of the owner's private
motoring.
______________________ 31.12..20-1 ____________________
131 RECEIVABLE FROM

SHAREHOLDERS 200
79
EXPENSES 200
Transfer of private use to the Drawings Account
______________________ ____________________
1.15 FIXED ASSET DEPRECIATION
1.15.1 The Meaning of Depreciation
If we should start with the dictionary definition of depreciation, we can tell that
it is a fall in the value. Despite the fact that you may not use the formal term
depreciation in your daily life, you must be very well aware that the things
belonging to you will almost always fall in value in the long-run. As an example,
your car, motorbike, bicycle, cellular phone, mp3 player or IPod will all
depreciate as the time goes on. Definitely, this rule can not be applied to all
goods. For instance, antiques, stamp collections and even specific nostalgic
cards can higher in value as the time goes by. However, the majority of assets
held for any period of time depreciate since first of all, they get older and
secondly, as they are used they wear out. That rule is true for almost all of the
fixed assets of a company such as motor vehicles, machinery, office equipment
and the buildings. You may wonder why we mentioned the buildings here. The
reason is simple, because they wear out too and in the longer-run, they have a
limited useful life. Just imagine the rows of leaky, decaying houses which
should be destroyed or think of the old small stores which are knocked down so
that new shopping centers can be built. The only fixed asset which does not
depreciate is usually the land. It is there to be used forever. However, when it
has mineral wealth like the coal, oil or iron ore, then it will have a limited life for
that specific purpose and it will depreciate as the minerals are extracted. In
accounting, when a fixed asset is purchased, it is written down on the accounts at
cost.
As an example:
May 12, 20-1 Purchased a computer for 2 000 YTL and it was paid by check.
So, the accounts will look like:

20-1 YTL 20-1 YTL
May 12 Checks Given 2 000

CHECKS GIVEN
80
20-1 YTL 20-1 YTL

May 12 Furniture and Fixt. 2 000

Here, the Furniture and Fixture Account reports us that this company owns a
computer that costs 2 000 YTL on May 12, 20-1. The company uses the
computer for making programs and so forth. However, after some years, the
computer will be sold. Now, let’s say, when the computer is bought in 20-1, it is
thought that the computer will be sold for 500 YTL on September 20, 20-4 after
four years of use. This means that it is clearly expected to depreciate by 1500
YTL in sum (2000 YTL – 500 YTL = 1500 YTL) during the period the business
owns it. Because of that reason, we can tell that the computer is expected to
depreciate by 375 YTL each year (1500 YTL / 4 years = 375 YTL). Please know
very well that this is the amount of depreciation, in other words the expected fall
in value of the computer each year. You should understand that it is not a cost of
operating the computer such as the costs of license, insurance, service and
repairs. So, according to you, into which account would operating costs like this
one be placed? The correct response is Fixed Assets Running Expenses Account.
(in General Administrative Expenses) By the way, as we are familiar with
expenses accounts, the sum for the year will be debited to the Profit and Loss
Account. Implement the same reasoning and you will say that we must debit the
Profit and Loss Account with the expense of depreciation. On the other hand,
there exists an important difference between the fixed assets running expenses
and depreciation. Despite the fact that both of them are debited to the Profit and
Loss Account at the end of the financial year, money is paid out to cover
computer running expenses through the year. On the other hand, no money is
paid for depreciation. We can also say that no check payable to 'depreciation' is
drawn. Surely, money must be paid out to purchase a fixed asset, however the
annual depreciation charged to the Profit and Loss Account does not make any
payment in cash necessary. So, depreciation is usually known as a 'non-cash
expense'.
So far, we have learned that a company normally depreciates all of its fixed
assets excluding the land. In other words, the debit side of Profit and Loss
Account includes depreciation amounts for some goods like buildings,
machinery and motor vehicles in addition to the other expenses of the company.
As a result of all these, there will be an increase in the total expenses of the
company. Naturally, the net profit will go down. You can check the following
for a better understanding…
81
Before charging depreciation:
20-1 YTL 20-1 YTL

Dec 31 Gen. Ad.Exp. 1 940
(excluding
depreciation)
Balance c/d (net
Dec 31 profit) 790
4 490 4 490
After charging depreciation:
20-1 YTL 20-1 YTL

Dec 31 Gen. Ad.Exp. 2 315
(including
depreciation)
Balance c/d (net
Dec 31 profit) 415
4 490 4 490
1.15.2 Depreciation Methods
In chapter 1.15.1, we looked at the depreciation on a computer that costed 2 000

YTL and was expected to be sold, after four years' use, for 500 YTL. The total
amount of depreciation was expected to be 1500 YTL, or 375 YTL each year.
Where the expected selling price (residual value) of the asset at the end of the
period of use can be estimated fairly accurately, an annual amount is easily
calculated:
(Cost price-Residual value)

------------------------------------ = Depreciation each year
Number of years
For example, the annual depreciation of a machine which costs 8 000 YTL and
that will be sold for 3 000 YTL after five years is:
82
8 000 - 3 000
------------------- = 1 000 depreciation each year
5
A business must make an estimate of fall in value of each fixed assets class
every year, or provision for depreciation. It is this provision for depreciation
which is charged to the Profit and Loss Account each year. When a fixed asset is
finally sold or scrapped, an adjustment can be made for any under or over-
provision for depreciation.
There are three main ways of calculating a provision for depreciation:

(a) straight-line method;
(b) reducing-balance (or diminishing-balance) method;
(c) revaluation method.
We shall consider all these in turn.
1.15.3 Straight-Line Depreciation
We should discuss the Straight-Line Deprection as the first leading way of

calculating a provision for depreciation. By implementing this method, a certain
percentage of the original cost of the fixed asset is taken each year. The money
amount is the depreciation for the year, and the cost of the fixed asset minus the
total depreciation to date is said to be the net book value.
For Example:
A machine is purchased for 8 000 YTL on February 14, 20-1 and it is to be

depreciated by the straight-line method at 20 percent each year. The firm's
financial year-end is December 31. The machine will depreciate as follows:
YTL
Cost on February 14, 20-1 8 000
Depreciation for 20-1 1 600
Net book value on December 31, 20-1 6 400
Depreciation for 20-2 1 600
Depreciation for 20—3 1 600
As you see, this method provides the same money amount for depreciation each
year.
83
1.15.4 Reducing-Balance (or Diminishing-Balance) Depreciation
With this method, a certain percentage of the reduced (or diminished) balance
(that is, the balance at the beginning of each year) is taken as the depreciation for
the year.
For Example:
The machine discussed for the example in Unit 1.15.3 is to be depreciated using
the reducing-balance method at 40 percent each year. Depreciation rate is two
times of straight-line depreciation rate. However, depreciation rate is not more
than 50 percent each year.
The machine will depreciate as follows:
YTL
Cost on February 14, 20-1 8 000
Depreciation for 20-1 (40% of 8000 ) 3 200
Just look above and you will quickly realize that the reducing-balance method
presents a decreasing amount of depreciation each year. This means, for
instance, in the second year the amount is less than in the first, and in the third
year it is less than in the second, and etc...
1.15.5 Straight-Line and Reducing-Balance Methods Compared
We have used the two methods of calculating depreciation for the same machine
but at different rates. The depreciation amounts for each year are:
Year Straight-line method Reducing-balance method

(20%) (40 %)
20-1 1600 YTL 3200 YTL
20-2 1600 YTL 1920 YTL
20-3 1600 YTL 1152 YTL
84
The straight-line method which provides the same depreciation amount each
year is generally used for fixed assets like buildings, machinery, fixtures and
fittings. On the other hand, the reducing-balance method which provides for
larger depreciation amounts in the first year but decreasing ones in the later
years, is usually used for vehicles since it reflects the way in which their value
will decrease. In line with those, a company selects the depreciation calculation
method which suits best and applies sensible percentage rates for different asset
categories. For instance, one rate for vehicles and another rate for buildings.
That technique will reflect the difference in the ways their values are anticipated
to change.
1.15.6 Depreciation and Double-Entry Book-keeping
After a company chooses the depreciation method it will use and the rate it will
apply, then it should record the entries in the books of account. There are two
separate ways of doing this: The traditional method and the modern method.
.
a. Direct Method
Now, we will go through an example to have a better knowledge of the Direct

Method. Here, a fixed asset account is maintained for each asset class and the
amounts presented for depreciation each year are credited to the account. For
example: the machine costs show that we bought 4 000 YTL on March 12, 20-1
and it is depreciated at 20 percent each year, implementing the straight-line
method. Thus, the Machinery Account should look like this for the first three
years of ownership:
MACHINERY AND EQUIPMENT

20-1 YTL 20-1 YTL
Mar.12 …………… 4 000 Dec.31 Gen.Adm.Exp. 800
Dec.31 Balance c/d 3 200


20-2 YTL 20-2 YTL
Jan.1 …………… 3 200 Dec.31 Gen.Adm.Exp. 800
Dec.31 Balance c/d 2 400

85
20-3 YTL 20-3 YTL

Jan.1 …………… 2 400 Dec 31 Gen.Adm.Exp. 800
Dec 31 Balance c/d 1 600

So, the net book value is the balance at the end of each year. In other words, it is
the cost of the asset minus depreciation to date. As you can see, the net book
value goes down as the machine gets older by each additional year's depreciation
amount. In the fixed asset account, which is the machinery in our example,
amounts of annual depreciation are kept on the credit side. Also note that the
double-entry book-keeping to this credit entry is finalized with a debit to
General Administrative Expenses Account. Because of this reason, the book-
keeping should be:
Dr. General Administrative Expenses Account

Cr. Fixed asset (machinery) account
with the annual amount provided for depreciation
A journal entry must be made for annual depreciation amounts along the
following lines:
______________________ 31.12..20-1 ____________________

EXPENSES 800
253 MACHINERY AND EQUIPMENT 800
Annual provision for depreciation
on …..
Method of depreciation …..
Percentage …….
______________________ ____________________
The General Administrative Expenses Account extract for each year, using the
same example figures as before, will appear as:

Provision for depreciation
20-1 YTL 20-1 YTL
Machinery and
Dec.31 Equip. 800
86

20-2 YTL 20-2 YTL
Machinery and
Dec.31 Equip. 800

20-3 YTL 20-3 YTL
Machinery and
Dec.31 Equip. 800
So, just as we have underlined, the effect of the entry for depreciation on
General Administrative Expenses Account and the transfer to the Profit and Loss
Account are the decrease in net profit or the increase in any net loss. The reason
is that an additional expense has been incurred, being a prediction of the
decrease in value of specific fixed assets that the company has had the advantage
of using through the course of the year. Another factor we should make clear is
that, when a company makes a provision for depreciation, it does not put an
amount of cash aside. In reality, depreciation is simply a book-keeping entry
which permits the predicted fall in value of fixed assets. Besides, you should
know that Provision for Depreciation must take place on the balance sheet.
There is no doubt that the ideal method of doing this is to indicate the fixed asset
at cost, and then subtract the full amount of provision for depreciation to date
from that amount. By the way, we should not only subtract this year’s amount.
We must include all amounts from the previous years to our subtraction. As a
result, using the same example, the balance sheet summary should appear as
follows:
Balance sheet of... on December 31, 20-1

Machinery and Equip. 3 200
87


By implementing this method, depreciation is subtracted from the cost price of

the asset. For sure, the amount which should be added into the assets side of the
balance sheet is the net book value. This is, in our example, 3 200 YTL on
December 31, 20-1, 2 400 YTL on December 31, 20-2 and 1 600 YTL on
December 31, 20-3.
b. Indirect Method
While the direct method shows the fixed asset account with provisions for
depreciation included on it, the indirect method uses two separate accounts for
the same transactions:
(i) a fixed asset account, which records the cost price of the asset;
(ii) a Provision for Depreciation Account, which records the amount of
depreciation set aside each year.
Again, we will use the example of machine costing 4 000 YTL on March 12, 20-
1 and being depreciated at 20 percent each year using the straight-line method.
Machinery and Equipment Account and the Provision for Depreciation Account
appear as follows for the first three years of ownership:

20-1 YTL 20-1 YTL
Mar.12 …………… 4 000 Dec.31 Balance c/d 4 000

88

20-2 YTL 20-2 YTL
Jan.1 Balance b/d 4 000 Dec.31 Balance c/d 4 000


20-3 YTL 20-3 YTL
Jan.1 Balance b/d 4 000 Dec.31 Balance c/d 4 000

ACCUMULATED DEPRECIATION
20-1 YTL 20-1 YTL
Dec. 31 Balance c/d 800 Dec.31 Gen. Adm. Exp. 800

20-2 YTL 20-2 YTL
Dec.31 Balance c/d 1 600 Dec.31 Balance b/d 800
Dec.31 Gen. Adm. Exp. 800

20-3 YTL 20-3 YTL
Dec.31 Balance c/d 2 400 Dec.31 Balance b/d 1 600
Dec.31 Gen. Adm. Exp. 800

After working on these two accounts, you should be able to realize that:
(h) The fixed asset account, which is the Machinery and Equipment Account in
our example, remains at cost.
(ii) Accumulated Depreciation Account keeps up the amounts presented for
depreciation on a yearly basis.
(iii) Those two accounts are balanced at the end of each financial year. It is
better we get used doing it (balancing the accounts) when preparing depreciation
accounts.
89
(iv) For each class of fixed assets, exists a separate Provision for Depreciation
Account.
Additionally, annual depreciation amounts are credited to the Provision for

Depreciation Account and this account has a credit balance every time. So, the
double-entry book-keeping is as follows:
______________________ 31.12..20-1 ____________________

EXPENSES 800
257 ACCUMULATED DEPRECIATION 800
Annual provision for depreciation
on …..
Method of depreciation …..
Percentage …….
______________________ ____________________
The Balance sheet extracts will be shown as:

Less Accumulated 800
depreciation to date

Less Accumulated 1 600

Less Accumulated 2 400
90
1.16 DISPOSALS OF FIXED ASSETS
Fixed assets—such as buildings, machinery or vehicles—are usually purchased

with the intention that they will be used in the business for some time to come:
They are depreciated in order to take account of their fall in value over that time.
When a fixed asset is sold, we find out if our provision for depreciation has been
accurate. Until the asset is sold and its price is known, the provisions are
estimates; the sale 'crystallizes' the situation and we can work out the 'gain' or
'loss' on sale. For example:
YTL
Cost price of machine 4 000
Less Provision for depreciation to date 2 400
Net book value at date of sale 1 600
Selling price 1 500
'Loss'on sale 100
As you can see above, a 'gain' or a 'loss' is only a book-keeping difference. In

our example, depreciation is underprovided. However, if depreciation was 2500
YTL, then we would have a net book value equal to the selling price. Thinking
reverse, when there is a 'profit' on sale, the depreciation will be overprovided.
This means, too much depreciation is provided during ownership of the asset.
1.17 BAD CREDITS AND PROVISION FOR BAD AND DOUBTFUL

CREDITS
1.17.1 Introduction
Now, it is time to focus on the debtors of a company. When we say debtors, it

refers to the amounts due to the company from its customers. Below, we will
mention the two aspects of debtors:
(a) Bad Credits - These are the amounts that a company is unable to gather from
customers for numerous reasons. Because of this reason, the amount is written
off in the company's accounts as being irrecoverable.
(b) Provision for bad and doubtful credits - This is the amount or proportion of
the debtors which the company thinks they may not pay the debt in the future.
On the other hand, it is not definite that these debts will become bad. Besides
these, the goal of writing off bad credits, and in making a provision for bad and
doubtful credits, is to be able to indicate a number (figure) for net debtors in the
balance sheet that accurately provides a collectable amount. Another eye-
catching point is that accountants also call net debtors as receivables and this
91
clearly reflects the idea - the amount of the total debtors number (figure) which
is receivable.
1.17.2 Written Off and Provision for Bad and Doubtful Credits
To better understand this topic, let’s begin with an example including the
following account that takes place in the sales ledger section:
CUSTOMERS
E.Yıldız
20-1 YTL 20-1 YTL
May 4 Domestic Sales 125 Jun 29 Cash 25
Agu 20 Banks 50
125 125
CUSTOMERS
E.Yıldız
20-2 YTL 20-2 YTL
Jan 1 Balance b/d 50 Mar 3 Cash 20

Now, assume that we are at the end of financial year 20-2 and we are assigned to
the task of going over the debtors' accounts to see if there are any bad credits
which should be written off before the financial year ends on December 31. So,
what can we say about E. Yildiz’s account? It indicates that goods totaling to
125 YTL were sold to this client on credit on May 4, 20-1. However, since that
date, it has been 20 months but we have only received payments with a value of
95 YTL. This means, the account balance is 30 YTL debit currently. In addition
to all these, let’s say we find out that the last statement sent was returned by the
Post Office and it was marked as 'not known at this address'. So, what should our
company do at that particular point? On enquiry, if our company is now
exhausted because of the operations aiming to recover credits, and if nothing has
convinced E. Yildiz to pay his debt, then we must record this account as a bad
credit. The composition of a provision for bad and doubtful credits (usually
called as provision for bad credits) is considered as a completely different
operation from the writing-off of bad credits. Finally, let’s show how that is
done by composing the following book-keeping entries:
92
______________________ 31.12..20-2 ____________________
128 DOUBTFUL TRADE RECEIVABLES 30

120 CUSTOMERS 30
______________________ ____________________
654 PROVISIONS 30
129 ALLOWANCES FOR DOUBTFUL
CURRENT TRADE RECEIVABLES 30
______________________ ____________________
So, if we use the example of E.Yildiz's account, the effect is going to be:
CUSTOMERS
E.Yıldız
20-2 YTL 20-2 YTL
Jan 1 Balance b/d 50 Mar 3 Cash 20
Dec 31 Doubtfull trade rec. 30

DOUBTFUL TRADE RECEIVABLES

E.Yıldız
20-2 YTL 20-2 YTL
Dec 31 Customer 50 Mar 3 Cash 20

PROVISIONS
Doubtful Trade Receivables
20-2 YTL 20-2 YTL
Dec 31 Allowance For Doub. 30 Dec 31 Profit and Loss Acc. 30

ALLOWANCES FOR DOUBTFUL CURRENT TRADE

RECEIVABLES
E.Yıldız
20-2 YTL 20-2 YTL
Dec 31 Balance b/d 30 Dec 31 Provisions 30

The transactions for this particular firm might be:
93
Customers
20-2 YTL 20-2 YTL
Feb.10 E. Yıldırım 8 Dec.31 Doubtfull Trade
Receivables Account 135
Mar. 8 N. Aksu 20
Mar.31 E. Yıldız 30
May 18 Merkez Ltd. 15
July 20 Kalyon Co. 40
Sep.17 L. Gemici 22
Profit and Loss Account (extract) for the year ended on December 31, 20-2
20-1 YTL 20-1 YTL

Dec 31 Cost of Merch. Sold xxx Dec 31 Domestic Sales xxx
Dec 31 Gen. Ad.Exp. xxx Dec 31 Other Incomes xxx
Provisions (Bad credits
Dec 31 written off) 135
Balance c/d (net
Dec 31 profit) xxx
The effect of debiting Profit and Loss Account with provision for bad and
doubtful credits is, of course, to reduce net profit.
Now, assume that at the end of the year, Yavuz Giray has debtors summing up to
3 000 YTL before writing off bad credits and creating a provision for bad
credits. Here, Yavuz Giray's first step will be going over the debtors' accounts to
learn if any must be written off as bad. However, note that in fact this must be a
continuous process carried on throughout the year, instead of a one time process
that is done at the end of the year. This first step can result in writing-off of
debtors. Let’s suppose it totals to 500 YTL in our example. So, Yavuz Giray is
now faced with the following position:
YTL
Gross debtors on December 31, 20-1 3 000

Minus Bad credits written off 500
2 500
94
So, do you think Yavuz Giray would do the right thing by showing debtors in
the balance sheet with a figure of 2 500 YTL? Well, if he would do this, that
would mean that he expected to collect all 2 500 YTL and he thought none of
the debts would become bad later. However, a great majority of companies
realize that, among all of their debtors, some will not pay their debts at any time.
For sure, Yavuz Giray can not know which specific debtors will go badly.
Anyhow, if he could know this, then he would never sell to those people on
credit in the first place. On the other hand, the historical record and previous
experiences provide him some clue and enlightens him that a certain percentage
of debtors will not pay their debts. Thus, it is necessary for Yavuz Giray to
reflect this on the accounts. Absolutely, this percentage changes from company
to company, and from trade to trade. As an example, a renting business will
usually have a higher percentage of bad debts compared to that of a bank.
Finally, let’s have a look at the accounting procedures that are used to create a
provision for bad debts:
A journal entry will be necessary. This will read:

______________________ 31.12..20-1 ____________________
128 DOUBTFUL TRADE RECEIVABLES 500

120 CUSTOMERS 500
______________________ ____________________
654 PROVISIONS 500

129 ALLOWANCES FOR DOUBTFUL
CURRENT TRADE RECEIVABLES 500
______________________ ____________________
As a result, using the example, the balance sheet summary should appear as
follows:

Customers 2 500
Doubtful Trade Receivable 500
Less Allowance for Doubtful
Current Trade Receivable - 500
Notes:
The amount of the provision for bad debts is calculated on the balance of debtors
outstanding after deducting bad debts written off.
95
1.18 ERRORS NOT SHOWN BY A TRIAL BALANCE
1.18.1 Errors Not Indicated by a Trial Balance
A trial balance is only an evidence for the arithmetical accuracy of a set of

accounts. On the other hand, some errors are not indicated by a trial balance
because of their characteristics. These errors are listed below:
 Error of Omission
 Reversal of Entries
 Mispost
 Error of Principle
 Error of Original Entry
 Compensating Error
Now, we will go over all of these in detail:
(a) Error of Omission
That stands for a company transaction which has been completely omitted from
the accounts. Because of this reason, no debit entry and no credit entry exists.
However, the trial balance will balance since the same amount has been omitted
from both the debit side of one account and the credit side of another.
(b) Reversal of Entries
In regards to this error, here a transaction has been entered in the correct
accounts and the amount is also correct. On the other hand, it is recorded on the
incorrect side of both accounts. As an example, if a machine is bought by check,
it might have been entered like this:
Dr. Checks Given

Cr. Machinery and Equipment
So, as you can see, this must definitely be entered the other way round. That is
the error we are talking about. However, you should also know that this error
will not be shown on the trial balance since there has been both a debit and a
credit entry for the same amount.
96
(c) Mispost
Concerning this error, a transaction has been entered in the wrong person's
account. As an example, the sale of goods on credit to A.Aktan is entered in
error to S.Aktan's account. So, the arithmetic of the book-keeping is right.
However, S.Aktan will absolutely not be happy at being charged for goods he
has never seen. He will also not wish these goods with a high probability. By the
way, errors belonging to this category can usually be discovered by sending out
regular statements of account to the clients. That way, you can be sure that the
client who has been charged for goods not supplied will inform you
immediately. Of course, having a healthy and errorless bookkeeping system is
always better than letting others discover the errors for you. Finally, errors
belonging to that category are usually called as errors of commission.
(d) Error of Principle
We face this sort of error when an item is entered in the incorrect category of
account. As an example, the cost of a van is completely different from the costs
of running it, such as the money spent on gas, oil and repairs (maintenance). So,
the cost of a vehicle must always be kept separately from the cost of running this
vehicle. In other words, a company will have both a Van Account and a Van
Running Expenses Account. It would definitely be an error of principle in case
both the cost of the van and the running expenses were put together in the same
account. Here, the trial balance would still be arithmetically correct, but do not
let this mislead you.
(e) Error of Original Entry
Regarding this error, the transaction amount is entered incorrectly in the

accounting system. So, both the debit and credit amounts will be incorrect.
Numerous factors can be the cause of this error. As an example, a badly or
blurry written number on a document could be entered wrong, or an invoice sum
could be added up falsely, or numbers could be reversed, like 85 YTL entered in
the accounts as 58 YTL. Of course, these kinds of errors affect both the debit
and credit entries in the accounts. However, they will not be indicated by the
trial balance. But remember, in case only one entry is made incorrectly, then the
trial balance will absolutely fail to agree, meaning that it will not balance.
Notes:
In regards to reversal of figures error, the discrepancy (difference) is either 9 or
divisible by 9. As an example, the difference between 45 YTL and 54 YTL is 9
97
YTL, and the difference between 85 YTL and 58 YTL is 27 YTL. As you can
see, the differences are the same, but both of them can be divided to 9.
(f) Compensating Error
Concerning this one, two errors cancel each other. For instance, assume that an
error was made while working out the balance of Purchases Account which
produced a calculated balance that is 10 YTL higher, and another error in the
Sales Account which produced a calculated balance that is 10 YTL higher too.
So here, the error in Purchases Account, which has a debit balance, would be
compensated by the error in Sales Account, which has a credit balance.
Compensating errors usually happen with round numbers like 10 YTL, 100 YTL
or even 1,000 YTL in some situations. That kind of error is usually discovered if
the casting (adding up) of the account is inspected. By the way, errors not
indicated by a trial balance can largely be prevented by running an efficient
well-designed accounting system. Also, we had previously mentioned the need
to circulate statements of account to the clients, as you can remember. Then,
another method of preventing errors is to divide the book-keeping system into
sections, like division of the ledger and the use of journals. Here, a different
individual will be responsible for each section. This means not only one
employee will make both the debit and credit entries for each company
transaction. On the other hand, many small companies do not have a high
number of transactions to employ more than one book-keeper. Moreover,
usually it is not possible to divide the system. So, one employee should do all the
work. Under these conditions, it will be beneficial if the owner of the company
closely supervises the book-keeper's work.
We should also underline the fact that, using account numbers will prevent
several problems of the mispost. Additionally, using computers for accounting
also lowers the number of errors in calculating the balances of accounts.
However, neither numbering of accounts nor using computers can completely
block every type of error in a book-keeping system.
1.18.2 Correcting Errors Not Indicated by a Trial Balance
When an error not indicated by a trial balance is discovered, it must be corrected

by means of a journal entry and then be passed through the proper accounts.
(a) The Omission Error
A credit sale of 59 YTL to Umut Mirzanli is omitted from the accounting

records.
98
______________________ 31.12..20-1 ____________________
120 CUSTOMERS 59
Umut Mirzanlı
600 DOMESTİC SALES 50
391 VAT RECEIVED 9
Credit sales, invoice no 874
is omitted from the accounts
______________________ ____________________
(b) Reversal of Entries
Receipt of 50 YTL in cash from Esref Kanatci, a debtor, is entered in error on

the payments side of the cash account and is debited to Kanatci's account.
Wrong Entry is:

______________________ 13.06.20-1 ____________________
120 CUSTOMERS 50
Kanatci
100 CASH 50
______________________ ____________________
______________________ 31.12.20-1 ____________________
100 CASH 100

120 CUSTOMERS 100
Kanatci
Correction of error: Cash of 50 YTL is
Received and entered to the credit of cash
account, and then debited to Esref Kanatci's account
______________________ ____________________
Notes:
When we correct a reversal of entries, we should 'take out' the incorrect entries
and then we should 'put through' the correct ones. Because of this reason, twice
the amount of the error is necessary to correct it. By the way, if only the amount
of error is used, it will just cancel out the original error but it will not correct it.
Concerning our example, a debit to cash of 100 YTL and a credit to Esref
Kanatci of 100 YTL would correct the error. On the other hand, we can not say
it would be a good accounting practice, since 100 YTL is not the amount of
original transaction. So, it is always ideal to indicate the amount of original error
99
being taken out, and then to point out a new accurate entry being put through the
accounts.
(c) Mispost
Credit sales of 118 YTL is entered to the account of Batuhan Celik instead of
Celik Ltd.
______________________ 31.12.20-1 ____________________
120 CUSTOMERS 118

Çelik Ltd.
120 CUSTOMERS 118
Batuhan Çelik
Invoice no 312 entered to the account of
Batuhan Celik instead of Celik Ltd.
is now corrected
______________________ ____________________
(d) Error of Principle
Motor vehicle expenses of 40 YTL is debited in error to the Motor Vehicles

Account.
______________________ 31.12.20-1 ____________________

EXPENSES 40
253 MOTOR VEHICLES 40
Correction of error: Expenses debited in error
to the Motor Vehicles Account on May 15, 20-1
______________________ ____________________
(e)Error of Original Entry
Credit purchase of goods with a value of 45 YTL from Recep Kosar is entered to
the account as 54 YTL.
______________________ 06.05.20-1 ____________________

Recep Koşar
153 MERCHANDİSE 46
391 VAT RECEİVED 8
Correction of error: Purchases invoice
no 603 for 54 YTL
______________________ ____________________
______________________ 31.12..20-1 ____________________
153 MERCHANDISE 38
100
Recep Koşar
Purchase of merchandise : purchase
order no 603
______________________ ____________________
Notes:
Despite the fact that 9 YTL could have been put through the accounts as a
correct amount, the best thing here is to 'take out' the incorrect amount and to
'put through' new entries for the correct amount.
(f) Compensating Error
Let’s say the Banks Account is discovered to be overcast (over-added) by 100

YTL, and on the opposite side the Customers Account is discovered to be
undercast (under-added) by the same amount.
______________________ 31.12.20-1 ____________________
120 CUSTOMERS 100

Karmen Co.
102 BANKS 100
Garanti Bank
Correction of overcast on the Banks Account
and compensating undercast on the Customer Acc.
______________________ ____________________
So, we have now studied all the corrections of journal entries for each kind of
possible error. But, please keep it in mind that the journal entries must then be
entered into the double-entry book-keeping system.
1.19 ERRORS INDICATED BY A TRIAL BALANCE
We had discussed errors not indicated by a trial balance earlier. But in this
chapter, we will discuss the errors that a trial balance indicates. These errors are:
(a) The opposite side balance as a different side one when compared to the
original characteristics of debit or credit balance of the account.
(b) The different balance amounts on the debit and credit sides of the related
accounts.
(c) Errors that arise when we add accounts or calculate the balances, which are
not compensated by other errors.
(d) Incorrect entry of an item like two debits or two credits.
1.20 STOCK RECORDS
101
The stock of a company is composed of the goods in which it trades. Stock is

generally a valuable part of a company's current assets and it is crucial that
proper records and control are kept over the stock movements. A stock control
system must:
(a) Show stock availability without the need to examine the physical stock. That
way, the stock position of a specific item can be ascertained with a fast pace
from the records in response. For instance, a phone enquiry can be provided as
an example here.
(b) Signal the need for re-ordering when stocks run inadequate. Here, the stock
control system should also be able to consider the current rate of usage and the
time required for delivery once a re-order has been placed. By the way, that is
called as the lead time.
(c) Keep a record which can be used to compute stock values.
(d) Act like a deterrent to pilferage.
(e) Let the stock holdings and movements to be reviewed easily, so that money
tied up in stock will be kept at the minimum.
Definitely, not all stock records meet these five criterias. Actually, both records
and the techniques of keeping them up to date change according to the needs of
the company. For example, a small-scaled shop does not update its stock records
after every sale. Because, it would take too much time and the customers would
not be happy about waiting in line. However, the increasing use of bar codes and
computerized checkouts in the retail trade should give you a clue that stock
records can be updated automatically in today’s world. Additionally, the
increasing usage and popularity of bar codes as well as computerized checkouts
also allow us to automatically re-order from the suppliers when the stocks are
running in low levels. Also know that, stock records are indeed critically
important for the majority of companies. That’s especially correct for businesses
where the goods in which they trade are of a high value and the number they sell
each day or each week is relatively less. We can provide cars, machines or
furniture as examples for this one. Finally, just like a company's store, a
wareshouse should also have correct records both from the accounting point of
view, and for providing a good service to the clients.
1.20.1 Storekeeping Procedures
When a purchase order is sent to an appropriate supplier by a company which

wishes to buy assets, a copy of the purchase order is passed to the stores of the
buying business indicating the expectation of delivery for the mentioned assets.
Of course, storekeeping involves other documents too. Now, we will discuss
these one by one.
102
(a) Delivery/Order Note
That is prepared by the supplier and provides details of the supplier, the buyer,
the goods, the quantity ordered and etc. It is also signed by the individual getting
the goods in the buyer's stores. Generally, one copy is handed to the carrier for
returning it to the supplier. This will serve as a proof of delivery.
(b) Goods Received Note (GRN)
That is prepared by the warehouse/storekeeping employees of the buyer. This

document includes the description of the goods, date of receipt, name of the
supplier, advice note number, quantity of goods received, damages or shortages
(in case they exist), and the storekeeper's signature. Also know that, the original
is passed to the accounts department for paying the supplier's invoice, and a
copy is passed to the purchasing department for reporting that the assets have
been received. Finally, another copy will be passed to the storekeeper in order to
prepare the stock record card.
(c) Stock Record Card
The GRN and the Stock Record Card are tightly related. Because, by using the
GRN, the storekeeper prepares or updates a stock record card for the new stock
received. We should learn that, this is a card which records receipts and issues of
the stock item. Additionally, it shows the balance of stock on hand. Plus, do not
forget that Stock Record Cards are kept together at the store’s office.
(d) Bin Card
That is a record card kept with the physical stock itself. Bin cards are attached to
the bins or racks containing the materials, using a different card for each item of
stock. Consequently, be aware that bin cards provide a description of the assets,
receipts and issues, and the balance remaining in the bin.
(e) Material Requisition Note / Issue Note
That is a simple store control document which must be completed before goods
can be taken from the stores. It includes data such as the items required, the
quantity, department or the individual who requisitions the item, date of issue
and signature of the individual who authorizes the transaction.
(f) Return Note
103
This document is used when assets withdrawn from the stores are returned for
any excuse.
1.20.2 Manual Stock Record Cards
First of all, we should be well-informed that all non-computerized (no

electronic) stock record systems use the same fundamental technique. Almost
always, a separate stock record card is put and used at a central place in the
stores for all products existing in stock. You can see a sample for stock record
card below. There, the reference column is used to write down the no. of the
delivery/advice note, or goods received note, or invoice no., covering stocks
received (also called stocks in). On the opposite side, when issues of stock are
made (known as stocks out), this time the no. of the material requisition note (or
issue note) is written down on the reference column. Finally, in case any stocks
issued are subsequently returned to stock, then a return note will be used. This
also means that the no. of the return note will have to be written down on the
reference column.
A stock record card
Stock Record Card

Item:
Date Ref. In Out Balance
Example:
Stock Record Card

Item: x
Date Ref. In Out Balance
20-1
Jan.1 Balance 240
Jan.8 Invoice No: 432 85 155
Jan.12 Order No: 1340 200 255
Jan.20 Order No: 1353 50 245
104
Jan.28 Order No: 1402 100 195
1.20.3 Stock Losses
As a rule, the stock record card must agree with a physical stock count, which is
the actual count up of the number of goods stored in the stock. However, in
some situations, a difference may occur between the two. If we are faced with
this condition, then we must check the stock record card carefully and we must
look at the documentation containing receipts and issues. In case we can not find
the cause of the difference, we must record the stock loss on the stock card.
Now, assume that, using the stock figures of the previous example, a physical
count of item “x” shows us that 185 items were stored in stock on January 31.
Also, let’s say our attempts to discover the difference were unsuccessful. So, in
line with these information, the stock card must be filled as follows:

Jan.28 Order No: 1402 100 195
Jan.31 Stock loss 10 185
By the way, if we discover continual stock losses, then we should run a detailed
investigation on this matter. That way, we can also understand if stocks are
being pilfered.
.
1.20.4 Computerized (Electronic) Stock Records
First of all, it is better for you to know that stock control is also called as the
inventory control. It is a crucial aspect of any company which can be handled by
a computer program or software. Actually, in today’s business world, several
small-scaled companies take advantage of microcomputer systems for their stock
control. Then, keep it in mind that, the main component of any computerized
(electronic) stock control system is the stock file. But, what really is the stock
file? If we should explain it with a plain description, we can say that it is a file
which stores the product or stock no., as well as the description and stock
currently held (book stock) of all the items a stock carries. A program (software)
like this will have a running balance of the stock of all items and it will make
additions when new supplies are received, then it will subtract when the stock is
issued. A great percentage of programs (software) also let stock levels to be
modified (e.g.: for stock losses) after stock-taking. Definitely, there are more
105
developed stock control systems today, which have a wider range of

specifications. These developed stock control systems are used for:
(a) valuing the stock on hand.

(b) determining the levels at which stock must be re-ordered.
(c) storing data on lead times.
(d) providing fast data on the quantity of stock in hand, as well as the quantity
on order.
(e) assigning the currently held stock for recognized future uses.
(f) providing recommendations on the management of total stock issues for the
current month or year.
(g) storing the supplier's product code no., as well as the supplier's name and
address - this will be very helpful for printing the orders.
(h) keeping in hand the retail price.
Additionally, almost all stock control programs (softwares) for computers are
menu-driven. The stock control program often includes a main menu containing
Stock Movements, Stock Enquiries, Reports and Product Updating, and etc.
Definitely, sub-menus may also exist. For example, the sub-menu for stock
movements might also be: Stock Ordered, Stock Received, Stock Issued, Stock
Returned, Stock Allocated and Stock Count.
Selecting the appropriate sub-menu provides user the information he/she needs
to bring the stock records up to date.
After a number of stock transactions have been entered, it might be necessary to

produce a report showing the stock status, that is, the different types of stock
held, together with quantities held and a stock valuation. A report of stock status
might appear as follows:
Date: 31.01.20-1 STOCK STATUS Page: 1

Product Description Book Re-order Unit Unit cost Book value
number stock level (YTL) (YTL) at cost
0002001 X …….. 180 100 Each 6.50 1170.00
0002002 Y …….. 425 150 Sq.m 1.25 531.25
0002003 Z …….. 260 80 Lb. 2.00 520.00
While a computerized stock control system can be used on its own, many can be
linked to other computer programs designed for a variety of accounting
106
functions. Thus, for example, invoicing, sales and purchases programs, journal
transactions can all be linked in to update stock records automatically.
1.20.5 Stock Valuations
At specified intervals and definitely at the end of a financial year, the owner,
CEO or CFO of a company would like to know the value of stock on hand.
a. Average Cost methods
Stock is generally valued with the avarege value. Average value equals to the
total cost of purchases divided by the total quantity of purchases.
As an example, let’s say the total cost of purchases for “x” goods is 4,500 YTL
and the total quantity of purchases for “x” goods is 1,200 units. So, the average
cost should be 4,500/1200= 3.75 YTL for each of “x” goods.
b. FIFO and LIFO methods
Stock is generally valued at the lower of cost and net realizable value. So, we
should understand that two separate values are compared, which are cost and net
realizable value. Cost includes the cost of purchase plus the cost of delivery. To
speak for the net realizable value, it is the amount which the item is expected to
sell for.
We should not forget that, where the cost price of stocks changes often, a great
deal of companies implement a famous policy called as the 'first in, first out'
(FIFO). As an example, assume that a company's stock of pens at January 28
consists of 75 units at a cost of 1 YTL each, bought on Jan. 12, and 100 units at
a cost of 1.25 YTL each, bought on Jan. 25.
An issue of 40 pens on January 30 will be valued at the unit price on Jan. 12,
which means equals to 1 YTL each. Doubtless, some companies implement the
'last in, first out' (LIFO) method instead of FIFO. In this situation, the issue on
January 30 would be made at the unit price of 1.25 YTL per pen.
1.20.6 Journal Entries of Stock Valuation
Example : We assume that, Purchases and Sales figures of Stock “A” are as
follows:
PURCHASES SALES
Unit Price of Unit Total Unit Price of Unit Total
107
Item YTL. YTL. Item YTL. YTL.
01.01.20-1 BS 9 20.00 180.00

08.03.20-1 10 25.00 250.00
10.06.20-1 6 25.00 150.00
02.08.20-1 5 30.00 150.00
21.11.20-1 10 35.00 350.00
__ ______ __ ______
24 580.00 16 500.00
a. Valuation of the Stock on Average Cost Method at the end of the period
Avarege cost is:
580.00 YTL / 24 = 24.17 YTL / Unit
The quantity of Stock “A” at the end of the year is:

24 – 16 = 8 Units.
So, the value of “A” Stock at the end of the year is:
8 x 24.17 YTL = 193.33 YTL
The cost of the goods sold is 580.00 – 193.33 = 386.67 YTL.
b. Valuation of the Stock on Weighted Average Cost Method
IN OUT BALANCE
_____________________ _____________________ _____________________
Unit Price of Unit Total Unit Price of Unit Total Unit Price of Unit Total
Date Item (YTL) (YTL) Item (YTL) (YTL) Item (YTL) (YTL)
________ _____________________ _____________________ _____________________
01.01.20-1 9 20.00 180.00 9 20.00 180.00
08.03.20-1 10 25.00 250.00 19 17.37 330.00
10.06.20-1 _ _ _ 6 17.37 104.22 13 17.37 225.78
02.08.20-1 5 30.00 150.00 18 20.88 375.78
21.11.20-1 _ _ _ 10 20.88 208.80 8 20.88 167.04
108
(c) Valuation of the Stock with FIFO Method
IN OUT BALANCE
_____________________ _____________________ _____________________
________ _____________________ _____________________ _____________________
01.01.20-1 9 20.00 180.00 9 20.00 180.00
08.03.20X1 10 25.00 250.00 9 20.00 180.00

10 25.00 250.00
19 430.00
10.06.20X1 _ _ _ 6 20.00 120.00 3 20.00 60.00

10 25.00 250.00
13 310.00
02.08.20X1 5 30.00 150.00 3 20.00 60.00

10 25.00 250.00
5 30.00 150.00
18 460.00
21.11.20X1 _ _ _ 3 20.00 60.00 3 25.00 75.00

_7 25.00 175.00 5 30.00 150.00
10 235.00 8 225.00
The cost of goods sold is 355.00 YTL and the value of Stock “A” at
the end of the year is 225.00 YTL.
(d) Valuation of the Stock with LIFO Method
IN OUT BALANCE
_____________________ _____________________ _____________________
________ _____________________ _____________________ _____________________
01.01.20-1 9 20.00 180.00 9 20.00 180.00
08.03.20X1 10 25.00 250.00 9 20.00 180.00

10 25.00 250.00
19 430.00
10.06.20X1 _ _ _ 6 25.00 150.00 9 20.00 180.00

4 25.00 100.00
13 280.00
109
02.08.20X1 5 30.00 150.00 9 20.00 180.00

4 25.00 100.00
5 30.00 150.00
18 430.00
21.11.20X1 _ _ _ 5 30.00 150.00

4 25.00 100.00
1 20.00 20.00
10 270.00 8 20.00 160.00
The cost of goods sold is 420.00 YTL and the value of Stock “A” at the end of
the year is 160.00 YTL.
(e) Entries of the Journal

______________________ 31.12..20-1 ____________________
621 COST OF MERCHANDISE SOLD 386.67

153 MERCHANDISE 386.67
The entry of the cost of goods sold
______________________ 31.12..20-1 ____________________
690 PROFIT OR LOSS FOR THE PERIOD 386.67

621 COST OF MERCHANDISE SOLD 386.67
Transfer of the cost of goods sold account to
the Profit or Loss Account
______________________ ____________________
MERCHANDISE
Stock “A”
20-1 YTL 20-1 YTL
Jan.1 Opening Stock 180.00 Dec.31 Cost of Merc.Sold 386.67
Mar.8 Purchases 250.00 Dec.31 Balance 193.33
Aug.2 Purchases 150.00
580.00 580.00

20-1 YTL 20-1 YTL
Dec.31 Merchandise 386.67 Dec.31 Profit or Loss Acc. 386.67
1.21 WAGES BOOKS AND RECORDS
1.21.1 Wages and Salaries
110
Wages are invariably a cost charged to the Trading Account. Salaries, on the
other hand, are an administrative expense charged in the Profit and Loss
Account. Another important point here is that Wages are paid (usually on a
monthly basis) to the employees engaged in producing goods or carrying out
work on goods, while those who carry out the administrative work in the office,
are paid salaries (usually monthly). Also, know that the general term which is
used to describe the calculation of amounts payable to the employees is known
as the payroll. Finally, Wages are usually paid on either a time basis or a piece-
work basis while Salaries are almost always paid on a time basis.
1.21.2 Time Basis
In companies where a time basis is preferred for the wages, the employee is paid
a certain rate for each hour he/she works. Especially speaking for the
international, American and British firms, the employees often use a weekly
time card/record. When starting the job or reporting for duty in the morning, the
employee takes his or her card from the rack and then places it in a slot in the
time machine or time clock, which saves the arrival time on the card. Surely, in
the lunch breaks and at the end of the day, the same method is implemented to
detect the time of departure. The other way is that the employee takes his or her
electronic card and slashes in the optic reader for the same procedure So, at the
end of the week, the card then contains an accurate record of the time which the
employee has spent at work.
In the next step, the hours are added and the total hours are computed. In
addition, the gross pay (the pay before any subtractions have been made) is
calculated by multiplying the number of hours worked with the hourly rate of
pay. In case any overtime has been worked, this is generally paid at a higher rate
than the regular hours – e.g. : 'time and a half, or 'double time'.
Example:
A company’s standard working hours for a week are 45 and the employees are
paid 5 YTL per hour. Plus, overtime is paid at `time and a half` for the first ten
hours of overtime, and then it is paid at `double time`. So, if Mahmut Altinkaya
worked 50 hours and Bora Altinordu worked 57 hours, the gross wage for each
employee is:
Mahmut Altinkaya:
45 hours at 5 YTL per hour (regular pay) 225.00 YTL
5 hours at 7.50 YTL per hour (time and a half) 37.50 YTL
111
Gross wage for the week 262.50 YTL
Bora Altinordu:
45 hours at 5 YTL per hour (regular pay) 225.00 YTL
10 hours at 7.50 YTL per hour (time and a half) 75.00 YTL
2 hours at 10.00 YTL per hour (double time) 20.00 YTL.
Gross wage for the week 320.00 YTL.
1.21.3 Piecework Basis
This system is actually based on the employee performance. Because, here each
employee earns parallel to the amount of work that he or she performs. As an
example, in factories a specific amount of money is paid for each unit of goods
produced or processed by the employees. So, faster employees have the
opportunity to earn more than the slower employees. By the way, in workplaces
where employees earn on a piecework basis, a minimum wage is often applied.
It is based on an hourly rate, which means that if the piecework earnings go
under hourly rate earnings, then the latter will be paid.
Example:
The following information is concerned of two employees:
Caner Kayhan
Aykut Kabulcu
Piecework rate per unit produced 50 p 50 p
Units produced 500 410
Hours worked 45 hrs. 47 hrs.
Rate of pay per hour (hourly rate of pay) 5 YTL 5 YTL
The company runs its piecework system with the rule that, if an employee's
piecework earnings go under earnings at the hourly rate, then the hourly rate
earnings are paid. Also, a week of 45 hours is in operation and the overtime is
paid at `time and a half`. So, using these data provided, please compute the gross
wage for each employee.
Caner Aykut:
Piecework rate: 500 units at 50 p per unit 250 YTL

Hourly rate: 45 hours at 5 YTL per hour 225 YTL
So, by looking at the scenario above, we can easily say that the piecework rate
with a gross wage of 250 YTL will be paid. Because, the piecework earnings are
112
not under earnings at the hourly rate (250 YTL > 225 YTL), as you can
recognize.
Kayhan Kabulcu:
Piecework rate: 410 units at 50 p per unit 205 YTL

Hourly rate: 45 hours at 5 YTL per hour 225 YTL
2 hours at 7.50 YTL per hour 15 YTL
240 YTL
Again, look above and this time you should say that the hourly rate with a gross
wage of 240 YTL will be paid. The reason is that the piecework earnings are this
time under earnings at the hourly rate (205 YTL < 240 YTL).
1.21.4 Deductions from the Wages
Remember that, we had computed the gross wages previously. In regards to this
section, we will start by learning that an employee's net wages are computed by
subtracting specific deductions from the gross wages. The second thing to learn
is that some of these specific deductions are compulsory while some others are
voluntary.
Compulsory deductions include:
(a) Income tax

(b) National Insurance Contributions (speaking generally and considering the
international companies, an employer must make a National Insurance
Contribution in respect of all his workers. That’s true for most of the companies
worldwide, even though not covering all).
Voluntary deductions include:
(a) Savings and Pension / Superannuation Schemes (however, note that some
superannuation schemes are compulsory)
(b) Union Contributions
(c) Social Club Contributions
1.21.5 Income Tax
The format implemented in many countries for collecting income tax payable by
an employee is called as the PA YE (Pay As You Earn). Here, the amount of
income tax due is computed and should be subtracted by the employer before the
wages are paid to the worker. Because of this reason, a great majority of wage
113
and salary earners pay a portion of their total yearly tax liability as a weekly or
monthly subtraction from the wages or salary. In the following step, the
employer sends the amount of income tax subtracted from the pay of the workers
to the tax authorities.
Afterwards, the tax authorities assign a tax code number for each employee,
which is used by an employer to compute the taxable pay of an employee. By
the way, the taxable pay is the amount on which the income tax is levied. So,
what is meant by the allowances (for example: Social Sequrity Duties) the
employee receives? Explaining straight, it is the amount of his or her income
which is not subject to the income tax. In other words, allowances are exempted
from the income tax.
Example:
Suppose that a personal allowance (National Insurance Contributions) rate is 14

% YTL per year and the tax rate is 15 %. In addition to this information, we
know that Kutlu Ozturk is single and he earns a gross wage of 1000 YTL per
month. On the opposite side, his brother Onur Ozturk is married and he earns
800 YTL gross each month. So, using these information, we will calculate the
taxable pay for Kutlu Ozturk and Onur Ozturk.
Kutlu Özturk
Gross Wage 1 000.00 YTL.
Mınus: National Insurance
Contributions 14 % 140.00 YTL.
Taxeble pay 860.00 YTL.
Tax 15 % 129.00 YTL.
Net Wage 731.00 YTL.
Onur Özturk
Gross Wage 800.00 YTL.
Mınus: National Insurance
Contributions 14 % 112.00 YTL.
Taxeble pay 688.00 YTL.
Tax 15% 103.20 YTL.
Net Wage 574.80 YTL.
Also, when someone’s income goes beyond his or her allowances, then the
income tax becomes payable at a certain rate, for example 20 percent. Sure thing
is that, as he or she earns more, a higher rate of tax is levied on the following
band of taxable income.
114
Example:
Assume that the rates of tax and the bands of taxable pay per year are as follows:
YTL
15% 1 - 7 500
20% 7 501 - 19 000
27% 19 001 - 43 000
35% 43 001 and over
Now, compute the income tax paid in one year by the employees below:
Hilal Yildiz: Taxable pay 18,000 YTL per year.

Yuksel Cam: Taxable pay 35,000 YTL per year.
Hilal Yildiz: 7 500 YTL at 15% 1 125 YTL

10 500 YTL at 20% 2 100 YTL.
Total income tax for year 3 225 YTL.
Yuksel Cam: 7 500 YTL at 15% 1 125 YTL

11 500 YTL at 20% 2 300 YTL
16 000 YTL at 27% 4 320 YTL.
Total income tax for year 7 745 YTL.
Among other things, the employer calculates the amount of income tax to be
subtracted from each employee's payment by using special tax tables.
Also, the wages officer uses the Taxable Pay Table to compute the tax payable.
Furthermore, since these calculations are based on cumulative sums of taxable
pays, the employer is required to reserve a weekly or monthly record of
calculations. Additionally, the employer should also have a record for each
employee of subtractions for Income Tax and National Insurance Contributions,
as well as the employer's own National Insurance Contributions. Another key
point here is that, this record is put on a form, which is presented after the
completion. This way, authorities can check the calculations and make sure that
they have received the payment of due amount.
1.21.6 National Insurance Contributions
Today, the majority of employees pay National Insurance Contributions. The

payment of contributions provides specific benefits to be demanded from the
State when it is needed. For instance, retirement pension and sickness benefits
can be mentioned here. By the way, the amount contributed by an employee
changes parallel to his or her earnings (14%). If an employee earns more, then
115
this means he will contribute higher amounts. Of course, he can not be required
to pay above a certain maximum amount. Finally, the employer is also
responsible to contribute an amount (15.5 – 17 %) in the name of each
employee.
1.21.7 Superannuation / Pension Contributions
Many employers run superannuation schemes under which the employees

deserve specific benefits, including a pension.
By the way, a payslip also contains the details of total amount of subtractions
made until that point through the current tax year for income tax, National
Insurance and superannuation.
Example (starting from gross wage)

YTL
I. Ersoy: Gross wage for October , 20-1 700
Income tax 15% - 20%
National Insurance 14%
Superannuation contribution: 5 % of gross wage
Cumulative subtractions made up to the previous pay day were:

YTL
Income tax 85.05
National Insurance 98.00
Superannuation 35.00
figures used for illustrative purposes only
I. Ersoy: Payslip for the month ended on January, 20-1
YTL YTL
Gross wage for the month 700.00
Minus: income tax 85.05
218.05
Net wage 481.95
Totals to date in the current tax year:
Income Tax 1020.60
A small-scaled company will keep the wages records of its workers in a wages
book or payroll sheet. On the other hand, a large-scaled company will need to
116
keep computer records, because the wages book or payroll will definitely not be
enough. By the way, a payroll sheet can be upgraded to a simultaneous records
system by using a series of loose sheets. The record card of all employees’ tax
and earnings can also be put on top of the payroll sheet, which is itself put over a
perforated sheet. In the next step, this perforated sheet can be separated to
compose the employee's pay slip.
1.21.8 The Entry of the Journal
Our journal entry of the wages for January is below:
According to I.Ersoy’s payslip.

______________________ 31.01..20-1 ____________________
770 GENERAL ADMINISTRATION

EXPENSES 700.00
360 TAXES PAYABLES 85.05
361 SOCIAL SECURITY DUTIES 133.00
PAYABLE
381 ACCRUED EXPENSES 481.95
The entry of the wages for January 20-1
______________________ ____________________
1.22 MANUFACTURING ACCOUNTS
1.22.1 The Process of Manufacturing
Until this point, while we ere studying the preparation of end-of-year accounts,
we have mentioned and formed Trading Accounts, Profit and Loss Accounts,
and Balance Sheets. To speak for the Trading Account, actually it compares the
price at which a company purchases goods with the price at which it sells them.
Then, the difference, following adjustments for the opening and closing stocks,
is the gross profit. Because of this reason, the Trading Account is perfect for
companies such as shops and wholesalers where goods are simply purchased at
one price and then sold at a higher one.
On the opposite side, a great majority of companies purchase raw materials or

partly manufactured goods, and then run or finalize a manufacturing process,
and finally sell the finished product to others. Now, have a look at Figure 1, it
provides an idea about the manufacturing process and the costs experienced at
117
each step. Soon, we are going to talk about some of the terms on this diagram in
detail.
From suppliers To customers
RAW FACTORY FINISHED

MATERIALS PRODUCT
Costs: Direct materials Direct labor Selling expenses

Direct expenses Administration expenses
Finance charges
PRIME COST
Factory overhead
expenses
PRODUCTION COST
TOTAL COST
Figure: 1. The process of manufacturing
(a) Direct Materials
This stands for the raw materials which are used to form the finished product. As
an example, think of a plastic chair with tubular steel legs. Here, a quantity of
plastic, a length of steel tubing and four rubber feet can be listed as the direct
materials. Note that they do not contain things such as, for instance, the drop of
oil which is used for the machine each time it bends the steel tubing into shape.
Because of this reason, the raw materials are easily detectable with the finished
118
product, and a 'per unit' cost for materials can be computed. Finally, as with
purchases in a Trading Account, the cost of carriage in is added to the direct
materials’ cost.
(b) Direct Labor
Direct Labor is the cost of workforce directly participating in the production of

finished goods. For example, employees such as machine operators can be
mentioned here. On the other hand, the labor costs of, for instance, the foreman
or storekeeper are indirect labor and are categorized under factory overhead
expenses. So, what is the reason for making this distinction, and how is this
distinction realized? Well, the answer of this question is in fact very simple.
Because, the reason for making this distinction is that, a machine operator is
continuously (non-stop) working at the production process and we can calculate
his or her costs per unit of production. However, for instance, the foreman is not
a member of the direct production process. Because of this reason, his or her
time should be charged to the whole production instead of a 'per unit' basis. So,
now you should also have understood how the distinction is realized.
(d) Other Direct Expenses
Direct Expenses are any special costs that can be detected with each unit
produced. Now, assume that you have designed a new children's toy and a
manufacturer wants to produce this product. He can offer to pay you a royalty,
for example it can be 20 YTL per unit, based on the number of products made.
Here, note that this is a direct cost to the manufacturer. Because, if he makes no
toys, he will pay you nothing and if he makes 1,000 toys, he will pay you 20,000
YTL, and so on.
This time, think about the following example: Let’s say a manufacturer, to run
and complete a job for a client, has to rent some special machinery. Here, the
rent cost will be charged as a direct expense of the particular job. Next, you can
think that electricity must be classified as a direct expense, since it is possible to
calculate the cost of electricity used by the machinery to manufacture each unit
of finished product. Actually, your thoughts are correct and electricity is
classified as a direct expense. However, this is only true for places where a great
deal of electricity is consumed per unit manufactured. On the other hand, in
places where electricity is not a significant cost, it is included to the factory
overhead expenses. Because, if the cost is not that high and large, then it is not
worth to calculate a ‘per unit cost’.
(e) Prime Cost
119
Prime cost is the basic cost of manufacturing a product before factory overhead
expenses are added. Below, you can see the simple formula for the Prime Cost:
Prime Cost = Direct Materials + Direct Labor + Direct Expenses.
(f) Factory Overhead Expenses
Factory Overhead Expenses are classified as all the other factory expenses of a
manufacturing company. They include:
(i) indirect materials: The cost of some indirect materials, like parcel, box, bare
kode, nidle, spare part, sewing thread, glue, nail, screw. Some of these expenses
do participate in the manufacturing process ( lining, thread, glue, screw ..), but
some others do not directly participate in the manufacturing process ( machine
oil, spare part, cleaning materials,).
(ii) indirect labor: The cost of foremen, storekeepers and other employees at the
factory who do not directly participate in the manufacturing process.
(iii) depreciation of fixed assets used in a factory: Plant and machinery can be
provided as examples here.
(iv) others: factory rent, rates, heating, lighting, power, insurance, repairs and
etc...
(g) Production Cost
Production Cost is the sum of all costs experienced while manufacturing the
product. Here is the formula for Production Cost.
Production Cost = Prime Cost + Factory Overhead Expenses
1.22.2 The Manufacturing Account
First of all, the Manufacturing Account computes the production cost of goods
completed. However, other costs of a company such as selling expenses,
administration expenses and finance charges are stored in the Profit and Loss
Account. This way, the sum of production cost plus these other costs provides us
the total cost of a company. Finally, subtracting the total cost from total sales
revenues provides us the net profit of firm for the period.
Notes:
120
(a) The Manufacturing Account is related with three types of stock. These are
raw materials, work in progress (stands for the value of work passing through
the factory but incomplete at the end of a financial year), and the finished goods.
(b) The cost of raw materials used is calculated with the formula below:
opening stock of raw materials + purchases - closing stock.
(c) Direct labor and direct expenses are added to the cost of raw materials used
to provide the prime cost.
(d) The factory overhead expenses are added to the prime cost.
(e) An adjustment is made for work in progress at the end of a Manufacturing
Account. That is done in the same way as for other stocks. Here, we add opening
stock and subtract the closing stock.
(f) A Manufacturing Account is simply balanced! What we have to do is
entering the sum of debit side to the credit side. After that, this sum is called as
the 'production cost of goods completed' and is carried down to the Trading
Account.
(g) The Trading Account is made ready the same way as before. However, there
are two exceptions:
(1) the opening and closing stock numbers are those for the finished goods.
(2) instead of (or besides) purchases, the number for production cost is brought
down from the Manufacturing Account.
Cost of Finished Goods Produced
(h) The Profit and Loss Account is completed in the standard (regular) way. But,
special attention must be paid to make sure no factory expenses are entered. The
factory part of the costs take place in the Manufacturing Account, while the
office part of the costs is indicated in the company's Profit and Loss Account.
(i) A balance sheet will finalize the year-end accounts and will also be
completed in the standard (regular) way. However, there is a minor difference in
the balance sheet. Here, all three types of stock take place in the current assets,
as you can see below:

Cash xxx Bank Loans xxx
Customers xxx Suppliers xxx
Inventories 6 900 Taxes Payables xxx
Raw Materials 2000 Capital xxx
121
Work in Progress 1400

Finished Goods 3500
Machinery xxx
xxxxx xxxxx
1.22.3 Accounts of Manufacturing
We can easily explain this subject with the following example:
The figures below belong to the accounts of Mercan Manufacturing Co. for the
year ended on December 31, 20-1
Stocks on January 1, 20-1:

raw materials 3 000
work in process 1 800
finished goods 2 300
Stocks on December 31, 20-1:

raw materials 4 100
work in progress 2 500
finished goods 5 600
Purchases of raw materials 46 400

Sales of finished goods 120 000
Factory rent 2 000
Office rent 1 000
Manufacturing wages 34 200
Factory electricity 1 800
Factory heating and lighting 1 100
Factory expenses and maintenance 1 500
Office Salaries and wages 22 400
Advertising 3 100
Office expenses 1 200
Depreciation of plant and machinery 2 600
Depreciation of office equipment 800
RAW MATERIALS
20-1 YTL 20-1 YTL
122
Jan.1 Beginning Stock 3 000 Dec.31 Cost of Raw Mat. 45 800

…… Purchases 46 400 Dec.31 Balance 4 100
49 400 49 400
DIRECT RAW MATERIAL COST

20-1 YTL 20-1 YTL
Dec.31 Cost of Raw Mat. 45 800 Dec.31 Work in process 45 800
DIRECT LABOR COST

20-1 YTL 20-1 YTL
….. ……… 34 200 Dec.31 Work in process 34 200
OVERHEAD COSTS
20-1 YTL 20-1 YTL
…… Factory Electricity 1 800 Dec.31 Work in process 7 000
…… Factory Heating 1 100
…… Factory Expenses 1 500
Dep. Of Plant and
…… mac. 2 600
7 000 7 000

20-1 YTL 20-1 YTL
…… Office rent 1 000 Dec.31 Profit or Loss for p. 25 400
…… Office Salaries 22 400
…… Office Expenses 1 200
…… Dep. of Office equip 800
25 400 25 400
MARKETING, SELLING AND DISTRIBUTION EXPENSES

20-1 YTL 20-1 YTL
….. Advertising 3 100 Dec.31 Profit or Loss for p. 3 100
123
3 100 3 100
DOMESTIC SALES
20-1 YTL 20-1 YTL
Sales of finished
Dec.31 Profit or Loss for p. 120 000 …… goods 120 000

WORK-IN-PROCESS
20-1 YTL 20-1 YTL
Jan 1 Beginning Stock 1 800 Dec 31 Finished goods 86 300
Dec 31 Raw Materials Cost 45 800 Dec 31 Balance 2 500
Dec 31 Direct Labor Cost 34 200
Dec 31 Overhead Costs 7 000
88 800 88 800
FINISHED GOODS
20-1 YTL 20-1 YTL
Jan 1 Beginning Stock 2 300 Dec 31 Cost of goods sold 83 000
Dec 31 Work in process 86 300 Dec 31 Balance 5 600
88 600 88 600
COST OF GOODS SOLD

20-1 YTL 20-1 YTL
Dec 31 Finished goods 83 000 Dec 31 Profit or Loss for p. 83 000


20-1 YTL 20-1 YTL
Dec 31 Cost of Goods S. 83 000 Dec 31 Domestic Sales 120 000
Dec 31 Gen. Adm. Exp. 25 400
Marketing, Selling
Dec 31 and Dist. Exp. 3 100
120 000 120 000
The Entries of Journal:
124
____________________ ______________________
710 DIRECT RAW MATERIAL COST 45 800

150 RAW MATERIALS 45 800
Spending raw materials transfer to the
Production costs
____________________ ______________________
____________________ ______________________
151 WORK IN PROCESS 45 800

711 DIRECT RAW MATERIAL
APPLIED 45 800
Transferring the direct material cost to
the Work in Process account
____________________ ______________________
711 DIRECT RAW MATERIAL

APPLIED 45 800
710 DIRECT RAW MATERIAL COST 45 800
Closing the applied account
____________________ ______________________
720 DIRECT LABOR COST 34 200

360 TAXES PAYABLE xxx
361 SOCIAL SECURITY DUTIES
PAYABLE xxx
381 ACCRUED EXPENSES xxx
Accruing of the Direct Labor cost
____________________ ______________________

721 DIRECT LABOR COST
APPLIED 34 200
Transferring the direct labor cost to
____________________ ______________________

APPLIED
____________________ ______________________
730 OVERHEAD COSTS 7 000

381 ACCRUED EXPENSES 7 000
Accruing of the Direct Labor cost
____________________ ______________________

731 OVERHEAD COSTS APPLIED 7 000
Transferring the overhead costs to
____________________ ______________________
731 OVERHEAD COSTS APPLIED 7 000
125
730 OVERHEAD COSTS 7 000

____________________ ______________________
____________________ ______________________
152 FINISHED GOODS 86 300

Transferring the finished goods to
the stock account
____________________ ______________________
____________________ ______________________
620 COST OF GOODS SOLD 83 000

(PRODUCT)
152 FINISHED GOODS 83 000
Transferring the cost of sold goods to
the cost account
____________________ ______________________
____________________ ______________________
120 CUSTOMERS 141 600

600 DOMESTIC SALES 120 000
391 VAT RECEIVED 21 600
The entry of the sales
____________________ ______________________
____________________ ______________________

EXPENSES 25 400
191 DEDUCTIBLE VAT xxx
100 CASH xxxx
The entry of general administrative
expenses
____________________ ______________________
760 MARKETING, SALES AND

DISTRIBUTION EXPENSES 3 100
191 DEDUCTIBLE VAT xxx
100 CASH xxxx
The entry of marketing, sales and
distibution expenses
____________________ ______________________
____________________ ______________________

EXPENSES 25 400
EXPENSES APPLIED 25 400
Transferring general adm. expenses to
Income Statement account
____________________ ______________________

EXPENSES APPLIED 25 400
126
EXPENSES 25 400
____________________ ______________________
____________________ ______________________
631 MARKETING, SELLING AND

DISTRIBUTION EXP. APPLIED 3 100
Transferring marketing expenses to
Income Statement account
____________________ ______________________
____________________ ______________________

DISTRIBUTION EXP. APPLIED 3 100
760 MARKETING, SALES AND
____________________ ______________________
____________________ ______________________
690 PROFIT OR LOSS FOR THE

PERIOD 111 500
620 COST OF GOODS SOLD 83 000
(PRODUCT)
EXPENSES 25 400
Transferring Loss Accounts to
____________________ ______________________
600 DOMESTIC SALES 120 000

690 PROFIT OR LOSS FOR THE
PERIOD 120 000
Transferring Profit Accounts to
____________________ ______________________
STATEMENT OF COST OF SALES

(.......................................... TL)
PRODUCT COST
A- Direct material 45 800

B- Direct Labor 34 200
C- Manufacturing Overhead Costs 7 000
D- Work in Process Used
1- Beginning Work-in Process Inventory (+) 1 800
127
2- Ending Work-in Process Inventory (-) 2 500
COST OF FlNlSHED GOODS PRODUCED 86 300
E- CHANGE IN FINISHED GOODS INVENTORY
1- Beginning Finished Goods Inventory (+) 2 300

2- Ending Finished Goods Inventory (-) 5 600
3- Internal Usage (-)
I- COST OF FINISHED GOODS SOLD 83 000
128
Income Statement:
GROSS SALES 120 000

DISCOUNT OF SALES
Sales Returns
NET SALES 120 000
Cost of Goods Sold (product) 83 000
Marketing, Selling and Dist.Exp. 3 100
INCOME AND PROFIT FROM
OTHER OPERATIONS 0
Interest Income 0
129
1.23 FINANCIAL STATEMENT ANALYSIS
Financial statement analysis focuses on the techniques used by internal

managers and analysts who are external to the organization. A major source of
their information is the annual reports and financial statements (income
statement, balance sheet, and statement of cash flows).
1.23.1 The Objectives of Financial Statement Analysis
Investors expect to receive dividends and hope that the stock's value will
increase while Creditors make loans to receive interest and principal. Both
groups bear the risk of not receiving their expected returns. They use financial
statement analysis to:
(1) predict the amount of expected returns,

(2) assess the risks associated with those returns.
Creditors generally expect to receive specific fixed amounts and have the first
claim on a company's assets, so they are most concerned with assessing short-
term liquidity, long-term solvency and profitability. The main reason is that
profitable operations are the company's main source of cash to repay loans.
Inrestors on the other hand are more concerned with profitability; dividends,
and future stock prices. Because, dividends and stock-price increases depend on
profitable operations. Creditors also assess profitability since profitable
operations are the company's main source of cash to repay loans.
The tools and techniques that the business community uses in evaluating
financial statement information can be divided into three main categories:
horizontal analysis, vertical analysis, and ratio analysis.
1.23.2 Horizontal Analysis
The study of percentage changes on comparative statements is called the

horizontal analysis. Firstly, computing a percentage change on comparative
statements requires two steps:
1. Compute the lira amount of the change from the base (earlier) period to
the later period.
2. Divide the lira amount of change by the base-period amount.
Horizontal analysis is illustrated for Kalsınlar Ltd. as follows :
130
Increase (Decrease) (Thousand YTL)
20-2 20-1 Amount Percent
Sales 14 000 11 400 2 600 22.8%

Net income 3 200 2 900 300 10.3%
The percentage change in Kalsınlar Ltd.'s sales during 20-2 is computed as

follows:
Lira amount of change
Persentage change = ----------------------------------
Base year amount
2 600 / 11 400 = 0.228
The percentage change in Kalsınlar Ltd.'s net income during 20-2 is computed
as follows:
Lira amount of change
Persentage change = ----------------------------------
Base year amount
300 / 2 900 = 0.103
Detailed horizontal analysis is made by comparing the income statement and

balance sheet.
Trend Percentages
Trend percentages are a form of the horizontal analysis. Also, trends are
important indicators of the direction a business is going. Aditionally, trend
percentages are computed by selecting a base year where amounts are set to be
equaivalent to hundred percent. Finally, the amounts of following years are
expressed as a percentage of the base amount.
Any year YTL

Trend % = ---------------------
Base year YTL
131
For example:
(Thousand YTL) 20-6 20-5 20-4 20-3 20-2 20-1
Net Sales 14,000 12,400 11,540 10,100 9,300 8,650

Cost of Goods Sold 9,630 8,500 7,920 6,600 5,940 5,300
Gross Profit 4,370 3,900 3,620 3,500 3,360 3,350
(Thousand YTL) 20-6 20-5 20-4 20-3 20-2 20-1
Net Sales 162 143 133 117 108 100

Cost of Goods Sold 182 160 149 125 112 100
Gross Profit 130 116 108 104 100 100
In this example, we computed trend percentages for a five year period starting
from 20-2. We also used 20-1 as the base year. By the way, trend percentages
for net sales are computed by dividing each net sales amount by the 20-1 amount
of 8 650 (Thousand YTL). Then, trend percentages for the cost of goods sold
are computed by dividing each cost of goods sold amount by the 20-1 amount of
5 300 (Thousand YTL). At last, trend percentages for gross profit are computed
by dividing each gross profit amount by the 20-1 amount of 3 350 (Thousand
YTL).
1.23.3 Vertical Analysis
Vertical analysis of a financial statement reveals the relationship of each

statement item to a specified base, which is the 100% figure. Every item on the
financial statement is then reported as a percentage of that base. Also, when an
income statement is subjected to rgw vertical analysis, net sales is usually the
base. It is known that some managers accept the cost of goods sold as the base.
For example, under normal conditions, a company's gross profit is 40% of net
sales. Plus, a drop in the gross profit down to 30% of net sales may cause the
company to report a net loss on the income statement. Finally, we should
emphasize that the Management, investors, and creditors consider a serious
decline in the gross profit as an alarm.
Each income statement item

Vertical analysis % = ---------------------------------
Net sales
132
For the vertical analysis of the balance sheet, the amounts are computed by
total assets which are set to be equivalent to 100 percent.
INCOME STATEMENT (Thousand

YTL)
20-2 % 20-1 %
Net Sales 16700 100.0 15200 100.0
Cost of Goods Sold 11450 68.6 10800 71.1
Gross Profit 5250 31.4 4400 28.9
Operation Expenses: 3090 18.5 2670 17.6
Marketing 530 3.2 350 2.3
Advertising 300 1.8 200 1.3
Researh and Development 120 0.7 280 1.8
General Administration Exp. 2140 12.8 1840 12.1
Operating Profit or Loss 2160 12.9 1730 11.4
Financial Expenses 260 1.6 20 0.1
Profit or Loss for the Period 1900 11.4 1710 11.3
Provision for Tax 380 2.3 342 2.3
Net Profit or Loss for the Period 1520 9.1 1368 9.0
BALANCE SHEET (Thousand YTL)

20-2 % 20-1 %
Assets
Current assets:
Cash 2,100 6.4 1,850 6.2
Accounts receivable 650 2.0 400 1.3
Materials inventory 800 2.4 1,200 4.0
Finished goods inventory 740 2.2 600 2.0
Total current assets 4,290 13.0 4,050 13.5
Property, plant, and equipment:
Land 5,000 15.2 5,000 16.6
Building and equipment 28,000 84.9 24,000 79.9
Accumulated depreciation -4,300 -13.0 -3,000 -10.0
Total property, plant,
and equipment 28,700 87.0 26,000 86.5
Total assets 32,990 100.0 30,050 100.0
Liabilities and Owners’ Equity

Current liabilities:
Accounts payable 1,050 3.2 770 2.6
Provisions for Tax 380 1.2 180 0.6
Total current Liabilities 1,430 4.3 950 3.2
Owners’ equity:
133
Capital 20,000 60.6 20,000 66.6

Retained earnings 9,000 27.3 8,200 27.3
Net Income 2,560 7.8 900 3.0
Total owners’ equity 31,560 95.7 29,100 96.8
Total liabilities and owners’ equity 32,990 100.0 30,050 100.0
So, for example, the vertical analysis percentage for the Cost of Goods Sold for
20-2 equals to 68.6 % (11 450 /16 700 = 0.686), and for the Total Current Assets
for 20-2, it equals to 13.0 % (4 290 / 32 990 = 0.13).
Common size statement
On a common-size income statement, each item is expressed as a percentage

of the net sales amount. Besides, we should know that Net sales is the
common size to which we relate the statement's other amounts. Finally, on
the balance sheet, the common size is total assets, or the sum of total
liabilities and stockholders' equity.
1.23.4 Benchmarking
Benchmarking is the practice of comparing a company to a standard set by

other companies, with a view towards improvement.
If we should explain in more detail, a company's records help us to understand

the former results and predict the future performance. Actually, the information
we can gather from a company's records is only limited to that specific company.
We may learn that gross profit has decreased or net income has in creased
steadily over the recent years. This information is definitely helpful, but it
does not explain how businesses in the same industry have succeed over the same
time period. Have other companies in the same line of business increased their
sales? Managers, investors, creditors, and other interested groups also need to
know how one company compares with other companies belonging to the
same line of business.
1.24 ACCOUNTING RATIOS
1.24.1 Introduction
This section is related with the accounting ratios which can be calculated from
the year-end accounts of a company. While the owner or CEO of a company will
be the first person concerned with whether the company has made a profit or
134
loss, the calculation of specific accounting ratios additionally helps to determine

if the company has improved or worsened its performance as compared with the
former year's.
There are three main types of comparisons used to evaluate financial ratios:
1. With a company’s own historical ratios (time series
comparisons)
2. With general rules of thumb specifying appropriate
levels for financial ratios ( bench marks)
3. With ratios of other companies or with industry
averages (cross sectional comparisons)
Annual reports typically support time series trend analysis by providing a table
of comparative ratios for 5 or 10 years.
Ratios are useful for financial analysis by investors because ratios capture
critical dimensions of the economic performance of the entity. The ratios are a
tool that managers use to guide, measure, control, plan and reward the workers.
1.24.2 Cost of Goods Sold and Profit & Loss Account
Below, you can see an Income Statement. It will help us to compute many
accounting ratios:
Gross Profit and Income Statement of Serdar Alper Ltd.

for the year ended on December 31, 20-1
YTL YTL
Opening Stock 8 000 Sales 90 000
Purchases 68 000 Less Sales returns 1 600
Less Closing stock 6 000 Net sales 88 400
88 400 88 400
Income Statement:
GROSS SALES 90 000

DISCOUNT OF SALES 1 600
Sales Returns 1 600
NET SALES 88 400
135

Marketing, Selling and Dist.Exp. 2 550
OPERATIONS 0
Interest Income 0
(a) Gross Profit Margin
Gross profit 100

-------------- x ----- = Gross profit as a percentage of sales
Net Sales 1
18 400 YTL 100

So, ------------------ x ----- = 21 %
88 400 YTL 1
As you can see, we have computed the gross profit margin as a percentage of the
sales that have been achieved through the year. So, what does this percentage
mean to us? It means that for every sales worth of 100 YTL, the company has
made a gross profit of 21 YTL. Do you think that is a satisfactory percentage for
the firm? We can not give a straight answer to this question. Because, we must
compare the result with those of former years. The figure must be more or less
the same each year.
(b) Gross Profit Mark-up
Gross profit 100

----------------------- x ----- = Gross profit as a percentage of the cost price
Cost of goods sold 1
18 400 YTL 100

So, ------------------- x ----- = 26 %
70 000 YTL 1
What does this percentage indicate? Well, it indicates the average percentage
that has been added to the cost prices for finding the price at which the goods are
to be sold. As we have mentioned before, that value must be compared with the
value of previous years.
136
The relationship between the gross profit margin and

the gross profit mark-up
Indeed, these two calculations use the identical information but approach the
calculation from separate point of views. For instance, Margin is the profit as a
percentage of the selling price. On the other hand, mark-up is the profit as a
percentage of the buying price. Now, we can write the following formula below:
Cost price + Gross profit = Selling price

6 YTL 1 YTL 7 YTL
So, the margin should be:
1 YTL 100
-------- x ----- = 14.3 %
7 YTL 1
and the mark-up should be:
1 YTL 100
-------- x ----- = 16.7 %
6 YTL 1
(c) Inventory (Stock) Turnover
Cost of goods sold

------------------------- = Stock turnover per year
Average stock held
The calculation above shows how many times the average stock has been turned
over through the year. In other words, it shows how many times the average
stock is sold and replaced with the new stock. By the way, 'Average stock' is
often computed by adding the opening and closing stocks, and after dividing this
sum by 2. Thus, in regards to our example:
Opening stock 8 000 YTL

Plus Closing stock 6 000 YTL
14 000 YTL
Divided by 2: Average stock = 7 000 YTL
137
Next, Stock turnover per year = 70 000 YTL / 7 000 YTL = 10
You should also know that, in case the stock turnover figure is divided by 10
(stock turnover equals to 10), then the answer is the number of months, on
average, that the stock remains in the store or warehouse prior to being sold and
replaced. Concerning our example, the answer is one month. However, dividing
the stock turnover figure by 52 will provide us the answer in weeks. (The answer
is five weeks in our example). Or dividing the stock turnover figure by 360 will
provide us the answer in days. (The answer is thirtysix days in our example).
Additionally, when we consider the stock turnover, it is usually a tough job to
decide whether the figure calculated is a good or bad one. Because, the decision
is tightly related with the type of a company. For instance, a stock turnover of
six times per year would be good for a furniture dealer. On the opposite side, it
would not be good for a fresh fruits seller. The reason is that, the fruit seller
should replace his/her stock (fresh fruits) much more frequently. This time, let’s
take another example. For instance, what would you anticipate the stock
turnover to be for a company selling only newspapers? Definitely, it must be
about 360 times per year. Because, you should think of this firm as if it is selling
different goods each day. This business should replace its stock everyday, so, the
stock turnover should be 360 times per year.
(d) Net Profit Margin
The net profit margin is calculated by using the formula below:
Net profit 100

------------ x ----- = Net profit as a percentage of sales
Net Sales 1
So, concerning our example, the net profit margin should be:
5 500 YTL 100

---------------- x ----- = 6.2 %
88 400 YTL 1
To have this formula work, we use the net profit from the Profit and Loss
Account, and the sales figure from the Trading Account. So, what does this
percentage stand for? Well, this percentage says that, for every 100 YTL of
sales, this company made a net profit of 6.22 YTL for the owner or CEO.
Definitely, that percentage would not mean anythng alone; hence it must be
138
compared with the percentages of former years' accounts. Here, any changes,
which may be even so small, must be searched in detail.
1.24.3 Ratios and Calculations of the Balance Sheet
The balance sheet below continues on from the Gross Profit and Profit & Loss
Account which we had studied previously in section 1.24.2 :
Balance sheet of Serdar Alper Ltd. on December 31, 20-1
Current Assets 23 100 Current Liabilities 13 100

Customers 16 400 Suppliers 7 400
Inventories (Stocks) 6 000 Taxes Payables 2 700
Fixed Assets(net) 35 500 Shareholders’ Equity 45 500
Machinery 38 000 Capital 40 000
Minus Accumulated 2 500 Net Profit 5 500
Depreciations
58 600 58 600
By using the balance sheet above, we can gather some valuable information.
(a) Working Capital
(i) Working capital = Current assets - Current liabilities
= 23 100 YTL – 13 100 YTL

= 10 000 YTL
But, why is the working capital important? Well, the concept of working capital
is important, because if the company has enough and satisfactory working
capital, then we can be sure that it will be able to pay its creditors easily, hold
sufficient stocks and will give its debtors enough time for payment. In addition,
as a company gets bigger, it has to hold larger stocks and increased debtors.
Parallel to this, the company’s working capital should also go up. Finally, we
can say that, by using this technique, computing the working capital of a
company yearly will present us the trend of the firm.
C urrent assets
139
(ii) Working capital ratio (Current ratio) = -----------------------------

Current liabilities
So, concerning our example, the working capital should be:
23 100 YTL
Working capital ratio (Current ratio) = ----------------- = 1.76
13 100 YTL
However, the working capital figure, as computed in (i) does not let us to
compare firms having different scales. In other words, the working capital is not
a good tool for us to look at companies with different sizes. Let’s explain this
better by providing an example. For instance, the working capital requirements
of a small-scaled store are completely different from those of a big-scaled
departmental store. Because, for example, a small-scaled manufacturing
company is usually in necessity of rather less working capital than does a big-
scaled company. Here, we should know that, the current ratio is actually used for
making comparisons more meaningful. Recall that, the balance sheet of Serdar
Alper Ltd. was providing us a current ratio of 1.67. So, what does it mean? This
means that, for every 1 YTL of current liabilities, there exists 1.76 YTL of
current assets. But, that is somehow on the low side. Because, a satisfactory
current ratio is often considered to be about 2:1, or something like 2 YTL of the
current assets for every 1 YTL of current liabilities. This ratio is indeed very
important. Because, if a creditor wants an immediate payment, there must be
enough current assets to be realized in order to meet his/her requirements. On
the other hand, a high ratio is also not so preferable. Because, for example a ratio
over 3:1 can show that the company is not using its working capital ideally.
Actually, such a high ratio can signal several points. As an example, the
company may have idle cash waiting in the bank account, or it may be allowing
debtors a very long period before the payment, or it may be running its stocks at
a very high level.
(b) Liquid Capital
Liquid capital is calculated with the following formula:
(i) Liquid Capital = (Current Assets- Stocks) – Current Lliabilities
= (23 100 YTL – 6 000 YTL) – 13 100 YTL

= 4 000 YTL
140
First of all, what do you understand from the term “liquidity” ? Well, when we
talk about the liquidity of an asset, we mean the ease and speed with which this
asset can be turned into cash. Another thing we should know beforehand is that,
the balance of money in a bank or the cash in our hand are, definitely 100%
liquid. We call these two as perfect liquids. Next, debtors are 'near-liquid'.
Because they are only one step away from the cash and we expect payments
from them. On the opposite side, stock is not as liquid as debtors since it should
go through the process of being turned into debtors before it becomes cash.
Because of all these reasons, we should consider debtors, bank and cash as the
liquid assets of a company. In the following step, we can subtract the current
liabilities, so we will reach to the amount of liquid capital. That amount shows
us what the surplus or deficit would be in case all the liquid assets were realized
to repay all the current liabilities.
Unfortunately, there is a problem with the liquid capital, and it is very similar to
the problem of working capital. The problem is that we always get the results
and answers in YTL. Although this can help an individual company to make
comparisons from year to year, it does not let us to compare firms with separate
scales. Because of this reason, we should compute the liquid ratio.
(Current assets - Stocks)

(ii) Liquid ratio (Acid-test ratio) = --------------------------------
Current liabilities
(23 100 YTL – 6 000 YTL)

= ----------------------------------- = 1.30
13 100 YTL
In the example above (ii), the liquid assets almost balance against the current
liabilities. As you can see, for each 1 YTL of current liabilities, there exists 1.30
YTL of liquid assets. If we should make a comment about this ratio, we can say
that it is ok. Because, a liquid ratio of 1:1 makes sense and definitely a ratio of
1.5:1 is a better one. However, if the ratio is higher, then we can say the
company is tying up severely in debtors and bank. Moreover, we can tell that the
company owns idle money which is not working, and it is just waiting there
without any advantages. By the way, any ratio better than 1:1 shows that the
firm can cover all of its current liabilities without any difficulty. Of course, a
good ratio like this will also tell us that the company will not have to panic
against any shocks or crisis. Also, they will not have to sell their fixed assets or
stocks immediately at bargain prices, when faced with a crisis or shock. Finally,
please keep it in mind that the liquid ratio is also called as the quick ratio or the
acid test ratio.
141
Liquidity and Profitability. There is a dilemma between the liquidity and

profitability. For example, very high current and liquid ratios, although
indicating liquidity, can give us a hint that funds are lying idle. For sure, we
should look at to the opposite side of this situation. Low current and liquid ratios
are generally thought to be an indication of illiquidity, but can reflect a more
efficient and profitable administration of assets. Furthermore, there are no
“ideal” current and liquid ratios for a company. Because, each company must
determine the levels which will best satisfy their needs. Absolutely, very low or
very high ratios will both be harmful for all companies.
(c) Credit Allowed to Customers (Accounts Receivable Turnover)
Average of Accounts Receivable

Number of months' credit allowed = ----------------------------------------- x 12
Credit sales
We assume that Customers is the average of Accounts Receivable in our

example.
16 400 YTL
------------------ x 12 = Credit allowed for 2.22 months
88 400 YTL
That computation provides us the number of months' where credit was allowed
to the debtors on average. Concerning our example above, after goods are sold
on credit, it approximately takes two months for the debtors to pay. However, in
case the answer is to be presented in days, then we should multiply by 360
instead of 12:
16 400 YTL
------------------ x 365 = 67.7 days
88 400 YTL
Moreover, computing this figure for numerous sets of accounts lets us to

discover the trend for a specific company. Also, please note that, while we
comment on the trend of a company, we should be careful about the type of a
firm and we should learn if the figures are reasonable or not. As an example, if
we are investigating the accounts of a candy shop, probably we will not observe
any substantial debtors on the balance sheet. Finally, if the period of credit
allowed is likely to increase, then it can be guessed that the company’s credit
controls are inefficient.
142
(d) Credit Received from Suppliers (Accounts Payable Turnover)
Average of Accounts Payable

Number of months' credit received = -------------------------------------- x 12
Credit purchases
In our exemple, Suppliers is the average of Accounts Payable.
7 400 YTL
= ----------------- x 12 = 1,3 months' credit received
68 000 YTL
Also, in case the answer is to be presented in days, then we should multiply by

360 instead of 12:
7 400 YTL
------------------ x 365 = 39.7 days
68 000 YTL
This calculation, similar to credit allowed, can also be done in weeks or days.
Just like the previous one, the owner will look for a trend also here. A general
increment in credit received can mean that the company is finding it tough to
pay its way as a result of cash shortages.
(e) Return on Capital Employed
Net profit
Return on capital employed = ------------ x 100
Capital
5 500 YTL
= ----------------- x 100 = 13.75 % return
40 000 YTL
The ratio of return on capital employed is a crucial one to compute since it

compares the net profit of Profit and Loss Account with the owner's capital. This
way, the ratio of return on capital employed provides us a percentage return on
the investment made in the company. You should know that, for a basic balance
sheet, it is ideal to use the opening capital balance as the capital employed. In
143
addition, Return on Capital Employed can be used for comparing one company
with another. However, if we do not have any other evidence or data in support,
we should be extra careful in making decisions.
(f) Ratio of Plant Assets to Long-Term Liabilities
Fixed Assets (net)

Ratio of Plant Assets to Long-Term Liabilities= --------------------------
Long Term Liabilities
In our case, there is no any long term liabilities.
(g) Ratio of Liabilities to Stockholders’ Equity
Total Liabilities
Ratio of Liabilities to Stockholders’ Equity = ---------------------------------
Total Stockholders’ Equity
13 100
= ------------- = 28.8 %
45 500
This ratio is being used to indicate the margin of safety for creditors.
(h) Number of Times Interest Charges Earned (interest coverage)
Income before Tax

and Interest Expenses
Number of Times Interest Charges Earned = -----------------------------
Interest Expenses
5 500 + 900
= ------------------ = 7.11 times
900
We are using this number to assess the risk for debtholders, corcerning number
of times interest charges were earned.
(i) Ratio of Net Sales to Assets
144
Net Sales
Ratio of Net Sales to Assets = --------------------------
Average Total Assets
88 400
= ------------ = 1.50
58 600
We are using this ratio to assess the effectiveness of the use of assets.
(j) Rate Earned on Total Assets (ROA)
Net Income + Interest expenses

Rate Earned on Total Assets = -----------------------------------------
5 500 + 900
= ----------------- = 10.92 %
58 600
or
Operating Rate of Return Operating Income (Before interest and taxes)

On Total Assets (ROA) = ---------------------------------------------------------
6 400
= ------------- = 10.92 %
58 600
This rate shows us the profitability of the assets.
145
(k) Rate Earned on Common Stockholders’ Equity (ROE)
Net Income
Rate Earned on Common Stockholders’ Equity = ---------------------------
Average Common
Stockholders’ Equity
5 500
= -------------- = 12.08 %
45 500
This rate is used to assess the profitability of the investment by common

stockholders.
(l) Accounting Rate Of Return (Arr)
When calculating the profit you may not include depreciation, book values
of stock overheads, and etc… - all figures that would be excluded when
considering relevant cash flow approaches.
Estimated average annual profit

ARR = --------------------------------------- x 100
Average investment
(m) Present Value
All future cash flows are discounted to the present value and then added.
Present value = future value x discount factor.
The discount rate represents the benefit that can be earned elsewhere, e.g. the bank.
This rate is usually called the cost of capital.
(n) Internal Rate Of Return (Irr)
The rate of interest (discount) at which the NPV = 0.
146
May be found by linear interpolation or extrapolation.
The formula for the IRR is:
IRR = L + ( NL / NL-NH) x (H-L)
Where L = Lower rate of interest

H= Higher rate of interest
NL= NPV at lower rate of interest
NH = NPV at higher rate of interest
(o)Stock Market Debt Ratios
Interest paid per annum

Simple Intrest Yield = ----------------------------------
Current Market Value
(p) Equity Ratios
Net Income - preference dividend

Earnings Per Share (EPS) = ----------------------------------------------
Number of ordinary share in issues
Current Share Price

P/E Ratio = --------------------------
Earnings Per Share
A higher P/E ratio indicates that the market perceives the earnings as being of
higher quality - a combination of lower risk and/or higher future growth.
1.25 CASH FLOW STATEMENTS
The Statement of cash flows reports all the cash activities of a company during a
given period. Also, it explains the causes for the changes in cash by providing
information about operating, financing and investing activities.
1.25.1 The Advantages and Importance of Cash Flow Statements
147
A Cash Flow Statement uses data from the accounting records (the Profit and
Loss Account is also included here) and the balance sheet. It is prepared for
showing an overall view of money flowing in and out of a company through an
accounting period.
A cash flow statement is especially interested in the liquidity of a company and

tells to the owner, CEO or shareholders why, after a year of good profits for
instance, there is a decreased balance in the bank or a larger bank overdraft at
the end of the year than there was at the beginning of the year.
Plus, you should guess that cash flow statements are significant since they deal
with flows of money. There is no doubt that it is usually a shortage of money
which causes most firms to go bankruptcy, instead of a low quality product or
service. Besides, think of countless companies, from the smallest firm to the
largest one, all of them include cash flow statements as a part of their accounts
which they prepare and pass to shareholders. We believe this is a perfect hint
about the importance of cash flow statements. Finally, in terms of sole traders
and partnerships, the data that the statement includes is of critical interest to the
owner(s) and to a lender, like a bank.
1.25.2 Cash Flows
Cash flow statements do have three sections:
(a) operating activities

(b) investing activities
(c) financing activities
(a) Operating Activities
Operating activities are generally activities or transactions that effect the income
statement. The greatest source of cash flow for a company is often the one which
is generated from the operating or trading activities of the company.
Cash Inflows
Collections from customers
Interest and dividends collected
Other operating receipts
Cash Outflows
Cash payments to suppliers
148
Cash payments to employees

Interest and taxes paid
Other operating cash payments
The net cash inflow from operating activities is computed like this:
Net profit (before interest and tax)

plus depreciation for the year
plus decrease in debtors, or minus increase in debtors
plus increase in creditors, or minus decrease in creditors
plus decrease in stock, or minus increase in stock
By the way, depreciation is added to the net profit. The reason is that
depreciation is a non-cash expense. So, no currency is paid by the company in
regards to depreciation charged to the Profit and Loss Account.
Please be careful about the fact that variances in the main working capital items
of stock, debtors and creditors have an influence on cash balances. For instance,
an increment in stock decreases cash, while a decrease in debtors highers cash.
(b) Investing Activities
Investing activities involve providing and collecting cash as a lender or as an

owner of securities, and acquiring and disposing of plant, property, equipment
and other long term productive assets. This part of the Cash flow statement
indicates the cash flows that are related to the purchase or sale of fixed assets.
For example:
Cash Inflows
Sale of property, plant, and equipment
Sale of securities that are not cash equivalents
Receipt of loan repayments
Cash Outflows
Purchase of property, plantand equipment
Purchase of securities that are not cash equivalents
Making loans
(c) Financing activities
149
Financing activities involve obtaining resources as a borrower or issuer of

securities and repaying creditors and owners. The financing part of the statement
indicates the cash flows in regards to shares and loans. Cash Inflows and Cash
Outflows can be provided as two examples here.
cash inflows:
(i) increment in capital/share capital.
(ii) highering/increment of medium/long-term loans.
(iii) issuing debt securities.
(iv) dividends received.
cash outflows:
(i) capital/share capital repayment.
(ii) medium/long-term loans repayment.
(iii) repurchase of equity' shares.
(iv) dividends paid (drawings for a sole trader or partnership company).
You should realize that the change in cash/bank balances does not take place in
this section.
The Rise or Decrease in Cash
The subtotals from the five major areas of company activity are summed up to
provide the increment/(fall) in cash for the year. After that follows a
reconciliation of the cash at the beginning of the year, plus the increment or
minus the fall for the year, which in the next step equals to the balance of cash at
the end of the year. Here, be careful about the fact that “cash” contains cash
itself and the balance in the bank.
Two approaches can be used to compute cash flow operating activities (or
operations). By the way, computing it as collections less operating
disbursements is called the direct method. Also, adjusting the previously
calculated accrual net income from the income statement to reflect only cash
receipts and outlays is called the indirect method.
There are two examples of cash flow statement, that are prepared as Direct and
Indirect Method as indicated below1:
STATEMENT OF CASH FLOW (000 YTL)

(Direct Method)
1
Charles T., Horngren, Walter T.Harrison, Linda S. Bamber, “Accounting”. Prentice Hall
International Inc., USA, 4.ed., 1999, p.716, 733
150
Cash flows from operating activities:

Receipts:
Collections from customers 271
Interest received on notes receivable 10
Divdends received on investments in stock 9
Total cash receipts 290
Payments:
To suppliers (133)
To employees (58)
For interest (16)
For income tax (15)
Total cash payments (222)
Net cash inflow- from operating activities 68
Cash flows from investing activities:
Acquisition of plant assets (306)
Loan to another company (11)
Proceeds from sale of plant assets 62
Net cash outflow from investing activities (255)
Cash flows from financing activities:
Proceeds from issuance of common stock 101
Proceeds from issuance of long-term notes payable 94
Payment of long-term notes payable (11)
Payment of dividends (17)
Net cash inflow- from financing activities 167
Net (decrease) in cash (20)
Cash balance, December 31, 20-1 42
STATEMENT OF CASH FLOW (Thousand YTL)

(Indirect Method)
Cash flows from operating activities:
Net income 41
Add (subtract) items that affect net income
and cash flows differently:
Depreciation 18
Gain on sale of plant assets (8)
Increase in accounts receivable (13)
151
Increase in interest receivable (2)

Decrease in ınventony 3
Increase in prepaid expenses (1)
Increase in accounts payable 34
Decrease in salary and wage payable (2)
Decrease in accrued liabilities (2) 27
Net cash inflow from operating activities 68
Cash flows from investing activities:
Acquisition of plant assets (306)
Loan to another company (11)
Proceeds from sale of plant assets 62
Net cash outflow from investing activities (255)
Cash flows from financing activities:
Proceeds from issuance of common stock 101
Proceeds from issuance of long-term notes payable 94
Payment of long-term notes payable (11)
Payment of dividends (17)
Net cash inflow- from financing activities 167
Net (decrease) in cash (20)
Analysis of Effects of Transactions on Cash 2
Type of Transaction Change in Cash

OPERATING ACTIVITIES:
Sales of goods and services for cash +
Sales of goods and services on credit 0
Receive dividends or interest +
Collection of accounts receivable +
Recognize cost of goods sold 0
Purchase inventory for cash –
Purchase inventory on credit 0
Pay trade accounts payable -
Accrue operating expenses 0
Pay operating expenses -
Accrue taxes 0
Pay taxes -
2
Charles T. Horngren, Gary L. Sundem, John A. Elliott., “Introduction to Financial
Accounting”, Prentice Hall, USA, 7.Ed., 1999, p.401
152
Accrue interest 0
Pay interest -
Prepay expenses for cash -
Write off prepaid expenses 0
Charge depreciation or amortization 0
INVESTING ACTIVITIES:
Purchase fixed assets for cash -
Purchase fixed assets by issuing debt 0
Sell fixed assets +
Purchase securities that are not cash equivalents -
Sell securities that are not cash equivalents +
Make a loan -
FINANCING ACTIVITIES:
Increase long-term or short-term debt +
Reduce long-term or short-term debt -
Sell common or preferred shares +
Repurchase and retire common or preferred shares -
Purchase treasury stock -
Pay dividends -
Convert debt to common stock 0
Reclassify long-term debt to short-term debt 0
Here is another example of cash flow statement:
CASH FLOW STATEMENT YTL
A- CASH AT THE BEGINNING OF THE PERIOD 1 300

B- CASH INFLOWS WITHIN THE PERlOD 33 530
1. Cash From Sales 14 300
a) Net Sales 12 700
b) Decrease in Trade Receivables 1 600
c) Increase in Trade Receivables (-)
2. Cash From Other Operations 8 220
3. Cash Received from Extraordinary Income and Profit 800
4. Cash Received from Increase in Short Term Liabilities
a) Securities Issued
b) Credits Obtained
c) Other Increases
5. Cash Received from Increase in Short Term Liabilities 10 000
b) Credits Obtained 10 000
c) Other Increases
6. Cash Received From Share Capital lncrease
7. Cash Received From Share Premium
8. Other Cash Received From Cash Inflows 210
153
C - CASH OUTFLOWS WITHIN THE PERIOD 33 710

1. Cash Outflows due to Costs 10 840
a) Cost of Sales 8 600
b) Increase in inventories 1 540
c) Decrease in Trade Payables 700
d) Increase in Trade Payables (-)
e) Expenses not Requiring Cash Payments Such as
Depreciation and Provisions (-)
f) Decrease in Inventories(-)
2. Cash Outflows due to Operating Expenses 11 630
a) Research and Development Expenses
b) Marketing, Selling and Distribution Expenses 3 850
c) General Administrative Expenses 9 400
d) Expenses not Requiring Cash Payments Such as
Depreciation and Provisions (-) - 1 620
3. Cash Outflows Related to Other Expenses and Losses 830
a) Ordinay Expenses and Losses 830
b) Other Expenses and Losses not Requiring Cash
Payments(-)
4. Cash Outflows due to Financial Expenses 400
5. Cash Outflows due to Extraordinary Expenses and Losses 560
a) Extraordinary Expenses and Losses 560
b) Expenses and Losses Not Requiring Cash Payments (-)
6. Cash Outflows Due to investment in non-current assets
7. Cash Outflows Due to Short Term Liability Payments 2 000
a) Current Maturities of Marketable Securities 2 000
b) Principal Payments of Marketable Securities
c) Other Payments
8. Cash Outflows Due to Long Term Liability Payments
a) Current Maturities of Marketabte Securities
c) Other Payments
9. Taxes and Other Similar Charges Paid 3 450
10. Dividends Paid 4 000
11. Other Cash Outflows
D- CASH AT THE END OF THE PERIOD (A+B-C) 1 120
E- INCREASE OR DECREASE IN CASH (D-A) - 180
154
CHAPTER 2 : COST ACCOUNTING
2.1 CLASSIFICATION OF COSTS
Here, we will have a look at topics which are related with the classification of
costs. However, we will start with the classification and coding system that you
can observe in a library. The reason is that a great majority of this book’s readers
will be familiar with the workings of classification and coding system in a
library. Naturally, libraries can not work without a classification and coding
system. Because, in case libraries did not have such a system, the only way of
keeping books and periodicals would be to store them up as they come. Of
course, in this situation, trying to locate a book in a library, which does not use a
classification and coding system would be impossible. Definitely, for an
accountant in a big company, the same problem would be experienced. Because,
if costs and revenues were not completely classified and coded, trying to keep
track of profits and losses would be impossible. Also know that, the historic cost
and revenue data that is explained in management accounting is entirely the
identical cost and revenue data studied by the financial accountants. On the other
hand, financial accounting is only interested in the nature of cost or revenue. As
an example, it looks whether a cost is wages, rent or raw material. However,
management accounting focuses on the purpose of cost. For instance, it is
concerned whether the wages cost takes its roots from manufacturing,
maintenance or administration. Also, in case the wages cost for example takes its
roots from the manufacturing, then management accounting determines whether
155
it is a direct or indirect cost. Additionally, if we concentrate on the works of a

financial accountant, we will observe that when an invoice arrives for payment,
or when the payroll is being investigated, one of the first things occuring is the
allocation made to a division, department or product. This way, the correct
account will be debited in the purchases or general ledger. Absolutely, there
exists only one way for such an allocation to be made. In case the costs
associated with that invoice or payroll charge have been classified in the first
place, then this allocation can be made. You should know that, if no
classification did exist, all charges could end up in the same account. Another
scenario is that, there would be no other way to decide how much of a cost had
belonged to one specific department. For instance, we could never have an idea
about the cost of department T, and we could never compare it with the costs of
departments X, Y and Z.
Now, let’s study a little bit on terminology… Classification can be defined

briefly as 'The arrangement of items in logical groups in regards to their nature
and purpose’. If the items are arranged in regards to their nature, this is
subjective classification. However, if the items are arranged in regards to their
purpose, then that is objective classification. Subjective classification is
implemented to show the nature of the expenditure. We can provide materials or
labor as examples here. On the other hand, objective classification reports us, for
example, which cost center or cost unit is to be charged. Surely, we will focus on
the two separate, but complementary cost classification schemes. For the first
scheme, we will study the general classification of costs for a manufacturer
which lets us to build up the costs of making a product or providing a service.
This will be in a way, which we will be able to tell with complete certainty, that
a t-shirt will cost x YTL to make or that it will cost y per page to provide a word
processing service. Moreover, the classification helps the management
accountant to tell his or her management co-workers in the organization how the
cost came to be x YTL for the t-shirt or y YTL for the word processing service.
By the way, the second cost classification scheme is related with the abstract
division of costs into these categories:
■ absorbed vs. marginal

■ sunk vs. committed
■ opportunity vs. incremental.
Generally, scheme one will be used with the intention of cost accounting and
cost determination. On the other hand, scheme two will be used with the
intention of decision-making.
2.1.1 Cost Classification of Costs for Cost Accounting
156
The management accountant can store the costs of products made in his or her
organization on a cost card. Regarding the definition of cost card, it is a recorder
of all of the materials, labor, and overhead costs which arise in the processing of
a job, product or service.
If the costs are not classified, then the cost card will appear as the cost card
below. If classification does not exist, the cost of every product manufactured
can only be an average of all costs divided by the total number of units
manufactured. Actually, that would not be a severe problem in case only one
product was being manufactured. However, considering the business world, how
many t-shirt manufacturers do you know, which make one model with no model
versions? Additionally, how many word processing and printing offices do you
know, which only process one type of document? Know that, once a model is
varied, its cost structure relative to the first model will also change with a high
probability. Because of this reason, the more variations of a model will mean a
more unrepresentative average cost of reality.
In addition, when the accountant owns a cost classification system, he or she can
keep track of the organization's costs in detail. Also, his or her performance
reports will be much more meaningful. Definitely, in case the accountant owns a
full classification system, every product and variation can be reported separately.
COST CARD YTL
Direct materials: 4 960

Raw material X 2 400
Raw material Y 1 860
Raw material Z 700
Direct labor: 2 180

Dept. A 950
Dept. B 800
Dept. C 430
Prime cost 7 140
Overheads: 570
Supervision 200
Electricity 80
Insurances 50
Indirect labor 110
Indirect materials 130
………
………
Total manufacturing cost 7 710
157
Absolutely, these issues are very important for the management accountant.
Because, in case the management accountant did not classify the organization's
costs, then the answers for questions concerning stock valuation, decision
making, and controlling the organization's operations would be left unanswered.
Also, in case the management accounting system could not present detailed cost
summaries, the informational nature of the management accounting
department’s output would be at a very low level. A total average cost per unit,
by the way, can provide some idea about the efficiency of manufacturing
departments. However, it does not permit detailed insights about the quantities
and costs of each direct material used in manufacturing. Besides, total average
cost per unit does not emphasize the related direct labor costs of manufacturing.
Finally, the details of overhead costs related with manufacturing will for sure
persist as a mystery.
Direct materials
Direct labor Prime

Cost
Other Direct
expenses
Production
Overhead Costs: cost
Indirect materials
Indirect labor Total cost
Indirect expenses of sales
Administration expenses
Selling expenses
Distribution expenses Period
Research expenses costs
Development expenses
Financial expenses
Figure2: General classification system for a manufacturer
Notes:
- The term 'production cost' is identical to the cost of goods manufactured.
- The term 'indirect cost' is identical to factory overheads.
158
2.1.2 General classification of costs for a manufacturer
Our discussion below will explain all of the terms in detail, that we mentioned
earlier, representing a general classification system for a manufacturer.
The elements of cost
Material costs, labor costs and overhead costs are also called as the three
elements of cost. This description provides us a basic view of the classification
of costs. Keep in mind that, by defining each of the terms in a figure, we will
learn how this scheme will fit into any manufacturing organization.
Direct costs
First of all, know that, a direct cost is only classified as direct if the element of
cost being discussed can be directly related with the product being
manufactured.
1. Direct materials. Regarding direct materials, a material is only classified as

direct if it is incorporated in the finished product. For instance, if we are talking
about the manufacture of a wooden furniture, the pieces of wood that are turned
into chair legs, and the foam padding which is put into the seat of a chair, must
both be classified as direct materials.
2. Direct labor. Let’s explain this term by giving an example. For instance, the
labor costs of the workers who prepare the wood that turns into the finished
chair and the labor costs of the workers who montage the pieces of the chair are
both direct labor costs, because these individuals are directly participating in the
making of the finished product.
3. Direct expense. A direct expense is often considered as a special cost. For

example, renting a special machine or tool, the costs of a special design, or the
payment of a license fee or royalties are all direct expenses. They are
categorized as a direct expense since the cost is directly related with a specific
design or product, contrary to the organization's regular and daily range of
products. Now, let’s discuss the normal costs and normal products. For instance,
a textile manufacturer can make a range of six separate designs of t-shirt. Here,
all costs of these normal products are categorized as normal, under the related
headings. On the other hand, in case a client wants 300 t-shirts of a special
design, here all of the costs related with that special design will be assignable to
that design. This means, if the manufacturer must hire a special cutting or
sewing machine particularly for that job, then such hiring costs will be a direct
159
expense. Just like that, the costs experienced by the design department in
drawing up the working plans will be a direct expense. But, the direct materials
and direct labor costs will be categorized in the normal way for this condition.
So, all direct materials will be debited to the related direct materials account, and
etc...
Overhead costs
Firstly, we should know that, in the factory environment, any cost which is not a
direct one should be categorized as an indirect cost. Now, think of a material
which is used in the factory but is not a direct material. In this situation, this
material must be an indirect one. If we should give some examples for indirect
material costs, we can mention the cleaning materials, lubricants, grease, and
materials which are all parts of the finished product, but can not be thought as
direct materials. Of course, this can seem paradoxical, for a direct material to be
categorized as an indirect one; however this is not inevitably the case. For
instance, despite the fact that sewing thread used to sew a t-shirt together is most
clearly a part of the finished t-shirt, its cost can be so little that it will not be
important. We also say that these costs are not significant Thus, in this situation;
it will be classified as an indirect cost. Significance, in this context, can be
explained in a variety of ways. For example, in the case of a sewing thread,
manufacturer can spend 600 YTL on the sewing thread per year for making 20
000 t-shirts. Here, the average cost of sewing thread per t-shirt is 600 YTL / 20
000 t-shirt = 0.03 YTL per t-shirt. So, in case the manufacturer prefers to work
to the nearest 0.01 for cost data intentions, the cost of sewing thread will be
insignificant. As a result, the sewing thread is definitely a part of the finished
product; however the cost is controlled only in total as an indirect cost. Finally,
keep in mind that there are potentially thousands of various indirect costs.
Product, Period and Conversion Costs
First of all, the direct and indirect costs together form the product costs. The
product cost is “The cost of a finished product built up from its cost elements”.
Next, all other costs, like administration costs, selling costs and etc., are called
as period costs. By the way, just like CIMA tells, period costs are also called as
the fixed costs and fixed overhead costs. Then, fixed overhead cost is: “The cost
which is incurred for a period, and which, within certain output and turnover
limits, tends to be unaffected by fluctuations in the levels of activity (output or
turnover)” . Note that product costs are those which are assigned to stocks since
they are tightly related with production activities, instead of being related with
time. On the opposite side, period costs are charged on the profit and loss
160
account in the period in which they are incurred, since they are relevant to time,
instead of being tightly related with the manufacturing process. Finally, if we
should provide some examples of period costs, administration expenses, selling
expenses, distribution expenses, research expenses, development expenses, and
financial expenses can be listed as good examples.
INDIRECT COSTS
Materials
Sewing thread
Glue
Screws
Nuts
Finishing fabrics
Cleaning materials
Spares
Lubricants
Labor
Supervision
Materials handlers
Machine setters
Maintenance operatives
Cleaners
Holiday fee
Overtime premium
Overhead Expenses
Rent
Rates
Insurance
Electricity
Water Charges
Administration Costs
Depreciation:
Buildings
Equipment
Maintenance Materials
161
Maintenance Wages
Phone Charges
Postal Costs
Costs of Security
1. Administration expenses. These are costs of operating the administration

side of the company, containing the accounting department(s), the legal
department, the personnel department, and the computer office. These also
contain all related labor costs and overhead expenses. Furthermore, know that
corporation tax and value added tax (V.A.T.) are costs which have to be borne
by the company (temporarily, at least, for V.A.T.), and would be considered
under the categorization of administration expenses.
2. Selling expenses. The selling expenses are the costs of carrying the selling
operation of the company and they contain labor and overhead costs, as well as
any particular selling costs like trade fair costs and advertising costs.
3. Distribution expenses. The distribution expenses contain the costs of

moving finished goods from the manufacturer to the buyer. They include not
only labor and overheads, but also the costs related with the storage and moving
of goods after the manufacturing departments are finished with them.
After that, research and development expenses can be indicated separately or

together (see below). Some companies will have none of these expenses while
others will have one or both. By the way, research and development (R&D)
costs are the ones which are faced by many firms as a result of their works and
attempts to conduct research, as well as to introduce newer and better
components, products and ingredients.
4. Research costs. Research costs do relate to the department which carries the
research into new material inputs and etc. As an example, a research department
can be comprised of a chemical laboratory, a mechanics laboratory, or a
psychology department. Absolutely, the work and effort of such departments can
result in success. Because, their output may be beneficial for further
development into improved or new products, processes and etc. Definitely, in
some conditions, the research department can also be unsuccessful, which will
mean failure. Also, be aware that the costs of research department are subject to
financial accounting regulation. So, research costs are recorded as an expense
according to the Accounting Standards.
5. Development costs. Development costs arise from the department in an

organization which carries the work arising from, for instance, the research
162
department. Moreover, development work can arise from an idea received from
a worker or a client with the help of a suggestion scheme. Development costs are
the costs of making commercial products based on the research and may be
deferred and matched against future revenues.
6. Financial expenses. First of all, it is best to learn that the financial expenses
are also sometimes called as the finance expenses. They are the costs related
with providing the financials of a company. In some situations, a chaos can exist
about what forms a financial cost. For instance, some individuals will categorize
the cost of bad debts as a financial expense when bad debts are clearly a selling
cost. However, a financial expense is concerned particularly with the interest
costs of debentures, bank loans and mortgages. Also note that, the dividends on
preference and ordinary shares are appropriations of profit, but not expenses.
Because of this reason, they do not take place in that list.
Finally, conversion costs are the costs which are related with turning the raw
materials into finished products. This means, conversion costs are the direct
labor costs, direct expenses, as well as being factory overheads.
2.1.3 The Classification of Costs for Decision Making
Below, we will learn that there are links between pairs of costs. However, the
final three costs taking place in the list is an exception. By the way, know that
not always a link between the pairings will exist. Because of this reason, the
classification below shows costs in pairs and contrasts between them:
■ Absorbed vs. Variable Costs.

■ Sunk and Committed Costs.
■ Opportunity and Incremental Costs.
■ Avoidable vs. Unavoidable Costs.
■ Fixed vs. Variable Costs.
■ Controllable vs. Non-Controllable Costs.
■ Standard (Regular) Costs.
■ Post-Manufacturing Costs.
■ Life-Cycle Costs.
a. Absorbed and Variable Costs
Absorbed Costs
163
Starting with a basic explanation, an absorbed cost or overhead is the one that is
charged to products or services. Generally, this means that overhead costs are
stored department by department or activity pool by activity pool, and in the
next step averaged over the number of units produced or prepared. Thus, the
well-known formula below is often used for absorbed costs:
Total Overhead
---------------------
Absorption Base
For instance, suppose that the maintenance department is faced with a cost of
100,000 YTL. These are overhead costs which we have talked under
classification scheme one. Plus, suppose that the company has made 10,000
units. In this situation, we should average these maintenance costs over 10,000
units. In line with these, the average absorbed cost or overhead is computed like
this:
100,000 YTL
------------------ = 10 YTL per unit
10,000 units
This means, all units of output will now absorb and be charged 10 YTL by way
of their shares of maintenance costs. Definitely, this analysis, in other words this
rule, is true for all overhead costs, as well as being true for maintenance.
Variable Costs
Variable costs are the costs which are only experienced if a job or operation is
performed. For instance, if we do not travel inside the city on bus, then we do
not need to pay the price of bus. It is as simple as that! Just like this, in case we
do not make product X, then there should be a whole series of costs which will
not be experienced. As a result, variable costs of making product X are the costs
which are faced basically because of making product X. So, the issue of variable
cost underlines the fact that it is a cost which changes with output. In other
words, variable cost varies parallel to the output level. Because of this reason, if
we make more of product X, total variable cost will then be greater. Now, let’s
think of making furniture. For instance, let’s say making a batch of 10 chairs
will make us face the wood costs of 200 YTL. What about making 10 batches
each of 10 chairs? What would it cost to us? Well, it would make us face costs
of 2,000 YTL (10 batches x 200 YTL wood costs per batch). As you can clearly
164
understand from this example, making more of a product will mean a higher
total variable cost, as we mentioned before.
b. Sunk and Committed Costs
Sunk Costs
First of all, let’s define the sunk costs: A sunk cost is the one which has already
been faced at the time a decision is being considered. Because of this reason, it is
not important for the new decision being considered. Also, sunk costs are
usually considered together with variable and related costs. By the way, keep in
mind that, these costs are not important in a decision-making condition, since
there is nothing that can be done to cancel the decision to invest in them. For
instance, once a PC has been bought, paid for, and set up, it is sunk. Similarly,
once we have purchased and taken delivery of a new Volkswagen commercial
vehicle, it is thought as a sunk cost investment. Let’s also give an example for
covering the sunk cost. For instance, a sunk cost would be covered where a
market research questionnaire has been conducted and all the costs faced in
conducting it out have been paid for. Of course, this questionnaire will be
followed by a proposal to invest in the new machinery for developing a new line
of products. Consequently, the market research questionnaire, which has already
been finalized and paid for, will be a sunk cost and it will not be important for
the decision currently in hand.
Committed Costs
Committed costs are the ones which should be faced so that the company can go
on to function. However, it is a well-observed fact that the management may
have little or no discretion about them. If we should give some examples of
committed costs, rent of infrastructure (e.g. buildings), rates payable to the local
authority, and employer's liability insurance can be mentioned.
c. Opportunity and Incremental Costs
Opportunity Costs
Originally, the term opportunity cost belongs to the science of economics. So,
just like several terms used by accountants, it is also borrowed from the
economists. If we should describe the term opportunity cost, we can say that it is
described as being the cost of an opportunity forgone. For instance, in case we
decide on our entertaining budget of 10,000 YTL annually to visit Prague for a
165
holiday, then we can not watch our favorite soccer team Galatasaray SK week
after week through the season. So, here the opportunity cost of the holiday in
Prague is forgoing watching our favorite soccer team Galatasaray SK. Another
example: Let’s say we got a job offer and we immediately accepted it by signing
a contract which forbids us to work elsewhere for one year. Here, after signing
the contract, we can get another job offer which can offer us a higher salary and
better conditions, within the same year. So, we will not be able to accept that job
offer because of the contract we signed. So, accepting the first job can also make
us face an opportunity cost. Finally, let’s say we completed our undergraduate
studies and we decided to pursue an MBA (Master of Business Administration).
Here, if we start and go through our MBA (not part-time or executive), the
opportunity cost is that we will not be able to work full-time in the job industry.
In other words, job experience and payment is the opportunity cost here. Finally,
as you can clearly see, the concept of opportunity cost symbolizes a sacrifice.
Incremental Costs
The first thing to know is that, an incremental cost stands for the increase of one
alternative’s cost over another. Therefore, it is also called as a differential cost,
which means the difference between costs of alternatives. Now, let’s go through
a simple example to comprehend this issue better. Below, we have to select one
of the two investment opportunities, so the incremental cost must be:
Opportunity X 100,000 YTL

Opportunity Y 97,500 YTL
Incremental Cost 2,500 YTL
Again, the concept of incremental cost is not a difficult one to grasp, and it is at
the same time widely used in decision making.
d. Avoidable and Unavoidable (or Incurred) Costs
Explaining basically, if you do not have to incur a cost, it is avoidable. Because

of this reason, an avoidable cost is the one which would be avoided in case a job,
process or operation was not undertaken. On the opposite side, an unavoidable
cost should be incurred whether the decision is taken or will be taken. For
instance, according to the rules of UEFA (The Union of European Football
Associations), all soccer teams of Europe participating in UEFA Champions
League or UEFA Cup have been put in the position of incurring unavoidable
costs by being required to have modern stadiums, meeting the universal
standards. This cost is unavoidable, because if a soccer club does not follow this
166
UEFA rule, it is banned from European competitions, such as UEFA Cup and
UEFA Champions League.
e. Fixed and Variable Costs
In this section, we will discuss fixed and variable costs briefly. Because, here we
are not going to think about the nature and behavior of costs. On the other hand,
here we will think about the general differences between fixed and variable
costs.
Fixed cost is the one which remains unchanged against big changes in output or
activity level. If a cost remains unchanged, in spite of even a big change in the
level of output or activity, then we can state that this cost is a fixed one. For
instance, under normal situations, we will say that the rental costs of a building
or machine is going to be a fixed cost, since a fixed cost remains the same,
independently from the number of units a company produces. This means, even
if the output was zero, we would still be faced with the rental cost. If we higher
our output level by, for instance, 30%, by how much will the rent’s cost go up?
If the answer is that there will not be any change in the level of the rent cost,
then we can say that we are very likely faced with a fixed cost.
On the opposite side, a variable cost is the one which tends to change with the
level of output. If a cost changes in direct proportion to any change in the level
of output or activity, then the cost here is a variable one. In other words, if there
exists a direct relationship between the level of output and cost, then we are
talking about a variable cost. Similarly, if a company’s labor cost is a direct one,
we would think, in general that the more units we produce, the more would be
incurred in labor costs. Again, generally, for one unit increase in output or
activity, we would anticipate one unit increase in direct labor costs. For instance,
a raw material cost is a good example of variable cost. Suppose that, for every
chair we manufacture in our furniture factory, we will use, 0.20 meter cube of
wood strips at a cost of, let’s say, 12 YTL. So, if we manufacture one chair, we
will use 12 YTL of wood; however for 20 chairs, we need 240 YTL worth of
wood and etc. Thus, as you can see, the costs change in proportion to output as
does the amount of raw material.
Plus, there exists semi-variable cost, sometimes also known as the semi-fixed
cost. This one is a mixed cost that has both a fixed and a variable element in it.
For example, phone costs are semi-variable costs. Because, it has a fixed rental
charge and a variable cost per unit of phone time. So, the total phone cost must
be a mixture of fixed and variable costs.
167
f. Controllable and Non- Controllable Costs
A controllable cost is the one, which can be controlled by the related

responsibility center manager. On the other hand, a non-controllable cost is the
one, which the responsibility center is unable to control, or affect. For example,
rent of buildings is almost always a centrally negotiated cost, yet the cost of
renting a room or an area may be allocated to a department. That department
manager is definitely not able to control the rent cost allocated to him or her.
g. Standard Costs
Generally, standard costs are defined as pre-determined costs of a unit of

material, labor or overheads’ input. Additionally, we should emphasize that
standards are developed via methods of detailed opinions on material input
requirements, such as the quantity and values of labor required to finish the
given tasks; and the value of overhead to be faced in a job, process or operation.
h. Post-Manufacturing Costs
In the first place, know that, for some companies, post-manufacturing costs can
be very important. Because, at this point, we are studying the costs which are
faced once the goods have left the factory. For instance, in terms of a white
goods manufacturer (e.g. refrigerators), the post-manufacturing costs can contain
installation costs (e.g. setting up a refrigerator) plus costs of the one-or two-year
guarantee which will usually apply to these goods. Definitely, we can have a
problem here since these post-manufacturing costs are non-value adding.
However, parallel to where we draw the line in the end of the production
process, customizing products can make us face post-manufacturing costs which
do also add value. As an example, just think of customized (modified)
automobiles. Here, we have the car already manufactured, plus it has been sold
and can be used as any other regular car. On the opposite side, the owner of a car
can now demand different wheels, different interior trim, and a modified engine.
Thus, the job will now incur more costs, however there will be an extra amount
of revenue which will not only match those costs, but will supply extra profit,
accordingly value, too.
Next, note that some firms can experience superiorities with the help of their
post-manufacturing activities. For instance, consider a fine wine or Scotch
whisky club. Here, we have a wonderful example of value adding post-
manufacturing operations. By the way, post-production costs are related with
product introduction and retention decisions. As a result, post-manufacturing
costs should be detected, recorded and investigated with special care.
168
i. Life-Cycle Costing
First of all, let’s learn the definition of life-cycle costing. Generally speaking,
life-cycle costing is the practice of gathering, through their life-times, the best
use of physical goods at the least total cost to the entity. So, it can only be done
with a combination of management, finance, engineering and other disciplines.
Thus, life-cycle costing is clearly concerned with the relationship between what
a customer pays for a product and the total cost customer faces through the life
cycle of using it. Also, know that life-cycle costing was extensively discussed
during the 1970s by the management accounting profession, and today it has
clearly became a significant subject for several companies. The leading reason
for the extensive discussion in the 1970s was that authorities had realized a
critical point, as stated by Yoshikawa et al in 1993: 'Experience has shown that
up to 90% of the producer's costs for a product is committed during the planning
and design stages'.
Because of this reason, life-cycle costing must be an extremely important

consideration for any management accountant. So, the influence of life-cycle
costing is that, from the aspect of asset acquisition for instance, not only direct
costs of purchasing, setting, installing and operating these assets will be
considered, but the longer-run costs like repairs, maintenance, upgrading, and
replacement will also be considered. Additionally, as a result of such methods as
life-cycle costing, the management accountant needs a strong education
background and he must also have a talent for acquiring skills, as well as
possessing knowledge that cover all disciplines within his or her company.
Regarding this concept, the best management accountant is the one who spends a
serious amount of time through his or her early days with the company, learning
industrial, engineering and other similar disciplines related to that mentioned
firm. After that, the ideal management accountant will frequently renew such
knowledge and skills by touring round the facility on a regular basis.
2.1.4 Estimating Cost Behavior
The term “cost behavior” means the way a cost can be predicted as fixed,
variable or semi-variable. Additionally, the term cost behavior means the way a
cost can behave in a linear or a non-linear way. Thus, this chapter is related with
realizing the variability and linearity of costs.
a. Mathematical Conventions
169
We will take advantage of some mathematics. The conventions below are

introduced at the moment. So, we will develop arguments surrounding the
function of a straight line. In other words, we will look at the functions below:
(1) y=a
(2) y = bx
(3) y = a + bx
Starting from function (1), it says that the value of dependent variable y, is equal
to a, which is a fixed cost. Then, function (2) says that the value of dependent
variable y, is equal to b multiplied by x. Let’s now explain function (2) in more
detail. This equation means that when b, the variable cost per unit, is multiplied
by x, the volume of output, stands for the total variable cost of something. After
that, function (3) symbolizes a semi-variable cost. According to this equation, y
is equal to fixed cost a, plus the total variable cost, bx.
So, as you can see, here we are dealing with linearity. However, if we face a
function in which we discover that there is more than one variable cost, then we
must use the equation below:
y = a + b1x + b2x + b3x

Above, each variable cost is represented by the letter b and is also given a
subscript number, from 1 to 3. Regarding this example, the function includes
three separate variable costs per unit. In other words, we are studying a case in
which we multiply each variable cost per unit (variable cost per unit one is
shown by b1, variable cost per unit two is shown by b2 and variable cost per unit
three is shown by b3) by the output and next add the result of that to the fixed
costs and a, then gather a prediction of total costs.
b. Definition and Description of Cost Behavior
Let us begin this section with an example. For instance, situations where cost of
a rent highers, goes down or remains unchanged when the level of output is
highered can all be shown as examples of cost behavior. Now, assume that our
company decides to higher the number of units we produce from 1,500 units per
year to 2,500 units per year. So, do you think we will spend more on employee
costs after this change? To make a long story short, the concepts we will face in
this chapter are related with fixed and variable cost behaviors. Also, in the next
section, we will study the cost behavior in three steps: First, we will explain the
three categories of cost; secondly, we will implement our definitions to numeric
data; and thirdly, we will plot these numeric data on scatter graphs as a last
attempt to appreciate the meaning of separate categories of cost behavior.
170
c. Numeric Illustration of Cost Behavior
Three historic costs faced by a company help us to understand the cost behavior
in a practical way. You can definitely guess that fixed, variable and semi-
variable costs do describe the way which these costs behave. You do not even
need a reference for that. Absolutely, it is not that easy every time. In other
words, by just examining the data on such a table, you can not always see how
any of these costs behave. Consequently, until this point, we have mentioned the
three categories (types) of costs in an abstract way. However, the best method of
mentioning, discussing and appreciating cost behaviors is indeed to plot them on
a scatter graph.
d. Scatter Graphs
First of all, a scatter graph is a graph or a chart on which we plot the raw data. It
is named as a scatter graph since data will usually seem to be scattered over the
area of the graph. The advantage of plotting these data on a graph is that a visual
image is created organizing the data in a way, which provides the maximum
effect. Remember, sometimes a picture is worth a thousand words!
Costs
YTL 500 --
--
--
--
Total Cost
--
250 --
200 --
150 -- Variable Cost
--
50 --
0 --
Fixed Cost
| | | | | | | | | | | |
5 10 15 20 25 30 35 40 45 50 55 60
Units
Figure 3: Presantation of variable and fixed costs
171
1. The Independent Variable - This is the variable x, horizontal axis. It stands

for the output (production or sales, for instance).
2. The Dependent Variable - This is the variable y, vertical axis. It stands for the
total costs.
Graphs explain the behavior of fixed costs located on the fixed cost column. The
graph shows, for instance, the case of rent, where the rent does not vary
irrespective of whether the output is zero or thousand units. So, it does not
matter how many units are produced, since rent remains the same. Finally, a
fixed cost graph is indicated by the equation below:
y=a
Here, y is the total cost and a is the fixed cost.
The graph illustrates the variable cost in a graphical format. Indeed, this figure
indicates a perfectly variable cost. Because, there is a direct relationship between
the numbers of units produced or provided, and the material, labor or overhead
inputs used for these units. A direct material is also an excellent example here.
Consequently, a variable cost graph is indicated by the following equation:
y = bx.
Here,
y is the total cost.

b is the variable cost per unit.
x is the number of output units.
We can observe how a semi-variable cost behaves when the cost is plotted
against output. As we mentioned before, a good example for the semi-variable
cost is the phone account. This is a semi-variable cost since there is a fixed
charge payable every period, which does not change with the number and
duration of calls made, in addition to a variable cost per unit. In other words,
let’s say we have a cellular phone and a GSM number. Here, when we will pay
for the calls we have made, we will pay a fixed amount plus a variable amount,
which changes with the number and duration of calls. We will always pay this
fixed amount even if we will not talk any, but the variable amount will change
from time to time. That is the reason why the phone account is an example for
172
semi-variable cost. Finally, following the mathematical conventions we

mentioned earlier in this chapter, a semi-variable cost graph is shown in the
algebraic format with the following equation:
y = a + bx
Here:
y is the total cost.

a is the fixed cost.
b is the variable cost per unit.
x is the number of units of output.
f. Analysis of Accounts Technique for Cost Behavior Prediction
We can generally categorize costs as fixed, variable, or semi-variable. The table

below is set in line with the analysis of accounts technique for cost behavior
identification. As an important point, the analysis of accounts technique matches
behavior to a cost on the basis of logical patterns. For instance, rent is often
provided as the ideal example for implementation of such a categorization.
Analysis of accounts technique runs based on the idea that 'everyone would
categorize a cost this way'. This means, if we take the issue of a room or flat’s
rent cost, and analyze that cost over a range of output levels, we would expect to
discover that although output levels vary clearly, the rent cost will remain fixed.
At last, we can say that, the identical sort of analysis can be implemented for all
costs and the conclusions would look similar to the table below.
■ Rent costs are fixed costs.

■ Management salary costs are fixed costs.
■ Direct material costs are variable costs.
■ Phone costs are semi-variable costs.
TABLE: 1 Cost Classification
Fixed Variable Semi-Variable

Costs Costs Costs
Rent Direct Materials Electricity
Depreciation (Amortization) Direct Labor Phone
Insurances Water Gas
Management Salaries Power Pension Cost
Rates Goods Received Traveling Cost
173
Wages of Guards Electricity

Supervision Costs
Because of this reason, whenever we see a rental cost, we immediately state that
it is a fixed cost. On the other hand, direct material costs are variable costs, and
phone costs are semi-variable costs. By the way, when you will carefully look at
the table above, you will see that one item, electricity, takes place in two
separate columns at the same time. There is no problem here, since electricity
can be shown as a good example for both variable costs and semi-variable costs.
Electricity can be variable for our company because we can negotiate with the
electricity supply firm for it to be that way. However, our company can still be
in a situation of having a fixed charge as well as having a variable cost per unit
element to the electricity costs. Therefore, in this condition, electricity must be a
semi-variable cost for us. Furthermore, keep it in mind that, analysis of accounts
technique requires high qualification. Because, although there exists several
costs which can easily be categorized as fixed, variable and semi-variable, there
also exists several costs which can not be categorized unless we first analyze
them very carefully. So, the intuitive categorization system which is defined by
the analysis of accounts technique is only to be used for rough and ready
computations. In other words, we must use the analysis of accounts technique
where there is no other alternative left (for instance, lack of other information
available). Also, the analysis of accounts technique can be used when the costs
are known to agree within such a categorization.
2.1.5 Arithmetical Prediction of Cost Behavior
Although graphical analysis is very beneficial, and while it is suggested that we

start almost all analysis of cost behavior by drawing a scatter graph, there exists
some problems about it. For instance, one of the leading problems with graphical
analysis is that, it is usually not accurate enough. This means, even with very
advanced spreadsheet and statistics software, which are available for most
computers, graphs can still be tough to comment on. Regarding this, another
eye-catching problem is that the lines which are drawn on a graph are sometimes
so thick to provide us a correct reading. Besides, not drawing graphs well, for
instance, breaking axes in an irregular way, by working with irregular scales, all
result in problems with commenting on graphs. On the opposite side,
arithmetical techniques are often able to provide highly correct results, even to
the toughest problems. Finally, know that although a company prediction for
cost estimation can be done via graphical analysis, an arithmetical solution must
be looked for in this situation. Below, you can see that we can show the
arithmetical prediction of cost behavior in the best manner, by going through an
174
example.
EXAMPLE:
We can compute the cost of producing a group of 2000 t-shirt:
We assume that:
- The materials cost is 3.00 YTL per t-shirt
- Direct Labor cost equals to 2.50 YTL per t-shirt
- Variable overhead costs is 0.75 YTL per t-shirt
- Fixed overhead cost equals to 3 000 YTL for the period
The first method to find total variable cost is to add together all of the variable
costs per unit:
b = materials + labor + factory variable overheads

b = 3.00 YTL + 2.50 YTL + 0.75 YTL
b = 6.25 YTL total variable cost per unit.
y = bx + a
b is total variable costs per unit

x is production quantity
a is total fixed overhead costs
So, when x= 2000 units, total variable cost is:
bx = 6.25 x 2000 = 12 500 YTL
Total cost = total variable costs + Fixed overhead costs
Total cost equals to 15 500 YTL (12 500 + 3 000 )
For the second method, calculate each variable cost per unit on its own, and
modify the cost function like this:
y = a + b1x + b2x + b3x
b1 = the variable material cost per unit.

b2 = the variable labor cost per unit.
b3 = the variable factory overhead cost per unit.
175
y = 3 000 + 3.00*2000 + 2.50*2000 + 0.75*2000

y = 3 000 + 6 000 + 5 000 + 1 500
y = 15 500 YTL
a. The High-Low Technique
The High-Low Technique is a rapid and easy method of determining cost

behavior. This technique is rapid and easy since it only requires two data
elements for each of the 'x' and the 'y' variables. The two required data elements
are the high and low reading for the variables. Regarding this technique, 'high'
means the value for 'y' variable, assigned the highest value of 'x' variable. Then,
'Low' means the 'y' variable associated with the lowest value for 'x' variable.
Now, we will work through two examples which will let us to understand this
issue completely:
Regarding Product 1, the high and low values we are searching for are:
variable 'x' variable'y'
High 400 3 000

Low 0 1 600
Regarding Product 2, the high and low values we are searching for are:
variable 'x' variable 'y'
High 550 3 400

Low 0 2 200
The scenario above proves us that the high and low values of variable 'y' are
tightly related with the high and low values of variable 'x'. Also, by looking to
the information above, we can tell that the high value of costs for Product 1 is 3
000 YTL. Please be careful that 3 000 YTL is the high value although it is not
the highest cost value in absolute terms. We are faced with a condition where the
high and low readings signal that costs are behaving in a manner which is
absolutely not the case. So, by combining the two extra-ordinary values, a
prediction of y = a + bx will not have much relation with the reality: In other
176
words, it leads into an error. On the other hand, it also provides a more logical
prediction of y = a + bx. The reason is that, it seems some relationship exists
between the 'x' and the 'y' variables. Consequently, we are not always required to
draw a diagram for predicting the values of 'a' and 'b', because we can also
achieve this arithmetically.
b. Arithmetical Prediction with the High-Low Technique
Firstly, let us begin with the example of Product 1 and predict 'a' and 'b'. In terms
of Product 1, the high and low values were:
High 400 3 000

Low 0 1 600
Now, we solve for the prediction of variable 'b' first by calculating the
differences between two data elements and then computing the average cost per
unit, 'b':
High 400 3 000

Low 0 1 600
Difference 400 1 400
So, 'b' = 1 400 YTL / 400 units = 3.50 YTL.
This is really logical since the total cost changes only because the variable cost
element of it changes. So, when we will produce more units, the total costs will
be higher. However, the fixed cost component of total costs does not change,
even if we face great fluctuations in output. As a result, if we determine the total
change in total costs and then divide it by the total change in output, we will
have a prediction of the change rate, 'b'. After that, to compute the value for 'a',
we substitute for 'b' in either the high or low data. Thus, using the high data for
substitution goals, the total cost at an output of 400 units will be:
3 000 YTL = a + 3.50 YTL x 400 units
So:
a = 3 000 YTL - (3.50 YTL x 400)
177
a = 3 000 YTL – 1 400 YTL

a = 1.600 YTL
As a result, we can say that:
y = a + bx = 1 600 YTL + 3.50 YTL x
If you will use the low data, you will again find the same value for 'a', just as we
did here. Finally, we must repeat the same process for Product 2, from the
example provided above.
Examples with y = a + bx estimates
Now, since we have calculated the estimates for 'a' and 'b', we must practice
using them in the next step.
Example:
Compute the value of ‘y’ for Product 1 when:
I. x = 200 units
II. x = 500 units
Solution of Example:
I. y = a + bx
y = 1 600 YTL + 3.5 YTL per unit x 200 units
y = 1 600 YTL +700 YTL = 2300 YTL
II. y = a + bx
y = 1 600 YTL + 3.5 YTL per unit x500 units
y = 1 600 YTL + 1750 YTL = YTL 3350
However, we must emphasize that the High-Low Technique is subject to several

limitations. For instance, in case the data we are analyzing are either non-linear
or follow no real pattern, the High-Low Technique can be completely
inappropriate. Moreover, just as we said previously, the representations of fixed,
variable and semi-variable costs are a little bit basic. Especially, they do not
consider the relevant range, which seems to be the leading weakness. If we
should explain the term relevant range, it means the levels of output or activity
178
over which a company has directly relevant experience. So, if a firm states that
its variable costs are 3.00 YTL per unit, then we must be cautious immediately,
because this statement must be qualified by linking the variable cost to a range
of output.
2.2 ABSORPTION COSTING
2.2.1 Definition of Absorption Costing
Absorption costing, or full costing, is concerned with finding the full cost of a
product or service. This means that we need to determine the sum of fixed,
variable and semivariable costs of a unit, activity, product or service: This is
exactly what we call as the full cost.
By absorption, we mean: “Overheads charged to products or services by means

of absorption rates”. Also, an absorption rate is: “A rate charged to a cost unit
intended to account for the overhead at a predetermined level of activity” .
The following worked example shows how to calculate an overhead absorption
rate (OAR), and discusses some of the problems built into such rates.
Example :
Ozgur Umut Mut Ltd. makes five entirely unrelated products and the total cost
of land and buildings rent is 41 500 YTL per year. Total output for a year is:
Product Units
1 3 000
2 2 200
3 1 000
4 9 000
5 1 400
Calculate the amount of rent to be absorbed by, or charged to, each product
made by Ozgur Umut Mut Ltd.
One approach to this problem is to find an average cost per unit of output. Using
the easiest of the available methods, we can find an overhead rate per unit for
rent costs by applying:
total rent cost

------------------------
179
total units of output
In that case, this is:
41 500 / 16 600 = 2.50 YTL per unit.
Note that 16 600 units is the sum of all units produced, considering all five
products made by Ozgur Umut Mut Ltd. 3 000 + 2 200 + 1 000 + 9 000 + 1 400
= 16 600. Here, for every unit of output, rent costs an average of 2.50 YTL per
unit of output, and therefore we should absorb 2.50 YTL for rent costs every
time a unit of output is produced. So, if we have made 20 units of output, the
overhead costs that we would absorb will be:
20 units x 2.50 per unit = 50 YTL.
This is an easy solution, but it could be misleading. Dividing rent by the units of
output, we have assumed, at least, that all the units of output are the same: That
is, they are equal in all respects in terms of material, labor and overhead inputs.
However, the information provided to us tells us that the products were entirely
unrelated – potentially so different in all respects. The implication here is that
the overhead cost - rent in this case - may not be related to units of output; it
might be better related to, say, the time spent on a machine. If, in Ozgur Umut
Mut Ltd example, the machine hours per unit of output, are:
Product Hours Units Total Hours
1 1.6 3 000 4 800

2 1.0 2 200 2 200
3 2.5 1 000 2 500
4 0.6 9 000 5 400
5 4.0 1 400 5 600
Total 20 500
We can calculate an overhead absorption rate per machine hour based on:
total rent cost

------------------------
total machine hours
In that case, this is:
41 500 YTL / 20 500 = 2.02 YTL per machine hour
180
The meaning of this rate is that for every hour a machine is operated, an average
of 2.02 YTL will be incurred by the overheads. So, if we ran a machine for 10
hours, we would absorb:
10 hours x 2.02 YTL per machine hours = 20.20 YTL for overheads.
Now, we have two rates: per unit and per machine hour, and they are 2.50 YTL
and 2.02 YTL respectively. By applying these rates and calculating the
overheads absorbed by each method, we will see a serious problem caused by
the overheads. In the case of those two absorption rate methods, we have
absorbed 41 500 YTL in total for the production we have achieved. But if we
look to product-by-product basis, we can see radical differences between the
overheads absorbed. Table below gives us an insight into the kind of differences,
arised by different OARs (Overhead Absorption Rates):
Product Units rate Machine hour Differences

of overhead rate of
absorption overhead
absorption
YTL YTL YTL
1 7 500 9 716 2 216
2 5 500 4 464 - 1 036
3 2 500 5 070 2 570
4 22 500 10 928 -11 572
5 3 500 11 322 7 822
Total 41 500 41 500
We should work through the arithmetic for the table by looking at the workings
for products 1 and 2.
Product 1
per unit rate basis
3 000 units x 2.50 YTL per unit = 7 500 YTL
per machine hour rate basis
3 000 units x 1.6 hours per unit x 2.02 YTL per machine hour = 9 716 YTL
Product 2
per unit rate basis
2 200 units x 2.50 YTL per unit = 5 500 YTL
per machine hour rate basis
181
2 200 units x 1 hour per unit x 2.02 YTL per machine hour = 4 464 YTL
The problem shown in the table above tells that, the amount of overheads
absorbed by each product will depend entirely upon the overhead absorption rate
(OAR) used. Furthermore, if the wrong rate is used, the wrong amount of
overheads will be absorbed. In the case of Ozgur Umut Mut Ltd, this is most
striking in the case of product 4, which shows an absorption difference of 11
572 YTL between the two methods of absorption. We use the rate which most
closely reflects the way overhead behaves or is driven. Generally, an overhead
absorption rate is:
overhead cost
-------------------------------------------
total units of absorption basis
The general view is that there are just a few OAR methods worthy of
consideration, and it is common to find just six of these methods discussed:
1. Units of output rate.

2. Direct labor hours rate.
3. Machine hours rate.
4. Prime cost percentage.
5. Material cost percentage.
6. Wages cost percentage.
Furthermore, the often presented view is that, of these six bases, the direct labor
hour basis is usually the most appropriate since it closely reflects the basis by
which overheads are driven. The formula for the calculation of six rates are:
overheads
Units of output rate = -------------------------
total units of output
overheads
Direct Labor hour rate = ----------------------------------
total labor hours worked
overheads
Machine hour rate = ------------------------------------
total machine hours worked
182
overheads
Prime cost percentage = ------------------------- x 100
total prime costs
overheads
Direct materials cost percentage = ------------------------- x 100
total material costs
overheads
Direct labor cost percentage = ------------------------- x 100
total labor costs
Example:
The following data were extracted from Enes Olgun Co. for the year ended on
January 31, 20-1:
Direct Materials Cost 220 600

Direct Labor Cost 187 500
Prime Cost 408 100
Overhead Costs 75,000
Total costs 483 100
Additionally, the following details are relevant to this period:
Labor hours worked 25 000

Machine hours worked 37 500
Units produced 6 000
Now, we will calculate the six OARs mentioned above.
Now, let’s apply the formulas mentioned previously:
75 000
Units of output rate = ----------- = 12.50 YTL per unit
6 000
183
75 000
Direct Labor hour rate = ------------ = 3.00 YTL per labor hour
25 000
75 000
Machine hour rate = ------------- = 2.00 YTL per machine hour
37 500
75 000
Prime cost percentage = ------------ x 100 = 18.37
408 100
75 000
Direct materials cost percentage = ------------- x 100 = 34
220 600
75 000
Direct labor cost percentage = --------------- x 100 = 40
187 500
We try to determine the most accurate estimation of unit costs for our
management colleagues, so we need to be sure that, the OAR we finally use for
our calculations is the correct one. Choosing an OAR that is not sufficiently
representative of the situation we try to depict, can have severe business policy
implications for our organization.
2.2.2 Choosing the best overhead absorption rate (OAR)
The units of output OAR basis is satisfactorily used if the organization is making
or providing only one product, or a range of very similar products. If there is
more than one product on offer, and/or the products are significantly different
from each other, as our examples so far have shown, using this OAR method
will not give accurate and consistent results. If we are to use the direct labor
hour OAR method, we have to be certain that there is a good relationship
between labor hours worked, and the incidence of overhead that we are seeking
to absorb. Any shift away from the dominance or importance of labor hours
worked in an Organization may lead to the need of reviewing the OAR method
to be used. In the case of a highly automated organization - for example a car
184
factory - machine hour rates could well be the most sensible basis on which to
base OARs. Also, when employees are working in a machine-dominated
environment, the use of labor-based rates will be inappropriate, and will
probably lead to errors in costings and estimations.
The three cost percentage rates - prime cost, materials cost and labor cost - can
all be discussed together. It is possible that, at one time or another, a statistical
relationship is to be found between the incidence of overheads and prime cost, or
materials cost, or labor cost. Logically, the method of attaching overhead rates to
costs of production is flawed. Because the method assumes that since materials
cost is high, the overhead cost must also be high. One excellent argument that
helps to dispel the myth of a connection between material value and incidence of
overheads is the case of the very expensive block of metal that is bought on a
just-in-time basis. The metal is received, worked on straight away, and then
shipped immediately to the customer for whom the product was intended. This
piece of metal will have incurred relatively few overheads since it moved
through the organization very quickly. A second example is that of the raw
material which is inexpensive per kilogram, but is very bulky. It is bought in
large quantities, and is stored in a purpose-built warehouse until it is used. If this
second material is stored, on average, for two or three months before being used,
it will actually incur relatively high amounts of overhead (storage charges,
security, materials handling). Yet using the material cost percentage rate of
overhead absorption will show that this material absorbs relatively few
overheads.
Similar arguments that apply to materials also apply to labor costs, and therefore
to prime costs. Cost percentage rates are not sensible rates on which to base
OAR methods, unless relationships between such costs are proven to persist over
the long term. There are many other overhead absorption bases to discuss and
we will be defining and discussing these when we are going to talk about
activity-based costing.
2.2.3 The predetermined aspects of OARs
Be careful about CIMA's definition of an overhead absorption rate, which is

provided above. Concentrate on the use of word predetermined: This means that
the rates are set in advance. So, if we are going to use an OAR for next month, it
is possible that an OAR will be set for an entire financial year as a part of the
annual budgeting process. To do this, we modify the OAR formula:
budgeted total overheads

--------------------------------
185
budgeted absorption basis
The most significant problem to be encountered when attempting to set a

predetermined OAR is to decide on a relevant activity level. There is a variety of
levels of activity that could be used in setting the predetermined OARs. For
example:
 theoretical (or ideal) activity;

 practical activity;
 expected actual activity;
 normal activity.
The theoretical activity level is known as the ideal activity level because it deals
only with what can be achieved when working at a 100% of capacity, with no
allowances made at all for stoppages for any reason.
Practical activity levels allow for unavoidable stoppages, and take account of the
fact that machinery, although it can often work continuously for days and
sometimes for weeks, will eventually need to be stopped for maintenance or
repair. The practical activity level also allows for late deliveries of materials and
labor skills shortages. If practical activity reflects high levels of efficiency, the
expected actual activity level takes matters a stage further and allows for other
stoppages and delays due to inefficiencies: It takes a slightly more pessimistic,
some would say a more realistic view of man and machine.
The normal activity rate is based on the idea that overhead rate should not be
changed merely because existing facilities are used to a greater or lesser extent
in different periods.
The idea here is that a job or product or service should not cost more to produce
in December than it did in January, solely because predetermined levels of
output varied between the two periods.
As we have said earlier, when a predetermined OAR is used, we apply the OAR
to a job or product in order to charge or absorb an amount of overhead. It should
be expected that the actual overheads incurred will be different to the
predetermined overheads. This is fine providing that the difference is not
excessively large, and that, on average, the differences tend to cancel each other
out (this view is in alignment with the normal activity level view).
2.2.4 Consequences of using predetermined OARs: under and over-

absorption of overheads
186
When a difference between actual and absorbed overheads does occur, what
should we do?
For example, using the direct materials cost percentage of overhead absorption,
we can calculate the amount of overheads that are overabsorbed or
underabsorbed.
Overheads absorbed:
= Direct materials cost x Direct materials cost percentage
= 82 000 x 0.34
= 27 880 YTL
Actual overheads:
= 29 100 YTL
Since Sabri Sahin Co. has absorbed 29 100 YTL – 27 880 YTL = 1 220 YTL
less than the actual overheads incurred, we are dealing with an underabsorption
of overheads. Using the normal activity level as the basis of the predetermined
OARs, it should be expected that the under and over-absorption amounts will
tend to cancel each other out over the longer term. Hence, many organizations
will only write off the balance on the over and under-absorptions annually. This
write off takes place by debiting or crediting the profit and loss account with an
under or over-absorption respectively. In exceptional circumstances, a large over
or under-absorption may occur at any time. In this case, that balance can be
written off immediately by debiting or crediting the profit and loss account.
For control purposes, therefore, we need departmental overhead absorption rates.
2.2.5 Departmental overhead rates
In fact, we can easily understand why we need departmental overhead rates. For
example assume that our organization consists of two departments, A and B.
Department A has 40 employees and the employees use no machinery or
equipment whatsoever for their work. On the other hand, there are only 3
employees in department B and this department is highly mechanized, with very
little work being done by hand. If we were to use an organization-wide labor
hour rate in this situation, we would be heading for potential problems with
department B since only insignificant amounts of work are carried out by labor
in that department. The same is true as far as machine hour rates are concerned
with department A. When overhead data have already been analyzed, those costs
are said to be allocated. If a cost is a common cost and can be found only in
total, it needs apportioning.
187
a. Cost Allocation and Cost Apportionment
Cost allocation is: ’That part of cost attribution which charges a specific cost to a
cost center or cost unit’. Cost apportionment is: ‘That part of cost attribution
which shares costs among two or more cost centers or cost units in proportion to
the estimated benefit received, using a proxy, e.g. square meters’.
Many authors of articles and textbooks use the word allocation when they mean
apportionment. That is, they discuss overhead cost assignment under the heading
of allocation. We hope that, the definitions just provided should clarify the true
usage of words.
Because we are now interested in data provided on a departmental basis, we

have a lot more work to do in order to calculate predetermined departmental
OARs. The scheme of work to undertake is:
1. Determine the level of activity that is to be categorized as normal, and which

will be used for all OAR determination.
2. Prepare total and departmental budgets of all overhead expenses for all
producing and service departments.
3. Prepare budgetary data that will allow for the apportionment of overhead
costs.
4. Allocate and apportion the overheads.
5. Reapportion service department overheads to the producing departments.
6. Calculate the departmental predetermined OARs.
This list is really a plan for dealing with any situation involving the allocation
and apportionment of overheads, and the calculation of predetermined OARs.
Note the following points:
Step 1, the setting of normal level of activity, is done as a part of the budget
preparation routine, and along the lines of discussion we had in this chapter
earlier.
Steps 2 and 3, the preparation of departmental budgets and data which allows for
the apportionment of overheads, is, again, determined as a part of the budgeting
routine.
Consider the example on table below relating to Mustafa Hazret Co., which
takes us through the overhead aspects of predetermination of OARs, but
assumes that the budgetary aspects are taken care of elsewhere. The data we start
188
with will be taken from the ledgers of the business, together with such analysis
of costs as will be found with the payroll: departmental wages analysis.
The summary on the table already includes departmental information for four
cost headings: These are allocated costs. Also, such costs as indirect material
costs can be allocated by means of the analysis of material requisitions. It should
be easy to discover where each individual has spent. Then, indirect labor costs
can be allocated by means of the analysis of the payroll: It should be easy to
discover where each individual has worked, how much he or she has been paid
and so on. Finding out where people have spent their time is done by means of
clock card analysis, job card analysis, or time sheet analysis. The depreciation of
buildings is being set by the management, and can therefore be allocated, and the
water costs can be allocated because each department is, let's say, having its
water usage metered. All other departments need the common overhead costs
apportioned to them. That is, no amount of analysis or metering can be, or is
being, carried out. We have to estimate the amount of overhead cost that each
department should suffer in proportion to the estimated benefit received. The
estimation of benefits received by a department can sometimes cause problems;
but in theoretical exercises, the basis on which apportionments are carried out
are usually suggested by the problem under consideration. The àdditional
information', or its equivalent, is usually the place that tells us the basis on which
to apportion costs.
TABLE :1 Departmental factory overhead summary: before apportionment
Service Production
departments departments
Total A B 1 2 3
Indirect materials 8 000

Indirect labor 13 000
Repairs and
maintenance 2 000
Depreciation 1 300
Rates 3 000
Insurance 600
Electricity 3 500
Water 800
Total 32 200
Table below contains the additional information we are going to use to apportion
the remaining overhead costs. These costs relate to the departmental factory
overhead summary above. The total value of indirect materials we need to
apportion is 8 000 YTL. Table of additional information contains five items of
189
information for us to consider for apportionment purposes. The question is:

Which of these five bases is the most suitable for apportioning the materials
cost? In the absence of any other indications to the contrary, the number of
materials requisitions would seem to be the most suitable: That is, the basis that
most nearly relates to the behavior of materials costs. We have arrived to this
basis on two grounds:
1. On the ground that it is one of the most related to the cost we are seeking to
apportion.
2. On the ground of elimination of all other bases.
b. Overhead apportionment calculations
We can work through the calculations now, starting with the indirect materials
cost and working our way down the departmental summary, until all of the
overheads costs have been allocated or apportioned, as well as departmental
totals arrived at.
There are two parts for this calculation, as there are for all overhead cost
apportionments:
1. Derive the constant that all other calculations depend upon.
2. Apply the constant department by department.
By the way, the constant is the total cost (indirect materials in this case) divided
by the total number of units of the apportionment basis (the number of material
requisitions in this case).
TABLE 2 : Additional information to assist apportionment of overheads
Service Production
Total A B 1 2 3
_____________________________________________
KwHrs 1 200 35 51 480 377 257
Area (m2) 2 800 373 373 654 746 654
Material
requisitions 4 000 250 50 800 1250 1650
Maintenance
hours 1 800 180 540 450 360 270
Cost of plant
(YTL) 520 000 100 000 48 000 160 000 132 000 80 000
Indirect labor, insurance and water will be apportioned according to accrual or
190
estimate costs.
Service Production
Total A B 1 2 3
____________________________________________
Indirect labor 13 000 1 400 1 000 6 200 3 500 900
Insurance 600 80 420 100
Water 800 60 100 210 200 130
8000 YTL
--------------------------- = 2.00 YTL per requisition
4 000 requisitions
Definitely, the constant is no more or less than an average cost per unit of
apportionment. In this example, the indirect materials cost, on average, is 2.00
YTL for every requisition made to the stores.
Service departments
A 2 YTL x 250 = 500 YTL
B 2 YTL x 50 = 100 YTL
Production departments
1 2 YTL x 800 = 1 600 YTL
2 2 YTL x 1250 = 2 500 YTL
3 2 YTL x 1650 = 3 300 YTL
Total 8 000 YTL
Note that, the sum of these apportionments equals to the sum we started with,
8000 YTL. If it did not, there would be something wrong with our calculations.
By the way, these results are then entered into the departmental factory overhead
summary on the apportionment table, along with all other results that you should
now determine.
TABLE Departmental overhead costs summary after apportionment of

overheads
Service Production
Total A B 1 2 3
__________________________________________
191
Indirect materials 8 000 500 100 1 600 2 500 3 300

Indirect labor 13 000 1 400 1 000 6 200 3 500 900
Repairs and
maintenance 2 000 200 600 500 400 300
Depreciation 1 300 250 120 400 330 200
Rates 3 000 400 400 700 800 700
Insurance 600 80 420 100
Electricity 3 500 100 150 1 400 1 100 750
Water 800 60 100 210 200 130
__________________________________________
Total 32 200 2 910 2 550 11 530 8 930 6 280
Totals on the table above are our estimates for overhead costs of operating each
department within our manufacturing unit: The total overheads for Production
Department 1 amount to 11530 YTL, and for the Production Department 2, they
amount to 8930 YTL, and etc... These results form the basis of any performance
reports issued to the managers of these departments. Before we calculate the
departmental overhead absorption rates, there is one further stage of work we
have to carry out. We have to reapportion the costs of all service departments
into the production departments' costs, because although a service department
fulfils useful function, it does not work on the products that are being made.
Consequently, it is not possible to directly absorb overhead cost units of output
from a service department.
c. Allocation (reapportionment) of the service departments' overheads to

the production departments
If we stop our overhead summary here, we will not be able to achieve the
objective of cost and/or profit assessment. We might argue that it is a waste of
time apportioning costs to service departments in the first place, if they are only
going to be reapportioned straight away. Arguing this way would cut against the
grain of true management accountant and manager. Because, if the
apportionment into the service departments does not take place, how would we
know how much those departments do cost to operate?
There are three distinct methods of calculating the allocation of costs from the
service departments into the production departments:
1. the direct method;

2. the step (sequential) method, and
3. the algebraic method (reciprocal method), which consists of two approaches:
(a) simultaneous equations; and

(b) matrix algebra.
192
In this section, the algebraic method is not explained in detailed. Because, the
algebraic method is an enhancement of the step method and uses either
simultaneous equations or matrix algebra to solve the problems. So, it is not
useful in the practice. The direct method uses the bases of apportionment
technique that we have been discussing so far: That is, we find a suitable basis of
apportionment for each service department and reapportion to the production
departments on that basis. Finally, the step method bases its reapportionments on
the basis of use to which service departments' services are put by other
departments.
d. The direct method
When companies allocate service department costs only to the production

departments, they use the direct method. Keep in mind that, the direct method is
the simplest and most straightforward way to allocate service department costs.
Now, assume we have a company named Faruk Pazarli Co., and we take it as an
example to illustrate the direct method. Also, say that the direct method takes
total overheads of 2910 YTL and 2550 YTL for service departments A and B
respectively, as its starting point. Also suppose that the direct method
reapportions these amounts according to the most appropriate reapportionment
basis. For example, we have to know (assume) that department A is a material
stores department, and department B is a maintenance department.
On the basis of information supplied in this case, and our earlier example, we
should reapportion the material stores department's costs on the basis of number
of material requisitions, and the maintenance department's costs on the basis of
maintenance hours. The totals derived above for the departmental overhead
expenditures of Faruk Pazarli Co. and the reapportionments are given on the
table below.
TABLE: Overhead Costs Reapportionment
Service Production
Total A B 1 2 3
________________________________________
Overhead Costs 32 200 2 910 2 550 11 530 8 930 6 280
Reapportionment
Department A - 2 910 629 983 1298
Department B - 2 550 1 063 850 637
________________________________________
Total 32 200 13 222 10 763 8 215
193
So, we have now all of the overheads apportioned and reapportioned into the
three production departments, and the service department overhead accounts
have a zero balance.
Calculation of the departmental overhead absorption rates:
The final step to take through this lengthy procedure is to find the departmental
overhead rates we have been looking for. Now that we have all of the overheads
allocated, apportioned and reapportioned into the production departments, we
can carry out that calculation.
TABLE: Additional information to assist reapportionment of departmental

overheads
Production
Departments
Total 1 2 3
____________________________________
Material
requisitions 3 700 800 1250 1650
Maintenance
hours 1 080 450 360 270
The departmental overhead absorption rates are now found by dividing the
respective departmental overhead expenditures by the OAR base:
For Department A:
Department materials requisition

------------------------------------------- x Department A Overhead
total material requisitions
800
Department 1 -------- x 2910 = 629 YTL
3700
1250
Department 2 -------- x 2910 = 983 YTL
3700
1650
194
Department 3 -------- x 2910 = 1298 YTL

3700
For Department B:
Department maintenance hours

------------------------------------------- x Department B Overhead
total maintenance hours
450
Department 1 -------- x 2550 = 1063 YTL
1080
360
Department 2 -------- x 2550 = 850 YTL
1080
270
Department 3 -------- x 2550 = 637 YTL
1080
For Department A, overheads are absorbed at a rate of 0.786 YTL (2910/3700)

per materials requisition. Similarly, for Department B, overheads are absorbed at
a rate of 2.36 YTL (2550/1080) per maintenance hours.
e. The Step Method (sequential method)
The sequential or step method of allocation recognizes that interactions among

service departments do occur. The sequential methods do not completely
recognize service department interaction. Cost allocations are performed in a
step down fashion following a predetermined ranking procedure. In this method,
the sequence is defined by ranking the service departments in order of the
amount of service rendered, from the greatest to the least. Degree of service is
usually measured by the direct costs of each service department. One important
feature of many organizations that we alluded while discussing the direct method
of allocation was that, one service department could carry out work for another
service department. This causes a problem of circular nature in that we may
allocate reciprocal service costs in an infinite loop. For example, when we
195
allocate service departments A and B, we might find that the two service
departments do work for each other. In such circumstances we invoke the
repeated distribution method: That is, we accept that, although in the extreme
this method accepts the infinite loop, the method usually only carries on for four
to six iterations at the most: Not infinitely .
Let us consider our example again.
TABLE: Departmental overhead costs summary after Apportionment of

overheads
Service Production
Total A B 1 2 3
__________________________________________
Indirect materials 8 000 500 100 1 600 2 500 3 300
Indirect labor 13 000 1 400 1 000 6 200 3 500 900
Repairs and
maintenance 2 000 200 600 500 400 300
Depreciation 1 300 250 120 400 330 200
Rates 3 000 400 400 700 800 700
Insurance 600 80 420 100
Electricity 3 500 100 150 1 400 1 100 750
Water 800 60 100 210 200 130
__________________________________________
Total 32 200 2 910 2 550 11 530 8 930 6 280
The overhead distribution summary following the use of repeated distribution

method is shown on the table below. We will begin from the first service
department and we will apportion total overhead costs of Depertment A to the
other departments (service and production departments).
TABLE: Additional information to assist reapportionment of departmental

overheads
Service Production
Departments Departments
Total A B 1 2 3
____________________________________________
Material
requisitions 3 750 50 800 1250 1650
Maintenance
196
hours 1 080 450 360 270
Service Production
Total A B 1 2 3
_________________________________________
Overhead Costs 32 200 2 910 2 550 11 530 8 930 6 280
Reapportionment
Department A - 2 910 39 621 970 1280
Department B - 2 589 1 079 863 647
_________________________________________
Total 32 200 13 230 10 763 8 207
The departmental overhead absorption rates are now found by dividing the
respective departmental overhead expenditures by the OAR base:
For Department A:

50
Department B -------- x 2910 = 39YTL
3750
800
Department 1 -------- x 2910 = 621 YTL
3750
1250
Department 2 -------- x 2910 = 970 YTL
3750
1650
Department 3 -------- x 2910 = 1280 YTL
3750
For Department B:
197

------------------------------------------- x Department B Overhead
450
Department 1 -------- x 2589 = 1079 YTL
1080
360
Department 2 -------- x 2589 = 863 YTL
1080
270
Department 3 -------- x 2589 = 647 YTL
1080
For Department A, overheads are absorbed at a rate of 0.776 YTL (2910/3750)
per materials requisition. Similarly, for Department B, overheads are absorbed at
a rate of 2.39 YTL (2589/1080=) per maintenance hours.
Here, you should remember our previous teachings, when we discussed the need
to complete understand that service center departments had to control their
overhead costs, and in order to do so, they had to know what their costs were.
Preparing overhead distribution summaries and reapportionment schedules are
relevant to the organization seeking to control its overhead costs. In all
situations, we will see that the control of service center costs is being carried out
by treating cost centers as if they are profit centers.
f. Reciprocal Method of Allocation
The reciprocal method of allocation recognizes all interactions among service

departments. Also, under the reciprocal method, the total cost of each service
department is determined, where the total cost reflects interactions among
service departments as we have mentioned. Then, the new sum of service
department costs is allocated to the production departments. This method
fully accounts for service department interaction.
Then, to determine the total cost of a support depart ment, so that it reflects
interactions with other service departments, a system of simultaneous linear
equations must be used. Each equation, which is a cost equation for a service
department, is defined as the sum of department's overhead costs plus the
198
proportion of service received from other support departments:
Total cost = Overhead costs + Allocated costs
The method is best described using an example, employing the same data used
to illustrate the direct and sequential methods. The allocation ratios needed for
the simultaneous equations are interpreted as follows:
Service Production
Total A B 1 2 3
_____________________________________________
Material
requisitions 4 000 250 50 800 1250 1650
Maintenance
hours 1 800 180 540 450 360 270
For Department A:

------------------------------------------
50
Department B -------- = 0.014
3750
800
Department 1 -------- = 0.213
3750
1250
Department 2 -------- = 0.333
3750
1650
Department 3 -------- = 0.44
3750
199
For Department B:

------------------------------------------
180
Department A -------- = 0.143
1260
450
Department 1 -------- = 0.357
1260
360
Department 2 -------- = 0.286
1260
270
Department 3 -------- = 0.214
1260
Department B (B) receives 1.4 percent of Department A (A)'s output and A

receives 14.3 percent of B’s output. Now let A be equal to the total cost of
department A, and B equal the total cost of department B. As previously
indicated, the total cost of a service department is the sum of its overhead
costs plus the proportion of service received from other service departments.
The cost equation for each service department can be expressed as follows:
A = Overhead costs + Share of B's cost

A = 2910 + 0.143 B (Department A's cost equation)
200
B = Overhead costs + Share of power's costs

B = 2550 + 0.014 A (Department B's cost equation)
A = 2910 + 0.143 (2550 + 0.014 A)

A = 2910 + 365 + 0.002 A
0.998 A = 3275
A = 3281
Substituting this value for A into equation B yields the total cost for B;
B = 2550 + 0.014 (3281)

B = 2550 + 45
B = 2595
So, since the equations are solved, the total costs of each service department
are now known. These total costs, unlike the direct or sequential methods, reflect
all interactions between the two service departments.
Now, after learning the total costs of each service department, the allocations
to production departments can be made. These allocations are based on the
departmental overhead absorption rates of each department.
For Department A:

50
Department B -------- x 3281 = 45 YTL
3750
800
Department 1 -------- x 3281 = 700 YTL
3750
1250
Department 2 -------- x 3281 = 1093 YTL
3750
201
1650
Department 3 -------- x 3281 = 1443 YTL
3750
For Department B:

---------------------------------------- x Department B Overhead
180
Department A -------- x 2595 = 371
1260
450
Department 1 -------- x 2595 = 927
1260
360
Department 2 -------- x 2595 = 741
1260
270
Department 3 -------- x 2595 = 556
1260
Service Production
Total A B 1 2 3
_________________________________________
Overhead Costs 32 200 2 910 2 550 11 530 8 930 6 280
Reapportionment
Department A - 3281 45 700 1093 1443
Department B 371 -2 595 927 741 556
_________________________________________
202
Total 32 200 13 157 10 764 8 279
2.3 JOB AND BATCH COSTING
2.3.1 Introduction
The aim of this chapter is introducing to the reader some of the practical
applications of cost accountant’s work. To an extent, the value of this chapter’s
work is questionable for some organizations in that they are now working with
more sophisticated models. However, one of the aims of this book is to
encourage the reader to look at his or her accounting environment and question
the role of management accounting in it. Here, we encourage the reader to take
both simple and complex business/commercial situations. Additionally, we wish
readers to apply cost and management accounting principles to them, and we
start by looking at the examples where job costing is applicable in simple
situations. We then move on to the examples of process costing applications in
more complex situations. This chapter helps the reader to overcome such
deficiencies by encouraging him or her to consider the nature and the meaning of
his or her organization’s work.
Then, in between job costing and process costing is the batch costing. Batch
costing actually can apply to both simple and complex situations. By the way,
one aspect that is worthy of prime consideration relates to losses and gains in
processing situations. The reason for examining losses and gains in processing
situations is that, it provides an opportunity to investigate what should happen
when a gain or a loss is known to occur in a process. We discuss in detail how
such gains and losses are dealt with as they arise, and the implications of gains
and losses that are not anticipated. This chapter does not, however, cover the
bookkeeping aspects of job, batch or process costing, except very brief sections
in the introductory parts of discussion on process costing.
2.3.2 Basic product costing systems
A product costing system is broken down into four elements:
1. overall control system;

2. basic product costing system;
3. treatment of fixed production overhead; and
4. method of cost control.
By the way, in this chapter we are concerned with the second of these four
elements, the basic product costing system. This is:
203
For specific orders;

- Job costing
- Contract Costing
- Batch Costing
For continuous operations

- Process Costing
Furthermore, specific order costing is defined as: “The basic cost accounting
method applicable where work consists of separate contracts, jobs or batches”.
2.3.3 Job costing
We can start our discussion of the basic product costing systems with the
discussion of job costing. A job is defined as: “A customer order or a task of
relatively short duration” ; and job costing as: “A form of specific order costing;
the attribution of cost to the jobs”.
With job costing, we deal with one-off situations, organizations that carry out
functions and services on a one-at-a-time basis. Good examples of job costing
situations include jobbing builders, who will provide a householder, or a shop
owner, or a factory owner with a service that they provide for no one else. The
jobbing builder will build an extension, or renovate some property to a design
that will probably not be copied anywhere else at any time: In other words, it is a
one-off job. Even though many jobbing enterprises are small scaled, we can not
suggest that all jobbing enterprises are undertaken on a small scale. An
engineering shop may be working on a job for the customer that takes several
months and many man/machine hours to complete. A batch of a good or service
provided by an organization for a customer may consist of a batch of several
hundred items, each selling for hundreds if not thousands of liras.
2.3.4 Batch Costing
Batch costing, as the following definitions clearly show, is only a small variation
of job costing. A batch is: À group of similar components which maintains its
identity throughout one or more stages of production and is treated as a cost
unit'; and batch costing is À form of specific order costing; the attribution of
costs to the batches'.
Considering a batch, what we deal with is a group of items that are closely
related, and are being made for a single customer, or are being made all at the
204
same time. The key point of our purpose is that the group of items maintains its
identity as a batch: Serial numbers, product numbers, production numbers, all
identify the goods as a batch. We can easily imagine a batch costing situation if
we suppose that MUDO wins a contract to make, say, a batch of ten motorcycle
trailers, all of the same design and specification. Freddie could easily set up and
operate a situation whereby the ten trailers are all made and accounted for as a
batch of ten units. Additionally, we can imagine a situation in any organization
that carries out jobs, such as MUDO and M&S, whereby several of the same
units are made several times over. We can assume for the purposes of this
discussion that, such repetition of units will constitute a batch. By the way, the
accumulation and recording of costs under batch costing is very similar to the
techniques used with job costing. So we do not need to discuss it separately here.
Finally, try to solve the relevant batch costing questions at the end of this chapter
for practice.
2.4 PROCESS COSTING
2.4.1 The nature of processing industries
Process costing is a part of the basic product costing systems scheme. Process
costing is defined under the heading of continuous operation/process costing, as:
“The costing method applicable where goods or services result from a sequence
of continuous or repetitive operations or processes. Costs are averaged over the
units produced during the period”. This definition can suggest that the subject
content of job costing etc., could be classified as process costing since many jobs
could be the subject of repetitive processes or operations. By process costing, we
mean the situation such as the processing of chemicals, the manufacture of
textiles, cardboards, and cars, and the canning of fruits and vegetables. We are
concerned with the process costing to look at operations and systems whereby a
product or service moves from one stage of a process to another until a product
is completed. An example will definitely help to clarify this issue.
2.4.2 Cost accumulation
For the simplest types of cardboard, and as far as cost accumulation is

concerned, the majority of raw materials are put into the process of slurry-
making. If a cardboard has to be coated, as per Process 3, further materials will
205
be added there. Labor and overhead costs are being incurred all of the time,
however.
With process costing, we need to accumulate costs process by process, or stage

by stage. For instance, we can assume that the cardboard we are costing is a
coated one. As an example; Process 1 has materials, labor and overhead costs,
Process 2 has labor and overhead costs, Process 3 has materials, labor and
overhead costs, and Process 4 has etc. For every process of cardboard
manufacturing, detailed records have to be kept relating to the materials, labor
and overheads; they can not just be accumulated at the time the product is
completed. This means that all employees have to be aware of their role in the
cost accumulation process. All information must be collected carefully and
passed on as soon as it is possible. Although the machinery and technology
required for cardboard manufacture are very expensive, the overall process is
relatively simple to comprehend. However, do not mix that with the manufacture
of motor vehicles. Because an average motor car is made up of in excess of
15,000 different parts, ranging from wheels and tyres, to windscreens and
electronic components. Motor car assembly is a long, involved, technical
procedure that must be very carefully divided into processes. Consequently, the
costing system has to be equally sophisticated.
2.4.3 Process cost accounts
Now, by using some imaginative data and a vertical layout, we will try to see the
overall make-up of process cost accounts for a three-process operation or
product. The accounts are really full and they are proper ledger accounts,
although their presentation has been greatly simplified here for demonstration
purposes.
It should be relatively simple to assess what is happening through the three

processes, as far as materials, labor and overheads are concerned. Additionally,
suppose that when we reach to the end of Process I, products are transferred to
Process 2, then onto Process 3, and at the end of Process 3, they are considered
complete and are transferred to finished goods stock.
Similarly, assume that labor and overhead costs were incurred at every stage in
the making of goods, but materials were incurred in Process 1 and Process 3
only, further materials not being required in Process 2. Now, say we are told that
the number of units passing through three processes in the period is 1,000. Thus,
we can calculate the costs per unit at each stage in the production process. The
costs per unit are:
Process 1: 1 300 YTL / 1,000 units = 1.30 YTL per unit
206

We have just calculated costs per unit on the basis that 1,000 units came out of
Processes 1, 2, and 3 - without any losses at all. In most circumstances, what
goes into a process is often not what comes out. This means that if, say, 1,000
units worth of resources were put into Process 1, only 950 units worth of output
may have emerged. The same could be true of Processes 2 and 3, or any other
process for that matter. It is also possible, in certain circumstances, that more
units come out at the end of a process than could have been anticipated, given
the amount of resources that went into the process; this can be true when
moisture content is an important factor. If the water content of one batch of
concrete should be, say, 15% and it turns out to be 18%, then the final weight of
the batch of concrete will be different from the weight expected - unless the
masses and densities of all inputs are the same.
The consideration of production losses leads us on to the discussion of normal

and abnormal losses and gains in the production.
2.4.4 Normal loss
A normal loss is the one which is unavoidable, uncontrollable and is a natural

consequence of the production or service providing the process. We have
already seen an example of normal loss: When the cardboard is trimmed of its
deckle edge: That is, when the rough edging is trimmed to make it a neat edge,
we are faced with a normal loss. The key point about normal losses is that they
are fully expected and probably quantifiable in advance. So, with the cardboard,
if we know that a strip two centimeters wide is the size that is always trimmed
off both sides of the roll of finished cardboard, we can anticipate the size and
value of trimmings. The following example helps us to understand the
implications of normal losses:
1,000 units of a material worth 12 000 YTL were put into the process in
November. Additionally, labor costs of 10 000 YTL, and overheads costs of 5
000 YTL were incurred. Also, outputs from the process amounted to 900 units.
Then, the normal yield is 90% of the inputs of materials. Finally, the loss of
materials in process is sold for 3 YTL per unit.
Now, reading the question again, the normal loss is shown as an output in the
process account. It amounts to a weight of 100 units, based on the inputs of
207
1,000 units and the normal yield of 90% of materials input. So, the cost per unit,
on which all valuations are based, is calculated by using the following formula:
normal costs
Cost per unit = ---------------------
normal output
12 000 YTL + 10 000 YTL + 5 000 YTL

= --------------------------------------------------
900 units
= 30 YTL per unit
Thus, all the good units of output are valued at this rate now.
What happens here is that the normal loss is `discounted' by being deleted from
the good output. This means that the total costs of output are applied only to the
normal good units: 90% of the raw material inputs. Also, normal loss has no
value; it is expected to be lost and may play no further part in the costing
process. The materials, labor and overhead costs expended on the normal loss
are, therefore, being written off .
2.4.5 Normal losses with a scrap value
So far we have assumed that normal losses are considered to be waste: That is,
they have no scrap value. We did this actually for simplification purposes.
However, we have to reconsider the case now since losses indeed have a scrap
value. Definitely, when losses will have a scrap value, the formula for
determining the average normal cost per unit will need to be modified:
Cost per unit:
normal costs - scrap value of normal loss

= ----------------------------------------------------
normal output
208
The normal loss amounts to 100 units, the normal yield is 900 units (90% of the
inputs of materials), and the materials weigh 1,000 units. Finally, the scrap value
of normal loss is 100 units at 3 YTL per unit: A total of 300 YTL to take credit
for.
Applying the formula to calculate cost per unit of good output:
Cost per unit
(12 000 YTL + 10 000 YTL + 5 000 YTL) – 300 YTL

-----------------------------------------------------------------
900 units
26 700 YTL
= ----------------
900 units
= 29.67 YTL per unit
The effect of change is that, the scrap value of losses is used to offset the normal
production values of inputs into production.
2.4.6 Abnormal losses
Unfortunately, it is rarely the case that only normal losses incur. For a variety of
reasons, organizations will incur losses in excess of those expected. Thus, they
will he suffering abnormal losses. This section considers how we should deal
with abnormal losses in the process accounts. By definition, an abnormal loss
arises by chance or by poor management of resources, and is both controllable
and unexpected.
Cardboard again can provide us an example of abnormal loss. On many

occasions throughout a normal working week, the cardboard may break as it is
passing through the machine. The reason for the break can range from operator
errors to poor raw materials. Once the cardboard has broken, it takes a while to
feed it back into the machine. The lost output is an example of abnormal loss,
since it is unexpected and largely controllable. There may be elements of
predictability about breakages, and in such cases, there may be both normal and
abnormal aspects to such breakages.
The first point to note about abnormal losses is that, they must be valued at their
full accounting value. Unlike normal losses which have their value absorbed into
209
the unit cost of the good units, the abnormal losses are shown in their true cost to
the organization. The main reason for this is so that the manager of the process
can understand the full impact of his or her inefficiencies: that is, the greater the
value of such losses, the greater his or her incentive to put matters right.
EXAMPLE:
Outputs from the process amount to 850 units. The normal output or normal
yield is 90% of 1,000 units, which is 900 units. Finally, the abnormal loss
amounts to normal yield less than the actual yield:
900 units - 850 units = 50 units.
As far as costs per unit are concerned, since the losses have no scrap value, we
are merely dividing normal costs by normal outputs:
12 000 YTL + 10 000 YTL + 5 000 YTL

Cost per unit = ------------------------------------------------
900 units
27 000 YTL
= -----------------
900 units
= 30 YTL per unit
The normal output (900 units) used in the cost per unit calculation is equal to the
sum of abnormal loss, and transfers to the following process.
2.4.7 Abnormal gains
If we are having a good day, there may be no abnormal loss, but actually we can
experience a situation where the yield is higher than normally expected. In such
a condition, we have the abnormal gain. As we will see, the accounting for an
abnormal gain may cause us a few problems to start with, because we always
have to account for the normal loss in full. Working through the following
example will clarify this point, however. As with the abnormal loss, we will
keep the work as simple as possible by assuming that there is no scrap value for
the losses.
EXAMPLE:
210
The normal loss is 10% of the inputs of 1,000 units. Thus, it is exactly 100 units.
Also, the actual yield is greater than the normal or expected yield of total inputs.
So it is less than normal loss:
940 units - 900 units = 40 units.
This excess output represents an abnormal gain. The cost per unit is, as has been
the case so far, based on normal costs and inputs. This gives us the same view of
abnormal gains’ value, as we had on abnormal losses.
By the way, abnormal gains are valued at their full economic value, at least for
management control purposes.
If materials, labor and overhead costs are 12 000 YTL, 10 000 YTL and 5 000
YTL respectively;
12 000 YTL + 10 000 YTL + 5 000 YTL

Cost per unit = -------------------------------------------------
900 units
= 30 YTL per unit
We have the abnormal gain of 40 units valued at its full economic value.
2.4.8 Work in progress
Evaluating work in progress in process costing situations is often not an easy

task. Because it is not just a matter of going along a cardboard-making machine,
or looking along a car assembly line and counting up the number of `X' items
and ‘Y’ units in progress, and then deciding on the work-in-progress value for
the end of the period. In other words, usually there are complicated situations.
Take the making of cars as an example. Let us assume that at the end of an
accounting period, the assembly line for vehicles will be stopped and there are
cars in various stages of output. Some are just started to be made, others have a
chassis, four wheels and the body; and others have chassis, wheels, body, seats,
and engine, etc. So, at a particular time, all units in progress will be at different
stages of completion. As far as the accountant is concerned, the stage of
completion that one car has reached is a vital knowledge, because at each stage,
every vehicle will contain different levels of materials, labor, and overhead
inputs. The car with only chassis, wheels and body clearly contains fewer parts
and materials than the car which contains chassis, wheels, body, seats and the
211
engine. The first of these two cars in progress will have been worked on to a
lesser extent than the second car, and will therefore contain a lesser charge for
materials, labor and overheads.
Given this sort of situation in a process industry, we need a method that will
allow us to deal with items in progress, that are not at the same stage of
completion with each other. Well, the method developed to deal with this
situation is known as equivalent units. We should be aware, however, that many
processing organizations never have any work in progress, and for them the
concept of equivalent units is irrelevant. Cardboard manufacturers who simply
make one standard size of board and do nothing with it once it comes off the
machine, will have no work in progress. Cardboard can not really be partly
finished. Dairies that simply bottle fruit juice will have no work in progress
since the fruit juice being processed needs to be fresh and will not be stored in
process. Consequently, the next section is concerned with organizations such as
shirt manufacturers that can and do have work that is partly finished at the end of
an accounting period.
2.4.9 Equivalent units
Equivalent units are defined as : “Semi finished units representing uncompleted

work, that are used to apportion costs between work in process and completed
output”. Actually, when we represent our work in progress as equivalent whole
units, we deal with semi finished units of output. We are doing this for cost
accounting purposes, so that we can estimate as accurately as possible the cost of
completed output and stocks of work in progress. For instance, we can deal with
two in-progress cars that we have just discussed, and we can have an estimate of
amount for each of the materials, labor and overheads, that each uncompleted
car contains.
Also, as an example, assume there are two washing machines. We have washing
machine one having 20% of all of the materials, whereas washing machine two
has 50% of its material inputs already complete. Also, washing machine one has
30% of its labor inputs and washing machine two 60% of its labor inputs already
complete. The overhead expenditure amounts to 20% complete for washing
machine one and 30% complete for washing machine two. We are additionally
stating that every washing machine will be assessed for its degree of completion
as a seperate item of work in progress. By the way, it is probably right to say that
when there is a large number of items involved, or complex technical situations
to cope with, work-in-progress degrees of completion will be designated by
areas of the factory, department, or division. This means that the washing
machine factory might split the assembly line into five areas, and within area
212
one, for example, all washing machines will be assumed to have, say, 20% of
materials, 15% of labor and 5% of overheads already spent on them. Finally, in
area two, the proportions could be 20%, 30% and 10% for materials, labor and
overheads respectively.
If every work item in progress were dealt seperately, the costs of inventory
valuation could be prohibitive. Because all the work in progress would have to
be assessed separately. Such assessments would take a long time and be very
expensive for most medium to large-sized organizations. In terms of equivalent
units, washing machine one is 20% complete regarding materials, 30% complete
regarding labor and 20% complete regarding overheads. We can talk, therefore,
in terms of 20% of a washing machine for materials usage and work-in-progress
valuation, and so on. We can now work through a more detailed example, which
will allow us to test the arguments we have just seen. The example will also help
us to build on the arguments for cost accounting purposes. The following
example is concerned with closing work in progress.
In June, an organization had spent 8 000 YTL worth of materials on putting

1,000 units into a process, together with 6 720 YTL worth of labor and 2 790
YTL worth of overheads. At the end of the period, 900 completed units were
recorded as having been finished, and 100 units remained at work, in progress
closing stock. The work in progress had reached to the following stages of
completion:
%
Materials 100
Labor 60
Overheads 30
Now, we will calculate the average cost per unit. This will be computed for units
reaching to the end of this process, together with the total costs of all units, also
reaching to the end of the process.
Actually, we need to concentrate on the work in progress. Because material

inputs in the work in progress amount to 100%, and we are saying that all of the
material that will be put into these products has already gone into them. With
labor and overheads, there is a further 40% and 70% to be spent on them,
respectively.
We can now prepare a statement of evaluation in which we identify all

equivalent units. This enables us to calculate a cost per equivalent unit, and,
213
finally, we can work out a full cost per unit for transfers out, work in progress,
and normal and abnormal losses and gains.
2.4.10 Calculation of equivalent units
Equivalent units = Completed Units + ( work in process at the end of the

period * stage of completıon)
For Materials:
completed units 900
work in progress 100 units x 100% 100
equivalent units 1000
For Labor:
completed units 900
For Overheads:
completed units 900
Costs per equivalent unit

Materials: 8 000 YTL / 1,000 equivalent units (eu) = 8.00 YTL per eu
Labor: 6 730 YTL / 960 eu = 7.00 YTL per eu
Overheads: 1 790 YTL / 930 eu = 3.00 YTL per eu
------
Total 18.00 YTL per completed unit
Value of the work in progress:
Value of the work in progress =Total Costs – value of completed goods

= (8 000 + 6720 + 2790) – ( 900* 18.00)
= 17 510 – 16 200
= 1 310 YTL
The other account method:
Materials 100 eu x 8.00 YTL per eu = 800 YTL

Labor 60 eu x 7.00 YTL per eu = 420 YTL
Overheads 30 eu x 3.00 YTL per eu = 90 YTL
214
Total 1 310 YTL
Value of completed goods transfer to the subsequent process:
900 units of good that have been recorded as complete and transferred out of the
process are valued at the total cost per eu of 18.00 YTL
900 completed units x 18.00 YTL = 16 200 YTL
2.4.11 The first in first out (FIFO) method of valuation
The previous example was about situations where there were closing work in
progress. However, the following example will add further consideration of
opening work in progress. We need to be aware from now on that since we are
dealing with stocks, we need to consider stock (inventory) valuation methods. In
the context of work stocks (inventories) in progress in process costing situations,
the two methods we will discuss are the first in, first out (FIFO) method and the
weighted average method. The FIFO method of valuing stocks of work in
progress assumes that the opening stock of goods brought down from the
previous period are to be worked on first and are therefore always assumed to
have been completed in the current period (unless we deal with a very lengthy
process when units take a long time to move from the start of all necessary
processes to the end). Finally, the weighted average method assumes that units
of output can not be separated out, and therefore the only way to value stocks is
to average the values.
Example:
In October, the opening work in progress of 100 units had a value of 1600 YTL,
and was completed as follows:
%
Materials 80
Labor 60
Overheads 50
During October, materials, labor and overheads were added as follows:

Materials 1,000 units, with a value of YTL 8 000; labor with a value of 6 720
YTL; and overheads with a value of 2 790 YTL. At the end of the period, there
were 200 units of production still incomplete, and the production manager
215
estimated that the degree of completion for work in progress closing stock was:
%
Materials 60
Labor 50
Overheads 50
For the number of completed units, good units of output was 900.
Now, we will calculate the average cost per unit. This will be computed for units
reaching to the end of this process together with the total costs of all units, also
reaching to the end of the process.
Solution:
Since the FIFO method assumes that it is possible to split out individual units,
and that the opening units of work in progress are to be completed during the
period, we need to calculate the equivalent units in three separate stages:
Opening work in progress, the units started and completed in the period, and the
closing work in progress.
Opening work in progress
As we are trying to assess the costs, which relate to units completed during the
period, we only need to consider the work done during that period. The
following calculation reflects this. For example, the opening stock of work in
progress is 80% complete as far as its material inputs are concerned. Therefore,
only 100% - 80% = 20% is required as an addition for this period. This is also
similar for labor and overheads. Consequently, the equivalent units for work in
progress b/d are:
Materials 100 units x 20% = 20 eu

Labor 100 units x 40% = 40 eu
Overheads 100 units x 50% = 50 eu
Units started (initiated) and completed in the period
The example tells us that 900 units (100 + 1000 – 200) were completed during
the period. We should obviously accept this to be true, but we need to adjust that
figure to find how many units were actually both started and completed in the
period. Since 900 units were completed in the period, and since 100 units of
216
opening work in progress are assumed to have been completed in this period,
then 800 units must have been both started and completed in that period. These
units are 100% complete in all respects.
Closing work in progress
This calculation is similar to the one we have completed for opening work in
progress:
Materials 200 units x 60% = 120 eu

Labor 200 units x 50% = 100 eu
Overheads 200 units x 50% = 100 eu
Summary of equivalent units
In order to evaluate the work in progress (WIP) and production units, we should
summarize what we have:
Equivalent units:
Materials Labor Overheads Total
___________________________________
Opening WIP 20 40 50 110
Started and
completed 800 800 800 800
Closing WIP 120 100 100 320
___________________________________
940 940 950 1 230
Note that the total column is not the sum of individual columns (materials, labor
and overheads). The total column shows the number of units that each output or
stock aspect represents. Also, the individual column details show the equivalent
units for stock and valuation purposes. We can extend this table now to allow the
evaluation of various output aspects:
Evaluation statement
______________________________________
Total costs (YTL)(1) 8 000 6 720 2 790 17 510
Equivalent units
(from previous
table) (2) 940 940 950 1 230
Cost per eu (YTL)
217
(1)/(2) = (3) 8.51 7.15 2.94 18.60
For the Cost per eu, look at the Total Column. The sum of 18.60 YTL is now the
sum of individual columns. It is these values that we use to evaluate the costs of
processing the units worked on during the period. Note that the balance brought
down on the work-in-progress account is kept separate, as the FIFO method
dictates it as a must.
Evaluation
YTL YTL YTL YTL
___________________________________________
Opening WIP,
to finish 170.20 285.90 146.84 602.94
Started and
Completed 6 808.50 5 719.20 2 349.48 14 877.18
Closing WIP 1 021.30 714.90 293.68 2 029.88
____________________________________________
8 000.00 6 720.00 2 790.00 17 510.00
This evaluation statement is prepared by multiplying each of the equivalent units

by the cost per equivalent unit. For example, concerning materials, the opening
WIP to finish is made up of the equivalent units for this category of 20 eu,
multiplied by the cost per eu of 8.51 YTL, which equals to 170.20 YTL. All of
the other costs in the evaluation statement are derived this way.
Also note that the totals found in the evaluation statement must agree with the
total costs provided in the first part of the overall evaluation statement. This is
true since we are allocating and apportioning those selfsame total costs.
However, in this demonstration, the rounding errors, which are obtained from
the calculations have been left in. Actually, it is a simple task simply to remove
them at any stage.
Units transferred out
218
The value of units transferred out of this process is made up of the opening work
in progress value brought down, plus the value of the materials, labor and
overhead costs added during the period, plus the value of the materials, labor and
overheads spent on the units that were started and completed during this period.
Work in progress:
brought down 1 600.00
added this period 602.94
Units started and completed this period 14 877.18
Totals 17 080.12
The Value of Closing work in process
The Value of Closing Stock = Opening stocks of work in process + this period
costs - Value of transfer of completed goods
= 1600.00 + 17 510 – 17 080.12

= 2 029.88 YTL
The other calculation method of the value of closing work in process :
Materials 120 eu x 8.511 YTL per eu = 1 021.28 YTL

Labor 100 eu x 7.149 YTL per eu = 714.90 YTL
Overheads 100 eu x 2.937 YTL per eu = 293.70 YTL
Totals 2 029.88 YTL
2.4.12 The weighted average method of valuation
The weighted average method of valuation of production costs is based on the

fact that, given the nature of process we deal with, we may not split out the
various degrees of completion and we can not be certain about what was in
progress at the start of the period, and actually what was completed during this
period. We can study again on the previous example to illustrate how the
weighted average method works. However, the information provided for that
exercise needs to be changed a little, to help it make a more realistic weighted
average, rather than a FIFO based exercise.
For Example:
219
In May, the opening work in progress of 100 units had a value of 900 YTL, and
that value was broken down as follows:
YTL
Materials 400
Labor 300
Overheads 200
Also during May, materials, labor and overheads were added as follows:
Materials 1,000 units, with a value of 6 000 YTL; labor with a value of 4 200
YTL; and overheads with a value of 2800 YTL. Additionally, at the end of the
period, there were 200 units of production still incomplete, and the production
manager estimated that the degree of completion for the closing stock of work in
progress was:
%
Materials 60
Labor 40
Overheads 30
Plus, the number of completed units and the good units of output were 900.
Now, we will calculate the average cost per unit, for the units reaching to the end
of this process, together with the total costs of all units reaching to the end of the
process.
Solution:
Because we will be averaging many of the figures given, there are fewer
workings for this method than there were with the FIFO method. We can go
straight to the evaluation statement.

YTL YTL YTL YTL
_____________________________________
Work in progress b/d 400 300 200 900
220
Costs for the period 6 000 4 200 2 800 13 000

_____________________________________
6 400 4 500 3 000 13 900
We are not provided the equivalent units for the opening stock of the work in
progress, but we are given the information for the closing stock of work in
progress. The table we should draft, therefore, for the number of units processed
is:

______________________________________
Completed units 900 900 900 2 700
Work in progress c/d 120 80 60 260
______________________________________
Equivalent units 1 020 980 960 2 960
Check if you can see where the work in progress costs per eu have come from.
Costs per eu (YTL) 6.27 4.59 3.13 13.99
Evaluation
YTL YTL YTL YTL
______________________________________
Completed units 5 643.60 4 131.80 2 817.50 12 592.90
Work in
progress c/d 752.40 367.20 187.50 1 307.10
_______________________________________
6 399.48 4 500.16 3 003.00 13 900.00
The Value of Closing work in process
The Value of Closing Stock = Opening stocks of work in process + this period
costs - Value of transfer of completed goods
= 900.00 + 13 000.00 - 12 592.90

= 1 307.10 YTL
221
The Other Account method of the Value of Closing work in process :
Materials 120 eu x 6.274 YTL per eu = 752.40 YTL

Labor 80 eu x 4.592 YTL per eu = 367.20 YTL
Overheads 60 eu x 3.125 YTL per eu = 187.50 YTL
Totals 1 307.10 YTL
Now, we need to look at the losses in process and how we deal with them as far
as their impact on work in progress is concerned. We also need to look at their
FIFO and weighted average implications.
2.4.13 Losses in process
In many industries, losses can happen at any point in a process. They can occur
at almost the very beginning of a process, and they can happen at the inspection
stage in the end of a process. Our task is to carry out the cost accounting
procedures, that will enable us to identify the true costs per unit, no matter when
the units are deemed lost. The following example helps us to illustrate the points
involved.
EXAMPLE:
In October, 4 000 units of Product A were put into process, and the inputs during
the period were:
YTL
Materials 10 000
Labor 6 000
Overheads 4 000
Also, at the end of the period, 400 units of product were still in process, and their
various degrees of completion were:
%
Materials 60
Labor 40
Overheads 40
Plus, an allowance is made for normal losses in process when 5 % of the units
222
are put into the process. All losses can be sold, and they have a scrap value of
2.00 YTL per unit. By the way, the units scrapped in this period were scrapped
at the following degrees of completion:
%
Materials 80
Labor 70
Overheads 50
Finally, a total of 3 300 units were transferred out of the process.
Required:
Using the weighted average method of valuation, carry out the relevant
calculations for this process for October. Work to three decimal places whenever
necessary.
Solution:
The first and most important point to remember about this example is that, it
says we have to use the weighted average method of evaluation. Note that
rounding errors are left in the following solution. But, these are not serious
errors and will not cause any problem. They are left in so that there is no
misunderstanding about how the individual parts of solutions are derived. The
most efficient way to work through this exercise is, as in a few of previous
examples, to work down the statement of evaluation, in which we can identify
the relevant costs for the period and the equivalent units. Then from there we can
identify the costs per equivalent unit.
Also note that when we worked through the exercises dealing with normal losses
as well as abnormal losses and gains, we deducted the value of any scrap value
from the process account without difficulty. Now, however, we have the split
complication due to various degrees of completion of cost elements. The rule
that is adopted for dealing with scrap values is to deduct them from the material
costs, as demonstrated below.

YTL YTL YTL YTL
223
_____________________________________
Costs incurred
in October 10 000 6 000 4 000 20 000
Scrap value of
normal loss (400) - - (400)
_____________________________________
9 600 6 000 4 000 19 600
Scrap value of normal loss equals to 4000*0.05*2.00 = 400
Note: Prove the following equivalent unit values and make sure you agree with
them

_____________________________________
Completed units 3 300 3 300 3 300 3 300
Normal loss - - - 200
Abnormal loss 80 70 50 100
Work in progress c/d 240 160 160 400
_____________________________________
3 620 3 530 3 510 4 000
Remember that the normal loss units are not valued, as part of the overall cost
per equivalent unit. The cost per equivalent unit is based on normal outputs, and
the normal loss is excluded from the calculation so that the costs of those units
are fairly spread across the normal good units of output. The abnormal units are,
of course, included as a part of the calculations since they need to be fully
evaluated, for management and cost control reasons:

YTL YTL YTL YTL
______________________________________
Costs per eu 2.652 1.700 1.139 5.490
224
Evaluation
YTL YTL YTL YTL
______________________________________
Completed units 8 751.60 5 610.00 3 759.40 18 121.00
Normal loss - - - -
Abnormal loss 212.16 119.00 57.05 388.21

Work in progress c/d 636.48 272.00 182.31 1 090.79
______________________________________
9 600.24 6 001.00 3 998.76 19 600.00
225
CHAPTER 3: MANAGERIAL ACCOUNTING
3.1 COST- VOLUME PROFIT ANALYSIS
Cost volume profit (CVP) analysis is related to the previous chapter, variable
costing. In other words, the principles derived and applied in the previous
chapter are applicable here. In fact, in this section, we examine the problems
with the assumptions of CVP analysis in detail. Regarding the volume aspect of
CVP analysis, we refer to the relationship between output or activity, and costs
or profits. That is, we assume that if volume changes, so will costs and profit.
The work we have already done on estimating the behavior of costs can be
highly relevant to the work of this section. In order for CVP analysis to have any
value, we need to be able to distinguish between our fixed, variable and semi-
variable costs. Hence, the management accountant of an organization trying to
apply CVP analysis needs first to estimate cost behavior.
Breakeven analysis is the first aspect of CVP analysis that we will be looking at.
For breakeven analysis, we are looking to an organization for trying to assess the
point at which neither a profit nor a loss is made. It is advantagous for any
organization to know its breakeven point. Because this helps the company to
know the extent of any leeway it has, when it comes to reacting competitive
pressures, economic upheavals and so on.
3.1.1 Breakeven analysis
Knowledge of breakeven analysis is useful from a managerial decision-making

standpoint because of many reasons. We primarily study it is so that we can
identify for any organization the level at which it is operating at any time, in
relation to its breakeven point. In times of depression or recession, or intense
competition within an industry, profit margins may be squeezed to such an
extent that management may need to keep a daily watch on pricing policies.
Breakeven analysis takes an organization and combines knowledge of its sales
and costs in ways that illustrate whether it is operating near to or far away from
its breakeven point. So, if an organization is operating at levels of output near to
its breakeven point, even small changes in activity can result in profit and loss,
or survival and non-survival. Similarly, an organization operating in levels of
activity significantly away (in a positive manner) from its breakeven point has a
large margin of safety, and will benefit from this. The organization will also
know that it has relatively large margins for manoeuvre even if there is
competition from within its industry. Without knowledge of its breakeven point,
an organization will be putting itself at a disadvantage. Because with such
226
knowledge, the organization can act on any of its variables in response to

changes in levels of competition, performance of the economy and so on.
3.1.2 Graphical analysis of the breakeven point
The best way to illustrate breakeven analysis is graphically. The remainder of

this section therefore centers around a variety of breakeven and profit charts.
Many of the charts we will be using are based on the simple scenario outlined in
the following basic data: An organization has revenues of 10 YTL per unit and a
maximum activity level of 900 units. Additionally, fixed costs are 5 000 YTL
and total costs amount to 7 700 YTL at 900 units.
AND PROFITS
REVENUES , COSTS
TOTAL
REVENUE
VARIABLE
COSTS
7140
FIXED
COSTS
714 ACTIVITY LEVEL (UNITS)
In this figure, the vertical axis is `Revenues, costs, and profits'. On the
mentioned axis, all three of these variables can be measured. We can assess, at
any level of output, the sales values, the total costs, and the amount of profit or
loss being achieved. The amount of profit or loss is determined by finding the
difference between total revenue and total cost curves at any level of activity.
All we have done in the figure is plotting the data supplied and then, assuming
linearity, joining these data points to their relevant places on the vertical axis.
Also, note that the sales line must pass through the origin. In the case of total
costs, we have joined it with the vertical axis at the level of fixed costs. Because,
at zero activity, total costs equal fixed costs. Thus, the figure is a basic chart
achieving our objectives. When we plot the total revenue of an organization
against its total costs, we have a graph that shows where these two curves cross
227
each other: This is the breakeven point of that organization. On this graph, we
can see that the breakeven point of this organization is 714 units of activity, or a
revenue of 7,140 YTL.
We abbreviate some definitions as follows:
TR = Total Revenue (Total Sales)

TC = Total Cost
FC = Fixed Cost
VC = Variable Cost
BP = Breakeven Point
SP = Sales Price per unit
At the Breakeven Point, TR equals to TC,

TR = TC
TR = Sales Price per unit * Activity level
TC = FC + Total VC
TC = FC + (VC * Activity level)
SF * Activity level = FC + (VC * Activity level)
So, at the breakeven point:

Activity level (SP – VC) = FC
At the Breakeven Point :
Activity level = FC / (SP - VC)
In our exemple,
VC = 7700-5000
Total VC is 3000 YTL
VC per unit is 2700 / 900 = 3.00 YTL
5000 / (10.00 – 3.00)

5000/ 7.00 = 714 units
We can expand this basic diagram and include the fixed cost curve. Although the
breakeven point does not change as a result of this extra information, we do now
see more clearly the influence that fixed costs have on the breakeven point and
profits; and we can deduce the level of variable costs by subtracting the value of
fixed costs from the value of total costs at any level of activity we choose. For
example, at the breakeven point, variable costs equal to total costs less fixed
costs: That is, 7700 YTL – 5000 YTL = 2,700 YTL. Similarly, we can deduce
the variable costs per unit from the same information. We have just found that
total variable costs equal to 2,700 YTL, when activity is 900 units. Therefore,
228
the variable cost per unit is:
2 700 YTL / 900 units = 3.00 YTL per unit
3.1.3 The influence of fixed costs on the breakeven point
When the fixed cost is high, business is vulnerable to small fluctuations in

activity. However, the low fixed cost organization can withstand large changes
in activity before it faces a problem. Now, think of another example. Let’s
change the basic data: Revenues are the same as before, but now we are
assuming that fixed costs are 6 500 YTL rather than 5 000 YTL. The effect of a
change in fixed costs should be obvious. The fact that fixed costs are now high
relative to all other variables, means that the breakeven point has shifted to the
right. The new breakeven point is just over 929 units.
6 500/ 7.00 = 929 units
In this example, the breakeven point is almost off the graph: This organization
will have to operate beyond maximum sales (previously given as 900 units) to
show any profit at all. Even a small downward change in the level of activity for
this organization would have serious consequences, since it would almost
immediately move into a loss-making position.
Also know that, an organization with a relatively low level of fixed costs has
much more freedom of action (a greater margin of safety) than the organization
which has large fixed costs. Such freedom of action stems from the organization
being in a position of having 900 units as maximum sales, yet the breakeven
point is 714 units. This represents a large margin of safety for the organization.
3.1.4 Contribution and the contribution ratio
We defined the term contribution in terms of sales, variable costs and fixed
costs. We said that an understanding of the term `contribution' is crucial to an
understanding of much of the work that goes into the use of breakeven and CVP
analyses. We must discuss this idea again in detail, before we can continue with
our discussion of breakeven analysis.
Contribution (which is also known as contribution margin and sometimes

marginal income) is the sales value less variable cost of sales.
Contribution = Total Sales - Variable Cost of Sales
229
Contribution = TR - VC
This is total contribution. We will find it useful to make a distinction between

gross contribution and net contribution.
a. Gross contribution is the contribution identifiable with manufacturing or

operations. In this example, it is sales less variable manufacturing costs.
b. Net contribution is the gross contribution less other (non-manufacturing)

variable costs; or sales less total variable costs.
It is sometimes helpful to calculate the two different values of contribution since

it gives further insights into managerial performance.
As an example, say output and sales are 20 000 units, the selling price per unit is
6 YTL, variable production costs per unit equals to 2.00 YTL and variable
administration costs are 1.50 per unit.
The contribution ratios express the rate at which contribution is generated by an

organization, or product, or service, rather than expressing contribution in
absolute terms. By the way, contribution ratio is also called as the profit/volume
ratio or P/C ratio. Although these two are not very good alternative titles, we
ought to know them since we can certainly come across them through our
readings. Returning to our example above, the gross C/S ratio is, using the total
sales and contribution information, or using the unit sales and contributıon
information:
In total:
Sales 120 000
minus: variable production costs 40 000
Gross Contribution 80 000
minus: variable administration costs 30 000
Net Contribution 50 000
50 000 YTL
---------------- = 0.42 or , 42 %
120 000 YTL
230
Per unit:
Sales 6.00
less: variable costs 2.00
Gross Contribution 4.00
less: variable administration costs 1.50
Net Contribution 2.50
As a ratio,
The basic C/S ratio is:
Contribution
---------------
Sales
By the way, we can modify the C/S ratio to incorporate the variations of gross
and net contribution:
Gross contribution
Gross C/S ratıo = ------------------------
Sales
Net C/S ratio = Net contribution / Sales
2.50 YTL
------------ = 0.42 or 42 %
6.00 YTL
Note that the ratio can be expressed as a decimal or as a percentage. Either

presentation is acceptable, and the answers using either presentation will be
identical. The net C/S ratio is:
50 000 YTL
---------------- = 0.42 or ,42 %
120 000 YTL
3.1.5 Contribution amount
We had assumed that sales price was 10 YTL per unit and the variable cost was
4 YTL per unit. Also, say fixed costs return to their original value of 5 000 YTL.
231
At any level of output, we can assess contribution by calculating the difference

between total revenue and variable cost. At a sales level of 500 units, total
revenues less variable costs equals to 3 000 YTL; at sales of 800 units, the
contribution is 4 800 YTL, and at a sales level of 1000 units, total revenues less
variable costs amount to 6 000 YTL. So, the contribution will be greater than
fixed costs.
3.1.6 The margin of safety (contribution rate)
When we first started to disuss breakeven analysis in this section, we used the
term margin of safety. We said: An organization operating at levels of activity
significantly away (in a positive manner) from its breakeven point has a large
margin of safety, and will benefit from this knowledge. We had also stated that,
the organization will then know that it has relatively large margins for
manoeuvre even if there is competition from within its industry.
Furthermore, the idea of magrin of safety is very useful. Because, as we

underlined previously, magrin of safety contains information about how `safe' an
organization is from changes in any one or more of the variables influencing
profit levels. To calculate the margin of safety of an organization, we need to
know its maximum sales (or normal sales, actual sales, or budgeted sales,
depending on what we are trying to assess) and the level of sales at its breakeven
point. From our basic data, we find that the value of margin of safety is:
maximum sales - sales at the breakeven point
= (10 YTL per unit x 900 units) – (10 YTL per unit x 714 units)
= 9 000 YTL - 7140 YTL
= 1860 YTL
It is also a very common practice to express the margin of safety either in unit
terms:
maximum sales units - sales units at the breakeven point
= 900 units - 714 units

= 186 units
232
Magrin of safety can also be calculated as a fraction or percentage. The

percentage calculation here, based on values, is:
maximum sales - breakeven sales

Contribution Rate = ------------------------------------------ x 100
maximum sales
9 000 YTL – 7 140 YTL

= --------------------------------- x 100
9 000 YTL
1 860 YTL
= ----------------- x 100
9 000 YTL
= 20.66 %
Verify that the same result is obtained using the unit values to calculate the
margin of safety percentage:
max. sales units - sales units at the breakeven point

Margin of safety = ----------------------------------------------------------------- x 100
maximum sales units
900 - 714
= -------------- x 100
900
186
-------- x 100
900
= 20.66 %
If an organization is currently operating at loss (that is, to the left of its

breakeven point), its margin of safety turns into its margin of danger.
233
3.1.7 The unit breakeven point
The unit breakeven point is also called as the unit profit graph. Here, example is
based on normal capacity being 100%, and all other levels of capacity stems
from there. The benefit of preparing a unit breakeven chart is crystal clear. It
shows the effects on costs and profit of varying volume or activity. Also, these
graphs show `vividly the influence of fixed costs on the product unit cost'. This
is really true. Because we can see the way total cost per unit curve falls
dramatically over the earlier levels of output, which is perfectly consistent with
the behavior of fixed costs per unit.
Example: Sales price per unit is 10 YTL, normal capacity is 800 units, variable
cost per unit is 4 YTL, and the total fixed cost equals to 5 000 YTL.
So, Fixed Cost per unit is 5000 YTL / 800 units = 6.25 YTL at normal
capacity. At the capacity of 500 units, fixed cost per unit is 10 YTL. Finally, at
the capacity of 1000 units, fixed cost per unit is 5 YTL. So, we can say that the
fixed cost per unit falls when the production capacity increases. Finally, we can
say that variable cost per unit is constant, being 4 YTL.
3.1.8 The profit/volume (P/V) table
The breakeven chart is a very useful form of presentation for organizational data.
Because from these charts we can not only see the breakeven point of the
organization, but we can also evaluate the contribution, variable cost per unit,
and so on.By the way, an alternative form of presentation is the profit/volume
(p/v) chart. This chart gives much of the same information as the breakeven
chart, but in a different way.
EXAMPLE:
Production Capacity (Units)
200 400 600 800 834 1000
_____________________________________________
Variable cost/unit 4.00 4.00 4.00 4.00 4.00 4.00
Fixed cost/unit 25.00 12.50 8.33 6.25 6.00 5.00
Total /unit 29.00 16.50 12.33 10.25 10.00 9.00
Selling price/unit 10.00 10.00 10.00 10.00 10.00 10.00
Profit/(loss)/unit -19.00 -6.50 -2.33 -0.25 0 1.00
A quick check of this p/v chart confirms the results we obtained using a
breakeven chart: Namely, when activity is zero units, profit is a negative value,
234
which equals to the fixed costs; the breakeven point is 834 units and represents 8
340 YTL worth of revenue; and at a maximum sales of 1 000 units, total profit is
1000 YTL.
The main advantage of p/v chart is that it is less complicated compared to a

breakeven chart. It does have a drawback, however, it is not as informative as
the breakeven chart. Because, the breakeven chart contains cost information as
well as profit information.
3.1.9 The multiproduct p/v table
Most organizations that manufacture, trade or provide a service, have a portfolio

of more than one product. Thus, we should consider how to deal with a situation
where there is more than one product, or there exists a product group, to contend
with. The table below reflects the standard mix of an organization whose total
revenue is 340 000 YTL, total variable costs equal to 180 000 YTL, and total
fixed costs equal to 90 000 YTL.
Product Revenue Variable Contribution

C/S Rank
(YTL) costs (YTL) (YTL) ratio
(%)
___________________________________________
1 70 000 32 000 38 000 54 3
2 40 000 14 000 26 000 65 1
3 80 000 35 000 45 000 56 2
4 60 000 36 000 24 000 40 4
5 90 000 63 000 27 000 30 5
Total 340 000 180 000 160 000
minus: Fixed costs 90 000
Profit 70 000
The multiproduct p/v table provides management a pictorial representation of all

of its organizational activities. As far as each product is concerned, the steeper
the profit line of each product, the greater is the contribution. In the example
above, product 2 has the steepest slope, followed by product 3, and then product
1, next product 4 and finally product 5. By the way, the slope of product lines for
each product is perfectly consistent with the C/S ratios. For example, the slope
of the profit line for product 2 is 0.65; for product 3 it is 0.56, etc. These are the
exact numbers.
235
TABLE: Coordinates for a multiproduct p/v table
Products Cumulative Cumulative

rank order sales (YTL) profit (YTL)
Initial 0 - 90 000
Product 2 40,000 - 64 000
Product 3 120 000 - 19 000
Product 1 190 000 19 000
Product 4 250,000 43 000
Product 5 340 000 70 000
Until selling product 1, profit is always negative. This tell us that the breakeven
point is approximately 155 000 YTL.
3.2 BUDGETING AND BUDGETARY CONTROL
Budgeting and budgetary control is a set of knowledge and skills from which we
can derive a significant benefit, no matter whether we are the largest
organization in the world or the poorest individual. Budgeting, as this chapter
shows, imbues us with a sense of discipline that we can not gain from anywhere
else. The budgeting system is a feed forward system in that, by using it, we
attempt to anticipate what we will do and what is going to happen during the
budget period. As we will see, however, budgeting has little to offer without its
cool brother, budgetary control. Unless we use and question the budgets we
prepared during the budgeting process, we will never know whether we prepared
good, bad or indifferent budgets. Budgetary control is the feedback link that
allows us to monitor what actually happened during the budget period, it also
alerts us on incidents that did not occur in accordance with our plans. Finally, it
gives us clues as to what we should do in order to correct for what went wrong.
3.2.1 Definitions
It is often said that the budget is a financial plan. However, as we will see in this
chapter, and in many other management accounting textbooks, there is more to a
budget than that. A budget can be a financial plan, as well as being a quantitative
plan. That is, a budget can help us anticipate the needs of raw materials, people
inputs, overhead costs and capital expenditures in terms of quantities other than
236
cash. Thus, a budget is a formal plan of action expressed in monetary and other
quantitative terms.
At last, a budget can be drawn up for an entire organization, any segment of the
firm such as a department or sales territory or division, or for a significant
activity such as the production and sale of a specific product.
3.2.2 Budgetary control
Budgetary control is the establishment of budgets, which relate the

responsibilities of executives to the requirements of a policy. Budgetary control
also refers to the continuous comparison of actual results with the budgeted
ones. It may be secured by individual action in terms of policy objectives, or it
can provide a basis for revision.
Also, a budget is a statement setting out the monetary or numerical aspects of an

organization's plans for the coming week, month or a year. However, budgetary
control is the analysis of what happened when those plans came to be put into
practice, and what the organization did or did not do to correct any variations
from these plans.
3.2.3 The benefits of budgeting
Many of us prepare budgets on a personal level. How much is our income for the
month? Also, for example, how much are we going to spend? Most importantly,
is there anything left over? It seems true, however, that many businessmen do
not prepare budgets for their businesses. Thus, even though managers prepare
budgets for their relatively simple lives, when it comes to the much more
complex situation of their business, they prefer to let cash inflows and outflows
look after themselves. The purpose of this part of the chapter is to demonstrate
that budgets are useful, informative and communicative. We will see that a
budget is a necessity, not a luxury. We will also see some of the problems faced
in organizations: For example, the nature of the organization and the interactions
of people working in them.
By applying the principles of budgeting and budgetary control to our

organization's activities, we gain tremendous benefits. Because, when we
prepare our budgets, we are planning. Also, we have to consider the future, our
methods, technology, people and so on. By planning, we at least take an
overview of what it is we are budgeting for. Also having planned, we are half
way towards controlling what we are planning for. Providing that we use our
plans as targets to be achieved and so forth, we will communicate our findings to
the relevant managers and carry out investigations when things do not go
237
according to the plan. We then control our operations through our management
colleagues taking the necessary corrective action. Additionally, when we apply
the principles of budgeting and budgetary control to our organization, we help
with coordination of the various parts of the organization. As an important point,
when parts of our organization are interdependent, coordination is vital. This is
especially true when we deal with limiting factors. Because, if a limiting factor
impacts on several departments, coordination is crucial. So, budgeting helps to
ensure coordination of effort to optimize the application of limiting factor.
Finally, budgeting and budgetary control are prime users of accounting
responsibility. Because, when we set up budget, cost and profit centers and so
on, we do so with the aim of assigning specific targets and deadlines for
responsible center managers. By the way, budget center managers have their
own budgets: They know what they need to achieve, how to achieve it, what
their deadlines are, and so forth.
3.2.4 Applicability of budgeting and budgetary control
Budgeting can be applied to virtually every situation. It does not matter whether
we work in the public or private sector of the economy. Also, we may work for a
profit-making or even a non-profit-making business. Similarly, your company
may be engaged in trading, manufacturing or service. In all of these situations,
budgeting and budgetary control is of use to you. As we will see, there are many
issues underlying the use of a budgeting system that need careful consideration.
For example, we will see that budgeting systems can not just be imposed on an
organization, nor do they run themselves. Managers at all levels often resent
budgets and budget targets for a variety of reasons.
In order for businesses to remain competitive and be progressive, or even, in

some cases, to survive, more information is needed about the economic
environment in which they operate. More information is also needed on day-to-
day operations- internally generated information. Accurate, complete and
effectively communicated information is the lifeblood of any organization.
Actually, it is the basis on which management must make decisions.
By the way, one of the greatest contributions of a good management information

system is providing management the time to direct more of its energies for
unsolved human and social problems prevalent in the organization.
Unfortunately, however, from the non-accounting manager's point of view,

accounting is a very specialized language, the meaning of much of which is not
obvious to the uninitiated. As a result, a communication gap often yawns
between a management accountant and an operations manager. Many
238
communications problems arise because managerial accounting reports are

primarily quantitative in nature with little or no narrative explanation. Sorting
out such communication problems, therefore, should be seen as a priority
because of the barrier created by them.
The traditional assumptions are now considered hurtful by most people's
standards, and if we accept these assumptions, we will be hurtful in the
expectations we have of ourselves and our subordinates. If we apply the
traditional assumptions to reporting, we will have reports that are concerned
solely with financial returns, detailed output information and so on. There will
be strict criteria on which to base the results of subordinates, and deviations
from those criteria could incur severe penalties. The modern assumptions are
more realistic and give management accountants more of an insight into how
people really want to carry out a reporting process. A more enlightened approach
will lead to a more enlightened set of reporting requirements. Targets that are set
by agreement between superior and subordinate, rather than imposed by the
superior, would be one outcome of a more enlightened approach to be included
in the reports prepared and published by the management accountant. Finally
know that, we return to the behavioral aspects of budgeting later in this chapter.
3.2.5 The budgeting process
Sometimes it is easy to dismiss the budgeting process in the beginning when the
first budget is prepared. This is also true when everything is complete as the
master budget is finalized. However, the budgeting process begins for many
organizations a long time before the budget period begins and the it ends once
the budget period has ended. This means that the budgeting process is a very
lengthy process. Typically, for a large organization, the pre-budgeting phase can
begin up to a year before the budget period starts. Also, for local government
councils, the budgeting process usually starts in October of the year preceding
the budget period, with the draft budget manual being sent to finance officers,
who will discuss this draft with their departmental staff (with a view to adoption
or amendment). By the way, the budgetary planning phase is completed in
December (made ready for the beginning of January) when the printed budget
book is published and the approved estimates are put into the financial control
system.
Then, the budget period is the one for which a set of budgets is prepared:
Typically the budget period is of one year's duration, and will be designed to
coincide with an organization's financial or fiscal year. There is no reason why a
budget period has to be one year, but typically it is. Indeed most organizations
have a budget period analyzed between the calendar months (or periods) while
others have a year’s system of four periods (each period equals to three months).
239
Note that these divisions of a budget period are control periods and the budget
period is: `The period for which a budget is prepared and used, which may then
be subdivided into control periods'.
In a similar way to that in which the financial year is divided, the organization
will be divided up into budget centers. Here, it is good to know that a budget
center is: À section of an entity for which control may be exercised and budgets
are prepared' . Also, a budget center, like a cost or profit center, is a section of an
organization (division, department, building, individual) for which a separate
budget is prepared. Another important point is that, the overall budgeting
process takes place within the planning cycle. Concerning this, keep in mind that
the planning cycle incorporates corporate planning and budgetary control. Now,
if we should provide another desciption, corporate planning is defined as, ‘The
formulation, evaluation and selection of strategies for the purpose of preparing a
long term plan of action to attain the objectives.’ Finally, it is better for you to
learn that corporate planning is also called as the long range planning.
Preparing the operating budget
We will prepare the operating budget as follows:

 Sales budget
 Production budget
 Direct materials purchases budget
 Direct labor budget
 Overhead budget
 Selling and administrative expenses budget
 Ending finished goods inventory budget
 Cost of goods sold budget
 Budgeted Income Statement
 Cash Budget
 Budgeted Balance Sheet
Sales Budget:
Sales is the key business activity. Budgeted total sales for each product is the
sale price multiplied by the expected number of units sold.
For example, if our sales estimate and unit selling price for quarter periods are:
240
Quarter
1 2 3 4 Total
Sales Units 1,000 1,200 1,500 2,000 5,700

Unit selling price (YTL) x 10 x 10 x 10 x 10 x 10
Budgeted sales (YTL) 10,000 12,000 15,000 20,000 57,000
Budgeted sales = sales quantity x unit sales price
Production Budget:
The production budget describes how many units must be produced in order to
meet sales and satisfy the ending inventory requirements. Thus first, we must
calculate the units to be produced.
Units to be produced = Expected unit sales + Units in ending inventory – Units

in beginning inventory
Quarter
1 2 3 4 Total
Sales Units 1,000 1,200 1,500 2,000 5,700

Desired ending inventory 240 300 400 200 200
Total needs 1,240 1,500 1,900 2,200 5,900
Minus: Beginning inventory -180 -240 -300 -400 -180
Units to be produced 1,060 1,260 1,600 1,800 5,720
Direct materials purchases budget:
After the production schedule is completed, the budgets for direct materials,
direct labor and overhead can be prepared. Here, it is wise to know that, the
direct materials budget is a purchases budget. Also, it depends on the expected
use of materials in production and raw materials inventory need of the firm.
For example, say we are using two raw materials (A and B) for the product in
241
the production process. This means we should calculate raw materials to be

purchased for each raw material.
Purchases = Direct materials needed for production + Desired direct materials

in ending inventory – Direct materials in beginning inventory
Raw material A
Quarter
1 2 3 4 Total

Direct materials per unit x 1 x 1 x 1 x 1 x 1
Production needs 1,060 1,260 1,600 1,800 5,720
Total needs 1,186 1,420 1,780 1,906 5,826
Minus: beginning inventory -58 -126 -160 -180 -58
Direct materials to
be purchased 1,128 1,294 1,620 1,726 5,768
Cost per unit (YTL) x 3 x 3 x 3 x 3 x 3
Total purchase cost of
Raw-material A (YTL) 3,384 3,882 4,860 5,178 17,304
Raw material B
Quarter
1 2 3 4 Total

Direct materials per unit x 5 x 5 x 5 x 5 x 5
Production needs 5,300 6,300 8,000 9,000 28,600
Total needs 5,930 7,100 8,900 9,530 29,130
Minus: beginning inventory -390 -630 -800 -900 -390
Direct materials to
242
be purchased 5,540 6,470 8,100 8,630 28,740

Cost per gr. (YTL) x 0.20 x 0.20 x 0.20 x 0.20 x 0.20
Total purchase cost of
Raw-material B (YTL) 1,108 1,294 1,620 1,726 5,748
Total direct materials

purchases cost (YTL) 4,492 5,176 6,480 6,904 23,052
Direct labor budget:
The direct labor budget shows the total direct labor hours needed and the
associated cost for the number of units in the production budget. Additionally,
know that the budgeted hours of direct labor is determined by the relationship
between labor and output.
For example, let’s assume that direct labor time per unit is 0.12 hours and
average wage is 10.00 YTL per hour.
Quarter
1 2 3 4 Total

Direct labor time
per unit (hr.) x 0.12 x 0.12 x 0.12 x 0.12 x 0.12
Total hours needed 127.2 151.2 192.0 216.0 686.4
Average wage
per hour (YTL) x 10 x 10 x 10 x 10 x 10
Total direct labor
cost (YTL) 1,272 1,512 1,920 2,160 6,864
Overhead budget:
The overhead budget shows the expected cost of all indirect manufacturing
items. Definitely, there is no readily identifiable input-output relationship for
overhead items. Here, there are a series of activities and related drivers. Past
experience can be used as a guide to determine how these overhead activities
vary with their drivers. Furthermore, individual items that will vary are
243
identified and the amount that is expected to be spent for each item per unit of
activity is estimated. Finally, individual rates are then totaled to obtain a variable
overhead rate.
For example, suppose that overhead rate is 5.00 YTL per budgeted direct labor
hour.
Quarter
1 2 3 4 Total
Budgeted direct labor hours 127.2 151.2 192.0 216.0 686.4

Variable overhead rate x 5 x 5 x 5 x 5 x 5
Budgeted variable
Overhead (YTL) 636 756 960 1,080 3,432
Budgeted fixed
Overhead (YTL) 1,645 1,645 1,645 1,645 6,580
Total overhead (YTL) 2,281 2,401 2,605 2,725 10,012
Unit-cost computation:
We can calculate the fixed overhead rate as Total Budgeted Fixed Overhead /
Total Budgeted Direct Labor Hours.
So, fixed overhead rate is:

6580 / 686.4 = 9.59 YTL per direct labor hour.
Direct material cost for A is: 1 x 3.00 = 3.00 YTL

Direct material cost for B is: 5 x 0.20 = 1.00 YTL
Direct materials (3 YTL + 1 YTL) 4.00

Direct labor (0.12 hr. x 10 YTL) 1.20
Overhead:
Variable (0.12 hr. x 5 YTL) 0.60
Fixed (0.12 hr. x 9.59 YTL) 1.15
Total unit cost 6.95
Ending Finished Goods Inventory Budget
244
Finished goods 200 units x 6.95 YTL = 1,390 YTL
The cost of goods sold schedule can be prepared using the budget of direct
materials, the budget of direct labor, the budget of overhead and ending finished
goods inventory budget.
Cost of Goods Sold Budget
Direct materials used (YTL) 22,880

Direct labor used 6,864
Overhead 10,012
Budgeted manufacturing costs 39,756
Beginning finished goods 1,251
Goods available for sale 41,007
Minus: Ending finished goods - 1,390
Budgeted cost of goods sold 39,617
Direct materials used = Beginning materials inventory + Material Purchases –

Ending materials inventory
Selling and administrative expenses budget
Selling and administrative expenses budget outlines planned expenditures for

non-manufacturing activities. Then note that, selling and administrative
expenses can be broken down into fixed and variable components. Also do not
forget that some budgeted operating expenses, such as sales commissions and
delivery expenses, vary with sales. Other expenses, such as rent and insurance
are the same each month.
Quarter
1 2 3 4 Total
Planned sales in units 1,000 1,200 1,500 2,000 5,700
Variable selling and
administrative
expenses per unit x 0.10 x 0.10 x 0.10 x 0.10 x 0.10
Total variable expenses 100 120 150 200 570
Fixed selling and
245
administrative expenses:
Salaries 1,420 1,420 1,420 1,420 5,680
Utilities 50 50 50 50 200
Advertising 100 200 300 500 1,100
Depreciation 150 150 150 150 600
Insurance --- --- 500 --- 500
Total fixed expenses 1,720 1,820 2,420 2,120 8,080
Total selling and admini-
strative expenses (YTL) 1,820 1,940 2,570 2,320 8,650
With the completion of budgeted cost of goods sold schedule, we have all the
operating budgets needed to prepare an estimate of Income Statement.
Budgeted Income Statement (YTL)
Sales 57,000
Minus: Cost of goods sold -39,617
Gross margin 17,383
Minus: Selling and administrative
expenses -8,660
Operating income 8,733
Minus: Interest expense - 60
Income before taxes 8,673
Minus: Income taxes (20%) -1,735
Net income 6,938
The Cash Budget
Beginning cash balance 5,200

Add: Cash receipts
(cash and credit sales) 10,600
Total cash available 15,800
Minus: Cash disbursements -15,777
Minus: Minimum cash balance - 1,000
Total cash needs -16,777
Excess or deficiency (-) of cash - 977
Add: Cash from loans 1,000
Minus: Loan repayments ----
Ending cash balance 1,023
246
Budgeted Balance Sheet

Assets
Current assets:
Cash 1,023
Accounts receivable 1,500
Materials inventory 424
Finished goods inventory 1,390
Total current assets 4,357
Property, plant, and equipment:
Land 1,100
Building and equipment 36,500
Accumulated depreciation -7,760
Total property, plant,
and equipment 29,840
Total assets 34,197
Liabilities and Owners’ Equity

Current liabilities:
Accounts payable 1,381
Provisions for Tax 1,735
Total current Liabilities 3,116
Owners’ equity:
Capital 20,000
Retained earnings 4,143
Net Income 6,938
Total owners’ equity 31,081
Total liabilities and owners’ equity 34,197
3.2.6 Budgetary control
This section is concerned with the evaluation stage of long-term and short-term
planning phases. At this particular point, we should stress that budgeting is a part
of corporate planning. If senior management did not develop any objectives for
their organization, and did not share those objectives with their subordinates,
there would be no possibility of anyone preparing budgets, other than, perhaps, a
rudimentary cash budget. The assessment stage in budgetary control concerns
the organization by looking at the economic environment external and internal to
it. From the assessment of the organization in its environment, the senior
management will develop the objectives that it wishes its organization to pursue.
Having set its objectives, senior management will then set up a budget
committee whose task is to find how the objectives may be met. Moreover, it is
usual for the budget committee to consider how they can achieve the objectives
247
in a variety of ways before one overall and acceptable set of budget is prepared.
Absolutely, once the evaluation stage is complete, the corporate plan can be
finalized.
The corporate plan contains the following sections:
 forecast of relevant environmental factors;

 corporate objectives;
 strategies;
 divisional/departmental plans;
 personnel implications;
 financial implications.
By the way, a budget committee is a crucial aspect of the budgeting process

since its membership contains senior, middle and junior executives of the
organization. Besides, the work budget committee carries out is central to the
budgeting process. Because it is this committee that oversees the preparation of
functional and other budgets. Moreover, know that the budget committee will
base much of its work on the budget manual, which is a document that contains
the organization's budgeting procedures in detail, together with specimens of the
forms to be used in the budgeting process.
Consequently, budget process concerns the use of budgets, the comparison of

budgets with actuals, reporting back to the management, taking corrective action
and drawing conclusions for future budget periods.
3.2.7 Interrelationship of budgets
One of the key reasons why management accountants and other planners are
using spreadsheets more and more for budgeting purposes is because of the
many interrelationships that exist in budgeting and budgetary control. If we are
preparing budgets for our organization, we will quickly find that the sales budget
has strong links with the stock budget, and it in turn has strong links with the
cash budget. When, then, the sales budget is changed, the stock and cash budgets
will also have to change. Similarly, if the stock levels are changed, say, as a
result of a revision of managerial policy during the budgeting process, then that
could impact on both the sales and cash budgets. This section uses an example to
demonstrate the full impact of the interrelationships of budgets and it does so in
a wholesaling environment. The kinds of changes we are discussing here are
perfectly dealt by using a spreadsheet, and we can carry out sensitivity analysis
of our budgets so easily once we have properly programmed our spreadsheet.
248
3.2.8 Cash budgeting
When an organization fails, it usually does so for a lack of cash. In this stuation,
an organization has no notes and coins, lines of credit run dry, loans are called
in, and so on. Because of this kind of chain of events, cash budgeting is of
crucial importance since it can help organizations to anticipate its cash needs,
and, in many cases, anticipation of such needs is the dividing line between the
going concern and liquidation.
There are three important points associated with cash budgeting:

1. the accuracy of forecasts;
2. participation of everything;
3. timing: The actual cash flow
By the way, a cash budget is of limited value if the forecasts on which it is based
are inaccurate. Whilst it is not possible to attain decimal point accuracy with
most forecasts, a large measure of accuracy is called for when dealing with a
budget of such central importance as the cash budget. If significant items are left
out of the cash budget, this will limit the impact of it. In the case of the
organization preparing a cash budget for the first time, covering all aspects of
the cash budget may not be entirely possible. Very quickly, however, the
organization will have to ensure that all aspects are covered by the budget. Once
we appreciate the elements of cash budgeting, we observe that it is relatively
straightforward. Also, when using a spreadsheet, cash budgets can be, if properly
programmed, updated instantly. Every change in a component cell of a
spreadsheet leads to a change in every linked cell. Thus, for example, if sales
changes, total revenue, net cash receipts and the cash balance carried down
changes, and so on. Besides, when using a manual system, any changes to sales
lead to the same changes as with the spreadsheet determined model, but the
changes will take longer to work out.
3.2.9 Budgetary control: an introduction to variance analysis
There is little point in an organization committing large amounts of resources to

the budgeting exercise only to ignore the fruits of that labor. The key to the
success of budgetary control exercise lies in using the budgets, and taking any
necessary action as a result of having used them. The CIMA (1991) definition of
budgetary control helps us to see what is involved in it. Actually, budgetary
control is the establishment of budgets, which relate the responsibilities of
executives to the requirements of a policy. Budgetary control also refers to the
continuous comparison of actual results with the budgeted ones. It may be
secured by individual action in terms of policy objectives, or it can provide a
249
basis for revision.
The essence of this definition is that, having prepared and circulated the budgets,
the organization must continuously compare what has happened with what it felt
should have budgeted. That is indeed variance analysis. Once the difference
between the actual and the budget has been determined (the variance),
investigations are carried out to determine why there is a difference and what, if
anything, should be done about that difference. Of course, the principle of
management by exception will be applied by any organization using a system of
budgetary control.
After that, the performance report is a perfect vehicle for the management
accountant to let his or her management team know how near or far they are to
achieve their targets. Definitely, such performance reports may be prepared
daily, weekly, monthly or with a particular needed frequency. Finally, the
folowing performance report is indicative of the kind of report that a
management accountant might issue:
Department A
Ugur Yucel, Manager
April, 20-1
Current month Year to date

Actual Budget Variance Actual Budget Variance
YTL YTL YTL YTL YTL YTL
Direct materials 10 560 10 000 (560) 45 360 42 200 (3 160)

Direct labor 8 840 8 970 130 36 480 37 300 820
Prime cost 19 400 18 970 (430) 81 840 79 500 2 340
Overheads 3 760 3 500 (260) 12 340 11 000 (1 340)
Total costs 23 160 22 470 (690) 94 180 88 500 1 000
This performance report for department A is a simplified version of what

Manager Ugur Yucel would probably receive. However, for our purposes it will
be sufficient. Here, also note that all items of the expenditure have a variance:
Some have brackets round and others do not. The bracket around a variance
means that the variance is adverse or unfavourable. An adverse expenditure
variance arises when the actual expenditure exceeds the budgeted expenditure.
On the other hand, a favourable variance has no bracket round and it represents
the situation where actual expenditure is less than the expected budgeted
expenditure. Then, know that the second point we should look at is the
250
significance of the variance. In this regard, the level of significance is set for the
organization either intuitively or as a result of static analysis. We can assume
that the level of significance for this department is 10 % of the total budget. In
this case, then, the only significant variance is the direct materials variance. This
variance is 5.60 % of the budget of YTL 10 000 as you can see in the table
above. Finally, Ugur Yucel will now have to look into the reason, or reasons,
why this variance has arisen.
3.3 FLEXIBLE BUDGETING
Certainly, budgeting and budgetary control are the panacea for all managerial
ills. We could easily be fooled into thinking that, by identifying variances and
acting on the significant ones, we are likely to solve all of our organization's
problems quickly and effectively. However, in this chapter we cover both
flexible budgeting and standard costing, and not just standard costing by itself.
In this context, a lot of standard costing variances stem directly from the nature
and behavior of flexible budgeting. But once we have appreciated the underlying
nature of flexible budgeting, we will then be in an excellent position to move on
to a full discussion of standard costing and variance analysis.
We will also discuss, in this chapter, the relationship between flexible budgeting
and variable costing. Whilst we will not dwell on this link, we ought to be aware
of it since in reality the two aspects of management accounting are likely to be
found together.
3.3.1 Flexible Budgeting
First of all, taking allowance of volume differences is known as the flexible

budgeting, which is defined as: À budget which, by recognizing different cost
behavior patterns, is designed to change as volume of output changes'.
Additionally, a flexible budget is defined as: ‘The budgeted cost ascribed to the
level of activity achieved at a budget center in a control period.’
Furthermore, it comprises the variable costs in a direct proportion to volume

achieved, and the fixed costs as a proportion of the annual budget.
Moreover, when we prepare the budget for a business before the budget period
actually gets under way, we set the hours and costs of the plant and machinery’s
maintenance for a period.
This budget may be known as the fixed budget. Also, note that the adverse
variance of 690 YTL is 10% of the budgeted amount and, assuming a
251
significance level of, say, 5.60%, we would need to investigate why that
difference has arisen. By the way, one of the factors that investigators will
discover when they look into the reasons for the variance is that the budget
allowed for 30 000 hours' production time to be worked, whereas 39 000
production hours were actually worked (that is, actual output is 30% higher than
the budgeted output). Well, keep in mind that this is important because of its
influence on the variable costs of the department. By definition, variable costs
vary with output; and since the actual output is 30% higher than the budgeted
output, the variable costs can be expected to be radically different from the
budgeted variable costs prepared during the budgeting process.
Following that, a flexible budget can only be constructed after the period to
which it relates has finished, and the actual output levels are known. So now,
having fully allowed for the influence of differing levels of output between
budget and actual, we can see that the variance has changed from being 10% of
the total budgeted cost to being less than 2%, which is much little significant.
Plus, know that the flexible budget gives a fairer representation of the period's
results. The reason is that, variable costs are made to relate directly to the level
of output which was actually attained. Besides, the flexible budget report gives
us a much more realistic insight into the performance of a department or an
organization than does the fixed budget report. By allowing for actual levels of
output rather than possibly unrealistic levels of output, we are making a
comparison. That is, we are looking at two sets of information that are closely
related, rather than two sets of data that may be grossly unrelated. Actually, the
flexing of a budget for differences in levels of output gets rid of the influence of
volume, but it does not get rid of any other influences. Additionally, the other
influences that will remain in the results of a department's performance include
materials, labor costs per unit or hour, labor efficiency, power consumption,
costs associated with buying and running fixed assets, and so on.
3.3.2 Flexible budgeting and variable costing
Since flexible budgeting concerns itself with the effects of activity volume
changes on both fixed and variable costs, we can usefully consider linking
flexible budgeting with variable costing. However, we should be careful that we
do not need to employ variable costing in order to use flexible budgeting, but we
should be aware of the possible links.
Example:
Based on the following information, prepare the fixed and flexible budgetary
control statements using the variable costing approach:
252
Per unit Actual for

based on a the period
budget of 1,100 units
1,000 units
YTL YTL
Sales 30 32 500
Direct materials 12 16 300
Direct labor 8 8 100
Variable overheads 2 2 500
Contribution 8 5 600
Fixed overhead 4 4 800
Profit 4 800
There are two aspects to this solution. First, the fixed budget has been prepared
for us to clearly see the differences that can arise when the flexible budgeting
system is not in place; and secondly, the statements are presented in the variable
costing format.
Fixed budget statement
Per unit Fixed Actual for Variance

based on a budget the period
budget of
Units 1 000 1 000 1 100

YTL YTL YTL YTL
253
Sales 30 30 000 32 500 (2 500)

Direct materials 12 12 000 16 300 (4 300)
Direct labor 8 8 000 8 100 (100)
Variable overheads 2 2 000 2 500 (500)
Contribution 8 8 000 5 600 (2 400)
Fixed overhead 4 4 000 4 800 (800)
Profit 4 4 000 800 (3 200)
In order to achieve the numbers of Fixed budget column, we need to multiply the
per unit costs by the number of units, that the fixed budget has been based on.
This is 1,000 units in this case.
The fixed budget sales are:

1,000 units x 30 YTL per unit = 30 000 YTL
Similarly, the total fixed budget direct materials cost is:

1,000 units x 12 YTL per unit = 12 000 YTL
The variance column is included since we are required to prepare a budgetary

control statement, and a variance column must also be a part of such statement.
Now, have a look at the table below, which shows the variances as a percentage
of fixed budget. Assuming for the sake of argument, a 20% exception level, the
direct materials variance, variable overheads variance and the fixed overheads
variance are exceptional and would need to be investigated.
Variance
percentages
Sales - 8.33
Direct materials -35.83
Direct labor -1.25
Variable overheads -25.00
Contribution -30.00
Fixed overhead -20.00
Profit -80.00
The flexible budget, based on the number of units actually produced during the
period, is shown in the table below:
254
Flexible budget statement
Per unit Filexble Actual for Variance

based on a budget the period
budget of
_________________________________________
Units 1 000 1 100 1 100
YTL YTL YTL YTL

_________________________________________
Sales 30 33 000 32 500 (500)
Direct labor 8 8 800 8 100 700
Variable
overheads 2 2 200 2 500 (300)
Contribution 8 8 800 5 600 (3 200)
Fixed overhead 4 4 400 4 800 (400)
Profit 4 4 400 800 (3 600)
In terms of workings, the table is different only in one respect to the fixed
budget statement. That is, the number of flexible budget units is the same as the
actual number of units. Remember, this is one of the key concepts of flexible
budgeting. The other key concept is that, the fixed costs remain the same as they
were in the fixed budget. Fixed costs do not vary in relation to the changes in
output. So, for example, the flexible budgeted sales quantity is:
1 100 actual units sold x 30 YTL per unit = 33 000 YTL. Then, the flexible
budgeted direct materials quantity is: 1 100 actual units made x 12 YTL per unit
= 13 200 YTL.
By the way, the flexible budget variances are radically different from the fixed
budget statement variances, and this is confirmed by the percentage variation
from budget that we see below in the table. If we will carefully look at this table,
we see that only one variance is significant. This is for the direct materials with a
significance level of 20%. All other variances have changed dramatically from
the values given by the fixed budget statement.
Variance
Percentages
255
Sales - 1.51
Direct materials -22.72
Direct labor 7.95
Variable overheads -13.63
Contribution -36.36
Fixed overhead - 9.09
Profit -81.82
3.3.3 Flexible budgeting only explains volume effects
We have flexed a budget in terms of its volume. However, this only takes care of
the variations between the fixed and flexible budget for reasons of volume
effect. Whilst adjusting for changes in volume is a valid thing to do, there are
usually many more variables at work in an organization than just the volume of
output and sales. The rest of this discussion on flexible budgeting will highlight
some of the other reasons for variations between budgeting and the actual
outturn. This will lead us into standard costing.
3.4 STANDARD COSTING
3.4.1 Standards and standard costing
Concerning examples we have dealt with in this section, we have used such
items as unit selling prices, unit costs and other unit-based information. These
unit-based pieces of information are standards, and a standard is a predetermined
measurable quantity set in defined conditions.
By a predetermined measurable quantity, we mean precisely what we have been

seeing. In regards to the detailed analyses of all our operations, we have a very
good idea what our selling price per unit will be, which is the standard selling
price. Also, we know what our material cost per unit should be, which is the
standard material cost, and so on. Since we are generating these standards as a
part of the budgeting process, they are, by definition, predetermined. This means
they are set in advance. By the way, “standard” is a general term and it can
concern any probability.
Following that, a standard cost is the one expressed in monetary terms. It is built
up from an assessment of the value of cost elements. In addition, its main uses
are providing bases for performance measurement, controlling by exception
reporting, valuing stock and establishing selling prices. Furthermore, a standard
cost is a carefully predetermined cost, that is usually expressed on a per unit
basis. Plus, know that the term “budgeted cost” usually refers to a total amount.
256
Next, as far as this definition is concerned, we have already seen some of its
aspects. Performance measurement and exception reporting can be provided as
examples. Note that we have not yet seen how we can build up a standard cost
“from an assessment of the value of cost elements”.
Setting Standards
Accountants help managers set price standards. For example, these can cover
direct materials (quantity discounts, early-payment discounts, freight and
receiving costs, and purchase prices), direct labor (payroll taxes and hourly wage
rates), and the overhead (the overhead allocation bases and the allocation rates).
In relation with this issue, know that the standards for direct materials and direct
labor are frequently set by engineers and production managers. For instance,
engineers may perform a time-and-motion study to analyze every movement.
Their aims are to (1) eliminate unnecessary work, (2) reduce the time and effort
required for the needed task, and (3) set a standard time for the wiring activity.
Then, another approach of setting standards is to base them on continuous

improvement goals. Here, management signals to employees the importance of
continually finding ways to cut the costs. Besides, companies also work with
their suppliers to set continuous improvement standards for direct materials
prices. Whether managers use engineering studies, continuous improvement
goals, or some other approach, they usually set currently attainable standards,
which allow normal amounts of waste and spoilage. For sure, this represents a
very good performance that can be achieved, but with difficulty.
Best practice may be an internal benchmark from inside the company, or an

external benchmark from other companies. Internal benchmarks are easy to
obtain, but how does a manager obtain external benchmark data? Well, this is
also not that tough since companies can purchase external benchmark data from
the consulting firms.
Then, in assessing standards, we also need one further definition before we

progress. This is the standard hour, which is described as: `The quantity of work
achievable at standard performance in an hour or minute'. But a standard hour is
not 60 minutes. It is 1 000 units, 100 meters, 20 kilograms or 3 sandwiches
made. For example, if, working at standard performance, (working at an average
rate of output for the relevant grade of labor) I can mix 50 kilograms of flour in
20 minutes, and, in one employment day I actually mix, say, 300 kilograms of
flour, then I have achieved:
257
300 kg
-------- = 6 standard hours
50 kg
Note that we might have attended work for eight hours to mix that amount of
cement, but at a standard rate of performance, we have achieved 6 standard
hours. Precisely, how we arrive at the standard rate of performance is a matter
for work measurement and work study. We will be assuming that these
departments have done their work and have established standards for us. As an
example, for production standards, such as the rates of output from the factory,
we would rely on the production departments.
3.4.2 Standards and flexible budgeting
This discussion now takes us back to budgeting. In the examples we have

already seen, we were concerned only with the total sales, total material costs,
total labor costs, and so on. While we are interested in these total costs, a
consideration of standard costs and hours means that we can take a two-level
view of an organization. The two-level view means we look at both the unit-
based information and the total information concerning our organization.
Example :
The flexible budgeting manufacturing cost statement for a company belongs to
the month of January:
Standards Flexible Actual Total

Budget costs variances
_______________________________________
Units 10,000 10,000
Manufacturing costs YTL YTL YTL YTL
_______________________________________
Direct labor 8 80 000 86 400 (6 400)
Variable overheads 2 20 000 18 200 1 800
The additional information in support of this statement, derived from the cost
accounting records is:
1. The standard costs per unit are based on the following relationship:
(a) Direct materials are used at the rate of 3 kg at 4 YTL per kg; direct labor
258
takes 1.6 hours at 5 YTL per hour.

(b) Variable overheads are absorbed on the basis of direct labor cost at
0.25 YTL of direct labor cost.
2. The actual cost per unit is based on the following relationship:
(a) Direct materials are used at the rate of 3.2 kg at 4.30 YTL per kg; direct
labor takes 1.8 hours at 4.80 YTL per hour.
(b) Variable overheads are accurated on the basis of direct labor cost at
0.30 YTL of direct labor cost.
There are many ways to solve this problem. However, we will use the method
demonstrated by Williamson (1990), and it is this technique that will be followed
throughout this section.
For this example, then, the solution is as follows:
i. Materials Cost Variances
Total Direct Materials Cost Variance:
Standard Direct Materials Cost - Actual Direct Materials Cost
(SP x SQ) - (AP x AQ)
(4 x 3 x 10 000) - (4.30 x 3.2 x 10 000)
120 000 - 137 600 = - 17 600 YTL
Price Variance:
(SP - AP) x AQ
(4 - 4.30) x (3.2 x 10 000) = - 9 600 YTL
All of this is the responsibility of the buyer. In other words, nobody will ask the
production manager to be accountable for any of this variance at all. In fact, at
this stage, the production manager may not even have seen the material yet.
Usage Variance:
(SQ - AQ) x SP
259
(3 x 10 000) - (3.2 x 10 000) x 4 = - 8 000 YTL
The production manager is responsible for all of this variance. The buyer has
nothing to do with the usage of material in the ordinary course of events.
The workings here are:
The actual materials cost is given and it is 137 600 YTL

SP x AQ = 4 YTL per kg x (3.2 kg x 10 000 units)
= 128 000 YTL;
SP x SQ = 4 YTL per kg x (3 kg x 10 000 units)
= 120 000 YTL.
This represents the kg. of materials that should have been used at standard
efficiencies, given the actual output of 10,000 units of the finished product.
ii. Labor Cost Variances

Total Direct Labor Cost Variance:
Standard Direct Labor Cost - Actual Direct Labor Cost
(SR x SH) - (AR x AH)
(5 x 1.6 x 10 000) - (4.80 x 1.8 x 10 000)
80 000 - 86 400 = - 6 400 YTL
Rate Variance:
(SR - AR) x AH
(5 - 4.80) x (1.8 x 10 000) = 3 600 YTL
Hour (Efficiency) Variance:
(SH - AH) x SR
(1.6 x 10 000) - (1.8 x 10 000) x 5 = - 10 000 YTL
The workings here are:
The actual labor cost is given and it is 86 400 YTL;
SR x AH = 5 YTL x (1.8 hours per unit made x 10 000 units actually made)
260
= 90 000 YTL;
SR x SH = 5 YTL x (1.6 hours per unit made x 10 000 units actually made)
= 80 000 YTL
This represents the direct labor hours that should have been used at standard
efficiencies, given the actual output of 10 000 units of the finished product.
iii. Variable overheads variances
Total Variable Overheads Variance:
Standard Variable Overhead Costs – Actual Variable Overhead Costs

(SR x SH) - (AR x AH)
[(5 x 0.25) x (1.6 x 10 000)] – [(4.80 x 0.30) x (1.8 x 10 000)] =
20 000 – 25 920 = - 5 920 YTL
Spending Variance
(AR x AH) – (SR x AH)
[(4.80 x 0.30) x (1.8x10 000)] – [(5 x 0.25) x (1.8 x 10 000)] =

(1.44 x 18 000) – (1.25 x 18 000) =
25 920 – 22 500 = 3 420 YTL
Efficiency variance
(SR x AH) – (SR x SH)

[(5 x 0.25) x (1.8 x 10 000)] – [(5 x 0.25) x (1.6 x 10 000)] =
(1.25 x 18 000) – (1.25 x 16 000) =
22 500 – 20 000 = 2 500 YTL
This represents the direct labor hours that should have been used at standard
efficiencies, given the actual output of 10,000 units of the finished product.
Actual or Price or Direct

Flexible Usage overheads
261
costs variances variance

YTL YTL YTL
AR x AH (4.80 x 0.30) x (1.8 x 10 000) = 1.44 x 18 000 = 25 920

Spending variance 3 420
SR x AH
Variable
overheads (5 x 0.25) x (1.8 x 10 000) = 1.25 x 18 000 = 22 500
variance
Efficiency variance 2 250
SR x SH (5 x 0.25) x (1.6 x 10 000) = 1.25 x 16 000 = 20 000
3.4.3 Fixed overhead variances
By definition, fixed costs are not expected to change despite wide fluctuations in
output or production. For this reason, a standard fixed cost per unit of output is
not a useful concept for managerial planning and control purposes. However, we
know from earlier discussions that standard fixed costs are useful for product
costing purposes. In absorption costing, we derived fixed overhead absorption
rates for product costing purposes, for example. The idea behind using a
standard fixed overhead absorption rate is to use it for calculating job and
product costs as soon as they are complete, rather than waiting until the end of
accounting period. Also, standard fixed overhead absorption rate assists the
bookkeeping function if the accountant can debit job and product accounts as
jobs and products are completed, rather than waiting until the end of the period,
when, possibly, thousands of entries will have to be caught up with. Finally,
using predetermined fixed overhead absorption rates allows for constant fixed
cost allocation throughout the period. Thus, product prices will not fluctuate
wildly from period to period as they might otherwise do.
Also, when we use a standard fixed overhead absorption rate, the total fixed
production overheads absorbed behave like a variable cost. That is, as
production increases, the total fixed overhead absorbed by the production also
increases. However, since the total budgeted fixed overhead does not vary,
differences arise between budgeted and absorbed fixed overhead. So, we will be
discussing three fixed overhead variances in this section. They are defined as
follows:
262
a. Fixed overhead total variance
‘(Standard absorbed cost) - (Actual fixed overhead production overhead)’

(CIMA 1991). Algebraically, we can represent this variance as:
SC - AC
b. Fixed overhead expenditure variance
‘(Budgeted fixed production overhead) - (Actual fixed production overhead)’

Algebraically, we can represent this variance as:
BFO - AFO
c. Fixed overhead volume variance
‘(Standard absorbed cost) - (Budgeted fixed production overhead)’

Algebraically, we can represent this variance as:
SC - BFO
Fixed production overhead expenditure variance = Fixed production overhead

total variance + Fixed production overhead volume variance.
We can deal with them in a similar way in which we dealt with the direct
materials, direct labor, and the variable overheads variances.
Now, let’s define the terms we use:
1. The actual fixed overhead cost is either the total fixed overhead cost as given
in the ledgers, or it is the actual hours worked multiplied by the actual fixed
overhead cost per hour:
AH x AR
2. The budgeted fixed overhead cost is the budgeted hours multiplied by the
standard fixed overhead absorption rate per hour:
263
BH x SR
3. The standard fixed overhead cost is the standard hours allowed multiplied by
the standard fixed overhead absorption rate per hour:
SH x SR
We can clearly illustrate this calculation with an example:
For Example:
S. Evren Seker Co. manufactures jeans and the data of company at the end of an
accounting period are:
Actual fixed overheads 200 000 YTL

Budgeted fixed overheads 214 500 YTL
Actual activity level 10 000 units
Standard hour 3 per unit.
Budgeted activity level 11 000 units
Standard fixed overhead absorption rate is:
Budgeted fixed overhead costs 214 500

---------------------------------------- = --------------
Budgeted activity level 11 000 x 3
= 6.50 YTL per hour
Total Fixed Overhead Costs Variance
SC – AC
214 500 – 200 000 = 14 500 YTL
Fixed Overhead Expenditure Variance
BFO - AFO
(6.50 x 3 x 10 000) – 200 000 = 195 000 – 200 000 = - 5 000 YTL
Fixed Overhead Volume Variance
264
SC - BFO
214 500 - (6.50 x 3 x 10 000) = 214 500 - 195 000 = 19 500 YTL
3.4.4 The meaning of variances
The fixed production overhead expenditure variance represents the difference

between the actual fixed overheads and the budgeted fixed overhead. The
variance is caused by a combination of price and volume factors related to the
use of fixed overhead inputs. The total of the fixed overhead expenditure
variance on its own is not particularly informative. Any meaningful analysis of
this variance requires a comparison of the actual expenditure for each individual
item of fixed overhead expenditure against the budget.
Additionally, the fixed production overhead volume variance does not indicate
whether production performance has been either good or bad. It merely tells us
the difference between the activity used in the absorption of fixed costs and the
activity level used in calculating the standard fixed overhead absorption rate.
Hence, if there is a volume variance, it indicates that production facilities are
over or under-used relative to management's expectations on budget preparation
time.
3.4.5 Reconciliation of budgeted and actual profit
It is possible to reconcile the differences between the budgeted and the actual net
profit for an organization. This is done by generating a report that starts with the
budgeted net profit and then adding or subtracting variances, as relevant, to that
profit and arriving at the actual net profit. The reason for carrying out such a
reconciliation is partly to prove that the workings have been correctly carried
out. Because if they had not been correctly carried out, then the actual profit on
the reconciliation statement would not agree with the actual profit on the profit
and loss account! Additionally, the reconciliation statement is prepared to
illustrate to management the relationship between the budgeted and actual
profits.
3.4.6 Setting standards
Standard costing is most effective where products or services and their processes
are standardized. For example, this is realized when there is only one product
and the processes are continuous. Examples of standard costing implementations
can be listed as:
265
1. Oil refining.
2. Pharmaceuticals.
3. Process industries where the same products are being made continuously, such
as cars, canned fruits and vegetables.
4. Engineering products where the same product is made continuously.
5. A standardized service, such as word processing.
Then, standards have to be set for every aspect of a business's activities which
are to be controlled by the standard costing reporting routine. Thus, we need to
set standards for direct materials, direct labor and overheads.
a. Setting standards for direct materials
There are several basic principles which ought to be learned in setting standards
for direct materials. Firstly, cost depends on both quantity and price, therefore it
will be necessary to forecast standard quantities and prices for all direct
materials used in the manufacture of each product or the provision of each
service. The buyer, the production manager and the accountant should work
together on setting such standards since the actual amount of material used in the
past may not be that laid down in the current material specifications for each
product. The reasons for this situation include changing specifications. Changes
due, for example, to design changes, or cost efficiencies, or changes in
technology can be mentioned in this regard. Also, the standard quantity of each
material issued to production should include an allowance for normal production
losses. Even with the best and most efficient machinery/technology, losses are
almost certain to occur in the production of a product or the provision of a
service.
After that, in setting standard prices, we should consider historic prices, but
make ourselves aware that past prices are not relevant unless they remain
unchanged. Additionally, if prices are expected to remain relatively stable, an
average of the expected prices could be used. Rapid inflation and/or exchange
rate fluctuations can soon render standard prices out of date. If this is the case,
they may have to be reviewed at shorter intervals than one year to ensure that
reports on variances and stock valuations are realistic. Remember that, standard
prices are the responsibility of the purchasing department. The cheapest prices
might not always be the best. Delivery, quality and continuity of supply should
also be considered.
b. Setting standards for direct labor
266
The procedures for setting standard costs for direct labor follows the same
approach as for direct materials. The basic approach is to determine the
quantity of labor required and the price that will have to paid for it. The
most important aspect here is that of standard hours. To provide a
description, a standard hour is defined as being: `The quantity of work
achievable at standard performance in an hour or minute` .
For example, let’s say at standard performance, it takes 10 minutes to repair a

leaky value. Therefore, if 30 leaky values are repaired, 5 standard hours are
recorded. That is, each valve is repaired in ten sixtieths (one-sixth) of an
hour. This is one-sixth of a standard hour. Therefore, when 30 leaky
valves are repaired, the number of standard hours achieved is:
1
---- x 30 leaky valves repaired = 5 standard hours
6
The standard hours per batch will be determined by, for example, a detailed
analysis of previous batches of the same product or estimates of what should
happen when making this product. Such an analysis will include work and
method study, and so on. Therefore, the standard cost of labor for a product
or service includes standard hours to be worked and the standard rates of
pay for each hour.
c. Setting standards for overheads
Overheads are always a problem. Even with standard costing, we can not
eliminate all of the problems which arise. One of the critical problems with
setting standards for overheads is the one of output or activity levels.
There are various levels of overhead that might be considered when
evaluating standard costs and overheads. The 100% ideal level of output is
the absolute physically possible maximum number of hours that can be
worked or operated. The practical level of output represents the ideal minus
some allowance for the absolute minimum of interruptions. Such
interruptions might be due to planned maintenance and so on. The normal
level of output allows, over and above the practical level of output, for
breaks in activity for reasons such as meal breaks, potential stoppages due to
breakdowns, stockouts and so on. The expected attainable level of output
adds further allowances on to the normal stoppages and results in an
267
activity level that management can really expect to be achieved.
d. Activity levels and fixed overhead rates
As we have seen several times in this book, when fixed costs and activity levels
are put together, interesting results can emerge. The relationship between
levels of activity and fixed costs is that the more units are produced, assuming a
constant fixed cost, the lower the average fixed cost per unit becomes.
3.5 ACTIVITY-BASED COSTING
In this section, we will look in detail at activity-based costing (ABC) and

activity-based costing management (ABCM). We know that ABC is not a
new concept. Actually, ABC has been discussed under different names for
at least two decades now. We also know that the issues on which ABC is
based are probably centuries old. Nevertheless, ABC has led to a change of
mind set for many management accountants. There are a few review points
that are worthwhile looking at before moving forward with the ABC debate.
First of all, ABC does not solve all of the management accountant's
overhead assignment problems. Because, costs may still require some
element of arbitrary apportionment. As an example, where they represent
resources shared by more than one product and where jointness exists in
the use of cost drivers, we can talk about that matter. Then, allocation can
provide a means of rationing shared resources and overhead rates
represent a set of taxes on the use of these resources. Additionally, cost
allocation can reduce prerequisite consumption by managers. Note that
ABC can contribute directly here by strengthening the monitoring capacity
of the costing system through the visibility, which it brings to the 'hidden
factory' of overhead services. ABC also provides a direct control link
between providers of activities and the users of their output. Plus, the
existence of cost driver rates provides the mechanism for the cross
charging of costs, which will initiate the type of monitoring behavior
described above.
268
Finally, the assignment of overheads still takes place, first, because it is

necessary for ABC to work, and secondly, because it does provide some
useful functions.
3.5.1 Introduction to ABC
There are three key areas of ABC:
1. Product cost differentiation.

2. Activities and their cost drivers.
3. Identification of non-value added cost improvement opportunities.
In the early days of the history of cost accounting, from the middle of the
nineteenth century to the mid-1970s, management accountants would
happily allocate and apportion overhead costs on the bases that these were
considered fair at the time. A study of cost accounting techniques from
this period will reveal that this kind of apportionment bases were widely
applied. Additionally, several studies have shown that organizations were
quite happy to recover their overheads by using a single plant-wide
overhead absorption rate. A survey reported in 1988 that in the United
States almost one-third of companies canvassed used a single plant-wide
overhead absorption rate. A similar study of British management
accounting practice revealed that small business organizations tended to
use a single plant-wide overhead absorption rate, as did some larger
organizations with high overhead costs.
The product and service costs derived from traditional allocation and
apportionment methods were used, even though they may have been
inappropriate, for a number of reasons:
• Overheads were relatively unimportant, as a proportion of total costs.
• When organizations were labor intensive, rather than capital intensive,
the direct labor hour rate basis of apportionment of overheads was a
sufficiently appropriate method to use.
• Before the advent of computerization and office automation, ABC could
only have meant an even more massive bureaucracy than before.
• All organizations were behaving the same way, so it was unnecessary to
develop such innovations as ABC.
• Competition, if it existed, was relatively regional, not global, so
detailed cost knowledge was not vitally important.
269
• Organizations were much less diversified than they are now, so there
was little impetus.
Whilst these reasons will not be applicable to all organizations, they do indicate
the nature of the need for ABC. In an increasingly automated, globally
competitive environment, an organization's management must have reliable cost
information. Because, unreliable cost information is an open invitation to
disaster.
Thus, reliable cost information is now considered by many to help with an

organization's competitive advantage. In the same way that the application of
information and computer technology has given many organizations a
competitive edge, the reliability of cost information also gives an organization a
leading superiority over other organizations whose cost information is not so
reliable. Definitely, the organization that depends only on unreliable cost
information must be in a weaker position than the organization that has
reliable cost information. If cost information is unreliable, it is also difficult to
control. By the way, there is evidence to suggest that, variable costs are not
controllable in the short term. However, controllable overhead costs amount to
25-30% of total product costs.
In the service sector of an economy, of course, the gains to be made can be
significantly greater. This will be true when overhead costs account for as much as
60%, or more, of total costs. In the case of overheads, therefore, there is much
more scope to influence total costs through monitoring and controlling overhead
costs than there is in trying to control the direct costs. As a result, ABC is, rightly,
concerned largely with monitoring and controlling overhead costs.
3.5.2 The benefits of ABC

A simple example will show how ABC generates more accurate product and
service costs. ABC recognizes that it has activities that cause costs to change,
and that the cost of these activities should be based on such activities. For
example, this means that if a fork-lift truck is being used to move raw materials
from one area of a warehouse to another, the costs of using that fork-lift truck
must be identified with such movement, and not simply calculated on an
arbitrary basis. Absolutely, identifying costs with their activity bases means
more than ever that the management accountant has to understand the nature of
the production and service process, whether his or her organization is a
manufacturing or service organization.
270
Example:
Product “x” passes through a variety of stages when being converted from raw
materials into a finished product. Throughout the production process, 2 direct labor
hours are needed to carry out the conversion process in making 30 units, and quality
control will spend 25 minutes on attempting to ensure that the product meets the
strict requirements of the organization's customers. Finally, the quality control
overheads are absorbed at the rate of either 30 YTL per quality control hour or 45
YTL per direct labor hour.
Required
Using the direct labor hour basis (conventional costing) and the ABC method, determine
the overhead costs of the product.
Solution:
We need, first, to determine the activity from which the quality control
overheads are derived. Under the conventional costing system, the
implication here is that, the direct labor hour basis would have been used to
recover (absorb) the quality control overheads. Using ABC, we would say that the
reason for the existence of the quality control overheads is the act of quality
control. That is, the need to check for making sure that what the customer gets
is what he or she wants. In this case, the activity base of quality control is the
time spent on controlling quality. The solution to this problem is therefore as
follows:
Traditional costing ABC

Direct labor Quality control
hour (dlh) basis hour (qch) basis
Overheads
absorbed qch 2 dlh x 45 YTL per dlh 25/60 qch x 30 YTL
Overheads absorbed
Per unit 90 YTL / 30 units 12.50 YTL / 30 units
= 3 YTL = 0.42 YTL
271
This is a simplified example, but it does illustrate the possible distortion that
the conventional costing system can lead to. If an inappropriate overhead
absorption basis is used to calculate product or service costs, the costs reported
will be unreliable. Using ABC, we have an overhead cost of 0.42 YTL per unit
of output rather than the 3.00 YTL per unit under the traditional cost accounting
system. So, we should be able to agree that ABC is giving us a more
realistic view of the costs. The realistic view comes from using the correct cost
driver. That is, we have identified the reason behind the existence of activity
being undertaken (quality control). The activity is driving the cost. Without the
cost driver, there would be no cost to worry about. By the way, a cost driver is
Àn activity which generates cost'.
The examples just worked through give us an insight into what Cooper and
Kaplan (1987)3 as well as others call complexity related costs. The conclusion
drawn from a complex situation is that costs vary with the range of items
produced, not with the volume of items produced. Cooper and Kaplan give the
following example to illustrate this point:
Plant A Plant B
Makes 1 million of A Makes 100,000 of A

+ 900,000 of 199 similar products
Simple environment, Complex: 200
few set-ups, products, frequent
stock movements, etc. set-ups, stock movements, etc.
The reasoning here is quite straightforward, when 100,000 of the product are
made, together with the other 199 products, the infrastructure required to
manage this diverse range, must be more complex than the situation where only
one product is made. The diversity of 200 products will involve many machine
setups and startups, stock movements, supervision and inspection problems, and
so on. The problem is, however, that a traditional cost accounting view does not
appreciate the significance of diversity. For example, as Cooper and Kaplan
point out, if a product with a production run of 8000 units is made, it will be
allocated 0.08% of the production overheads (assuming a units of output
overhead absorption rate), whereas a run of 100,000 units of a product would be
allocated the same proportion of production overheads, 10% in this example.
Relatively, both 800 units and 100,000 units are being charged with the same
overheads, but they are not driving the overheads equally. The benefits of ABC,
then, are that they address the issues of where costs come from, and by doing so,
3
Cooper,R. And Kaplan R.S.,”How Cost Accounting Systematical Distorts Product Cost”,
Accounting and Management:Field Study Perspectives, Harvard Business School, 1987.
272
they also address the issue of diversity and complexity of the production/service
structure.
Then, when discussing complexity in the automobile industry, the question

asked: `how long would it take in [a] minimum efficient scale assembly plant to
produce one of every possible end unit combinations for the automobile
company?' The answers were:
Honda 45 minutes
Toyota 1 day
Chrysler 220,000 years
General Motors 7,800,000,000,000,000 years
36 trillion years for any model.
There were 200 different models
under production at the time.
Whatever advantages GM enjoyed in economies of scale, technology,

experience and vertical scope, they more than lost regarding the diseconomies of
product line complexity. The minimum efficient scale assembly plant they refer
to, produces one car per minute for 16 hours a day, 250 days a year.
CHAPTER 4: PROBLEMS
4.1 COST ACCOUNTING PROBLEMS
1. Please categorize the expenditures below as fixed or variable:

Direct Material Costs
Direct Labor Costs
Indirect Material Costs
Indirect Labor Costs
Electricity Expenses
Rental Expenses
Fuel Expenses (Heating)
Gasoline Expenses (Vehicles)
Insurance Expenses
Depreciation Expenses (Buildings)
Depreciation Expenses (Machinery)
Depreciation Expenses (Movable Assets)
Quality Safety Expenses
273
Maintenance Expenses
Inventory Expenses
Phone Expenses
Service Expenses
Purchasing Expenses
Managerial Expenses
Sales Expenses
2. What are the expense components of Direct Material Costs?

3. What are the expense components of Direct Labor Costs?
4. What are the expense components of Overhead Costs?
5. What are the subsidiary materials?
6. What are the business materials?
7. By using which absorption rate you can distribute the expenditures below
to the departments?
Indirect Material Costs

Indirect Labor Costs
Electricity Expenditures
Rental Expenditures
Fuel Expenditures (Heating)
Gasoline Expenditures (Vehicles)
Insurance Expenditures
Depreciation Expenditures (Buildings)
Depreciation Expenditures (Machinery)
Maintenance Expenditures
Inventory Expenditures
8. In case Overhead Costs are loaded to the production as a negative value,

which loading norms can be used?
9. In 20-1, the Overhead Costs for Company Katrina Tinio (Philippines)

were 400 000 YTL. In the same year, the other data were as follows:
Direct Labor Costs : 2 500 000 YTL

Direct Material Costs : 3 200 000 YTL
Direct Labor Hours : 120 hrs
Machinery Hours : 200 hrs
Production Quantity : 7 200 units
In the period of January 20-2, the remaining information was observed as

listed:
274
Direct Material Costs : 540 000 YTL

Direct Labor Costs : 260 000 YTL
Total Direct Labor Hours : 6 100 hrs
Production Quantity : 430 units
Year 20-2 Estimated Monthly Inflation Rate : 1%
According to the information above, please calculate the Overhead Costs

that will be loaded to the production (consider various methods).
10. The data of Company Le Thi My Hanh (Vietnam) for May 20-1 are as
follows:
YTL
Beginning Period Raw Materials Inventory : 230 000
Purchases during the Period : 2 400 000
Ending Period Raw Materials Inventory : 310 000
Beginning Work-In-Process Inventory : 120 000
Ending Work-In-Process Inventory : 90 000
Beginning Finished Goods Inventory : 450 000
Ending Finished Goods Inventory : 520 000
Direct Labor Costs : 1 100 000
Beginning Period Subsidiary Materials Inventory : 300 000
Subsidiary Material Purchases during the period : 740 000
Ending Period Subsidiary Materials Inventory : 220 000
Indirect Labor Costs : 220 000
Factory Electricity Expenditures : 70 000
Factory Fuel Expenditures : 80 000
Factory Depreciation Expenditures : 30 000
Factory Insurance Expenditures : 6 000
Factory Maintenance Expenditures : 15 000
Company Headquarters Electricity Expenditures : 50 000
Company Headquarters Fuel Expenditures : 20 000
Company Headquarters Depreciation Expenditures : 44 000
Company Headquarters Insurance Expenditures : 8 000
Company Headquarters Maintenance Expenditures : 32 000
Using the information above, please solve for the following:
a- Direct Material Costs
275
b- Overhead Costs
c- The cost of materials being processed
d- The cost of materials completed
e- The cost of finished goods sold
f- Prepare the cost of goods sold statement
11. The data of Company Gokhan Baykal for November 20-1 are as follows:
YTL
Beginning Period Raw Materials Inventory : 280
Purchases during the period : 1 400
Ending Period Raw Materials Inventory : 150
Beginning Work-In-Process Inventory : 80
Ending Work-In-Process Inventory : 120
Beginning Finished Goods Inventory : 70
Ending Finished Goods Inventory : 160
Direct Labor Costs : 800
Overhead Costs : 360
Domestic Sales : 3 100
Sales Returns : 50
Marketing, Selling and Distribution Expenses : 60
General Administration Expenses : 200
Exchange Gains : 40
Profit On Sale of Marketable Securities : 5
Provisions (-) : 14
Exchange Losses : 15
Financial Expenses : 130
Other Extra-Ordinary Expenses and Losses : 8
Using the information above, please compute the following:
a- The cost of raw materials and supplies used in the production

b- The cost of materials being processed
c- The cost of materials completed
d- The cost of finished goods sold
e- The cost of goods sold statement
f- The income statement
12- The production data of Company Karen Shein Christiansen (U.S.A.) for
November 20-1 are as follows:
Cost of raw materials used : 780 000 YTL

276
Overhead Costs : 492 000 YTL

Beginning Work-In-Process Inventory : 280 000 YTL
Beginning Finished Goods Inventory : 112 500 YTL
Quantity processed in production : 240 units

Quantity of Beginning Work-In-Process Inventory : 40 units
Quantity of Beginning Finished Goods Inventory : 15 units
Quantity of materials completed : 250 units
Quantity of materials sold : 180 units
According to the information above, calculate the following:
a- The cost of one unit of processed goods covered in total production

b- The cost of one unit for finished goods completed
c- The cost of one unit for finished goods sold
d- Ending Work-In-Process Inventory
e- Ending Finished Goods Inventory
13. The production data of Company Burak Yilmaz for January 20-6 are as
follows:
Direct Material Costs : 1 340 000 YTL

Overhead Costs : 400 000 YTL

Quantity of finished goods sold : 110 units
According to the information above, please solve for the following:

f- The cost of sales statement
14. The production data of Company Izzet Ilhan for October 20-1 are as
follows:
277
Direct Material Costs : 900 000 YTL

Beginning Work-In-Process Inventory : 80 000 YTL

Beginning Finished Goods Inventory : 110 000 YTL

Quantity of Beginning Work-In-Process Inventory : 8 units
Quantity of Beginning Finished Goods Inventory : 10 units
Quantity of finished goods sold : 80 units
The Overhead Cost is loaded to the production as 40% of Direct Material

Costs.
According to the information above, calculate the following:

f- The cost of sales statement
15. The production data of Company Ilker Gokyokus in February 20-2 are as
follows:
Beginning Period Raw Materials Inventory : 780 000 YTL.

Raw Materials Purchases during the Period : 2 300 000 YTL.
Direct Labor Costs : 600 000 YTL.
Overhead Costs : 490 000 YTL.
Beginning Period Work-In-Process Inventory : 280 000 YTL.
Beginning Finished Goods Inventory : 100 000 YTL.
Ending Period Raw Materials Inventory : 1 450 000 YTL.
Quantity in Production : 200 units

Beginning Period Work-In-Process Inventory : 50 units
Beginning Period Finished Goods Inventory : 10 units
Finished Goods : 190 units
Finished Goods Sold : 180 units
According to the information above, please solve for the following:
278

b- The cost of one unit for finished goods
f- The Cost of Goods Sold Statement
16. The Trial Balance of Company Mucahit Akverdi at the end of October 20-1 is
as follows:
TRIAL BALANCE - OCTOBER
20-1
ACC. DEBIT CREDIT
CODE ACCOUNT NAME DEBITS CREDITS BALANCE BALANCE
100 CASH 230,000 90,000 140,000
101 CHECKS RECEIVED 340,000 240,000 100,000
102 BANKS 520,000 260,000 260,000
CHECKS GIVEN AND PAYMENT
103 ORDERS 120,000 340,000 220,000
CUSTOMERS, ACCOUNTS
120 RECEIVABLES 2,400,000 1,670,000 730,000
121 NOTES RECEIVABLES 250,000 200,000 50,000
ADVANCES GIVEN FOR PURCHASES
195 OF INVENTORIES 50,000 50,000
150 RAW MATERIALS AND SUPPLIES 5,860,000 3,420,000 2,440,000
SEMI FINISHED GOODS, WORK-IN-
151 PROCESS 4,550,000 3,900,000 650,000
152 FINISHED GOODS 4,120,000 1,700,000 2,420,000
PREPAID EXPENSES FOR FUTURE
180 MONTHS 150,000 150,000
191 DEDUCTIBLE VAT 175,000 175,000
193 PREPAID TAXES AND FUNDS 300,000 300,000
253 PLANT, MACHINERY AND EQUIPMENT 1,700,000 1,700,000
255 FURNITURE AND FIXTURES 930,000 930,000
257 ACCUMULATED DEPRECIATION 535,000 535,000
300 BANK LOANS 400,000 400,000
320 SUPPLIERS, ACCOUNTS PAYABLES 300,000 860,000 560,000
360 TAXES AND FUNDS PAYABLE 50,000 125,000 75,000
361 SOCIAL WITHOLDINGS PAYABLE 60,000 110,000 50,000
381 EXPENSE ACCRUALS 150,000 180,000 30,000
391 VAT PAYABLE 200,000 200,000
500 CAPITAL 5,000,000 5,000,000
600 DOMESTIC SALES 160,000 6,900,000 6,740,000
602 OTHER INCOME 310,000 310,000
620 COST OF GOODS SOLD (PRODUCT) 1,700,000 1,700,000
MARKETING, SELLING AND
631 DISTRIBUTION EXPENSES 40,000 40,000
GENERAL ADMINISTRATION
632 EXPENSES 590,000 590,000
642 INTEREST INCOME 25,000 25,000
654 PROVISIONS 25,000 25,000
OTHER ORDINARY EXPENSES AND
659 LOSSES 275,000 275,000
279
660 FINANCIAL EXPENSES (SHORT TERM) 30,000 30,000

OTHER EXTRA-ORDINARY EXPENSES
689 AND LOSSES 40,000 40,000
RAW MATERIALS AND SUPPLIES
710 EXPENSES 2,550,000 2,550,000
RAW MATERIALS AND SUPPLIES
711 REFLECTION 2,550,000 2,550,000
720 DIRECT LABOR COSTS 2,300,000 1,360,000 940,000
721 DIRECT LABOR COSTS REFLECTION 1,360,000 1,360,000
730 OVERHEAD COST 890,000 640,000 250,000
731 OVERHEAD COST REFLECTION 640,000 640,000
760 DISTRIBUTION EXPENSES 55,000 40,000 15,000
DISTRIBUTION EXPENSES
761 REFLECTION 40,000 40,000
770 EXPENSES 700,000 590,000 110,000
771 EXPENSES REFLECTION 590,000 590,000
780 FINANCIAL EXPENSES 40,000 30,000 10,000
781 FINANCIAL EXPENSES REFLECTION 30,000 30,000
37,060,000 37,060,000 13,945,000 13,945,000
Also, the Beginning Period Raw Materials Inventory of the business is 180
000 YTL and the Ending Period Raw Materials Inventory is 920 000 YTL.
Finally, if the Ending Work-In-Process Inventory is 1 100 000 YTL and the
Ending Finished Goods Inventory is 1 150 000 YTL., then please solve for
the following:
a. Journal Entries of Production

b. The Cost of Goods Sold Statement
c. Income Statement
17. Company Burc Maruflu has Injection, Shaping and Montage production
departments and Energy, Storage and Maintenance service departments. The
distribution of Direct and Indirect Costs to the departments are as follows:
COSTS (YTL) TOTAL ENERGY STORAGE MAINTEN. INJ. SHAPING MONTAGE
Direct Materials 600 000 520 000 70 000 10 000

Direct Labor 340 000 140 000 110 000 90 000
TOTAL 940 000 660 000 180 000 100 000
Indirect Materials 120 000 30 000 15 000 14 000 30 000 20 000 11 000
Indirect Labor 80 000 15 000 14 000 20 000 11 000 10 000 10 000
Electricity 60 000 5 000 5 000 2 000 34 000 12 000 2 000
Rent 150 000 20 000 25 000 15 000 62 000 21 000 7 000
Insurance 20 000 1 000 2 000 2 000 8 000 6 000 1 000
TOTAL 430 000 71 000 61 000 53 000 145 000 69 000 31 000
The apportionment rates are as follows:
Labor
Material hours Fixed Budgeted
Kw/h. m2 requisitions for maintain. Invest. Overhead C.
280
ENERGY 10 20 120 4 30 000 15

STORAGE 10 25 400 - 8 000 10
MAINTAINANCE 4 15 80 6 6 000 15
INJECTION 68 62 650 15 140 000 28
SHAPING 24 21 540 10 200 000 20
MONTAGE 4 7 230 2 50 000 12
The Overhead Cost is planned to be 80% of the Direct Raw Materials Cost.
15% of that is loaded to the Energy Department, 20% to the Storage and
17% to the Maintenance service. Please solve for the following:
a. The distribution of Overhead Costs from service departments to the

production departments using the Graded Distribution Method.
b. The distribution of Overhead Costs from service departments to the

production departments using the Planned Distribution Method.
c. The journal entries of distribution.
18. Company Gencer Irenler has the Mixing and Capsulation production
departments besides to the Energy and Quality Control service departments.
The apportionment of costs to the departments are as follows:
COSTS TOTAL ENERGY QUALITY CONT. MIXING CAPSULATION
Direct Raw Materials 1 200 000 730 000 470 000

Direct Labor 900 000 640 000 260 000
Overhead 520 000 150 000 170 000 110 000 90 000
TOTAL 2 620 000 150 000 170 000 1 480 000 820 000
The apportionment rates are as follows:
Material Labor hours

Kw/h. m2 requesitions for quality
ENERGY 10 20 40 10
QUALITY CONTROL 10 25 210 8
MIXING 90 75 350 35
CAPSULATION 50 60 560 40
The Overhead Cost is budgeted to be 50% of the Direct Labor Cost. 30% of
that is loaded to the Energy Department and 35% is loaded to the Quality
Control Department. Please solve for the following:
281

production departments using the Mathematical Distribution Method.
c. Journal entries of distribution.
19. Company Cetin Gokmen has Cooking and Freezing production

departments in addition to the Maintenance and Service utility departments.
The firm’s data of Overhead Costs belonging to the period of September
2002 are as follows:
MAINTENANCE SERVICE COOKING FREEZING
Overhead Costs (Estimated) (YTL) 360 000 200 000 80 000 45 000
Labor Hours for Maintenance 10 15 40 65
Service Quantity 20 15 80 255
Machinery Hours - 80 640 430
The Overhead Cost is distributed to the Maintenance Department based on

the Labor Hours for Maintenance and is distributed to the Service
Department based on the Service Quantity. Each unit of finished goods
receives 250 YTL of raw materials and labor share from the Cooking
Department in addition to 80 YTL of raw materials and labor share from the
Freezing Department. The company has produced 4,100 units in September.
Please solve for the following:

b. The total share each unit of finished goods receives from the Cooking
and Freezing production locations.
20. Company Inan Bal has “a” and “b” service departments besides “1”,”2”
and “3” production departments. The distribution of Overhead Costs to the
departments in October 20-1 along with other related data are as follows:
COST OVERHEAD ACTIVITY STAFF M2 DIRECT LABOR

LOCATIONS COST LEVEL QUANTITY HOURS
A 160 000 Direct Labor Hours 10 40 140 000

B 220 000 Staff Quantity 20 70 80 000
1 90 000 m2 60 130 270 000
2 54 000 Direct Labor Hours 40 140 310 000
3 75 000 Direct Labor Hours 80 80 120 000
282
a. Distribute the Overhead Cost using the mathematical distribution

method.
b. Suppose that 1 YTL of Overhead Cost per Direct Labor Hour is loaded
to Production Department A and 1 200 YTL of Overhead Cost per one Staff
Quantity is loaded to Production Department B. Using this information,
distribute the Overhead Cost with the Planned Distribution Method.
c. Write down the Journal Entries of the apportionments.
21. The Company Hasan Ak’s Overhead and Direct Costs are distributed to
the departments in July 20-2 as follows:
TOTAL ENERGY STORAGE SHAPING PAINTING
Overhead Cost 930 000 480 000 150 000 210 000 90 000
Direct Raw Materials 2 050 000 1 880 000 170 000
Direct Labor 950 000 640 000 310 000
Cost apportionment rates:
KW/h. Receipt Quantity

ENERGY 60 10
STORAGE 20 250
SHAPING 240 460
PAINTING 80 130
The Overhead Cost is loaded to the production as 40% of Direct Raw

Materials Cost. The 50% of this estimated Overhead Cost is distributed to
the Energy Department and 15% of it is distributed to the Storage. The final
differences between the actual and planned Overhead Costs will be
distributed using the Direct Distribution Method.
a. Show the Cost Distribution Table using the Mathematical Distribution

Method.
b. Show the Cost Distribution Table using the Planned Distribution
Method.
c. Write down the Journal Entries of Distribution.
d. Supposing 2 100 units are produced, calculate the finished goods’ per
unit cost.
22. Company Ender Arici has Shaping, Rectification and Montage

production departments in addition to the Energy and Maintenance service
283
departments. Also, distribution of Direct and Indirect Costs to the

departments are shown below:
COSTS (YTL) TOTAL ENERGY MAINT. SHAP. RECT. MONT.
Direct Raw Material 400 000 220 000 100 000 80 000
Direct Labor 250 000 110 000 90 000 50 000
TOTAL 650 000 330 000 190 000 130 000
Indirect Mat. 140 000 40 000 15 000 40 000 30 000 15 000
Indirect Labor 100 000 25 000 30 000 20 000 10 000 15 000
Electricity 60 000 5 000 10 000 30 000 10 000 5 000
Rent 150 000 20 000 15 000 70 000 25 000 20 000
Insurance 50 000 5 000 5 000 20 000 15 000 5 000
TOTAL 500 000 95 000 75 000 180 000 90 000 60 000
Additional information to assist reapportionment of departmental overheads

are provided:
Labor Hours
Kw/h. for Maintenance
ENERGY 10 20
MAINTENANCE 10 10
SHAPING 60 80
RECTIFICATION 30 50
MONTAGE 10 20
The Overhead Cost is planned to be 120% of the Direct Labor Cost. 40% of
it is loaded to the energy department and 25% is loaded to the Maintenance.
Please solve for the following:

production departments using the Direct Distribution Method.
production departments using the Step Distribution Method.
c. The distribution of Overhead Costs from service departments to the
d. The distribution of Overhead Costs from service departments to the
23. Company Hayrettin Senol operates in the tricot knitting sector and
conducts its production activities based on jobs. The firm has Knitting,
Sewing and Packaging services. Company Hayrettin Senol’s data belonging
to the October period are as follows:
284
In the beginning of October, the firm has been working on Job K1. The costs
concerning this job are listed below:
Raw Materials 60 000 YTL.

Labor 34 000 YTL.
Overhead 15 000 YTL.
Also in October, a new one, Job K2 has been received and the costs
belonging this month are shown below:

Labor 90 000 YTL.
Concerning the Raw Materials Cost of 120 000 YTL, one part of that cost
equivalent to 40 000 YTL was used in Job K1 and the other part of that cost
equivalent to 80 000 YTL was used in Job K2.
Then, the Labor Costs and the Overhead Costs are distributed to the jobs
based on the Raw Materials Costs. Finally, Job K1 has been completed.
REQUIRED:
a. Find the cost of Job K1 which has been completed.
b. Calculate the value of Work-In-Process Materials at the end of October.
24. Company Yasin Saritas is doing business based on the jobs. The firm’s
data for November 20-2 are as follows:
Beginning Inventories:
Raw Materials and Supplies 380 000 YTL
Work-in-Process Materials 350 000 YTL
Finished Goods 320 000 YTL
The Work-in-Process Costs are distributed to the jobs as follows:
TOTAL RAW DIRECT OVERHEAD

MATERIAL LABOR COST
ORDER 10 100 000 34 000 30 000 36 000

ORDER 11 120 000 42 000 36 000 42 000
ORDER 12 130 000 45 000 38 000 47 000
TOTAL 350 000 121 000 104 000 125 000
285
In November, Raw Materials and Supplies costing 150 000 YTL with a
V.A.T. of 27 000 were purchased by the company for a total price of
177 000 YTL Also, Raw Materials and Supplies costing 280 000 YTL were
taken from the inventory and used in production. Finally, in this period, the
Direct Labor Cost was 240 000 YTL and on this amount, an income tax of
40 000 YTL and a social security contribution of 20 000 YTL were
implemented. The Raw Materials and Supplies, as well as Labor Costs were
distributed to the jobs as mentioned below:
RAW MATERIAL DIRECT LABOR

ORDER 10 90 000 70 000
ORDER 11 80 000 60 000
ORDER 12 20 000
ORDER 13 110 000 90 00
TOTAL 280 000 240 000
In November, the Overhead Costs were loaded to the production with a rate
of 75% of the Direct Labor Cost. The Overhead Cost observed in November
was as follows:
Social Sec.
Overhead Costs AMOUNT V.A.T. Income Tax Cont.
Indirect Materials 40 000 6 000

Indirect Labor 50 000 12 000 4 000
Depreciation 25 000
Energy 14 000 2 560
Rent 28 000 5 600
Insurance 5 000
Others 30 000 4 500
TOTAL 192 000 13 060 17 600 4 000
At the end of November, the completed jobs were billed at these amounts:
AMOUNT V.A.T.
ORDER 10 500 000 90 000
ORDER 11 480 000 86 400
ORDER 12 400 000 72 000
TOTAL 1 380 000 248 400
Finally, the Marketing Costs of the period were 70 000 YTL + 12 600 YTL
(V.A.T.) and the General Administration Costs were 80 000 YTL + 14 400
286
YTL (V.A.T.).
REQUIRED:
1. Find the cost of jobs.
2. Calculate the value of Ending-Period Inventories.
3. Write down the Journal Entries of job costs belonging to November.
25. Company Mehmet Saritas operates in the tricot knitting sector and
conducts its production activities based on jobs. The firm has Knitting,
Sewing and Packaging services. Company Mehmet Saritas’s data belonging
to the October period are as follows:
In the beginning of October, the firm has been working on Job 42. The costs
concerning this job are listed below:

Labor 74 000 YTL.
Furthermore, in October, two new orders (Order 43 & 44) have been
received. Job 43 will be supplied by outsourcing and the fibers used for
knitting will be obtained by the company giving the order. In October, also
fibers totaling to a price of 472 000 YTL (400 000 YTL + 72 000 V.A.T.)
have been purchased. One part of these fibers, worth of 140 000 YTL have
been used for Job 42 and the other part worth of 250 000 YTL have been
used for Job 44. Then, labor costs of 320 000 YTL are observed in October
and this amount has been paid after the deduction of social security
contributions (45 000 YTL) and income tax (50 000 YTL). Next, the
Overhead Cost for October totals to 69 000 YTL (60 000 YTL + 9 000
V.A.T.). Besides, the distribution of Labor Costs and the Overhead Costs to
the orders occurs in accordance with the production quantities and the
difficulty rates.
ORDERS PRODUCTION DIFFICULTY

QUANTITY RATE
42 600 Units 2
43 840 Units 1
44 500 Units 1.5
The General Administration Costs for October totals to 331 000 YTL (280
000 YTL + 51 000 YTL V.A.T.). At the end of the October month, Job 42
and Job 43 have been completed and billed to the ordering customers
287
respectively as 600 000 YTL + 108 000 YTL V.A.T. and 200 000 YTL and
36 000 YTL V.A.T.
REQUIRED:
1. Find the cost of jobs.

2. Calculate the value of Ending-Period Inventories.
3. Prepare the Cost of Sales Statement.
4. Prepare the Income Statement for October.
5. Write down the Journal Entries of Job Costs belonging to October.
26. Company Gurkan Ekin is doing business based on the jobs and has three
service departments of Cutting, Pressing and Painting for the production.
The firm currently has 100 orders for the Wardrobe production and 35
orders for the Door production. The mentioned jobs were received in April
20-1 and the company has still been working on them. The firm has had the
following costs until today:
WARDROBE DOOR
Raw Materials 360 000 180 000

Labor 290 000 120 000
Overhead 74 000 45 000
General Administration 150 000
At the end of April 20-1, the company has a Raw Materials Inventory of 50
000 YTL Besides, in May, the business has received 40 orders for Table
production and in regards to the existing orders, the company has purchased
raw materials of 472 000 YTL (400 000 + 72,000 V.A.T.). Also, labor costs
of 520 000 YTL have occurred and this amount has been paid after the
deduction of income taxes (80 000 YTL) and social security contributions
(70 000 YTL). Moreover, May’s Overhead Cost has been observed as 125
000YTL (110 000+ 15 000V.A.T.) and the Overhead Costs are loaded to the
production as 25% of Direct Labor Costs. Then, the General Administration
Costs have been 160 000 YTL in May. Finally, the distribution of Raw
Materials and Labor to the jobs is as follows:
WARDROBE DOOR TABLE
Raw Materials 130 000 80 000 170 000
288
Labor 140 000 100 000 280 000
At the end of the May month, Wardrobe and Door jobs have been completed
but the billing operation has not been competed yet.
REQUIRED:
a. Prepare the Cost Cards of Jobs.
b. Prepare the Cost of Goods Sold Statement.
c. Prepare the Income Statement for December.
d. Provide the Journal Entries for December 20-2.
27. Company Ali Kizil has been working on three jobs coded A1, A2 and
A3. The mentioned jobs are treated in the Cutting, Handwork and Polishing
workplaces. On November 1, the costs of jobs indicate the following:
JOBS RAW MATERIALS LABOR OVERHEAD TOTAL
A1 18 000 10 000 7 000 35 000

A2 15 000 12 000 5 000 32 000
A3 8 000 6 000 2 000 16 000
83 000
Also, in November, Raw Materials valued 13 000 YTL have been used and
their distribution to the jobs is as follows:
A1 2 000
A2 8 000
A3 3 000
Additionally, the distribution of Labor Costs to the workplaces and jobs is

listed below:
JOBS CUTTING HANDWORK POLISHING TOTAL
A1 1 000 3 000 1 000 5 000

A2 2 000 4 000 2 000 8 000
A3 2 000 1 000 1 000 4 000
17 000
Next, the distribution of November’s Overhead Costs to the workplaces is
289
provided below:
CUTTING HANDWORK POLISHING TOTAL

Overhead Costs 2 100 1 900 1100 5 100
In November, the Overhead Cost is loaded as 40% of the Direct Raw

Materials Cost. Also, the distribution of the estimated Overhead Cost to the
workplaces is 40% for the Cutting workplace, 30% for the Handwork
workplace and 30% for the Painting-Polishing workplace.
Finally, at the end of November, jobs A1 and A2 have been completed and
sent to the finished goods inventory.
REQUIRED:
a. Prepare the Cost Card for Job A1.
b. Write down the Journal Entries for November’s costs.
28. Company Onur Aydin implements the process costing system. In

November 20-1, the firm has started a production of 10,000 units. Then on
November 1, 20-2, the Beginning Work-In-Process Inventory has been
3,000 units. Also, the completion degrees for the Beginning Work-In-
Process Inventory are shown below:
Raw Materials : 30%

Labor and Overhead : 50%
After that, on November 31, 20-2, the Work-In-Process Inventory has been
5,000 units. Finally, the completion percentages of the Ending Period Work-
In-Process Materials are shown below:
Raw Materials : 60%

Labor and Overhead : 40%
REQUIRED:
a.Calculate the equivalent unit quantities using the FIFO method.
b. Calculate the equivalent unit quantities using the average costing
system.
29. Company Erdogan Yucel has three processes in the production. The data
of the first process concerning December 20-2 period are shown below:
290
Quantities:
Beginning Period Work-In-Process 1 500
Beginning in the Production Process 8 000
Transferred out to next process 7 500
Ending Period Work-In-Process 2 000
Costs:
Beginning Period Work-In-Process
Raw Materials 12 000
Labor 30 000
Overhead 8 000
Process Costs:
Labor 540 000
Overhead 50 000
Stages of completion:
Begin. Period End. Period
Work-In-Process Inv. Work-In-Process Inv.
Raw Materials 50% 80%
Labor 40% 50%
Overhead 40% 50%
REQUIRED:
a. Prepare the Production Cost Statement using the average costing

method.
b. Prepare the Production Cost Statement using the FIFO method.
30. Company Mehmet Sinan Pirimoglu has two processes in the production.
Data concerning the period of January 20-2 are as follows:
PROCESS 1 PROCESS 2
QUANTITIES:
Beginning Period Work-In-Process 1 000 b. 1 500 b.
Beginning in the Production Process 6 000 b. 0 b.
Received from previous process --- 5 000 b.
TOTAL 7 000 b. 6 500 b.
Transferred out to next process 5 000 b. 6 000 b.
291
End. Period Work-In-Process Mat. 2 000 b. 500 b.

TOTAL 7 000 b. 6 500 b.
COMPLETION STAGES FOR WORK-IN-PROCESS:

(same for the Beginning and Ending periods)
Labor and Overhead 30% 60%
COSTS
Beginning Period Work-In-Process
Previous Process Costs ---- 133 000 YTL.
Process Costs
Raw Materials 20 000 YTL. 40 000 YTL.
Labor 50 000 YTL. 34 000 YTL.
Overhead 32 000 YTL. 19 000 YTL.
TOTAL 102 000 YTL. 93 000 YTL.
Process Expenditures
Labor 140 000 YTL. 230 000 YTL.
TOTAL 410 000 YTL. 440 000 YTL.
REQUIRED:
a. Calculate the per unit costs of both processes using the weighted average
And FIFO methods of valuation.
b. Write down the Journal Entries of Processes.
31. Company Susan Losapio has two processes in the production. Data of
the first process belonging to December 20-1 period are shown below:
Quantities:
Beginning in the Production Process 8 000 b.
Transferred out to the next process 7 000 b.
Ending Period Work-In-Process 1 000 b.
292
Costs:
Period Costs:
Raw Materials 160 000 YTL
Labor 540 000 YTL
Overhead 50 000 YTL
Stages of completion:
Ending Period Work-In-Process Inventory
Raw Materials 50%

Labor 40%
Overhead 40%
REQUIRED:
Prepare the Production Cost Statement using the weighted average of

valuation Method.
32. Company Burton Reynolds has two processes in the production. Data
concerning the period of January 20-1 are as follows:
PROCESS 1 PROCESS 2
QUANTITIES:
Beginning in the Production Process 10 000 b. 0 b.
Received from the Previous Process --- 8 000 b.
TOTAL 12 000 b. 9 000 b.
Transferred out to the Next Process 8 000 b. 7 000 b.
Ending Period Work-In-Process 4 000 b. 2 000 b.
TOTAL 12 000 b. 9 000 b.
COMPLETION STAGES FOR WORK-IN-PROCESS
Beginning Period
Ending Period
293
COSTS
Begin. Period Work-In-Process
Process Costs
Labor 80 000 YTL. 70 000 YTL.
TOTAL 140 000 YTL. 190 000 YTL.
Labor 700 000 YTL. 800 000 YTL.
TOTAL 1 100 000 YTL. 1 500 000 YTL.
REQUIRED:
a.Calculate the per unit costs of both processes using the Average Costing
and FIFO methods.
33. Company Renay McManus has two processes in production. The data
PROCESS 1 PROCESS 2
QUANTITIES:
Beginning in the Production Process 10 000 b. 5 000 b.
TOTAL 12 000 b. 9 000 b.
Transferred out to the Next Process 8 000 b. 7 000 b.
Ending Period Work-In-Process 4 000 b. 2 000 b.
COMPLETION STAGES FOR WORK-IN-PROCESS
Beginning Period
Ending Period
294
COSTS
Begin. Period Work-In-Process
Process Costs
Labor 80 000 YTL. 70 000 YTL.
TOTAL 140 000 YTL. 190 000 YTL.
Labor 700 000 YTL. 1 200 000 YTL.
TOTAL 1 100 000 YTL. 2 400 000 YTL.
REQUIRED:
and FIFO methods.
34. Company Lara Mertan has two processes in the production. Data
PROCESS 1 PROCESS 2
QUANTITIES:
Begin. Period Work-In-Process 2 000 b. 1 000 b.
Beginning in the Production Process 10 000 b. 5 000 b.
TOTAL 12 000 b. 13 800 b.
Transferred out to the next process 7 800 b. 11 300 b.
Damaged Materials 200 b. 500 b.
End. Period Work-In-Process Mat. 4 000 b. 2 000 b.
COMPLETION STAGES FOR WORK-IN-PROCESS MATERIALS
Beginning Period
Labor and Overheads 50% 50%
295
Ending Period
COSTS
Begin. Period Work-In-Process Mat.
Process Costs
Labor 80 000 YTL. 70 000 YTL.
TOTAL 140 000 YTL. 190 000 YTL.
Labor 700 000 YTL. 1 200 000 YTL.
TOTAL 1 100 000 YTL. 2 400 000 YTL.
REQUIRED:
and FIFO methods.
4.2 MANAGERIAL ACCOUNTING PROBLEMS
1. Please answer the following questions briefly:

a- What is the difference between Expenditure and Cost terms?
b- What does the Break-even Point mean?
c- Which factors determine a company’s debt limit?
d- What can be the two examples for Semi-Variable Costs?
e- Which factors affect a company’s need for Net Operating Capital?
f- If you were the CEO of a company, what data you would request from the
managers?
2. Kamil Cokbilir is the accountant of SARDEN Company, which produces

computer monitors. He has prepared the company’s three month income
statement that is dated 01.01.20-1 - 31.03.20-1. The mentioned income statement
is shown below.
On 31.03.20-2, when the company’s truck was on the way to deliver 200
296
monitors to their customer, an accident happened and all of the monitors were
damaged. The firm had not prepared any invoice for the mentioned monitors
before the accident. After that unexpected event, the SARDEN Company had a
meeting with their insurance company which had insured the monitors with a
contract. At the end of the meeting, it was agreed that the insurance company
would provide compensation for the monitors based on their costs.
As a result of that, the firm provided their income statement to the insurance
company. However, the insurance company claimed that the cost of the monitors
was exaggerated. SARDEN Co.’s executive committee gave an immediate
response to the insurance company’s claim and they insisted that the monitors’
cost was calculated correctly by their accountants.
Finally, Kamil Cokbilir said that he had not included the sales and insurance
compensations to the income statement and had not reduced them from the
inventories. The reason was that the invoices were not prepared and the
insurance amount was not certain yet.
INCOME STATEMENT (YTL.) 31.03.20-2
GROSS SALES 38 720

SALES DEDUCTION (410)
NET SALES 38 310
COST OF SALES :
Cost of Goods Sold : (27 200)
Begin. Per. Raw Mat. Inventory 1 300
Raw Material Purchases 12 400
End. Per. Raw Mat. Inventory (2 200)
Raw Materials Used 11 500
Salaries 8 600
Overhead Cost 15 100
Total Production Cost 35 200
Begin Per. Finished Goods Inv. 500
End. Per. Finished Goods Inv. (8 500)
GROSS PROFIT 11 110
OPERATING EXPENSES (8 000)
Market., Sell. and Dist. Expenses 1 400
General Administration Expenses 6 600
INCOME FOR THE PERIOD 3 110
PROVISION FOR INCOME TAX (1 368)
NET INCOME FOR THE PERIOD 1 742
The company produced 1 000 monitors and sold 800 of them in the first three
months of 20-2. Also, 50 monitors had turned over from 20-1. The salaries
include and cover all of the employees’ salaries except those of the sales staff.
297
The following components are included to the overhead costs:
Electricity 2 450
Fuel (Gasoline) 3 500
Maintenance 700
Facility (Building) Rent 1 000
Depreciation 4 000
Insurance Cost 800
Overdue cost 1 200
Financial Expenses 1 450
Only 10% of the electricity expenses are related with the administrative division
of the company and the fuel (gasoline) cost is related with the heating need of the
firm. Additionally, the insurance cost is related with the goods inventory and
machinery, the overdue (term difference) cost is related with the purchased raw
materials, and the financial expenses are related with the received credits. Then,
the three-month period depreciation rate of the machinery and fixture assets is
5%. On the balance sheet, one can read the machinery as 54 000 YTL. Also, in
the year 20-2, there were no purchased or sold tangible fixed assets.
At last, in the year 20-2, the company desired to experience a capacity increment
via the improvement investment. However, during the feasibility studies, it was
determined that a 20% capacity increment would cause a 5% increase in the
labor cost and a 10% increase in the overhead cost. So, the business cancelled the
capacity increment plan.
REQUIRED:
a. Please comment on the cost of finished goods presented to the insurance

company.
b. Please comment on the income statement prepared by Kamil Cokbilir.
c. Please prepare your own income statement dated 31.03.20-2.
3. Omer Turkmen Company produces radios. The model of the mentioned radios
is FM. The firm has an annual production capacity of 60 000. In the year 20-2,
the business sold 50 000 radios and the selling price per radio was 120 YTL.
The production data belonging to the year 20-2 are shown below:
Variable cost per unit: 55 YTL.
Fixed production cost: 900 000 YTL.
Variable marketing and distribution expenses per unit: 10 YTL.
Fixed marketing and distribution expenses: 500 000 YTL.
298
REQUIRED:
a. The market research run by the firm points that in case the sales price is
lowered to 100 YTL., the total sales would higher to 60 000 units. However, this
strategy will cause booms for the fixed marketing and distribution expenses.
Please calculate the maximum fixed marketing and distribution expenses, which
will maintain the company’s operating profit and will lower the sales price per
unit to 100 YTL.
b. The production department of the company will make some modifications on
the production of radio model FM. These modifications will cause the fixed
production cost to increase by 10 000 YTL and the unit variable production cost
to increase by 3 YTL. Please find the minimum sales price per unit which will
keep the firm’s operating profit when the sales quantity will be 50 000 units.
4. The monthly printing capacity of the BORONAY Press (printing house) is 2

000 machinery hours. The mentioned printing house has two important
customers. In January, the data concerning these two customers are as follows:
TAYLAN Co. MERK Co. TOTAL

Sales 110 000 YTL. 70 000 YTL. 180 000 YTL.
Variable Costs 38 000 YTL. 42 000 YTL. 80 000 YTL.
Contribution Margin 72 000 YTL. 28 000 YTL. 100 000 YTL.
Fixed Costs 55 000 YTL. 35 000 YTL. 90 000 YTL.
Operating Profit 17 000 YTL. -7 000 YTL. 10 000 YTL.
Machinery Hours 1,400 hrs. 600 hrs. 2 000 hrs.
In February, MERK Company has requested an additional volume of order (job)

from BORONAY Press (printing house) totaling 70 000 YTL. Thus, MERK
Company’s order (job) volume in February is 70 000 YTL higher than their
volume of January. When the mentioned order (job) will be accepted,
BORONAY Press will face an additional expenditure equivalent to variable costs
and the machinery hours spent for MERK Company in January. To speak for
TAYLAN Company, they have requested the same volume of order (job). This
means, TAYLAN Company’s order (job) volumes in February and January are
exactly the same. As a final note, in February, BORONAY Press will accept the
job offers of TAYLAN and MERK Companies as its capacity permits.
REQUIRED:
Suppose that total machinery hours and the fixed costs of January will not
change in February. How can the operating profit of BORONAY Press’ be
maximized? Please explain and present your calculations.
299
5. Cetin Mutlu Company produces its own heaters with the brand name Zet. In
20-1, the firm had produced 1200 Zet heaters. The costs for the mentioned
product in the year 20-1 were as follows:
Direct Raw Materials Cost 5 800 YTL.

Direct Labor Cost 7 100 YTL.
Overhead Costs 1 700 YTL.
Also, in 20-1, the company’s General Administration Expenses and the

Marketing, Selling and Distribution Expenses were as follows:
General Administration Expenses 1 120 YTL.

Marketing, Selling and Dist. Expenses 350 YTL.
Cetin Mutlu Company wants to increase the production of Zet heaters to 2,000
units in 20-2 with an additional investment. It is also estimated that the Raw
Materials Cost will increase by 15% and the Labor Cost will increase by 10% in
20-2. Furthermore, it is forecasted that the Overhead Cost will be 2 990 YTL in
20-2 with 2,000 units of capacity and 20% price increment. Then, the firm
desires to have an Ending-Period Inventory of 200 heaters at the end of 20-2. As
an additional information, the business had no finished goods inventory at the
beginning of 20-1 and they had 100 heaters remaining at the end of the same
year (20-1). The inventories are evaluated based on the Average Costing
Method.
The firm also predicts that the General Administration Expenses will reach to 2
220 YTL in 20-2 with the capacity increment and the 20% price rise. Besides, it
is thought that Marketing, Selling and Distribution Expenses will grow by 10%
in 20-2.
Finally, in 20-1, the sales price per unit of finished goods was 14 YTL and it will
only be possible to increase that amount by a maximum of 10% in 20-2.
REQUIRED:
Based on the Variable Costing System, is increasing the production of Zet heater
a good idea? Please interpret.
6. The planned and actual income statements of Ridvan Kayaci Company dated
31.12.20-1 are as follows:
INCOME STATEMENT (YTL) Budgeted Actual
Sales 4 200 5 400
300
Cost of Goods Sold:

Cost of Raw Materials Used 1 860 2 200
Labor Cost 1 020 1 200
Overhead Cost 960 1 125
Total Production Cost 3 840 4 525
Begin. Period Finished Goods Inv. 250 250
4 090 4 775
Ending Period Finished Goods Inv. 440 597
Cost of Goods Sold 3 650 4 178
Gross Profit 550 1 222
Operating Expenses :
Mark., Sell. and Dist. Expenses 180 230
Total Operating Expenses 450 720
Operating Profit 100 502
QUANTITIES BUDGETED ACTUAL
Beg. Per. Fin. Goods Inv. 100 units. 100 units.

End. Per. Fin. Goods Inv. 140 units. 200 units.
Finished Goods Sold. 1 200 units. 1 500 units.
Beg. Per. Raw M. Inv. 200 units. 200 units.
End. Per. Raw M. Inv. 200 units. 100 units.
Raw mat. quantity
per one unit of fin. goods 3 units. 2,5 units.
Labor hours to produce
one unit of finished goods 2 hrs. 2,5 hrs.
Also, in the year 20-1, Ridvan Kayaci Company was able to achieve a 40%
capacity increment with an additional investment. Furthermore, on the organized
income statements, absorption (full) costing system was implemented. In other
words, the labor and overhead costs that are included to the production cost
cover both the variable and fixed costs.
REQUIRED:
a. Suppose that Ridvan Kayaci Company’s planned production quantity is 1 200
units and the actual production quantity is 1 500 units. Please prepare the firm’s
actual income statement based on the variable costing system.
b. At the beginning of the question, you were provided the planned and actual
income statements of the company along with the quantities. Please compare the
planned and the actual income statements of the business, and use the quantities
data to comment on the variances.
7. The planned and actual income statements of Bahadir Barutcu Company dated
31.12.20-1 are as follows:
301
INCOME STATEMENT (YTL) Budgeted Actual
Sales 4 260 6 390

Cost of Goods Sold:
Overhead Cost 940 1 210
4 290 6 860
Gross Profit 460 310
Operating Expenses : 280 290
In the year 20-1, Bahadir Barutcu Company planned to produce 300 units of
finished goods and sell 280 units of them. However, in the same year (20-1), the
company experienced a 50% capacity increment with an additional investment
and sold 450 units of finished goods. Moreover, the average cost per one unit of
finished goods was 10 YTL in the year 20-0. Also, the firm had planned to use 2
units of raw materials per one unit of finished goods. On the other hand, 2.2 units
of raw materials were used per one unit of finished goods. Then, the planned
labor hours per one unit of finished goods were 3 and the actual labor hours were
also observed as 3 in the end. Finally, the finished goods inventory is evaluated
based on the average costing system.
REQUIRED:
a. Please prepare Bahadir Barutcu Company’s actual income statement based on
the variable costing system.
b. Please calculate Bahadir Barutcu Company’s cost and income variances using
the income statements and the cost data above.
8. Ismihan N. Kilicarslan Company’s planned and the actual income statements

dated 31.12.20-2 are as follows:
INCOME STATEMENT (YTL) BUDGETED ACTUAL
Sales 41 832 47 600

Cost of Goods Sold:
Labor Cost 7 000 12 000
Overhead Cost 5 050 5 470
302
30 300 38 720
Gross Profit 12 120 9 520
General Administration Expenses 4 500 4 900
Mark., Sell. and Dist. Expenses 1 800 2 300
Total Operating Expenses 6 300 7 200
Operating Profit 5 820 2 320
QUANTITIES PLANNED ACTUAL
Beg. Period Finished Goods. 10 units. 10 units.

End. Period Finished Goods 14 units. 20 units.
Raw mat. quantity
per one unit of fin. goods 3 units. 2,5 units.
In the year 20-2, Ismihan N. Kilicarslan Company experienced a 20% capacity

increment with an additional investment. Also, the firm had planned to produce 1
000 units in 20-2, but they produced 1 200 units as a result of the capacity
increment. The Absorption (full) costing system was implemented on the
organized income statements. In other words, all of the labor cost included to the
production cost is variable, and the overhead cost and the general administration
expenses cover both the fixed costs and the variable costs.
Finally, the firm’s average finished goods cost per unit is 25 TYL for the year
20-1.
REQUIRED:
a. At the beginning of the question, you were provided the planned and actual
income statements of the company along with the quantities. Please compare the
planned and the actual income statements of the business, and use the quantities
data to comment on the variances.
b. Please prepare the actual income statement of the firm based on the variable
costing system.
9. Ender Demir Company’s planned and the actual income statements dated
31.12.20-2 are presented below:
INCOME STATEMENT PLANNED ACTUAL
Sales 40 545 49 500
303
Cost of Goods Sold:

Labor Cost 10 000 12 000
30 300 39 300
General Administration Expenses 6 600 8 400
Mar., Sell. and Dist. Expenses 2 800 3 200
Total Operating Expenses 9 400 11 600
Operating Profit (Loss) 1 405 (620)
QUANTITIES BUDGETED ACTUAL
End. Period Finished Goods 15 units. 20 units.

Raw materials quantity
per one unit of fin. goods 2,5 units. 3 units.
Ender Demir Company obtained a 25% capacity increment with the help of an
additional investment in the year 20-2. In the same year (20-2), originally the
firm had planned to produce 800 units but they produced 1 000 units owing to
the capacity increment. Absorption (full) costing system was implemented on the
organized income statements. In other words, the labor cost and the overhead
cost included to the production cost contain both the variable costs and the fixed
costs. Additionally, the general administration expenses and the marketing,
selling and distribution expenses are comprised of fixed costs. At last, the firm’s
average finished goods cost per unit is 30 YTL for the year 20-1.
REQUIRED:
a. At the beginning of the question, you were provided the planned and
actual income statements of the company along with the quantities. Please
compare the planned and actual income statements of the business, and use the
quantities data to comment on the variances.
b. Please prepare the actual income statement of the firm based on the
variable costing system.
10. N. Can Okay Company produces ovens and the firm’s target is to sell 150
units in 20-2. Also, 30% of the company’s sales are the export sales and the
business assumes that the beginning period inventories and the ending period
304
inventories will remain in the same level of quantity. In 20-1, the average cost
per one unit of finished goods was 86 YTL. Then, it is estimated that the sales
price per unit of finished goods in 20-2 will be 190 YTL in the domestic market
and will be $ 100 in the foreign market. Moreover, it is forecasted that the raw
materials cost per one unit of finished goods will be 64 YTL and the labor cost
per one unit of finished goods will be 30 YTL in 20-2. Next, the Overhead Costs
are loaded as 40% of the direct labor. Finally, the General Administration
Expenses are planned to be 5% of the total production cost, and the Marketing,
Selling and Distribution Expenses are planned to be 10% of the sales revenues.
The company’s Income Statement at the end of 20-2 is shown below:
INCOME STATEMENT (YTL.)
SALES 24 840
Export Sales 640
COST OF GOODS SOLD:
Raw Materials Cost 9 800
Labor Cost 4 700
Overhead Costs 1 240
Beginning Period Finished Goods . (+) 32
Ending Period Finished Goods . (-) 71
GROSS PROFIT 9 139
OPERATING EXPENSES:
General Administration Cost 930
Marketing, Selling and Distribution Expenses 2 600
In the year 20-2, there was no change in the export sales price. However,
although it was thought that $1 would be equiavalent to 1.50 YTL as the year’s
average, it was equivalent to 1.60 YTL at the end of the year. Following that, the
average sales price per unit was 180 YTL for the domestic market and 138 ovens
were produced in 20-2. Finally, while the standard labor time for one unit of
finished goods had been 4 hours before, it occured as 4.2 hours at the end of 20-
2.
REQUIRED:
Please calculate and interpret N. Can Okay Company’s sales revenue and the
cost variances for the year 20-2.
11. Elcin Yilmaz Company produces a toothbrush set named and coded SERT
41. Below, you can see the Income Statement concerning this product for the
305
year 20-1.
INCOME STATEMENT ( Thousand YTL)
SALES 4 816
COST OF GOODS SOLD:
Cost of Raw Materials Used 1 600
Labor Cost 1 200
Overhead Cost 630
Beginning Period Finished Goods Inv. (+) 176
Ending Period Finished Goods Inv. (-) 88
GROSS PROFIT 1 298
OPERATING EXPENSES:
General Administration Expenses 824
Marketing, Selling and Distribution Expenses 108
Total Operating Expenses 932
INCOME FOR THE PERIOD 366
The planned quantities and unit values regarding the SERT 41 coded toothbrush
set for the year 20-1 are listed below:
Sales Quantity: 40 500 units

Ending Period Inventory Quantity: 1 130 units
Beginning Period Inventory Quantity: 4 000 units
Average Sales Price Per Unit: 135 YTL
In 20-1, the actual ending period inventory quantity for the mentioned toothbrush
set was 1 035 units. The inventories are evaluated based on the average costing
system and the actual average sales price per unit was 120 YTL in 20-1. Also, in
20-1, the raw materials cost was 10% and the labor cost was 15% higher than the
planned ones. Next, the overhead cost was loaded to the costs as 40% of the
direct raw materials cost. After that, the general administration expenses were
estimated to be 25% of the total production cost and the marketing, selling and
distribution expenses were estimated to be 2% of the total sales.
Finally, although the standard time per one unit of finished goods was planned to
be 0.6 hours, the actual time per unit occured as 0,7 hours.
REQUIRED:
Please calculate and discuss the variances between planned and actual
values for the year 20-1.
306
12. Puren Buget Company produces the BAK 1050 product. The planned and
actual income statements concerning this product at the end of 20-1 are shown
below:
INCOME STATEMENT (Thoudand YTL) PLANNED ACTUAL
SALES 1 846 1 500

COST OF GOODS SOLD
Begin. Per. Raw Materials Inventory 45 45
Purchases 1 200 970
1 245 1 015
End. Period Raw Materials Inventory 80 65
Raw Materials Used 1 165 950
Labor Cost 335 296
Overhead Cost 80 72
Production Cost 1 580 1 318
Begin. Period Work-In-Process Mat. Inv. 150 150
1 730 1 468
End. Period Work-In-Process Mat. Inv. 210 115
The Cost of Materials Completed 1 520 1 353
1 840 1 673
The Cost of Finished Goods Sold 1 560 1 263
GROSS PROFIT 286 237
OPERATING EXPENSES:
Market., Selling and Dist. Expenses 120 132
PROFIT FOR THE PERIOD 126 70
INCOME TAX. (-) 42 23
GROSS PROFIT FOR THE PERIOD 84 47
The company had planned to sell 13 000 units of BAK 1050 product for the year
20-1. However, the actual number was 11 140 units. Also, in the year 20-0, the
average raw materials cost per unit was 30 YTL. Then, it was estimated that the
average purchasing price of the raw materials per unit would be 42 YTL in the
year 20-1. Next, the firm had planned to use 2.4 units of raw materials per 1 unit
of finished goods, but they used 2.1 units of raw materials. Then, the business
had calculated that 4 hours of labor would be spent per 1 unit of finished goods
in the year 20-1. The labor salaries per hour were observed as 10% higher than
the planned ones. The overhead cost is loaded based on the direct labor cost.
After that, the completion rate of the beginning period work-in-process materials
is 100% in terms of raw materials and 60% in terms of labor. The cost per unit of
beginning period finished goods inventory is 95 YTL. Another important point is
that the ending-period finished goods inventory is evaluated based on the FIFO
method. Finally, the ending-period finished goods quantity had planned to be
307
2435 units but the actual quantity was 3475 units.
REQUIRED:
Please calculate and interpret the sales and cost variances.
13. Irem Keskin Company’s financial statements at the end of year 20-2 are
indicated below:
BALANCE SHEET (YTL.) INCOME STATEMENT (YTL.)

31.12.20-2 31.12.20-2
ASSETS SALES 550 000

CASH, BANKS 42 000 COST OF GOODS SOLD (-)
ACCOUNTS RECEIVABLES 65 000 Begin. Per. Raw Mat. Inv. 40 000
INVENTORIES 150 000 Purchases 210 000
Finished Goods 90 000 End. Per. Raw Mat. Inv. 60 000
MACHINERY 100 000 Raw Materials Used 190 000
ACC. DEPRECIATION (40 000) Labor 110 000
Total Assets 317 000 Overhead Costs 80 000
Production Cost 380 000
LIABILITIES Begin. Per. Finish. Goods Inv. 45 000
BANK LOANS 66 000 425 000
PRO. FOR INCOME TAX. 50 000 End. Per. Finish. Goods Inv. 90 000
PREPAID INCOME TAX. (8 000) Cost of Goods Sold 335 000
CAPITAL 100 000 GROSS PROFIT 215 000
RESERVES 4 000 OPERATING EXPENSES (-) 60 000
NET INC. FOR THE PERIOD 105 000 Market., Sell. and Dist. Exp. 10 000
Total Liabilities 317 000 General Admin. Expenses 50 000
PRO. FOR INCOME TAX. 50 000
NET PRO. FOR THE PERIOD 105 000
Irem Keskin Company produced 60 units of finished goods and sold 55 of them
in the year 20-2. The cost per unit of finished goods was 3 000 YTL in the year
20-1. The inventories are evaluated based on the average costing system. Also,
the beginning-period raw materials inventory was 100 units in the year 20-2.
Finally, the company uses 3 units of raw materials to produce 1 unit of finished
goods.
The sales and the purchasing figures concerning the last three months of year 20-
2 are as follows:
OCTOBER NOVEMBER DECEMBER

Total Sales (YTL.) 44 000 45 000 66 000
Sales Quantity (Units) 6 7 8
Total Purchases for Raw Materials (YTL) 16 000 18 000 20 000
308
The budgetary figures concerning the first three months of year 20-3 are as
follows:
JANUARY FEBRUARY MARCH
Sales Quantity (Units) 10 10 12
End.-Period Finish. Goods Inv. (Units) 2 2 3
End.-Period Raw Mat. Inv. (Units) 30 30 30
It is estimated that the company will sell 110 units in the year 20-3. The sales
price for the first three months of 20-3 was determined by increasing
December 20-2’s average sales price by 5%. Moreover, it is forecasted that, in
the first three months of 20-3, the raw materials cost will increase by 3%
monthly compared to the average cost of the year 20-2. Besides, it is guessed that
the labor cost will increase by 2.5%, the variable overhead cost will increase by
2% and the general administration expenses will increase by 4% in this three
months period.
Then, for the purchases, the business pays 50% of the price by cash and the
remaining portion is paid by checks which have 90 days fixed term. In regards to
the sales policy, the business receives 25% of the sales price by cash and the
remaining part is received by checks which have 60 days fixed term.
The depreciation rate is 5% for 3 months. Also, the inflation rate is 3% for three
months and the tax rate is 20%. In January, the firm will buy machinary valued
at 40 000 YTL. The mentioned machinary will be imported and its price will be
paid in January 20-3. In case the company’s cash situation will not be sufficient,
the firm will use bank credits. Following that, the capital will be increased to 150
000 YTL in March and one fourth of the remaining capital will be paid via cash.
Additionally, in March, 60 000 YTL portion of the year 20-2’s profit will be
distributed after it is seperated from the second legal reserve.
REQUIRED:
Please prepare the company’s forecasted (pro-forma) income statement and
balance sheet dated 31.03.20-3.
14. The financial statements prepared by Burc Aka Company at the end of year
20-2 are shown below briefly:
309
SALES 210 000

SALES DEDUCTIONS 8 000
GROSS SALES 202 000
COST OF GOODS SOLD (-)
Direct Labor 35 000
Cost of Production 156 000
Begin. Per. Work-In-Process Inv. 2 000
158 000
End. Per. Work-In-Process Inv. 4 000
Cost of Materials Completed 154 000
Begin. Per. Finished Goods Inv. 10 000
164 000
End. Per. Finished Goods Inv. 2 000
GROSS PROFIT 40 000
OPERATING EXPENSES (-)
Market., Sell. And Dist. Expen. 5 000
General Admin. Expenses 25 000
NET INC. FOR THE PERIOD 7 000
BALANCE SHEET (YTL.)
ASSETS
CASH, BANKS 30 000
ACCOUNTS RECEIVABLES 35 000
INVENTORIES 8 000
Raw Materials 6 000
Finished Goods 2 000
MACHINERY 15 000
ACC. DEPRECIATION -3 000
Total Assets 85 000
LIABILITIES
BANK CREDITS 20 000
PAYABLES (DEBT) 4 000
PREPAID TAX AND INS. -2 000
CAPITAL 45 000
RESERVES 8 000
Total Liabilities 85 000
The company produced 340 units and sold 360 units in the year 20-2. The
310
beginning period finished goods inventory is 30 units and the beginning period
raw materials inventory is 50 units. 4 units raw materials and 1.40 labor hours
are used to produce 1 unit of finished goods. The variable overhead cost is
loaded to the cost of production according to the raw materials cost. In the year
20-2, the fixed overhead cost was 25% of the total overhead cost. The ending
period inventories are evaluated based on the average costing system.
Additionally, in the year 20-3, the firm will be able to higher its production
volume by putting its inactive capacity to good use. Plus, in the same year, the
business predicts that they can higher the sales to 600 units by increasing the
previous year’s sales price by 10%.
Following that, in the year 20-3, the raw materials cost will increase by 20% and
the direct labor salaries per hour will increase by 10%. Moreover, it is estimated
that the inflation rate will be 10% in 20-3.
The company desires to have a raw materials quantity of 100 units and a finished
goods quantity of 30 units at the end of 20-3. Besides, in the same year, the
company will pay its bank credits (loans). The firm will go for a capital
increment which wil be used for the required financials of this action. Finally,
the credits (loans) interest valued at 4 000 YTL will also be paid to end the
current bank credits. Income tax rate is 20%.
REQUIRED:
a. Please prepare the company’s budget for the year 20-3.
b. Please solve for the firm’s forecasted (pro-forma) balance sheet and income
statement at the end of 20-3.
c. Please comment on the company’s plans for the year 20-3.
15. The Actual Income Statement together with the Planned and Actual Data of
Bilge Gursoy Company belonging to the year 20-0 are as follows:
ACTUAL INCOME STATEMENT (Thousand YTL) QUANTITIES ACTUAL PLANNED
Beg. Per. Fin. Goods 1 000 units. 1 000 units.

SALES 2 400 End. Per. Fin. Goods. 1 800 units. 2 000 units.
COST OF GOODS SOLD (-) Finished Goods Sold. 12 000 units. 15 000 units.
Begin. Per. Raw Materials Inv. 40 Beg. Per. Raw M. Inv. 2 000 units. 2 000 units.
Purchases 1 152 End. Per. Raw M. Inv. 2 000 units. 1 500 units.
------- Raw mat. quantity
1 192 per one unit of fin.
311
End. Per. Raw Materials Inv. 60 goods. 3 units. 2 units.

------- Labor hours to
Raw Materials Used 1 132 produce one unit
Labor 768 of finished goods 2,4 hrs. 2,5 hrs.
General Admin. Expenses 128 Dir. Lab. Salary per h. 25 YTL/hrs. 20 YTL/hrs.
------- Overhead Costs 10 YTL/unit 9 YTL/unit
Begin. Per. Finish. Goods Inv. 100
-------
2 128
End. Per. Finish. Goods Inv. 278
-------
-------
GROSS PROFIT 550
OPERATING EXPENSES (-) 376
Market., Sell. and Dist. Expen. 120
General Admin. Expenses 256
-------
OPERATING PROFIT 174
The Raw Materials Inventory was evaluated using the FIFO method and The
Finished Goods Inventory was evalauted using the Average Costing System. The
purchasing price per one unit of raw materials is planned to be 28 YTL and the
sales price per one unit of finished goods is planned to be 220 YTL. The
Marketing, Selling and Distribution Expenses are predicted to be 5% of the sales
and the General Administration Expenses are estimated to be 10% of the total
production cost.
REQUIRED:
a. Prepare the forecasted (pro-forma) income statement dated 31.12.20-1.
b. Calculate the production quantity for actual finished goods.
c. Calculate the cost variances for direct raw materials.
d. Calculate the cost variances for the direct labor.
16. Ipek Ili Company’s planned and actual income statements dated 31.12.20-2
are as follows:
INCOME STATEMENT (YTL) Planned Actual
Sales 44 800 65 410

Cost of Goods Sold:
Raw Materials Cost 20 700 39 600
Labor Cost 10 200 14 250
312

Begin. Period Finished Goods Inv. 2 600 2 600
42 900 68 550
Ending Period Finished Goods Inv. 4 900 7 800
Operating Expenses 2 800 2 900
Operating Profit 4 000 1 760
Also, Ipek Ili Company had planned to produce 600 units of finished goods and
sell 560 units of that quantity in the year 20-2. However, in the same year, an
additional investment of 10 000 YTL provided a capacity increase and a
production of 860 units (finished goods). Moreover, it is calculated that the
additional investment would lead to a 10% increase in the labor costs and a 20%
increase in the overhead costs. Another important issue was that the average
finished goods cost per unit was 60 YTL in the year 20-1. The finished goods
inventory is evaluated based on the average costing system. Following that, the
standard direct labor hours are 5 hrs. per one unit of finished goods. 30% of the
planned overhead cost is comprised of fixed overhead cost. Finally, the annual
depreciation rate is 20%.
REQUIRED:
Please prepare the budgeted income statement of Ipek Ili Company based on the
additional investment. Also, please compare the corrected and the actual budget
figures, and interpret the variances.
17. The financial statements of KALSAS Company at the end of March 20-1 are
as follows:
BALANCE SHEET (YTL.) 31.12.20-0
ASSETS
CASH, BANKS 3 000
ACCOUNTS RECEIVABLES 14 000
INVENTORIES 65 000
Finished Goods 45 000
MACHINERY 100 000
ACC. DEPRECIATION (40 000)
Total Assets 142 000
313
LIABILITIES
BANK LOANS 50 000
LIABILITIES 15 000
PREPAID INCOME TAX. (9 000)
CAPITAL 50 000
RESERVES 6 000
Total Liabilities 142 000

31.03.01 31.12.00
BUDGETED ACTUAL
SALES 160 000 400 000

Begin. Per. Raw Mat. Inv. 20 000 14 000
Purchases 28 000 92 000
48 000 106 000
End. Per. Raw Mat. Inv. 16 000 20 000
Raw Materials Used 32 000 86 000
Labor 34 000 110 000
Overhead Costs 23 000 80 000
Production Cost 89 000 276 000
Begin. Per. Finish. Goods Inv. 45 000 28 000
134 000 304 000
End. Per. Finish. Goods Inv. 40 000 45 000
GROSS PROFIT 66 000 141 000
OPERATING EXPENSES (-) 39 000 90 000
Market., Sell. and Dist. Expen. 22 000 37 000
General Admin. Expenses 17 000 53 000
OPERATING PROFIT 27 000 51 000
FINANCIAL EXPENSES 18 000 21 000
PROFIT FOR THE PERIOD 9 000 30 000
PRO. FOR INCOME TAX. 3 500 12 000
GROSS PRO. FOR THE PERIOD 5 500 18 000
During the executive meeting organized to evaluate the company’s financial

situation belonging to March 20-1’s first three months, KALSAS Company CEO
Engin Eryılmaz has stated that the firm is faced to a worse condition compared to
the previous year.
The Sales Manager İhsan Kömürcü has said that the current negative scenario
has no relationship with the sales because the sales quantity was 8% above the
planned one of 375 units. Additionally, he has told that there were no deviations
and changes in the sales prices, and the real reason behind the unwelcomed
314
situation was the increase in costs. Furthermore, Mr. Kömürcü has expressed that
the process to collect the receivables had now been faster and only 40% of the
sales revenue was transferred to the next month as receivables. Finally, he has
emphasized that the business had an extra advertising expenditure totaling to 10
000 YTL, but that had helped them to increase the sales.
The Production Manager Beyhan Mutlu has implied that they had decreased the
inventory quantity, eliminated unnecessary inventories and operated with lesser
inventories in terms of raw materials and finished goods compared to the
previous year. Moreover, she has underlined the fact that the raw materials
quantity was 800 units at the beginning of the period and they had decreased it to
577 units. Likewise, she has said that the finished goods inventory was 180 units
at the beginning of the period and they had lowered this quantity to 148 units.
Plus, Mrs. Mutlu has also noted that the FIFO method was used and labor costs
were lowered. For instance, overtime hours were eliminated, some excess
employees were laid off, labor hours per one unit of finished goods were lowered
to 1.1 hrs from 1.3 hrs, and raw materials quantity per one unit of finished good
was dropped to 3.8 units from 4.0 by using more quality raw materials. Next, she
has said that the share of fixed overhead cost in the total overhead cost had
increased because of the three-month 5% depreciation of the new machinery
valued at 100 000 YTL. Besides, the rent of the factory, 2000 YTL per month,
was another factor which had caused the share of fixed overhead cost to increase
in the total overhead cost. Finally, Mrs. Mutlu has indicated that the variable
overhead cost had increased by 12% in the three-month period.
The Purchasing Manager Ayhan Alim has explained that because of the cash and
liquidity restrictions of the company, they were only able to pay 30% of the raw
materials’ price by cash and the remaining part would be paid by check that had
four months term. As a result, the raw materials were purchased with an
additional cost of 4% compared to the planned one.
The Human Resources Manager İsmail Doğan has told that the salaries of
employees were increased 20% for the first six months of the year 20-1 just as it
was planned. Similarly, the salaries of the administrative staff was highered
25%. Also, the company had saved 800 YTL after laying off some of the
employees and eliminating excess overtime hours. Finally, Mr. Doğan has said
that the total general administration expenses were 10% above the planned
expenses and that was caused by the sales contributions.
The Financial Manager Gülçin Bozkurt has pointed that the cash outflows were
more than they had to be and the receivables and cash inflows were not enough
to cover them. Also, she has stated that they were only able to receive short-term
315
credits with a 6% monthly interest rate. As a result, the financial expenses were
recognized 1.8 times more than the planned values. Finally, Mrs. Bozkurt has
said that the company had some unnecessary inventories and these inventories
had to be used to generate cash. Using that method, she has requested to avoid
the use of unnecessary credit.
REQUIRED:
Please prepare the actual income statement of the KALSAS Company covering
the first three months of the year 20-1 and then comment on the budget
variances.
18. In the year 20-2, Tolga Belle Company planned domestic sales of finished
goods totaling 800 units and export (overseas) sales of finished goods totaling 50
units. The U.S. dollar currency is used for the export (overseas) sales.
Additionally it is calculated that, on an average, 1 U.S. dollar will be equivalant
to 1.60 YTL in the year 20-2. Also, the average cost per one unit of finished
goods was 20 YTL in the year 20-1. The business desired 30 units of finished
goods to remain at the end of year 20-2. The ending period finished goods
inventory and the ending period raw materials inventory are evaluated based on
the average costing system. Besides, the firm planned to use 2 units of raw
materials per one unit of finished goods. Next, the beginning period raw
materials inventory is 80 units. The company predicts that, in the year 20-2, the
average purchasing price per one unit of raw materials will be 7.00 YTL. Plus,
Tolga Belle Company had planned that 2.1 standard labor hours would be used
per one unit of finished goods. Finally, the variable portion of the overhead cost
was loaded as 20% of the raw materials cost.
The company’s planned income statement at the end of year 20-2 is as follows:
INCOME STAEMENT (YTL.)

SALES 26 940
Export (Overseas) Sales 1 440
COST OF GOODS SOLD:
Begin. Per. Raw Mat. Inv. 480
Purchases 12,880
13 360
End. Per. Raw Mat. Inv. 1,252
Raw Materials Cost 12 108
Labor Cost 9 135
316
Overhead 2 827
Beg. Per. Finished Goods Inv. (+) 320
End. Per. Finished Goods Inv. (-) 991
GROSS PROFIT 3 541
OPERATING EXPENSES :
Mar., Sell. and Dist. Expenses 850
PROVISION FOR INCOME TAX 292
NET INCOME FOR THE PERIOD 1 169
In the year 20-2, the business was able to achieve the planned production
amount. However, the raw materials inventory and the finished goods inventory
were above the expected quantities because of the economical crisis. At the end
of the period, the finished goods inventory had 36 units and the raw materials
inventory had 180 units. Then, the domestic sales price per one unit of finished
goods was 10% below the planned price. On the other hand, there were no
changes for the export (overseas) sales price. But, the export (overseas) sales
quantity was observed as 40% below the planned quantity and the average
exchange rate was 1.70 YTL/$. Also, in the year 20-2, the firm had paid 7.20
YTL on average per one unit of raw materials. Moreover, 2.10 units of raw
materials were used to produce 1 unit of finished goods. Unfortunately, there
were some problems concerning production so the actual labor hours per one
unit of finished goods were 2.3. The labor cost was 5% higher than the planned
labor cost. Furthermore, the fixed overhead cost was exactly equivalent to the
planned one and the variable overhead was 10% higher than the planned variable
overhead. Then, the general administration expenses were recognized as 1 310
YTL and the marketing, selling and distribution expenses were recognized as
975 YTL. Finally, in the year 20-2, the tax rate was 20% and the predicted
inflation rate was 10%.
REQUIRED:
a. Please prepare the actual income statement of the company for the year 20-2.
b. Please calculate the cost and sales revenue variances comparing the planned
and the actual income statements of the firm.
19. The actual financial statements of Euclid Dupuis Co. at the end of year 20-2
are as follows:
BALANCE SHEET (YTL)
317
20-1 20-2
ASSETS
CASH, BANKS 15 000 20 000
ACCOUNTS RECEIVABLES 32 000 35 000
INVENTORIES 90 000 150 000
Finished Goods 50 000 90 000

MACHINERY 100 000 100 000
ACC. DEPRECIATION (-) (20 000) (40 000)
---------- -----------
Total Assets 217 000 265 000
LIABILITIES
PAYABLES (DEBT) 69 000 24 000
TAX PROVISIONS 10 000 7 000
PREPAID TAX AND INS. (6 000) (8 000)
CAPITAL 130 000 200 000
RESERVES 4 000 14 000
NET INC. FOR THE PERIOD 10 000 28 000
-------- ----------
Total Liabilities 217 000 265 000
INCOME STATEMENT (YTL.) 20-2
SALES 430 000

Begin. Per. Raw Mat. Inv. 40 000
Purchases 210 000
----------
250 000
End. Per. Raw Mat. Inv. 60 000
----------
Labor 110 000
----------
Begin. Per. Finish. Goods Inv. 50 000
----------
430 000
End. Per. Finish. Goods Inv. 90 000
----------
----------
GROSS PROFIT 90 000
318
Market., Sell. and Dist. Expen. 12 000

General Admin. Expenses 43 000 55 000
-------- --------
TAX PROVISION (-) 7 000
--------
GROSS PRO. FOR THE PERIOD 28 000
The company produced 400 units and sold 370 of them in the year 20-2. The cost
per one unit of finished goods was 400 YTL in 20-1. The inventories are
evalauted based on the average costing system. Also, in 20-1, the cost per one
unit of raw materials was 40 YTL. The business always uses 4 units of raw
materials to produce 1 unit of finished goods and that is a standard procedure.
Following that, the variable overhead cost is loaded as 50% of the direct labor
cost. Besides, the fixed overhead is comprised of the depreciation cost.
Next, in the year 20-2, the company desired to sell 800 units. Similarly, in the
same year, the firm also desired 50 units of finished goods inventory and 800
units of raw materials inventory to remain. When the business compared the
actual and planned costs, they could notice some rises. For instance, the raw
materials purchasing cost per unit had a 20% increment, the labor cost had a 10%
growth and the overhead cost had a 20% increment. In the year 20-2, 4.2 units of
raw materials were used to produce 1 unit of finished goods. Also, the company
used to spend 2 labor hours per 1 unit of finished goods before. So, that was their
planned labor hours. But, the actual labor hours were 2.1. Plus, the firm’s
average planned sales price for the finished goods did match the actual one.
Finally, the inflation rate is 40% and the tax rate is 20%.
REQUIRED:
a. Please calculate the quantity of planned finished goods.

b. Please calculate the quantity of planned raw materials.
c. Please calculate the quantity of actual finished goods.
d. Please calculate the quantity of actual raw materials.
e. Please calculate the unit cost of actual raw materials used.
f. Please calculate the unit purchasing cost of planned raw materials.
g. Please calculate the unit purchasing cost of actual raw materials.
h. Please calculate the actual labor hours.
i. Please calculate the actual labor hours salary.
j. Please calculate the planned labor hours.
k. Please calculate the planned labor hours salary.
l. Please calculate the actual overhead cost per unit.
m. Please calculate the planned overhead cost per unit.
n. Please calculate the actual finished goods cost per unit for the year 20-2.
319
o. Please calculate the planned finished goods cost per unit for the year 20-2.
p. Please prepare the planned income statement of the company for the year 20-2.
q. Please calculate the cost variances for the raw materials.
r. Please calculate the cost variances for the labor.
s. Please calculate the cost variances for the overhead.
t. Please calculate the variances for the sales revenue.
20. The actual financial statements of Behlul Kilinc Co. at the end of year 20-2
are as follows:
INCOME STATEMENT (YTL.) 20-2
SALES 6 800
Begin. Per. Raw Mat. Inv. 240
Purchases 7 462
End. Per. Raw Mat. Inv. 2 102
Labor 1 000
Overhead Costs 940
Begin. Per. Finish. Goods Inv. 700
8 240
End. Per. Finish. Goods Inv. 2 020
GROSS PROFIT 580
General Admin. Expenses 400
PROFIT FOR THE PERIOD 180
The company produced 400 units and sold 340 of them in the year 20-2. The
firm’s average finished goods cost per unit was 14 YTL and average raw
materials cost per unit was 3 YTL for the year 20-1. Also, Behlul Kilinc
Company planned to produce 500 units of finished goods and desired 100 units
of finished goods inventory as well as 400 units of raw materials inventory to
remain in the year 20-2. The accrued purchasing raw materials quantities are
1820 units. Then, in the year 20-2, 3 units of raw materials were planned to
produce 1 unit of finished goods. But, the actual spending units of raw materials
per 1 unit of finished goods are 3.5. Also, the company was planned to spend 1.4
labor hours per 1 unit of finished goods. But, accrued labor hours are 1.25 labor
hours per 1 unit of finished goods. The inventories are evalauted based on the
average costing system.
320
Following that, the price per unit of purchasing raw materials were 14% and the
labor salaries per hour were 25% higher than the planned amounts. There are 300
YTL depreciation expenses in total overhead costs. The other overhead costs are
variable. Following that, the variable overhead costs are accrued 10% higher
than the planned ones. Next, the operating expenses are loaded according to
production units. Besides, the operating expenses per produced unit are accrued
10% less than the planned one. Finally, in 20-2, the planned sales price per unit
of finished goods is 20% higher than accrued sales price per unit.
REQUIRED:
a. Please prepare the budgeted income statement of the company for the year
20-2.
b. Please calculate the cost and sales revenue variances comparing the planned
and the actual income statements of the firm.
21. Aybars Altiok Company’s planned and actual income statements dated
31.12.20-1 are indicated below:
INCOME STATEMENT Planned Actual
Sales 5 200 7 100

Cost of Goods Sold:
Cost of Raw Materials 2 400 4 000
5 040 7 470
Gross Profit 560 350
Operating Expenses 240 290
Aybars Altiok Company planned to produce 600 units and sell 580 of them in
the year 20-1. However, in the same year (20-1), the business produced 800 units
as a result of an additional investment which had created a capacity increment.
The firm took into consideration that the additional investment would lead to a
10% increment in the labor cost, a 20% increment in the variable overhead cost
and a 200 YTL increment in the fixed overhead cost. A finished goods inventory
of 30 units was taken over from the year 20-0. Plus, the finished goods inventory
is evaluated based on the average costing system. The standard direct labor hours
per one unit of finished goods are 6 and the actual direct labor hours were
exactly the same as this number. Finally, 40% of the budgeted overhead costs is
321
comprised of the fixed overhead cost.
REQUIRED:
Please prepare Aybars Altiok Company’s planned income statement based on the
additional investment, then comment on the variances by comparing the
organized and actual budgetary figures.
APPENDIX: 1 CHART OF ACCOUNTS
ASSETS
1 CURRENT ASSETS
10 CASH ASSETS (LIQUID ASSETS)
100 CASH ON HAND
322
101 CHECKS RECEIVED

102 CASH IN BANKS
103 CHECKS GIVEN AND PAYMENT ORDERS
108 OTHER CASH AND CASH EQUIVALENTS
11 MARKETABLE SECURITIES
110 SHARE CERTIFICATES

111 PRIVATE SECTOR BONDS
112 PUBLIC SECTOR BONDS
118 OTHER MARKETABLE SECURITIES
119 RESERVE ADJUSTING VALUE OF MARKETABLE SECURITIES
12 TRADE RECEIVABLES
120 CUSTOMERS
121 NOTES RECEIVABLE
122 DISCOUNTS OF NOTES RECEIVABLE (-)
124 UNEARNED INTEREST INCOMES OF LEASING (-)
126 DEPOSITS AND GUARANTEES GIVEN
127 OTHER TRADE RECEIVABLES
128 DOUBTFUL TRADE RECEIVABLES
129 PROVISIONS FOR DOUBTFUL CURRENT TRADE RECEIVABLES
13 OTHER RECEIVABLES
131 RECEIVABLE FROM SHAREHOLDERS

132 RECEIVABLE FROM PARTICIPATIONS
133 RECEIVABLE FROM SUBSIDIARY COMPANIES
135 RECEIVABLE FROM EMPLOYEES
136 OTHER VARIOUS RECEIVABLES
137 DISCOUNT OF OTHER RECEIVABLE (-)
138 DOUBTFUL OTHER RECEIVABLES
139 PROVISIONS FOR DOUBTFUL OTHER RECEIVABLES
15 INVENTORlES
150 RAW MATERIALS AND SUPPLIES

151 WORK-IN-PROCESS
152 FINISHED PRODUCTS
153 MERCHANDISE
157 OTHER MATERIALS
158 RESERVE ADJUSTlNG INVENTORIES (-)
159 ADVANCES TO SUPPLIERS FOR GOODS & SERVICES
17 CONSTRUCTION AND REPAIR COSTS
170 CONSTRUCTION AND REPAIR COSTS

178 CONSTRUCTION INFLATION ADJUSTMENT ACCOUNT
179 ADVANCES GIVEN TO SUB-CONTRACTORS
323
18 PREPAID EXPENSES AND INCOME RECElVABLES
180 PREPAID EXPENSES FOR THE FOLLOWING MONTHS

181 ACCRUED INCOME
19 OTHER CURRENT ASSETS
190 DEFFERED VAT

191 DEDUCTIBLE VAT
192 OTHER VAT
193 PREPAID TAXES AND FUNDS
195 JOB ADVANCES
196 ADVANCES TO PERSONNEL
197 INVENTORY SHORTAGES
198 OTHER VARIOUS CURRENT ASSETS
199 PROVISION FOR OTHER CURRENT ASSETS
2 FIXED ASSETS
20 TRADE RECEIVABLES
220 CUSTOMERS
221 NOTES RECEIVABLES
222 DISCOUNTS ON NOTES RECEIVABLES (-)
224 UNEARNED INTEREST INCOMES OF LEASING (-)
226 DEPOSITS AND GUARANTEES GIVEN
227 OTHER TRADE RECEIVABLES
229 PROVISION FOR DOUBTFUL TRADE RECEIVABLES (-)
231 RECEIVABLE FROM SHAREHOLdERS

232 RECEIVABLE FROM PARTICIPATION
233 RECEIVABLE FROM SUBSIDIARY COMPANIES
235 RECEIVABLE FROM PERSONNEL
237 REDISCOUNT ON OTHER NOTES RECEIVABLE (-)
239 PROVISION FOR OTHER DOUBTFUL RECEIVABLES
24 FINANCIAL FIXED ASSETS
240 SECURITIES HELD AS LONG-TERM INVESTMENTS

241 RESERVE ADJUSTING THE VALUE OF SECURITIES HELD AS L/T
INVESTMENS
242 PARTICIPATIONS
243 COMMITMENTS TO PARTICIPATIONS
244 RESERVE ADJUSTING THE VALUE OF PARTICIPATIONS
245 INVESTMENTS IN SUBSIDIARY COMPANIES
246 COMMITMENTS TO SUBSIDIARY COMPANIES
247 RESERVE ADJUSTING THE VALUE INVESTMENTS
248 OTHER FINANCIAL ASSETS
324
249 RESERVE ADJUSTING THE VALUE OF OTHER FINANCIAL ASSETS
25 TANGIBLE ASSETS
250 LAND
251 LAND IMPROVEMENTS
252 BUILDINGS
253 MACHINERY AND EQUIPMENTS
254 MOTOR VEHICLES
255 FURNITURE AND FIXTURES
256 OTHER TANGIBLE FIXED ASSETS
257 ACCUMULATED DEPRECIATION
258 CONSTRUCTIONS IN PROGRESS
259 ADVANCES TO SUPPLIERS OF TANGIBLE FIXED ASSETS
26 INTANGlBLE ASSETS
260 RIGHTS
261 GOODWILL
262 PRE-OPERATING EXPENSES
263 RESEARCH AND DEVELOPMENT EXPENSES
264 LEASEHOLD IMPROVEMENTS (SPECIAL COSTS)
267 OTHER INTANGIBLE FIXED ASSETS
268 ACCUMULATED AMORTIZATION OF INTANGIBLE
269 ADVANCES GIVEN TO SUPPLIERS
27 EXTRA ORDINARY USEFUL LIFE ASSETS
271 RESEARCH EXPENSES

272 PREPARATION AND IMPROVEMENT EXPENSES
277 OTHER ASSETS SUBJECT TO SPECIAL AMORTIZATION
278 ACCUMULATED AMORTIZATION
279 ADVANCES GIVEN TO SUPPLIERS OF ASSETS SUBJECT TO SPECIAL
AMORTIZATION
28 PREPAID EXPENSES AND INCOME ACCRUALS

280 PREPAID EXPENSES FOR FUTURE PERIODS
281 INCOME ACCRUALS
29 OTHER FIXED ASSETS
291 DEDUCTIBLE VAT IN FUTURE PERIODS

292 OTHER VAT
293 INVENTORIES TO BE USED IN THE LONG-TERM
294 INVENTORIES AND TANGIBLE FIXED ASSETS TO BE SOLD
295 PREPAID TAXES AND DUTIES
297 OTHER VARIOUS NON-CURRENT ASSETS
298 RESERVE ADJUSTING INVENTORIES TO BE SOLD
299 ACCUMULATED DEPRECIATION OF TANGIBLE FIXED ASSETS
LIABILITIES
325
3 CURRENT LlABILITIES
30 FINANCIAL LIABILITIES (F.BORROWINGS)
300 BANK LOANS

301 ACCOUNTS PAYABLE ON LEASING
302 DEFERRED FINANCIAL COSTS ON LEASING (-)
303 CURRENT PORTION OF LONG-TERM LOANS
304 CURRENT PRINCIPAL, INTEREST AND INSTALLMENT PAYABLES ON
BONDS
305 COMMERCIAL PAPER
306 OTHER MARKETABLE SECURITIES ISSUED
308 VALUE DIFFERENCE IN ISSUANCE OF MARKETABLE SECURITIES
309 OTHER CURRENT FINANCIAL PAYABLES
32 TRADE LIABILITIES
320 ACCOUNTS PAYABLE

321 NOTES PAYABLE
322 DISCOUNT OF NOTES PAYABLE (-)
326 GUARANTEES AND DEPOSITS RECEIVED
329 OTHER CURRENT TRADE PAYABLES
33 OTHER LIABILITIES
331 OTHER PAYABLES TO SHAREHOLDERS

332 OTHER PAYABLES TO PARTICIPATIONS
333 OTHER PAYABLES TO SUBSIDIARY COMPANIES
335 PAYABLES TO EMPLOYEES
336 OTHER VARIOUS PAYABLES
337 DISCOUNT OF OTHER NOTES PAYABLE (-)
34 ADVANCES
340 ADVANCES FROM CUSTOMERS

349 OTHER ADVANCES RECEIVED
35 CONSTRUCTION AND REPAIR PROGRESS BILLINGS

350 CONSTRUCTION AND REPAIR PROGRESS BILLINGS
36 INCOME TAXES PAYABLE AND OTHER LIABILITIES
360 TAXES PAYABLES

361 SOCIAL SECURITY DUTIES PAYABLE
368 UNPAID, RESCHEDULED TAXES AND DUTIES PAYABLE
369 OTHER DUTIES PAYABLE
37 PROVISIONS FOR DUE AND EXPENSE
326
370 PROVISIONS FOR TAXATION INCOME AND RELATED DUTIES

371 PREPAID INCOME TAXES AND RELATED DUTIES
372 RESERVE FOR EMPLOYEE TERMINATION INDEMNITIES
373 RESERVE FOR COSTS
379 OTHER PROVISIONS AND ACCRUED LIABILITIES
38 DEFERRED INCOME AND ACCRUED EXPENSES
380 DEFERRED INCOME FOR SHORT TERM

381 ACCRUED EXPENSES
39 OTHER SHORT TERM LIABILITIES
391 VAT RECEIVED

392 OTHER VAT RECEIVED
393 HEAD OFFICE AND BRANCH CURRENT ACCOUNTS
397 INVENTORY OVERAGES
399 OTHER VARIOUS CURRENT LlABILITIES
4 LONG-TERM LlABILITlES
40 FINANCLAL LIABILITIES (F.BORROWINGS)

400 BANK LOANS
401 ACCOUNTS PAYABLE ON LEASING
402 DEFERRED FINANCIAL COSTS ON LEASING (-)
405 BONDS ISSUED
407 OTHER MARKETABLE SECURITIES ISSUED
408 VALUE DIFFERENCE IN ISSUANCE OF SECURITIES ISSUED
409 OTHER FINANClAL LIABILITIES
42 TRADE LIABILITIES
420 SUPPLIERS
421 NOTES PAYABLE

422 DISCOUNT OF NOTES PAYABLE (-)
426 DEPOSITS AND GUARANTEES RECEIVED
429 OTHER TRADE PAYABLES
43 OTHER LIABILITIES
431 DUE TO SHAREHOLDERS

432 DUE TO PARTICIPATIONS
433 DUE TO SUBSIDIARY COMPANIES
436 OTHER NON-CURRENT VARIOUS PAYABLES
437 REDISCOUNT OF OTHER NOTES PAYABLE (-)
438 "NON-CURRENT UNPAID, RESCHEDULED PAYABLES TO
THE GOVERMENT
44 ADVANCE RECEIVED
440 ADVANCES FROM CUSTOMERS
327
449 OTHER ADVANCES RECEIVED
47 PROIiISIONEN FOR DUE AND EXPENSE
472 RESERVE FOR EMPLOYEE TERMINATION INDEMNITIES

479 OTHER PROVISIONS AND ACCRUED LIABILITIES
48 DEFERRED INCOME AND ACCRUED EXPENSES
480 DEFERRED INCOME

481 ACCRUED EXPENSES
49 OTHER LONG-TERM LIABILITIES

492 VAT DEFERRED TO FOLLOWING YEARS
493 INSTALLATION PARTICIPATION
499 OTHER VARIOUS NON-CURRENT LIABILITIES
5 SHAREHOLDERS' EQUITY (STOCKHOLDERS' EQUITY)
50 PAID - IN CAPITAL
500 CAPITAL
501 UNPAID CAPITAL (-)
502 CAPITAL ADJUSTMENT POSITIVE VARIANCE
503 CAPITAL ADJUSTMENT NEGATIVE VARIANCE
52 CAPlTAL RESERVE
520 SHARES OF STOCKS ISSUANCE PREMIUMS

521 INCOME ON CANCELLED SHARES OF STOCKS
522 REVALUATION SURPLUS OF TANGIBLE FIXED ASSETS
523 REVALUATION SURPLUS OF PARTICIPATIONS
529 OTHER CAPITAL RESERVES
54 PROFIT RESERVE
540 LEGAL RESERVE

541 STATUTORY RESERVE
542 EXTRAORDINARY RESERVE
548 OTHER PROFIT RESERVES
549 SPECIAL FUNDS
57 PRIOR YEAR PROFIT
570 RETAINED EARNINGS
58 PRIOR YEAR LOSS (- )
580 ACCUMULATED LOSS
59 PROFIT FOR THE PERIOD (LOSS)
328
590 NET PROFIT FOR THE PERIOD

591 NET LOSS FOR THE PERIOD (-)
60 GROSS SALES
600 DOMESTIC SALES

601 EXPORT SALES
602 OTHER SALES
61 SALES RETURNS AND ALIOWANCES
610 SALES RETURNS (-) .

611 SALES DISCOUNTS (-)
612 OTHER DEDUCTIONS (-)
62 COST OF GOOD SOLD
620 COST OF GOODS SOLD (PRODUCT) (-)

621 COST OF GOODS SOLD (MERCHANDISE) (-)
622 COST OF SERVICES RENDERED (-)
623 COST OF SALES (OTHER) (-)
63 OPERATING EXPENSES
630 RESEARCH AND DEVELOPMENT EXPENSES (-)
631 MARKETING, SELLING AND DISTRIBUTION EXPENSES (-)

632 GENERAL ADMINISTRATIVE EXPENSES (-)
64 OTHER OPERATING REVENUES (INCOME)
640 DIVIDENDS RECEIVED-PARTICIPATIONS

641 DIVIDENDS RECEIVED-SUBSIDIARY COMPANIES
642 INTEREST AND OTHER FINANCIAL INCOME
643 COMMISSION INCOME
644 PROVISIONS NO LONGER REQUIRED ,
645 PROFIT ON SALE OF MARKETABLE SECURITIES
646 FOREIGN EXCHANGE GAINS
647 INCOME FROM DISCOUNTS OF NOTES PAYABLE
648 PROFIT ON INFLATION ADJUSTMENT
649 OTHER VARIOUS INCOME FROM OPERATIONS
65 OTHER OPERATING EXPENSES ()
653 COMMISSION EXPENSES (-)

654 PROVISIONS (-)
655 LOSS ON SALE OF MARKETABLE SECURITIES
656 EXCHANGE LOSSES
657 INCOME FROM DISCOUNT OF NOTES RECEIVABLE
329
658 LOSS ON INFLATION ADJUSTMENT

659 OTHER EXPENSES (-)
66 FINANCIAL EXPENSES
660 FINANCIAL EXPENSES ON CURRENT BORROWINGS

661 FINANCIAL EXPENSES ON NON-CURRENT BORROWINGS
67 EXTRAORDINARY INCOME AND PROFIT
671 PRIOR PERIOD REVENUES AND PROFITS (-)

679 OTHER EXTRAORDINARY INCOME
68 EXTRAORDINARY EXPENSES AND LOSS
680 IDLE CAPACITY EXPENSES (-)

681 PRIOR PERIOD EXPENSES (-)
689 OTHER EXTRAORDINARY EXPENSES (-)
690 PROFIT OR LOSS FOR THE PERIOD
691 PROVISIONS FOR TAXES PAYABLE AND OTHER
STATUTORY OBLIGATIONS (-)
692 NET PROFIT OR LOSS FOR THE YEAR
698 INFLATION ADJUSTMENT ACCOUNT
COST ACCOUNT AS REQUlRED BY 7/A OPTION
70 COST CONTROL ACCOUNT
700 COSTS CONTROL ACCOUNT

701 COST CHARGE ACCONT
71 DIRECT MATERIAL AND OTHER MATERIAL EXPENSES
710 DIRECT RAW AND OTHER MATERIAL EXPENSES

711 DIRECT RAW AND OTHER MATERIAL EXPENSES APPLIED
712 DIRECT RAW AND OTHER MATERIAL PRICE VARIANCE
713 DIRECT RAW AND OTHER MATERIAL UNIT VARIANCE
72 DIRECT LABOR EXPENSES

720 DIRECT LABOR EXPENSES
721 DIRECT LABOR EXPENSES APPLIED
722 DIRECT LABOR WAGES VARIANCE
723 DIRECT LABOR TIME VARIANCE
73 MANUFACTURING OVERHEAD EXPENSES
730 OVERHEAD COSTS

731 OVERHEAD COSTS APPLIED
732 OVERHEAD COSTS BUDGET VARIANCE
330
733 OVERHEAD COSTS PRODUCTIVITY VARIANCE

734 OVERHEAD COSTS CAPACITY VARIANCE
74 COST OF SERVICES RENDERED
740 COST OF SERVICES RENDERED

741 COST OF SERVICES RENDERED APPLIED
742 COST OF SERVICES RENDERED VARIANCE
75 RESEARCH AND DEVELOPMENT EXPENSES
750 RESEARCH AND DEVELOPMENT EXPENSES .

751 RESEARCH AND DEVELOPMENT EXPENSES APPLIED
752 RESEARCH AND DEVELOPMENT EXPENSES VARlANCE
76 MARKETING, SALES AND DISTRIBUTlON EXPENSES
760 MARKETING, SALES AND DISTRIBUTION EXPENSES

761 MARKETING, SALES AND DISTRIBUTION EXPENSES APPLIED
762 MARKETING, SALES AND DISTRlBUTION EXPENSES VARIANCE
77 GENERAL ADMINlSTRATION EXPENSES
770 GENERAL ADMINISTRATION EXPENSES

771 GENERAL ADMINISTRATION EXPENSES APPLIED
772 GENERAL ADMINISTRATION EXPENSES VARIANCE
78 FlNANCIAL EXPENSES
780 FINANCIAL EXPENSES

781 FINANCIAL EXPENSES APPLIED
782 FINANCIAL EXPENSES VARIANCE
APPENDIX: 2 DETAILED BALANCE SHEET
DETAILED BALANCE SHEET

(.......................................... YTL)
ASSETS
I- CURRENT ASSETS
A- Liquid Assets
331
1-Cash
2- Checks Received
3- Banks
4- Checks Given and Payment Orders (-)
5- Other Liquid Assets
B- Marketable Securities
1- Share Certifıcates
2- Private Sector Bonds and Notes
3- Public Sector Bonds and Notes
4- Other Marketable Securities
5- Decrease in Marketable Securitics (-)
C- Trade Receivables
1- Customers
2- Notes Receivable
3- Rediscount of Notes Receivable(-)
4- Deposits And Guarantees Given
5- Other Trade Receivables
6- Doubtful Trade Receivables
7- Provision for Doubtful Trade Recivables(-)
D- Other Receivables
1- Receivable From Shareholders
2- Receivable From Participations
3- Receivahle From Subsidiary Companies
4- Receivable From Employees
5- Other Various Receivables
6- Rediscount on Other Notes Receivables (-)
7- Doubtful Other Receivables
8- Provision for Other Douptf'ul Receivables (-)
E- Inventories
1- Raw Material and Supplies
2- Work-in Process
3- Finished Goods
4- Merchandise (Trade Goods)
5- Other Inventories
6- Provision for Inventories (-)
7- Advances Given for Purchases
F- Contract Progress Costs
1- Contracrt Progress Costs
2- Advances Given to Sub-Contractors
G- Prepaid Expenses and Income Accurals
1- Prepaid Expenses for Future months
2- Accrued Income
H- Orher Current Assets
1- Deferred VAT
2- Deductible VAT
3- Other VAT
4- Prepaid Taxes and Funds
5- Work Advances Assets (-)
6- Advances to personnel
7- Inventory Shortages
8- Other Current Assets
9- Provision for Other Current Assets
TOTAL CURRENT ASSETS

II- FIXED ASSETS
A- Trade Receivables
1- Customers
2- Notes Receivable
3- Rediscount of Notes Receivable(-)
4- Deposits And Guarantees Given
5- Provision for Doubtful Trade Reccivables(-p-)
B- Other Receivables
332
1- Receivable From Shareholders

2- Receivable From Participations
3- Receivable From Subsidiary Companies
4- Receivable From Employees
5- Other Various Receivables
6- Rediscount on Other Notes Receivables (-)
7- Doubtful Other Receivables
8- Provision for Other Doubtf'ul Receivables
C-Financial Fixed Assets
1- Long-term Securities
2- Decrease in Value of Securities (-)
3- Participation
4- Capital Commitmens for Participation (-)
5- Decrease in Value of Participation Shere (-)
6- Subsidiaries
7- Capital Commitments for Subsidiaries (-)
8- Decrease in Value of Subsidiaries Shares (-)
D-Tangible Assets
1- Land
2- Land Improvements
3- Buildings
4- Machinery and Equipments
5- Motor Vehicles
6- Furniture and Fixtures
7- Other Tangible Fixed Assets
8- Accumulated Depreciation (-)
9- Construction in Progress
10- Advances To Suppliers of Tangible Fixed Assets
E- Intangible Assets
1- Rights
2- Goodwill
3- Pre-Operating Expenses
4- Research and Development Expenses
5- Leasehold Improvements
6- Other Intangible Fixed Assets
7- Accumulated Amortization (-)
8- Advances To Suppliers
F- Extra Ordinary Useful Life Assets
1- Research Expenses
2- Preparation and Development Expenses
3- Other Extra Ordinary Useful Life Assets
4- Accumulated Amortization (-)
5- Advances To Suppliers
G- Prepaid Expenses and Accrued Income
1- Prepaid Expenses for Future Periods
2- Income Accruals
H-Other Fixed Assets
1- Deductible VAT In Future Periods
2- Other VAT
3- Prepaid Expenses and Funds
4-Other Fixed Assets
TOTAL LONG TERM ASSETS
TOTAL ASSETS
LIABILITIES
1- CURRENT LIABILITIES
A-Financial Liabilities
1- Bank Loans
2- Current Portion of Long-Term Loans
3- Current Maturities of Bonds and Accrued Interest
4- Bonds and Notes Issued
333
5- Other Securities Issued

6- Value Difference of Securities Issued (-)
7- Other Financial Liabilities
B-Trade Liabilities
1-Suppliers
2- Notes Payables
3- Rediscount on Notes Payables (-)
4- Deposits and Guarantees Received
5- Other Trade Payables
C-Other Liabilities
1- Due to Shareholders
2- Due to Participations
3- Due to Subsidiaries
4- Due to Personnel
5- Other Liabilities
6- Rediscuunt on Other Notes Payable (-)
D- Advances Received
E- Accrued Contract and Maintenance Income
1- Accrued Contract and Maintenance Income
F- Taxes Payable and Other Fiscal Liabilities
1-Taxes Payables
2- Social Security Duties Payable
3- Unpaid, Rescheduled Taxes And Duties Payable
4- Other Duties Payable
G- Provisions For Due And Expense
1- Provisions for Taxation Income And Related
2- Prepaid Income Taxes And Related Duties
3- Provisions For Employee Termination Indemnities
4- Provisions for other Depts and Liabilities
H- Deferred Income And Accrued Expenses
1- Deferred Income
2- Accrued Expenses
I- Other Short-Term Liabilities
1- VAT Received
2- Other VAT
3- Head Office and Branch Current Accounts
4- Inventory Overages
5- Other Short Term Liabilities
TOTAL SHORT TERM LlABlLlTlES
II- LONG TERM LlABILITIES
A- Financial Liabilities
1- Bank Loans
2- Bonds Issued
3- Other Securities Issued
4- Value Difference of Securities Issued (-)
5- Other Financial Liabilities
B- Trade Liabilities
334
1- Suppliers
2- Notes Payables
3- Rediscount on Notes Payables (-)
4- Deposits and Guarantees Received
5- Other Trade Payables
C- Other Liabilities
1- Due to Shareholders
2- Due to Participations
3- Due to Subsidiaries
4- Due to Personnel
5- Rediscount on Other Notes Payable (-)
6- Non-Current Unpaid- Rescheduled Payables To the Goverment
7- Other Liabilities
D- Advance Received
E- Provisions For Due And Expense
1- Provision for Termination Indemnities
2- Provision for Other Debts end Expenses
F- Deferred Income And Accrued Expenses
1- Deferred Income
2- Accrued Expenses
G- Other Long-Term Liabilities
1- VAT Deferred to Following Years
2- Installation Participation
3- Other Long Term Liabilities
TOTAL LONG TERM LIABILITIES
III- SHAREHOLDERS EQUITY
A- Paid-in Capital
1-Capital
2- Un-paid Capital
B- Capital Reserves
1- Share Premium
2- Share Premium of' Cancelled Shares
3- Revaluation Fund of Tangible Fixed Assets
4- Revaluation Fund of Investment
5- Other Capital Reserves
C- Profit Reserves
1- Legal Reserves
2- Statutory Reserve
3- Extaordinary Reserves
4- Other Reserves
5-Special Funds
D- Retained Eamings
E- Accumulated Loss (-)
F- Net Profıt (Loss) for the Period
TOTAL SHAREHOLDERS EQUITY
TOTAL LIABILITIES
FOOTNOTES:
APPENDIX: 3 DETAILED STATEMENT OF INCOME
DETAILED STATEMENT OF INCOME

(................................... YTL)
A- GROSS SALES
1- Domestic Sales
335
2- Export Sales
3- Other Sales
B- SALES RETURNES AND ALLOWANCES(-)
1- Sales Returns (-)
2- Sales Discounts (-)
3- Other Deductions (-)
C- NET SALES
D- COST OF GOODS SOLD
1- Cost of Goods Sold (Product) (-)
2- Cost of Goods Sold (Merchandise) (-)
3- Cost of Services Rendered (-)
4- Cost of Sales (Other) (-)
GROSS PROFlT OR (LOSS)
E- OPERATING EXPENSES (-)
1- Research and Development Expenses (-)
2- Marketing, Selling And Distribution Expenses (-)
3- General Administration Expenses (-)
OPERATING PROFlT OR (LOSS)
F- INCOME AND PROFIT FROM OTHER OPERATIONS
1- Dividend Income from Affiliates
2- Dividend lncome from Subsidiaries
3- Interest lncome
4- Commission Income
5- Provisions no Longer Required
6- Profit on Sale of Marketable Securities
7- Exchange Gains
8- Rediscount Income
9- Other Income and Profıt
G- EXPENSES AND LOSSES FROM OTHER OPERATIONS (-)
1-Commission Expenses (-)
2- Provisions (-)
3- Loss on Sale of Marketable Securities (-)
4- Exchange Losses (-)
5- Rediscount Income (-)
6- Other Income and Profıt (-)
H- FINANCIAL EXPENSES
1- Financial Expenses (Short Term) (-)
2- Financial Expenses (Long Term) (-)
OPERATING PROFlT OR (LOSS)
I- EXTRAORDINARY REVENUES AND PROFITS
1- Previous Period Revenues and Profıts
2- Other Extraordinary Revenues and Profıts
J- EXTRAORDINARY EXPENSES AND LOSSES (-)
1- Idle Capacity Expenses and Losses (-)
2- Previous Period Expenses and Losses (-)
3- Other Extraordinary Expenses and Losses (-)
PROFIT OR (LOSS) FOR THE PERIOD
K- PROVISIONS FOR TAXES PAYABLE AND

OTHER STATUTORY OBLIGATIONS (-)
NET PROFIT OR (LOSS) FOR THE YEAR
APPENDIX: 4 STATEMENT OF COST OF SALES
336
STATEMENT OF COST OF SALES

(..........................................YTL)
PRODUCT COST
A- Direct Material
B- Direct Labor
C- Manufacturing Overhead Costs
D- Work in Process Used
1- Beginning Work-in Process Inventory (+)

2- Ending Work-in Process Inventory (-)
COST OF FlNlSHED GOODS PRODUCED
E- CHANGE IN FINISHED GOODS INVENTORY
1- Beginning Finished Goods Inventory (+)

2- Ending Finished Goods Inventory (-)
3- Internal Usage (-)
I- COST OF FINISHED GOODS SOLD
TRADING OPERATIONS
A- Beginning Inventory (+)

B- Purchases During The Period (+)
C- Ending Inventory (-)
II- COST OF MERCHANDISE SOLD
III- COST OF SERVICES RENDERED
IV COST OF SALES (l+II+III)
APPENDIX: 5 CASH FLOW STATEMENT
CASH FLOWS STATEMENT
A- CASH AT THE BEGINNING OF THE PERIOD
337
B- CASH INFLOWS WITHIN THE PERlOD

1. Cash From Sales
a) Net Sales
b) Decrease in Trade Receivables
c) Increase in Trade Receivables (-)
2. Cash From Other Operations
3. Cash Received from Extraordinary Income and Profit
b) Credits Obtained
c) Other Increases
b) Credits Obtained
c) Other Increases
6. Cash Received From Share Capital lncrease
7. Cash Received From Share Premium
8. Other Cash Received From Cash Inflows
C - CASH OUTFLOWS WITHIN THE PERIOD

1. Cash Outflows due to Costs
a) Cost of Sales
b) Increase in Inventories
c) Decrease in Trade Payables
d) Increase in Trade Payables (-)
e) Expenses not Requiring Cash Payments Such as
f) Decrease in Inventories(-)
2. Cash Outflows due to Operating Expenses
a) Research and Development Expenses
b) Marketing, Selling and Distribution Expenses
c) General Administrative Expenses
d) Expenses not Requiring Cash Payments Such as
3. Cash Outflows Related to Other Expenses and Losses
a) Ordinay Expenses and Losses
b) Other Expenses and Losses not Requiring Cash
Payments(-)
4. Cash Outflows due to Financial Expenses
5. Cash Outflows due to Extraordinary Expenses and Losses
a) Extraordinary Expenses and Losses
b) Expenses and Losses Not Requiring Cash Payments (-)
6. Cash Outflows Due to investment in non-current assets
7. Cash Outflows Due to Short Term Liability Payments
a) Current Maturities of Marketable Securities
c) Other Payments
8. Cash Outflows Due to Long Term Liability Payments
a) Current Maturities of Marketabte Securities
c) Other Payments
9. Taxes and Other Similar Charges Paid
10. Dividends Paid
11. Other Cash Outflows
D- CASH AT THE END OF PERIOD (A+B+C)
E- INCREASE IN CASH (B-A)
APPENDIX: 6 FUNDS FLOW STATEMENT
FUNDS FLOW STATEMENT
338
A. SOURCES OF FUNDS
1. Funds provided from Operatiorıs
a) Operating Profit
b) Depreciation and Amortization
c) Other Expenses not Requiring Fund Outflow
d) Other Income not Providing Fund Inflow (-)
2. Sources From Extraordinary Operations

a) Extraordinary Profit
b) Expenses not Requiring Fund Outflow
c) Income not Providing Fund Inflow
3. Reductions in Current Assets
4. Reductions in Amounts of Fixed Assets
5. Increase in Short Term Foreign Sources
6. Increase in Long Term Foreign Sources
7. Share Capital Increase
8. Premiums on Capital Stock
B. USE OF FUNDS
1. Funds Flow Relating to Operating Activities
a) Operating Loss
b) Depreciation
c) Expenses not Involving Outflow of Funds
d) Income Not Involving Inflow of Funds
2. Fund Usage due to Extraordinary Operations

a) Extraordinary Loss
b) Expenses Not Involving Outftow of Funds
c) Income Not Involving Inflow of Funds
3. Increase in Current Assets
4. Increase in Amounts of Fixed Assets
5. Reductions in Short Term Foreign Sources
6. Reductions in Long Term Foreign Sources
7. Share Capital Decrease
8. Increase on Capital Stock
9. Taxes and Other Similar Charges Paid
10. Dividends Paid
339

ACCOUNTING1 Cevdet

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

ACCOUNTING1 Cevdet

Uploaded by

Copyright:

Available Formats

FINANCIAL ACCOUNTING, COST ACCOUNTING AND MANAGERIAL ACCOUNTING

CHAPTER 1: FINANCIAL ACCOUNTING

1.1 BOOK-KEEPING AND ACCOUNTING

1.1.1 Book-keeping and Accounting in Business

We can usually observe familiar and similar headlines as well as announcements

Book-keeping is the recording of business transactions in books of account and we

1.1.2 Abilities of Book-keeping / Accounting System

Indeed, a lot of information can be gathered from the book-keeping or accounting

(a) the sales,

Moreover, as a student of book-keeping, you will usually need to practice your

1.1.3 Business Transactions

In book-keeping and accounts, we record the transactions of a particular company.

1.1.4 Some Accounting Terms

1.2 DOUBLE ENTRY AND ACCOUNTS

Business transactions always consist of two aspects:

As a book-keeper, your duty is to record the transactions of a specific business

Date Transaction Gain Loss

A book-keeping system is comprised of a number of separate accounts which, when

The book-keeper's responsibility is to enter the transactions of the business into

Jan 1. Started the business with 2,000 YTL in cash.

FURNITURE AND FIXTURE

FURNITURE AND FIXTURES

1.3 THE TRANSACTIONS

MACHINERY AND EQUIPMENTS

FURNITURE AND FIXTURE

20 Mar. 20-1 Paid Checks Given 900 YTL by banks.

Here is another transaction:

FURNITURE AND FIXTURES

OTHER VARIOUS RECEIVABLES

Apr 28. 20-1 Arici Co. pays 150 YTL by check.

OTHER VARIOUS RECEIVABLES

1.4 PURCHASES, SALES AND RETURNS

1.4.1 The Use of Purchases and Sales Accounts

1.4.2 Purchases for Cash or Check

1.4.3 Purchases on Credit

CASH, BANKS OR OTHERS

1.4.4 Sales for Cash or Check

We must still go on to follow the same book-keeping orders. For example:

1.4.5 Sales on Credit

Again, the same book-keeping rules apply. For example:

CASH, BANKS OR OTHERS

1.4.6 More About Sales and Purchases Accounts

Marchandise and Sales Accounts are used to record transactions of the

1.4.7 Returns Accounts

1.4.8 Returns Outwards Account

Returns Outwards Account (Marchandise) always has transactions entered on

1.4.9 Returns Inwards Account

Jun 24 Accounts Payable 100

Jun 29 Customers 65

1.5 BALANCING-OFF ACCOUNTS

1.5.1 Why Should We Balance the Accounts?

Amount debited : 2 000 YTL

Balance : 1 420 YTL

By the way, double-entry book-keeping accounts similar to the ones we have

1.5.2 The Way to Balance-off the Accounts

Unfortunately, for some students, balancing the accountings correctly is tough.

1.6 THE TRIAL BALANCE

1.6.1 Getting to Know the Trial Balance

To provide a brief definition, a trial balance is a list of the balances of accounts

Trial balance of (business x) at (date y)

Account: Totals Balance

Total 10 180 10 180 3 610 3 610