BBAW2103 Financial Accounting BOOK

BBAW2103
Financial Accounting
Copyright © Open University Malaysia (OUM)

BBAW2103
FINANCIAL
ACCOUNTING
Noor Asma Jamaludin
Nor Asma Lode
Junaidah Hanim Ahmad
Azlan Zainol Abidin
Amin Ali
Norazita Marina Abd Aziz
Prof Dr Ku Nor Izah Ku Ismail
Dr Natrah Saad
Zurida Azahari

Fourth edition 2021 (CS)
Third edition 2013
Second edition 2012
First edition 2008
Developed by Centre for Instructional Design and Technology, OUM.

Copyright © Open University Malaysia (OUM), BBAW2103
All rights reserved. No part of this work may be reproduced in any form or by any means without
the written permission of the President of Open University Malaysia (OUM).
www.oum.edu.my

Table of Contents
Course Guide ix – xiv
Topic 1 Accounting Environment 1

1.1 Introduction to Accounting 2
1.1.1 Definition of Accounting 2
1.1.2 Users of Accounting Information 2
1.1.3 Branches of Accounting 4
1.1.4 Professional Accounting Bodies in Malaysia 5
1.2 Fundamental Accounting Concepts 6
1.2.1 Qualitative Characteristics of Accounting Information 7
1.2.2 Accounting Assumptions 11
1.2.3 Basic Principles of Accounting 14
1.2.4 Accounting Constraints 18
1.3 Types and Objectives of Financial Statement 19
1.3.1 Income Statement 20
1.3.2 Statement of Changes in OwnerÊs Equity 21
1.3.3 Balance Sheet 22
1.3.4 Statement of Cash Flows 23
Summary 27
Key Terms 28
Topic 2 Basic Rules of Accounting 29

2.1 Accounting Cycle 29
2.2 Accounting Equation 31
2.2.1 Analysis of Transaction 32
2.2.2 Summary of Analysis 37
2.3 Chart of Accounts 39
2.4 Format of Account 41
2.5 Rules of Debit and Credit 42
2.5.1 Normal Balance 44
Summary 48
Key Terms 49

iv  TABLE OF CONTENTS
Topic 3 Recording Process 50

3.1 Steps in Recording Process 50
3.1.1 Journal 51
3.1.2 Journalising and Posting of Entry 52
3.1.3 Example of Analysis and Summary of Transaction 59
3.1.4 Trial Balance 87
Summary 92
Key Terms 93
Topic 4 Adjusting Entries 94

4.1 Adjusting Entries 94
4.1.1 Prepaid Expenses 95
4.1.2 Unearned Revenue (Unearned Income) 99
4.1.3 Accrued Expenses 100
4.1.4 Accrued Revenue 101
4.2 Preparation of Adjusted Trial Balance 103
Summary 113
Key Terms 113
Topic 5 Completing the Accounting Cycle 114

5.1 Preparation of Financial Statements 115
5.1.1 Income Statement 115
5.1.2 Statement of Changes in OwnerÊs Equity 120
5.1.3 Balance Sheet 122
5.2 Preparation of Closing Entries 136
5.2.1 Steps in Preparation of Closing Entries 136
5.3 Preparation of Reversing Entries 139
Summary 143
Key Terms 143
Topic 6 Financial Reporting Standards 144

6.1 Statutory Requirement 145
6.2 Financial Report 148
6.2.1 Non-financial Information 148
6.3 Main Financial Statements 150
6.3.1 Statement of Comprehensive Income 151
6.3.2 Statement of Financial Position 153
6.3.3 Statement of Changes in Equity 154
6.3.5 Notes to the Accounts and Accounting Policies 155
Summary 158
Key Terms 158

TABLE OF CONTENTS  v
Topic 7 Trading Business Environment 159

7.1 Differences Between Trading Firms and Service Firms 159
7.2 Important Transactions in Trading Firms 163
7.2.1 Purchases 163
7.2.2 Sales 163
7.2.3 Discounts 164
7.2.4 Returns and Allowances 166
7.2.5 Transportation Cost 169
Summary 171
Key Terms 172
Topic 8 Accounting for Inventory 173

8.1 Methods of Recording Inventory 174
8.1.1 Periodic Inventory System 174
8.1.2 Perpetual Inventory System 175
8.2 Journal Entry for Periodic and Perpetual Inventory System 176
8.3 Examples of Recording Journal Entries 182
8.4 Inventory Valuation 186
8.4.1 Specific Identification 187
8.4.2 First in First Out Method (FIFO) 189
8.4.3 Last in First Out Method (LIFO) 190
8.4.4 Weighted Average Method 192
8.5 Format of Income Statement for Trading Firms 193
8.5.1 Single Level Income Statement 194
8.5.2 Multiple Level Income Statement 195
8.6 Closing Entries 200
Summary 208
Key Terms 209
Topic 9 Cash Management and Control 210

9.1 Composition of Cash 210
9.2 Cash Management 211
9.3 Internal Control of Cash 212
9.3.1 Internal Control of Cash Receipts 213
9.3.2 Internal Control of Cash Disbursements 214
9.3.3 Bank Statement as Mechanism of Internal Control 216
9.4 Bank Reconciliation 217
Summary 220
Key Terms 221

vi  TABLE OF CONTENTS
Topic10 Financial Statement Analysis 222

10.1 Purpose of Financial Statement Analysis 223
10.2 Sources of Information 224
10.3 Basis of Comparison 225
10.4 Techniques of Analysis 226
10.5 Horizontal Analysis 227
10.5.1 Comparison of Horizontal Analysis for 2 Years 228
10.5.2 Comparison of Horizontal Analysis for a 232
Sequential Period (Trend Analysis)
10.6 Vertical Analysis 233
10.6.1 Vertical Analysis for Balance Sheet 233
10.6.2 Vertical Analysis for Income Statement 235
10.7 Financial Ratio Analysis 238
10.8 Liquidity Ratio 239
10.9 Efficiency Ratio 241
10.10 Profitability Ratio 243
10.11 Debt Management Ratio 247
10.12 Sample of Ratio Calculations 249
Summary 264
Key Terms 264
Answers 265

COURSE GUIDE

COURSE GUIDE  ix
COURSE GUIDE DESCRIPTION

You must read this Course Guide carefully from the beginning to the end. It tells
you briefly what the course is about and how you can work your way through
the course materials. It also suggests the amount of time you are likely to spend
in order to complete the course successfully. Please keep on referring to the
Course Guide as you go through the course materials as it will help you to
clarify important study components or points that you might miss or overlook.
INTRODUCTION
BBAW2103 Financial Accounting is one of the courses offered at Open University
Malaysia (OUM). This course is worth 3 credit hours and should be covered over
8 to 15 weeks.
COURSE AUDIENCE
This is a core course for learners taking the Bachelor of Management, Bachelor of
Business Administration, Bachelor of Marketing, Bachelor of Tourism
Management and Bachelor of Hospitality Management programmes. For learners
undergoing the Bachelor of Human Resource Management, this is a basic major
course.
As an open and distance learner, you should be able to learn independently

and optimise the learning modes and environment available to you. Before you
begin this course, please ensure that you have the correct course materials,
understand the course requirements, and know how the course is conducted.
STUDY SCHEDULE
It is a standard OUM practice that learners accumulate 40 study hours for
every credit hour. As such, for a 3 credit hour course, you are expected to
spend 120 study hours. Figure 1 shows the student learning time (SLT).

x  COURSE GUIDE
Figure 1: Student Learning Time
COURSE LEARNING OUTCOMES

By the end of this course, you should be able to do the following:
1. Explain the fundamental concepts, principles and roles of financial

accounting information in a business organisation.
2. Illustrate the complete accounting cycle for services and trading companies
according to the accounting and reporting standards.
3. Evaluate the accounting process in trading companies, internal control and

financial statement analysis tools for better decision making.

COURSE GUIDE  xi
COURSE SYNOPSIS
This course is divided into 10 topics. The synopsis for each topic is listed
as follows:
Topic 1 discusses the Accounting Environment. It introduces you to accounting

fundamentals, involving the definition of accounting, users of accounting
information, branches of accounting, professional accounting bodies in Malaysia
as well as the fundamental concepts found in accounting. Also discussed are the
accounting assumptions and the four main types of financial statements in
financial reporting, namely Income Statement, Statement of Changes in Equity,
Balance Sheet and Statement of Cash Flows.
Topic 2 discusses the Basic Rules of Accounting. It begins with an understanding

of the accounting equation that leads to the usage of accounts as well as the rules
of debit and credit for each type of accounts (asset, liability and owner equity
accounts). The rules of debit and credit will also include the normal balance for
each type of accounts.
Topic 3 explains the accounting cycle which is basically the steps taken in the
recording process and preparation of financial statements. It includes the journal
entry, transfer of entries to ledger and consequently the preparation of a balance
sheet. A complete example of the whole process is included to provide better
understanding of the accounting cycle.
Topic 4 discusses the types of adjusting entries that affect the accounts in the
income statement and balance sheet. An adjusted trial balance is prepared after the
adjusting entries have been recorded and transferred.
Topic 5 completes the accounting cycle by using information from the adjusted
trial balance in Topic 4 to prepare the four basic components of financial
statements. The closing entries and reversal entries will also be covered in this
topic.
Topic 6 will discuss the requirements to prepare financial reports or annual reports
by registered business entities, statutory requirement on financial reporting, main
financial statements and accounting concepts as well as notes to the accounts.
Topic 7 introduces trading business activities, including purchases, sales,

transportation costs and discounts.

xii  COURSE GUIDE
Topic 8 covers accounting for trading, comprising preparation of journal entries,

inventory valuation and income statement. Emphasis will be given on accounting
for inventory using the perpetual and periodic inventory systems. The preparation
of income statement involving single and multiple levels will also be focused on.
Topic 9 covers cash management principles and internal control mechanisms for
cash. The preparation of bank reconciliation statement is also emphasised in this
chapter.
Topic 10 introduces us to financial statement analysis using the horizontal and

vertical analysis and financial ratio analysis. Financial ratio analysis that will be
discussed includes the liquidity, efficiency, profitability and debt management
ratios. These financial analyses are important in decision-making.
TEXT ARRANGEMENT GUIDE

Before you go through this module, it is important that you note the text
arrangement. Understanding the text arrangement will help you to organise your
study of this course in a more objective and effective way. Generally, the text
arrangement for each topic is as follows:
Learning Outcomes: This section refers to what you should achieve after you
have completely covered a topic. As you go through each topic, you should
frequently refer to these learning outcomes. By doing this, you can continuously
gauge your understanding of the topic.
Self-Check: This component of the module is included in strategic locations

throughout the module. It may be located after one subtopic or a few subtopics.
It usually comes in the form of a question. When you come across this component,
reflect on what you have already learnt thus far. By attempting to answer the
question, you should be able to gauge how well you have understood the
subtopic(s). Most of the time, the answers to the questions can be found directly
in the module itself.
Activity: Similar to Self-Check, the Activity component is also placed at various

locations or junctures throughout the module. This component may require you to
answer questions, explore short case studies or conduct an observation or research.
It may even require you to evaluate a given scenario. When you come across an
Activity, you should try to reflect on what you have gathered from the module
and apply it to real situations. You should, at the same time, engage in Higher
Order Thinking skills (HOTs) i.e. analysing, synthesising and evaluating instead
of only recalling and defining.

COURSE GUIDE  xiii
Summary: You will find this component at the end of each topic. It summarises
various important parts of each topic and helps you to recap the whole topic.
By going through the summary, you should be able to gauge your knowledge
retention level. Should you find points in the summary that you do not fully
understand, it would be a good idea for you to revisit the details in the module.
Key Terms: This component can be found at the end of each topic. You should
go through this component to remind yourself of important terms or jargon used
throughout the module. Should you find terms here that you are not able to
explain, you should look for the terms in the module.
References: A list of relevant and useful textbooks, journals, articles, electronic

contents and sources can be found in this section. The list may appear in a few
locations such as in the Course Guide (in the References section), at the end of
every topic or at the back of the module. You are encouraged to read or refer to
the suggested references to obtain additional information and enhance your
overall understanding of the course.
PRIOR KNOWLEDGE
There is no prior knowledge needed.
ASSESSMENT METHOD
Please refer to myINSPIRE.
REFERENCES
Horngren, C. T., Harrison, W. T. Jr., & Bamber, L. S. (2002), Accounting (5th ed.),
Prentice Hall, New Jersey.
Larson Kermit D., Wild John J., & Chiappetta Barbara, (2004) Fundamentals
accounting principles, (17th ed.), McGraw Hill.
Roger, H. H et al. (1997), Accounting: A business perspective, (7th ed.), Irwin US.
Warren et. Al (2001), Accounting: Customized by school of accountancy UUM for

business accounting students, Thompson Learning.

xiv  COURSE GUIDE
Warren, C. S., Reeve, J. M., & Fess, P. E. (2004), Accounting (21st ed.), International
Thompson Publishing, Ohio, USA.
Weygandt Jerry J., Keiso Donald E., & Kimmel Paul D., (2004) Accounting
principles, (7th ed.), John Wiley & Sons, Inc.
TAN SRI DR ABDULLAH SANUSI (TSDAS)

DIGITAL LIBRARY
The TSDAS Digital Library has a wide range of print and online resources
for learners. This comprehensive digital library, which is accessible through the
OUM portal, provides access to more than 30 online databases and several of
them are shown in Figure 2. As an OUM learner, you are encouraged to make
full use of the resources available through this library.
Figure 2: Among the Online Databases Available at TSDAS Digital Library

Topic

Accounting
1 Environment

LEARNING OUTCOMES
By the end of this topic, you should be able to:

1. Explain the meaning, role and importance of accounting;

2. Identify the users and branches of accounting;

3. Describe the main functions of professional accounting bodies
in Malaysia; and

4. Assess the qualitative characteristics of financial information,
assumptions, principles and constraints in accounting.

INTRODUCTION
Accounting plays an important role in our daily lives without us realising it.
Accounting is a financial information system that helps us make better economic
decisions. It is sometimes referred to as the language of business since it
communicates the financial performance and well being of an organisation.
We might assume that accounting is only important to businessmen or

accountants. In fact, we also need accounting in our daily lives. We need financial
information to make economic decisions. For example, when making a decision
on buying a new car, we need to know the total net income in a month (gross
income minus all expenses) to know whether we can afford to buy the car. We
also need to estimate other costs that might be involved in having a car.
This example is only a decision at an individual level. For a business entity, it

might need to make a decision on whether to buy a new building or just rent it
for operational purposes. Even though it is a higher level decision, the decision-
maker still requires the necessary financial information.

2 TOPIC 1 ACCOUNTING ENVIRONMENT
In this topic, you will be introduced to the basics of financial accounting. Among
them are the definition and branches of accounting, users of accounting
information, professional accounting bodies in Malaysia as well as the
fundamental concepts in accounting.
1.1 INTRODUCTION TO ACCOUNTING

What is accounting? Let us find the answer in this subtopic. In this subtopic we
will look at the definition of accounting and who are the users of accounting
information. Besides that, you will also learn what are the branches of accounting
and the professional accounting bodies in Malaysia.
1.1.1 Definition of Accounting

Accounting is an information system that prepares reports on the economic
activities of an entity for users to help them make better decisions. More
accurately:
Accounting is a process to identify, measure, record and present the

economic information of an entity to the users in order to help them make
evaluations or economic decisions.
Economic information are information related to economic activities; whereas an

entity refers to a business unit.
1.1.2 Users of Accounting Information

Users of accounting information are parties that use the accounting information
for specific purposes. The information required by the users might differ between
one group and another. Users of accounting information can be divided into two
groups - internal users and external users as reflected in Figure 1.1.

TOPIC 1 ACCOUNTING ENVIRONMENT 3
Figure 1.1: Users of accounting information
Now, let us look at each group:

(a) Internal users are parties that have direct access to the resources of an entity
and usually involved in the management of the entity, for example the
management of the company.
(b) External users would be the parties who do not have direct access to the
resources of the company and do not involved in the management of the
entity, for example the shareholders.
The other differences between these two groups are summarised in Table 1.1.
Table 1.1: Differences between Internal Users and External Users
Differences Internal Users External Users

Types of information Information that can help Information required are
required them make planning and different depending on the
exercise control over the type of decisions made.
entity.
Example:
Investor:
Require information on
the profitability of the
company before making
decision to invest.
Loan providers:
Require information on
the stability and liquidity
of the company before
making decision on giving
out credit.
How does the information Using the status or Limited to what is made
been obtained? position in the company. available by the company.
Example:
Annual report published
by the company.
1.1.3 Branches of Accounting

Accounting is divided into several different branches or other specialised fields.
Among them are:
(a) Financial Accounting;
(b) Management Accounting;
(c) Taxation; and
(d) Auditing.
These branches are not static as they evolve in time and requirement. The two
most important branches taught at foundation level are financial accounting and
management accounting. This financial accounting course will combine two of
the most basic and important accounting branches; that are financial accounting
and management accounting. Even though this course focuses on financial
accounting, it is important for you to know some of the differences between these
two branches. Let us look at Table 1.2.
Table 1.2: Differences between Financial Accounting and Management Accounting
Differences Financial Accounting Management Accounting

Preparation of report Preparation of financial Preparation of financial and
reports of an entity for non-financial information that
external and internal users are required by parties in the
but focus is given to the company for planning,
external users. evaluating and controlling
purposes of the operations of
an entity.
Standard or Format Financial reports produced Report is produced at any

are periodically and in time based on requirement
accordance to specified and is not subject to any
standard or format. standard or format.
Taxation or tax accounting is concerned with the computation and management

of income tax under the income tax laws. Almost every government in this world
imposes various taxes on eligible individuals and corporations to raise the
nationÊs revenue. Knowledge in taxation allow us to plan our tax obligations and
file our tax returns with the relevant government agencies.
On the other hand, auditing is a study of the systematic process in accounting

that examine the reliability and credibility of the accounting information
presented by an organisation. It involves reviewing and evaluating all

supporting documents or evidence to verify the economic transactions that are

purported to have taken place in the organisation. The procedures are done in
accordance with specific auditing standards to ensure that the financial
information are properly prepared to represent a true and fair view of the
financial information.
1.1.4 Professional Accounting Bodies in Malaysia

We also need to familiarise ourselves with the organisations that are involved in
the accounting profession in Malaysia. The organisations are:
(a) Malaysian Institute of Accountants (MIA)

MIA was established under the Accountants Act 1967 as the main
accounting body in the country. Overall, it functions as the core body in
regulating the accounting profession. Other major functions of MIA as
discussed in the Accountants Act 1967 are:
(i) To set the required qualification in order to become a member;
(ii) To provide training and education for practitioners or those who are
interested in becoming accounting practitioners;
(iii) To control the accounting practices in Malaysia; and
(iv) To protect the accounting interest in Malaysia.
(b) The Malaysian Institute of Certified Public Accountants (MICPA)

MICPA, formally known as „The Malayan Association of Certified Public
Accountants‰, was established in 1958 under the Companies Ordinances.
On 6 July 1964, the name was changed to „The Malaysian Association of
Certified Public Accountants‰ to reflect the change of name from Malaya to
Malaysia. Since February 2002, it is known as „The Malaysian Institute of
Certified Public Accountants‰. Among the main objectives and functions of
MICPA are:
(i) To advance the accounting theories and practices in all aspects;
(ii) To train and evaluate the competent members;
(iii) To ensure the independence of professional accountants; and
(iv) To oversee the practices and professional conducts of its members.
(c) Malaysian Accounting Standards Board (MASB)

MASB was established under the Financial Reporting Act 1997. Among the
main functions of MASB are:
(i) To set and approve new accounting standards;

(ii) To revise or accept the usage of existing standards as approved

accounting standards; and
(iii) To develop the conceptual accounting framework.
(d) Financial Reporting Foundation (FRF)

FRF was established under the Financial Reporting Act 1997 together with
MASB. Among the main functions of FRF are:
(i) To provide opinion to MASB on matters to be implemented;
(ii) To evaluate the performance of MASB; and
(iii) To be responsible for the overall funding of the operation of MASB,
including to approve its budget.

You may want to visit the following websites for further information regarding
the professional accounting bodies in Malaysia:
(a) Malaysian Institute of Accountants (MIA), www.mia.org.my
(b) The Malaysian Institute of Certified Public Accountants (MICPA),
www.micpa.com.my
(c) Malaysian Accounting Standards Board (MASB), www.masb.org.my
(d) Financial Reporting Foundation (FRF), www.masb.org.my
EXERCISE 1.1
1. Provide examples of common decisions made by both internal

and external users.
2. How does Financial Accounting and Management Accounting
assist users in making decision?
1.2 FUNDAMENTAL ACCOUNTING CONCEPTS

Do you know what are the fundamental accounting concepts? Well, in this
subtopic you will be exposed to the qualitative characteristics of accounting
information and accounting assumptions. Besides that we will look at the basic
principles of accounting and accounting constraints.

1.2.1 Qualitative Characteristics of Accounting

Information
In this subtopic, you will be exposed to the qualitative characteristics of
accounting information. For a start, let us look at what is qualitative
characteristics of accounting information.
Qualitative characteristics of accounting information refer to the

characteristics that must be present in the accounting information to make it
useful.
These characteristics are divided into two categories; primary and secondary
qualities. The primary qualities of accounting information are relevant and
reliable. While the secondary qualities are comparability and consistency. In
summary, accounting information is only useful if it has relevance, reliability,
comparability and consistency qualities.
Figure 1.2 shows the summary for qualitative characteristics of accounting

information.
Figure 1.2: Qualitative characteristics of accounting information
Let us discuss this further.
(a) Relevance
In everyday terms, we might describe relevant as important or being
related. In accounting, relevant is described as something that makes a
difference in arriving at a decision. In other words, something is said to be
relevant if it influences or affects the decision being made.
The extent to which information is considered relevant depends on its

importance in decision making and may differ between one decision maker
to another. Information that is relevant to you might not be relevant to
another person and vice versa.
For example, suppose you are an investor and you intend to buy shares of a
public listed company. What kind of information might be relevant to your
needs? You might want to know the profitability and performance of the
said company for the past five years, including new projects or products for
the company that will be profitable in the future. This information is
relevant as it will influence your decision. Suppose the information that
you obtained showed that the company is experiencing continuous losses
for the past five years and it does not have any new projects. Will you still
proceed with the proposal to invest in the company? Probably not.
Figure 1.3 shows an example of performance information of a company in

order to assist investors in decision making.
Figure 1.3: Performance information of a company to assist investor in decision

making
After knowing the meaning of relevant, you must also know how certain
information are said to be relevant. To become relevant, the information
must have three characteristics, namely feedback value, forecast value and
timeliness.
(i) Feedback Value
Relevant information must be able to assist users in substantiating or
correcting early expectations matters at hand.
(ii) Forecast Value
Relevant information must be able to assist users in forecasting.
(iii) Timeliness
Relevant information must be obtained before it becomes obsolete or
unusable.

(b) Reliability
Reliability means that users can rely or depend on the said information to
make good decisions. This characteristic is important because users might
not have the time or expertise to evaluate some information. Generally,
users simply depend on the information presented by the related entity and
assume it to be true. This information is then used in decision making.
Reliability does not mean that the said information must be precise. This is
because in accounting there are a lot of information that involves estimation
and approximation that might not be precise. What is important is that the
estimation and approximation made must be reliable.
Reliable information must have the following characteristics:

(i) Verifiable
This means that the accounting information could be verified
objectively by another person using the same method.
(ii) Objective
Objective in this case means that the information is not biased.
Information contained in the financial statements must be able to
fulfill the requirements of various users and not concentrating on
certain groups only.
(iii) Trustworthy
Information presented is based on the actual result of economic
activities using specified methods.
(c) Comparability
Comparability means that the information can be compared whether
among companies, industries or different periods. This will enable users to
identify the similarities or differences that might exist in the said
information. This characteristic is important because information that can
be compared is more useful.
Let us look at an example. Assume that you were told that the net profit of
a business in the year 2011 was RM5 million. Is this information useful?
This information would only be meaningful if you can compare it with the
net profit of the business in the year 2010 or the net profit of other
businesses in the same industry as shown in Figure 1.4. Thus, financial
statements contained in the Annual Report also include information on the
previous year in addition to the current year for comparison purposes.

Figure 1.4: Profitability comparison
(d) Consistency
Consistency means that an entity must use the same accounting procedures
in every period. It is for the purpose of enabling comparison to be made
more effectively. In other words, a company cannot change their accounting
procedure every year. This does not mean that the company cannot change
the accounting procedure at all. Changes can still be made, but the
company must make complete disclosure in the financial statement to
explain to the users why they are making the changes and the effect of the
changes towards the financial statements.
SELF-CHECK 1.1
What are the important qualitative characteristics of accounting

information?
ACTIVITY 1.1
In your opinion, what will happen to a business entity if it only

presents the qualitative characteristics of main accounting information
in its annual report?
EXERCISE 1.2
1. State the qualitative characteristics of accounting information.

2. Explain the meaning of comparability and provide an
example to show its role in making accounting information
useful.

1.2.2 Accounting Assumptions

In this subtopic we will discuss about accounting assumptions. There are four
accounting assumptions, created to aid the reporting entity and the users, which
are generally accepted. They are:
(a) Assumption of Separate Entity
For the purpose of accounting, an entity is assumed to be separated from its
owner and also other entities. An accounting entity is an economic entity in
its own right which controls resources involving economic activities. All
activities relating to the accounting entity must be separated from the
owner Ês activities or other accounting entitiesÊ activities. The examples
below should explain this concept clearly.
Example 1:
Assume that you own a business, your personal economic activities must be
kept separate from the businessÊ economic activities. If you wish to buy
products for personal use, you cannot take the businessÊ money and assume
that as part of the business activities. Instead, you must record it as
drawings. The Drawings Account shows the money or products from the
business taken by the owner for personal use.
Example 2:
Supposing you have just set up a business which offers computer repair
services. As it is a small business and you are the sole proprietor, the
businessÊ cash is deposited into your private account. Assume that on 31
December 2010, the bank balance of your account is RM5,000. Based on
your record, RM1,000 is the money from your business and the balance of
RM4,000 is funds for your studies.
If you did not comply with the assumption of separate entity and assume
RM5,000 is the money from your business, you might make an inaccurate
business decision. You might feel that your business has adequate funds
while in fact only RM1,000 is the businessÊ cash. Although all the money
belongs to you, from the accounting perspective, RM1,000 is for the
business funds and the balance of RM4,000 is the money for your education
purposes.
Segregation would enable you to evaluate the financial status of the

business much better and to make accurate decisions to enhance the
performance of the business. If an owner has more than one business entity,
each entity must be assumed as separate entity from the others.

Let us look at an example.
Assuming that Mr. Ali owns three different businesses, all three are
considered to be separated from accounting perspective. Accounting
records must be maintained separately; assets and liabilities for each
business cannot be mixed together. Segregation would enable the owner to
know the performance for each business.
As a simple example, suppose that Mr. AliÊs businesses show the following
result on 31 December 2010:
Table 1.3: Mr. AliÊs Business
Business Transaction (RM)

Business 1 Profit 6,000
Business 2 Loss 8,000
Business 3 Profit 12,000
If the assumption of separate entity is not complied with and all the entities
are assumed as one, Mr. Ali will have an overall business profit of
RM10,000 [RM6,000 + (-8,000) + RM12,000]. Based on this result, Mr. Ali
might be satisfied and might not take any measures for improvement.
However, by preparing separate accounts, Mr. Ali will know that Business
2 is facing problems as it is suffering a loss of RM8,000, while Business 3 is
performing very well with a profit of RM12,000.
(b) Assumption of Going Concern
According to this assumption, an entity is assumed to continue to exist and
in operation in the future. This assumption is important because it enables
the principle of historical cost to be applied. According to the historical cost
principle, all assets and liabilities must be recorded at the purchase price
(original cost). For most assets, this cost would be depreciated throughout
the life span of the assets to depict its usage. However, asset of property
would not be depreciated as its value would always appreciate.
As an example, a machine with a life span of 25 years will be depreciated

for 25 years based on the assumption of going concern. With this
assumption, the entity would continue to exist for a period of more than 25
years. If we assume that the entity would exist only for another 10 years in
absence of this assumption, we obviously cannot use 25 years as the basis
for calculating the depreciation.

The assumption also enables users to make decisions without any doubt or
worries. Suppose you are interested to invest in a company that has
consistently achieved high profits in the past few years. However, you were
informed that the company would exist only for another five years. Would
you still continue with your plan to invest in the said company? Generally,
we will only invest when we believe the company will continue to exist in
the future.
(c) Assumption of Monetary Unit
According to this assumption, all economic activities are measured and
valued in currency unit. In Malaysia, the currency unit used is Malaysian
Ringgit (RM). Only transactions that can be stated in currency unit will be
recorded for accounting purposes. Currency unit enables the transactions to
be summarised, reported and compared. Before the existence of currency,
transactions were conducted by way of exchanging goods (barter system).
The non-existence of currency unit had created difficulties in ascertaining
the value of transactions. With a countryÊs standard currency unit, we
would be able to value every product.
However, this assumption has two weaknesses, that are:

(i) It restricts the scope of accounting. Only transactions that can be
measured in monetary terms will be taken into account, neglecting
other factors that have impact on the business.
(ii) It assumes that the value of currency is constantly stable, whereas we
know that the currency value is always changing.
(d) Assumption of Accounting Period

In the assumption of going concern, we assumed that the entity will
continue to operate for an unlimited period. However, users (whether
manager, shareholders, loan providers or other parties) require periodical
measurements to help them making decisions. With this assumption, the
lifetime of the entity is divided into a certain period for the purpose of
reporting its economic activities. Normally the period selected is one year.
Financial reports must be produced every accounting year.
The selected accounting period can start from 1 January and ends on 31
December, or starts from 1 July and ends on 30 June the following year, and
so on depending on the operation of the company. For example, if an entity
is established on 1 March, it might choose an accounting period that starts
from 1 March and ends on 28 February of the following year. This
accounting period can be changed if the entity feels that there is a need to
do so.

Table 1.4 shows examples of accounting period.
Table 1.4: Examples of Accounting Period
Starting Date Ending Date

1 January 2010 31 December 2010
1 July 2010 30 June 2011
1 March 2010 28 February 2011
There are also companies which produce reports within a period of less than a
year, for example monthly, quarterly or half yearly. These reports are known as
interim reports. Interim report is normally produced to fulfill the requirement of
users that might need a more up-to-date report.
ACTIVITY 1.2
There is a company that has obtained high profits consistently for the
past 5 years and would exist for a period of another 10 years. Would
you invest in the company? Explain your decision.
1.2.3 Basic Principles of Accounting

After understanding the qualitative characteristics of information and accounting
assumptions, you will be exposed to the basic principles of accounting, which are
the principles used in the process to identify, measure, evaluate and report
financial information. There are four basic principles that you must know as
shown in Figure 1.5.

Figure 1.5: Basic principles of accounting
Now, let us look at the explanation of each principle.

(a) Principle of Historical Cost
According to this principle, all business resources will be recorded based on
historical cost, which is the original cost at time of purchase. Although the
value of the resources might change in the future, no adjustment will be
made to recognise the changes in the value.
For example, you want to buy a piece of land for your business site. The
seller set the price at RM80,000. You do not agree with the price and ask the
seller to sell it at RM70,000. After negotiation, the seller agreed with the
price of RM72,000. In this case, the land would be recorded at the value of
RM72,000 in your financial statement. Five years later, you wish to revalue
the land. The assessor informed you that the value of the land had
appreciated to RM120,000. Although there is a high appreciation in value,
you must still record it at the value of RM72,000, which is the original cost
of the land during the purchase.
The principle of historical cost is justified by its high reliability. The value
recorded in the financial statement is based on the original cost at the time
of purchase supported by documentation. This advantage is also a
weakness for certain parties. These parties criticised the failure of the

principle to recognise any possible changes in asset value. Regardless, this

principle is still adopted.
Alternatively, more and more managers prefer to record their resources at

fair value or current market value. Fair value is the value that is agreed by
both seller and buyer at an armÊs length transaction. It is argued that this
value is more relevant to reflect an organisationÊs well being since it
represents the current value of its resources. For example, a parcel of land
in a strategic location was bought for RM50 million 10 years ago will not be
worth the same now. To record it at historical cost, which is RM50 million,
would be misstating the assetÊs worth at present time. Using fair value
accounting, the land might be recorded at twice the price it was originally
purchased due to supply and demand of the current market.
(b) Principle of Income Recognition

Principle of income recognition provides guidance regarding when and
how to recognise income. The three conditions that must be complied with
before income is recognised are:
(i) The seller had performed the necessary actions to obtain the income
(for example, providing the goods for trade or rendering services);
(ii) The amount of income can be measured objectively; and
(iii) The income can be collected.
Normally, income is recognised at the point of sale. The point of sale refers
to a situation whereby ownership has been transferred from the seller to the
buyer, notwithstanding whether the cash has been received or not. For an
entity that offers services, the point of sale is when the service has been
provided to the customer.
However, in certain cases, the point of sale method is inappropriate. There

are several different methods that can be used, for instance the percentage
of completion and cash basis methods.
(i) Percentage of Completion Method is normally used by companies
involved in the construction industry which takes a long time to
complete. For example, a housing project might take three years to
complete. It would be inappropriate to recognise the revenue only
after the project is completed. This is because revenue and expenses
accrued throughout the duration of the project that could be
determined periodically based on the degree of completion. This
method is more appropriate because it complies with the accounting
period principle and provides a true picture of the project
development.

(ii) Cash Basis Method complies with the basis of cash

accounting.According to this method, revenue is only recognised
when cash is received. This method is applied in credit transactions
when cash receipts are not assured.
(c) Principle of Matching

This principle matches the expense (effort) with the revenue (benefit
obtained from the effort). The matching of the revenue with the expense
will be done when the transaction has completed. To comply with this
principle, two steps will be involved, which are:
(i) First Step
Recognition of the revenue for a specific period.
(ii) Second Step
Recognition of all the expenses involved in ascertaining the revenue.
For example, when we provide services to customers, we will recognise the

revenue according to the principle of income recognition. Then, we will
recognise all the expenses involved in generating the revenue and match
them with the revenue. The difference between the revenue and the
expense will be either profit or loss. If revenue is more than expense, the
difference will be net profit. However, if the revenue is less than expenses,
the difference will be recognised as net loss. Figure 1.6 summarises the
concept of profit and loss.
Figure 1.6: The relationship between revenue and expense
(d) Principle of Full Disclosure

The principle stresses for the full disclosure of all relevant information and
material in the financial statement whether in the statement itself or in the
notes to the accounts. This is to ensure that the users can make proper
decisions. The disclosure of financial statements will be explained in detail
in Topic 6.

EXERCISE 1.3
1. What is the purpose of accounting?

2. Briefly explain the main functions of Malaysian Institute of
Accountants (MIA) and Malaysian Accounting Standards Board
(MASB).
3. What is the importance of accounting assumptions?
4. How are the accounting period and going concern assumptions
related?
5. Why is the principle of income recognition important?
6. What is meant by materiality in accounting?
7. How does the balance sheet of an entity provide a useful source
of information?
8. Explain the weaknesses exist in the assumption of monetary
unit.
9. Describe three conditions that must be fulfilled before revenue
can be recognised.
1.2.4 Accounting Constraints

We have seen the principles that must be complied with in accounting. However,
there are constraints or obstructions that might result in these principles not
being complied with. The main constraints in accounting are:
(a) Cost-Benefit Relationship
Before deciding on obtaining specific information, a company would
normally analyse the cost involved and the benefit that may be gained from
the information. If the cost of obtaining the information is very high but the
benefit generated is not so much, the company might not reveal the
information even though all information must be completely disclosed in
accordance with the principle of full disclosure.
(b) Materiality
Materiality refers to the effect of an item towards the overall operation of
the entity. An item is considered immaterial if it does not affect the decision
that will be made. Materiality is often measured based on size. A
transaction that involves a huge amount is normally treated as material. A

material transaction must be disclosed in detail, while immaterial

transactions are sometimes combined or not disclosed in detail.
For example, a small amount of expense like a purchase of stamps and fares
are combined into one account known as sundry expenses. Another
example will be the practice of approximation. You can see examples in the
annual report published by companies. Generally, companies would not
record the cents value, but instead will round the figures up to the nearest
ringgit (example: RM471.20 is recorded as RM471). For larger companies, it
might make the approximation to the nearest hundred ringgit (example:
RM525,795 is recorded as RM525,800).
On the other hand, materiality may also be affected by the nature, not the
size, of the transaction. For example, those transactions that might involve
bribery or environmental damage in any form might be relevant to a
personÊs decision making whether to invest or not to invest in a particular
company.
1.3 TYPES AND OBJECTIVES OF FINANCIAL

STATEMENT
After the transactions have been identified, analysed and recorded, we need to
prepare a report for the users. This report is the final product of the accounting
process and is known as financial statement. There are five types of financial
statement that you need to know:
(a) Income Statement/Statement of Comprehensive Income;
(b) Statement of Changes in Owner Ês Equity/Statement of Changes in Equity;
(c) Balance Sheet/Statement of Financial Position ;
(d) Statement of Cash Flows; and
(e) Information on Accounting Policy and Explanatory Notes.
These statements are interconnected with one another. The title for each
statement must contain the reporting entityÊs name, type of statement and the
reporting period covered. In this section, we will see in summary, the format for
each of the four statements based on the transactions for Reen Cyber Service. We
will learn about the preparation of each statement in detail in Topic 5.

Figure 1.7: Types of business
Let us take a look at Figure 1.7. Generally, businesses are divided into three
types, which are sole proprietorship, partnership and company. Sole
proprietorship is owned by a single owner while partnership is owned by 2 to 20
owners. Financial statements for these two types of business are not subject to the
standards released by MASB. Therefore, there might be several formats used by
these two types of business.
Companies can be divided into private and public companies. Private companies
can be owned by 2 to 50 owners. However, there are unlimited number of
owners for public companies. To protect the public interest in public companies,
the preparation of their financial statements is subject to the standards released
by MASB, whether in the form of accounting method, disclosure and reporting
format.
1.3.1 Income Statement

This statement is also known as Profit and Loss Statement which lists all the
revenues and expenses incurred by the entity for a specific period. The difference
between the revenue and expense will result in either net profit or net loss.
Excess of revenue over expense will give us net profit, while expense in excess of
revenue will give us net loss. Figure 1.8 shows the income statement for Reen
Cyber Service for the month ended 30 November 2010.

Figure 1.8: Income statement
1.3.2 Statement of Changes in Owner’s Equity

This statement shows the changes in ownerÊs equity for a specific accounting
period. OwnerÊs equity will increase when the owner makes a capital investment
or when the entity gains net profit. OwnerÊs equity will decrease when the owner
makes drawings or when the entity incurs net loss. Figure 1.9 shows the
statement of changes in ownerÊs equity for Reen Cyber Services.
Figure 1.9: Statement of changes in owner Ês equity

1.3.3 Balance Sheet

This statement is also known as the financial position statement, listing all the
assets, liabilities and ownerÊs equity of the entity on a specific date. The purpose
of this statement is to show the financial status of the entity on a specific date.
There are two formats normally used, which are the statement format and
accounts format. The accounts format places the asset on the left side with
liability and ownerÊs equity on the right side (refer to Figure 1.10 and
Figure 1.11).
Figure 1.10: Balance sheet in accounts format
In the statement format, the asset, liability and ownerÊs equity are listed
vertically.

Figure 1.11: Balance sheet in statement format
1.3.4 Statement of Cash Flows

This statement reports all the cash receipts and payments of the entity in a
specific period. Through this statement, the users will know the sources of cash
received and why cash is paid. The difference between cash inflows and outflows
will provide the final cash account balance of the entity. This balance will be the
same as the cash amount shown in the Balance Sheet. In the cash flow statement,
cash transactions are divided according to the type of activities, which are
operating, investing and financing activities. Figure 1.12 shows the cash flow
statement for Reen Cyber Services.

Figure 1.12: Statement of cash flow
Cash flows from operating activities include cash receipts and payments from a
business main activities such as trading and staff salaries. Cash flows from
investing activities involve cash transactions from purchases and sales of non-
current assets. Cash flows from financing activities are long-term cash
borrowings and repayments lenders and cash investments and withdrawals
made by owner.
ACTIVITY 1.3
Discuss the issues that might arise if a business entity did not disclose
the relevant information in its financial statement. Present in your
tutorial.

EXERCISE 1.4
1. The accounting process does NOT include:

A. Identification
B. Verification
C. Recording
D. Communication
2. Which of these is NOT a qualitative characteristic of accounting

information?
A. Materiality
B. Reliability
C. Relevant
D. Comparability
3. One example of internal user is:

A. Inland Revenue Board
B. Investor
C. Creditors
D. Management
4. Net Loss in a period will result when:

A. Liabilities exceed assets
B. Assets exceed income
C. Expenses exceed income
D. Income exceeds liabilities
5. For the purpose of simplifying accounting, the business owner

and business entity are assumed as the same.
True False

6. The accounting period for all businesses must start from 1

January and ends at 31 December each year.
True False
7. The monetary unit assumption allows accounting to measure
economic events for recording purpose.
True False
8. Income statement shows the net profit or loss of a business
entity at a specific date.
True False
9. Fair value accounting provide a more reliable measurement of
assets compared to historical cost accounting.
True False
EXERCISE 1.5
1. Below are the assets and liabilities accounts balances for Seri
Consultation Services as at 31 December 2008 including the
revenue and expense incurred throughout the year 2008. On 1
January 2008, the capital of Miss Seri Devi (the owner) is RM22,200.
Throughout the year, she made a cash drawings of RM6,000 but no
records of it has been made.
Account Amount (RM)

Accounts payable 1,200
Accounts receivable 18,855
Supplies 8,480
Supplies expenses 6,300
Tax expenses 4,200
Salary expenses 18,000
Sundry expenses 1,265
Rental expenses 14,400
Utility expenses 7,350
Service income 78,750
Cash 23,300

Required:
Based on the information given, prepare:
(a) Income Statement for the year ended 31 December 2008.
(b) Statement of Changes in Owner Ês Equity for the year ended 31
December 2008.
(c) Balance Sheet as at 31 December 2008.
2. A summary of cash flows during the period ended 30 June 2011

for Samrah Florist is provided below:
Cash receipts from: RM

Customer 38,000
Owner investment 10,000
National Bank 25,000
Sales of old equipment 3,500
Cash payments from:

Purchases of motor vehicles 33,000
Suppliers 15,000
Staff salaries 6,000
Utilities 1,285
Drawings by owner 500
Interest on loan 1,250
The cash balance on 1 July 2010 was RM2,170.
Required: Prepare a statement of cash flows for Samrah Florist for the
year ended 30 June 2011.
The users of accounting information consist of internal users and external

users.
The difference between financial accounting and management accounting

are:
– Financial accounting prepares the financial report for external users while
management accounting prepares the monetary and non-financial
information for internal users.

– The financial reports in financial accounting is produced periodically and

subject to specified format while the report for management accounting is
produced according to specific needs and not subject to specified
standards.
The professional bodies involved in the accounting profession are Malaysian

Institute of Accountants (MIA), The Malaysian Institute of Certified Public
Accountants (MICPA), Malaysian Accounting Standards Board (MASB) and
Financial Reporting Foundation (FRF).
The assumptions and fundamental principles of accounting consist of:

– Assumption of separate entity;
– Assumption of going concern;
– Assumption of monetary unit;
– Assumption of accounting period;
– Principle of historical cost;
– Principle of income recognition;
– Principle of matching; and
– Principle of full disclosure.
Financial statement is the final product of the accounting process and it

consists of Income Statement, Statement of Changes in Owner Ês Equity,
Balance Sheet and Cash Flow Statement.
Accounting Auditing External users Management accounting

Fair value Materiality
Financial accounting Monetary unit
Full disclosure Qualitative characteristics
Going concern Separate entity
Historical cost Taxation
Internal users

Topic

Basic Rules of
2 Accounting

LEARNING OUTCOMES

1. Explain the accounting cycle;

2. Apply the accounting equations;

3. Analyse transactions based on the accounting equation;
4. Describe the chart of accounts for recording and summarise the
effect of transactions on financial statement;
5. Explain the format of accounts used; and
6. Assess the rule of debit and credit for each type of accounts.

INTRODUCTION
Before anything is recorded in the accounts, we need to identify what events
have occurred that relate to the business entity. These events must have
economic consequences to the business to be considered a transaction. After the
transactions are identified they must be analysed and properly classified before
they actually enter the recording system.
2.1 ACCOUNTING CYCLE

As explained in Topic 1, accounting is a process, which is repeated every period
to report the performance and financial position of an organisation. It starts with
recognising and recording business transactions and ends with a complete set of
financial statements. This whole process is known as the accounting cycle. The
main steps involved in the accounting cycle are:

30 TOPIC 2 BASIC RULES OF ACCOUNTING
(a) Identifying business transaction;

(b) Analysing transactions;
(c) Journalising transactions;
(d) Posting transactions to ledger accounts;
(e) Preparing trial balance;
(f) Preparing adjusting entries at the end of period;
(g) Preparing adjusted trial balance;
(h) Preparing financial statements; and
(i) Closing temporary accounts.
This can be depicted in Figure 2.1.
Figure 2.1:The accounting cycle
The first two steps will be discussed in this topic while the rest of the steps,
which is the recording process, will be detailed in the next topic.

TOPIC 2 BASIC RULES OF ACCOUNTING 31
The accounting cycle starts when you can identify a transaction that affects the
business entity economically. Each transaction must be accompanied by a source
document to verify that the transaction actually occurs. Each source document
will be analysed and used as a basis of recording a transaction. For example,
when a purchase of inventory is made, the firm will either received an ÂinvoiceÊ if
it purchases on credit or a ÂreceiptÊ if it purchases with cash. Either one of this
document will be kept as evidence that the transaction, i.e. purchases of
inventory, has taken place. So, a source document is important to prove that an
economic event has taken place in a business entity. Now we can begin to
analyse the transaction using the rules in accounting equation.
2.2 ACCOUNTING EQUATION

Accounting equation is the basis of accounting that will always be used each time
before we record a transaction. It consists of three components or basic elements,
which are asset, liability and owner Ês equity.
What is asset?
Asset is the resources that can bring economic benefit, owned by the entity.
For example cash, building and fittings.
For each resource, there must be a claim or rights on it. A simple example, if you
own some money, the money belongs to you. If you buy a vehicle with bank
loan, the ownership of the vehicle is claimed by the bank until you have settled
your loan. In other words, the vehicle is not owned by you (but is owned by the
bank) until you have settled your entire loan.
It is the same in business. Every asset owned by the business can be claimed
either by the owner itself, or loan providers. Rights or claims made by the loan
providers are known as liabilities, whereas the rights or claims made by the
owner itself are known as equities.
Loan providers have priority over the rights to the business assets. If the entity is
facing problems, it must first settle its loans. The owner can only claim his rights
if there are assets left. Therefore, liability is put ahead of owner Ês equity in the
accounting equation as shown below:
ASSET = LIABILITY + OWNERÊS EQUITY

SELF-CHECK 2.1
A business has assets of RM120,000. RM50,000 is the ownerÊs capital

and the balance is bank loan. What is the accounting equation?
2.2.1 Analysis of Transaction

You must always remember that the accounting equation is always equal
regardless of the transaction that has transpired. All transactions can be stated by
changes in the three components of the accounting equation. Now we will look at
a few common transactions and analyse the results on the accounting equation.
We will use the example of a sole proprietor business owned by Reen. Reen, who
is skilled in the computer field, has established her own company on 1 November
2010. For a start, the business (Reen Cyber Service) offers services in computer
consultancy. If successful, Reen intends to expand her business to sell computers.
The following is a list of transactions incurred by Reen Cyber Service throughout
the month of November 2010:
Table 2.1: List of Transactions for Reen Cyber Service, November 2010
No. Date (Nov) Transactions

1 1 Reen invested cash of RM30,000 into Reen Cyber Service.
Purchased a piece of land valued at RM20,000. The business
2 2
paid cash RM5,000 and the balance is financed by bank loan.
3 4 Purchased office supplies valued at RM2,700 on credit.
Received revenue from consultancy services provided to
4 15
customer. The customer paid RM15,000 cash.
Paid staff salary expense RM4,250; Rental expense RM1,600;
5 30
Utility expense RM900 and Other expenses RM550.
6 30 Made payment for account payable of RM1,900.
7 30 Unused office supplies valued at RM1,100.
Reen withdrew money from the business amounting to
8 30
RM4,000 for her personal use.

All the transactions in Table 2.1 are pertaining to Reen Cyber Service. The
personal transactions of the owner (Reen) will not be taken into account if it does
not involve the business. Now we have to analyse each transaction to see their
effects on the accounting equation.
Figure 2.2 shows the effect of revenue, capital, expenses and drawings on
ownerÊs equity.
Figure 2.2: Analysis of transaction
Transaction 1:
Reen invested cash of RM30,000 into Reen Cyber Service. Again, it needs to be
emphasised that we are only interested in transactions involving Reen Cyber
Service, and not ReenÊs personal transactions. Therefore, even though the cash
owned by Reen was reduced by RM30,000, the cash owned by Reen Cyber
Service has increased by RM30,000. This capital was contributed by Reen.
Therefore, owner Ês equity will increase by RM30,000.
Transaction ASSET = LIABILITY + OWNERÊS EQUITY

Cash Capital, Reen
1 30,000 = 30,000
Transaction 2:
The business entity purchased a piece of land valued at RM20,000, paying
RM5,000 by cash and the balance of RM15,000 being financed by bank loan.
From this transaction, the business will have a new asset (land) valued at
RM20,000. The businessÊ cash is reduced by RM5,000 while a new liability of
RM15,000 is created. Bank loan is always represented by the account Notes
Payable (NP). Note that the equation still holds true. The asset section increased
by RM15,000 and the liability section also increased by RM15,000.
„Balance‰ shows the final balance for each item after every transaction.

OWNERÊS
Transaction ASSET = LIABILITY +
EQUITY
Cash + Land NP Capital, Reen

Balance 30,000 = 30,000
2 (-5,000) + 20,000 = 15,000
Balance 25,000 20,000 = 15,000 30,000
Transaction 3:
Purchased office supplies valued at RM2,700 on credit. The asset will increase by
RM2,700. The purchase by credit will create a new liability, which is Account
Payable (AP).
OWNERÊS
EQUITY
Cash + Land + Supplies NP + AP Capital,
Reen
Balance 25,000 + 20,000 = 15,000 + 30,000
3 2,700 = 2,700
Balance 25,000 20,000 2,700 = 15,000 2,700 30,000
Normally, office supplies bought are not only used in the current accounting period.
The purchase of office supplies are prepaid expenses. The usage of office supplies for
the specific period is recorded by using the account Supplies Expenses.
Transaction 4:
Received revenue from consultancy services provided to customer. The customer
paid RM15,000 cash.
OWNERÊS
EQUITY
Capital,
Cash + Land + Supplies NP + AP
Reen
Balance 25,000 + 20,000 + 2,700 = 15,000 + 2,700 + 30,000
15,000
4 15,000 = service
revenue
Balance 40,000 20,000 2,700 = 15,000 2,700 45,000

Service revenue is one of the components in ownerÊs equity. The other

components are expenses and drawings. Revenue will increase the ownerÊs
equity while expenses and drawings will reduce it.
Transaction 5:
Paid salary expense RM4,250; rental expense RM1,600; utility expense RM900
and other expenses RM550.
OWNERÊS
EQUITY
Reen
Balance 40,000 + 20,000 + 2,700 = 15,000 + 2,700 + 45,000
5 (-4,250) = (-4,250)
paid salary
(-1,600) = (–1,600)
paid rental
(-900) = (-900)
paid utility
(-550) = (-550)
paid
sundry
Balance 32,700 + 20,000 + 2,700 = 15,000 + 2,700 + 37,700
In this transaction, all the expenses were paid by cash. Therefore, cash will
decrease according to the amount involved. Each expenses item has to be
recorded separately and cannot be combined. As explained in Transaction 4,
expenses will reduce owner Ês equity.
Transaction 6:
Made payment for account payable of RM1,900. When the business paid
RM1,900, cash will decrease by RM1,900 and liability will also decrease by
RM1,900.

OWNERÊS
EQUITY
Reen
Balance 32,700 + 20,000 + 2,700 = 15,000 + 2,700 + 37,700
6 (-1,900) = (-1,900)
Balance 30,800 + 20,000 + 2,700 = 15,000 + 800 + 37,700
Transaction 7:
At the end of the month, the unused office supplies were valued at RM1,100. The
office supplies was originally bought for RM2,700. The value of office supplies
used up during the period is RM1,600 (RM2,700 – RM1,100)
OWNERÊS
EQUITY
Reen
Balance 30,800 + 20,000 + 2,700 = 15,000 + 800 + 37,700
7 (-1,600) = (-1,600)
Supplies
expenses
Balance 30,800 + 20,000 + 1,100 = 15,000 + 800 + 36,100
Transaction 8:
Reen withdrew money from the business amounting to RM4,000 for her personal
use.
OWNERÊS
EQUITY

Reen
Balance 30,800 + 20,000 + 1,100 = 15,000 + 800 + 36,100
8 (-4,000) = (-4,000)
cash
drawings
Balance 26,800 + 20,000 + 1,100 = 15,000 + 800 + 32,100

Drawings is the reverse of capital investment. Capital investment will increase

the capital (example in the form of cash) of the business. Drawings will reduce
the capital. At the end of the accounting period, the drawings account will be
closed and the balance will be transferred to the capital account. Therefore,
drawings will be recorded as a reduction in capital account. Although both
drawings and expenses reduced capital, there is a clear difference between these
two types of accounts. Drawings are not for the purpose of generating revenue,
but for the owner Ês personal use.
2.2.2 Summary of Analysis

Some important items that we must be aware of during the analysis of
transaction:
(a) Each transaction will affect, either as an increase or decrease, one or more
components in the accounting equation. However, each transaction will
definitely involve more than one item in the financial statements;
(b) The accounting equation explained at the earlier stage will always be equal.
You can examine this yourself by looking into the „Balance‰ section after
every transaction analysis; and
(c) Owner Ês equity will increase with investment from the owner and revenue,
while drawings by the owner and expenses will reduce owner Ês equity.
Table 2.2 is a summary of analysis for all the transactions of Reen Cyber Service.
After all the transactions have been recorded, we will discover that the
accounting equation will still be equal.

Table 2.2: Summary of Analysis of Transaction for Reen Cyber Service, November 2010
OWNER
EQUITY

Reen
1 30,000 = 30,000
investment
by Reen
Balance 30,000 = 30,000
2 -5,000 20,000 = 15,000
Balance 25,000 + 20,000 = 15,000 + 30,000
3 2,700 = 2,700
Balance 25,000 + 20,000 + 2,700 = 15,000 + 2,700 + 30,000
4 15,000 = 15,000
service
revenue
Balance 40,000 + 20,000 + 2,700 = 15,000 + 2,700 + 45,000
5 (-4,250) = (-4,250)
paid salary
(-1,600) = (-1,600)
paid rental
(-900) = (-900)
paid utility
(-550) = (-550)
paid sundry
Balance 32,700 + 20,000 + 2,700 = 15,000 + 2,700 + 37,700
6 (-1,900) = (-1,900)
Balance 30,800 + 20,000 + 2,700 = 15,000 + 800 + 37,700
7 (-1,600) = (-1,600 )
expenses
supplies
Balance 30,800 + 20,000 + 1,100 = 15,000 + 800 + 36,100
8 (-4,000) = (-4,000) cash
drawings
Balance 26,800 + 20,000 + 1,100 = 15,000 + 800 + 32,100

47,900 = 15,800 + 32,100
47,900 = 47,900

2.3 CHART OF ACCOUNTS

When we analysed the transactions in the example of Reen Cyber Service, we
have recorded and summarised the transactions that occurred using the
accounting equation format. Although this format is easy to understand, it will
become difficult to use when there are a lot of transactions to be recorded daily.
From the example in the previous subtopic, we have analysed 8 transactions in a

period of one month. In an actual situation, a medium-sized service firm may
have several transactions in a day. If we use that accounting equation format, we
will need a huge amount of space. Whenever there is a new item, we must add it
into the limited columns available. We need to reshuffle the whole original
format to accommodate this change. This also applies if errors are detected. It
would be difficult for us to make any alteration without re-arranging the whole
original format.
As a result, the accounting system was created to show the increase or decrease
of each item in the financial statement separately. The separate recording of each
item is known as account. As an example, cash account is a separate recording
especially to show the increase or decrease in the cash item. This also applies to
other items like account payable, service revenue and salary expense.
The group of accounts in a business entity is known as ledger. The list of

accounts in the ledger is known as a chart of accounts. Chart of accounts was
created particularly to enable the users of financial statements to refer to specific
accounts. Each account is given a special number as reference. These accounts are
normally listed systematically in the financial statement. Normally in the chart of
accounts, balance sheet items (asset, liability and ownerÊs equity) are put in front,
followed by income statement items (revenue and expense).
SELF-CHECK 2.2
Why must transactions be recorded in accounts and not some other

format? Explain.

Now let us look at Figure 2.3 which summarises the concept of ledger and chart
of accounts.
Figure 2.3: Ledger and chart of accounts
Figure 2.3 explains the chart of accounts clearly. This chart will be used as an
example in this topic. New accounts will be introduced in the following units
when the entity increases its business scope. The chart is created by the entity
itself. Therefore, the chart of accounts between one entity and another entity
might be different.
Table 2.3 shows the chart of accounts for Reen Cyber Service. Its chart of accounts
consists of only two digits. The first digit will show the type of account (example:
1 for asset account, 2 for liability account, 3 for owner Ês equity account, 4 for
revenue account and 5 for expense account). The second digit will show the
account itself. For larger businesses, the chart might consist of three to four digits.
If the entity has a branch at different location, the first digit might be used to
show the branch location.

Table 2.3: Chart of Accounts for Reen Cyber Service
Accounts in Balance Sheet Accounts in Income Statement
1 ASSETS 4 REVENUE
11 Cash 41 Service revenue
12 Account receivable
14 Supplies
15 Insurance prepayment
17 Land
18 Office equipment
2 LIABILITIES 5 EXPENSES
21 Account payable 51 Salary expenses
22 Notes Payable 52 Rental expenses
23 Deferred Rental 53 Utility expenses
54 Supplies expenses
3 OWNERÊS EQUITY
55 Sundry expenses
31 Capital, Reen
32 Drawings, Reen
EXERCISE 2.1
Which of these events can be considered as a transaction and must be
recorded? Explain.
(a) The death of a branch manager.
(b) The capital contribution of the owner into the business.
(c) The hiring of new staff.
(d) The inventory taken by owner from business.
2.4 FORMAT OF ACCOUNT

Do you know how many account formats are available for company? Now, we
will look each account which has three sections:
(a) Title or name of the account, which is the name of the items recorded in
that particular account.
(b) Debit section on the left side.
(c) Credit section on the right side.

The debit and credit section are used to record either the increase or decrease in
the specific account. However, do remember that, debit does not necessarily
show an increase and that credit does not necessarily show a reduction. It
depends on the type of account. This subject will be explained in detail later
under the rule of debit and credit.
Accounts are also known as T-accounts due to their shapes that look like the letter T
(refer Figure 2.4).
Figure 2.4: T-Account (simple format)
Each section of the T-account should have four columns in the debit section and
four columns in the credit section (refer Figure 2.5).
Debit Account Title Credit
Date Description Reference Amount Date Description Reference Amount
Figure 2.5: T-Account (detailed format)
There is another format of account known as the three column account (refer Figure
2.6). Although in fact there are actually six columns in this accountÊs format, the
three columns refer to the debit, credit and balance columns. An advantage of this
format is that it can show the latest account balance at any particular time.
Date Description Reference Debit Credit Balance
Figure 2.6: Three column account format
2.5 RULES OF DEBIT AND CREDIT

We have previously stated that asset, liability and ownerÊs equity are the three main
components in the accounting equation. Other items that are involved include
drawings, revenue and expense. Every transaction that occurs will involve debit and
credit and every transaction will affect at least two accounts. For every transaction,
the total debit must be equal to the total credit. This is the basis of the double entry
system. This rule of debit and credit is important to ensure that we make accurate
recording. Table 2.4 shows the rules of debit and credit for each type of accounts.
Table 2.4: Rules of Debit and Credit
Type of Account Increase Decrease

Asset Debit Credit
Liability Credit Debit
Capital Credit Debit
Drawings Debit Credit
Revenue Credit Debit
Expense Debit Credit
Table 2.4 shows that when the asset account increases, we will debit the said
account. For example, when the entity receives cash, we will debit cash account.
When the asset account decreases, we will credit the said account. For example,
when the entity made cash payment, we will credit the entityÊs cash account.
Refering to Table 2.4, we will discover that the nature of the asset account is
opposite to that of the liability and ownerÊs equity accounts. To observe this more
clearly, please refer back to the accounting equation we had learnt:
The asset item is on the left side while the liability and ownerÊs equity are on the
right side. Asset is the economic resources owned by the entity while liability and
owner equity are parties claiming ownership on the asset. Therefore, asset is the
opposite of liability and ownerÊs equity.
SELF-CHECK 2.3
Identify the characteristics that allow an event to be viewed as a

transaction and therefore must be recorded.

2.5.1 Normal Balance

Normal balance is included in the rule of debit and credit. This refers to the
balance ordinarily shown in the account.
Let us take the asset account as an example. When asset increases, the account is
debited. When asset decreases, the account is credited. Therefore, the normal
balance for asset account is debit. This is because the reduction in asset normally
would not exceed the increase that had occurred. As a simple example, if we
have cash of RM1,000 in the bank, normally we cannot withdraw more than the
said value. Table 2.5 shows the rules of debit and credit including the normal
balances for each type of accounts.
Table 2.5: The Rules of Debit and Credit Including Normal Balances
Type of Account Increase Decrease Normal Balance

Asset Debit Credit Debit
Liability Credit Debit Credit
Capital Credit Debit Credit
Drawings Debit Credit Debit
Revenue Credit Debit Credit
Expense Debit Credit Debit

Note that the normal balance for each account is the same as the increase in the
said account.
The rule of normal balance is important as it may help you to identify errors. For
example, if the land account has a credit balance, you might have made a mistake
in recording. However, you must also remember that normal balance is the balance
that is ordinarily shown. The cash account that normally has a debit balance can
also have a credit balance. This occurs when a company has withdrawn more cash
than what is available. This might occur if the company has an overdraft
agreement with the bank. When an entity has an overdraft agreement with the
bank, it will be allowed to withdraw more money than what it is available in its
account. The amount that can be withdrawn is subject to agreement.
ACTIVITY 2.1

EXERCISE 2.2
1. What is meant by account, ledger and chart of accounts?

2. Describe two account format of that you have learnt. Which is
the easier format? Which format do you find more helpful?
3. What is the importance of source documents? Give some
examples of source document.
4. Briefly explain the rules in accounting equation.
5. Drawings and expense will reduce ownerÊs equity. Discuss the
difference between these two terms.
6. Claims made by third parties on a business assets are called:
A. Assets
B. Liabilities
C. Owner's equity
D. Expenses
7. Which of the following accounts have a normal debit balance?
A. OwnerÊs capital
B. Deferred rental
C. Prepaid expense
D. Service revenue
8. A credit balance in which account might indicate an error?
A. Rental revenue
B. Accounts payable
C. Drawings
D. Capital

9. If revenue = RM12,000; expense = RM8,400 and drawings by

owner = RM2,000; how much is the net profit or net loss for that
period?
A. Net profit RM5,600
B. Net loss RM3,600
C. Net profit RM1,600
D. Net profit RM3,600
10. If the total assets increased by RM15,000 and the total liabilities
decreased by RM10,000; ownerÊs equity had:
A. Increased by RM5,000.
B. Decreased by RM5,000.
C. Increased by RM25,000.
D. Decreased by RM25,000.
EXERCISE 2.3
Answers the questions below.
1. Determine the appropriate amount in the spaces marked „?‰

(a) 84,000 = ? + 38,000
(b) ? = 72,000 + 28,000
(c) 125,000 = 50,000 + ?

2. State the effects of the following transactions on the asset, liability and
ownerÊs equity. An example is shown in transaction (a):
Transaction Effect
(a) Paid debts to supplier. Asset decreased, Liability
decreased.
(b) Purchased office equipment by cash.
(c) Owner took cash from the business
for personal use.
(d) Paid staff salary for the
current period.
(e) Received cash from customer to settle
his account receivable.
(f) Owner contributed office
equipment for business use.
3. Mr. Ashwin established a tour agency on 1 June 2007.

The transactions for the month are as follows:
(a) Deposited cash into the business account totaling RM20,000.
(b) Purchased supplies on credit for RM800.
(c) Made payment to supplier for RM620.
(d) Received cash on the services provided for RM4,200.
(e) Paid staff salary of RM1,000.
(f) Paid transportation of RM700 and sundry expenses of RM150.
(g) Paid office rental of RM1,200.
(h) Charged customer RM2,500 for services provided.
(i) Supplies unused at the end of the period is valued at RM250.
(j) Mr. Ashwin took cash from the business totaling RM750 for
his personal use.
Required:
(a) State the effect of each transaction and the balance after each
transaction using the accounting equation format that you have
learnt.
(b) Create the accounting equation for Mr. Ashwin business after the
last transaction for that month.

4. For each of the independent effect of accounting equation below,

describe a possible transaction:
(a) Increase in asset, increase in liability
(b) Increase in asset, increase in owner equity
(c) Decrease in asset, decrease in liability
(d) Decrease in asset, decrease in ownerÊs equity
(e) Increase in liability, decrease in ownerÊs equity
(f) Increase in one asset, decrease in another asset
The accounting cycle describes all the activities involved in the accounting
process to produce a complete set of financial statements.
All transactions to be recorded in the books of accounts must be supported by

appropriate source documents.
The accounting equation is fundamental in accounting and it consists of three

components, namely asset, liability and owner Ês equity.
The chart and format of accounts used to present the financial report of an
organisation.
The rules of debit and credit are fundamental to the double entry system.
The rules of normal balance for each type of account are used to assist in
identifying errors in recording.

Accounting cycle Debit

Accounting equation Liabilities
Assets Normal balance
Charts of accounts OwnerÊs equity
Credit Source document

Topic Recording
3 Process
LEARNING OUTCOMES
1. Prepare journal entries;
2. Post journal entries to ledger; and
p
3. Prepare trial balance.
INTRODUCTION
Do you still remember the topics that we have discussed previously? We have
discussed how to analyse transactions, we will now learn about recording
process. Recording is the most important step in accounting for a business entity.
However, before recording, we must identify the event that had occurred. Only
events that occur to the business entity will be recorded in the entityÊs book. Not
all events are transactions, for example, recruitment of staff. Although it will
affect the entity economically, this event is not considered as a transaction.
3.1 STEPS IN RECORDING PROCESS

Once the entityÊs transactions are identified, they must be recorded according to
the accounting procedure specified. Recording begins with journal entry, then
post to ledger and finally preparation of trial balance. This process is illustrated
in Figure 3.1.

TOPIC 3 RECORDING PROCESS 51
Figure 3.1: Steps in recording process
3.1.1 Journal
Journal is the first book to be used in the recording process. Recording in journals
(journalising) is the first process of recording. Transactions are recorded
chronologically in the journal before been transferred to ledger. There are two
main types of journal, the general journal and special journal.
(a) General Journal

General journal is the journal normally owned by all entities. This journal
can be used to record all kinds of transaction like sales, purchases, cash
receipts and cash payments.
(b) Special Journal

Large businesses normally have many transactions. Special journals are
created to avoid confusion due to many entries made in the general journal.
The type of special journal created depends on the needs of the entity.
For example, an entity that have numerous cash transactions might want to
create Cash Receipts Journal and Cash Payment Journal that will be
specially used for cash transactions. All the other transactions can still be
recorded in the General Journal. This segregation will simplify recording
and control. Among the special journals that are commonly used are:
(i) Purchase Journal: Particularly for recording purchases of goods on
credit.
(ii) Sales Journal: Particularly for recording sales of goods on credit.
(iii) Cash Receipt Journal: Particularly for recording all cash received.
(iv) Cash Payment Journal: Particularly for recording all cash payment.

52 TOPIC 3 RECORDING PROCESS
However, this course will only emphasise to the general journal. The format of
general journal is shown in Figure 3.2.
Figure 3.2: Format of general journal
It is important to ensure that journalising is done correctly. This is because this

information will be transferred to ledger for the purpose of preparing the
financial statement. Errors made in the journal will result in errors in the
financial statement. The name of accounts used must be specified in the
beginning and used consistently in order to avoid confusion.
ACTIVITY 3.1
In your opinion, what are the appropriate journals for a book shop in a
school? Discuss.
3.1.2 Journalising and Posting of Entry

After the transactions have been recorded in the journal, it will be posted to the
ledger. This process is known as transfer of entry or posting. We will now record
the transactions of Reen Cyber Service in the General Journal and then post them
to the ledger using the T-account format using the double entry system.
Transaction 1:
On 1 November, Reen invested RM30,000 as capital for Reen Cyber Service
business. From our analysis in Topic 2, we know that this transaction will

increase the cash and owner Ês equity by RM30,000. According to the rules of
debit and credit, the increase in asset account (cash) will be debited and increase
in ownerÊs equity account (capital) will be credited.
When recording, note that the name of the account to be debited is listed first,
followed by the name of account to be credited. The name of the credited account
will be aligned slightly to the right to differentiate it from the account to be
debited.
Journal entry:
General Journal pg 1
Date Description Reference Debit (RM) Credit (RM)

Nov 1 Cash 30,000
Capital, Reen 30,000
(Cash invested by Reen)
Journal 1: General Journal for Transaction 1
Post to ledger:
Cash
RM
Nov 1 Capital, Reen 30,000
Capital, Reen
RM
Nov 1 Cash 30,000
Ledger 1: Ledger for Transaction 1
Transaction 2:
On 2 November, the business purchased a piece of land valued at RM20,000. A
total of RM5,000 cash had been paid while the balance is financed by bank loan
(notes payable).
Note that even though this transaction involves more than two accounts, the total
amount of debit is still equal to the total amount of credit.

Journal entry:

Nov 2 Land 20,000
Cash 5,000
Notes payable 15,000
(Purchased land by cash
and bank loan)
Post to ledger:
Land
RM
Nov 2 Cash 5,000
Notes Payable 15,000
Cash
RM RM
Nov 1 Capital, Reen 30,000 Nov 2 Land 5,000
Notes Payable
RM
Nov 2 Land 15,000
Transaction 3:
On 4 November, the business bought office supplies valued at RM2,700 on credit.
Journal entry:

Nov 4 Supplies 2,700
Accounts Payable 2,700
(Purchased supplies by
credit)

Post to ledger:
Supplies
RM
Nov 4 Accounts Payable 2,700
Accounts Payable
RM
Transaction 4:
On 15 November, the business received revenue from consultancy services
provided to a customer. The customer paid cash of RM15,000.
Journal entry:

Nov 15 Cash 15,000
Service revenue 15,000
(Cash received for services
provided)
Post to ledger:
Cash
RM RM
15 Service revenue 15,000
Service revenue
RM
Nov 15 Cash 15,000
Transaction 5:
On 30 November, the business paid salary expenses (RM4,250), rental expenses
(RM1,600), utility expenses (RM900) and sundry expenses (RM550).

Journal entry:

Nov 30 Salary expenses 4,250
Utility expenses 900
Sundry expenses 550
Cash 7,300
(Cash payment for the said
expenses)
Post to ledger:
Cash
RM RM
15 Service revenue 15,000 30 Salary expenses 4,250
Sundry expenses 550
Salary expenses Rental expenses
RM RM
Nov 30 Cash 4,250 Nov 30 Cash 1,600
Utility expenses Sundry expenses
RM RM
Nov 30 Cash 900 Nov 30 Cash 550
Transaction 6:
On 30 November, the business paid its debt to the supplier of supplies purchased
on 4 November for RM1,900.

Journal entry:

Nov 30 Accounts Payable 1,900
Cash 1,900
(Payment to accounts
payable)
Post to ledger:
Cash
RM RM
Sundry expenses 550
30 Accounts payable 1,900
Accounts Payable
RM RM
Nov 30 Cash 1,900 Nov 4 Supplies 2,700
Transaction 7:
Unused office supplies on 30 November were valued at RM1,100.
Journal entry:

Nov 30 Supplies expenses 1,600
Supplies 1,600
(Recording usage of
supplies)

Post to ledger:
Supplies
RM RM
Nov 4 Accounts payable 2,700 Nov 30 Supplies expenses 1,600
Supplies expenses
RM
Transaction 8:
On 30 November, Reen took RM4,000 cash from the business for her personal use.
Journal entry:

Nov 30 Drawings, Reen 4,000
Cash 4,000
(Cash drawings by
owner)
Post to ledger:
Cash
RM RM
Sundry expenses 550
30 Drawings, Reen 4,000

Drawings, Reen
RM
Nov 30 Cash 4,000
How are you doing so far? Can you understand the recording process at this
stage? By using the same transactions, we have prepared the journal entries and
transferred them to ledger. The journalising and posting process that we have
done is a very simple example for you to better understand the basic process,
emphasising only on the date, accounts and amounts involved. In the next
example, we will perform postings in detail involving reference column.
3.1.3 Example of Analysis and Summary of Transaction

The double entry system is very useful for analysing the effects of transactions.
According to the system, every transaction will affect at least two items in the
financial statements. In analysing the transactions, three important things must
be dealt with:
(a) Determine whether the transaction will affect the asset, liability, ownerÊs
equity, revenue or expense accounts.
(b) For every account involved, determine whether the account will increase or
decrease.
(c) Decide whether the increase or decrease should be recorded as debit or
credit.
You might feel difficult at this stage to make an analysis or feel there are too
many things to remember. However, with familiarisation and frequent practice,
you will find that these three things can be done simultaneously.
We will now continue with the example of Reen Cyber Service by extending the
transactions to December. In December, we will see more transactions. We will
analyse the transactions one by one with emphasis on the types of transaction
that have not been analysed before. The transactions throughout December are
listed in Table 3.1.

Table 3.1: Transactions for the Month of December
Date
No. Transactions
(Dec 2010)
1 1 Paid insurance premium of RM4,800 for coverage against losses

due to fire and burglary for a period of 24 months.
2 1 Paid office rental for the month of December of RM1,600.
3 1 A company planned to rent the land owned by Reen Cyber

Service. The business rented the land for three months for RM720.
The tenant paid the amount in cash.
4 4 Purchased office equipment on credit from Office Equipment Sdn

Bhd totalling RM3,600.
5 6 Paid RM360 to advertise the business in the newspaper.
6 11 Paid RM800 for the transaction on 4 December.
7 13 Paid salary of temporary staff for RM1,900 for the first two weeks
of December.
8 16 Received RM6,200 cash from customer for services provided.
9 16 Provided services valued at RM3,500 to a customer. The customer

promised to pay next month.
10 20 Made another payment of RM1,800 for transaction on 4 December.
11 21 Customer made payment for account receivable of RM1,300.
12 23 Purchased supplies by cash for RM2,900.
13 27 Paid salary of temporary staff for RM2,400 for the last two weeks
of December.
14 31 Paid telephone and electricity bill for the month December for
RM620 and RM450 respectively.
15 31 Received cash of RM5,740 from customer on the services

provided.
16 31 Billed customer for the services provided of RM2,240.
17 31 Reen made cash drawings of RM4,000.

Transaction 1:
Paid insurance premium for 24 months totalling RM4,800.
Have you ever paid insurance premium? If you own a vehicle, you will be
familiar with paying insurance premium. Insurance premium must be paid at the
beginning of the coverage period. Payment made in advance is known as prepaid
expenses and it is an asset. The asset you get is the insurance coverage for 24
months starting from 1 December 2010.
Analysis 1 and 2: Prepaid insurance account (asset) increased by

RM4,800. Cash account (asset) reduced by RM4,800.
Accounts involved and
effects of transaction
Analysis 3: Prepaid insurance account (asset) increased: debit

Rule of debit and credit Cash account (asset) reduced: credit
Journal entry:

Dec 1 Prepaid insurance L15 4,800
Cash L11 4,800
(Paid insurance premium
for 24 months)
Post to ledger:
Prepaid Insurance Account No: 15
Date Description Reference Debit (RM) Credit (RM) Balance

Dec 1 Cash J2 4,800

Cash Account No: 11

Dec 1 Cash J2 4,800
In this example, we did not use the T-account format. Instead, we used the three
column account format to make you more familiar with the different types of
accounting format available. This format is better as it can show the balance after
each transaction. The balance column is supposed to show final balance after
each transaction including the previous transactions in November. However, in
this section, the column is left blank to avoid confusion. After completing all the
transactions, we will combine all the processes of journal entries and entry post
to ledger. After that, you will be able to understand better the function of the
balance column in this three column account format.
Note that for reference purposes, the account number (refer to the chart of
accounts in Table 2.3 from Topic 2) must be recorded in the Reference column in
the journal, while the page of General journal is recorded in the Reference
column in the accounts.
Transaction 2:
Paid RM1,600 rental for the month of December.
This transaction is prepaid expense as the rental expense was paid at the
beginning of December. However, it is different from transaction 1 in terms of
the coverage period.
In transaction 1, the premium paid was for 24 months. In this transaction, the
rental paid was only for one month. For such a short period, we normally do not
use the prepaid rental account. This is easier as we need not make any
adjustments at the end of the period. The adjustments will be taught in detail in
Topic 4.

Analysis 1 and 2: Rental expenses account (expense) increased by

Accounts involved and RM1,600. Cash account (asset) reduced by RM1,600.
Analysis 3: Rental expenses account (expense) increased: debit

Rule of debit and credit Cash account (asset) reduced: credit
Journal entry:

Dec 1 Rental expenses L52 1,600
Cash L11 1,600
(Paid rental expenses
for December
Post to ledger:
Rental expenses Account No: 52

Dec 1 Cash J2 1,600
Cash Account No: 11

Dec 1 Rental expenses J2 1,600
ACTIVITY 3.2
Do you still remember the accounting constraints on materiality that
we had studied earlier? Can you relate it to the recording of
Transaction 2? Discuss with your coursemates.

Transaction 3:
Received RM720 from the landÊs tenant for rental of three months.
In this transaction, the business received payment in advance of the specific

period. This created an obligation or commitment on the business. By receiving
three months rental in advance, Reen Cyber Service is responsible to supply land
for rental in that three monthsÊ period.
This is a liability (the business „owes‰ services to the tenant) and the account
created is deferred rental account. The deferred rental will be recognised as
rental revenue at the end of the period when the services have been provided.
Analysis 1 and 2: Cash account (asset) increased by RM720.

Accounts involved and Deferred rental account (liability) increased by
effects of transaction RM720.
Analysis 3: Cash account (asset) increased: debit
Rule of debit and credit Deferred rental account (liability) increased: credit
Journal entry:

Dec 1 Cash L11 720
Deferred rental L23 720
(Cash received for three
months' rental)
Post to ledger:
Cash Account No: 11

Dec 1 Deferred rental J2 720

Deferred rental Account No: 23

Dec 1 Deferred rental J2 720

Transaction 4:
Purchased office equipment on credit for RM3,600.
Analysis 1 and 2: Office equipment account (asset) increased by

Accounts involved and RM3,600. Accounts payable (liability) increased by
effects of transaction RM3,600.
Analysis 3: Office equipment account (asset) increased: debit

Rule of debit and credit Accounts payable (liability) increased: credit
Journal entry:

Dec 4 Office equipment L18 3,600
Accounts payable L21 3,600
(Purchased office
equipment on credit)

Post to ledger:
Office Equipment Account No: 18

Dec 4 Accounts payable J2 3,600
Accounts Payable No: 21

Dec 4 Office equipment J2 3,600

Transaction 5:
Paid RM360 for advertisement in newspaper.
For large businesses that always advertise their products or services. For an
advertisement that involves large sums, a specific account (Advertisement
expenses) will be created for this purpose. However, if the advertisement
expenses seldom occur and immaterial, it is often recorded as sundry expenses.
In the example of Reen Cyber Service, we will use the sundry expenses account
to record this expense.
Analysis 1 and 2: Sundry expenses account (expense) increased by

RM360. Cash account (asset) decreased by RM360
Analysis 3: Sundry expenses account (expense) increased: debit

Cash account (asset) decreased: credit
Rule of debit and credit
Journal entry:

Dec 6 Sundry expenses L55 360
Cash L11 360
(Payment for
advertisement expenses)
Post to ledger:
Sundry Expenses Account No: 55

Dec 6 Cash J2 360

Cash Account No: 11

Dec 6 Sundry expenses J2 360

Transaction 6:
Paid supplier (for transaction on 4 December) amounting to RM800.
Analysis 1 and 2: Accounts payable (liability) decreased by RM800.

Cash account (asset) decreased by RM800.
Analysis 3: Accounts payable (liability) decreased: debit

Rule of debit and credit Cash account (asset) decreased: credit
Journal entry:

Dec 11 Accounts payable L21 800
Cash L11 800
(Payment for
advertisement expenses)
Post to ledger:
Accounts payable No: 21

Dec 11 Cash J2 800

Cash Account No: 11

Dec 11 Accounts payable J2 800
Transaction 7:
Paid salary of temporary staff for the first two weeks of December totalling
RM1,900.
Analysis 1 and 2: Salary expenses account (expense) increased by

RM1,900. Cash account (asset) decreased by
RM1,900.
Analysis 3: Salary expenses account (expense) increased: debit
Journal entry:

Dec 13 Salary expenses L51 1,900
Cash L11 1,900
(Salary payment for

temporary staff)
Post to ledger:
Salary expense Account No: 51

Dec 13 Cash J2 1,900

Cash Account No: 11

Dec 13 Salary expenses J2 1,900
Transaction 8:
Received RM6,200 cash for services provided:
Analysis 1 and 2: Cash account (asset) increased by RM6,200.

Accounts involved and Service revenue account (revenue) increased by

Rule of debit and credit Service revenue account (revenue) increased: credit
Journal entry:

Dec 16 Cash L11 6,200
Service revenue L41 6,200
(Received cash for

services provided)
Post to ledger:
Cash Account No: 11

Dec 16 Service revenue J2 6,200

Service revenue Account No: 41

Transaction 9:
Billed customer for RM3,500 for services provided.
Analysis 1 and 2: Accounts receivable (asset) increased by RM3,500.

Analysis 3: Accounts receivable (asset) increased: debit

Journal entry:

Dec 16 Accounts receivable L12 3,500

(Billed customer for
services provided)
Post to ledger:
Accounts receivable No: 12



Dec 16 Accounts receivable J2 3,500
Transaction 10:
Payment of RM1,800 to supplier (for transaction on 4 December).
Analysis 1 and 2: Accounts payable (liability) decreased by RM1,800.

Accounts involved and Cash account (asset) decreased by RM1,800.
Analysis 3: Accounts payable (liability) decreased: debit

Journal entry:

Dec 20 Accounts payable L21 1,800
Cash L11 1,800

(Payment to accounts
payable)
Post to ledger:
Accounts payable No: 21


Cash Account No: 11

Dec 20 Accounts payable J3 1,800
Transaction 11:
Customer paid cash RM1,300 as payment on its accounts receivable.
Analysis 1 and 2: Cash account (asset) increased by RM1,300

Accounts involved and Accounts receivable (asset) decreased by RM1,300
Rule of debit and credit Accounts receivable (asset) decreased: credit
Journal entry:

Dec 21 Cash L11 1,300
Accounts receivable L12 1,300

(Received cash from
customer)
Post to ledger:
Cash Account No: 11


Accounts Receivable No: 12

Transaction 12:
Purchased supplies by cash for RM2,900.
Analysis 1 and 2: Supplies account (asset) increased by RM2,900.

Accounts involved and Cash account (asset) decreased by RM2,900.
Analysis 3: Supplies account (asset) increased: debit
Journal entry:

Dec 23 Supplies L14 2,900
Cash L11 2,900

(Purchase supplies by
cash)
Post to ledger:
Supplies Account No: 14


Cash Account No: 11

Dec 23 Supplies J3 2,900
Transaction 13:
Paid salary of temporary staff for the last two weeks of December totalling
RM2,400.
Analysis 1 and 2: Salary expenses account (expense) increased by

RM2,400.
effects of transaction Cash account (asset) decreased by RM2,400.
Analysis 3: Salary expenses account (expense) increased: debit

Journal 21: Ledger for Transaction 13

Journal entry:

Dec 27 Salary expenses L51 2,400
Cash L11 2,400

(Payment for salary of
temporary staff)
Post to ledger:
Salary expenses Account No: 51


Cash Account No: 11

Dec 27 Salary expenses J3 2,400
Transaction 14:
Made payment for telephone and electricity bill for RM620 and RM450,
respectively.
The payment of bills like electricity, water and telephone are normally grouped
into the utility expenses account. This is because the expenses incurred are
normally immaterial in terms of amount and significance until the entity has to
open a separate account for each type of bill. Therefore, the total utility expenses
paid on this date are RM1,070.
Analysis 1 and 2: Utility expenses account (expense) increased by

RM1,070.
Analysis 3: Utility expenses account (expense) increased: debit

Journal entry:
Dec 31 Utility expenses L53 1,070
Cash L11 1,070

(Payment for telephone
and electricity bill for
December)

Post to ledger:
Utility expenses Account No: 53

Cash Account No: 11

Dec 31 Utility expenses J3 1,070
Transaction 15:
Received cash RM5,740 for services provided.
Analysis 1 and 2: Cash account (asset) increased by RM5,740.


Journal entry:
Dec 31 Cash L11 5,740

(Received cash for
services provided)

Post to ledger:
Cash Account No: 11


Transaction 16:
Billed customer for RM2,240 for services provided.
Analysis 1 and 2: Accounts receivable (asset) increased by RM2,240

effects of transaction RM2,240
Analysis 3: Accounts receivable (asset) increased: debit

Journal entry:

Dec 31 Accounts receivable L12 2,240

(Billed customer for
services provided)

Post to ledger:
Account Receivable No: 12


Transaction 17:
Owner made cash drawings of RM4,000.
Analysis 1 and 2: Drawings account (contra owner equity) increased

by RM4,000
Analysis 3: Drawings account (contra owner equity) increased:

debit
Rule of debit and credit
Cash account (asset) decreased: credit
Notes: Although the drawings account is a type of owner equity account, it has
an opposite feature against the ownerÊs equity. Therefore, we will put the word
„contra‰ to show the difference.
Journal entry:
Dec 31 Drawing, Reen L32 4,000

Cash L11 4,000
(Cash drawing by
Reen)

Post to ledger:
Drawings, Reen Account No: 32

Cash Account No: 11

Dec 31 Drawings, Reen J3 4,000
After analysing all the transactions one by one, we will now combine all the
journal entries and entries posting involved throughout the month of November
and December 2010.
The following are the general journal entries and postings throughout November
and December 2010.

GENERAL JOURNAL pg 1
Date Account and Description Reference Debit (RM) Credit (RM)

Nov 1 Cash L11 30,000
Capital, Reen L31 30,000
(Investment by Reen)
2 Land L17 20,000
Cash L11 5,000
Notes payable L22 15,000
(Purchase of land by cash and
bank loan)
4 Supplies L14 2,700
(Purchase of supplies on credit)
15 Cash L11 15,000
(Received cash for services
provided)
30 Salary expenses L51 4,250
Rental expenses L52 1,600
Utility expenses L53 900
Sundry expenses L55 550
Cash L11 7,300
(Payment of expenses by cash)

30 Account payable L21 1,900
Cash L11 1,900
(Payment to accounts payable)

30 Supplies expenses L54 1,600
Supplies L14 1,600
(Recording of supplies usage)

30 Drawings, Reen L32 4,000
Cash L11 4,000
(Cash drawings by owner)

Dec 1 Prepaid Insurance L15 4,800
Cash L11 4,800
(Paid insurance premium)
1 Rental expenses L52 1,600
Cash L11 1,600
(Paid rental for December)
1 Cash L11 720
Deferred rental L23 720
(Cash received for three
months rental)
4 Office equipment L18 3,600
(Purchased office equipment on
credit)
6 Sundry expenses L55 360
Cash L11 360
(Payment for advertisement
expenses)
11 Accounts payable L21 800
Cash L11 800
Cash L11 1,900
(Payment for salary of temporary
staff)
16 Cash L11 6,200
provided)
16 Accounts receivable L12 3,500
(Billed customer for services
provided)


Dec 20 Accounts payable L12 1,800
Cash L11 1,800
21 Cash L11 1,300
(Received payment for
accounts receivable)
23 Supplies L14 2,900
Cash L11 2,900
(Purchased of supplies by
cash)

Cash L11 2,400
(Payment for salary of
temporary staff)
31 Utility expenses L53 1,070
Cash L11 1,070
(Payment of telephone and
electricity bill)
31 Cash L11 5,740
provided)
31 Accounts receivable L12 2,240
(Billed customer for services
provided)
31 Drawings, Reen L32 4,000
Cash L11 4,000
Journal 26: General Journal for Reen Cyber Service for the month of November and
December 2010

GENERAL LEDGER
Cash Account No: 11
Debit Credit Balance

Date Description Reference
(RM) (RM) (RM)
Nov 1 Capital, Reen J1 30,000 30,000
2 Land J1 5,000 25,000
15 Service revenue J1 15,000 40,000
30 Salary expenses J1 4,250 35,750
Rental expenses J1 1,600 34,150
Utility expenses J1 900 33,250
Sundry expenses J1 550 32,700
30 Accounts payable J1 1,900 30,800
30 Drawings, Reen J1 4,000 26,800
Dec 1 Prepaid insurance J2 4,800 22,000
Rental expenses J2 1,600 20,400
Deferred rental J2 720 21,120
6 Sundry expenses J2 360 20,760
11 Accounts payable J2 800 19,960
21 Accounts receivable J3 1,300 23,760
23 Supplies J3 2,900 20,860
31 Utility expenses J3 1,070 17,390
31 Drawings, Reen J3 4,000 19,130
* It was previously explained that the „Balance‰ column will show the updated
balance after each transaction. Can you relate to it now?


(RM) (RM) (RM)
Dec 16 Service revenue J2 3,500 3,500
21 Cash J3 1,300 2,200

(RM) (RM) (RM)
Nov 4 Accounts payable J1 2,700 2,700
30 Supplies expenses J1 1,600 1,100
Dec 23 Cash J3 2,900 4,000
Prepaid insurance Account No: 15

(RM) (RM) (RM)
Dec 1 Cash J2 4,800 4,800
Land Account No: 17

(RM) (RM) (RM)
Nov 2 Cash J1 5,000 5,000
Notes payable J1 15,000 20,000

(RM) (RM) (RM)
Dec 4 Accounts payable J2 3,600 3,600


(RM) (RM) (RM)
Nov 4 Supplies J1 2,700 2,700
30 Cash J1 1,900 800
Dec 4 Supplies J2 3,600 4,400
11 Cash J2 800 3,600
20 Cash J3 1,800 1,800
Notes Payable Account No: 22

(RM) (RM) (RM)
Nov 2 Land J1 15,000 15,000
Deferred Rental Account No: 23

(RM) (RM) (RM)
Dec 1 Cash J2 720 720
Capital, Reen Account No: 31

(RM) (RM) (RM)
Nov 1 Cash J1 30,000 30,000
Drawings, Reen Account No: 32

(RM) (RM) (RM)
Nov 30 Cash J1 4,000 4,000
Dec 31 Cash J3 4,000 8,000

Service Revenue Account No: 41

(RM) (RM) (RM)
Nov 15 Cash J1 15,000 15,000
Dec 16 Cash J2 6,200 21,200
Accounts receivable J2 3,500 24,700
31 Cash J3 5,470 30,440
Account receivable J3 2,240 32,680
Salary Expenses Account No: 51

(RM) (RM) (RM)
Nov 30 Cash J1 4,250 4,250
Dec 13 Cash J2 1,900 6,150
27 Cash J3 2,400 8,550
Rental Expenses Account No: 52

(RM) (RM) (RM)
Nov 30 Cash J1 1,600 1,600
Dec 1 Cash J2 1,600 3,200
Utility Expenses Account No: 53

(RM) (RM) (RM)
Nov 30 Cash J1 900 900
Dec 31 Cash J3 1,070 1,970
Supplies Expenses Account No: 54

(RM) (RM) (RM)
Nov 30 Supplies J1 1,600 1,600

Description Debit Credit Balance

Date Reference
(RM) (RM) (RM)
Nov 30 Cash J1 550 550
Dec 6 Cash J2 360 910
3.1.4 Trial Balance

Trial balance is a list of all the accounts used including the corresponding balances at
a specific date. Normally the trial balance would be prepared at the end of the
specific accounting period and the debit and credit totals need to be equal.
The main purpose of preparing the trial balance is to ensure that the total
debit and credit balances are the same. Unequal amount of total balances indicate
that errors had happened in any one of the stages in the recording process,
whether during the journal entry, posting to ledger or the preparation of the trial
balance itself.
However, it must always be kept in mind that a balanced trial balance does not
necessarily mean that there are no errors. Examples of errors that can occur even
though the trial balance is balanced are:
(a) The transaction has not been recorded at all in the journal;
(b) The transaction entry has not been posted to the ledger;
(c) The transaction of entry posted to ledger had been done twice; and
(d) The use of wrong account during journalising or posting.
In the first case, the transaction was not recorded at all. Both the debit and credit
sections were not affected. Therefore, the trial balance will be balanced, only
the total would be less than what it should have been. In the second case, the
transaction had been recorded in the journal without being posted to ledger. The
result is the same as with the first case because the trial balance is prepared based
on the ledger balance.
In the third case, the entry was posted correctly but twice. The trial balance will
be balanced, only the total would be more than what it should have been. In the
final case, the debit and credit amount is equal, only that they have been
recorded on the wrong side of the accounts. The final balance of the trial
balance would be the same as it should be but there will be errors in the last
balance of the individual accounts. For example, when a business purchased

supplies by cash, the correct entry should be to debit the supplies account and to
credit the cash account. However, a mistake was made by debiting cash and
crediting supplies. Although the accounts have been recorded wrongly, the trial
balance will still be balanced. Only the individual balances in the cash account
and supplies account will be incorrect. This error is quite difficult to detect as the
final amount in the trial balance is still equal.
The following is the trial balance for Reen Cyber Service as at 31 December 2010.
The balances of the accounts were derived from the previous general ledger.
Reen Cyber Service

Trial Balance
as at 31 December 2010
Account Debit Credit
Number Accounts (RM) (RM)
11 Cash 19,130
12 Accounts receivable 4,440
14 Supplies 4,000
15 Prepaid insurance 4,800
17 Land 20,000
18 Office equipment 3,600
22 Notes payable 15,000
23 Deferred rental 720
31 Capital, Reen 30,000
41 Service revenue 32,680
51 Salary expenses 8,550
52 Rental expenses 3,200
53 Utility expenses 1,970
54 Supplies expenses 1,600
55 Sundry expenses 910
TOTAL 80,200 80,200
Figure 3.3: Trial balance

EXERCISE 3.1
1. What is the difference between journal and ledger in the recording

process?
2. What is the primary purpose of a trial balance?
3. Group the following accounts according to its type (asset, liability,
owner Ês equity, revenue or expense):
(a) Vehicle
(b) Insurance expenses
(c) Prepaid insurance
(d) Rental revenue
(e) Deferred rental
(f) Supplies
(g) Supplies expenses
(h) Accounts receivable
EXERCISE 3.2
The accounts in the ledger of Samurai Laundry Shop contain the

following balances on 30 April 2011:
ACCOUNT TITLE RM
Account Payables 10,263
Account Receivables 11,654
Capital 46,381
Cash ?
Drawings 570
Equipment 48,350
Insurance expense 1,800
Loan 32,500
Repair expenses 971
Salaries expenses 4,832
REQUIRED: Prepare a trial balance as at 30 June 2011 for Samurai

Laundry Shop and fill in the missing cash account figure.

EXERCISE 3.3
1. Cindy established Cindy Insurance Agency on 1 April 2011. The

effects of all transactions throughout April 2011 are summarised in
the following schedule:
OwnerÊs
Asset = Liability + Equity
Capital,
Trans. Cash + AR + Supplies = AP + Cindy
a. +5,000 +5,000
Capital,
Cindy
b. +275 +275
c. +3,250 +3,250
Service
revenue
d. -750 -750
Paid rental
expense
e. -125 -125
f. +1,875 +1,875
Service
revenue
g. -577 -390
Paid utility
Expense
-187
Paid sundry
expense
h. -1,250 -1,250
Paid salary
i. -162 -162
Paid
supplies
j. -500 -50 -550

Drawings,
Cindy

Required:
(a) Prepare the journal entries for all the above transactions.
(b) Transfer the entries to ledger using the 3 column account format.
(c) Prepare the trial balance as at 30 April 2011.
2. The following are the chart of accounts and accounts balances

for Edlin Enterprise on 1 February 2011:
Account No Accounts Balance as at 1/2/11

(RM)
101 Cash 15,238
104 Supplies 427
301 Capital, Edlin 26,910
302 Drawings, Edlin
401 Service revenue
501 Rental expenses
502 Advertisement expenses
503 Utility expenses
509 Sundry expenses
Transactions involving Edlin Enterprise throughout the month

of February 2011 are as follows:

Date Transactions
Feb 1 Purchased office supplies by cash RM274.
2 Edlin withdrew cash from business totalling RM2,000 for personal
use.
5 Received RM2,740 cash from customer for payment on accounts
receivable.
9 Purchased office equipment valued at RM4,000 on credit. The seller
agreed to give a discount of RM150 from the amount.
15 Made payment to accounts payable for RM1,200.
18 Received cash for services provided for RM580.
25 Paid RM420 to advertise its business in the newspaper.
28 Paid telephone bills (RM75 for Edlin's house and RM135 for business)
and electricity bills (RM42 for Edlin's house and RM80 for business).
All the payments had been made using money from his savings.
29 Paid RM1,200 for rental of business premises.

30 Paid RM220 to repair the office equipment.
Required:
(a) Prepare the journal entries to record all the above transactions by
using the accounts listed in the chart of accounts for Edlin
Enterprise.
(b) Post the entries to ledger by using the three column account format.
(c) Prepare the trial balance as at 28 February 2011.
Transactions are recorded in the journal before being transferred into the
ledger.
The general ledger is used to record all kinds of transactions whereas special
journals are created to avoid confusion due to many entries made in the
general journal.
The main purpose of preparing the trial balance is to ensure that debit and
credit balances are equal.
Assets Ledger
Chart of Accounts Liabilities
Credit Posting
Debit Revenue
Expenses Trial Balance
Journal

Topic Adjusting
4 Entries
LEARNING OUTCOMES
1. Describe the types of adjusting entries; and
p 2. Prepare the Adjusted Trial Balance.
INTRODUCTION
In the previous topic, you came across unadjusted trial balance. In this topic, we
will discuss the preparation of adjusting entries for the purpose of preparing
the adjusted trial balance. The adjusted trial balance is prepared after the
adjusting entries have been recorded and transferred.
4.1 ADJUSTING ENTRIES

You might wonder why adjusting entries need to be discussed before completing
the accounting cycle. The answer becomes clearer once you know what adjusting
entries are.
Adjusting entries are additional accounting information recorded at the

end of the accounting period to accurately match the revenues with expenses.
It is the main element in accrual-basis accounting. Accrual basis refers to

revenues or expenses which are recognised in the current period irrespective of
whether cash has been received. It is different from cash basis accounting, where
revenues or expenses are only recognised when they involve cash receipts or
payments.

TOPIC 4 ADJUSTING ENTRIES 95
Adjusting entries will affect at least one income statement account (revenue or
expense) and one balance sheet account (asset or liability). After the
adjustments, the accounts in the trial balance will show the updated balances,
which will then be used to prepare the financial statements.
Prepaid and accruals are the basis for making adjusting entries. Prepaid refers to
cash received or paid before revenues or expenses are recorded, while accruals
are revenues or expenses which are recorded before cash is received or paid.
Adjusting entries are divided into:

(a) Prepaid expenses;
(b) Unearned revenue (Unearned income);
(c) Accrued expenses; and
(d) Accrued revenue.
Now, let us look at each of the adjusting entries in detail.
4.1.1 Prepaid Expenses
Prepaid expenses refer to all expenses that have been paid in advance by cash
but the benefit from the expenses has not been received or obtained.
It is an asset to the business and will be written off after it has been used or when
it expires. Adjusting entries must be made at the end of the accounting period to
recognise assets that have been written off as expenses.
Examples of prepaid expenses are prepaid rental and prepaid insurance.
Example 4.1
On 1 April 2010, Encik Zaini rented a house and paid a total of RM900 for the
first three months. The landlord had set the rental at RM300 per month. The
journal entries are as follows:
1 April 2010 Dr. Rental Prepayment RM900

Cr. Cash RM900

96 TOPIC 4 ADJUSTING ENTRIES
When the entry is transferred to ledger, the accounts involved will be:
Rental Prepayment Account Cash Account

RM RM
1 April Cash 900 1 April Rental prepayment 900
The trial balance on 30 April 2010 before adjustment shows the rental
prepayment account with a normal debit balance of RM900. This amount is
incorrect if used for the purpose of preparing the financial statement.
Therefore, an adjusting entry is needed to update and match the expenses

accurately so that the correct total is reported in the financial statements.
The adjusting entry is as follows:
30 April 2010 Dr. Rental expenses RM300*

Cr. Rental prepayment RM300
Rental paid for three months is RM900, which is rental prepayment.

*One third of the total rental prepayment for a period of one month (April) is:
1/3 900 = 300
When the adjusting entry is transferred to the ledger, it would involve one
account from the income statement (rental expenses account) and one account
from the balance sheet (rental prepayment account).
Figure 4.1: Process of transferring adjusting entries to ledger

The adjusting entries that had been transferred to ledger are as follows:
Rental Prepayment Account

RM RM
1 April Cash 900 30 April Rental expenses 300
Balance 600
Rental Expenses Account

RM
30 April Rental prepayment 300
The adjusting entries had recognised the rental expenses for a period of one
month in April, which is RM300. The rental prepayment account had been
credited by RM300, causing the balance in the account to decrease by RM300.
Therefore, the rental prepayment account has been updated from RM900 to
RM600.
Depreciation Expenses
Depreciation expenses are provisions against the cost of fixed assets like
plant, equipment and vehicle.
It is an expense throughout the lifespan of the asset. The concept used for asset
and depreciation is the same as with prepaid expenses.
Cash paid by the business to acquire the asset is viewed as a prepaid expense.
In other words, the cash is paid in advance before the asset is used. Adjusting
entries must be recorded as the asset expires or when the asset has been
used by the business. The entry is made at the end of the accounting period and
acknowledges the usage of the asset as expenses.
Example 4.2
On 1 Jan 2011, Mazni Enterprise purchased a vehicle for office usage valued at
RM60,000 by cash. This vehicle is estimated to have a lifespan of 10 years. The
journal entries for this transaction are as follows:
1 Jan 2011 Dr.Vehicle 60,000

Cr. Cash 60,000

When the entry is transferred to ledger, the accounts involved will be:
Vehicle Account Cash Account

RM RM
1 Jan Cash 60,000 1 Jan Vehicle 60,000
An adjusting entry is required at the end of the accounting period to record

the expenses for the use of the vehicle, which will be as follows:
31 December 2011 Dr. Depreciation expenses 6,000*

Cr. Accumulated Depreciation – Vehicle 6,000
*The straight line method was used to calculate the depreciation expenses.
Formula:
(Cost of Assets - Scrap Value)
Useful Life
(RM60,000 – 0/10 year) = RM6,000 per year
The adjusting entry is then transferred to ledger and will involve one account
from income statement (depreciation expenses account) and one account from
balance sheet (accumulated depreciation of vehicle account, which is a contra
account for asset).
Depreciation Expenses Account

RM
31 Dec Acc. Depreciation 6,000
Accumulated Depreciation Account

RM
31 Dec Depreciation Exp. 6,000
The debit entry of RM6,000 in the depreciation expenses account reflects the
businessÊ use of the asset for the one year period, while the credit balance in the
accumulated depreciation account for vehicle shows the total depreciation on the

asset to date. The total accumulated depreciation will be deducted from the total
asset to provide the book value or carrying value of the asset:
RM
VehicleÊs cost as at 1 Jan 2011 60,000
(-) Accumulated depreciation – vehicle (6,000)
VehicleÊs book value as at 31 December 2011 54,000
4.1.2 Unearned Revenue (Unearned Income)
Unearned revenue refers to cash which is received in advance before goods or

services have been provided.
This is an obligation or liability to the business entity. Cash received cannot be

recognised as revenue for that period because the goods or services will only be
provided at a future date.
Example 4.3
On 1 December 2010, Ayu Beauty Company received RM800 cash from a

customer. This payment was for services that the Company will provide on 1
January 2011. The journal entry is as follows:
1 December 2010 Dr. Cash 800

Cr. Unearned revenue 800
When the entry is transferred to the ledger, the accounts involved will be:
Cash Account Unearned Revenue Account

RM RM
1 Dec Unearned 800 1 Dec Cash 800
revenue
On 31 December 2010, a liability of RM800 was created for Ayu Beauty

Company because cash was received while the services had not yet been
provided. The liability will cease to exist and the revenue can be recognised
once the company had provided the services on 1 January 2011. The adjusting
entry to recognise the revenue is as follows:

1 January 2011 Dr. Unearned revenue 800

Cr. Service revenue 800
from income statement (service revenue account) and one account from balance
sheet (unearned revenue account).
Unearned Revenue Account

RM RM
1 Jan Service revenue 800 31 Dec Cash 800
Service Revenue Account

RM RM
1 Jan Unearned revenue 800
When unearned revenue account is debited, the business entity ceases to

have the liability and the revenue is recognised as the services which are now
being provided.
4.1.3 Accrued Expenses
Accrued expenses refer to all expenses incurred but have not yet been paid or
recorded because there was no cash outflow from the business entity.

Accrued expenses are a liability as an obligation exists that must be settled by the
business. At the end of the accounting period, the business entity must record/
recognise all expenditure even though no cash outflow occurred. Examples of
accrued expenses are salary payable, rental payable, interest payable and tax
payable.

Example 4.4
Haruman Company has not paid its staff salary for the month of December 2010,
totalling RM4,500 due to financial problems. However, the company promised to
pay the salary in January 2011. On 31 December 2010, the adjusting entry will
be as follows:


31 December 2010 Dr. Salary Expenses 4,500

Cr. Salary Payable 4,500

from income statement (salary expenses account) and one account from balance
sheet (salary payable/ salary accrued account).

Salary Expenses Account Salary Payable Account
RM RM
31 Dec Salary 4,500 31 Dec Salary 4,500
payable expenses

This adjusting entry will recognise the salary expenses for the period even
though cash outflow from the business has not occurred while the salary
payable or salary accrued is a liability to the business entity at that date.
4.1.4 Accrued Revenue
Accrued revenue refers to the revenue that had been obtained but there is no
cash inflow into the business entity.

This happens when the goods or services were provided to the customer but the
customer has not paid for it yet.
Accrued revenue is an asset as the benefit in the form of cash will be obtained by
the business entity in the future. Examples of accrued revenue are rental revenue
receivable, service revenue receivable and interest revenue receivable.
Example 4.5
Geelang Company rented out a section of its building at the monthly rate of
RM1,200 which must be paid at the end of the month. However, the tenant failed
to pay the rental for the month of December 2010 but promised to settle the rental
in the month of January 2011. The adjusting entry required for Geelang Company
would be:
31 December 2010 Dr. Rental receivable 1,200

Cr. Rental revenue 1,200
from income statement (rental revenue account) and one account from balance
sheet (rental receivable or rental revenue accrued account).
Rental Receivable Account

RM
31 Dec Rental revenue 1,200
Rental Revenue Account

RM
31 Dec Rental receivable 1,200
At the end of the accounting period, revenue that has been recorded or recognised
totalled RM1,200 even though there is no cash inflow while asset increased by
RM1,200 when rental receivable was debited.
If there is no adjustment, the account balances presented in the financial

statements will not comply with the principle of revenue recognition and
principle of matching. Therefore the financial statements published were
presented without complying with the GAAP (Generally Accepted Accounting
Principles).
All the adjustments made to the account balances in the trial balance will
produce the Adjusted Trial Balance. The Adjusted Trial Balance will be used as
the basis in the preparation of the financial statements. The Adjusted Trial
Balance will be discussed in the next subtopic.
EXERCISE 4.1
Explain the meaning for each of the following:

(a) Accrued Revenue;
(b) Accrued Expenses;
(c) Prepaid Expenses; and
(d) Unearned Revenue.

4.2 PREPARATION OF ADJUSTED TRIAL

BALANCE
In this subtopic, we will discuss the process of preparing the Adjusted Trial
Balance. The Adjusted Trial Balance is a trial balance which is prepared after
taking into account all the adjusting entries that have been journalised and
transferred. The Adjusted Trial Balance will also show the balance of all the
accounts irrespective of whether they were involved in the adjustment. The
accounts involved in the adjustment will show the updated or adjusted balance.
The purpose of preparing the Adjusted Trial Balance is to show the effect of
all financial events that had occurred in the accounting period. The Adjusted
Trial Balance is to verify that the total debit and total credit are equal for all the
accounts in the ledger after the adjustments.
You must refer to the information in the Unadjusted Trial Balance for Reen Cyber
Service in Topic 3 (refer Figure 3.3: Trial Balance) for the preparation of this
Adjusted Trial Balance. For your reading convenience, the unadjusted balance
had been included in Table 4.2.
Additional information relating to adjustments for Reen Cyber Service is as

follows:
(a) The supplies in hand at 31 December 2010 totalled RM1,520.
(b) The insurance premium that had expired throughout the year totalled
RM200.
(c) Unearned rental revenue at 31 December 2010 totalled RM480.
(d) Salary accrued but not yet paid at 31 December 2010 totalled RM500.
(e) Interest revenue accrued but not yet recorded for the month of
December totalled RM1,000.
(f) Depreciation for office equipment for the month of December totalled
RM100.
The adjustment entries that must be recorded by Reen Cyber Service as at 31

December 2010 are as per Table 4.1:

Table 4.1: Adjustment Entries
Debit Credit
(RM) (RM)
31 December Supplies expenses 2,480
Supplies 2,480
31 December Insurance expenses 200
Insurance prepayment 200
31 December Unearned rental revenue 240
Rental revenue 240
31 December Salary expenses 500
Salary accrued 500
31 December Accounts receivable 1,000
Interest revenue 1,000
31 December Depreciation expenses 100
Accumulated 100
depreciation for office
equipment

Table 4.2: Unadjusted Trial Balance
Reen Cyber Service

Trial Balance
Account Debit Credit

Number Accounts (RM) (RM)
11 Cash 19,130
14 Supplies 4,000
15 Insurance prepayment 4,800
17 Land 20,000
22 Notes payable 15,000
23 Unearned rental revenue 720
31 Capital, Reen 30,000
41 Interest revenue 32,680
51 Salary expenses 8,550
53 Utility expenses 1,970
54 Supplies expenses 1,600
TOTAL 80,200 80,200
The treatment for each additional item of information are as follows:
(a) The supplies account shown in the Unadjusted Trial Balance is the
opening balance at 1 January 2010 which is RM4,000. The additional
information stated the current balance, which is the balance at 31 December
2010 totalling RM1,520.
Therefore, the difference between both the balances is the supplies

expenses that must be recognised/recorded, which is RM2,480.

Supplies Account – Supplies Account = Supplies Expenses

(Opening Balance) (Current Balance)
RM4,000 – RM1,520 = RM2,480
This adjusting entry affects one account in Income Statement (supplies

expenses) and one account in Balance Sheet (supplies account).
The current balance for supplies account is RM1,520, which is RM4,000

(opening balance) – RM2,480 (credit entry from adjustment) which
resulted in the same total as stated in the additional information.
(b) Insurance prepaid account with debit balance totalling RM4,800 showed
insurance prepaid for a period of 24 months starting 1 December 2010.
Therefore, the insurance expenses at 31 December 2010 that must be
recognised total RM4,800 ÷ 24 = RM200.
This adjusting entry causes the insurance prepayment account in the

Balance Sheet to have a current balance of RM4,600 (RM4,800 – RM200)
while insurance expenses of RM200 will be recognised in the income
statement for the period.
(c) Unearned rental revenue account has a normal credit balance of RM720
which showed total cash for the rental received in advance for three
months. Therefore, the rental revenue that need to be recognised for the
month of December is 1/3 x RM720 = RM240.
The effect of this adjusting entry is the unearned rental revenue

account in the Balance Sheet which will be reduced by RM240 to RM480
while the rental revenue of RM240 will be reflected in the Income
Statement.
(d) Salary accrued or unpaid for the month of December totalled RM500. The
salary accrued will increase the total expenditure and is a liability to the
business entity. The adjusting entry will recognise this salary expense as an
item in the Income Statement and the salary payable or salary accrued as a
balance sheet item totalling RM500 for the period.
(e) Interest revenue accrued for the business entity but yet to be recognised or
recorded totalled RM1,000. This amount is an asset and will increase the total
revenue of the business entity. The adjusting entry will recognise the interest
revenue as an item in the Income Statement and accounts receivable account
in Balance Sheet will show a total of RM1,000 for the period.

(f) Depreciation of office equipment for the month of December totalling

RM100 will increase the total expenditure for that business entity. The
adjusting entry will recognise the depreciation as an expenses item in
the income statement and will affect one account in balance sheet, the
accumulated depreciation account which is a contra account for asset.
The worksheet as per Table 4.3 is used to prepare the Adjusted Trial Balance
for Reen Cyber Service for two months ending at 31 December 2010.
Table 4.3: Worksheet for Reen Cyber Service
Adjusted Trial
Trial Balance Adjustment
Balance
Dr. Cr. Dr. Cr. Dr. Cr.
Name of Account
(RM) (RM) (RM) (RM) (RM) (RM)
Cash 19,130 19,130
Accounts receivable 4,440 (5) 1,000 5,440
Supplies 4,000 (1) 2,480 1,520
Insurance prepayment 4,800 (2) 200 4,600
Land 20,000 20,000
Office equipment 3,600 3,600
Accounts payable 1,800 1,800
Unearned rental revenue 720 (3) 240 480
Notes payable 15,000 15,000
Capital, Reen 30,000 30,000
Drawings, Reen 8,000 8,000
Interest revenue 32,680 (5) 1,000 33,680
Salary expenses 8,550 (4) 500 9,050
Rental expenses 3,200 3,200
Utility expenses 1,970 1,970
Supplies expenses 1,600 (1) 2,480 4,080
Sundry expenses 910 910
Insurance expenses (2) 200 200
Rental revenue (3) 240 240
Salary accrued (4) 500 500
Depreciation expenses (6) 100 100
Accumulated depreciation – (6) 100 100
equipment
80,200 80,200 4,520 4,520 81,800 81,800

You can also prepare the Adjusted Trial Balance for Reen Cyber Service
without using the sheet by:
(a) Preparing the adjusting entries.
(b) Updating all the account involved with the adjusting entries
(c) Entering the current balance that had been adjusted into the Adjusted
Trial Balance as shown in Table 4.4.
Table 4.4: Adjusted Trial Balance

Reen Cyber Service
Adjusted Trial Balance
RM RM
Cash 19,130
Accounts receivable * 5,440
Supplies * 1,520
Insurance prepayment * 4,600
Land 20,000
Office equipment 3,600
Unearned revenue * 480
Drawings, Reen 8,000
Interest revenue * 33,680
Salary expenses * 9,050
Supplies expenses * 4,080
Sundry expenses 910
Insurance expenses ** 200
Rental revenue ** 240
Salary accrued ** 500
Depreciation expenses ** 100
Accumulated depreciation – equipment ** 100
81,800 81,800
* Updated accounts
** New accounts created after the adjusting entries.

After the adjustments are made, you will find that the ledger accounts in the
Adjusted Trial Balance show the same total debit and total credit. This Adjusted
Trial Balance will be used in the preparation of the financial statements,
which will be discussed in the next topic.
ACTIVITY 4.1
In your opinion, what are the uses of the Adjusted Trial Balance for
small businesses? Discuss.
SELF-CHECK 4.1
When is the right time to prepare the Adjusted Trial Balance? Explain.
EXERCISE 4.2
Information for adjustments is as follows:

1. Supplies in hand at 31 December 2010 amounted to RM750.
Supplies at 1 January 2010 totalled RM1,000.
2. Depreciation of equipment for the year 2010 totalled RM400.
3. Interest accrued on notes payable totalled RM300.
4. Insurance expired throughout the year 2010 totalled RM1,500.
5. Revenue accrued at 31 December 2010 totalled RM750.
6. Unearned revenue received throughout the year 2010 totalled
RM5,000.
Required:
Prepare the adjusting entries at 31 December 2010.

EXERCISE 4.3
Dapur Rona is a firm that provides catering services. Khadim, who is

the new accounts clerk, has prepared the following trial balance as at
30 June 2011.
Dapur Rona
Trial Balance as at 30 June 2011
Accounts Debit (RM) Credit (RM)
Cash 36,000
Raw materials supplies 28,500
Prepaid rent 162,000
Furniture and fittings 255,000
Accumulated depreciation – 65,400
furniture and fittings
Unearned revenue 30,000
Capital 153,000
Wages expense 176,400
Utility expense 18,000
Total 607,500 879,300
The following additional information must be considered as at 30 June 2011:

(a) Raw materials in hand as at 30 June amount to RM7,650.
(b) Office rent expired during the year is RM144,000.
(c) Accrued revenue earned but not yet recorded are RM21,900.
(d) Depreciation of furniture and fittings during the year is RM16,500.
(e) Wages accrued but not paid as at 30 June is RM6,900.
(f) Unearned revenue as at 30 June is RM7,500.
(g) Interest revenue on savings in bank earned but not recorded is RM240.
Required:
1. Prepare a corrected trial balance as at 30 June 2011.
2. Prepare the adjusting entries as at 30 June 2011.
3. Prepare an adjusted trial balance as at 30 June 2011.

EXERCISE 4.4
1. Asoka Travel and Tours prepared the following unadjusted trial

balance on 31 December 2010 for its first year of operation:
Debit (RM) Credit (RM)

Cash 10,350
Account receivables 67,500
Supplies 16,200
Motor vehicles 341,100
Account payable 15,750
Capital 234,000
Drawings 13,500
Revenue earned 407,250
Salary expense 94,500
Petrol expense 8,100
Rent expense 24,000
Utilities expense 51,750
675,000 675,000
An analysis of the accounts shows the following:

(a) Unbilled revenue on 31 December were RM5,325.
(b) Supplies on hand on 31 December were RM3,600.
(c) Depreciation on motor vehicles was estimated to be RM12,300 for
the year.
(d) The amount of unearned revenue in the above balance represents
all the deposits from customers received during the year for
booking trips. Half of these trips have been taken by the end of the
year.
(e) Unpaid bills on utilities on 31 December amounted to RM1,800.
Required:
(a) Prepare the appropriate adjusting journal entries.
(b) Prepare an adjusted trial balance as at 31 December 2010 for Asoka
Travel and Tours.

EXERCISE 4.5
The trial balances before and after adjustments for Bamba Management
Consultant at the end of the period are as follows:
Trial Balance as at 30 June 2011
Before Adjustments After Adjustments

Debit(RM) Credit(RM) Debit(RM) Credit(RM)
Cash 20,800 20,800
Account receivables 17,600 18,800
Supplies 4,600 1,400
Prepaid insurance 8,000 5,000
Equipment 28,000 28,000
Accumulated 7,200 9,800
depreciation-
equipment
Account payables 11,600 11,600
Salary payable - 2,200
Unearned fees 3,000 1,200
Capital 31,200 31,200
Fees revenue 90,000 93,000
Salary expense 34,000 36,200
Supplies expense - 3,200
Rent expense 30,000 30,000
Insurance expense - 3,000
Depreciation - 2,600
expense -
equipment
143,000 143,000 149,000 149,000
Required: Find the adjusting entries that were made and prepare their
journal entries.

In this topic, you have been introduced to the following items:

Prepaid expenses
Unearned revenue
Accrued expenses
Accrued revenue
The preparation of Adjusted Trial Balance is for the purpose of showing

the effect of all financial events that had occurred in the specific accounting
period and to aid in the preparation of final accounts and financial
statements.
Accrued Expense Depreciation

Accrued Revenue Prepaid Expenses
Adjusted Trial Balance Unearned Revenue
Adjusting Entries

Topic Completing the
5 Accounting
Cycle
LEARNING OUTCOMES
1. Prepare the financial statements consisting of income statement,
statement of changes in owner Ês equity, balance sheet statement and
p
cash flow statement;
2. Construct closing entries; and
3. Prepare reversing entries.
INTRODUCTION
Do you still remember how to prepare Adjusted Trial Balance, which we have
learned in the previous topic? Now, you will learn how to prepare financial
statements. These are prepared after all transactions are recorded or journalised,
transferred and summarised in the trial balance. The financial statements are also
known as the accounting report that reports the financial status at the end of the
accounting period.
The four main components of financial statements, comprising income

statement, statement of changes in ownerÊs equity, balance sheet and
s t a t e m e n t o f cash flow, are prepared based on information from the adjusted
trial balance. The preparation of cash flow statement also requires all information
related to cash that can be found in the records.
In this topic, you will also be exposed to closing and reversal entries to complete
the accounting cycle.

TOPIC 5 COMPLETING THE ACCOUNTING CYCLE 115
5.1 PREPARATION OF FINANCIAL

STATEMENTS
This topic will only discuss the preparation of financial statements for service-
oriented businesses for a sole proprietor. As you know, financial statements
consist of four statements, which are:
(a) Income Statement;
(b) Statement of Changes in OwnerÊs Equity;
(c) Balance Sheet; and
(d) Statement of Cash Flows.
5.1.1 Income Statement
Income Statement refers to the financial statement which presents the

operational results of the business entity for a specific period.
It is also known as the summary of revenue and expense for a specific period
whether it is one month, three months, six months or a year. If the business
entityÊs total revenue is more than total expenditure, then the net profit will be
reported in its income statement.
Total Revenue > Total Expense = Net Profit
If the total expense exceeds total revenue, the business entity will report a
net loss.
Total Expense > Total Revenue = Net Loss
The matching process is used to determine the net profit or net loss. The contents
in the Income Statement comprise five main elements:
(a) Name of business entity
Example: Noora Jaya Company
(b) Title of statement, which is Income Statement

116 TOPIC 5 COMPLETING THE ACCOUNTING CYCLE
(c) Report period and date.

Example: For the month/year ended 31 December 2010.
(d) Revenue and expenditure items.
(e) Net profit/loss
Figure 5.1 shows the format for Income Statement:
Figure 5.1: Format of income statement for service firms

The revenue and expense items are the main components in the income
statement. Revenue is the gross revenue obtained from business activities that
were conducted for the purpose of generating revenue. Normally, revenue is
derived from sales of goods, provision of services, rental of land and loans.
Figure 5.2 shows examples of sources of revenue.

Figure 5.2: Examples of sources of revenue
Revenue obtained will increase the total asset and owner equity for a business
entity. For example, the main revenue for a car wash business is revenue from
the car wash services provided. Other examples of revenue are fees, commission,
interest, dividend, royalty and rental.
Expenses are costs to the assets or services used or provided in the process to
generate the revenue.
Expense will reduce the total asset and owner equity. Examples of expense for a
car wash business are water, cleaning materials and staff salary.
The steps involved in preparing the Income Statement for Reen Cyber Service are
as follows:
(a) You must analyse the information reported in the following Adjusted
Trial Balance:

Reen Cyber Service

Adjusted Trial Balance

RM RM
Cash 19,130
Supplies 1,520
Insurance prepayment 4,600
Land 20,000
Unearned interest revenue 480
Drawings, Reen 8,000
Sundry expenses 910
Insurance expenses 200
Rental revenue 240
Salary payable 500
Depreciation expenses 100
Accumulated depreciation 100
81,800 81,800
(b) Extract all the revenue and expense items only because these are the
main components in the preparation of an Income Statement.
The following are all the revenue and expense items found in the
Adjusted Trial Balance for Reen Cyber Service.


Rental revenue 240
Sundry expenses 910
19,510 33,920
(c) Calculate the net profit or loss by adding all the revenue items and
deducting all the expense items. If the total revenue exceeds total
expenditure, then net profit is obtained. If total expense exceeds total
revenue then net loss is obtained.
Total revenue is RM33,920 which includes an interest revenue of RM33,680 and

a rental revenue of RM240. Total expense, which is RM19,510 will be deducted
from the total revenue of RM33,920 to generate the net profit of RM14,410.
RM
Total revenue 33,920
Total expense (19,510)
Net Profit 14,410
(d) Finally, you must enter all the items involved (revenues, expense and
net profit) into the income statement format.

Reen Cyber Service

Income Statement
For two months ended 31 December 2010
RM RM
Revenue:
Rental revenue 240
33,920
Less expenses:
Sundry expenses 910
Depreciation expenses 100 (19,510)
Net Profit 14,410
This total will be reported in

the statement of changes in
ownerÊs equity
5.1.2 Statement of Changes in Owner’s Equity
Statement of changes in ownerÊs equity is a summary of changes in the ownerÊs

equity that occurred in a specific period.
This statement is related to the Income Statement and Balance Sheet (which will
be discussed after this) and is prepared at the end of the accounting period.
Equity is the ownerÊs claim on the total asset. It equals the total assets after
deducting all the liabilities.

Equity consists of the following items:

(a) Opening capital;
(b) Yearly retained profit or loss;
(c) Drawings; and
(d) Closing capital.
Drawings refer to the total cash or goods taken by the business entityÊs owner for
personal use.
Statement of Changes in Equity for Reen Cyber Service:
Reen Cyber Service

Statement of Changes in OwnerÊs Equity
For two months ended 31 December 2010
RM
Capital Reen, 1 November 2010 30,000* from income statement
Net profit 14,410
Drawings (8,000)*
Capital Reen, 31 December 2010 36,410 will be reported in the balance sheet
* Total opening capital and drawings were taken from the Adjusted Trial Balance.
Normally, this statement is not prepared and is only shown in the notes to the
accounts (which will be discussed at the end of this unit). Items in this statement
will be shown either in the income statement or in the balance sheet. For
example, the yearly retained profit/loss is shown in the income statement while
the total closing capital is shown in the balance sheet.
The statement of changes in equity contains the total net profit taken from the
income statement that had been prepared previously. From the statement of
changes in equity thus prepared, the closing capital is obtained. This total will be
reported in the balance sheet statement. Therefore, the statement of changes in
equity has linked the income statement with the balance sheet.

5.1.3 Balance Sheet

Balance sheet or statement of financial position is a statement which reports the
financial status of the business at a point of time. The financial status of a
business entity covers the control on its economic resources, financial structure
and sustainability in the long term. Balance sheet contains three main
components, which are:
(a) Asset
Asset is an economic resource owned by a business entity that can bring
benefit to the business entity in the future. Asset exists in a business due to
past occurrences and transactions. Asset is a valuable resource to the
company as it can be used or exchanged to generate products or provide
services.
Asset is recorded in the balance sheet based on historical cost, which is the
original cost of purchase. Three characteristics that enable a resource to be
classified as an asset are:
(i) The resource can help the business entity to generate cash inflow in
the future, whether directly or indirectly.
(ii) The resource must benefit the business entity in the future and the
entity has controlling power on the said resource. Controlling power
means that the entity can prevent other people from using the said
resources.
(iii) Transaction or event that gives the rights to the business entity to
control the said resource had occurred. If the transaction of
purchasing the resource had not occurred then the resource cannot be
considered as an asset to the entity.
Asset consists of current asset and long-term asset as can be seen in

Figure 5.3.
Figure 5.3: Asset

(i) Current Asset

Current asset is an asset that is expected to be exchanged for cash or
sold or used in a period of one year or in the operating cycle period
(whichever is longer).
Operating cycle refer to the time frame taken by the business entity to process
as well as to sell the inventory, to collect accounts receivable (AR) as well as to
transform the accounts receivable into cash as shown in Figure 5.4.
Figure 5.4: Operating cycle
Current assets include:

• Cash;
• Trading securities/short-term investment;
• Items receivable;
• Inventories; and
• Prepayment expenses.
Cash includes cash in hand and cash in savings/current accounts in

the bank. Cash that cannot be used immediately is known as cash
equivalents. It is also classified under cash items.
Marketable securities or short-term investment comprise investment

in equity securities (example: investment in stocks) and investment in
debt security (example: investment in bonds). Investments in both of
these securities are considered current assets because these
investments are ready to be sold or traded. These two types of

investments can be exchanged for cash by the business entity in a

period of a year or in the operating cycle period, whichever is longer.
Items receivable is created when the business entity has provided

services or sold goods but the cash is yet to be received. Items
receivable are accounts receivable (AR), notes receivable, interest
receivable and fees receivable.
Prepaid expenses can also be classified as item receivable, for

example, rental prepayment, salary prepayment, insurance
prepayment.
Inventory for a business entity is different according to the type of

business. A business entity which provides services do not have
inventory. This is different from a business entity that produces/
manufactures its goods. It will have raw material inventories, work in
process inventories and finished goods inventory (all these types of
inventories will be discussed in Topic 5). Similarly, businesses that
buy and sell goods (trading firms) have inventory for retail stocks.
(ii) Long-term Asset/Non-current Asset

Long-term asset is an asset that can be used in the business or held for
a longer period, usually more than a year. Long-term asset comprises
non-current assets, other long-term assets and intangible assets.
• Long-term Asset
Land, plant, building and equipment are examples of long-term
assets. It has physical form and is used in the operation of the
business entity. All these assets must be depreciated, except for
land. Land need not be depreciated as its value is always
appreciating while plant, equipment and building must be
depreciated as the value of the assets will reduce as they get older.
Long-term asset is also known as non-current asset or tangible

asset.
In the balance sheet, non-current assets are presented at their

original or historical cost less the corresponding accumulated
depreciation.

• Other Long-term Asset

Other long-term assets include long-term investment, deferred
expenditure and amounts that are involved in the long term such
as item receivable.
These investments consist of investment in securities such as

investment in stocks and bonds that would not be exchangeable
for cash in the short period. Other long-term investments include
investment in property that is held for speculation purposes or for
use in future operation and investment in special funds such as
pension funds.
Long-term investments are investment held by the business

entity for a period of more than one year.
The amount involved in the long term is amount which is

expected to be received after a year. It includes accounts
receivable, notes receivable, receivable from director, receivable
from transaction between companies and other item receivables.
Deferred expenses are prepaid expenses for a long-term period

like deferred tax, companiesÊ restructuring expenses and
businessÊ preliminary expenses.
• Intangible/Non-physical Asset
Goodwill, patent, copyright and trademark are intangible assets
because they lack physical substance. The economic benefits that
can be provided by the intangible assets to the business entity in
the future are difficult to evaluate. Examples of other intangible
assets are franchise, trade names and computer softwareÊs cost.
Generally, intangible assets are amortised in a period of five to 40
years. The intangible asset will be reported in the balance sheet at
book value, which is cost less accumulated amortisation expenses.
Figure 5.5 shows types of long-term assets.

Figure 5.5: Long-term assets
In short, assets are economic resources that can generate benefit for the entity in
the future. Table 5.1 shows a summary on assets.
Table 5.1: Summary of Assets
Current Assets Long-term Assets/Non-current Assets
1. Expected usage within one year or 1. Can be used or held by the

operating cycle period business for more than one year
2. Comprises of: 2. Comprises of:

(a) Cash; (a) Long-term asset/non-current
asset (land, plant, building,
(b) Trading securities/short-term;
equipment); and
(c) Item receivables;
(b) Other long-term assets (long-
(d) Inventory; and term investment, deferred
expenditure).
(e) Prepayment expenses.
Intangible asset (patent,
copyright, trademark)
SELF-CHECK 5.1
Describe the difference between current assets and long-term assets.

State the items contained in these two types of assets.

(b) Liability
Liability is an obligation or responsibility of a business entity to external
parties like creditors or other business entities that have claims on the said
business. Liability is presented in the balance sheet to help users of financial
statements to measure the extent of the claims of other entities towards the
business entityÊs resources. Liability is divided into two, which are current
liability and long-term liability (non-current liability) as can be seen in
Figure 5.6.
Figure 5.6: Types of liability
(i) Current Liability

Current liability is a responsibility or obligation that is expected to be
paid using the current asset or by creating another current liability
within the period of one year. Current liabilities include:
• Bank loan or overdraft;
• Item payable;
• Portion of current long-term liability; and
• Deferred revenue.
Bank loan exists when a business entity applies for loan from the
bank, which must be settled within a year. Meanwhile, overdraft is a
facility given to current account holders to make withdrawal in excess
of the savings available.
Item payable consists of accounts payable (AP) and notes payable. It

exists when a business entity makes credit purchase from another
business entity. AP exists without any written agreement between the
two business entities but only via verbal agreement. It is different
from notes payable which has written agreement between the two
business entities.
Other items payable are salary payable, rental payable, interest payable,
which are expenses accrued or payable by the business entity. The
service is already received by the business entity but the payment is still
outstanding or there is no cash outflow from the business entity.
Portion of current long-term liability occurs when there is a portion

from the long-term liability that must be settled in a yearÊs period. The
total is classified as current liability and not long-term liability. The
balance will be classified as long-term liability.
The cash received will be the current liability to the business entity as
long as the services have not been provided. Examples of deferred
revenue are unearned fees, unearned revenue and deposit from
customers.
Deferred revenue refers to the cash received from the customer

but the services have not been provided yet.
(ii) Long-term Liability/Non-current Liability

Compared with current liability, long-term liability is a responsibility
or obligation that would not be settled or paid within the period of
one year. Long-term liabilities include:
• Bonds payable;
• Notes payable;
• Inter-company loan; and
• Secured loan.
Bonds payable are long-term liabilities or obligation to a business

entity. The entity must settle the total cash received from the bonds
issued within a period which may exceed one year, that is, upon
maturity of the bonds.
Notes payable are transactions involving credit with written

agreement between the two business entities. The business entity
which received the notes payable with maturity date exceeding one
year means that it has a liability/responsibility that must be settled in
that period.
Inter-company loan involves obligation or responsibility between

companies that must be settled within the specific period which
exceeds one year.
Secured loan is a liability of a business company towards another party,

for example, a bank or financial institution. The institution will get the
business entityÊs assets (such as land and building) as security for the
loan provided to the company. Table 5.1 shows a summary of liabilities.

Table 5.2: Summary of Liabilities
Liabilities
Economic benefit that must be sacrificed by transferring the asset or providing
services/goods to another business entity.
Current Liability Long-term Liability/
Non-current Liability
1. Expected to be paid within a 1. Expected to be settled within the
period of one year period > one year
2. Comprises of: 2. Comprises of:
• Bank loan; • Bonds payable;
• Item payable; • Notes payable;
• Portion of current long-term • Inter-company loans;
liability; and • Secured loan; and
• Deferred revenue. • Contingent liability.
(c) OwnerÊs Equity

OwnerÊs equity means rights or claims against the assets of the business by the
owner. OwnerÊs equity is the excess of total asset against total liability of the
business. OwnerÊs equity for each ownership business structure differ:
• For company, ownerÊs equity consists of paid-up capital, premium
shares, retained earnings and reserve.
• For partnership, ownerÊs equity consists of total capital account for all
partners.
• For sole proprietorship, ownerÊs equity consists of capital account
contributed by its sole owner.
Now you know all the items that need to be reported in the balance sheet,
namely, asset, liability and ownerÊs equity.
The following balance sheet statement reports all items of asset, liability
and ownerÊs equity found in the Adjusted Trial Balance and Statement of
Changes in ownerÊs equity for Reen Cyber Service:

Reen Cyber Service

Balance Sheet as at 31 December 2010
RM RM RM
Non-current assets:
Land 20,000
Accumulated depreciation (100) 3,500
23,500
Current assets:
Cash 19,130
Supplies 1,520
Insurance prepayment 4,600 30,690
Less: Current Liabilities:
Salary payable 500
Unearned revenue 480 (2,780)
Net current assets 27,910
51,410
Finance by:
OwnerÊs Equity
Capital, Reen 36,410*
Non-current liability:
51,410
From the statement of changes in ownerÊs equity
• If the statement of changes in equity has not been prepared, all the
items in that statement would be shown in the balance sheet for the
purpose of reporting the closing capital as at 31 December 2010.
Net assets refer to the difference between net current assets and net current
liabilities. This item must be reported according to the regulation and
standards approved by the Malaysian Accounting Standards Board (MASB)
Financial Reporting Standard 101: Presentation of Financial Statements.

To ensure that you have understood what you have learned, complete the
following exercise.
EXERCISE 5.1
Information in the adjusted trial balance for KhairunnisaÊ Consulting

Services at 30 June 2010 are as follows:
KhairunnisaÊ Consulting Services

Adjusted Trial Balance as at 30 June 2010
Debit Credit
Cash 56,350
Office supplies 12,300
Rental prepayment 4,400
Accumulated depreciation – office equipment 10,725

Unearned Fees 10,980
Notes payable – long-term 100,000
Salary payable 7,100
Capital, KhairunnisaÊ 51,990
Fees revenue 119,280
Insurance expenses 3,500
Total 317,675 317,675
From the information above:

1. Prepare the income statement for the period ended 30 June 2010
for KhairunnisaÊ Consulting Services.
2. Prepare the balance sheet as at 30 June 2010.


You will next be exposed to the fourth financial statement, the statement of cash
flows which summarises the cash received and cash payment for the period. It
presents the basic cash information for operating, investing and financing
activities. The cash flow statement can help users of accounting information to
evaluate the capability of the company to:
(a) Generate positive cash flow in the future; and
(b) Settle its debts, pay dividends and provide loans to external parties.
Statement of cash flows can be classified under three activities (see Figure 5.7),
which are, operating activities, investing activities and financing activities.
Figure 5.7: Statement of cash flows
Now, let us look at the explanation for each activity.
(a) Operating Activities

Operating activities involve cash transactions that affect the businessÊ net
profit, which are any cash received, such as cash from sales, and any cash
payments, such as payment for purchases. Only cash received and payment
related to the operation of the company are taken into account. FRS 107 also
specified interest and dividend received as part of items from operating
activities. However, both these items can also be classified as investing or
financing activities, which will be discussed later.
(b) Investing Activities

The second activity is investing activities and would normally involve long-
term asset items, such as purchase and sale of non-current assets. Any
profit or loss from the sale of non-current asset will not be included in the
calculation of net cash flow from investing activities.

(c) Financing Activities

This activity normally involves long-term liability and equity items such as
issuance of share and payment of all debts. If there is profit or loss during
the payment of all debts, it will not be taken into account while generating
the net cash flow from financing activities.
Examples of Cash Received and Payments for each of the activities are as follows:
Operating Activities
Cash Received From: Cash Payment For:

Sale of goods Purchase of goods
Service revenue Staff wages and salary
Fees revenue Utility expenses
Rental revenue Rental expenses
Investing Activities

Sale of non-current asset Purchase of non-current asset
Sale of investment Purchase of shares (invest)
Collection of loan provided to other Provision of loan to other entities
entities
Financing Activities

Loan or debt of the company from Repayment of loan/debt
external parties
Issuance of shares Share buyback
Examples for each activity above are reported in the Cash Flow Statement shown
as follows:
Cash balance as at 1 January 2010 is zero as the business is newly established.

Air Molek Enterprise

Statement of Cash Flows
for the Period Ended 31 December 2010
Operating Activities RM RM
Received:
Collection from customer 6,500
Payment:
Staff salary (1,200) (1,200)
Net cash flow from operating 5,300
Sale of land 22,000
Sale of shares 18,000
Net cash flow from investing 40,000
Investment by owner 50,000
Net cash flow from financing 50,000
Total increase in cash 95,300
Cash balance as at 1 January 2010 0
Cash balance as at 31 December 2010 95,300
For your information, the Statement of Cash Flow must take into account all cash
related transactions. This means that you must refer to Topic 3, which is the
recording of information related to incoming or outgoing cash flow.

Statement of Cash Flows for Reen Cyber Service is as follows:
Notes to Solution:
Reen Cyber Service

Statement of Cash Flows
For the Period Ended 31 December 2010
Operating Activities RM RM
Received:
Cash from customers 13,960
Payment:
Cash to suppliers (2,600)
Expenditure (15,030) (17,630)
Net cash flow from operating (3,670)
Drawings by owner (4,000)
Total increase/(decrease) in cash (7,670)
Cash balance 1 December 2010 26,800
Cash balance 31 December 2010 19,130
Cash total is the same as the total reported in balance sheet.
(i) Cash from a customer totalled RM13,960, which is the total cash received
throughout the month of December. You can refer to the journal entry done
in Topic 3 relating to accounts receivable. RM13,960 was total cash received
for 1 December for RM720; 16 December for RM6,200; 21 December for
RM1,300 and 31 December for RM5,740.
(ii) Payment to suppliers totalling RM2,600 was for transaction on 11 December

2010 for RM800 and 20 December for RM1,800.
(iii) Cash for payment of expenditure was from all transactions related to
expenses and outgoing cash flow. Examples of expenses involved are rental
expenses, insurance expenses, sundry expenses and utility expenses. You
can try by using the same way we had derived the total cash from
customers. You will find that total for all expenses are RM15,030. Therefore,
the net cash flow from the operating activities totalled (RM3,670), which is
(RM13,960 – RM17,630).

(iv) What had happened to the overall cash flow? The cash flow had decreased
by RM7,670 throughout the month of December. This is different from the
one reported in the income statement for the period ended 31 December,
that is the net profit of RM14,410. This is because the entity had used the
accrual basis in recognising the revenue and expenditure, without taking
into account the incoming or outgoing cash.
(v) Total cash balance as at 1 December 2010 which is RM26,800 refers to cash
transaction throughout the month of November 2010.
SELF-CHECK 5.2
Briefly explain the four financial statements which are included in the
preparation of financial reports.
5.2 PREPARATION OF CLOSING ENTRIES

In this subtopic, you will learn how to prepare the closing entry. Drawings
account will be closed directly to the capital account.
Closing entry refers to the temporary closing of accounts, where all the
accounts in the income statement (revenue and expenses accounts) will be
transferred to the revenue summary account.
The purpose of closing entry is to measure the profit accurately. It is also for the
purpose of making the temporary accounts into zero balance for the next period.
5.2.1 Steps in Preparation of Closing Entries

Temporary accounts are accounts related only to the current accounting period
which will be closed, for example, expenses accounts and drawings account. The
fixed accounts (such as asset, liability and owner equity), however, will not be
closed. These accounts are related to one or more accounting periods in the
future with its balance reported in the balance sheet. Closing entry is done at the
end of the accounting period.

The steps for making closing entries are as follows:

(a) All revenue accounts will be debited and revenue summary account will be
credited.
(b) All expenses accounts will be credited and revenue summary account will
be debited.
(c) Transfer balance from revenue summary account into capital account.
(d) Drawings account will be credited and capital account will be debited.
Figure 5.8 shows the summary of preparing the closing entry.
Figure 5.8: Summary for preparation of the closing entry

Closing entries for Reen Cyber Services as at 31 December 2010 are as follows:
31 December 2010
Dr. Interest revenue 33,680

Rental revenue 240
Cr. Revenue Summary 33,920
(Closing of all revenue accounts)
Dr. Revenue Summary 19,510
Cr. Salary expenses 9,050
Sundry expenses 910
(Closing of all expenses accounts)
Dr. Revenue Summary 14,410
Cr. Capital, Reen 14,410
(Closing of revenue summary account)
Dr. Capital, Reen 8,000
Cr. Drawings 8,000
(Closing of drawings account)
Notes to Solutions:
(i) All revenue accounts will be closed by debiting the specific accounts and
creating a revenue summary account. With this all the revenue accounts
will have a zero balance while the revenue summary account will have
RM33,920 credit balance.
(ii) All expenses accounts will be closed by crediting the said accounts. With
this all the expenses accounts for that period will have a zero balance.
Meanwhile, the current balance of revenue summary account will become
RM14,410 after taking into account the expenses transferred over to this
account.

(iii) Balance in the revenue summary account of RM14,410 will be transferred to

the capital account. If it is a credit balance, it would be net profit, while if it
has a debit balance, it will be net loss. This balance will be the same net
profit reported in the income statement prepared in the previous topic.
SELF-CHECK 5.3
What are the steps required to prepare a closing entry?
5.3 PREPARATION OF REVERSING ENTRIES

What do you understand about reversing entry?
Reversing entry is a reversal to the adjusting entry from the previous period
but only related to accruals, which are accrued revenue and accrued expenses.
Reversing entry is usually prepared on the first day of the next accounting
period. It is to simplify the accounting process because it separates the expenses
or revenue for the two accounting periods. However, a business entity has a
choice on whether to prepare this reversal entry or not.
Example 5.1
At the end of year 2009, Mas Merah Company has accrued salary expenses of
RM800. The adjusting entry recorded was:
31 December 2009 Dr. Salary Expenses 800

Cr. Salary Payable 800
At 31 December, closing entry must be made to close the salary expenses account
as this account is temporary. The entry needed is:
31 December 2009 Dr. Revenue Summary 800

Cr. Salary expenses 800
If Mas Merah Company prepares the reversal entry on the first day of the next
accounting period, the reversal entry would be:

1 January 2010 Dr. Salary payable 800

Cr. Salary expenses 800
At 15 January 2010, Mas Merah Company made an actual salary payment of

RM2,000. The journal entry involved would be:
15 January 2010 Dr. Salary expenses 2,000

Cr. Cash 2,000
After all the journal entries had been transferred to the ledger, the accounts
involved are:
Salary Expenses Account

RM RM
31 Dec 2009 Adjustment 800 31 Dec 2009 Closing 800
15 Jan 2010 Payment 2,000 1 Jan 2010 Reversal 800
Salary Payable Account

RM RM
31 Dec 2009 Balance c/f 800 31 Dec 2009 Adjustment 800
1 Jan 2010 Reversal 800 1 Jan 2010 Balance b/d 800
Revenue Summary Account
RM
31 Dec 2009 Closing 800
Cash Account
RM
1 Jan 2010 Payment 2,000
Salary expenses account as at 15 January 2010 has a debit balance of RM1,200

(RM2,000 – RM800). This means this total will be recognised as salary expenses
for the accounting period of 2010. Therefore, the role of reversal entry is to
separate the expenses for the two accounting period, that is for the years 2010
and 2009.

As at 15 January 2010, the balance for salary payable account will be 0, that is,
after the reversal entry had been transferred to salary payable ledger. The
revenue summary account will be closed by debiting the capital account while
cash account will be permanently reported in the balance sheet.
EXERCISE 5.2
1. The trial balance for Berkat Enterprise as at 30 June 2011 is as
follows:
Cash 3,425
Supplies 1,270
Office equipment
Salary payable 925
Capital 29,000
Drawings 5,200
Total 100,000 100,000
Adjustment information:
(a) Supplies in hand as at 30 June 2011 totalled RM380.
(b) Insurance premium expired for the year totalled
RM315.
(c) Yearly depreciation for office equipment totalled
RM4,950.
(d) Salary accrued but yet to be paid as at 30 June is
RM440.
(e) Service revenue accrued but yet to be recorded totalled
RM1,000.
(f) Unearned revenue as at 30 June totalled RM750.

From the information provided, you are required to:

(a) Prepare the journal entries to record all the adjustments.
(b) Prepare the Income Statement and Balance Sheet at the end of the
accounting period.
(c) Prepare the closing entries.
2. Mekar Serumpun Company paid salary to its workers once in every

six days (the salary for Saturday until Thursday will be paid on
Thursday). Friday is a holiday for Mekar Serumpun Company. The
company pays a daily rate of RM20 as salary to its workers. The
company had decided that 31 December is the last day for its
accounting period and 31 December 2010 falls on a Wednesday.
Based on the above information, prepare the reversing entries and
transfer the entries to the corresponding ledgers for the final week of
year 2010.
3. Information in the Adjusted Trial Balance of Moiz Real Estate

Company as at 31 December 2010 are as follows:
Moiz Real Estate Company

Trial Balance as at 31 December 2010
Cash 6,850
Supplies 2,540
Accumulated depreciation – office equipment 19,400
Capital, Moiz 58,000
Drawings, Moiz 10,400
Depreciation expenses 5,430
Total 200,000 200,000

From the information above, you are required to:
(a) Prepare the income statement, statement of changes in

equity and balance sheet statement.
(b) Prepare the closing entries.
• The preparation of Financial Statements is done after the transactions have

been recorded, journalised, transferred and summarised in the Trial Balance.
• The Financial Statements prepared for an entity include:

– Income Statement or Statement of Comprehensive Income
– Statement of Changes in Equity
– Balance Sheet or Statement of Financial Position
– Statement of Cash Flows
• The preparation of closing entries must be done for the purpose of measuring
the profit accurately and to make the temporary accounts into zero balance
for the next accounting period.
• The preparation of reversing entries must be done on the first day of the
next accounting period. This is a reversal to the adjusting entries made in
the previous period and is related only to accruals (accrued revenue and
accrued expenses).
Closing Entry Long-term

Current Asset Asset Long-term
Current Liability Liability
Financial Statements Reversing Entry

Topic Financial
6 Reporting
Standards
LEARNING OUTCOMES
1. Describe the statutory requirements for the preparation of

p a financial report or an annual report;
2. Examine content in an annual report comprising financial

information and non-financial information; and
3. Prepare financial statements that must be presented in the key

financial statements according to FRS 101.
INTRODUCTION
Do you know that business entities are required to report their financial status in
a formal report at the end of each accounting period? This report is also known
as the financial report or annual report. Why is it so? The purpose of the report
is to present the financial status of the business entity for a specific accounting
period.
In this topic, we will discuss the statutory requirements that call for business
entities, especially public companies, to prepare the financial report or annual
report for publication purpose. Later, at the end of this topic, we will discuss the
contents of the financial reports released by business entities which comprise
financial information and non-financial information.

TOPIC 6 FINANCIAL REPORTING STANDARDS 145
6.1 STATUTORY REQUIREMENT

Let us begin by analysing the statutory requirements for the preparation of this
financial report. Public companies are required to inform relevant stakeholders of
their business operations and performance. This is important especially for a
company type of entity ownership because of the segregation between the owner
and the management.
In this type of company, not all owners will be involved in the management of
the company. There must be some kind of legislation on its financial reporting, so
that what is presented to them represents the „true and fair‰ view of the
company they have invested in and that the management is transparent in its
actions.
Financial reports are very useful and important for users of accounting
information such as investors, creditors, government, economic analysts and
other interested users. This is because financial reports help them to conclude on
the performance and financial status of a business entity. Financial reports are
also prepared to fulfil statutory requirements.
The regulations that must be complied with in the preparation of financial

reports are Companies Act 1965, Securities Commission 1995, Financial
Reporting Act 1997 and Income Tax Act 1967, whilst organisations such as Bursa
Malaysia Berhad and Central Bank of Malaysia require business entities to
submit financial reports.
Figure 6.1 shows the summary of statutory bodies that require annual reports.
Figure 6.1: Statutory bodies that require annual reports from business entities
Now, let us go through each statutory body in detail.

146 TOPIC 6 FINANCIAL REPORTING STANDARDS
(a) Companies Act 1965

You will now be introduced to the first regulation that requires the
preparation of t h e annual report, which is Companies Act 1965.
Business institutions formed as companies are bound by Companies
Act 1965 with regard to the preparation of financial and accounting report.
It is stated clearly under Schedule VI: Account and Audit of the
Companies Act 1965.
Sections 169 (1), (2), (3), (4) and (5) of the Companies Act 1965 require a
newly incorporated business entity registered with the Registrar of
Companies to prepare an annual report not later than 18 months from the
date of its incorporation. For the following years, the annual report
must be prepared at the end of each accounting period. A business entity
will be fined or its registration will be annulled by the Registrar of
Companies if it fails to prepare the annual report.
To enhance your understanding of the companiesÊ rules and regulations

stated before, you can refer to Section 169 of the Companies Act 1965.
(b) Securities Commission 1995

Securities Commission 1995 is a statutory body established under the
Securities Commission Act 1993. This commission emphasises the
importance of standard financial reporting. It also has statutory power
that requires business entities to comply with its regulation.
Regulation 8 of the commission requires all companies that are listed

on the Stock Exchange to prepare their accounts according to the approved
accounting standards. Companies can be imposed with disciplinary action
or fine if they failed to comply with this regulation.
(c) Financial Reporting Act 1997

The Financial Reporting Act 1997 had established an accounting
standards setting body that is the Malaysian Accounting Standards Board
(MASB) on 1 July 1997. Companies registered in this country must observe
the stipulated regulations, by complying with the accounting standards
approved by MASB. Beginning January 2005, the existing MASB standards
were renamed as Financial Reporting Standards (FRS) in line with similar
moves by other countries in the world to change the name of their
standards. FRS 101 (in replacement of MASB 1), for example, sets the
overall requirements for the presentation of financial statements, guidelines
for their structure and minimum requirements for their content.

The standards would further be converged as International Financial

Reporting Standards (IFRS) in 2012, when Malaysia decided to fully adopt
the international standards issued by the International Accounting
Standards Board (IASB). This move is in line with the globalisation of
capital markets and MalaysiaÊs efforts to continuously serve the investing
community better by conforming to the international standards. Please refer
to the Financial Reporting Act 1997 for further information.
(d) Income Tax Act 1967

Compliance with the Income Tax Act 1967 is a legal requirement. This
Act is important as it includes specific provisions relating to the
retention of accounting records of business entities for the purpose of
tax calculations (Sections 82, 108 and 110).
(e) Bursa Malaysia Berhad

Next is Bursa Malaysia Berhad, which requires all business entities listed
on its exchange to comply with several conditions as follows:
(i) A printed financial report must be distributed within six months from
the last financial date to the shareholders and Bursa Malaysia Berhad;
(ii) Annual audited accounts must be in the form of a Consolidated
Financial Statement; and
(iii) Annual audited accounts must be prepared according to the
standards approved by MASB and the Companies Act 1965.
Consolidated accounts are the accounts of a parent company combined

with the accounts of its subsidiaries.
(f) Central Bank of Malaysia

The Central Bank of Malaysia or Bank Negara Malaysia had prepared
a guideline relating to financial reporting for financial institutions of this
country under the Banking and Financial Institutions Act 1989. This
guideline deals with general disclosure in the preparation of financial
statement and detailed disclosures are highly encouraged.
SELF-CHECK 6.1
Explain the importance of business entities to comply with the

regulations as set by the statutory bodies in this country.

EXERCISE 6.1
List the regulations and organisations that require financial reporting.
6.2 FINANCIAL REPORT

What is inside a financial report? Let us take a look at the information contained
in the financial report in detail. The Companies Act 1965 (Section 169) had
stipulated the contents that must be reported in the financial report/annual
report. Other than that, most of the business entities have also include
additional information such as corporate information and structure.
The contents and presentation format of the annual reports prepared by business
entities are normally different depending on the policy adopted by the
management. There are two main components in financial report/annual report
for a business entity – financial and non-financial information.
6.2.1 Non-financial Information

Non-financial information should comprise the following:
(a) ChairmanÊs Report

Report on financial performance or financial status of the company. A
chairmanÊs report also specifies future planning and prospects including
dividend payout to shareholders based on available proof, such as the
profit or loss status and the current economic situation.
(b) Notice of Annual General Meeting

This notice is an invitation to the annual general meeting which is
distributed to all members or shareholders. It usually states the date, time,
meeting venue, meeting agenda and other related matters. The notice is
normally prepared by the company secretary.
(c) Corporate Information and Structure

Corporate information relates to information on members of the board of
directors, company secretary, audit committee, registered office, principal
bankers, auditors and corporate lawyers. The company structure states
information relating to subsidiaries and associated companies including

percentage of share ownership on subsidiaries and associated companies

within the groupÊs structure.
Associated company – When a business entity has a percentage share

ownership of 20 - 50% in another business entity.
(d) Summary of Financial Information

This report compares a summary of the companyÊs past financial results,
usually for the past five to ten years. The information is normally presented
in the form of graphs or charts to show comparison between the previous
and the current results.
(e) AuditorsÊ Report

AuditorsÊ report is the opinions given by Auditors as an independent
external party who are appointed by the company. The auditors provide
opinion after checking and auditing all the accounts and financial report,
according to the standards and procedure. This report is for the purpose of
verifying that all the information prepared and reported in the annual
financial statements had given a true and fair view.
(f) Statement of Corporate Governance

This statement is required for companies to declare that they use the
Malaysian Code of Corporate Governance and follow the principles and
practices outlined by the referred code.
(g) Statement of Corporate Social Responsibility

This statement outlines a companyÊs commitment of its corporate
responsibilities and their involvement in achieving these objectives. The
areas that are covered mainly include activities that affect the environment,
community, workplace and marketplace.
Non-financial information discussed earlier can be seen in Figure 6.2.

Figure 6.2: Non-financial information
SELF-CHECK 6.2
State the contents of non-financial information.
ACTIVITY 6.1
If you intend to invest by buying shares in a company, is it important

for you to evaluate or read the companyÊs prospectus yourself? Why?
Discuss with your coursemates.
6.3 MAIN FINANCIAL STATEMENTS

Previously, you have been exposed to non-financial information. Now, the
discussion will revolve around financial information which forms the most
important part o f the annual report and will be presented as the main
financial statements. Let us take a look at the main financial statements that
must be presented as listed by FRS 101.

6.3.1 Statement of Comprehensive Income

The first financial statement discussed here is the statement of comprehensive
income for the accounting period. It reports the financial performance by
showing profit or loss during the accounting period. All related accounting
information must be disclosed in the statement of comprehensive income.
The following are the minimum accounting information required by FRS 101 for
reporting purposes:
(a) Revenue;
(b) Finance costs;
(c) Share of the profit or loss of associates and joint ventures accounted for
using the equity method;
(d) Tax expense;
(e) A single amount comprising the total of:
(i) The post-tax profit or loss of discontinued operations; and
(ii) The post-tax gain or loss recognised on the measurement to fair value
less costs to sell or on the disposal of the assets or disposal group(s)
constituting the discontinued operation;
(f) Profit or loss;
(g) Each component of other comprehensive income classified by nature
(excluding amounts in (h));
(h) Share of the other comprehensive income of associates and joint ventures
accounted for using the equity method; and
(i) Total comprehensive income.
An entity is also expected to disclose the following items in the statement of

comprehensive income as allocations for the period:
(a) Profit or loss for the period attributable to:
(i) Non-controlling interests; and
(ii) Owners of the parent.
(b) Total comprehensive income for the period attributable to:
(i) Non-controlling interests; and
(ii) Owners of the parent.

A company can present an analysis of expenses recognised in profit or loss using

a classification based on either their nature or function within the entity,
whichever provides information that is reliable and more relevant. In the „nature
of expense‰ format, the company aggregates expenses within profit or loss
according to their nature (for example, depreciation, purchases of materials,
transport costs, employee benefits and advertising costs) and does not reallocate
them among functions within the entity. This method may be simple to apply
because no allocations of expenses to functional classifications are necessary. An
example of a classification using the nature of expense method is as shown in
Figure 6.3:
Revenue X
Other income X
Changes in inventories of finished goods and work in X
progress
Raw materials and consumables used X
Employee benefits expense X
Depreciation and amortisation expense X
Other expenses X
Total expenses (X)
Profit before tax X
Figure 6.3: An example of a classification using the nature of expense method
The second form of analysis is the „function of expense‰ which classifies

expenses according to their function as part of cost of sales or, for example, the
costs of distribution or administrative activities. At a minimum, an entity
discloses its cost of sales under this method separately from other expenses. This
method can provide more relevant information to users than the classification of
expenses by nature but allocating costs to functions may require arbitrary
allocations and involve considerable judgement. An example of a classification
using the function of expense method is as shown in Figure 6.4:

Revenue X
Cost of sales (X)
Gross profit X
Other income X
Distribution costs (X)
Administrative expenses (X)
Other expenses (X)
Profit before tax X
Figure 6.4: An example of a classification using the function of expense method
6.3.2 Statement of Financial Position

Statement of financial position or balance sheet is the statement that shows the
financial status of a business entity at any one time. This statement reports the
status of assets, liabilities and owner Ês equity.
FRS 101 requires business entities to report the following items, which are the
minimum disclosure in the statement of financial position/balance sheet:
(a) Property, plant and equipment;
(b) Investment property;
(c) Intangible assets;
(d) Financial assets (excluding amounts shown under (e), (h) and (i));
(e) Investments accounted for using the equity method;
(f) Biological assets;
(g) Inventories;
(h) Trade and other receivables;
(i) Cash and cash equivalents;
(j) The total of assets classified as held for sale and assets included in disposal
groups classified as held for sale in accordance with FRS 5 non-current
assets held for sale and discontinued operations;
(k) Trade and other payables;
(l) Provisions;
(m) Financial liabilities (excluding amounts shown under (k) and (l));
(n) Liabilities and assets for current tax, as defined in FRS 112 income taxes;
(o) Deferred tax liabilities and deferred tax assets, as defined in FRS 112;
(p) Liabilities included in disposal groups classified as held for sale in
accordance with FRS 5;
(q) Non-controlling interests, presented within equity; and
(r) Issued capital and reserves attributable to owners of the parent.
However, several of the above items will only be studied in the more advanced
accounting curriculum.
6.3.3 Statement of Changes in Equity

Statement of changes in equity is the statement that reports the changes in
the equity for the accounting period. The disclosures required by FRS 101 in this
statement are as follows:
(a) Total comprehensive income for the period, showing separately the total
amounts attributable to owners of the parent and to non-controlling
interests;
(b) For each component of equity, the effects of retrospective application or
retrospective restatement recognised in accordance with FRS 108; and
(c) For each component of equity, a reconciliation between the carrying
amount at the beginning and the end of the period, separately disclosing
changes resulting from:
(i) Profit or loss;
(ii) Each item of other comprehensive income; and
(iii) Transactions with owners in their capacity as owners, showing
separately contributions by and distributions to owners and changes
in ownership interests in subsidiaries that do not result in a loss of
control.

As the name implies, the statement of cash flow reports information relating to
cash transactions. The cash flow statement shows the changes in cash that
occurred for the business entity during a specific period. Information from this
statement is very important to users of financial information as it reports how
cash was generated and used; and the ability of the business entity to generate
cash in the future.
FRS 107 sets out requirements for the presentation and disclosure of cash flow
information. Basically, it requires business entities to report the net cash flow
from the following activities (which were previously discussed in Topic 1):
(a) Operating activities;
(b) Investing activities; and
(c) Financing activities.
All the statements discussed before must be reported in the annual report by
comparing two accounting periods which is the current period and the previous
period.
6.3.5 Notes to the Accounts and Accounting Policies

What are notes to the accounts and accounting policies? Notes to the accounts
refer to the detailed descriptions relating to the accounts reported in the
statements of financial position and comprehensive income. FRS 101 considers
notes to the accounts as an integral part of financial reporting. Basically, the
notes:
(a) Present information about the basis of preparation of the financial
statements and the specific accounting policies used;
(b) Disclose the information required by FRSS that is not presented elsewhere
in the financial statements; and
(c) Provide information that is not presented elsewhere in the financial
statements but is relevant to an understanding of any of them.
For example, among the notes to the accounts reported in the financial report are
in relation to:
(a) Accounting policy;
(b) Debtors Account/Account Receivable;
(c) Inventory Account;
(d) Investment;
(e) Share capital;
(f) Reserves; and
(g) Contingent liabilities.
The function of notes to the accounts is to provide an explanation to the users

of accounting information on how the total of the accounts reported in the
financial statements are derived.
Accounting policies for a business entity refer to the accounting policies practised
by the entity in preparing and presenting the financial statement. These
accounting policies are subject to the standards released by MASB and the
accounting bodies. They usually include the measurement basis/bases used in
preparing the financial statements and the other accounting policies used that are
relevant to an understanding of the financial statements. Examples of accounting
policies that must be disclosed by a business entity are:
(a) Basis of measurement used (for example, historical cost, current cost, net
realisable value, fair value or recoverable amount);
(b) Basis of consolidation for consolidated accounts;
(c) Meaning of consolidated companies;
(d) Meaning of associated companies; and
(e) Basis of accounting for fixed asset and the methods used for calculation of
depreciation.
It is important for a company to inform users of the measurement basis/bases

used in the financial statements because this will significantly affect usersÊ
evaluation of the companyÊs performance and financial position. Disclosure of
important accounting policies would also assist users in understanding how
transactions, other events and conditions are reflected in the reported financial
statements.

EXERCISE 6.2
1. What is the purpose of preparing a financial report?
2. What are the differences between financial and non-financial

information? Provide examples of each.
Financial Information Non-financial Information
3. Why are notes to the accounts being prepared?

4. For each of the statements below, state whether it is TRUE or FALSE:
(a) All companies are bound by Companies Act 1965 with
regards to the aspect of preparation of financial report.
(b) Under the Companies Act 1965, a newly formed company
must prepare its financial report not later than 12 months
from the date of its incorporation.
(c) Provisions under the Securities Commission Act 1993 apply
to all types of companies.
(d) The Malaysian Accounting Standards Board(MASB) was
established in 1997 to set, issue and review the accounting
standards for corporate financial reporting in Malaysia.
(e) Bursa Malaysia Berhad requires entities under its exchange
to distribute their printed financial report to their
shareholders within 3 months from the last financial date.
(f) Bank Negara Malaysia has its own set of guidelines relating
to financial reporting for public companies in Malaysia.
(g) Compliance with approved accounting standards is required
by both companies listed in Securities Commission and
Bursa Malaysia Berhad.
(h) The notice of annual general meeting is an invitation to the
board of directors to attend the companyÊs annual general
meeting.
(i) AuditorÊs report is prepared by an external auditor who is
hired by the shareholders to verify the true and fair view of
the financial reports of the company they invest in.
(j) The statement of financial position shows the financial
performance and status of a business entity at any one time.

ACTIVITY 6.2
Obtain an annual report of a listed company and observe the reporting

of financial and non-financial information.
1. List the main content in each of the statements presented in the
financial report section.
2. Analyse and briefly describe the content of the notes to the
accounts and accounting policies.
3. Identify the non-financial information that are disclosed in the
annual report.
• A financial report prepared by a business entity shows the financial

status of the business which is useful to investors, creditors, government,
economic analysts and other interested users.
• Financial and non-financial information are the main components in the

financial/annual report of a business entity.
• FRS 101 lists the financial statements that must be presented in the key
financial statements. These are:
– Statement of Financial Position;
– Statement of Comprehensive Income;
– Statement of Changes in Equity;
– Statement of Cash Flows; and
– Notes to the Accounts and Accounting Policies.
Accounting policies Non-financial information

Financial information Notes to the accounts
Financial report Statutory requirement
Financial statements

Topic Trading
7 Business
Environment
LEARNING OUTCOMES
1. Explain the differences between trading firms and service firms; and
2. Describe the important transactions in trading firms.
p
INTRODUCTION
Do you still remember the topics we discussed previously? We have discussed
the accounting environment and recording process as well as the way to
complete the accounting cycle. We have also discussed the types of adjusting
entries that will affect the accounts in the income statement. However, you might
notice that those transactions only focused on service firms rather than
inventories.
Thus, in this topic, let us shift focus to trading firms where inventories are
particularly discussed. We will start by looking at the differences between
trading firms and service firms and then we will identify the important
transactions in trading firms.
7.1 DIFFERENCES BETWEEN TRADING FIRMS

AND SERVICE FIRMS
Trading firms are businesses that buy goods with the intention of reselling the
goods to its customers. For that reason, trading firms usually have inventories of
goods to be resold, which is not the case with service firms. The differences

160 TOPIC 7 TRADING BUSINESS ENVIRONMENT
between trading firms and service firms can be narrowed down to the revenue
and expense items which appear in the Income Statement as shown in Figure 7.1.
Figure 7.1: Difference in income statement for service firms and trading firms
Service firms generally derive their revenue from services which they provide to
customers. For example, the revenue of accounting firms relate to fees from
conducting audits in organisations. For an income statement of service firms,
revenue from these services is reported as fees earned (or service revenue). Net
operating income for service firms is the difference between the fees earned and
the operating expense involved in offering the services. This can be clearly seen
in the previous Figure 7.1.
However, the situation is different for trading firms, where revenue is generated
from activities of buying and selling goods. In other words, trading firms buy
goods and then resell them to their customers with an intention of making profit.
When goods are sold, the revenue received is reported as sales revenue. It is
important to note that before selling, the trading firms would have, of course,
purchased their goods from suppliers. The cost of buying the merchandise will
also need to be recorded. This expense item is known as cost of goods sold. The
difference between sales revenue and cost of goods sold is known as gross profit.
Gross profit is the profit before deducting the operating expense involved in
buying and selling these goods.
You must be thinking that practically in businesses, not all goods bought can be
sold and wondering what would happen to those unsold goods, right? Generally,
goods which are unsold by the end of the accounting period will be kept as
inventory. This inventory will be reported in the current asset section of the
companyÊs balance sheet. As a note, you have now started to identify the
transactions involved in the income statement (sales, cost of goods sold and gross
profit) and balance sheet (trading goods inventory).

TOPIC 7 TRADING BUSINESS ENVIRONMENT 161
On the other hand, trading transactions are recorded in the accounts using the
rules of debit and credit. Do you still remember the rules of debit and credit that
we have learned in Topic 1 until Topic 6?
Income statements for trading and service firms are different as both involve
different activities. As indicated earlier, trading firms buy goods from suppliers
and then resell the goods in order to generate profit. There are two types of
trading firms:
(a) Retailers
Retailers are trading firms that buy goods from wholesalers and resell it
directly to consumers. Examples of retailers are supermarkets and retail
shops such as those which sell electrical goods and furniture.
(b) Wholesalers
Wholesalers are trading firms that buy goods directly from manufacturers
in large quantities. Wholesalers do not sell the goods directly to consumers;
instead, they sell them to retailers.
The characteristics of trading firms are:

(a) Buy goods for resale;
(b) Goods sold will be reported as sales revenue and cost of goods sold is the
cost of inventory sold;
(c) Cost of goods sold will be deducted from sales revenue to obtain gross
profit;
Gross Profit = Sales revenue – Cost of goods sold
(d) Operating expense will be deducted from gross profit to obtain net
operating income; and
Net Operating Income = Gross profit – Operating expense
(e) Goods or inventory that is not sold by the end of the accounting period will
be treated as closing inventory and will be reported as current asset in
balance sheet.
As trading firms deal with goods, they must have an efficient inventory system
to value the opening inventory and closing inventory effectively. There are two
types of inventory management system, namely, periodic inventory system and

perpetual inventory system. This inventory management system will be

discussed in detail in Topic 8.
ACTIVITY 7.1
Give two examples of trading companies that are successful and famous
in Malaysia. What are their success factors? Discuss with your class
mates.
EXERCISE 7.1
1. Tick ( ) in the correct column. Gross profit is derived when:
True False
(a) Operating expense is deducted from net

operating income.
(b) Sales revenue is more than operating

expenses.
(c) Sales revenue is more than cost of goods

sold.
(d) Operating expenses are more than cost of

goods sold.
2. Berjaya Sdn Bhd recorded sales revenue of RM110,000, cost

of goods sold totalled RM70,000 and operating expense is
RM20,000. Calculate:
(a) Gross profit; and
(b) Net operating income.

7.2 IMPORTANT TRANSACTIONS IN TRADING

FIRMS
For trading firms that sell on credit, the businessÊ operating cycle includes the
following transactions:
(a) Purchase of goods;
(b) Sale of goods; and
(c) Collection of accounts receivable.
For cash sales, however, the operating cycle is related only to buying and selling
goods involving cash. This operating cycle will be repeated throughout the
lifetime of the business.
There are five important types of transactions in a trading firm, which are:
(a) Purchases;
(b) Sales;
(c) Discounts;
(d) Returns and allowances; and
(e) Transportation cost.
Let us take a look at each transaction in detail.
7.2.1 Purchases
Purchase transactions involve purchasing goods to be resold. Any item bought
for use in the business, such as purchase of property, plant and equipment
(which are fixed asset), is not regarded as a purchase. Purchases can be made via
cash or credit. Credit purchases will be supported by purchase invoices. Copies
of sales invoices from the seller are regarded as purchase invoices. The buyer can
only recognise the purchase or inventory in its business when the ownership of
the goods purchased has been transferred from the seller to the buyer.
7.2.2 Sales
Sales involve the transfer of ownership of goods or inventories from the seller to
the buyer. Based on the principle of income recognition as stated in the Financial
Reporting Standard 118 (FRS 118), sales revenue will be recorded when goods
have changed hands from the seller to the buyer. Similar to purchases, sales can
also be made either by cash or credit. For credit sales, the duration taken to
transfer the goods from the seller to the buyer depends on the delivery terms
stated. In addition, credit sales may involve cash discounts, depending on the
credit payment period.
7.2.3 Discounts
Discounts are price reductions given by the seller to the buyer.

There are two types of discount:
(a) Quantity Discount

Quantity discounts are discounts given for purchases made in bulk.

The purpose of giving quantity discounts is to encourage the buyer to buy
in large quantities. No journal entry is needed to record the quantity
discount as this amount will be deducted directly from the original price,
leaving the net sales figure in the invoice. Now, take a look at this example
of a quantity discount:
Example:
If quantity purchased is between:
3000 – 4000 units, then a 10% discount will be given.
4001 – 5000 units, then a 20% discount will be given.
This shows that the more units are purchased, the higher the discount
obtained.

(b) Cash Discount
Cash discounts are offered for credit purchases to encourage prompt
payment.

Cash discounts are price reductions given if payment is made within the
discount period.


If quantity discount is given together with cash discount, the cash discount
will be calculated after deducting the quantity discount amount.
Credit terms are the terms given by the seller to the buyer on the
duration to make payment.

Several credit terms that are commonly used are:
(i) 2/10, n/30

This credit term means that a discount of 2% will be given if payment
is made within 10 days from the date of invoice, while the payment
period (without discount) is for a period of 30 days. If purchases were
made on 5 January, the expiry period for cash discount is on 15
January (5 January + 10 days = 15 January). This means that a 2%
discount will be obtained if payment is made on or before 15 January.
(ii) n/30
No discount is given but the total purchase amount must be settled
within 30 days.
(iii) 4/15, n/eom

4% discount will be given if payment is made within 15 days and the
payment period is at the end of the current month. EOM as stated
here means end of month.
Cash discount can be categorised into two. These are:
(i) Purchase Discount

Purchase discount, which is also known as discount received, takes
place when the buyer pays the amount owing rising from the
purchase transaction within the discount period.
As a result of this discount, the price paid will be less than the price
stated in the purchase invoice. In the periodic system, the purchase
discounts account (with normal credit balance) will be set off (contra)
against the purchases account.
(ii) Sales Discount

Sales discount or discounts given are price reductions offered by the
seller to the buyer who pays the amount due from the purchase
transaction within the discount period.

Sales discounts or discounts given are price reductions given to credit sales if
the customer pays up within the discount period.

In this situation, cash payable by the customer or debtor will be less
compared to the original price stated in the invoice. An example of a
transaction involving purchase discount and sales discount is shown
in Figure 7.2:

Figure 7.2: Example of a transaction involving purchase discount and
sales discount of purchase discount
EXERCISE 7.2
1. Explain the meaning of the credit term 2/10, n/30.

2. Explain the meaning of sales discount.
3. Explain the meaning of purchase discount.
7.2.4 Returns and Allowances

Returns exist when a buyer returns goods to the seller due to misspecifications or
damages of the goods received. Returns can be categorised into purchase returns
and sales returns depending on the firmÊs position, either as a buyer or a seller.
Recall the example where Besta Sdn Bhd sold goods to Ali Company, in the
previous Figure 7.2. In that illustration, Besta Sdn Bhd is the seller while Ali
Company is the buyer. Now, let us assume that Ali Company has returned goods

to Besta Sdn Bhd following the misspecifications of the product. In this case, the
goods returned is known as purchase return for Ali Company as they relate to
purchases that occurred earlier. On the other hand, the returned goods received
by Besta Sdn Bhd (seller) will be viewed as sales return as they relate to their
earlier sales.
Further details on purchase returns and allowances, and sales returns and
allowances are explained here:
(a) Purchase Returns and Allowances

When buyers purchase goods but are subsequently not satisfied with the
goods received, they have the right to return the goods to the supplier. This
is known as purchase return from the buyerÊs perspective. For credit
purchases, the return made will reduce the amount in the accounts
receivable balance. For cash purchases, cash will be refunded to the buyer.
Alternatively, buyers may choose to keep the goods with them and obtain a
price reduction from the seller. This option will give rise to purchase
allowances. In this case, the buyer needs to send a debit memo to the seller
as a reminder to reduce the buyerÊs account balance. Example of a debit
memo is shown in Figure 7.3.

Figure 7.3: Example of a debit memo
Purchase returns and allowances account is the contra account for

purchases account and the normal balance is on the credit side.

(b) Sales Returns and Allowances

From the sellerÊs perspective, sales returns occur when a buyer or customer
returns goods which are damaged or for other valid reasons. Sales
allowances, on the other hand, exist when a buyer chooses to keep the
damaged goods. In this situation, the seller must adjust the invoice price to
enable the outstanding balance to be reduced by sending a credit memo to
the buyer. An example of a credit memo is shown in Figure 7.4.
Figure 7.4: Example of a credit memo
EXERCISE 7.3
1. Choose the most accurate answer. The account which is related to

sales and has a normal debit balance is:
(a) Sales discounts.
(b) Sales returns and allowances.
(c) Both (a) and (b).
2. Explain the meaning of purchase returns and allowances.
3. Describe sales returns and sales allowances.

7.2.5 Transportation Cost

In general, transportation terms are specified in trade.

The transportation term will decide who will pay for the transportation cost
(either the buyer or the seller) and the point for the goods to be transferred
from the seller to the buyer.

Transportation costs can be classified into two:
(a) FOB Shipping Point

In the FOB shipping point term, the goods are said to be transferred from
the seller to the buyer when the goods are sent by the seller to the
transportation company: lorry, ship and others. In this instance, the goods
will belong to the buyer and can be recorded as buyerÊs inventory at the
time of purchase. The transportation cost would be borne by the buyer and
will be recorded as carriage inwards. A carriage inwards account would
normally have a debit balance and be added to the purchase cost to arrive
at the cost of goods sold in the income statement. Figure 7.5 summarises the
treatment of shipping cost in a FOB shipping point term.

Figure 7.5: FOB shipping point

(b) FOB Destination

The ownership of the goods will be transferred from the seller to the buyer
when the goods reach the buyerÊs destination, which is the buyerÊs warehouse.
The goods purchased will be owned by the buyer and can be recorded as
buyerÊs inventory when the buyer receives the goods. The seller will bear the
transportation cost and record it as carriage outwards after the transportation
cost has been paid. This carriage outwards will be included in the income
statement of the seller as a part of the operating expenditure. Figure 7.6
summarises the treatment of shipping cost in a FOB destination term.

Figure 7.6: FOB destination
SELF-CHECK 7.1
Explain the reason companies provide sales returns and allowances to

their customers.

ACTIVITY 7.2
1. Discuss the purpose of giving discounts. In your opinion, why do
business entities provide discounts to their buyers?
2. Discuss the importance of having return allowances to the buyer
and seller. Post your answer in the forum.
3. In groups, make a comparison between FOB shipping point and
FOB destination. List down the differences. Discuss which FOB
term is suitable for a business selling computers.
EXERCISE 7.4
Describe the differences between FOB shipping point and FOB

destination.
Income statement for trading and service firms are different due to the
different activities involved. There are two types of trading business which
are retailers and wholesalers.
The main characteristics of trading firms are:

Goods are purchased for resale.
Goods sold are treated as sales revenue, while cost of goods sold relate to
the cost of inventories which have been sold.
Gross profit can be calculated by deducting cost of goods sold from sales
revenue.
Net operating income can be calculated by deducting operating
expenditure from gross profit.
Unsold goods at the end of the business accounting period are treated as
closing inventory and reported as current asset in the balance sheet.

Important transactions for trading firms are:

Purchases
Sales
Discounts
Returns and allowances
Transportation cost
Cash discounts Purchases

Cash sales Quantity discounts
Credit sales Sales
Credit terms Sales Returns and Allowance
Discount

Topic Accounting
8 for Inventory
LEARNING OUTCOMES
1. Explain the methods of accounting for inventory;
2. Describe the differences in the journal entries for Periodic Inventory
p System and Perpetual Inventory System;
3. Prepare journal entries for trading transactions;
4. Differentiate inventory valuation;
5. Prepare the income statement for trading business; and
6. Prepare the closing entries.
INTRODUCTION
We know that trading firms buy goods for the purpose of resale. This is what we
have learned in the previous topic. In accounting, these goods are called inventories.
Financial Reporting Standard (FRS 102) describes inventories to include not only
finished goods held for resale (as in the case of trading firms) but also incomplete
goods that need further processing and materials or supplies to be consumed in the
production of the finished goods (for manufacturing firms). It is important to
account for inventory because it affects both the income statement and balance sheet.
In this topic, we will be introduced to the methods of accounting for inventory.

We will also take a look at the journal entries for Periodic Inventory System and
Perpetual Inventory System. Later on, we will look at some examples of journal
entries, learn about inventory valuation and identify the format of the income
statement for trading firms. Finally, at the end of this topic, we will learn how to
prepare the closing entries.
Now, let us begin!

174 TOPIC 8 ACCOUNTING FOR INVENTORY
8.1 METHODS OF RECORDING INVENTORY

Before we go in depth on the inventory system, let us identify what constitutes
the cost of inventory. According to FRS 102, the cost of inventory for trading
firms comprises:
(a) Purchase price;
(b) Import duties and other taxes, if any; and
(c) Transportation or handling costs attributable to the acquisition of the
goods.
In relation to transportation cost, the reference should be made to transportation

terms (refer to Topic 7 for details) to determine whether or not that is part of
inventory costs for the buyer.
As you know, trading firms buy goods for the purpose of resale. The goods
purchased will become inventory for the business entity. There are two methods
of recording inventory: Periodic Inventory System and Perpetual Inventory
System. Let us read about these methods in detail.
8.1.1 Periodic Inventory System

Under the Periodic Inventory System, the amount of the inventory will only be
known by calculating the inventory physically. The stock count is made at the
end of the accounting period, when the total closing inventory is needed to
calculate the cost of goods sold. Companies do not have to update information
on the total inventory in the store. The characteristics of Periodic Inventory
System are:
(a) Goods purchased would be recorded in the Purchases Account;
(b) Transportation cost would be recorded in the Carriage Inwards Account;
(c) Goods returned will be recorded in the Purchase Returns and Allowances
Account;
(d) Discount received obtained will be recorded in the Purchase Discounts
Account;
(e) Inventories (in record) would not be reduced when goods were sold;
(f) The calculation of inventories physically is done periodically, e.g. once
a year; and
(g) This system is used by businesses selling low-priced items which may not
derive any significant benefit from the preparation of inventory records.

TOPIC 8 ACCOUNTING FOR INVENTORY 175
In the Periodic Inventory System, companies must calculate the cost of goods
sold at the end of the accounting period. The calculations for cost of goods
purchased and the cost of goods sold are done in the income statement. The
calculation for cost of goods purchased is shown in Figure 8.1:
Figure 8.1: Calculation for cost of goods purchased
The opening inventory amount for the current year will be the closing inventory
for the previous year. This closing inventory amount will be determined by
physical calculation.
8.1.2 Perpetual Inventory System

Under the Perpetual Inventory System, an inventory account will be created and
the inventory records will always be updated. The usage of this method enables
the company to know the inventory account balance at any time by checking the
balance of the said account. Every transaction affecting the inventory will be
recorded in the inventory account. The characteristics of the Perpetual Inventory
System are:

(a) Inventory Purchased will be recorded in the Inventory Account. Therefore,

the Inventory Account will increase when purchases are made.
(b) Transportation Cost will be recorded in the Inventory Account. The

transportation cost will increase the balance in the Inventory Account.
(c) Purchase Returns and Allowances including Purchase Discounts will be

recorded in the Inventory Account.
(d) Sales of Inventory will be recorded at two prices, sales price and cost price.
The sales recorded at selling price will show the total sales revenue, while
the recording at cost price will show the total cost of goods sold and
decrease in inventory account.
In the Perpetual Inventory System, there is no need to calculate the cost of goods
purchased and the cost of goods sold. Companies can know the value of cost of
goods sold directly by checking the balance in the cost of goods sold account.
This is because each time goods or inventories are sold, it will be recorded in the
Cost of Goods Sold Account at cost value.
SELF-CHECK 8.1
Explain the methods of inventory recording for business entities.
8.2 JOURNAL ENTRY FOR PERIODIC AND

PERPETUAL INVENTORY SYSTEM
As a continuation from the previous subtopic, these are the differences in the
journal entries for Periodic Inventory System and Perpetual Inventory System:
(a) Cash and Credit Sales

If cash or credit sales are made, journal entries are needed to record the
sales at sales price. In Periodic Inventory System, the journal entry is only
recorded for sales at the sales price without any entry for cost price. In
Perpetual Inventory System, journal entries must be made to record the
sales at both the sales and cost prices. Cash or credit sales at cost are made
by debiting the cost of goods sold account.

(b) Sales Returns and Allowances (Cash and Credit)

In the Periodic Inventory System, the journal entries for sales returns and
allowances are recorded at sales price only. However, for Perpetual
Inventory System, the sales returns and allowances made on cash sales or
credit sales must be recorded at sales and cost price. The journal entry to
record the returns at cost price can be done by crediting the cost of goods
sold account.
Now, let us take a look at Table 8.1 which shows the different journal entries
between the two inventory systems while Table 8.2 shows the journal entries for
the related transactions, from the view of the buyer and seller.

178
Table 8.1: Differences in Journal Entries for Periodic Inventory System and Perpetual Inventory System
TOPIC 8
ACCOUNTING FOR INVENTORY

Table 8.1: Differences in Journal Entries for Periodic Inventory System and Perpetual Inventory System (continuation)
TOPIC 8

179
Table 8.2: Illustration of Journal Entries for Buyer and Seller

Table 8.2: Illustration of Journal Entries for Buyer and Seller (continuation)
TOPIC 8

181
EXERCISE 8.1
1. Inventory was purchased at cost of RM2,000 on 15 July, with the

credit terms 2/10, n/30. On 18 July, a credit memo was received
from the supplier due to damage to goods for RM100. Prepare the
journal entries for payment made on 24 July, using the perpetual
inventory system.
2. A credit sale was made on 10 July totalling RM800 with the credit
terms of 2/10, n/30. On 12 July, RM100 goods were returned.
Prepare the journal entry on 19 July to record the cash received
from customer.
8.3 EXAMPLES OF RECORDING JOURNAL

ENTRIES
Now, let us take a look at Table 8.3 which shows the transactions of Selasih Sdn
Bhd throughout December 2011.
Table 8.3: Transactions of Selasih Sdn Bhd throughout December 2011
Date Transaction
December 3 Purchased goods from Firdaus Sdn Bhd for RM4,000, FOB shipping
point terms, 2/10, n/30 with prepayment of carriage for RM120.
December 5 Purchased goods from Kenari Sdn Bhd for RM8,500, with FOB
destination terms 1/10, n/30.
December 6 Sold goods bought on 3 December to Hijrah Sdn Bhd at the price of
RM5,800.
December 8 Purchased office supplies by cash for RM150.
December 10 Returned RM1,300 of goods purchased on 5 December from Kenari
Sdn Bhd
December 13 Paid Firdaus Sdn Bhd for purchases made on 3 December, after
discount.
December 14 Purchased goods by cash of RM10,500.
December 15 Paid Kenari Sdn Bhd for the purchases made on 5 December, after
deducting returns on 10 December and discount.

December 16 Received cash for sales made to Hijrah Sdn Bhd on December 6, after
deducting discount.
December 19 Sold goods, payment made via American Express credit card for
RM2,450. Cost of goods sold is RM980.
December 22 Sold goods to Cerating Sdn Bhd total RM3,480, credit terms 2/10,
n/30. Cost of goods sold is RM1,400.
December 24 Sold goods by cash for RM4,350. Cost of goods sold is RM1,750.
December 25 Received returns from Cerating Sdn Bhd for sales made on 22
December, RM1,480. Cost of goods returned is RM600.
December 31 Received cash from American Express for sales made on 19 December
and the service charges is RM140.
Required:
Prepare journal entries for the transactions in Table 8.3 using perpetual inventory
and periodic inventory system.
Solution:
The journal entries for the transactions in Table 8.3 are shown in Table 8.4.
Table 8.4: Journal Entries for the Transactions of Selasih Sdn Bhd
throughout December 2011
(a) Using Perpetual Inventory System
Date Descriptions Debit (RM) Credit (RM)

Dec 3 Inventory 4,120
Accounts payable – Firdaus SB 4,120
Accounts payable – Kenari SB 8,500
Dec 6 Accounts receivable – Hijrah SB 5,800
Sales 5,800
Cost of goods sold 4,000
Inventory 4,000
Dec 8 Office supplies 150
Cash 150
Dec 10 Accounts payable – Kenari SB 1,300
Inventory 1,300
Dec 13 Accounts payable – Firdaus SB 4,120
Inventory 80
Cash [4,000 – (2% 4,000) + 120] 4,040


Cash 10,500
Dec 15 Accounts payable – Kenari SB 7,200
Inventory [(8,500 – 1,300) 1 %] 72
Cash [8,500 – 1,300 – 72] 7,128
Dec 16 Cash 5,684
Sales discount 116
Accounts receivable – Hijrah SB 5,800
Dec 19 Accounts receivable – American Express 2,450
Sales 2,450
Cost of goods sold 980
Inventory 980
Dec 22 Accounts receivable – Cerating SB 3,480
Sales 3,480
Inventory 1,400
Dec 24 Cash 4,350
Sales 4,350
Inventory 1,750
Dec 25 Sales returns and allowances 1,480
Accounts receivable – Cerating SB 1,480
Inventory 600
Dec 31 Cash 2,310
Credit card expenses 140
Accounts receivable – American Express 2,450


(b) Using Periodic Inventory System
Date Descriptions Debit (RM) Credit (RM)

Dec 3 Purchases 4,000
Carriage Inwards 120
Accounts payable - Firdaus SB 4,120
Accounts payable - Kenari SB 8,500
Dec 6 Accounts receivable - Hijrah SB 5,800
Sales 5,800
Dec 8 Office supplies 150
Cash 150
Dec 10 Accounts payable - Kenari SB 1,300
Purchase Returns/Returns Outwards 1,300
Dec 13 Accounts payable - Firdaus SB 4,120
Purchase Discount (2% x 4,000) 80
Cash [4,000 – 80 + 120] 4,040
Cash 10,500
Dec 15 Accounts payable - Kenari SB 7,200
Purchase Discount [(8,500 – 1,300) x 1%] 72
Cash [8,500 – 1,300 – 72] 7,128
Dec 16 Cash 5,684
Sales discount (5800 x2%) 116
Accounts receivable - Hijrah SB 5,800
Dec 19 Accounts receivable - American Express 2,450
Sales 2,450
Dec 22 Accounts receivable - Cerating SB 3,480
Sales 3,480
Dec 24 Cash 4,350
Sales 4,350
Dec 25 Sales returns and allowances 1,480
Accounts receivable - Cerating SB 1,480
Dec 31 Cash 2,310
Credit card expenses 140
Account receivable - American Express 2,450

EXERCISE 8.2
Cempaka Sdn Bhd conducts trading activities for the month of

May. At the start of May, Cempaka Sdn Bhd has a cash total of RM5,000
and the capital contributed by Abu Bakar totalled RM5,000.
May 1 Purchased trading goods for RM6,000 from Depot Wholesaler,

with terms 2/10, n/30.
May 2 Sold goods worth RM4,500 to Rahmat, credit terms 2/10, n/30.
Cost of goods is RM3,000.
May 5 Returned goods worth RM200 to Depot wholesaler.
May 9 Received full payment, after deducting discount, from Rahmat for
the sales of RM4,500 made on 2 May.
May 10 Paid Depot Wholesaler.
May 11 Purchased supplies from supplier by cash for RM900.
May 12 Purchased goods by cash for RM2,400.
May 15 Received refund of RM230 for goods purchased on 12 May
from supplier due to the goods being of unsatisfactory quality.
May 17 Purchased goods from Harrods Sdn Bhd for RM1,900, FOB
shipping point, with terms 2/10, n/30.
May 19 Paid carriage of RM250 for purchases made on 17 May.
May 24 Sold goods by cash for RM6,200. Cost of goods sold is RM4,340.
May 25 Purchased goods from Horizon Sdn Bhd for RM1,000, FOB
destination, terms 2/10, n/30. Goods were only received on 28
May.
May 27 Paid Harrods Sdn Bhd for the purchases made on 17 May.
May 29 Refunded RM100 for damaged goods. The cost of goods returned
is RM70.
May 31 Sold goods of RM1,600 to Rahmat, with terms n/30. The cost of
goods sold is RM1,120.
Required:
(a) Prepare journal entries for the above transactions by using the
Perpetual Inventory System.
(b) Prepare ledgers for each of the entries.
(c) Prepare the Income Statement for the month ended 31 May 2011.

8.4 INVENTORY VALUATION

We have learnt how to record the inflow and outflow of inventories i.e. through
either the periodic or perpetual system. Before recording, we need to first know
how to compute the costs of inventory. This is known as inventory valuation.
Inventory valuation is important because it affects the value of closing inventory
in both the income statement and the balance sheet.
The choice of inventory valuation is crucial when the purchasing costs of

inventories are not the same. For instance, purchasing cost of 100 units of LCD
television from supplier A might be different from the cost of purchasing the
same quantity of a similar product from supplier B. Even if the purchase was
made from the same supplier, the cost of purchase for November 2011 might be
higher than the cost paid for similar inventory in February 2011 due to inflation
or increase in price. As a result of date and suppliers change, it is not surprising
for companies to have inventories bought at different prices. The question is,
how do we calculate the value of these inventories? Let us read further about
these four possible methods of inventory valuation.
8.4.1 Specific Identification

Under this method, inventories are recorded by identifying their original costs.
This approach assumes that costs can be matched against the physical movement
of the inventory. This method is suitable for companies having a low level of
inventory which are high in value such as properties and equipment. To
illustrate, assume that Seri Jaya Sdn Bhd has the following record of inventory
for December 2011 as shown in Table 8.5 .
Table 8.5: Record of Inventory of Seri Jaya Sdn Bhd for December 2011
Date Purchase Sale (unit) Balance (unit)

Dec 1 300 RM5 300
Dec 15 620 RM7 920
Dec 21 480 440
Dec 27 510 RM8 950
Dec 31 715 235
1,430 units 1,195

Additional information relating to sales is as shown in Table 8.6:
Table 8.6: Additional Information Relating to Sales
Date Explanation
Dec 21 200 units from opening balance on Dec 1
280 units from purchases made on Dec 15
Dec 31 100 units from opening balance on Dec 1
The value of inventory using the specific identification is presented below

using both the periodic and perpetual inventory systems.
(a) Periodic Inventory System

Table 8.7 shows the cost of goods sold while Table 8.8 shows the ending
inventory.
Table 8.7: Cost of Goods Sold
Units Sold Cost Value

300 RM 5 RM 1,500
430 RM 7 RM 3,010
465 RM 8 RM 3,720
1,195 RM 8,230
Table 8.8: Ending Inventory
Balance (Units) Cost Value

0 RM 5 RM 0
190 RM 7 RM 1,330
45 RM 8 RM 360
235 RM 1,690
(b) Perpetual Inventory System

Table 8.9 shows the value of inventory presented using the Perpetual
Inventory System.

Table 8.9: Value of Inventory Using Perpetual Inventory System
Date Purchase Sale Balance

Dec 1 Opening balance 300 RM5 = RM1,500
Dec 15 620 RM7 = RM4,340 300 RM5 = RM1,500
620 RM7 = RM4,340
Dec 21 200 RM5 = RM1,000 100 RM5 = RM500
280 RM7 = RM1,960 340 RM7 = RM2,380
Dec 27 510 RM8 = RM4,080 100 RM5 = RM500
340 RM7 = RM2,380
510 RM8 = RM4,080
Dec 31 100 RM5 = RM500 190 RM7 = RM1,330
150 RM7 = RM1,050 45 RM8 = RM360
465 RM8 = RM3,720 RM1,690
COGS = RM8,230
8.4.2 First In First Out Method (FIFO)

The FIFO method assumes that inventories are sold according to the ascending
order of the purchase date. In other words, inventory that is purchased first will
be sold first. Hence, the cost of goods sold will reflect the earliest purchased cost
while the closing inventory will be recorded using the current purchased cost.
Hence, FIFO will result in higher value of ending inventory, lower value of cost
of goods sold and generate a higher profit when used during the periods of
rising prices. To illustrate, refer to Seri Jaya Sdn Bhd. Based on the information
on inventory flow, we can record the inventory as follows:

inventory.
300 RM 5 RM 1,500
620 RM 7 RM 4,340
275 RM 8 RM 2,200
1,195 RM 8,040


235 RM8 RM1,880
235 RM1,880

Inventory System.

Table 8.12: Value of Inventory Using Perpetual Inventory System

Dec 15 620 RM7 = RM4,340 300 RM5 = RM1,500
620 RM7 = RM4,340
Dec 21 300 RM5 = RM1,500 440 RM7 = RM3,080
180 RM7 = RM1,260
Dec 27 510 RM8 = RM4,080 440 RM7 = RM3,080
510 RM8 = RM4,080
Dec 31 440 RM7 = RM3,080 235 RM8 = RM1,880
275 RM8 = RM2,200
COGS = RM8,040
8.4.3 Last In First Out Method (LIFO)

The LIFO method assumes that inventories are sold according to the descending
order of the purchase date. In other words, inventory that is purchased last will
be sold first. Hence, the cost of goods sold will reflect the latest purchased cost
while the closing inventory will be recorded at earlier prices. Hence, in an
inflationary environment, LIFO will result in lower value of ending inventory,
higher value of cost of goods sold and consequently, lower profit. For financial
reporting purposes, FRS 102 clearly rules out the use of LIFO in inventory
valuation. Yet, for knowledge purposes, we can use the inventory flow
information of Seri Jaya Sdn Bhd to better understand this method of calculating
inventory.



inventory.

510 RM8 RM4,080
620 RM7 RM4,340
65 RM5 RM325
1,195 RM8,745


235 RM5 RM1,175

Inventory System.

Table 8.15: Value of Inventory using Perpetual Inventory System

Dec 15 620 RM7 = RM4,340 300 RM5 = RM1,500
620 RM7 = RM4,340
Dec 21 480 RM7 = RM3,360 300 RM5 = RM1,500
140 RM7 = RM980
Dec 27 510 RM8 = RM4,080 300 RM5 = RM1,500
140 RM7 = RM980
510 RM8 = RM4,080
Dec 31 510 RM8 = RM4,080 235 RM5 = RM1,175
140 RM7 = RM980
65 RM5 = RM325
COGS = RM8,745

8.4.4 Weighted Average Method

As the name implies, weighted average method uses the average cost of the
goods available for sale to calculate cost of inventory. The use of average cost
levels out the differences in prices of the inventory. The weighted average cost is
computed by dividing the cost of goods available for sale with number of
inventory (in unit). Mathematically, it can be expressed as follows:
Cost of goods available for sale

Weighted average cost per unit
Units of inventory available for sale

inventory.
Units Available for Sale Cost Value

300 RM5 RM1,500
620 RM7 RM4,340
510 RM8 RM4,080
1,430 RM9,920
RM9,920
Weighted Average cost per unit
1, 430
RM6.94

235 RM6.94 RM1,631

Table 8.18 shows the value of inventory presented using Perpetual
Inventory System.

Table 8.18: The Value of Inventory using Perpetual Inventory System

Dec 15 620 RM7 = RM4,340 920 RM6.351 = RM5,842
Dec 21 480 RM6.35 = RM3,048 440 RM6.352 =RM2,794
Dec 27 510 RM8 = RM4,080 950 RM7.243 =RM6,878
Dec 31 715 RM7.24 = RM 5,177 235 RM7.244 =RM1,701
COGS = RM8,225
Calculation:
1 [(300 RM5) + (620 RM7)] / (300 + 620) = RM6.35 per unit
2 (RM5,842 – RM3,048) / (920 – 480) = RM6.35 per unit
3 (RM2,794 + RM4,080) / (440 + 510) = RM7.24 per unit
4 (RM6,878 – RM5,177) / (950 – 715) = RM7.24 per unit

EXERCISE 8.3
In what circumstances are the different methods of inventory valuation

useful? Discuss with your coursemates.
8.5 FORMAT OF INCOME STATEMENT FOR

TRADING FIRMS
Income statements for trading firms contain three items which are not found on
income statements of service firms. They are:
(a) Sales revenue from trading goods;
(b) Cost of goods sold; and
(c) Gross profit.
Let us discuss the two types of statement that are normally used – single level
income statement and multiple level income statement.

8.5.1 Single Level Income Statement

In a Single Level Income Statement, all the expenditures are deducted in only one
step as shown in Figure 8.2, inclusive of cost of goods sold.
Cost of Goods Sold
Figure 8.2: Example of Single Level Income Statement
In the income section, companies would not report the gross sales, sales returns
and allowances and sales discounts individually but will only report overall net
sales. Single Level Income Statement emphasises more on the total revenue and
total expenditure to determine the net profit. The Single Level Income Statement
also does not show directly the information on gross profit and revenue from
operations for analysis purposes.

8.5.2 Multiple Level Income Statement

Generally, a Multiple Level Income Statement comprises several sections and
sub-totals of those sections. Multiple Level Income Statement can be prepared
according to the Periodic Inventory System and Perpetual Inventory System, as
explained earlier in this topic.
In the Perpetual Inventory System, the closing balance of cost of goods sold can
be obtained directly from the account. This is because sales or sales returns and
allowances are recorded at sales and cost price. In comparison, information on
cost of goods sold for the Periodic Inventory System can only be obtained
through calculation which must be done physically.
Table 8.19 shows the format for a Multiple Level Income Statement using the
Periodic Inventory System, while Table 8.20 illustrates the format for Multiple
Level Income Statement using the Perpetual Inventory System.
Table 8.19: Multiple Level Income Statement – Periodic Inventory

System of Angsana Berhad for 30 June 2011
RM RM RM RM
Revenue:
Sales XX
(–) Sales returns and allowances XX
Sales discount XX (XX)
Net sales XX
Less: Cost of goods sold
Opening inventory XX
Purchases XX
(–) Purchases returns and allowances XX
Purchases discount XX (XX)
Net purchases XX

(+) Carriage inwards XX

Cost of goods purchased XX
Cost of goods ready for sale XX
(–) Closing inventory (XX)
Cost of goods sold XX
Gross profit XX
Add: Other income
Interest revenue
Rental revenue XX
Less: Operating expenditures XX
Sales expenses XX
Sales salary expenses
Advertisement expenses
Sales maintenance expenses XX
Store depreciation expenses
Total sale expenses XX
Administrative expenses XX
Administrative salary expenses XX
Equipment depreciation
expenses
Insurance expenses XX
Rental expenses
Total administrative expenses XX
Total sale and administrative XX
expenses
Revenue from operating XX
Total sales and administrative (XX)
expenses
Add: Other revenue
Interest revenue XX
* Cost of goods sold must be calculated according to the calculation explained earlier

Table 8.20: Multiple Level Income Statement – Perpetual Inventory System of Angsana
Berhad for 30 June 2011
RM RM RM
Revenue:
Sales XX
(–) Sales returns and allowances XX
Sales discount XX (XX)
Net sales XX
(–) Cost of goods sold XX
Gross profit XX
Add: Other income
Interest revenue
Rental revenue XX
Less: Operating expenditures XX
Sales expenses XX
Sales salary expenses
Advertisement expenses
Sales maintenance expenses XX
Store depreciation expenses
Total sale expenses XX
Administrative expenses XX
Administrative salary expenses XX
Equipment depreciation expenses
Insurance expenses XX
Rental expenses
Total sale and administrative expenses XX
Total sales and administrative expenses (XX)
Add: Other revenue
Interest revenue XX

Rental revenue XX XX
Less: Other expenditures
Interest expenses (XX) XX
Net profit XX
* Cost of goods sold can be determined by looking at the closing balance of the cost of
goods sold account

The major difference between these two formats is the total cost of goods sold
(COGS). In the Perpetual Inventory System, the cost of goods sold account was
created to record the credit sales or cash sales at cost. It is the same for returns. For
credit sales or cash sales, the returns will be recorded at sales price and cost price.
Therefore, the closing balance for the cost of goods sold can be determined from the
cost of goods sold account balance. On contrary, the accounting method for Periodic
Inventory System only records the credit sales and cash sales at sales price, therefore
numerical calculation must be done to obtain the cost of goods sold.

EXERCISE 8.4
The trial balance for Melati Sdn Bhd involved the following accounts for
the year ended as at 31 December 2011.
Melati Sdn Bhd Trial Balance 31 December 2011

Cash 23,400
Trading goods inventory 90,000
Land 92,000
Building 197,000
Accumulated depreciation – building 54,000
Equipment 83,500
Accumulated depreciation – equipment 42,400
Capital – Aminah 267,800
Drawings – Aminah 10,000
Sales 902,100
Sales discount 4,600
Repair expenses 5,900
Maintenance expenses 7,200
1,353,800 1,353,800
Additional information:
1. Depreciation for building is RM10,000 and equipment RM9,000
(both are administrative expenses).
2. Interest payable RM7,000 and notes payable still outstanding as at
31 December 2011.
3. Salary expenses are 80% for sales and 10% for administration.
4. Utility expenses, repair expenses and insurance expenses are 100%
for administration.
5. RM15,000 from the notes payable will mature this year.
6. Maintenance expenses are for sales expenses.

Required:
(a) Prepare the journal for adjusting entries.
(b) Prepare the Income Statement for the year ended 31 December
2011.
(c) Prepare the balance sheet as at 31 December 2011.
(d) Prepare the closing entries.
8.6 CLOSING ENTRIES

Now, let us move on to the closing entries. Closing entries are made at the end of
the accounting period of a company. It is the last process in the preparation of
accounts for the period. For trading firms, the closing entries are made to close all
the temporary accounts. The accounts involved are revenue accounts, expenses
accounts and drawings account. This is in accordance with the principle of
matching and principle of revenue and expenses recognition. By this action, the
accounts involved will not be added to the revenue and expenses of other
periods. All accounts involved in calculating net profit will be closed to the
revenue summary account.
Similarly, the drawings account will also be closed but transferred to the capital
account. Accounts for assets and liabilities will be maintained and carried
forward to the next accounting period. The format of closing entries for the
Periodic Inventory System is shown in Figure 8.3, while the format of closing
entries for the Perpetual Inventory System is shown in Figure 8.4.

1. Closing accounts with credit balances
RM RM
Dr Sales XX
Dr Interest revenue XX
Cr Revenue summary XX
2. Closing accounts with debit balances
RM RM
Dr Revenue summary
Cr Sales returns and allowances XX XX
Cr Sales discount XX
Cr Cost of goods sold XX
Cr Carriage outwards XX
Cr Insurance expenses XX
Cr Salary expenses XX
Cr Other expenses XX
3. Closing revenue summary account – if net profit
RM RM
Dr Revenue Summary XX
Cr Capital XX
Closing revenue summary account – if net loss
RM RM
Dr Capital XX
Cr Revenue Summary XX
4. Closing drawings account to capital account
RM RM
Dr Capital XX
Cr Drawings XX

Figure 8.3: Closing entries for trading firms using periodic inventory system

1. Closing accounts with credit balances

RM RM
Dr Inventory (closing) XX
Dr Sales XX
Dr Interest revenue XX
Dr Purchase returns and allowances XX
Cr Revenue summary XX
2. Closing accounts with debit balances

RM RM
Dr Revenue summary XX
Cr Inventory (closing) XX
Cr Sales returns and allowances XX
Cr Purchases XX
Cr Sales discount XX
Cr Carriage inwards XX
Cr Carriage outwards XX
Cr Insurance expenses XX
Cr Salary expenses XX
Cr Other expenses XX
3. Closing revenue summary account – if net profit

RM RM
Dr Revenue Summary XX
Cr Capital XX
Closing revenue summary account – if net loss

RM RM
Dr Capital XX
Cr Revenue Summary XX
4. Closing drawings account to capital account

RM RM
Dr Capital XX
Cr Drawings XX

Figure 8.4: Closing entries for trading firms using perpetual inventory system

Let us take a look at an example here.
Example:
Sejahtera Company has just started its retail business on 1 September 2011. Table
8.21 shows the transactions made by Sejahtera Company Sdn Bhd throughout the
month of September 2011:
Table 8.21: Transactions Made by Sejahtera Company Sdn Bhd

throughout the Month of September 2011
Date Transaction
Sept 1 Owner of Sejahtera Company, Farid invested cash of RM50,00 into the
business. Purchased and received inventory of RM10,000 bought on credit
from Azlan Company with the terms 2/10, n/30, FOB destination.
Sept 2 Sold inventory for RM8,000 on credit to Indah Company with terms 2/10,
n/30, FOB shipping point. Cost of inventory sold total RM3,200.
Sept 5 Returned RM500 of inventory purchased on 1 September from
Azlan Company as the inventory was found to be damaged.
Sept 9 Received cash from Indah Company for the sales made on 2 September.
Sept 10 Settled all debts to Azlan Company for purchase made on 1 September after
deducting returns on 5 September.
Sept 11 Purchased inventory totalling RM4,800 by cash.
Sept 15 Purchased inventory totalling RM4,000 on credit from Huda Company with
terms 1/10, n/30, FOB shipping point.
Sept 17 Paid carriage expenses of RM300 for purchases on 15 September.
Sept 22 Sold inventory totalling RM12,500 by cash to Cahaya Company. Cost of goods
sold totalled RM6,250.
Sept 25 Received inventory returned of RM200 from Cahaya Company for sales on
22 September. The cost of the inventory is RM100.
Sept 28 Sold inventory for RM3,500 on credit to Umi Company with terms n/30.
Cost of inventory sold is RM1,500.
Sept 30 Paid building rental for the month of September total RM2,000 and salary for
the month of September for RM6,000.

Required:
(a) Prepare the journal entries for the transactions is Table 8.21, assuming
Sejahtera Company adopts the Perpetual Inventory System.
(b) Prepare the Single Level of Income Statement for the month ended
30 September 2011.
(c) Prepare the closing entries for Sejahtera Company.
Answers
(a)
Date Description Reference Debit Credit

Sept 1 Cash 50,000
Capital, Farid 50,000
Sept 1 Inventory 10,000
Accounts payable – Azlan Company 10,000
Sept 2 Accounts receivable – Indah Company 8,000
Sales 8,000
Inventory 3,200
Sept 5 Accounts payable – Azlan Company 500
Inventory 500
Sept 9 Cash 7,840
Sales Discount (2% 8,000) 160
Accounts receivable – Indah Company 8,000
Sept 10 Accounts payable – Azlan Company 9,500
Cash 9,310
Inventory (2% x 9,500) 190
Cash 4,800
Accounts payable – Huda Company 4,000
Sept 17 Inventory 300
Cash 300

Sept 22 Cash 12,500

Sales 12,500
Inventory 6,250
Sept 25 Sales returns and allowances 200
Cash 200
Inventory 100
Sept 28 Accounts receivable – Umi Company 3,500
Sales 3,500
Inventory 1,500
Sept 30 Salary expenses 6,000
Cash 6,000
Sept 30 Rental expenses 2,000
Cash 2,000
(b) Sejahtera Company

Income Statement
for the Month Ended 30 September 2011
RM RM
Revenue:
Net sales (8,000–160+12,500–200+3,500) 23,640
Less Expenditure
Cost of goods sold (3,200+6,250–100+1,500) 10,850
Total expenditure (18,850)
Net profit 4,790


(c)
Date Description Reference Debit Credit

Sep 30 Sales (8,000+12,500+3,500) 24,000
Revenue summary 24,000
Sales return and allowance 200
Sales discount 160
Capital, Farid 4,790
Visit the following websites to obtain additional information on the topics discussed.
(a) Description: Guide to understanding Income Statement

http://management.about.com/cs/adminaccounting/ht/readincomestmt.
htm
(b) Description: Introduction to identifying Financial Statement

http://www.ibm.com/investor/financialguide/
EXERCISE 8.5
1. Prepare journal entries to record the following transactions for

Kelana Sdn Bhd by using the Perpetual Accounting System.
(a) On 2 March, Kelana Sdn Bhd sold RM800,000 goods to
Kenari Sdn Bhd, with credit terms 2/10, n/30. Cost of goods
sold is RM600,000.
(b) On 6 March, Kenari Sdn Bhd returned RM120,000 of goods
sold on 2 March due to damage. Cost of goods returned is
RM90,000.
(c) On 12 March, Kelana Sdn Bhd received payment from Kenari
Sdn Bhd.

2. Merlimau Sdn Bhd has trading account balances as follows:

Sales RM180,000
Discount RM2,000
Cost of goods sold RM100,000
Goods inventory RM40,000
Prepare the closing journal entries by recording the above items in the
revenue summary.
3. Information reported by Olen Sdn Bhd. are as follows:

(a) On 5 April, Olen purchased trading goods from Danau Sdn Bhd
totalling RM16,000, credit terms 2/10, n/30, FOB shipping point.
(b) On 6 April, Olen paid transportation cost of RM900 for goods
sold to Danau Sdn Bhd.
(c) On 7 April, Olen purchased equipment for RM26,000.
(d) Olen returned damaged goods of RM3,000 to Danau Sdn Bhd.
(e) On 15 April, Olen settled the outstanding amount to Danau Sdn Bhd.
Prepare the journal entries to record the transactions for Olen Sdn Bhd
using the perpetual inventory system. Assume payment was made on
4 May instead of 15 April.
4. On 1 September, Pertama Sdn Bhd had 30 calculators costing

RM20 each. The company adopts the perpetual inventory system. The
following transactions occurred throughout the month of September.

September 6 Purchased 80 calculators at the price of RM19 each from
Digital Sdn Bhd by cash.
September 9 Paid transportation RM80.
September 12 Sold 26 calculators at the price of RM20 per unit, or RM30
per unit if transportation cost is included.
September 14 A calculator priced at RM30 was returned to the company
as the customer had ordered in excess.
September 20 Sold 30 calculators at a selling price of RM30 each. These
calculators cost RM20 each.
Required: Prepare the journal entries for the transactions throughout

the month of September.

5. The following are the transactions for Selasih Sdn Bhd.
December 3 Selasih Sdn Bhd sold goods totalling RM480,000 to Desaru

Sdn Bhd, with terms 2/10, n/30, FOB shipping point. Cost
of goods sold amounted to RM320,000.
December 8 Desaru Sdn Bhd received allowances worth RM20,000 for
the goods purchased on December 3.
December 13 Selasih Sdn Bhd received payment from Desaru Sdn Bhd.
Required:
Prepare the journal entries to record the transactions for Selasih Sdn
Bhd, using the perpetual inventory system.
Assume that Selasih Sdn Bhd had received the payment from Desaru
Sdn Bhd on 2 January instead of 13 December. Prepare the journal
entries for the payment received on 2 January the following year.
There are two methods of recording inventory: Periodic Inventory System

and Perpetual Inventory System.
The differences between the Periodic and Perpetual Inventory Systems are in
cash and credit sales, and sales returns and allowances (cash and credit).
Three items that are found in income statements for trading firms but not in
income statements for service firms are sales revenue from trading goods,
cost of goods sold and gross profit.
There are four methods of inventory valuation – specific identification, first in

first out (FIFO), last in first out (LIFO) and weighted average.
There are two types of income statement for trading firms – single level
income statement and multiple level income statement.
The closing entries must be made at the end of the accounting period to close
all temporary accounts for trading firms.

Inventory Perpetual inventory system

Inventory valuation Single level income statement
Multiple level income statement Temporary accounts
Periodic inventory system

Topic Cash
9 Management
and Control
LEARNING OUTCOMES
1. Define cash equivalents;
2. Describe cash management principles;
p
3. Explain the internal control of cash; and
4. Prepare bank reconciliation.
INTRODUCTION
Cash is an important asset of a business. It is considered the most liquid asset of
the business and can be easily transferred from one party to another. Thus,
having sufficient cash is crucial for a business to be seen as financially sound,
especially for short-term survival. For instance, without cash, a business may not
be able to pay short-term creditors. Likewise, lack of cash may hinder a business
from acquiring other assets. Because of its liquidity and unidentifiable nature,
cash is seen as a vulnerable asset and always subject to misappropriation. Hence,
this topic will focus on the management and internal control of cash to secure
this business asset from fraudulent acts.
9.1 COMPOSITION OF CASH

Cash refers to money of any currency used as a medium of exchange, credit card
and electronic funds transfer at point of sale (EFTPOS). Cash also includes items
that are acceptable by banks or financial institutions for deposits such as
traveller's cheques, bank drafts and money orders. The sum of all these cash
items is normally presented as a single cash item in the balance sheet. In

TOPIC 9 CASH MANAGEMENT AND CONTROL 211
addition, there are companies which report cash and cash equivalent as one item
in their balance sheets. Cash equivalents are defined as highly liquid short-term
investments that can be easily converted into cash. To be considered as cash
equivalents, the investments must meet these two conditions:
(a) They are readily converted into a sum of cash; and
(b) They are very close to maturity date and will not be affected by changes in
interest rates.
Examples of cash equivalents are treasury bills, commercial paper and short-term
notes payable.
SELF-CHECK 9.1
Define cash equivalents.
9.2 CASH MANAGEMENT

Cash management is important to ensure that there is no over surplus or
shortage of cash in business. This can be achieved by coordinating the cash
relevant transactions such as receivables, purchase of inventories, payables, etc.
This can be done by establishing a proper cash flow system, which oversees the
inflow and outflow of cash. In addition to this, businesses should also observe
these broad principles of good cash management as set out here:
(a) Efficient Collection Policy of Accounts Receivable

A business should have a reasonable average collection time for receivables
to ensure cash is not tied up. This is important not only to ensure sufficient
cash available but also to avoid the potential of having bad debt.
(b) Delayed Payment of Accounts Payable

In this instance, a business should make use the credit terms given by the
suppliers. If the credit term is for 20 days, a business should settle their debt
closer to that due date. This enables the business to use the funds for other
purposes before settling the debt. In doing so, the business should not
undermine the risk of late payment because it may affect its credit ratings in
future.

212 TOPIC 9 CASH MANAGEMENT AND CONTROL
(c) Keeping a Minimum Level of Inventory

Similar to receivables, inventories also tie up cash. In addition, holding
inventories may require storage, insurance and manpower, which
consequently increase costs. Thus, a business should minimise its inventory
level, yet keep it adequate to meet the demands of customers.
(d) Investment of Cash Surplus

If a business has any surplus of funds, the funds should be invested wisely
such as in any short-term investments available. This is important to
generate more income for businesses.
(e) Proper Planning of Capital Expenditure

Capital expenditure normally requires a large amount of cash, thus
requiring proper planning. In this instance, it is essential to balance up
between internal and external financing to minimise the related costs of
funding, such as interest.
EXERCISE 9.1
Describe the principles of good cash management.
9.3 INTERNAL CONTROL OF CASH

In order to complement good cash management (as discussed in the previous
subtopic), businesses should also adopt proper internal control to safeguard and
ensure accuracy of recording cash transactions. This is particularly crucial for
businesses with a large volume of cash transactions as they may have potential
for making errors. The question is, how do we know that our internal control is
effective to protect business assets? Generally, for internal control to be effective,
it should meet these three basic guidelines:
(a) The separation of duties between the one handling cash and record-keeping
to minimise the tendency of cash misappropriation.
(b) Prompt deposit of cash receipt to produce a timely independent record.
This would prevent the cashier from using business funds for personal use.
(c) Payment by cheques for cash transactions to reduce the risk of cash theft.
This approach develops independent record by the bank on cash
disbursement. Also, authorisation by designated personnel for every
issuance of cheque would provide a cross-check on the accuracy of cash
recording.

Based on these guidelines, several internal control mechanisms are suggested.

These controls are classified into two categories. These are control of cash
receipts and control of cash disbursement. Let us take a look at each category in
detail.
9.3.1 Internal Control of Cash Receipts

Internal control of cash receipts ensures prompt deposit and proper recording of
cash receipts. Cash receipts normally arise from cash sales, collection of accounts
receivables, disposal of assets, dividend earned, etc. Each type of receipt may
differ in characteristics, thus requiring different procedures of internal controls.
The following are the different procedures of internal controls:
(a) Over-the-counter Cash Sales

For internal control purpose, cash sales should be recorded on a cash
register. The register prints every single transaction taking place. This
allows the customer to see the amount of purchase. For businesses, the
receipts printed out from the cash register provide evidence of cash sales. In
addition, most cash registers nowadays are linked to businessesÊ accounting
system, reinforcing the internal control system.
Pre-numbered sales dockets are another means of monitoring cash sales.

For each cash sales, pre-numbered sales dockets with one duplicate copy
are prepared. The original copy is given to customers while the cashier
retains the duplicate copy. At the end of the day, a supervisor calculates the
total number of sales dockets to ensure that none is missing.
In the event of mismatch between the amount of cash in a cash register and
the record of cash receipts, such difference should be recorded. If a cash
register shows record of RM500 but the cash count in the register is RM490,
the entry to record cash sales and its shortage is:
Cash 490
Cash Over and Short 10
Sales 500
On the other hand, if the cash count exceeds the amount of sales recorded
in a cash register, the Cash Over and Short will be credited. To illustrate,
assume the cash register shows a record of RM1,000 but the cash count is
RM1,010. The journal entry will be:

Cash 1,100
Cash Over and Short 100
Sales 1,000
(b) Cash Receipts by Mail

Cash receipts by mail normally involve the postage of cheques or money
orders. The internal control of such receipts begins with the person who
receives and opens the mail. Preferably, two staff are assigned the task of
presenting and opening the mail. The mail received should be duplicated in
three copies to be sent to the cashier, the accounting department and the
staff who opens the mail.
EXERCISE 9.2
Why is it important to have proper internal control of cash?
9.3.2 Internal Control of Cash Disbursements

Cash disbursements are normally made for cash purchases, settlement of
payables, ownerÊs withdrawals and payment of expenses. One way of cash
disbursement control is through payment by cheque as this mode of payment
needs authorisation from designated personnel. The voucher system could be
another way of controlling cash disbursement. Under this system, cash
disbursement needs to undergo two main procedures. These are:
(a) Verifying, approving and recording obligations for cash disbursement; and
(b) Issuing cheques for payment of verified, approved and recorded
obligations.
The main element of these procedures is that only approved departments and
individuals have the authority to incur such obligations.
Some business transactions may involve a small amount of cash. Thus, paying by
cheque may not be practical. In that instance, businesses may use petty cash. To
establish petty cash, businesses should make an estimation of the small expenses
to be made during the month or week. Then, payment will be transferred from
cash to petty cash. A petty cashier, who is responsible for the petty cash, can
make payments from the funds with all records kept intact. The petty cash is

normally reimbursed when it is nearing zero. To illustrate, assume Teja Sdn Bhd
establishes petty cash on October 1 for RM200. The entry for this transaction
would be:
Petty cash 200

Cash 200
For every payment made out of petty cash, the petty cashier must record them in
Petty Cash Payments Report. To illustrate, assume payments were made in
October for:
(a) Cleaning of RM30;
(b) Postage of RM15; and
(c) Courier service of RM45.
The petty cashier summarises the payments as shown in Figure 9.1.
Figure 9.1 Petty cash payment report
To reimburse the funds, the petty cashier will forward the petty cash payment
report to the companyÊs cashier. As shown in Figure 9.1, since RM90 was paid
from the petty cash, that same amount will be reimbursed by the cashier. After
the petty cashier cashes the cheque, the amount of cash in the petty cash will be
RM200 again.

9.3.3 Bank Statement as Mechanism of Internal

Control
When businesses open a current account with banks for their businesses, it is
common for them to receive a bank statement from the bank, at least once a
month. Even though the format of the statement may differ between banks, all of
them should include the following information:
(a) Beginning balance of the period;
(b) Cheques and other debits that decrease the account during the period;
(c) Deposits and other credits that increase the account during the period; and
(d) Ending balance for the period.
In theory, the bank statement should reflect exactly the same transactions and
events of the business. Thus, it is expected that the bank statement sent by the
bank should tally with the businessÊ Cash at Bank account. However, in reality, it
is not always the case. There are three situations that lead the two records (Bank
Statement and Cash at Bank account) to be in disagreement:
(a) Items that have been recorded in business account are not yet recorded by
banks, such as unpresented or outstanding cheques drawn by the business
and deposits in transit.
(b) Some items originated by the bank such as bank fees, charges and interest
and dishonoured cheques.
(c) Errors may have been made by either party.
EXERCISE 9.3
On 1 November 2011, Teraju Indah Sdn Bhd set up a petty cash fund for
RM350. On 28 November, the petty cashier requested to reimburse the
fund and submitted the following vouchers and receipts:
(a) Postage of RM15;
(b) Supplies purchased of RM28;
(c) Courier service of RM45; and
(d) Refreshment of RM37.
Prepare the entries to establish the petty cash and to reimburse the fund.

9.4 BANK RECONCILIATION

The disagreement between the bank statement and the Cash at Bank account
gives rise to the need for bank reconciliation. In preparing the bank
reconciliation, the following information needs to be gathered:
(a) Previous bank reconciliation;
(b) Cash at Bank account;
(c) Opening balance of Cash at Bank account; and
(d) Current Bank Statement which have not been reconciled.
Once all the information is gathered, we may begin preparing the bank
reconciliation by following these procedures:
1. Identify the bank statement balance.

2. Check any outstanding items and errors that understate the bank balance.
Add them to the bank balance.
3. Identify any outstanding cheques and errors that overstate the bank
balance. Deduct them from the bank balance.
4. Compute the adjusted bank statement balance, also called the corrected or
reconciled balance.
5. Identify the companyÊs Cash at Bank account.
6. Identify any unrecorded credit memoranda from the bank such as fees,
charges and errors understating the Cash at Bank account balance. Add
them to the Cash at Bank account.
7. Identify any unrecorded debit memoranda from the bank such as service
charges, and errors overstating the Cash at Bank Account. Deduct them
from the balance.
8. Compute the adjusted Cash at Bank account, also known as corrected or
reconciled balance.
9. Verify the two adjusted or reconciled balances. They should be equal if the
adjustments are performed accurately.
Assuming Teraju Indah Sdn Bhd had the following Cash at Bank account as
shown in Table 9.1 and Bank Statement as shown in Table 9.2, let us prepare the
bank reconciliation using the above procedures.

Table 9.1: Bank Account
Date Particulars Ref Debit Credit Balance
Oct 1 Balance 2,590.00 Dr
4 Abdullah – Cheque No. 304 / 150.00 2,440.00 Dr
6 Aziz / 420.00 2,860.00 Dr
10 Emily – Cheque No. 305 / 260.00 2,600.00 Dr
18 Basir / 185.00 2,785.00 Dr
23 Farid – Cheque 306 / 410.00 2,375.00 Dr
28 Govind – Cheque 307 3 80.00 2,295.00 Dr
29 Chong 2 340.00 2,635.00 Dr 5
Table 9.2: Bank Statement
MEGA BANK BERHAD

(5729030-K)
STATEMENT OF ACCOUNT
ACCOUNT NO. BRANCH DATE PAGE
042837928024 SEBERANG JAYA 31 OCTOBER 1
2011
DATE PARTICULARS DEBIT CREDIT BALANCE
October 1 Balance 2,800.00 Cr
6 Cheque 304 150.00 / 2,650.00 Cr
7 Cheque 303 210.00 2,440.00 Cr
12 Cash deposit 420.00 / 2,860.00 Cr
18 Cheque 305 260.00 / 2,600.00 Cr
Cash deposit 185.00 / 2,785.00 Cr
23 Cheque 306 410.00 / 2,375.00 Cr
25 Dividend – ABC 150.00 6 2,525.00 Cr
Bhd
Cheque 101 200.00 3 2,725.00 Cr
31 Insurance premium 20.00 7 2,705.00 Cr
Service charge 15.00 7 2,690.00 Cr 1
OPENING WITHDRAWAL DEPOSIT CLOSING BALANCE
BALANCE
NO. TOTAL NO. TOTAL
2,800.00 1,065.00 955.00 2,690.00


Table 9.3 shows the bank reconciliation of Teraju Indah Sdn Bhd.
Table 9.3: Teraju Indah Sdn Bhd

Bank Reconciliation
31 October 2011
Item RM Item RM
1 Bank statement balance 2,690.00 5 Book balance 2,635.00
Add: Add:
2 Deposit on 29 Oct in transit 340.00 6 Dividend earned 150.00
3,030.00 2,785.00
Deduct: Deduct:
3 Outstanding cheque 200.00 7 Insurance premium 20.00
3 Unpresented cheque 80.00 7 Service charge 15.00
4 Adjusted bank balance 2,750.00 8 Adjusted book balance 2,750.00

Balances are equal
Note: Cheque No. 303 amounting to RM210 is not adjusted in the current bank
reconciliation as the cheque was paid in the previous month (and not shown in
Cash at Bank account).
EXERCISE 9.4
Springfield Enterprise received a bank statement showing a different

balance than reported in the companyÊs bank account as at 30 June
2011. The details of the Bank Statement and Cash at Bank account are
as follows:
Bank Account
Date Particulars Ref Debit Credit Balance

June 1 Balance 1,750.00 Dr
4 Mahat - Cheque No. 376 200.00 1,550.00 Dr
7 Jamal 120.00 1,670.00 Dr
12 Rajan – Cheque No. 377 400.00 1,270.00 Dr
25 Karim 45.00 1,315.00 Dr
27 Omar – Cheque No. 378 175.00 1,140.00 Dr
30 Latif 80.00 1,220.00 Dr

MERCU TANDA BANK BERHAD

(7029030-K)
STATEMENT OF ACCOUNT
ACCOUNT NO. BRANCH DATE PAGE
08379224146 ALOR SETAR 30 JUNE 2011 1
DATE PARTICULARS DEBIT CREDIT BALANCE
June 1 Balance 1,750.00 Cr
6 Cheque 376 200.00 1,550.00 Cr
7 Cash deposit 120.00 1,670.00 Cr
18 Cheque book 15.00 1,655.00 Cr
25 Dividend – HP Bhd 60.00 1,715.00 Cr
26 Cheque 377 400.00 1,315.00 Cr
28 Cash deposit 45.00 1,360.00 Cr
30 Interest 95.00 1,455.00 Cr
OPENING WITHDRAWAL DEPOSIT CLOSING BALANCE

BALANCE
NO. TOTAL NO. TOTAL
1,750.00 615.00 320.00 1,455.00
Prepare a bank reconciliation statement as at 30 June 2011.
Cash includes short-term investment which can be easily converted into cash,
also known as cash equivalents.
Cash management helps businesses to monitor the inflow and outflow of

cash, so that business funds can be used in an optimal manner.
Internal control is important for both cash receipts and cash disbursement.
Bank reconciliation is prepared to reconcile the differences between the Bank

Statement (provided by banks) and the businessÊ Cash at Bank account.

Bank Reconciliation Cash Management

Bank Statement Internal Control
Cash Petty Cash
Cash Equivalent Reimbursement

Topic Financial
10 Statement
Analysis
LEARNING OUTCOMES
1. Explain the purpose of financial statement analysis;
2. Explain the sources of financial information;
p
3. Discuss the basis of item comparison in a financial statement;
4. Explain the three techniques of financial statement analysis;
5. Differentiate between Horizontal Analysis and Vertical Analysis in
evaluating financial statements;
6. Explain the importance of financial ratios in analysing and
interpreting accounting information;
7. Calculate and interpret the financial ratios that can be used to
measure profitability, liquidity, efficiency and debt management; and
8. Explain the purposes and the effectiveness of financial ratios to
evaluate liquidity, profitability and debt management.
INTRODUCTION
Now, let us read this final topic which explains financial statement analysis in
more detail. Generally, financial statement analysis provides useful information
for both internal and external users for decision-making. In particular, this
financial statement information will be used to evaluate the performance and
financial status of a company.

TOPIC10 FINANCIAL STATEMENT ANALYSIS 223
In this topic, we will take a look at the purpose of financial statement analysis
and the sources of financial information. We will also look at three techniques of
financial analysis.
10.1 PURPOSE OF FINANCIAL STATEMENT

ANALYSIS
The main function of financial statement analysis is to help users make better
decisions, whether for internal or external users of the company concerned.

Internal users of accounting information are individuals involved in the

management and operations of an organisation.

They include the management, internal auditors, other employees, consultants
and parties involved in decision-making in an organisation. Figure 10.1 shows
the internal users.
Figure 10.1: Internal users of accounting information
Internal users are responsible for planning strategies and executing the
companyÊs operations. Thus, the purpose of financial analysis is to provide them
with information in order to improve efficiency and effectiveness in producing
the output or services of the organisation.
External users of accounting information are not directly involved in the

operation of an organisation.

224 TOPIC10 FINANCIAL STATEMENT ANALYSIS
They comprise shareholders, creditors, non-executive directors, customers,

suppliers, legislators, lawyers, brokers, the media and others. Figure 10.2 shows
the external users of accounting information.

Figure 10.2: External users of accounting information
External users utilise accounting information to determine the financial status of

the company for their own purposes. Shareholders and creditors will evaluate
the investment and financing prospects of the company. Members of the board of
directors will analyse the financial statement for the purpose of monitoring the
effectiveness of decisions which have been made. Suppliers will use the financial
information to evaluate the credit standing of the organisations.
Generally, financial statement analysis is conducted to:

(a) Make the information more meaningful to enable users to make decisions;
and
(b) Assist users to measure the performance level and financial status of the
business.
SELF-CHECK 10.1
Do internal users need to obtain prior approval from external users

before implementing specific financial decisions? Why?
10.2 SOURCES OF INFORMATION

Financial statement analysis requires information for analysis. Financial
statement analysis is normally done using the annual report of organisations. The
annual report contains information in the form of:
(a) Income Statement or Statement of Comprehensive Income;
(b) Balance Sheet or Statement of Financial Position;
(c) Statement of Cash Flows;
(d) Statement of Changes in Equity;

(e) Notes to the financial statement;

(f) Summary of accounting methods used;
(g) ManagementÊs discussion and analysis of operating revenue;
(h) AuditorsÊ report; and
(i) Financial data comparison for several years.
10.3 BASIS OF COMPARISON

Financial information can be compared using three bases. They are:
(a) Within the Company

Using this basis, the company will compare the items in its financial
statements relating to two different years or more. The comparison of
the current yearÊs financial statement with that of the previous years will
show the trend that can be used for future predictions. For example, the
comparison of cash for the current year with that of the previous year will
show its increase or decrease within the company.
(b) Between Companies

Using this basis of comparison, the items in the financial statement of one
particular company are compared with those of other companies, all
of which are operating the same type of business. The comparisons are
made based on the financial statement published by the companies.
Comparisons between companies provide useful information on the
specific companyÊs status as compared to its competitors.
(c) Industry Average

This basis of comparison compares items in the financial statement of the
specific company with other companies in the related industry in general. A
comparison made between a company and industry average will provide
information on the companyÊs performance within the industry.
EXERCISE 10.1
State the differences between the following bases of comparison:

(a) Within company;
(b) Between companies; and
(c) Industry average.

ACTIVITY 10.1
How can the basis between comparisons for financial information

be useful for a printing company that has operated for the past
40 years? Discuss with your classmates.
10.4 TECHNIQUES OF ANALYSIS

Do you know that there are three techniques that may be used in evaluating
financial statement data? They are:
(a) Horizontal Analysis

Specially used for comparison within the company.
(b) Vertical Analysis

Can be used either for comparison within the company or between
companies.
(c) Ratio Analysis

Can be used for all the three bases of comparison, which are within
company, between companies and industry average.
Let us take a look at Figure 10.3 which summarises the analysis techniques
mentioned.
Figure 10.3: Analysis techniques

SELF-CHECK 10.2
Explain the three techniques of analysis in evaluating financial

statement data.
ACTIVITY 10.2
In your opinion, which analysis technique is suitable for a business

selling sports cars? Post your answer in the forum.
10.5 HORIZONTAL ANALYSIS

Now, let us take a look at the first technique which may be used in evaluating
financial statement data.
Horizontal analysis is a technique used to assess the trend of the items in the
financial statement (increasing or decreasing) in terms of the amount or the
percentage of fluctuation.
There are two characteristics of horizontal analysis:
(a) First, the comparison is made on every item in the financial statement for at
least two accounting period or years. The basis of comparison for these two
years (the current year and the previous year) will be set using the financial
statement of the previous year as the base to determine an increase or
decrease.
(b) Second, the comparison for sequential financial data is normally conducted
for several years, for example for 5 to 10 years or more. This comparison is
also known as trend analysis.
Horizontal analysis is classified into:

(a) Period of at least 2 years; and
(b) Period of more than 2 years – also known as trend analysis.

10.5.1 Comparison of Horizontal Analysis for 2 Years

The calculation for percentage of increase or decrease in horizontal analysis for a
period of 2 years is made using the following steps:
Step 1: Calculate the amount of change for the base year (previous year) and
the following year (current year), for every item in the financial
statement.
Step 2: Divide the amount of change, as calculated above, with the amount in
the base year for every item in the financial statement, to obtain the
percentage of change.
Change in Ringgit Current year amount Base year amount

Current year amount Base year amount
Percentage of change 100
Base year amount

Percentage of change in Cash in the Balance Sheet (Refer Table 10.2) is shown
here:
(Current year amount Base year amount)

Base year amount
RM90,500 RM64,700
RM64,700
39.9%
This shows that there is an increase of 39.9% of change from 2010 to 2011.
The calculation above is then repeated for each item in the balance sheet, income
statement and retained earnings statement.

The calculation for changes in marketable securities and non-current liability is

shown in Table 10.1:
Table 10.1: Percentage Change for Marketable Securities and Non-current Liability
Item Year Increase (Decrease)

2011 2010 Amount (RM) Percentage (%)
Marketable 75,000 60,000 75,000 – 60,000 = 15,000 15, 000
100 25
Securities 60, 000
Non-current 100,000 200,000 100,000 – 200,000 = (100,000) (100, 000)
100 (50)
Liability 200, 000
First step calculation
Second step calculation
The calculations show that marketable securities increase by 25% and non-
current liability decreases by 50%.
Now, let us take a look at Table 10.2 which shows the horizontal analysis for the
entire Balance Sheet of Anggerik Sdn Bhd. The format of the balance sheet is as
set out in FRS 101, „Presentation of Financial Statements‰. This comparative
balance sheet consists of balance sheet amounts from two accounting periods
arranged side by side. Next to that, each itemÊs change in both monetary term
and percentage is shown. Such changes will be examined to identify the intensity
of the change as well as whether they are favourable or unfavourable. In Table
10.2 also shows that cash and marketable securities increase substantially in 2011.
This reflects the high liquidity of the company.


Table 10.2: Anggerik Sdn Bhd: Comparative Balance Sheet
Anggerik Sdn Bhd

Comparative Balance Sheet
as at 31 December 2010 and 2011
Increase (Decrease)
2011 2010 Amount Percentage

(RM) (RM) (RM) (%)
Non-current Assets:
Long-term investment 95,000 177,500 (82,500) (46.5)
Building and Equipment (net) 444,500 470,000 (25,500) (5.4)
Intangible assets 50,000 50,000 – –
Total non-current assets 589,500 697,500 (108,000) (15.5)
Current Assets:
Cash 90,500 64,700 25,800 39.9
Marketable securities 75,000 60,000 15,000 25.0
Accounts receivable 115,000 120,000 (5,000) (4.2)
Inventory 264,000 283,000 (19,000) (6.7)
Expenses pre-payment 5,500 5,300 200 3.8
Total current assets 550,000 533,000 17,000 3.2
Current liability:
Accounts payable 210,000 243,000 (33,000) (13.6)
Total net current assets 340,000 290,000 50,000 17.2
929,500 987,500 (58,000) 5.9
Financed by owner and long-term
liability:
Owner Ês equity:
6% Preference shares, RM100 150,000 150,000 – –
Ordinary shares, RM10 500,000 500,000 – –
Retained earnings 179,500 137,500 42,000 30.5
Non-current liability 100,000 200,000 (100,000) (50.0)
Total owner Ês equity and long-term 929,500 987,500 (58,000) 5.9
liability
Table 10.3 shows the horizontal analysis for the Income Statement of Anggerik
Sdn Bhd. Comparative income statement is prepared similarly to comparative
balance sheet. It appears that net sales have increased almost 25 percent in 2011
as compared to the previous year. Also, the ability to obtain a profit of
20.7 percent on revenue growth of 24.8 percent is impressive.

Table 10.3: Anggerik Sdn Bhd: Comparative Income Statement
Anggerik Sdn Bhd

Comparative Income Statement
for the Year Ended 31 December, 2010 and 2011
Increase (Decrease)
2011 2010 Amount Percentage
(RM) (RM) (RM) (%)
Sales 1,530,500 1,234,000 296,500 24
(–) Sales return and allowance 32,500 34,000 (1,500) (4.4)
Net sales 1,498,000 1,200,000 298,000 24.8
(–) Cost of goods sold 1,043,000 820,000 223,000 27.2
Gross profit 455,000 380,000 75,000 19.7
(–) Sales expenses 191,000 147,000 44,000 29.9
(–) Administrative expenses 104,000 97,400 6,600 6.8
Net operating revenue 160,000 135,600 24,400 18.0
(+) Other revenue or profit 8,500 11,000 (2,500) (22.7)
(–) Other expenses and loss 6,000 12,000 (6,000) (50.0)
Profit before tax 162,500 134,600 27,900 20.7
Taxation 71,500 58,100 13,400 23.1
Profit after tax 91,000 76,500 14,500 19.0
Horizontal analysis for the Retained Earnings Statement of Anggerik Sdn Bhd is
shown in Table 10.4. The analysis indicates an increase of net profit of 19 percent
in 2011 compared to 2010.
Table 10.4: Anggerik Sdn Bhd: Comparative Retained Earnings Statement
Anggerik Sdn Bhd Comparative Retained Earnings Statement

as at 31 December, 2010 and 2011
Increase (Decrease)
2011 2010
Amount Percentage
(RM) (RM)
(RM) (%)
Retained earnings, 1 Jan 137,500 100,000 37,500 37.5
Current year profit 91,000 76,500 14,500 19.0
228,500 176,500 52,000 29.5
(–) Dividend
Preference shares 9,000 9,000 – –
Ordinary shares 40,000 30,000 10,000 33.3
49,000 39,000 10,000 25.6
Retained earnings, 31 December 179,500 137,500 42,000 30.5

10.5.2 Comparison of Horizontal Analysis for a

Sequential Period (Trend Analysis)
In this section, we are going to see a comparison of Horizontal Analysis for a
sequential period (Trend Analysis).
Horizontal Analysis for a sequential period or Trend Analysis is a

technique to evaluate the financial data for specific periods.
Trend analysis is a horizontal analysis involving the income statement and

balance sheet for three years or more. In a trend analysis, the item from the first
statement or the initial period is used as the base for comparison.
Example:
The Net Sales item taken from the Income Statements of Angsana Sdn Bhd for
the years 2007 to 2011, is shown in Table 10.5.
Table 10.5: Angsana Sdn Bhd – Net Sales Data for a Period of 5 Years
Angsana Sdn Bhd

2011 (RM) 2010 (RM) 2009(RM) 2008(RM) 2007 (RM)
Net sales
41,296 38,064 34,835 33,110 30,518
By using 2007 as the base year for comparison, calculation of increase or decrease
of the financial data for the following years is calculated as follows:
Amount for a specific year Base year amount

Change from base year 100
Base year amount
8.5%
Example:
Increase in net sales for year 2008:
RM30,518
RM33,110 RM30,518 100
RM30,518
8.5%

Therefore, net sales have increased by 8.5% in 2008 from the base year of 2007.
By using the sales figure for 2007 to 2011, a sequential period analysis is shown as
in Table 10.6.
Table 10.6: Angsana Sdn Bhd – Net Sales Data for a Period of 5 Years
Angsana Sdn Bhd

2011 2010 2009 2008 2007
(RM) (RM) (RM) (RM) (RM)
Net sales
41,296 38,064 34,835 33,110 30,518
135% 125% 114% 108% 100%
SELF-CHECK 10.3
What can you say about the trend in sales of Angsana Sdn Bhd from
2007 to 2011?
10.6 VERTICAL ANALYSIS

What is a vertical analysis?
A vertical analysis is a technique to evaluate items in a financial statement by

stating each of the items in terms of percentage as compared to the base
amount.
A vertical analysis shows the relationship of every item in the financial statement
in which one item is used as the base. The base item for a balance sheet is Total
Assets, and the base item for an Income Statement is Net Sales.
10.6.1 Vertical Analysis for Balance Sheet

To perform the vertical analysis, items found in the financial statement as stated
n FRS 101 must be presented according to the format shown in Table 10.8. This is
to facilitate the calculation of the percentages in the vertical analysis.

The vertical analysis can be performed more easily if (Total Assets) and (Total
Liability and OwnerÊs Equity) is shown in the analysis. The basis of comparison
in vertical analysis is based on (Total Assets) or (Total Liability and OwnerÊs
Equity). This can be illustrated based on the accounting equation:
Asset = Liability + OwnerÊs equity
Table 10.7 shows examples of the calculation for Cash and Accounts payable
items for 2011 and 2010.
Table 10.7: Calculation of Vertical Analysis for Balance Sheet
2007 2006
Cash Percentage:
RM90,500 RM64,700
Cash 100 100
100 RM1,139,500 RM1,230,500
Total assets
7.9% 5.3%
Accounts Payable Percentage:
RM210,000 RM243,000
Accounts Payable 100 100
100 RM1,139,500 RM1,230,500
Total Liability and Owner Equity
18.4% 19.7%

The vertical analysis for the entire Balance Sheet of Anggerik Sdn Bhd as at
31 December 2011 and 2010 is shown in Table 10.8.


Table 10.8: Anggerik Sdn Bhd: Comparative Balance Sheet

Anggerik Sdn Bhd
2011 2010
Total Percentage Total Percentage
(RM) (%) (RM) (%)
Current Assets:
Cash 90,500 7.9 64,700 5.3
Marketable Securities 75,000 6.6 60,000 4.9
Accounts receivable 115,000 10.1 120,000 9.8
Inventory 264,000 23.2 283,000 23.0
Expenses Prepayment 5,500 0.5 5,300 0.4
Total Current Assets 550,000 48.3 533,000 43.3
Non-current Assets:
Long-term Investment 95,000 8.3 177,500 14.4
Building and Equipment 444,500 39.0 470,000 38.2
(Net) Intangible Asset 50,000 4.4 50,000 4.1
Total Non-current Assets 589,500 51.7 697,500 56.7
Total Assets 1,139,500 100 1,230,500 100
Current Liability:
Accounts payable 210,000 18.4 243,000 19.7
Non-current Liability 100,000 8.8 200,000 16.3
Total Liabilities 310,000 27.2 443,000 36.0
Owner Ês Equity:
6% Preference Shares, RM100 150,000 13.2 150,000 12.2
Ordinary Shares, RM10 500,000 43.9 500,000 40.6
Retained Earnings 179,500 15.8 137,500 11.2
Total Owner Ês Equity 829,500 72.8 787,500 64.0
Total Liabilities and OwnerÊs Equity 1,139,500 100 1,230,500 100
The analysis can also be done by comparing the percentage of an item for one
year with its percentage for another year. For example, in 2010, total liabilities
comprise 36% of the total liabilities and ownerÊs equity. The corresponding figure
for 2011 is only 27.2%, implying that the usage of debts in year 2011 had
decreased as compared to 2010 The same approach can be used to analyse other
items.
10.6.2 Vertical Analysis for Income Statement

In a vertical analysis for an income statement, the item used as the base for
comparison is Net Sales. This can be seen in Table 10.9.

Table 10.9: Calculation of Vertical Analysis for Income Statement
2011 2010
Sales percentage:
Sales RM1,530,500 RM1,234,000
100 100 100
Net assets RM1,498.00 RM1,200.00
102.2% 102.8%
Administrative expenses percentage:
Administrative expenses RM104,500 RM97,400
100 100 100
Net sales RM1,498.00 RM1,200.00
6.9% 8.1%
The calculation results of vertical analysis for the entire Income Statement are
shown in Table 10.10.
Table 10.10: Anggerik Sdn Bhd: Comparative Income Statement
Anggerik Sdn Bhd

for 31 December 2011 and 2010
2011 2010
Total Percentage Total Percentage
(RM) (%) (RM) (%)
Sales 1,530,500 102.2 1,234,000 102.8
Sales return and allowance (32,500) 2.2 (34,000) 2.8
Net sales 1,498,000 100.0 1,200,000 100.0
Cost of goods sold (1,043,000) 69.6 (820,000) 68.3
Gross profit 455,000 30.4 380,000 31.7
Sales expenses (191,000) 12.8 147,000 12.3
Administrative expenses 104,000 6.9 (97,400) 8.1
Total operating revenue 160,000 10.7 135,600 11.3
Other revenue or profit 8,500 0.6 11,000 0.9
Other expenses or loss (6,000) 0.4 (12,000) 1.0
Profit before tax 162,500 10.9 134,600 11.2
Taxation (71,500) 4.8 (58,100) 4.8
Profit after tax 91,000 6.1 76,500 6.4

As explained previously regarding the Balance Sheet, analysis can be done by

comparing the percentage of an item for one year with its percentage for another
year. For example, in 2010, profit after tax (as percentage of net sales) is 6.4%. The
corresponding figure in 2011 is only 6.1%.
It is possible to identify the reason for the decrease by making the same
comparison for the other items. For example, in 2010, cost of goods sold (as
percentage of net sales) is 68.3%. The corresponding figure in year 2011 had
increased to 69.6%. This increase might be the reason for the decrease in the
percentage of profit after tax.
EXERCISE 10.2
1. The two methods of analysing financial statement are

Horizontal Analysis and Vertical Analysis. Describe the
differences between these two methods.

Horizontal Analysis Vertical Analysis

2. The data shown below are extracted from the Comparative
Balance Sheet of Bidara Sdn Bhd for the year ended 31
December 2010 and 2011.
31 December 2010 31 December 2011

Accounts receivable 500,000 400,000
Inventory 840,000 600,000
Total current assets 3,220,000 2,800,000
Prepare the horizontal and vertical analysis by using the above data.

10.7 FINANCIAL RATIO ANALYSIS

We will now go on to discuss financial ratio analysis. The classification of
financial ratios is shown in Figure 10.4.
Figure 10.4: Classification of financial ratios
Let us go into each financial ratio.
(a) Liquidity
Liquidity ratios measure the businessÊ short-term capability to discharge
its obligations or debts upon maturity and to fulfil unforeseen cash
requirements. This ratio is often used by short-term creditors.
(b) Efficiency
Efficiency ratios measure the level of efficiency and capability of the
management to operate its business, especially in the use of assets to
generate sales.
(c) Profitability
Profitability ratios measure the ability of a business to generate profit
within a specific period. It is used as an indicator to analyse the efficiency
and effectiveness of a business in achieving its profit.
(d) Debt Management

Debt management ratios measure the ability of a business to continue its
operations. The ratios that can be classified under debt management ratios
are interest coverage ratio, debt ratio, equity ratio and debt to equity ratio.

ACTIVITY 10.3
How are financial ratios important to service firms? Give an example

of a service firm.
10.8 LIQUIDITY RATIO

Liquidity ratios measure the businessÊ capability to discharge its short-term
financial obligation. However, long-term creditors also place importance on the
evaluation of the companyÊs liquidity.
Liquidity ratios can be used by a company to determine its debt repayment

capability in the short-term. Liquidity ratios are classified as:
(a) Working capital;
(b) Current ratio; and
(c) Quick ratio.
Table 10.11 explains each of the liquidity ratios.

Table 10.11: Classification of Liquidity Ratio

EXERCISE 10.3
1. Explain the meaning of current ratio and quick ratio, including

the formulae for both.
2. The following is part of the data extracted from the Balance

Sheet of Kenari Sdn Bhd.
Kenari Sdn Bhd Balance Sheet extract

CURRENT ASSETS RM
Cash 8,241,000
Marketable securities 1,947,000
Accounts receivable 12,545,000
Inventory 14,814,000
Expenses prepayment 5,371,000
TOTAL CURRENT ASSETS 42,918,000
CURRENT LIABILITY:
Total current liability 45,844,000
Calculate the:
(a) Working Capital
(b) Current Ratio
(c) Quick Ratio
10.9 EFFICIENCY RATIO

Efficiency ratios measure the level of efficiency and capability of the management
to operate its business, especially in the usage of assets to generate sales. Ratios
that can be classified as efficiency ratios are:
(a) Account receivable turnover;
(b) Average collection period;
(c) Inventory turnover; and
(d) Asset turnover
The calculation, purpose and description of each of these ratios will be described
in Table 10.12.
Table 10.12: Classification of Efficiency Ratio

10.10 PROFITABILITY RATIO

Profitability ratios measure the ability of a business to generate profit within a
specified period. They are used as an indicator to analyse the efficiency and
effectiveness of a business in achieving its profit. These ratios are very useful to
creditors, investors and owners. The ratios that can be classified as profitability
ratios are:
(a) Gross profit margin;
(b) Net profit margin;
(c) Return on asset;
(d) Return on ownerÊs equity;
(e) Return on ownerÊs equity ordinary shares;
(f) Earnings per share;
(g) Price earnings ratio;
(h) Dividend yield; and
(i) Dividend payout ratio.
The purposes and descriptions of each ratio will be explained in Table 10.13.

Table 10.13: Classification of Profitability Ratio

Table 10.13: Classification of Profitability Ratio (continuation)

Table 10.13: Classification of Profitability Ratio (continuation)

10.11 DEBT MANAGEMENT RATIO

Finally, the debt management ratio measures the ability of the business to
continue its operation. The ratios that can be classified as debt management ratio
are:
(a) Interest coverage ratio;
(b) Debt ratio;
(c) Equity ratio; and
(d) Debt to equity ratio.
The purposes and summary to calculate the debt management ratio are shown in
Table 10.14.

Table 10.14: Classification of Debt Management Ratio

ACTIVITY 10.4
Suppose you run a business selling computers. How can the

debt management ratios be able to help you in developing your
business?
EXERCISE 10.4
The following data is extracted from Income Statement of

Keris Sdn Bhd.

2011 (RM) 2010 (RM)
Net sales 6,420,000 6,420,000
Opening inventory 980,000 860,000
Purchases 4,440,000 4,661,000
Closing inventory 1,020,000 980,000
By using the information above, calculate the:

(a) Inventory turnover for year 2010; and
(b) Inventory turnover for year 2011.
10.12 SAMPLE OF RATIO CALCULATIONS

Table 10.15 shows a Financial Statement for Kenanga Sdn Bhd. The company
engages in a plastics-related business. The information on industry averages is
also enclosed.

Table 10.15: Kenanga Sdn Bhd

Comparative Income Statement with Industry Average
for the Year Ended 31 December 2011
Kenanga Sdn Bhd Industry
(RM) Average (%)
Net sales * 600,000 100
(Cash sales RM330,000)
Cost of goods sold 384,000 74.2
Gross profit 216,000 25.8
Sales and administrative expenses 194,000 22.5
Operating profit 22,000 3.3
Other expenses (4,000) 0.2
(Interest expenses RM3,000)
Profit before tax 28,000 3.1
Income tax expenses (5,000) 0.7
Net profit 13,000 2.3

Table 10.16 shows Kenanga Sdn Bhd Comparative Balance Sheet.

2011 (RM) 2010 (RM)

Current assets:
Cash 15,000 10,000
Marketable securities 10,000 15,000
Accounts receivable (net) 35,000 25,000
Inventory 55,000 40,000
Expenses pre-payment 5,000 5,000
Total current asset 120,000 95,000
Non-current asset 80,000 45,000
Total asset 200,000 140,000
Liabilities and owner equity:
Current liability 60,000 50,000
Non-current liability 15,000 10,000
OwnerÊs equity 125,000 80,000
Total liabilities and ownerÊs equity 200,000 140,000

The average ratios for the plastics industry are as shown in Table 10.17.
Table 10.17: The Average Ratios for the Plastics Industry
Ratio Industry Average

Current ratio 1.8 : 1.0
Quick ratio 1.1 : 1.0
Accounts receivable turnover 9.5 times
Average collection period 38 days
Inventory turnover 4.8 times
Asset turnover 2.3 times
Gross profit margin 25.8%
Net profit margin 3.1%
Return on asset 4.0%
Return on ownerÊs equityÊs ordinary shares 11.4%
Interest coverage ratio 2.8 times
Debt ratio 44.1%
Debt to equity ratio 120.2
Required:
(a) Prepare the vertical analysis for Kenanga Sdn BhdÊs Income Statement.
Compare it with the industry average and explain briefly the result of the
analysis.
(b) Calculate the following financial ratios and compare it with industry
average for 2011 for Kenanga Sdn Bhd. Explain your analysis results.
(i) Current ratio
(ii) Quick ratio
(iii) Accounts receivable turnover
(iv) Average collection period
(v) Inventory turnover
(vi) Asset turnover
(vii) Gross profit margin
(viii) Net profit margin
(ix) Return on asset
(x) Return on ownerÊs equityÊs ordinary shares
(xi) Interest coverage ratio
(xii) Debt ratio
(xiii) Debt equity ratio
Solution:
(a) Vertical Analysis

Table 10.18 shows a vertical analysis for Kenanga Sdn BhdÊs Income
Statement.

Comparative Income Statement with Industry Average
Kenanga Sdn Kenanga Sdn Bhd Industry

Bhd (RM) RMÊ000 % Average (%)
Net sales *
(Cash sales RM330,000) 600,000 600/600 100 100
Cost of goods sold 384,000 384/600 64 74.2
Gross profit 216,000 216/600 36 25.8
Sales and administrative 194,000 194/600 32.3 22.5
expenses
Profit from operating 22,000 22/600 3.7 3.3
Other expenses
(Interest expenses RM3,000) (4,000) 4/600 0.7 0.2
Profit before tax 18,000 18/600 3.0 3.1
Income tax expenses (5,000) 5/600 0.8 0.7
Net profit 13,000 13/600 2.2 2.3
(b) Ratio Analysis

Table 10.19 shows a ratio analysis for Kenanga Sdn BhdÊs Income
Statement.
Table 10.19: Ratio Analysis for Kenanga Sdn BhdÊs Income Statement
Industry
No Ratio Kenanga Sdn Bhd
Average
(i) Current ratio Current asset 1.8 : 1.0
Current liability
120, 000
60, 000
2.0 : 1.0

(ii) Quick ratio Quick asset 1.1 : 1.0

Current liability
15, 000 10, 000 35, 000
60, 000
1.0 : 1.0
Analysis result:
Quick ratio of the company is just enough to pay
the short-term debts quickly. This quick ratio is
less by 0.1 from the industry average.
(iii) Accounts Net credit sales 9.5 times
receivable
Average Net AR
turnover
60, 000 330, 000
(25, 000 35, 000)/ 2
9.0 times
Analysis result:
The AR turnover for year 2001 is 9 times. This
shows that the business is able to collect its debts
quickly. The industry average is 0.5 times more
than the company.
* AR = Account Receivable
(iv) Average 365 days 38 days
collection
*AR turnover
period
365
9
41 days
Analysis result:
The company is able to collect debts within 41
days. The efficiency of the company in debt
collection is late by 3 days compared to industry
average of 38 days.

(v) Inventory Cost of goods sold 4.8 times

turnover Average inventory
384, 000
(40, 000 55, 000)/ 2
8.1 times
Analysis result:
The higher the inventory turnover the better.
This shows the business is good in selling its
inventory and reduces the chances of obsolete
inventory. The companyÊs inventory turnover
of 8.1 times is twice as fast as the industry
average of 4.8 times.
(vi) Asset turnover Net sales 2.3 times
Average total asset
RM600,000
(RM140, 000 RM200, 000)/ 2
3.5 times
Analysis result:
The higher the ratio, the better. Asset
turnover for the company is better compared to
industry average of 2.3 times.
(vii) Gross profit Gross profit 25.8%
margin Net sales
RM216,000
RM600, 000
36%
Analysis result:
The higher the gross profit margin the better.
This indicates good purchasing management and
lower purchasing cost. The gross profit margin of
this company is better compared to industry
average. This shows the purchasing management
and cost of the company is 10.2% better than
industry average.

(viii) Net profit Net profit 3.1%

margin Net sales
RM13,000
RM600, 000
2.2%
Analysis result:
The lower the sales price, the higher the sales
revenue generated is being used for other
activities. The higher the ratio, the better
as it shows lower expenditure or cost needed to
generate sales.
The percentage of net profit margin for the
company is less than the industry average.
(ix) Return on Net profit 4.0%
asset Average total asset
RM13,000
(RM140, 000 RM200,000/2
7.6%
Analysis result:
This shows that profit return is 7.6% as
relates to management efficiency in using the
asset regardless of resources to finance the asset.
Return on the companyÊs asset is much better
compared to the industry average that only
contributes 4.0%.
(x) Return Net profit Dividend for preference shares 11.4%
on owner Average owner's equity
equityÊs
ordinary RM13,000 0
shares (RM80, 000 RM125,000/2
12.68%
Analysis result:
The higher the ratio the better as it shows the
business is capable of generating higher profit
for the shareholders. The company is able to
give 12.68% profit to the ordinary shareholders.
The return for the companyÊs ordinary
shareholders is 1.28% higher than industry
average, only a slight difference as compared to
the industry average.

(xi) Interest Net profit Taxation + Interest expenses 2.8 times

coverage ratio Interest expenses
RM13,000 RM5,000 RM3,000
RM3,000
7 times
Analysis result:
The higher the ratio, the better as it shows the
business is capable to pay the interest expenses.
This shows the company is able to obtain adequate
funds to pay interest upon the maturity date. The
company is able to use net profit after tax to pay
the interest expenses 7 times. The interest coverage
ratio is much better compared to industry average
that is only able to use 2.8 times from the profit
after tax to pay interest.
(xii) Debt ratio Total liability 44.1%
Total asset
RM75,000
RM200,000
37.5%
Analysis result:
To measure the percentage of total assets financed
by creditors. This shows that 37.5% from the
companyÊs asset are financed by creditors. The
total percentage debt ratio of company is lower
compared to industry average. This shows the
companyÊs asset management is better at 37.5%
compared to 44.1% for industry average.
(xiii) Debt to equity Total liability 120.2%
ratio Total owner's equity
RM75,000
RM125,000
60.0%
Analysis result:
To measure the percentage of liability covered by
owner equity. The lower the ratio, the better as it
shows the company is able to increase
liability whenever needed. The companyÊs debt
equity ratio is much better compared to the
industry average.

Now, let us take a look at Table 10.20 which ssummarises the Financial Ratios.
Table 10.20: Summary of Financial Ratios

Table 10.20: Summary of Financial Ratios (Continuation)

Table 10.20: Summary of Financial Ratios (Continuation)

EXERCISE 10.5
The following shows the Comparative Balance Sheet for Delima

Sdn Bhd.
Delima Sdn Bhd

Comparison Balance Sheet
as at 31 December, 2011 and 2010
2011 (RM) 2010 (RM)

Cash 20,000 30,000
Inventory 60,000 50,000
Equipment (net) 200,000 180,000
345,000 320,000
Mortgage (15%) 100,000 100,000
Ordinary shares @ RM10 140,000 120,000
Retained earnings 55,000 40,000
345,000 320,000
Additional information for the year 2011:

1. The sales account total is RM420,000. Sales return and
allowance totalled RM20,000.
2. Cost of goods sold is RM198,000.
3. Net income from operating activities totalled RM44,000.
Required:
Calculate the ratios listed below for 2011.
(a) Current ratio;
(b) Quick ratio;
(c) Accounts receivable turnover;
(d) Inventory turnover; and
(e) Return on sales.

EXERCISE 10.6
1. The financial information for Desa Sdn Bhd is shown below:
31 December 31 December
2011 2010
Current asset 125,000 100,000
Equipment (net) 400,000 330,000
Current liability 91,000 70,000
Long-term liability 144,000 95,000
Ordinary shares @ RM1 155,000 115,000
Required:
Prepare the Horizontal Analysis for year 2011 by using year
2010 as the base year.
2. The following is the comparative financial information for

Sentosa Sdn Bhd. The Balance Sheets are dated 31 December
2011 and 2010.
2011 2010
(RM) (RM)
Net Sales 800,000 720,000
Cost of sales 480,000 40,000
Interest expenses 7,000 5,000
Net revenue 64,000 42,000
Account receivables 120,000 100,000
Inventory 85,000 75,000
Total asset 600,000 500,000
Total owner equity 450,000 310,000
Required:
Calculate the following ratios for year 2011.
(a) profit margin;
(b) asset turnover;
(c) return on asset; and
(d) return on owner equity.

3. The information given relate to the Comparative Income Statement

and Balance Sheet for Teguh Sdn Bhd.
Teguh Sdn Bhd

as at 31 December 2011, 2010 and 2009
2011 (RM) 2010 (RM) 2009 (RM)
Cash 25,000 20,000 18,000
Accounts receivable (net) 50,000 45,000 48,000
Expenses prepayment 90,000 85,000 64,000
Investment 75,000 70,000 45,000
Equipment (net) 400,000 370,000 358,000
640,000 590,000 533,000
Current liability 75,000 80,000 70,000
Long-term liability 80,000 85,000 50,000
Ordinary share @ RM10 340,000 300,000 300,000
Retained earnings 145,000 125,000 113,000
640,000 590,000 533,000
Teguh Sdn Bhd
for the year ended 31 December 2011
2011 (RM) 2010 (RM)
Sales 740,000 700,000
Less: Sales return allowance 40,000 50,000
Net sales 700,000 650,000
Cost of goods sold 420,000 400,000
Gross profit 280,000 250,000
Operating expenses 230,000 215,000
Net Revenue 50,000 35,000
Additional Information:
1. The market values of ordinary shares for Teguh Sdn Bhd are RM4 for
year 2009, RM5 for year 2010 and RM7.95 for year 2011.
2. All dividends were paid by cash.
3. At 1 July 2011, 4,000 units of new ordinary shares were issued.
Required:
Calculate the following ratios for 2011 and 2010.
(a) Profit margin; (b) Asset turnover;
(c) Earnings per share; (d) Price earnings ratio;
(e) Dividend payout ratio; and (f) Debt ratio.

4. The following are Comparative Income Statement and Balance Sheet

of Teratai Sdn Bhd.
Teratai Sdn Bhd
Income Statement
2011(RM) 2010 (RM)
Sales 650,000 520,000
Less: Cost of goods sold 415,000 354,000
Gross profit 235,000 166,000
Sales and administrative 150,000 114,800
expenses
Interest expenses 7,200 6,000
Taxation 18,000 14,000
Les: Total expenses 175,200 134,800
Net Revenue 59,800 31,200
Teratai Sdn Bhd

2011 (RM) 2010 (RM)
ASSET
Current asset: 41,000 18,000
Cash
Marketable securities 18,000 15,000
Accounts receivable (net) 92,000 74,000
Inventory 84,000 70,000
Total current asset 235,000 177,000
Equipment (Net) 403,000 383,000
Total asset 638,000 560,000
LIABILITIES AND OWNERS EQUITY
Current liabilities:
Tax payable 23,000 20,000
Total current liabilities 135,000 130,000
Long-term liability:
Bond payable 130,000 80,000
Total liabilities 265,000 210,000
OwnerÊs equity:
Ordinary share@RM5 150,000 150,000
Total ownerÊs equity 373,000 350,000
Total liabilities and owners equity 638,000 560,000

Additional information:
1. Ordinary shares are sold at RM19.50 per share.
Required:
Calculate the following ratios for the year 2011:
(a) Current ratio; (h) Return on owner Ês equity;

(b) Quick ratio; (i) Earnings per share;
(c) Accounts receivable turnover; (j) Price earnings ratio;
(d) Inventory turnover; (k) Dividend payout ratio;
(e) Gross profit margin; (l) Debt to equity ratio; and
(f) Asset turnover; (m) Interest coverage ratio.
(g) Return on asset;
Financial statement analysis is prepared for the purpose of helping internal

and external users make better decisions.
Financial information can be compared by using three bases of comparison –

within the company (intra-company), between companies and industry
average.
Three analysis techniques are normally used to evaluate financial statement

data – Horizontal Analysis, Vertical Analysis and Financial Ratio Analysis.
Debt Management Ratio Internal Users

Efficiency Ratio Liquidity Ratio
External Users Profitability Ratio
Financial Statement Ratio Analysis
Financial Statement Analysis Trend Analysis
Horizontal Analysis Vertical Analysis

ANSWERS 265
Answers
TOPIC 1: ACCOUNTING ENVIRONMENT
Exercise 1.1
1. Internal users are people who have direct access to the resources of an entity
and are normally involved in the management of the company; an example
being the companyÊs management. These people are involved in planning
and controlling the activities of the company to enable it to achieve
specified objectives. Examples of common decision making are:
(a) does the company require additional capital or not; if the
company requires additional capital, would the company be applying
for loan or issue shares.
(b) does the company require additional asset; if the company requires
additional asset, would the company be buying or renting it.
(c) how much is the companyÊs excess cash, if any, should be utilised.
(d) how the company is going to overcome insufficient cash flow
problems it might be facing.
(e) the companyÊs strategy to expand the market for its products.
External users are people who do not have direct access to the
resources of the company and to not involved in the management of the
company. Examples of external users are investors, loan providers, Inland
Revenue Board, government agencies and the public. The types of decision
made are different according to user groups. For example, investors make
decisions on whether to invest in a company, loan providers make
decisions on whether to approve loans while the Inland Revenue Board
decide on the total tax to be imposed.
2. Financial accounting helps decision makers by preparing the entityÊs

financial reports for external and internal users; but is focused more on
external users. The financial report is released periodically and is subject to
specific standards and formats. The users are able to make decisions on the
performance and status of the company through this report.

266 ANSWERS
Management Accounting provides the financial and non-financial

information required by the management of the company for planning,
evaluating and controlling the operations of the entity. Reports may
be issued at any time according to requirement and are not subject to any
standards and formats. Through this report, the users are able to take the
necessary measures required for improvement in order to ensure that the
company achieves its objectives.
Exercise 1.2
1. The characteristics of accounting information can be divided into two
categories, primary characteristics and secondary characteristics. The
primary characteristics are comprised of relevance and reliability, while the
secondary characteristics are comparability and consistency.
2. Comparability means that the information can be compared; whether

among companies, among industries or across different periods. Let us
assume that you are interested in investing in a company. You were
informed that the net income of the company in year 2000 was RM10
million. Is this information useful?
Actually, it is only useful if you have other information that can be

compared with that figure. For example, the net income in 1999 for the
company was RM3 million. This information enables you to conclude
that the company has gained a huge increase in net income. What if you
were told that the net income of the company in 1999 was RM19 million?
You might not want to proceed with the investment because the company
has experienced a huge decline in net income. You would not be able to
come to this conclusion by only referring to the RM10 million figure.
Exercise 1.3
1. The purpose of accounting is to provide information to stakeholders about
the economic activities and conditions of a business so that they can make
informed decision. These stakeholders may have direct or indirect interest
in the business. The information provided usually takes in the form of
financial statements and can be analysed using different financial tools to
suit their purpose.
2. The main functions of Malaysian Institute of Accountants (MIA)

MIA was established under the Accountants Act 1967 as the main
accounting body in the country. Overall, it functions as the core body in

ANSWERS 267
regulating the accounting profession. Other major functions of MIA as

discussed in the Accountants Act 1967 are:
(i) to set the required qualification in order to become a member;
(ii) to provide training and education for practitioners or those who are
interested in becoming accounting practitioners;
(iii) to control the accounting practices in Malaysia; and
(iv) to protect the accounting interest in Malaysia.
Malaysian Accounting Standards Board (MASB)

MASB was established under the Financial Reporting Act 1997. Among
the main functions of MASB are:
(i) to set and approve new accounting standards;
(ii) to revise or accept the usage of existing standards as
approved accounting standards; and
(iii) to develop the conceptual accounting framework.
3. The purpose of accounting assumptions is to provide a foundation for the

accounting process. Four basic accounting assumptions are separate entity,
going concern, monetary unit and accounting period. Without these
assumptions, accounting cannot provide useful economic information. For
example, if we do not assume a business as a separate economic entity from
its owner, it would be very difficult to assess its performance and position
because the results of its activities are mixed with the owners activities
outside the business.
4. The going concern assumption assumes that a business will continue to be

in operation for the foreseeable future. Without this assumption, all
expenditure made by the business will be recorded as an expense, i.e. the
business will never have any assets. However, the time period that the
business operates in must be broken into specific intervals so that the firm
could monitor its success or failure from time to time. This is why we need
the accounting period assumption, which gives meaning to the changes in
the business performance and financial position.
5. The principle of income recognition provides preparers of financial

statements with the guidelines on when to recognise and record income.
This is important because if revenue is recognised too early, the statements
report revenue sooner than it should, then the business looks more
profitable than it actually is. The reverse is also true. In other words, the

268 ANSWERS
principle is created to avoid the manipulation of income in the financial

statements.
6. Materiality refers to the effect of an item towards the overall operation

of the entity. An item is considered immaterial if it does not affect the
decision that will be made. Materiality is often measured based on size or
nature of a transaction. A transaction that involves a huge amount is
normally treated as material. A material transaction must be disclosed
in detail, while immaterial transactions are sometimes combined or not
disclosed in detail.
7. The financial position of an entity, which is reflected by the balance sheet, is

affected by the economic resources it controls, its financial structure, its
liquidity and solvency, and its capacity to adapt to changes in the
environment in which it operates. Information about the economic
resources controlled by the entity and its capacity in the past to modify
these resources is useful in predicting the ability of the entity to generate
cash and cash equivalents in the future. Information about financial
structure is useful in predicting future borrowing needs and how future
profits and cash flows will be distributed among those with an interest in
the entity; it is also useful in predicting how successful the entity is likely to
be in raising further finance. Information about liquidity and solvency is
useful in predicting the ability of the entity to meet its financial
commitments as they fall due. Liquidity refers to the availability of cash in
the near future after taking account of financial commitments over this
period. Solvency refers to the availability of cash over the longer term to
meet financial commitments as they fall due.
8. The weaknesses in the assumption of monetary unit:
(a) Limiting the scope of accounting. This is because only transactions

that can be measured in monetary unit will be taken into
consideration in accounting, whereas there are many other factors
that will also affect the business. For example, the death of the
companyÊs manager, termination of staff, recognition by specific
bodies on the business achievements and other factors. All these
cannot be recorded in the financial statements as it cannot be stated in
monetary terms.
(b) Assuming the value of money is stable at all times; when we know
that the currency value fluctuates. You have often heard the
grumblings or even experienced the fluctuation in currency value. We
used to be able to buy several items with RM10 but not so presently.
In the early days, school children only took 20 cents to school, now

ANSWERS 269
they bring RM2. All these examples show that the currency value has
changed. In other words, the RM1 you have today will not have the
same value as the RM1 you will receive in a couple of monthsÊ time.
The fluctuation in the currency value should have been taken into
account when recording transactions but was ignored.
9. Three conditions that must be fulfilled before revenue can be recognised

are:
(a) The seller had done the necessary action to obtain the revenue
(for example, had supplied the goods for trade or rendered its
services to customer). The revenue cannot be recognised if the
goods or services are not supplied or rendered to the customer, even
though the customer had paid cash.
(b) The amount of revenue can be measured objectively. If the seller
had handed over the goods or provided the services, but have not
determined the amount that must paid by the customer, then the
revenue cannot be recognised.
(c) For credit transactions, the revenue can be collected. The seller had
handed over the goods or provided the services and had stated the
amount to be paid by the customer. If the seller is confident that
cash is collectable from the customer, then the revenue will be
recognised at the point of sale. However, if the seller is uncertain, then
the revenue will only be recognised when cash is received.
Exercise 1.4
1. B
2. A
3. D
4. C
5. False
6. False
7. True
8. False
9. False

270 ANSWERS
Exercise 1.5
1. (a) Seri Consultation Services Income Statement For the year ended 31
December 2008.
Seri Consultation Services

Income Statement
For the year ended 31 December 2008
RM RM
Service Revenue 78,750
(-) Expenses:
Tax expenses 4,200
Sundry expenses 1,265 (51,515)
Net income 27,235
(b) Statement of Changes in Owner Ês Equity for the year ended

31December 2008.
Seri Consultation Services Statement of

Changes in OwnerÊs Equity For the year
ended 31 December 2008
RM
Capital, Seri Dewi – 1 Jan 22,200
(+) Net income 27,235
49,435
(-) Drawings (6,000)
Capital, Seri Dewi – 31 Dec 43,435

ANSWERS 271
(c) Balance Sheet as at 31 December 2008.
Seri Consultation Services

Balance Sheet
As at 31 December 2008
RM
ASSETS
Cash (23,300 – 6,000) 17,300
Supplies 8,480
TOTAL ASSETS 44,635
LIABILITIES
Accounts Payable 1,200
OWNERÊS EQUITY
Capital, Seri Dewi 43,435
TOTAL LIABILITIES AND O.EQUITY 44,635

272 ANSWERS
2. Statement of cash flow for Samrah Florist for the year ended 30 June 2011:
Samrah Florist
Statement of Cash Flow
For year ended 30 June 2011
Cash flow from operating activities RM RM RM

Cash received from customers 38,000
(-)Staff salaries 6,000
Utilities 1,285 (7,285)
Net cash flow from operating activities 30,715
Cash flow from investing activities

Sales of old equipment 3,500
Purchase of new motor vehicle (33,000)
Net cash flow from investing activities (29,500)
Cash from financing activities

Owner investment 10,000
National Bank(loan) 25,000
35,000
(-)Drawings by owner 500
Interest on loan 1,250 (1,750)
Net cash flow from financing activities 33,250
Net increase in cash flow during the period 34,465
Cash as at 1 July 2010 2,170
Cash as at 30 June 2011 36,635

ANSWERS 273
TOPIC 2: BASIC ACCOUNTING RULES
Exercise 2.1
1. (a) It is not a transaction and must not be recorded. This is because it will
not affect the entityÊs financial position (will not affect the asset,
liability or owner equity) and cannot be measured in currency unit.
(b) It is a transaction and must be recorded. This will affect the entityÊs
financial position (increase asset and owner Ês equity) and can be
measured in currency unit.
(c) It is not a transaction and must not be recorded. This is because it will
not affect the entityÊs financial position (will not affect the asset,
liability or owner equity) and cannot be measured in currency unit.
Only after the staff has served the entity would it be obliged to pay his
salary. Only then there will be outflow of/decrease in asset and
ownerÊs equity.
(d) It is a transaction and must be recorded. This will affect the entityÊs
financial position (decrease asset and owner Ês equity) and can be
measured in currency unit.
Exercise 2.2
1. Account is a specific and separate accounting record for each item in the
financial statement. It records the increases and decreases in specific assets,
liabilities and ownerÊs equity items. All transactions that affect the items
will be recorded in the accounts. Chart of accounts is the list of accounts in
the ledger and their identification numbers.
2. T-Account and three column account. T-account is easier but the three
column account enables us to know the last balance after each transaction.
3. Source documents serve many purposes, including record keeping and

internal control. Source documents, especially from third parties, provide
objective and reliable evidence about transactions and their amounts.
Examples of source documents are sales invoice, bills from suppliers, bank
statements, receipts and cheque butts.
4. The accounting equation stated that Assets = Liabilities + Equity. This

equation is always in balance, both before and after each transaction. This

274 ANSWERS
means that if there is an increase in asset, there must be an increase in either

liability or equity, or both, or a decrease in another asset, by the same
amount.
5. Drawings are made by the owner for personal use while expenses are
incurred by the entity for the purpose of generating income. Drawings are
not considered in the calculation of net profit of loss, but are deducted
directly from owner's equity.
Expenses wil be matched against income. The difference between income

and expenses will be either net profit or net loss. This difference will be
added or deducted from owner's equity.
6. B
7. C
8. C
9. B
10. C
Exercise 2.3
1. (a) 46,000
(b) 100,000
(c) 75,000
2. (b) Asset increased, Asset decreased or has no effect on the Asset

(c) Asset decreased, Owner Ês Equity decreased
(d) Asset decreased, Owner Ês Equity decreased
(e) Asset increased, Asset decreased or has no effect on the Asset
(f) Asset increased, Owner Ês Equity increased

ANSWERS 275
3.
ASSET = LIABILITY + O.EQUITY

Trans + Capital,
action Cash + AR + Supplies = AP Ashwin
a. +20,000 +20,000
Investment by
Ashwin
Balance 20,000 = 20,000
b. +800 +800
Balance 20,000 800 = 800 20,000
c. Balance -620 -620
19,380 800 = 180 20,000
d. +4,200 +4,200
Service revenue
Balance 23,580 800 180 24,200
e. -1,000 -1,000
Salary expenses
Balance 22,580 800 = 180 23,200
f. -700 -700
Transportation
expenses
-150 -150
Sundry expense
Balance 21,730 800 = 180 22,350
g. -1,200 -1,200
Rental expenses
Balance 20,530 800 = 180 21,150
h. +2,500 +2,500
Service revenue
Balance 20,530 2,500 800 = 180 23,650
i. Balance -550 -550
Supplies
20,530 2,500 250 = 180 expenses
23,100
j. -750 -750
Drawings,
Ashwin
Balance 19,780 2,500 250 180 22,350
276 ANSWERS
4. (a) Purchase inventory(or any assets) on credit.

(b) Owner invests cash in the business.
(c) Repayment of loan with cash.
(d) Cash drawings by owner from business.
(e) Expense(e.g. salary, tax etc.) incurred but not yet paid.
(f) Cash received from debtors
TOPIC 3: RECORDING PROCESS
Exercise 3.1
1. Journal is the first book of entry for a transaction before the data is
transferred to the accounts. It discloses the complete effects of every
transaction and provides a chronological record of all transactions. A
ledger is an entire group of accounts maintained by an entity. It provides all
the information about changes in specific account balances.
2. The primary purpose of a trial balance is to prove the equality of debits and
credits after posting. A trial balance may also help to uncover errors in
journalising and posting and is useful in preparing financial statements.
3. (a) Asset
(b) Expense
(c) Asset
(d) Income
(e) Liability
(f) Asset
(g) Expense
(h) Asset

ANSWERS 277
Exercise 3.2
Samurai Laundry Service
Trial Balance as at 30 April 2011
ACCOUNTS RM RM
Account Payables 10,263
Account Receivables 11,654
Capital 46,381
Cash 31,519
Drawings 570
Equipment 48,350
Loan 32,500
Repair expenses 971
Salaries expenses 4,832
101,454 101,454

278 ANSWERS
Exercise 3.3
1. (a) Journal entries for all the transactions.
Apr 2011
a. Cash 5,000
Capital, Cindy 5,000
(Cash investment by Cindy)
b. Supplies 275
Accounts payable 275
(Purchase of supplies on credit)
c. Cash 3,250
(Cash received for services
provided)
d. Rental expenses 750
Cash 750
(Payment of rental by cash)
e. Accounts payable 125
Cash 125
f. Accounts receivable 1,875
Service revenue 1875
(Customer has not paid for
services provided)
g. Utility expenses 390
Sundry expenses 187
Cash 577
(Payment for expenses by cash)
h. Salary expenses 1,250
Cash 1,250
(Payment for salary by cash)
i. Supplies expenses 162
Supplies 162
(Usage of supplies)
j. Drawings 550
Cash 500
Supplies 50
(Cash and supplies drawings
by owner)

ANSWERS 279
1. (b) Post to ledger
Cash Account
(RM) (RM) (RM)
Apr 2011 Capital, Cindy 5,000 5,000
Service revenue 3,250 8,250
Rental expenses 750 7,500
Accounts payable 125 7,375
Utility expenses 390 6,985
Sundry expenses 187 6,798
Salary expenses 1,250 5,548
Drawings, Cindy 500 5,048
Account Receivable
(RM) (RM) (RM)
Apr 2011 Service revenue 1,875 1,875
Supplies Account
(RM) (RM) (RM)
Apr 2008 Account payable 275 275
Supplies expenses 162 113
Drawings, Cindy 50 63
Accounts Payable
(RM) (RM) (RM)
Apr 2008 Supplies 275 275
Cash 125 150
Capital Account, Cindy

(RM) (RM) (RM)
Apr 2011 Cash 5,000 5,000
Drawings Account, Cindy

(RM) (RM) (RM)
Apr 2008 Cash 500 500
Supplies 50 550

280 ANSWERS
Service Revenue Account

(RM) (RM) (RM)
Apr 2011 Cash 3,250 3,250
Rental Expenses Account

(RM) (RM) (RM)
Apr 2011 Cash 750 750
Utility Expenses Account

(RM) (RM) (RM)
Apr 2011 Cash 390 390
Sundry Expenses Account

(RM) (RM) (RM)
Apr 2011 Cash 187 187
Salary Expenses Account

(RM) (RM) (RM)
Apr 2011 Cash 1,250 1,250
Supplies Expenses Account

(RM) (RM) (RM)
Apr 2011 Cash 162 162

ANSWERS 281
1. (c) Trial Balance
Cindy Insurance Agency

Trial Balance
as at 30 April 2011

Cash 5,048
Supplies 63
Accounts payable 150
Capital, Cindy 5,000
Drawings, Cindy 550
Salary expenses 750
Rental expenses 390
Sundry expenses 162
TOTAL 10,275 10,275
2. (a) General Journal

Date Account and Description Reference Debit Credit
(RM) (RM)
Feb 1 Supplies L104 274
Cash L101 274
(Purchased supplies by cash)
2 Drawings, Edlin L302 2,000
Cash L101 2,000
5 Cash L101 2,740
(Received cash from customer for
payment of accounts receivable)
9 Office equipment L108 3,850
(Purchased office equipment
on credit)
15 Accounts payable L201 1,200
Cash L101 1,200

282 ANSWERS
18 Cash L101 580

Service revenue L401 580
(Received for services
provided)
25 Advertisement expenses L502 420
Cash L101 420
(Payment for advertisement)
28 Utility expenses L503 215
Cash L101 215
(Payment for businessÊs telephone and electricity bill)
28 Drawings, Edlin L302 117
Cash L101 117
(Payment for telephone and
electricity bill of owner Ês
house by cash from the
business)
28 Rental expenses L501 1,200
Cash L101 1,200
(Payment for rental of business
premises)
28 Sundry expenses L509 220
Cash L101 220
(Repair of office equipment by
cash)
2. (b) Post of entries to ledger
Cash Account No: 101

(RM) (RM) (RM)
Feb Cash 15,238
1 Supplies J1 274 14,964

2 Drawings, Edlin J1 2,000 12,964
5 Accounts receivable J1 2,740 15,704
18 Service revenue J1 580 15,084
25 Advertisement expenses J1 420 14,664
28 Utility expenses J1 215 14,449
28 Drawings, Edlin J1 117 14,332
28 Rental expenses J1 1,200 13,132
28 Sundry expenses J1 220 12,912

ANSWERS 283

(RM) (RM) (RM)
Feb 1 Balance 4,575
5 Cash J1 2,740 1,835

(RM) (RM) (RM)
Feb 1 Balance 427
1 Cash J1 274 701

(RM) (RM) (RM)
Feb 1 Balance 8,400
9 Account payable J1 3,850 12,250

(RM) (RM) (RM)
Feb 1 1,730
9 Office equipment J1 3,850 5,580
15 Cash J1 1,200 4,380
Capital Account, Edlin No: 301

(RM) (RM) (RM)
Feb 1 Balance 26,910
Drawings Account, Edlin No: 302

(RM) (RM) (RM)
Feb 2 Cash J1 2,000 2,000
28 Cash J1 117 2,117
Service Revenue Account No: 401

(RM) (RM) (RM)
Feb 18 Cash J1 580 580

284 ANSWERS
Rental Expenses Account No: 501

(RM) (RM) (RM)
Feb 28 Cash J1 1,200 1,200
Advertisement Expenses Account No: 502

(RM) (RM) (RM)
Feb 25 Cash J1 420 420
Utility Expenses Account No: 503

(RM) (RM) (RM)
Feb 28 Cash J1 215 215

(RM) (RM) (RM)
Feb 28 Cash J1 220 220
2. (c) Trial Balance
Edlin Enterprise Trial Balance

as at 28 February 2011
Account Accounts Debit Credit

Number (RM) (RM)
101 Cash 12,912
104 Utilities 701
301 Capital, Edlin 26,910
302 Drawings, Edlin 2,117
401 Service revenue 580
502 Advertisement expenses 420
503 Utility expenses 215
TOTAL 31,870 31,870

ANSWERS 285
TOPIC 4: ADJUSTING ENTRIES
Exercise 4.1
(a) Accrued Revenue
Accrued revenue refers to the revenue that has been obtained but there is
no incoming cash flow into the business entity. This happens when the
goods or services have been supplied to the customer but the customer has
not paid for it yet. Accrued revenue is an asset as the benefit in the form of
cash will be obtained by the business entity in the future. Examples of
accrued revenue are rental revenue receivable, service revenue receivable
and interest receivable.
(b) Accrued Expenses

Accrued expenses refer to all the expenditure that has incurred but has not
been paid or recorded because there is no outgoing cash flow. Accrued
expense is a liability as an obligation exists that must be settled by the
business. At the end of the accounting period, the business entity must
record/recognise all the expenditure even though no cash flow has
occurred. Examples of accrued expenses are salary payable, rental payable,
interest payable and tax payable.
(c) Prepaid Expenses

Prepaid expenses refer to all expenses that have been paid in advance by
cash but the benefit from the expenses has not been received or obtained. It
is an asset to the business and will be written off after it has been used or
when it has expired. Therefore, at the end of the accounting period,
adjusting entries must be made to recognise the asset that had been written
off as expense.
(d) Unearned Revenue

Unearned revenue refers to the cash received in advance but the goods or
services have not been supplied. This is an obligation or liability to the
business entity. Cash received cannot be recognised as an revenue for that
period because the goods or services will only be provided in the future.
Exercise 4.2
Adjusted Entries as at 31 December 2010
1. Supplies Expenses RM250

Supplies RM250

286 ANSWERS
2. Depreciation Expenses RM400

Accumulated Depreciation RM400
3. Interest Expenses RM300

Interest payable RM300
4. Insurance Expenses RM1,500

Insurance Prepayment RM1,500
5. Accrued Revenue/Revenue Receivable RM750

Service Revenue RM750
6. Cash RM5,000
Unearned revenue RM5,000
Exercise 4.3
1. Dapur Rona's Adjusting Entries as at June 30, 2011
(a) Raw materials expense/used RM20,850

Raw materials supplies RM20,850
(b) Rent expense RM144,000

Prepaid rent RM144,000
(c) Accrued revenue RM21,900

Service revenue RM21,900
(d) Depreciation expense RM16,500

Accumulated depreciation RM16,500
(e) Wages expense RM6,900

Accrued wages RM6,900
(f) Unearned revenue RM22,500

Service revenue RM22,500
(g) Interest receivable RM240

Interest revenue RM240

ANSWERS 287
2. Dapur Rona Adjusted Trial Balance as at June 30, 2011

Cash 36,000
Raw materials supplies 7,650
Prepaid rent 18,000
Furniture and fittings 255,000
furniture and fittings
Capital 153,000
Wages expense 183,300
Utility expense 18,000
Raw materials expense 20,850
Rent expense 144,000
Accrued revenue 21,900
Accrued wages 6,900
Depreciationexpense 16,500
Interest receivable 240
Interest revenue 240
TOTAL 788,940 788,940
Exercise 4.4
1. (a) Appropriate Adjusting Journal Entries.
(i) Revenue Receivable/Accrued Revenue RM5,325

Revenue earned RM5,325
(ii) Supplies expenses RM12,600

Supplies RM12,600
(iii) Depreciation expense RM12,300

(iv) Unearned revenue RM9,000

Revenue earned RM9,000

288 ANSWERS
(v) Utilities expenses RM1,800

Accrued utilities expenses RM1,800
1. (b) Adjusted Trial Balance as at 31 December 2010 for Asoka Travel and
Tours.
Adjusted Trial balance as at 31 December 2010
Debit Credit
Cash 10,350
Account receivables 67,500
Revenue receivable 5,325
Supplies 3,600
Motor vehicles 341,100
Accumulated depreciation 12,300
Accrued utilities expenses 1,800
Capital 234,000
Drawings 13,500
Revenue earned 421,575
Depreciation expense 12,300
Salary expense 94,500
Petrol expense 8,100
Rent expense 24,000
Insurance 48,000
Utilities expenses 53,550
694,425 694,425
Exercise 4.5
The adjusting entries that were made and prepare for Bamba Management
Consultant journal entries.
(1) Fees earned but not yet received, RM1,200

Account receivable RM1,200
Fee revenue RM1,200
(2) Supplies consumed during the period, RM3,200

Supplies expense RM3,200
Supplies RM3,200

ANSWERS 289
(3) Part prepaid insurance expired, RM3,000

Insurance expense RM3,000
Prepaid Insurance RM3,000
(4) Depreciation for equipment for the year, RM2,600

Depreciation expense RM2,600
(5) Unpaid salary amounted to RM2,200.

Salary expense RM2,200
Salary payable RM2,200
(6) Amount of unearned fees have been served, RM1,800

Unearned fees RM1,800
Fee revenue RM1,800
TOPIC 5: COMPLETING THE ACCOUNTING CYCLE
Exercise 5.1
1. Income statement for the period ended 30 June 2010 for KhairunnisaÊ
Consulting Services.

Income Statement
For the Period Ended 30 June 2010
RM RM
Fees Revenue 119,280
Less Expenditure:
Total expenditure (88,925)
Net revenue 30,355

290 ANSWERS
2. Balance sheet for KhairunnisaÊ Consulting Services as at 30 June 2010.

Balance Sheet
as at 30 June 2010
RM RM
Current Assets Current Liabilities
Cash 56,350 Accounts Payable 17,600
Accounts Receivable 41,600 Salary Payable 7,100
Office supplies 12,300 Unearned fees 10,980
Rental prepayment 4,400 35,680
129,750 Non-current Liabilities
Notes Payable 100,000
Total liabilities 135,680
Non-current Assets
Office equipment 99,000 OwnerÊs Equity
Less: Accumulated 10,725 Opening capital, 51,990
Depreciation 0000000 KhairunnisaÊ
Net book value 88,275 Net revenue 30,355
Closing capital,
KhairunnisaÊ 82,345
Total Assets 218,025 Total Liabilities & Equity 218,025
The balance sheet is presented according to the account format. You can also
use the report format as suggested by MASB1. If the report format is used,
the net assets reported are RM94,070. Therefore, the total assets will be
RM182,345. Total non-current liabilities and equity are the same at
RM182,345.
Exercise 5.2
1. (a) Adjusting Entries RM RM
Supplies expenses 890
Supplies 890
Accumulated depreciation 4,950
Salary Expenses 440
Salary payable 440

ANSWERS 291
Accounts Receivable 1,000

Unearned revenue 500
Service revenue 500
(b) Financial Statement
1. (b) (i) Income Statement for Berkat Enterprise For the Period Ended
30 June 2011
Berkat Enterprise
Income Statement
For the Period Ended 30 June 2011
RM RM
Depreciation expenses 4,950 (37,430)
Net profit (23,195)

292 ANSWERS
1. (b) (ii) Balance Sheet for Berkat Enterprise For the Period Ended
30 June 2011
Berkat Enterprise
Balance Sheet
30 June 2011
RM RM RM
Non-current Asset:
Accumulated Depreciation (14, 650) 37,000
Curent assets:
Cash 3,425
Account receivable 8,000
Supplies 380
Insurance prepayment 305 12,110
Current liablities:
Salary payable 1,365
Unearned revenue 750 2,115
Total current assets 9,995

46,995
Financed by:
Owner Ês Equity 29,000
Capital 23,195
Add: Net profit (5,200)
Less: Drawings 46,995

ANSWERS 293
1. (c) Closing entries for Berkat Enterprise For the Period Ended 30 June
2011
Closing entries RM RM
Service Revenue 60,625
Revenue Summary 60,625


Capital 23,195
Capital 5,200
Drawings 5,200
2. Mekar Serumpun Company reversing entries and transfer of the entries to

the corresponding ledgers for the final week of year 2010.
Adjusting entries RM RM
Salary expenses 100
Accrued/Payable Salary 100
Closing entry
Revenue summary 100
Salary expenses 100
Reversing entry
Accrued salary 100
Salary expenses 100
Entry for salary payment

Salary expenses 120
Cash 120

294 ANSWERS
Salary expenses
RM RM
31/12/10 Adjusting 100 31/12/10 Closing 100
100 100
01/01/11 Payment 120 01/01/11 Reversing 100
Accrued Salary
RM RM
31/12/10 Balance 100 31/12/10 Adjusting 100
100 100
01/01/11 Reversing 100 01/01/11 Balance 100
Revenue Summary
31/12/10 Closing RM100
Cash
01/01/01 Payment RM120
3. (a) (i)
Moiz Real Estate
Income Statement
RM RM
Revenue:
Less Expenditure:
Total expenditure 61,670
Net revenue 56,580

ANSWERS 295
3. (a) (ii)
Moiz Real Estate
Statement of Changes in Equity
RM
Capital, Moiz, 1 January 2004 58,000
Add: Net revenue 56,580
114,580
Less: Drawings (10,400)
Capital, Moiz, 31 December 2004 104,180
3. (a) (iii)
Moiz Real Estate
Balance Sheet
RM RM RM
Current Assets Current Liabilities
Cash 6,850 Accounts Payable 1,850
Accounts Receivable 14,000 Unearned revenue 2,500
Supplies 2,540 Total current liabilities 4,350
Total current assets 24,630 Owner Ês Equity
Capital, Moiz 104,180
Non-current Assets
Equipment 103,300
Acc Dep (19,400)
Net book value 83,900
Total Assets 108,530 Total Liabilities &
108,530
Equity
The above Balance Sheet was reported using the account format. If the
statement format is used, the total net assets would be RM20,280 and the
total assets would be RM104,180. The total equity would also be RM104,180.

296 ANSWERS
3. (b) Moiz Real Estate Closing Entries.
Closing Entries
RM RM


Capital 56,580
Capital 10,400
Drawings 10,400
TOPIC 6: FINANCIAL REPORTING
Exercise 6.1
1. Regulations that are linked with financial reporting
(i) The Companies Act 1965
(ii) The Securities Commission 1995
(iii) The Financial Reporting Act 1997
(iv) The Income Tax Act 1967
2. Organisations that are linked with financial reporting

(i) Bursa Malaysia Berhad
(ii) Central Bank of Malaysia
Exercise 6.2
1. The purpose of preparing a financial report is to provide information about
the financial position, performance and changes in the financial position of
a company that is useful in making economic decisions such investments
and lending decisions.

ANSWERS 297
2. Non-financial information is additional information comprising chairmanÊs

report, notice of annual general meeting, corporate information and
structure and others. All the information is related to the organisation itself,
while financial information comprises financial statements related to the
organisationÊs financial status. Financial information is the main and most
important information in a financial report. It includes information on
operating income, assets and liabilities, ownersÊ equity, growth rates and
key ratios such as earnings per share and dividend per share.
3. Notes to the accounts are prepared for the users of accounting information
to clarify the total of the accounts as reported in the financial statement.
4. (a) True
(b) False
(c) False
(d) True
(e) False
(f) False
(g) True
(h) False
(i) False
(j) False
TOPIC 7: TRADING BUSINESS ENVIRONMENT
Exercise 7.1
1. (a) False
(b) False
(c) True
(d) False
2. (a) Gross profit = Sales revenue – Cost of goods sold

= RM 110,000 – RM 70,000
= RM 40,000.

298 ANSWERS
(b) Net operating revenue = Gross profit – operating expenses

= RM40,000 – RM20,000
= RM20,000.
Exercise 7.2
1. 2/10, n/30
2% discount will be given if payment is made within 10 days from the
invoice date and the last payment period (without discount) is within 30
days.
2. Sales Discount
Price reduction will be given on credit sales if customer pays within
discount period.
3. Purchase Discount
Price reduction will be given by seller to buyer if buyer pays within
discount period.
Exercise 7.3
1. C
2. Purchase Allowance
Exists when buyer does not return the goods that do not meet specification
and seller agreed to reduce the purchase price.]
Purchase Return
Exists when buyer return the goods that do not meet specification.
3. Sales Allowance
Exists when buyer chooses to keep the damaged goods.
Sales Return
Exists when buyer returns the damaged goods.

ANSWERS 299
Exercise 7.4
The differences between FOB shipping point with FOB destination are as below:
FOB means Free On Board

FOB shipping point defined that the ownership of the goods will be transferred
from the seller to the buyer when the goods are sent by the seller to the transport
company (lorry, ship and others). The goods will belong to the buyer and can be
recorded as the buyerÊs inventory at the time of purchase. The transportation cost
would be borne by the buyer. The transportation cost paid by the buyer will be
recorded as carriage inwards. Carriage inwards account would normally have a
debit balance and will be added to the purchase cost to obtain the cost of goods
sold in the income statement.
FOB destination defined that the ownership of the goods will be transferred from
the seller to the buyer when the goods reached the buyerÊs destination, which is
the buyerÊs warehouse. The goods purchased will be owned by the buyer or can
be recorded as the buyerÊs inventory only when the buyer has received the
goods. The buyer cannot record the goods in its inventory during purchase but
only upon receiving the goods. The seller will bear the transportation cost and
record it as carriage outwards after it had been paid. Carriage outwards will be
included in the income statement as a part of the operating expenditure.
TOPIC 8: ACCOUNTING FOR INVENTORY
Exercise 8.1
1. Credit terms of 2/10, n/30 means that the company will receive 2% cash
discount if payment is made within 10 days from the date of invoice.
However, the last payment period is 30 days from date of invoice with the
amount to be paid as stated in the invoice.
Journal entry for the payment is as below:
RM RM
July 24 Dr Accounts receivable 1,900
(RM2,000 – RM100)
Cr Inventory (RM1,900 2%) 38
Cr Cash (RM1,900 – RM38) 1,862

300 ANSWERS
2. One credit sales was on 10 July totalling RM800 with credit terms 2/10,
n/30. On 12 July, RM100 worth of goods had been returned. Prepare
journal entries on 19 July to record the cash received by customer.
The journal entry for cash receipt is as below:
RM RM
July 19 Dr Cash (RM700 – RM14) 686
Dr Sales discount (RM700 2%) 14
Cr Accounts receivable
(RM800 – RM100) 700
Exercise 8.2
(a) Journal
Date Description Debit Credit

May 1 Inventory 6,000
Accounts payable (Depot 6,000
Wholesaler)
May 2 Accounts receivable (Rahmat) 4,500
Sales 4,500
Inventory 3,000
May 5 Accounts payable (Depot Wholesaler) 200
Inventory 200
May 9 Cash (RM4,500-RM90) 4,410
Sales discount (4,500 x 2%) 90
Accounts receivable (Rahmat) 4,500
May 10 Accounts payable (6,000 – 200) 5,800
Inventory (5,800 x 2%) 116
Cash 5,684
May 11 Supplies 900
Cash 900
Cash 2,400
May 15 Cash 230
Inventory 230
Accounts payable (Harrods) 1,900

ANSWERS 301
May 19 Inventory 250

Cash 250
May 24 Cash 6,200
Sales 6,200
Inventory 4,340
May 27 Accounts payable (Harrods) 1,900
Inventory (1,900 x 2%) 38
Cash 1,862
Accounts payable (Horizon) 1,000
May 29 Sales return and allowance 100
Cash 100
Inventory 70
May 31 Accounts receivable (Rahmat) 1,600
Sales 1,600
inventory 1,120
(b) Ledger
Cash
Date Description Debit Credit Balance
May 1 Balance 5,000
9 Accounts receivable 4,410 9,410
10 Accounts payable 5,684 3,726
11 Supplies 900 2,826
12 Inventory 2,400 426
15 Inventory 230 656
19 Inventory 250 406
24 Sales 6,200 6,606
29 Sales return and allowances 100 4,644

302 ANSWERS
Accounts receivable
May 2 Sales 4,500 4,500
9 Cash 4,410 90
9 Sales discount 90 0
31 Sales 1,600 1,600
Inventory
May 1 Accounts payable 6,000 6,000
2 Cost of goods sold 3,000 3,000
5 Accounts payable 200 2,800
12 Cash 2,400 5,084
15 Cash 230 4,854
19 Cash 250 7,004
28 Account payable 1,000 3,626
29 Cost of goods sold 70 3,696
Supplies
Cash 900 900
Accounts payable
May 1 Inventory 6,000 6,000
5 Inventory 200 5,800
10 Cash 5,684 0
17 Inventory 1,900 1,900
27 Cash 1,862 0
28 Inventory 1,000 1,000

ANSWERS 303
Capital – Abu Bakar

May 1 Balance 5,000
Sales
May 2 Accounts receivable 4,500 4,500
24 Cash 6,200 10,700
31 Accounts receivable 1,600 12,300
Sales Return and Allowance

May 29 Cash 100 100
Sales Discount
May 9 Accounts receivable 90 90
Cost of Goods Sold

May 2 Inventory 3,000 3,000
24 Inventory 4,340 7,340
31 Inventory 1,120 8,390
(c) Cempaka Sdn Bhd

Income Statement Extract
For the Month Ended 31 May 2011
RM RM
Sales revenue:
Sales 12,300
Less: Sales return and allowances 100
Sales discount 90 (190)
Net sales 12,110
Cost of goods sold (8,390)
Gross profit 3,720

304 ANSWERS
Exercise 8.4
(a) Adjusting Entries
Entries Debit Credit
1. Depreciation expenses – building 10,000
Accumulated depreciation – building 10,000
2. Depreciation expenses – equipment 9,000
Accumulated depreciation – equipment 9,000
3. Interest expenses 7,000
Interest payable 7,000
(b) Melati Sdn Bhd

Income Statement
For the Year Ended 31 December 2011
RM RM RM
Sales revenue:
Sales 902,100
Less: Sales Discount (4,600)
Net Sales 897,500
Cost of goods sold (709,900)
Gross profit 187,600
Less: Operating expenses
Sales expenses:
Salary expenses (69,800 80%) 55,840
Maintenance expenses 7,200 63,040
Administrative expenses
Salary expenses (69,800 20%) 13,960
Depreciation expenses – building 10,000
Depreciation expenses – equipment 9,000
Insurance expenses 3,500 61,760
Total operating cost (124,800)
Operating revenue 62,800
Other expenses – interest expenses (7,000)
Net revenue 55,800

ANSWERS 305
Melati Sdn Bhd

Balance Sheet
RM RM RM RM
Fixed asset:
Land 92,000
Building 197,000
Less: Accumulated depreciation (64,000) 133,000
Equipment 83,500
Less: Accumulated depreciation (51,400) 32,100 257,100
Current Assets:
Cash 23,400
Inventory 90,000 151,000
Current Liabilities:
Notes payable (mature in year 2001) 15,000
Interest payable 7,000 59,500
Net current asset/Working capital 91,500

348,600
Financed by:
Capital (267,800+55,800-10,000) 313,600
Long-term liability 35,000
348,600
(c) Recording Closing Entries

Dec 31 Sales 902,100
Dec 31 Revenue summary 846,300

306 ANSWERS
Maintenance expenses 7,200

Depreciation expenses – building 10,000
Depreciation expenses – equipment 9,000
Interest expenses 7,000
Dec 31 Revenue summary 55,800
Capital – Abu Bakar 55,800
Dec 31 Capital – Abu Bakar 10,000
Drawings 10,000
Exercise 8.5
1.
Mar 2 Accounts receivable 800,000
Sales 800,000
Inventory 600,000
Mar 6 Sales return and allowance 120,000
Inventory 90,000
Mar 12 Cash (680,000 – 13,600) 666,400
Sales discount (680,000 2%) 13,600
2.
Description Debit Credit
Sales 180,000
Goods inventory 40,000

ANSWERS 307
3. (i)
April 5 Inventory 16,000
April 6 Inventory 900
Cash 900
April 7 Equipment 26,000
April 8 Accounts payable 3,000
Inventory 3,000
April 15 Accounts payable (16,000-3,000) 13,000
Inventory [(16,000-3,000) 2%] 260
Cash (13,000-260) 12,740
(ii)
May 4 Accounts payable 13,000
Cash 13,000
4.
Sept 6 Inventory (80 RM19) 1,520
Cash 1,520
Sept 9 Inventory 80
Cash 80
Sept 12 Accounts receivable (26 RM30) 780
Sale 780
Cost of goods sold (26 RM20) 520
Inventory 520
Sept 14 Sales return and allowance 30
Accounts receivable 30
Inventory 20
Sep 20 Accounts receivable (30 RM30) 900
Sales 900
Cost of goods sold (30 RM20) 600
Inventory 600

308 ANSWERS
5. (a)
Dec 3 Accounts receivable 480,000
Sales 480,000
Inventory 320,000
Dec 8 Sales return and allowance 20,000
Dec 13 Cash (460,000 – 9,200) 450,800
Sales discount [(480,000 – 20,000) 2%] 9,200
(480,000 – 20,000)
(b)
Jan 2 Sales 460,000
(RM480,000 – RM20,000)
TOPIC 9: CASH MANAGEMENT AND CONTROL
Exercise 9.1
• Efficient collection policy of accounts receivable
A business should have a reasonable average collection time for receivables
to ensure cash is not tied up. This is important not only to ensure sufficient
cash available but also to avoid the potential of having bad debt.
• Delayed payment of accounts payable

In this instance, a business should make use the credit terms given by the
suppliers. If the credit term is for 20 days, a business should settle their debt
closer to that due date. This enables the business to use the funds for other
purposes before settling the debt. In so doing, the business should not
undermine the risk of late payment because it may affect its credit ratings in
future.
• Keeping a minimum level of inventory

Similar to receivables, inventories also tie up cash. In addition, holding
inventories may require storage, insurance and manpower, which
consequently increase costs. Thus, a business should minimize its inventory
level, yet adequate to meet the demands of customers.

ANSWERS 309
• Investment of cash surplus

If a business has any surplus of funds, the fund should be invested wisely
such as in any short term investments available. This is important to generate
more income to businesses.
• Proper planning of capital expenditure

Capital expenditure normally requires a large amount of cash, thus requiring
proper planning. In this instance, it is essential to balance up between internal
and external financing to minimize the related costs of funding, such as
interest.
Exercise 9.2
To safeguard and ensure accuracy of recording cash transactions, as well as
minimising the potential for making errors.
Exercise 9.3
Petty cash RM350

Cash RM350
To establish the fund
Postage expenses RM60

Supplies purchased RM28
Refreshment RM37
Cash RM125
To reimburse petty cash

310 ANSWERS
Exercise 9.4
Springfield Enterprise
Bank Reconciliation
31 June 2011
Item RM Item RM
Bank statement balance 1,455.00 Book balance 1,220.00
Add: Add:
Deposit in transit 80.00 Dividend earned 60.00
Interest 95.00
1,535.00 1,375.00
Deduct: Deduct:
Unpresented cheque 175.00 Cheque book 15.00
Adjusted bank balance 1,360.00 Adjusted book balance 1,360.00

Balances are equal
TOPIC 10: FINANCIAL STATEMENT ANALYSIS
Exercise 10.1
The bases of comparison for intra-company, inter-company and industry average
can be compared by looking at the financial information aspect.
(a) Within the company

It compares the items in the financial statement for two different years (or
more) for the same company. The comparison of current yearÊs financial
statement with previous years will show the trend of the company which
can be used for future predictions. For example, the comparison of cash
item for Selatan Sdn. Bhd. of the current year with previous years will show
the increase or decrease.
(b) Between companies

It compares the items in the financial statement of one company with one or
more companies operating the same type of business. The comparison
made is based on the financial statement published by the company. Inter-

ANSWERS 311
company comparison provides useful information on the companyÊs status

as compared to its competitors.
(c) Industry Average

This basis compares items in the financial statement of the company with
other companies in the related industry in general. Comparison made
between the company and industry average can provide information on the
companyÊs performance as compared to the industry.
Exercise 10.2
1. The difference between horizontal analysis with vertical analysis is that
horizontal analysis is used especially for comparison within the company
while vertical analysis can also be used for within the company or between
companies comparison. Ratio analysis is used in all three bases of
comparison, which are within the company, between companies and
industry average.
Horizontal analysis is a technique to evaluate the trend of items in the

financial statement (increase or decrease) in terms of amount or percentage
of change. The basis of comparison for these two years (the current year
and the previous year) will be set by using the financial statement of the
previous year as the base to determine an increase or decrease.
Vertical Analysis is a technique to evaluate the items in the financial

statement by stating each of the items in the form of percentage as
compared with the base amount. It shows the relationship of each item in
the financial statement with another item that is used as the base. In balance
sheet, the amount normally used as the base for calculation is Total Asset
for asset items, while Total Liability and OwnerÊs Equity will be used as the
base for liability and equity items. For Income Statement, the Net Sales will
be used as the base amount for each of the items in the income statement.

312 ANSWERS
2. Horizontal Analysis
Change in
Percentage
31 Dec 2010 31 Dec 2011 Amount Calculation
(%)
(RM)
Accounts 500,000 400,000 100,000 100k/500k 20%
receivable
Inventory 840,000 600,000 240,000 240k/840k 28.57%
Total 3,220,000 2,800,000 420,000 420k/3,220k 13.04%
current
assets

Vertical Analysis

31 Dec 2010 31 Dec 2011
Accounts 500,000 15.52% 400,000 14.28%
receivable
Inventory 840,000 26.08% 600,000 21.42%
Total asset 3,220,000 100% 2,800,000 100%
Exercise 10.3
1. The meaning of current ratio and quick ratio, including their formula, are
shown below:
Explanation Formula
Current ratio To measure the adequacy Current asset
of current asset to pay Current liability
current liability
Quick ratio To measure the businessÊs Quick asset*

capability to pay short-term Current liability
debt immediately.
*Quick asset comprise cash,
marketable securities and
accounts receivable.
2. (a) Working Capital = Current Asset – Current liability

= RM42,918,000 – RM45,844,000
= (RM2,926,000)

ANSWERS 313
Current asset
(b) Current ratio =
Current liability
42, 918, 000
=
45, 844, 000
= 0.94 : 1
Cash + Marketable security + AR

(c) Quick ratio =
Current Liability
8,241,000 + 1,947,000 + 12,545,000
=
45,844,000
= 0.50: 1
Exercise 10.4
Cost of goods sold
Inventory turnover =
Average inventory
Cost of Goods Sold Cost of Goods Sold

(2011) (2010)
Opening inventory 980,000 860,000
Add: Purchases 4,440,000 4,661,000
Cost of goods ready for sale 5,420,000 5,521,000
Less: Closing inventory 1,020,000 980,000
Cost of goods sold 4,400,000 4,541,000
(a) Inventory turnover Cost of goods sold

=
2011 Average inventory
4,400,000
980,000 + 1,020,000
2
4.4 times
(b) Inventory turnover Cost of goods sold

=
2010 Average inventory
4,541,000
860,000 + 980,000
2
4.9 times

314 ANSWERS
Exercise 10.5
Current Asset
(a) Current ratio =
Current Liability
20,000 + 65,000 + 60,000

=
50,000
= 2.9 : 1
Quick asset
(b) Quick ratio =
Current Liability
65,000 + 20,000
=
50,000
= 1.7 : 1
Credit sales (net)

(c) AR turnover =
Average AR (net)
400,000
=
62,500*
= 6.4 times
* [AR last year + AR current year]

2
60,000 + 65,000
2
62,500
Cost of goods sold

(d) Inventory turnover =
Average inventory
198,000
=
55,000 **
= 3.6 times
**[Inventory last year + Inventory current year]

2
50,000 + 60,000
2
55,000

ANSWERS 315
(e) Return on sales Net profit

(Profit margin) Sales (net)
44,000
420,000 - 20,000
11%
Exercise 10.6
1. Desa Sdn. Bhd.
Balance Sheet
2010 Increase (Decrease)
2011
(RM) Amount Percentage
(RM)
Basis Year (RM) (%)
Assets:
Current asset 125,000 100,000 25,000 25.0
Equipment (net) 400,000 330,000 70,000 21.2
Total Assets 525,000 430,000 95,000 22.1
Liabilities:
Current liability 91,000 70,000 21,000 30.0
Long-term liability 144,000 95,000 49,000 51.6
Total Liabilities 235,000 165,000 70,000 42.4
OwnerÊs Equity:
Ordinary shares @ RM1 155,000 115,000 40,000 34.8
Retained earnings 135,000 150,000 (15,000) (10.0)
Total ownerÊs equity 290,000 265,000 25,000 9.4
Total liabilities and ownerÊs equity 525,000 430,000 95,000 22.1
Net profit
2. (a) Profit margin =
Sales (net)
64,000
=
800,000
= 8%

316 ANSWERS
Net sales
(b) Asset turnover =
Average total asset*
800,000
=
550,000
= 1.5 times
* [Total asset last year + Total asset current year]

2
500,000 + 600,000
=
2
= 550,000
Net profit
(c) Return on asset =
64,000
=
550,000
= 11.6%

2
500,000 + 600,000
2
550,000
Net profit after tax

(d) Return on ownerÊs equity =
Average owner's equity's ordinary shares*
64,000
=
380,000
= 16.8%

ANSWERS 317
3. Ratio analysis for year 2010:
Formula 2010
(a) Profit margin Net profit 35,000
Sales (net) 650,000
5.4%
(b) Asset turnover Net sales 650,000
Average total asset* 561,500*
1.2 times
* [Total asset last year +
Total asset current year] *(533k+590k)/2
2 *561,500
Formula 2010
(c) Earnings per Net profit - Dividend 35,000
share for Preference Shares 30,000* unit
Average ordinary shares RM1.17
issued (unit)
*(300,000+300,000)/2
RM10
* 30,000
(d) Price earnings Market value of ordinary RM5.00

ratio shares per unit RM1.17
Earnings per share 4.3 times
(e) Dividend payout Cash dividend 23,000**

ratio Net profit 35,000
65.7%
**revenue year 2009 +
2010 current profit –
2010 retained
revenue
**113,000 +
35,000 – 125,000
=** 23,000
(f) Debt ratio Total liability 165,000
Total asset 590,000
28.0%

318 ANSWERS
Ratio analysis for year 2011:

Formula 2011
(a) Profit margin Net profit 50,000
Sales (net) 700,000
7.1%
(b) Asset turnover Net sales 700,000

Average total asset* 615,000*
1.1 times
* [Total asset last year + *(590k+640k)/2
Total asset current year] *615,000
2
Formula 2011
(c) Earnings per Net profit - Dividend 50,000
share for Preference Shares 32,000* unit
Average ordinary shares RM1.56
issued (unit) *(300,000+340,000)/2
RM10
* 32,000
(d) Price earnings Market value of ordinary RM7.95
ratio shares per unit RM1.56
Earnings per share 5.1 times
(e) Dividend Cash dividend 30,000**

payout ratio Net profit 50,000
60.0%
**revenue year 2010 +
2011 current profit –
2011 retained revenue
**125,000 +
50,000-145000
= **30,000
(f) Debt ratio Total liability 155,000
Total asset 640,000
24.2%

ANSWERS 319
Current Asset
4. (a) Current ratio =
Current Liability
235,000
=
135,000
= 1.7 : 1
Quick asset
(b) Quick ratio =
Current Liability
41,000 + 18,000 + 92,000
=
135,000
= 1.1 : 1
(c) Accounts receivable turnover =

650,000
=
83,000
= 7.8 times
* [AR last year + AR current year]
2
* 74,000 + 92,000
2
* 83,000
Cost of goods sold

(d) Inventory turnover =
Average inventory*
415,000
=
77,000
= 5.4 times
**[Inventory last year + Inventory current year]

2
70,000 + 84,000
2
77,000
Gross profit
(e) Gross profit margin =
Sales (net)
235,000
=
650,000
= 36.2%

320 ANSWERS
Net sales
(f) Asset turnover =
650,000
=
599,000
= 1.1 times

2
560,000 + 638,000
2
599,000
Net profit
(g) Return on asset =
59,800
=
599,000
= 10%

2
560,000 + 638,000
2
599,000
Net profit
(h) Return on ownerÊs equity =
Average owners equity's ordinary shares*
59,800
=
361,500
= 16.5%
* [Total owner equity last year + Total owner equity current year]
2
350,000 + 373,000
2
361,500

ANSWERS 321
Net profit - Dividend on preference shares

(i) Earnings per share =
Average ordinary shares issued (unit)*
59,800
=
30,000
= RM1.99
*RM150,000 / RM5 per share
*30,000 units share
Market value of ordinary shares per unit

(j) Price earnings ratio =
Earnings per share
RM19.50
=
RM1.99
= 9.8 times
Cash dividend*
(k) Dividend payout ratio =
Net profit
36,800
=
59,800
= 61.5%
*Opening retained earnings + Current net profit - Closing retained

earnings
*200,000 + 59,800 – 223,000
= 36,800
Total liability
(l) Debt to equity ratio =
Total owner's equity
265,000
=
373,000
= 71.0%
Net profit + Taxation+ Interest expenses*

(m) Interest coverage ratio =
Interest expenses
85,000
=
7,200
= 11.8 times
*Net profit + Taxation+ Interest expenses
= 59,800 + 18,000 + 7,200
= 85,000

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Copyright © Open University Malaysia (OUM)

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Developed by Centre for Instructional Design and Technology, OUM.

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Topic 1 Accounting Environment 1

Topic 2 Basic Rules of Accounting 29

Copyright © Open University Malaysia (OUM)

Topic 3 Recording Process 50

Topic 4 Adjusting Entries 94

Topic 5 Completing the Accounting Cycle 114

Topic 6 Financial Reporting Standards 144

Copyright © Open University Malaysia (OUM)

Topic 7 Trading Business Environment 159

Topic 8 Accounting for Inventory 173

Topic 9 Cash Management and Control 210

Copyright © Open University Malaysia (OUM)

Topic10 Financial Statement Analysis 222

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COURSE GUIDE DESCRIPTION

As an open and distance learner, you should be able to learn independently

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Figure 1: Student Learning Time

COURSE LEARNING OUTCOMES

1. Explain the fundamental concepts, principles and roles of financial

3. Evaluate the accounting process in trading companies, internal control and

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Topic 1 discusses the Accounting Environment. It introduces you to accounting

Topic 2 discusses the Basic Rules of Accounting. It begins with an understanding

Topic 7 introduces trading business activities, including purchases, sales,

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Topic 8 covers accounting for trading, comprising preparation of journal entries,

Topic 10 introduces us to financial statement analysis using the horizontal and

TEXT ARRANGEMENT GUIDE

Self-Check: This component of the module is included in strategic locations

Activity: Similar to Self-Check, the Activity component is also placed at various

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References: A list of relevant and useful textbooks, journals, articles, electronic

Warren et. Al (2001), Accounting: Customized by school of accountancy UUM for

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TAN SRI DR ABDULLAH SANUSI (TSDAS)

Figure 2: Among the Online Databases Available at TSDAS Digital Library

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We might assume that accounting is only important to businessmen or

This example is only a decision at an individual level. For a business entity, it

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1.1 INTRODUCTION TO ACCOUNTING

1.1.1 Definition of Accounting

Accounting is a process to identify, measure, record and present the

Economic information are information related to economic activities; whereas an

1.1.2 Users of Accounting Information

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Figure 1.1: Users of accounting information

Now, let us look at each group:

Table 1.1: Differences between Internal Users and External Users

Differences Internal Users External Users

1.1.3 Branches of Accounting

Table 1.2: Differences between Financial Accounting and Management Accounting