Bookkeeping vs.

Accounting

Bookkeeping
Process of detailed recording all
financial transaction of a business
Accounting
Process of detailed recording all
financial transaction, producing financial
statement & analysing financial
performance of a business
Why measuring/uses business profit and loss?

Who measures? Why measure?

Owner  To see the return on his investment
 To decide whether to continue in business or close the
business (to expand or not)
 To compare the profit with previous years/ other
business
 To plan for the future/assist decision-making
Who uses? Why?
Managers  To plan for the future/assist decision-making
 To see how well did the past performance go
Trade payables  To determine credit limit and term to be allowed
 To know the ability to pay upon demand
 To know debt collection period
Banks/ Other lenders  To see if loans or bank overdraft (for short term
requirement) can be given
 To see if business has funds to pay up
Investors/ Potential buyer  To know the profitability of the business
 To know market value of the business
Club members  To know if the club can continue to operate
Customers  To know the continuity of supply of goods
Employees/ Trade union  To know the continuity of the business ensure wages are
paid
 Job security
Government Department/  To compile business statistics
Tax  To ensure correct tax paid
The role of accounting in providing information for monitoring progress
and decision-making?

Monitoring progress Decision-making Comparison

Using accounting ratios & For future planning and With other similar
comparing with prior year’s expansion or budgeting business
performance
E.g. E.g. E.g.
 If trade debtors are  Can we buy additional  Are we leading
paying on time motor vehicle based compared to
 If stocks are idle on bank balance or competitors
 How did we improve loan needed  How big is our
compared to last year  Budget sales growth business
10% next year based
on past 3 years
growth of 5%
Meaning of assets, liabilities and owner’s equity

Assets Liabilities Equity/ Capital

Money & resources that Money that the company Money & resources used in
the company owns owes to others the business that belongs
E.g. E.g. to the owner.
 Cash  Trade Creditors
 Motor Car,  Bank Loan
Buildings, Land,  Vehicle Loans
Furniture etc.
 Debtors (those who
owe us money)
 Goodwill (can be
sold and converted
in cash)
 Explain and apply the accounting equation

BASIC/ Extended
Increase Credit Reduce Debit
Liabilities/Capital/ Equity/ Income
Increase Debit Reduce Credit
Expenses
Asset/ Expenses

CAPITAL
ASSETS +
LIABILITIES (C)/
Expenses
(L) EQUITY(E)+
(A) /(E)
Income (Y)

Buy Motor Vehicle (A inc)

Use of Sources of

funds – Owner paid (C inc)/ funds – WHERE

WHAT? Bank Loan (L inc)/ FROM?

Cash (A dec)

The equation indicates that sources of funds are equal to the uses of funds at
any point of time
Outline the double entry system of book-keeping

What is double entry Every transaction has two sides, debit and credit
system?
Two sides:
1. The receiver of the benefit
2. Giver of the benefit
&
1 must = to 2 at all times
Benefits of double  Less risk of errors
entry system?  Less risk of fraud
 Easier to prepare financial statements
 Easier to refer to previous transactions
Recognise the division of the ledger into the sales ledger, the
purchases ledger and the nominal (general) ledger
Ledger Book?
Division of Ledger
Advantage of Division of
Ledger
Books of Final entry with various accounts where
entries were transferred from Books of Original
entry
 Purchase Ledger Book – includes all the accounts
of Suppliers
E.g. Creditors/ Credit Suppliers/ Trade payables
 Sales Ledger Book – includes all the accounts of
Customers
E.g. Debtors/ Credit Customers/ Trade
receivables
 General (Nominal) Ledger Book – includes all the
rest of the accounts like Assets, Expenses, Total
Purchases, Total Sales, Total Purchases Returns,
Total Sales Returns.
E.g. Non-current Assets, Inventory, Capital,
Drawings, Sales, Income, Expenses
 Work can be shared between people so that it
can be completed on time accurately
 Easier for reference as the same type of
accounts kept together
 Easier to locate errors and implement checking
process
Understand the following business documents: invoice, debit note,
credit note, statement of account, cheque, and receipt

Invoice  Seller (Supplier) issues for credit sale to Buyer

(Customers)
 Full details of goods sold is shown
 Buyer refers as Purchase Invoice
 Seller refers as Sales Invoice
Debit Note  Buyer sends to Seller
 To inform faulty goods/ shortage/ overcharges been
made
Credit Note  Seller sends to buyer when faulty goods are received
back from buyer/ overcharge be made
 Reduce the amount owed by customer
Statement of Account  Seller sends to Buyer on credit transactions
 Why?
i. To show transactions during the month i.e. Sales,
Returns & Payment made
ii. To remind buyer, his amount due
iii. To agree records, settle difference
Cheque  A special bank note that acts as cash being paid by the
buyer.
Receipt  Proof that the cash payment has been made.
Items of information in #1-4 will be date, seller’s name & address, buyer’s name &
address, description & amount

Business documents acts as a proof that the transaction recorded in the occurred
Recognise the following business documents: invoice, debit note, credit
note, statement of account, cheque, and receipt
Recognise the following business documents: invoice, debit note, credit
note, statement of account, cheque, and receipt

Detail the
amount of
physical
cheque/ cash
they are
banking in bank
Recognise the following business documents: invoice, debit note, credit
note, statement of account, cheque, and receipt

Cheque
Counterfoil to
record the
details as per
the cheque Cheque portion
issued issued to others
Explain the advantage of using various journal/ books of prime entry

What?  Books of first entry

 Transactions first recorded here before entering to
ledger books.
 Known as Books of prime entry
Why recorded  For some transactions, journal provides the only prime
in the journal entry. E.g. Purchase/ Sales of Non Current Assets
 Error correction
before
 Reduce risk of omission
ledger?
Advantage of  Fewer transactions recorded in each of the
using various books/journal
 Allow work to be divided between several people
books
 Groups together similar type of transactions that allows
analysis by products/area
 Help in preparation of control account (Sales Ledger
Control & Purchase Ledger Control)
Explain the use of and process accounting data in the books of prime
entry: cash book, petty cash book, sales journal, purchases journal,
sales returns journal, purchases returns journal and the general journal

Business Books of Prime Entry For

Documents
Invoice (Purchase Purchase Journal (or Recording all credit purchases of
Invoice) Purchase Book) goods
Invoice (Sales Sales Journal (or Sales Recording all credit sales of goods
Invoice) Book)
Credit Notes Sent Sales Return Journal (or Recording all return inwards
Returned Inwards Book)
Credit Notes Purchase Return Journal Recording all return outwards
Received (or Returned Outwards
Book)
Receipts, Cheque Cash Book Recording all receipts and payments
issued of cash and cheques
Invoice General Journal (or Recording all other transactions
Journal) that can’t be recorded in any other
books:
 Correction of errors
 Provision for depreciation/
doubtful debts
 Opening entries i.e.
Inventory
 Purchase/ Sale of Non
Current Asset on credit

Why cash book is both a book of prime (original) entry and also part of
the ledger?

 It is a book of prime (original) entry because it is written up from business

documents.
 It is part of the double entry system as it acts as ledger accounts for cash
and bank
Where to post total of the credit notes & individual credit notes

Total Credit Notes Individual Credit Notes

Sent Received Sent Received
Sales Returns Purchase Returns Individual Debtors Individual
Account Account Account Creditors Account

Significance of the balance shown on the credit side of the cash book

 This represents an overdraft/what the trader owes the bank on that date

Why bank statement balance is on the opposite side to that shown in

the cash book?

Bank statement Cash book

Prepared from the viewpoint of bank Prepared from the viewpoint of
business.
E.g. When a bank receives deposit that is not owned by the bank, hence it is a
liability. Therefore deposits into bank will be: Dt Cash (of the bank) and Cr
Depositor. However, in the perspective of the depositor who is the owner of the
money, is an Asset. Therefore, it will Dt Bank and Cr Cash.
Reason for using a petty cash book

 Reduces the number of entries in the main cash book

 Removes the small cash payments from the main cash book
 Reduces the number of entries in the ledger
 Allows the chief cashier to delegate some of the work
 Provides training for junior staff members

Reason for a difference in the petty cash actual amount in the box and
petty cash book

 Lost or stolen cash

 Error brought forward or in counting cash
 Amount not recorded

Purpose of a narrative in a journal entry

 Useful because it may be necessary to recall the reasons

 It can involve non-regular transactions
 Can contain a reference to any prime documents
Why discount allowed?

Trade Discount (recorded on the Cash Discount (impacts @ NP

invoice & no ledger entry made level)
@ shown as Sales and impacts @
GP level)
 To encourage purchase in large  To encourage prompt payment/
quantities within the time given
 To encourage loyalty/ repeat
purchase

Impact of suppliers to business reduce the credit period (e.g. from 40

to 30 days) and increase the cash discount

 Opportunity to earn more cash discount hence pay lesser amount

 Have to pay earlier and may create cash flow problems
 If credit customers delay in paying, the business will have to use existing
money to pay the credit suppliers to earn the cash discount
 If cannot pay on time may be charged late payment interest
 If cannot pay on time relationship with suppliers may be damaged

Effect to profit if business reduces credit period (e.g. from 30 to 21

days) and reduce cash discount to 1% to credit customers

Profit may increase Profit may decrease

 amount of discount  credit customers may find
allowed/expense decreases another supplier offering better
 Credit customers may not pay in terms
time to receive cash discount
Effect to liquidity & profit if business increases cash discount to
credit customers

Liquidity Profit
 Business will receive payment  Decrease as increased cash
earlier and this money can be discount given
used for the business  May reduce bad debt and profit
 Will receive a lower amount than increase
previously because of additional
cash discount given

Advise advantage and disadvantage of direct debit/ online

transfer/ standing instruction of income collection/ expenses
payment

Income Collection Expenses Payment

Advantage
 Bad debts can be minimised were
set up from the start of the year
 The timing of cash receipts from
customers will be known
 Administration costs may be
reduced/ travel to bank time &
cost be reduced
Disadvantage
 Customers may prefer to choose
their own method of payment
 They may prefer to pay at a time
of their choosing
Advantage
 Will not be penalized for late
payment charges
 No action needed to be taken as
bank will automatically pay
 Administration costs may be
reduced/ travel to bank time &
cost be reduced
Disadvantage
 No choice of being able to pick
and choose when to make the
payment, when funds were
sufficient
 bank charges might increase
Direct Debit Vs Standing Instruction

Instructions to
Authorised bank to
bank to pay fixed
make payments on
amount at stated
demand by a person
dates to a person or
or company (no
company
fixed dated or
amounts)
Imprest system of Petty cash

Define? Each period petty cashier starts with a given amount of money
(the imprest) to spend from for day to day expenses. At the end
of the period the chief cashier will make up the cash equal to
the imprest amount.
Advantages  Chief cashier is aware the exact amount sent each period
 Reduce cash mishandling as at any point the remaining
balance and vouchers received has to be equal to the
imprest amount
Transaction Dt Petty Cash
Cr Cash Book
Trial Balance

Define? A list of all ledger account balances from various ledger books
on a particular date
Purpose/  To check arithmetical accuracy of ledger accounts
Advantage  Provide details to prepare final accounts
 To locate errors
 To proof double entry was made in each transactions
Limitation/  Does not prove that all transactions have been
Disadvantage recorded
 Cannot detect errors of duplicate posting
 Errors can exists even though the trial balance columns
agree
Key Points  All assets & expenses accounts are debited
 All liabilities & income accounts are credited
 All provisions are credited
 Closing inventory is not shown in the trial balance
 Capital account balance shown in the trial balance is the
opening balance. Due to trial balance drawn before
preparation of income statement is calculated as
closing capital account includes the profit for the year
Trial Balance Errors

Not revealed by Trial Balance Revealed by Trial

Balance
 Commission – entered in wrong  Posting wrong amount
creditor/debtor a/c in one of the two
E.g. debiting Khan instead of Kean with cash paid to accounts.
Kean E.g. Sales of $500 entered
 Complete reversal – Dt entry is on Cr side as Cr Sales a/c but Dt cash
and vice versa a/c as $550. Difference
E.g. debiting sales and crediting cash for cash sales amount of $50 be shows as
 Compensating – Error on Dt side cancels out disagreement
another error on Cr side of the same amount  Posting on wrong side
E.g. sales and purchases accounts overcast by same of an account
amount E.g. Wages paid $1500 and
 Principle – Included in a completely wrong Dt wages a/c but also Dt
class of account instead of Cr cash a/c
E.g. debiting motor vehicles account with motor  Omission to post an
expenses amount into ledger.
 Omission – Completely omitted from the E.g. Interest paid $200. Dt
books Interest a/c but omitted to
E.g. drawings completely omitted from accounting Cr Cash a/c. Differences
records shows disagreement
 Original entry – Wrong amount entered in  Ommission to enter an
book of original entry and used to post in the amount in trial balance
ledger while transferring
E.g. amount of sales invoice entered incorrectly in from ledger balances,
sales journal then the disagreement
is shown.
Suspense Account

Define? Errors made will affect the trial balance agreement. Suspense a/c is
created to park the differences arising from the errors. Once errors
are rectified, amount in the suspense a/c will be shifted into the
correct account(s).
Purpose/  To ensure that the trial balance totals agree
Advantage  To allow draft financial statements to be prepared
 To assist in the correction of errors
 To assist in ensuring errors are discovered
Types of  Entering different amounts in both entries of the transaction.
errors  Making two debit entries (or two credit entries) for a
transaction.
 Only entering one entry for a transaction.
 Arithmetic errors

Bank Reconciliation
Define?
Why
differences?
Cheque received and recorded
in cash book but yet to be
recorded as received by the
bank
Cheque paid out and recorded
in cash book but yet to be
recorded as paid by the bank
Why preparing?
How to prepare?
Why cheque may be dishonoured? – Bank refuses to pay/honour the
cheque
 insufficient funds in account
 no signature on cheque
 wrong signature
 no date
 words and figures do not agree
 cheque is out of date
Other option to discover is to prepare trial
balance or control account
A statement prepared by the trader to explaining the
differences of balance on the bank column in the cash
book and bank statement (is a record of payments in and
out of a bank account)
 (+) Entries recorded in the cash book but not in the
bank
a) Cheques deposited uncredited in the Bank
b) Cheques issued but unpresented in the Bank
 (-) Entries recorded in the bank but not in the cash
book
a) Direct deposits in the bank by customers
b) Direct collections made by bank on our behalf
c) Direct payments made by bank
d) Interest allowed and charged by the bank
e) Dishonoured cheques
 Ensure cash book entries are complete
 To discover bank/ cash book errors
 To discover dishonored cheques
Balance per cash book (+) & (-) items above = Balance
per bank statement
Note: Balance sheet will not balance if the bank statement
balance used because only balance on the business books
can be included in the balance sheet
Control Account (includes Sales Ledger Control Account(SLCA) & Purchase
Ledger Control Account (PLCA))
Characteristics: Advantages:
 Known as total accounts  Help in locating
 Acts as a summary of the ledger which it errors
controls  Help in checking
 Cash sales/purchases are not recorded arithmetical
 Provision for doubtful debts not shown in SLCA accuracy of the
since it is kept in general ledger & not in sales ledgers which they
ledger control
 Bad debts recovered not shown in SLCA  Provide summary
 Control account does not include capital and immediate
expenditure totals of the trade
 Control account includes only sales/purchases payables and the
of goods related to resale trade receivables
 SLCA relates to only trade receivables  Help to reduce
 PLCA relates to only trade payables fraud
Sales Ledger Control Account (SLCA) – What appears in individual
debtors account

Debit Credit
Items ( + Debtors) Source Items ( - Debtors) Source
Balance b/d Balance b/d
Credit Sales Sales book Sales Returns Returned
Inwards book
Refunds to customers Cash book Cash received Cash book
Dishonored cheque Cash book Bad debt written off General Journal
Late payment interest General Contra General Journal
charged to customers Journal
Balance b/f Balance c/f
Why Credit Balance b/d on SLCA
 Overpayment of amount due by a debtor
 Cash discount not deducted by debtor before payment made
 Goods returned by debtor after payment of amount due
 Payment made in advance by debtor
Why Information to prepare SLCA is from books of prime entry & not from
Sales Ledger?
SLCA acts as a check of Sales Ledger. If an error in the Sales Ledger it will not be
revealed by SLCA prepared from individual accounts in the ledger
Purchases Ledger Control Account (PLCA) – What appears in
individual creditors account

Debit Credit
Items ( - Creditors) Source Items ( + Creditors) Source
Balance b/d Balance b/d
Purchases Returns Returned Credit Purchases Purchases book
Outwards book
Cash paid Cash book Refunds from Supplier Cash book
Cash discount Cash book Late payment interest General
received charged by suppliers Journal
Contra General Journal
Balance c/f Balance c/f
Why Credit Balance b/d on PLCA
 Overpayment of amount due
 Cash discount not deducted before payment made
 Goods returned after payment of amount due
 Payment made in advance to creditor
Why Information to prepare PLCA is from books of prime entry & not from
Purchase Ledger?
PLCA acts as a check of Purchase Ledger. If an error in the Purchase Ledger it will
not be revealed by PLCA prepared from individual accounts in the ledger

Contra Entry

Meaning Purpose
Appears when an account in the sales Made when a supplier is also a customer
ledger is set against an account in the of the business and has account in both
purchase ledger ledgers
Capital & Revenue

Expenditure Revenue
Capital Receipt Expenditure Receipt
Money spend on Amounts received Money spent on Amounts received
acquiring, improving and which do not form the running of in the day-to-day
installing non-current part of the day- a business on a trading activities
assets to-day trading day-to-day and other items
activities basis of income
E.g. E.g. E.g. E.g.
 Purchase of any non-  Receipt of loan  Any expense  Sales
current asset  additional such as  commission
 legal costs for capital wages, rent, received
purchase of premises  proceeds of insurance,  interest
 cost of installation of sale of non- etc. received
non-current asset current asset  rent received
 cost of carriage on at book value
delivery of non-
current asset

Impact of incorrect recording

Income Statement – recording SOFP/ Balance Sheet

Cap. Exp as Rev. Exp
 Expenses overstated  NCA understated
 Profit is understated  Owner’s capital is understated
 Depreciation

Define An estimate of loss in the Non Current Assets from any cause over
the period of useful life
Why  Wear and tear – used overtime causes asset to wear out
Depreciate  Fix time period of usage
 Depletion – arises for NCA as wells and mines
/What
 Obsolete – Newer and better products reduces the demand
Causes? for existing assets as computers/ vehicles
Method i. Straight Line
Why Land is not depreciated?
– uses the same amount of depreciation each year
Why (i) is - calculated on cost i. Has indefinite expected life
better than (ii) - expected to benefit equally from the assets ii. Does not wear out
in depreciating - E.g. Buildings iii. Increases value over years

machinery? ii. Reducing Balance (Diminishing)

- uses same % rate of depreciation each year NBV = Cost less accumulated
i. Machinery depreciation
- calculated on book value
value may not - greater benefits gained in early years from the assets
fall heavily - E.g. Computer equipment, Motor Vehicles
Why Loose tools not depreciated
ii. SL easier to iii. Revaluation using SL?
calculate - value at the end of the year
i. Principle of materiality –too
iii. Difficult to - difference between the opening value and closing many items/too difficult/too
find reducing value is the depreciation charge costly to depreciate each item

balance rate - used for difficult to maintain detailed records of separately

ii. Certain amount of loss of tools
assets/ not practical – Link to MATERIALITY
CONCEPT (not waste time recording items of very small value)
- E.g. Loose tools, small items of equipment

Provision for Depreciation

Define? As saving a part of profit for the replacement of the asset

Why  To charge cost of capital expenditure to profit over the useful life of the
assets – link to MATCHING CONCEPT
maintain  To ensure value profit and assets are not overstated – link to PRUDENCE
provision? CONCEPT
Note: To ensure the % rate of depreciation is same every year – link to
CONSISTENCY CONCEPT
Understand the meaning of irrecoverable debts and recovery of
debts written off

Bad debt/ An amount owing to a business which will not be paid by the
Irrecoverable debts credit customer
Bad debt recovered/ Is when a credit customer pays some or all of the amount
Recovery of debts owed after the amount was written off as a
written off bad debt
Provision for Is an estimate of the amount which a business will lose in a
doubtful debts financial year because of bad debts
How to assess By comparing amount of actual bad debts with the provision
adequacy of made
Provision for
doubtful debts
Ways to reduce Bad  Reduce credit sales/sell on a cash basis
debt  Obtain references from new credit customers
 Fix a credit limit for each customer
 Issue invoices and monthly statements promptly
 Refuse further supplies until outstanding balance is
paid
 Give cash discount/discount for prompt payment
 Charge interest on overdue account
Reasons for  Ensure profit and asset of debtors not overstated–
maintaining a link to PRUDENCE CONCEPT
provision for  Amount of sales unlikely to be paid are treated as an
doubtful debts expenses of that particular year – link to
MATCHING CONCEPT
Understand the basis of the valuation of inventory at the lower of
cost and net realisable value

 Closing stock is known at year-end by physical count and recorded at cost.

 Ensure profit and asset of debtors not overstated– link to PRUDENCE
CONCEPT. Hence inventory is valued @ lower of cost and net realisable value
Cost NRV
Purchase price + any costs in bringing selling price - selling expenses to put
the inventory to its current position the goods in a saleable condition (e.g.
(carriage inwards). carriage outwards, commission and
repairs)

Discontinue purchasing slow moving item to avoid having obsolete

inventory in the future. Justify your answer by providing
advantages and disadvantages.

Advantages
 The obsolete inventory is a loss to
business and should avoid such
losses
 Holding inventory necessitates
storage costs
 If stops buying, funds are available
for other business opportunities
Disadvantages
 Need to consider the risky having
limited lines of inventory in the
future
 There may be customer demand in
future for discontinued item
 Customers have to start buying
discontinued item from another
supplier may also buy other items
where potentially losing sales

Prudence It avoids inventory/current

Value of inventory would assets/profit being overstated
be an application of the Accruals/ The loss arising from the damage
accounting principle (Matching) is recorded in the same year as the
damage occurred
Type of Ownership Advantages
Sole trader  Full control of the
business
 Decisions can be taken
quickly
 Profits do not have to
be shared/distributed
 Book-keeping and
accounting are simpler
Partnership  Losses can be shared
 Additional capital may
be available
 Responsibilities can be
shared
 Additional skills are
available
Limited companies  limited company,
owners personal assets
will be safer
 Able to raise money by
issuing shares
 Easier to obtain
finance for proposed
expansion
Disadvantages
 Unlimited liability for
debts
 Ability to raise capital
is limited
 Hard to take holidays
 Heavy sole
responsibility for
making day-to-day
business decisions
 Do not have full
control of the business
 Decisions must be
recognised by all
partners
 Share profits
 Disagreements can
occur
 Costs in setting up and
running is greater
 Company information
will be available to
public
 Book-keeping and
accounting are
complex and time
consuming
Explain the difference between a trading business and a service
business

Trading Service
 Business that buy goods and resell  Derive revenue from services
 Have inventories to resell provided
 Do not have inventories

Financial Statement

Income Statement Statement of Financial Position

A statement in which the profit or loss A statement showing the assets and
for the year is calculated liabilities of a business on a certain date

Terms in SOFP

Current Assets  Assets purchased for use not for resale

 Assets values do not fluctuate frequently
(Land/Building)
 Assets kept by the business for more than 12
months (Motor Vehicles)
 Assets acquired to aid the business earn revenue
(Machinery)
Non Current Assets  Assets purchased for resale (Inventory)
 Assets values do fluctuate frequently (Shares)
 Assets kept by the business for less than 12
months (Bank/Cash/Trade Debtors)
 Includes Intangible Assets
(Goodwill/patents/trademarks)
Current Liabilities  Liabilities due for repayment within 12 months
(Trade Creditors)
Non Current Liabilities  Liabilities not due for repayment within 12 months
(Bank Loan/ Debentures)
Capital  Owner Investment in the business
Partnership

Factors to  How much capital will he/she contribute?

consider  Will the annual profit be increased/loss reduced with the
injection of more capital?
before
 What share of profit/loss will he be offered?
going into  Will he be offered a salary?
partnership  How will the workload/responsibilities be shared?
 Will having partners be too many for the size of the business?
 What areas of expertise will he/she bring to the partnership?
 Will they be able to work together without disputes arising?
Importance  Interest on Capital
and a) To reward the partner investing the highest capital
b) To encourage partners to invest in the business
contents
 Interest on Drawings
of a a) To discourage partners from making excessive drawings
partnership b) To ‘penalise’ the partner who makes high drawings
agreement  Salary
a) To compensate for extra workload/responsibilities, running
the business, more experience, working or active partner

 Appropriation Account
 Continuation of the P&L account and prepared to show the
appropriation of profits and losses among the partners.
Special Acc for Partnership

 Includes Partners Salaries, Interest on Capital, Interest on Drawings

& Share of the remaining profit
 Profit to share = Net profit + Interest on Drawings (-) Interest on
capital (-) Salaries
The Interest on
 Drawings Account (each partner has their own account) Loan will be
 Capital Account (each partner has their own account) debited in P&L as

 Fixed Capital Acc (#) normal expense

 Fluctuating Capital Acc

Remember: Capital Acc is increased by profit, additional capital & reduced by drawings
 Current Account (each partner has their own account – if #)
 Used to complete the double entry of Appropriation Acc
 This account is used to close of Drawings Acc
 This account is credited with Interest on loan by Partner.
Partnership

Capital Account (Fixed)

A B A B
Details $ $ Details $ $
Permanent withdrawal of capital Opening Balance (b/d)
Closing Balance (c/d) Addition of Capital

Current Account (Fixed)

A B A B
Details $ $ Details $ $
Cash: Drawings Opening Balance (b/d)
Interest on Drawings Interest on Capital, Salary, Commission or
other remuneration
Loss transferred Interest on Loan
from P&L
Closing Balance (c/d) Share of profits (from Appropriation Acc)

Capital Account (Fluctuating)

A B A B
Details $ $ Details $ $
Cash: Drawings Opening Balance (b/d) or Initial Investment
Interest on Addition of Capital, Interest on Capital, Salary,
Drawings Commission or other remuneration
Loss transferred Interest on Loan
from P&L
Closing Balance Share of profits (from Appropriation Acc)
(c/d)
Impact on Drawings & How Interest on Drawings be an Advantage
Impact on Drawings Affect the cash/ working capital position
How Interest on  Discourages large or early cash withdrawals
Drawings be an  Additional income/ profits for the partnership
Advantage

Explain why the partnership agreement included clauses on each of

the following:
Interest on To discourage the partners from making excessive
drawings drawings
Interest on capital To reward the partner investing more capital
Partner’s salary To compensate for an unequal work-load

State and explain one advantage of maintaining both a capital and a

current account for each partner
 Easier to see amount invested by each partner
 Easier to calculate interest on capital
 Easier to see the profit retained by each partner
 Easier to see if a partner is making excessive drawings
Limited Liabilities

Limited liability is a legal entity which has a separate identity from its
shareholders, whose liability for the
company’s debts is limited to the amount they agree to pay
for their shares
Debenture is a long term loan which has a fixed rate of interest,
payable irrespective of the profit for the company. (do not
have voting rights & debenture holders are not members of
Definition

company)
Equity is the total funds provided by the shareholders of the
company
Issued share is the amount of capital issued to shareholders
capital
Paid up share is that part of the called up share capital for which the
capital company has received payment from shareholders
Called up share is that part of the issued share capital for which payment
capital has been requested from shareholders
Shareholders is owners of the share capital of a limited liability company
Limited Liabilities

Preference  fixed rate of dividend

share capital/  rank before ordinary shares for payment of dividend
Debetures  do not usually carry voting rights
 rank before ordinary shares in winding-up
 not member of the comapny
Ordinary share  are members of the company
capital  carry voting rights
 variable rate dividend is variable
 is a share of the profits
Dividend  paid to shareholders to distribute profits
 can be paid more than once (half way thru-INTERIM;
year end-FINAL)
 determining factors:
Features

a) Availability of profits
b) Availability of cash to pay
c) If it’s better to keep the profits to grow
d) If market value of shares be affected or not
General  transfers made in the statement of changes of equity
Reserves from the retained earnings
 may not necessarily be matched by cash balances
 WHY?
a) to set aside profit for re-investment
b) to indicate that part of the profit is not available for
distribution
c) to set aside profit for payment of future dividends
Retained profit  maintained to pay dividend in situations where there is
not enough cash
 to retain cash within the business
 for future usage when the profits are low/in a loss
 Limited Liability Company (LLC)
other than introducing
Ways to raise funds
Long term loan from
bank/financial institution
capital?
Government grant if available
Mortgage premises
Sale and lease-back of non-
current assets
Other than LLC
Long term loan from bank/financial
institution
Government grant if available
Mortgage premises
Sale and lease-back of non-current
assets
Admit a partner
Form a limited company
Limited Liabilities
Advantages
Ordinary  Shares could be sold to new
Shares or existing shareholders
 Shares are permanent
capital/do not have to be
repaid
 Dividends vary according to
the profit
Bank loan  Easier to set up/quicker to
obtain funds
 May be repaid early
Debentures  If expansion profitable,
potential for higher dividend
as debenture holders receive
fixed interest (s/h)
 Will not dilute their stake in
the company (s/h)
 Will not dilute their voting
power (s/h)
 Fixed rate of interest
Disadvantages
 It may take longer to raise the funds
 Increased dividends may have to be paid
 All the shares need to be sold in order to
raise the amount required
 Less control for existing shareholders
(s/h)
 New shares rank equally with existing
ordinary shares with regard to
dividend or repayment in winding up(s/h)
 A fixed rate of interest needs to be paid
each year
 The interest would be payable irrespective
of profit
 Must be re-paid in full within a fixed
period
 Security would have to be provided
 Annual profit reduced because of
debenture interest
 Interest must be paid irrespective of the
profit or loss position
 Reduced profit available for ordinary
shareholders
 Claim on assets in a winding-up
Change in Equity Statement

Share Capital Retained profit General Total (D)

(A) (B) reserves (C)
Balance b/d Balance b/d Balance b/d =sum(A,B,C)
(+) Additional (+) Current year =sum(A,B,C)
issues of Share profit
Capital
(-) Interim/ Final =sum(A,B,C)
dividends paid -
current year
(-) Final dividend =sum(A,B,C)
paid –previous
year
(-) Transfer to (+) Transfer from =sum(A,B,C)
general reserves retained profit
Total (A) Total (B) Total (C) Total (D)
Clubs & Societies

Receipts and payments Income and expenditure account &

account & Examples Examples
Shows opening and Shows surplus and
closing bank deficit for the year
balance
Makes no adjustment for Makes adjustment for Rent owed

accruals and accruals and Subscriptions in

prepayments prepayments advance
 Subscriptions in
arrears
 Money owed for
coach travel
Does not include non- Includes non-cash items Depreciation
cash items
Includes capital and Equipment Includes only revenue
revenue items items
Balancing figure Balancing figure
represents bank balance represents
surplus/deficit

Difference Between Trading Business & Clubs and Societies

Trading Business Clubs and Societies
a) Cash Book a) Receipts and payments account
 Summary of cash book, i.e. all cash and bank
transactions
 Op. Balance + Receipts - Payments
Aim of clubs and
b) Profit and societies are
Loss Account b) Income and Expenditure account mainly service to
society and
Net b/c/d doesn’t survival by
c) Net Profit
equate to balance in a) making income to
c) Surplus - due to accruals, cover expenses
d) Net Loss prepayment & is the prime
depreciation focus and not to
d) Deficit
be profitable
e) Capital
e) Accumulated Fund
 Subscription
 Amount paid by members for the right to use the facilities of club
 Subscription acc has 2 opening balances – Arrears & prepaid
 Impact of increasing subscription?
 The total amount receivable from members each year would increase
 The annual surplus for the year would increase
 This total receipts would increase per annum if all the members paid their
subscription in full each year
 This would reduce the overdraft if the Club has/ bank balance should
improve
 Membership may fall if the annual subscription is increased
 May mean that more members are late in paying their subscription or
subscriptions accrued increases

Accumulated Funds
 Surplus accumulated within the organization from day 1 (annual surpluses less
any annual deficits)
 Equivalent to Capital = Assets – Liabilities
 Can’t be distributed among members as none invested capital
Distinguish between direct and indirect costs

Direct Cost – directly identified & Indirect Cost – running of the

traced to the actual goods made; include production facility costs rather link to
raw materials and cost in converting to finished direct productive activity; mainly factory
goods related costs
Direct materials: Indirect labour:
 Physical commodities – steel, wood,  Cleaning staff
rubber  Security
 Chemicals  Canteen staff
 Ingredients for food and drinks –  Staff running nursery/ clinis
sugar, flour, meat  Supervisors
 Sub assemblies – switches, pump  Factory Accountant
 Components – nuts, screw, bolt
Direct labour: labour costs – wages, salary, Indirect expenses:
social security, pension of operatives engaged in  Cleaning materials
hands on production activities  Factory & office stationery
 Machine operators  Telephone
 Technicians  Tax
 Assembly line workers  Insurance
Involve directly in conversion of raw material to
 Material handling
finished goods
Cost result of occupying and running the factory
Direct expenses:
 Power
 Machine lubricant
 Packaging – milk bottles, cans, boxes
Understand prime cost and factory overheads

Prime Cost Factory Overheads

 Total of direct materials (+) direct
labour (+) direct expenses/royalties
 Total indirect materials, labour and
other costs which cannot easily
identified/ traced to goods or
services rendered.
 The cost are apportioned based on
the total goods produced.

Understand and make adjustments for work in progress

Define Raw materials-

 Goods remaining (at the year-end) which were purchased for
converting into finished goods
 Example – fabric, thread, buttons, zips, etc.
Work in progress
 Goods which are partly made (at the end of the year)
 Example – partly made shirt/blouse/jeans/etc.
Finished goods
 Completed clothes which are awaiting sale
 Example – completed shirt/blouse/jeans/etc
Adjustments Opening Inventory
– (+) purchases
is made (+) carriage inwards A (Cost of raw materials consumed) + purchases
to calculate (-) closing inventory of finished
total cost A + B = Prime Cost goods
of production (+) Direct Material
of finished (+) Direct labour B
goods
(+) Direct expenses
A+B+C = Cost of Production
(+) Total Indirect costs – C
(also known as factory overheads)
Why purchase finished
goods: Cheaper to buy and
Cost of Production
demand is higher than
Add: opening inventory of WIP production capacity
Less: closing inventory of WIP
Factory cost of production of finished goods
Incomplete Records

What  Accounting records not kept in double entry system.

 Usually in small companies
Why  Source documents not kept
 Lost accounting records – flood/ fire
 No accounting staffs
Advantages  Simple & Time Saving maintaining few records only
 Convenient since no rules and principles to be followed
 Cheaper compared to maintaining double entry in terms of
software and no of staffs
Disadvantages  Cant prepare trial balance and hence accuracy check is not
there
 The profit is based on estimation, hence cannot be relied upon
 Proper analysis of profitability and solvency cannot be made
for informed decision (e.g. may face problem in raising loans
from banks)

How to prepare KPI’s with incomplete records

COMPARISON METHOD ANALYSIS METHOD

 Profit for the year
(Closing Capital + Drawings) less (Opening
Capital + Additional Capital)
Mark Up = Gross profit measured as a %
 Sales = Cash Sales + Credit Sales
Credit Sales = (Received from Trade
Receivables (TR) + TR Closing + Sales
Returns + Discount Allowed + Bad Debts)
less TR Opening

to Cost Price [ GP/Cost x 100]  Purchases = Cash Purchases + Credit

Purchases
Margin = Gross profit measured as a % to Credit Purchases = (Paid to Trade Payables
Selling Price [ GP/Sales x 100] (TP) + TP Closing + Purchase Returns +
Discount Received) less TP Opening
 Cash transaction source will be Cash
Book (incl. Disc Allow’d & Disc Rec’d)
Statement of Affairs = List of
 Analysis of Accrued and Prepaid
Assets & Liabilities without
Revenue/ Expenses
maintaining double entry
 With above Income Statement and
SOFP can be drawn
Limitations of accounting statements

Historic Cost  The financial transactions are recorded at the actual cost
 Because of this it is difficult to compare transactions taking
place at different times
 No consideration of present value of money
Difficulties of Use of diverse set of accounting policies and its interpretation
definition impairs the level of comparability
Non-financial  The accounting records only show information which can be
aspects expressed in monetary terms/non-monetary items cannot be
recorded
 There are many other factors which affect the performance
of the business
 E.g. efficiency of management executives, goodwill of the
company, employee and employer relationship, efficiency of
workers, customer satisfaction, loyalty of customers,
competitive strength
COMNINED AREA
Questions
Why the outstanding loan interest
should not be credited to the loan
account
2 differences between a bank overdraft
and a bank loan
2 other ways of raising long-term funds.
IF to buy the extra factory machinery &
reduce cost of labour. Advantages &
Disadvantages.
 Loan interest is an expense
account/any accrued interest is a
current liability
 A loan is of fixed amount but an
overdraft is of varying amount.
 A loan is for a fixed term but an
overdraft may be paid back at any
time.
 A loan may require security but an
overdraft may be unsecured.
 A loan may have a fixed rate of
interest but an overdraft will have a
variable rate.
 Introduce additional capital
 Take a partner
 Convert to a limited company
 Mortgage the premises
 Borrow from family and friends
 See if government grants are
available
The savings in direct labour costs
The cost of production would reduce
Reducing cost of production and
maintaining selling price increase profit
The purchase would increase
depreciation and might also increase the
cost of repairs and power
The purchase might incur finance
charges if funds are not immediately
available. (1) However redundancy costs
might be incurred. (1) Would the
reduction in labour enable her to be
flexible enough to cope with
fluctuations in demand / to cover
holidays and sickness (1)? How easy
would it be to hire more labour if the
need arose (1)
?