Accounting Notes (Ta 098)

O LEVEL
ACCOUNTING
REVISION KIT
PREPARED BY:
AHMED SAYA
Contents
BASIC ACCOUNTING....................................................................................................................................... 4
BOOKS OF ORIGINAL ENTRY / PRIME ENTRY ...............................................................................................11
ADJUSTMENTS TO FINAL ACCOUNTS ..........................................................................................................13
ACCOUNTING CONCEPTS .............................................................................................................................15
DEPRECIATION .............................................................................................................................................17
BAD DEBTS ...................................................................................................................................................17
FINAL ACCOUNTS .........................................................................................................................................29
SOURCE DOCUMENTS……………………………………………………………………………………………………………………………37
DEPARTMENTAL ACCOUNTING ...................................................................................................................39

BANK RECONCILIATION STATEMENT ...........................................................................................................41
CONTROL ACCOUNTS ..................................................................................................................................46
ERRORS AFFECTING AND NOT AFFECTING TRIAL BALANCE ........................................................................48
MANUFACTURING ACCOUNTS ....................................................................................................................51
NON-PROFIT ORGANISATIONS (NPO) ..........................................................................................................57
INVENTORY VALUATION ..............................................................................................................................62
SINGLE ENTRY ..............................................................................................................................................66
INCOMPLETE RECORDS................................................................................................................................68
RATIO ANALYSIS ...........................................................................................................................................70
PARTNERSHIP ...............................................................................................................................................75
LIMITED COMPANIES ...................................................................................................................................85
PAYROLL ACCOUNTING................................................................................................................................97
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BASIC ACCOUNTING
ACCOUNTING is an art of
1. Classifying
2. Recording
3. Summarizing Business Transactions
4. Interpreting
5. Communicating
Transactions are day to day activities of the business which involves monetary value.
Business is an entity that transforms resources to perform activities to achieve business
objectives.
CLASSIFICATION OF ACCOUNTS
5 PILLARS OF ACCOUNTING:
1) ASSETS
2) LIABILITIES
3) CAPITAL ALCER
4) EXPENSES
5) REVENUES
ASSETS:
They are resources of business whether owned or owed. They are the possessions of the
business. They are divided into 2 categories:
➢ Non-Current Assets
➢ Current Assets
Non-Current Assets are those assets which are used in the course of the business for more than
an accounting period. They comprise of machines, motor vehicles, factories and so on. They are
also known as Fixed Assets.
Accounting period usually comprises of 12 months but in some cases, it can be extended up to
18 months.
Current Assets are those assets which are used in the course of the business for less than an
accounting period. Example: Inventory, Receivables, Cash and Cash Equivalents. They change
their form continuously.
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Inventory is the stock of goods. The goods which were bought or produced with an intention of
resale but are yet unsold are called Inventory.
Goods are all those things in which a business trades.
Receivables are those people or businesses to whom we have given credit or to whom we have
sold goods on credit. They are divided into categories:
➢ Trade Receivables
➢ General Receivables
Trade Receivables are all those people to whom we have sold goods on credit. They are also
known as Debtors.
General Receivables are all those people to whom we have lent money or have sold non-current
assets on credit.
Cash and Cash Equivalents means cash or bank.
Cash and
Cash
Equivalents
Trade Inventory
Receivables
LIABILITIES:
The resources owed by the business. They are the obligations of the business which the business
has to repay. They are divided into 2 categories:
➢ Non-Current Liabilities
➢ Current Liabilities
Non-Current Liabilities are also known as Long-term liabilities and they are owed by the business
for more than an accounting period. Examples: Long-term loans from banks and financial
institutions, and debentures. They are subject to fixed rate of interest which is charged on per
annum basis.
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Debentures are the I Owe You Certificates indicating the amount borrowed, the repayment date,
and the rate of interest. They are usually secured against mortgage.
Mortgage is a collateral agreement indicating that in case of non-payment, the amount of loan
will be recovered by selling off the asset which has been kept as a security.
Current Liabilities are those liabilities which have to be repaid within an accounting period and
hence comprises of payables (creditors), bank overdraft and short-term loans.
Payables are all those people or businesses from whom we have borrowed money or those from
whom we have bought non-current assets on credit or those from whom we have bought goods
on credit. They are divided into 2 categories:
➢ General Payables
➢ Trade Payables
General Payables are all those people or business from whom we have borrowed money or have
bought anything other than goods on credit.
Trade Payables are those from whom we have bought goods on credit.
Bank Overdraft is the facility provided by the bank to its loyal customers that if they want to
withdraw more amounts from the bank than is present in their bank account, then bank will allow
you to withdraw but will charge interest on overdraft on daily basis.
CAPITAL:
The resources owned by the business. They are the investments of the owner and hence
determine the ownership of the business.
BASIC ACCOUNTING EQUATION: CAPITAL = ASSETS - LIABILITIES
ASSETS
(All resources of the business)
Owned Owed
CAPITAL LIABILITIES
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Expenses are the day-to day running costs of the business without which it is practically
impossible to run the business. Example: Rent, Utility Bills, Wages and Salaries etc.
In accounting, expenditures are divided into 2 categories:
➢ Capital Expenditures
➢ Revenue Expenditures
Capital Expenditures are all expenditures associated to purchase of non-current assets. All
expenses incurred in bringing the non-current asset to its present location and condition is part
of Capital Expenditures. All those expenses which increase the life of the fixed asset or improve
the performance of fixed assets are Capital Expenditures. All expenses incurred till the asset is
available for use for the very first time are part of Capital Expenditures. Any major expenses
without which running of a non-current asset become impossible is part of Capital Expenditure.
If an asset is bought for the business purpose, then printing the logo of company on that asset
is also part of Capital Expenditure.
Other Examples of Capital Expenditures include:
➢ Patents
➢ Copyright
➢ Royalty
➢ Trademark
➢ Franchise
➢ License
Revenue Expenditures are the day-to-day running costs of the business and hence are the
Expense part of ALCER. Example: Utility bills, rent, wages and salaries, re-painting, re-decoration,
repair and maintenance. The fuel filled in asset ‘after the first time’ is also Revenue Expenditure.
If an expenditure incurred on an asset does not qualify to be a major expenditure, then it is also
Revenue Expenditure.
Revenues are earnings or incomes of the business. It is very important to realize that there is a
difference between revenues and profits. Profits are obtained after deducting all expenses from
revenues.
Profit = Revenues – Expenses
When a business makes sales, it generates Revenue. Similarly, if business earns commission, it
earns Revenue. When business gives its property on rent, it results in Revenue.
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Revenues are also divided into 2 categories:
➢ Capital Income
➢ Revenue Income
Capital Income is the income generated through sale of non-current asset or when the owner
introduces additional capital into the business.
Revenue Incomes are the normal earnings of the business which are part of Revenue category
of ALCER. Example: sales of goods, commission received or rent received, profit from sale of non-
current asset, discount received etc.
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RECORDING OF TRANSACTIONS
Transactions are recorded on the basis of double-entry system in the ledgers. Ledgers are also
known as T-accounts because they are in the shape of T. On the T-accounts, there is a title
indicating which T-account is it. A T-account has 2 sides; the left-hand side is called the Debit Side
and the right-hand side is called the Credit Side. When the transactions are recorded, we have
to follow the double-entry system based on dual-aspect concept which states that every debit
will be followed by an equal ‘amount’ of credit.
TITLE OF T-ACCOUNT
DEBIT SIDE (DR) CREDIT SIDE (CR)
RULES OF DEBIT AND CREDIT
DEBIT: Anything that comes into the business is debited.

CREDIT: Anything that goes out of the business is credited.
ASSETS
DEBIT SIDE (DR) CREDIT SIDE (CR) Increases on Debit Side
+ - Decreases on Credit Side
LIABILITIES
DEBIT SIDE (DR) CREDIT SIDE (CR) Increases on Credit Side
- + Decreases on Debit Side
CAPITAL
EXPENSES
DEBIT SIDE (DR) CREDIT SIDE (CR) Increases on Debit Side
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+ - Decreases on Credit Side

REVENUES
SUMMARISING OF TRANSACTIONS
In order to summarize the transaction, we need to balance off the T-accounts and then extract a
Trial Balance. The Trial Balance is a list of balances extracted from the ledgers to check the
arithmetical accuracy of the ledgers. After making the trial balance, in order to summarize the
performance of the business, we should prepare the final accounts. Final accounts comprise of
Income Statement and Statement of Financial Position. Income Statement shows the
profitability position of the business whereas the Statement of Financial Position shows the
details of assets, liabilities and capital on a certain date.
INTERPRETATION/ANALYSIS OF TRANSACTIONS
Once the transactions are summarized, they need to be interpreted and analyzed whether the
performance of the business has improved, deteriorated or remained constant in comparison to
last year’s performance or competitor’s performance. If the performance of the business has
improved, what caused it and if the performance of the business has deteriorated, what went
wrong. The tool used to interpret the business performance is called Ratio Analysis.
COMMUNICATION
Once the performance of the business has been analyzed, it is extremely important to
communicate the findings to all the relevant stakeholders. Stakeholders are all those people who
are directly or indirectly associated to the business e.g. owners, investors, government
authorities, banks, customers, suppliers, prospective buyers, etc.
Once all transactions and entries are recorded in the ledgers, the T-accounts need to be balanced
off. To balance off a T-account, the T-account will act like a weighing machine which has to be
balanced off. The balance will be put on the smaller side and will be called Balance Carried Down.
Balance Carried Down is always recorded on the last day of the accounting period. The balance
which is carried down is also Brought Down on the first day of the next period.
One all ledgers are balanced off the next task is to prepare a Trial Balance. A Trial Balance is a list
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of balances extracted from the ledgers to check the arithmetical accuracy of the ledgers.
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BOOKS OF ORIGINAL ENTRY / PRIME ENTRY
Before the transactions are recorded in the ledger or the T-accounts, they have to be posted in
the books of Prime entry. There are 6 books of prime entry which are as follows:
Cash Book: All transactions that involve cash or bank will pass through the Cash Book. Cash Book
is not only a book of original entry, it is also a ledger and hence transactions once recorded in the
Cash Book, indicates that one part of double entry is complete.
Sales Day Book: All transactions that involve ‘credit sales’ of goods are passed through this book.
It is also called Sales Journal.
Purchases Day Book: All transactions that involve ‘credit purchases’ of goods are passed through
this book. It is also called Purchases Journal.
Sales Returns Journal: It is also known as Returns Inwards Day Book. When our customers return
us goods which we had previously sold to them on credit is part of this book.
Purchases Returns Journal: It is also known as Returns Outwards Day Book. When we return
goods to our suppliers which we had previously bought on credit, it will pass through this book.
General Journal: All those transactions which do not come in any of the above 5 books are to be
passed through this book. In other words, all those transactions that neither involves cash, nor
bank or goods are passed through this book. Hence, credit purchases of non-current assets, credit
sales of non-current assets or return of non-current asset on credit will pass through this book.
Any amendment or correction of error will also pass through this book. Opening and closing
entries will also pass through this book.
Sometimes a 7th Book of Original entry is also used known as Petty Cashbook. Large
Organizations that have lots of transactions make use of the petty cashbook. All those
transactions that involve cash but of petty-small amount are passed through this book, so that
the burden of the main cashier is reduced and errors and omissions are avoided.
Petty Cashbook is based on imprest system. Imprest System means that first time a certain
amount is transferred from the main cashbook to the petty cashbook. Then all transactions which
are lower than a certain amount is passed through the petty cashbook and total amount spent
from the petty cashbook are compensated from the main cashbook at the end of each month.
This process of compensating is called reimbursement. Compensation is done so that the opening
and closing balance of the petty cashbook remains same. When opening and closing balances are
same it is called maintaining the petty cash float and the whole of this process is called Imprest
System.
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Once the transactions are recorded in the Books of Original entries they are posted to the ledgers.
Ledgers are divided into four categories:
1. Cashbook is not only a book of original entry but also a ledger. Transactions once posted in the
cashbook indicate one part of double entry is complete and hence we are not supposed to make
cash and bank account again, because they are already incorporated in the cashbook.
2. Sales Ledger contains accounts of all trade receivables.
3. Purchases Ledger contains accounts of all trade payables.
4. General Ledger contains accounts of all assets, liabilities, capital, expenses and revenues other
than cash, bank, trade receivables and trade payables.
ACCOUNTING TERMINOLOGIES
Sales/Revenues are the goods sold which were previously bought with an intention of re-sale.
Purchases are goods bought with an intention of re-sale.
Sales Returns are the goods retuned to us by our customers which we have previously sold to
them on credit.
Purchases Returns is when we return goods to our suppliers which we have previously bought
on credit.
Goods are all those things that a business trades in.

Inventory (previously known as Stock of Goods) are the goods bought or produced with an
intention of resale yet unsold.
Drawings: Whenever owner withdraws anything from the business, be it cash, goods or non-
current assets for personal use, it is called Drawings.
Contra is when an item does not fall in any category of ALCER but has opposite features of some
categories, and then it is called Contra of that category.
Discount is of two types:

Trade Discount is given on good bargain position and bulk purchase. It is NOT recorded anywhere
in the Books of Accounts. It is only present in the invoice.
Cash Discount is given on prompt payment and is of two types. Discount Allowed is when the
business allows discounts to its customers and is an expense. Discount Received is when the
business receives discounts from its suppliers and is an Income/Revenue. Cash discount is
recorded in the cashbook and its ledgers are present in the General Ledger.
Invoice Price/List Price minus Trade discount is equal to Purchase Price

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Purchase Price minus Cash discount is equal to Amount Paid.

ADJUSTMENTS TO FINAL ACCOUNTS
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Final Accounts are divided into 2 categories,
➢ Income Statement
➢ Statement of Financial Position
Income Statement:
It indicates profitability position of the business and indicates the earning capacity of the
business. It helps us in finding how much revenue is generated and through what sources and
how much expenses are incurred and by what means. It was previously known as Trading and
Profit and Loss Account.
Statement of Financial Position:

It shows the details of assets, liabilities and capital on a certain date. It was known as Balance
Sheet.
FINAL ACCOUNTS are prepared when the accounting year ends but it is published after 3 months.
Any changes occurring during these 3 months which impacts the figures of the previous year are
called Adjustments and hence they must be taken into consideration before the final accounts
are published so that the financial statements reflect a true and fair view of the business
performance and are reliable. Some adjustments that need to be incorporated are as follows:
Prepayments: They are also known as Prepaid Expenses or Expenses paid in advance. These are
the expenses paid but not yet incurred and hence are the current assets of the business. For
Example, School fees.
Accruals: They are the expenses incurred but not yet paid. They are the expenses due but unpaid
and are also known as Accrued Expenses, Outstanding Expenses and Owings. For
Example, Utility bills. Hence, accruals are the current liabilities of the business.
Accrued Income: They are the incomes earned but yet not received. They are also known as
Arrears and are current assets for the business. Example, Commission of a commission agent
Pre-received Income / Unearned Income: They are the incomes received (in advance) but yet
not ‘earned’ and hence are the current liabilities of the business. Example, school fees for the
school.
NOTE: At the end of the accounting period, all expenses and all revenues are transferred to the
Income Statement or profit and loss account.
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EXPENSES
Prepayments b/d xxx Accruals b/d xxx
Cash/Bank xxx Income Statement xxx
Accruals c/d xxx Prepayments c/d xxx
xxx xxx
PAAP
REVENUES
Accrued Income b/d xxx Pre-received Income b/d xxx
Income Statement xxx Cash/Bank xxx
Pre-received Income c/d xxx Accrued Income c/d xxx
xxx xxx
APPA
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ACCOUNTING CONCEPTS
Accounting Concepts are the guidelines and the principles based on which the whole accounting
system lies and which needs to be followed when passing accounting entries. The accounting
concepts are as follows:
1. Dual Aspect Concept: This concept states that accounting is based on double-entry system
which means that every debit will be followed by an ‘equal amount’ of credit.
E.g. Cash 5000
Bank 10000
Capital 15000
Cash 500
Bank 200
Commission received 700
Rent Expense 2500

Cash 500
Bank 2000
2. Money Measurement Concept: This concept states that only those transactions are recorded
in the books of accounts that have a monetary value (otherwise it will not be a transaction).
3. Business Entity Concept: This concept states that business is a separate legal entity different
from its owners which has a legal status. It has its own name, bank account on its personal name
and is responsible for its own actions. It can sue and it can be sued.
(The concept of “Drawings” exist because of this concept)
4. Going Concern Concept: This concept states that a business will continue its course of
operations in the foreseeable future. Foreseeable future is different for different businesses. For
a normal business, foreseeable future is at least an accounting period but for a high-tech industry
or oil-rigging company, foreseeable future can be as long as 10 years.
If the business plans to shut down, it must disclose it to all its relevant stakeholders that the going
concern concept has been hampered.
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5. Materiality Concept: This concept states that an item which is an asset for a small business,
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the same item might be an expense for a much larger business.

6. Consistency Concept: This concept states that accounting policies and procedures should not
vary from one accounting period to another. Only if the business feels that the current policy or
procedure is not reflecting the true and fair value of the business, then it is allowed to change
the policy once. But once the policy is changed, the business cannot revert back to old policy and
it must disclose why the policy has been changed.
7. Historical Cost Concept: This concept states that ‘non-current’ assets should be recorded in
the books of accounts at their original cost including all capital expenditures, despite any loss in
the value of non-current assets until and unless the asset is revalued or disposed off.
8. Prudence Concept: This concept states that expected losses are to be recorded in the books
of accounts as soon as they are expected whereas expected profits are not to be recorded until
and unless they are actually realized.
9. Accrual Concept: This concept states that expenses should be recorded as soon as they are
incurred irrespective of the fact whether they are paid or not. Similarly, profits will be recorded
as soon as they are ‘earned’ irrespective of whether they are received or not.
10. Matching Concept: This concept states that expenses of one year are to be matched with the
revenues of that year.
11. Substance over form: If an asset is bought on hire purchase or lease then despite the fact
that the asset is not yet owned by the business, it will still be treated as the non-current asset
and the amount not yet paid will be treated as liability of the business. It is also known as
‘Commercial Reality Concept’.
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DEPRECIATION
Depreciation is the loss in the value of fixed (non-current) assets over their useful life. It is charged
so that the cost of the asset could be distributed amongst the number of years it will be used as
per “Prudence” and “Matching” Concept.
Why does asset lose its value?
1. Time factor
2. Technological changes
3. Obsolescence
4. Wear and tear
5. Depletion
6. Inadequacy
7. Damage
8. Usage
Methods of charging Depreciation:
There are 7 methods of charging depreciation:
1. Straight line method
2. Reducing balance method
3. Revaluation method
4. Usage method
5. Mileage method
6. Depletion method
7. Sum of year digit method
Straight Line Method:
This school of thought suggests that same amount of depreciation is charged each year
throughout the life of the asset. The formula to calculate depreciation is
Depreciation = Cost – Scrap Value
Estimated Useful Life
Cost Price =Purchase Price + All capital expenditures
Scrap Value is the value generated from the asset once it is no more in the usable condition. (Also
known as Residual Value and Salvage Value)
Estimated useful life is an assumption as to how long will the asset be used in the business.
In order to find the “rate of depreciation”, we apply the following formula:
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Depreciation Rate = Depreciation x 100

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Cost
Straight line method of depreciation is also called “Depreciation on Cost”.
DEPRECIATION REPAIR AND MAINTENANCE TOTAL
YEAR 1 9000 0 9000
YEAR 2 9000 2000 11000
YEAR 3 9000 2500 11500
YEAR 4 9000 3500 12500
YEAR 5 9000 5000 14000
Example:
Given that the cost of an asset is $50000 which is expected to be sold for $5000 after being used
for 5 years. Find depreciation per year and the rate of depreciation.
Cost = 50000
Salvage Value = 5000
Life = 5 years
Depreciation = 50000-5000 = $9000/year
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Depreciation Rate = 9000 x 100 = 18%
50000
Cost 50000
Less: Year 1 Depreciation (9000)
Net Book Value/Reduced Cost 41000 (Also known as Written-down value)
Net Book Value/Reduced Cost 32000
Salvage Value 5000
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Reducing Balance Method:
This school of thought suggests that more depreciation must be charged in the initial years than
in the later years. This is because when the asset is new, it has little or no maintenance cost but
as asset gets older, the burden of ‘repair and maintenance’ starts increasing, therefore in order
to equalize the burden of asset, it is very important that initially more depreciation should be
charged and in later years, less depreciation to be charged.
Reducing balance method of depreciation is also known as “Depreciation on written-down
value”
Net Book Value/Reduced Cost/Written-down value = Cost – Accumulated Depreciation
DEPRECIATION REPAIR AND MAINTENANCE TOTAL
YEAR 1 12000 0 12000
YEAR 2 10000 2000 12000
YEAR 3 9000 2500 11500
YEAR 4 8000 3500 11500
YEAR 5 6000 5000 11000
Example:
Given that the cost of an asset is $50000 and it is to be depreciated using reducing-balance
method at the rate of 20% per annum. Find depreciation charges each year.
Cost 50000
Less: Year 1 Depreciation 20% of 50000 (10000)
Scrap Value 16384
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Formula to find the rate of depreciation using reducing balance method:
Rate = 1 - n√(R/C)
Where, R is the residual value
C is the cost
n is the estimated life in years
Example:
Given that the cost of an asset is $50000, it will be used for 5 years and has a residual value of
$10000. Find the rate of depreciation to be charged using reducing-balance method and also find
the depreciation charge each year.
R= 10000
C= 50000
n= 5 years
Rate = 1 – 5√10000/50000 = 27.5%
Cost 50000
Less: Year 1 Depreciation 27.5% (13750)
Scrap Value 10015
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STRAIGHT-LINE METHOD (DEPRECIATION PER YEAR)
10000
9000
8000
DEPRECIATION
7000
6000
5000
4000
3000
2000
1000
0
Year 1 9000
Year 2 9000
Year 3 9000
YEAR
Revaluation Method:
This school of thought suggests that depreciation should be based on market value of asset and
specifically applied to loose tools and land whose value changes as per the change in market
value.
Opening value of asset xxx
Add: Purchase of asset xxx
Less: Sale of Asset (at NBV) (xxx)
Less: Closing value of asset (xxx)
Depreciation for the year xxx
Usage Method:
This school of thought suggests that depreciation on an asset should be charged as per their
usage. The more the asset will be used, the higher the depreciation will be charged. This method
of depreciation is suitable for those assets which have a fixed life, either in terms of number of
hours or in terms of number of units produced. Hence, the formula to calculate depreciation is:
Depreciation = Units Produced x (Cost – Scrap Value)
Total Life In Units
Depreciation = Hours Consumed x (Cost – Scrap Value)
Total Life In Hours
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Example: Printer
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Year 1: 15000 pages Depreciation= 15000 x (79000-4000) = 22500
50000
Year 2: 10000 pages Depreciation= 10000 x (79000 - 4000) = 15000
50000
Year 3: 5000 pages Depreciation=5000 x (79000 - 4000) = 7500
50000
Year 4: 12000 pages Depreciation= 12000 x (79000 - 4000) = 18000
50000
Year 5: 8000 pages Depreciation=8000 x (79000 - 4000) = 12000
50000 pages 50000
Mileage Method:
This method is applied on vehicles, ships and airplanes. All vehicles have a life in terms of the
distance that they will travel and hence it is extremely important to depreciate them using
mileage method in accordance with the distance travelled.
Depreciation =Distance Travelled x (Cost – Scrap Value)
Total Life In Miles
Example: Given that a vehicle has a life of 3 years during which it can travel a maximum of 80000
miles. The expected mileage for the three years is; Year 1: 20000; Year 2: 25000, Year 3: 35000.
The cost of the vehicle is $175000 and it will be sold after 3 years for $1500.
Year 1: Depreciation=20000 x (175000 - 1500) = 40000
80000
80000
80000
Depletion Method:
This method is applicable on natural resources such as oil wells, coal mines and gas resources.
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Depreciation = Natural resources extracted x Cost

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Total natural resources available

Sum of years Digit method:
This school of thought suggests that depreciation should be charged on the basis of the life of
the asset. The more the life is left, the higher the depreciation is charged.
Example
Cost: 32000
S.V: 2000
Life: 5 years
1+2+3+4+5 = 15
Year 1: Depreciation= 5 x (32000 - 2000) = 10000
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Q - Apply all the depreciation methods on the given data:

Cost: 30000
R.V: 3000
Life: 3 years
How to record Depreciation?
✓ Depreciation Expense for the year
✓ Provision for Depreciation Accumulated Depreciation (Contra Asset)
Double Entries to record Depreciation:
Income Statement DR xxx
Provision for Depreciation CR xxx
Disposal of an asset:
Net Book Value/Reduced Cost/Written-down value = Cost – Accumulated Depreciation
Case 1:
Cost 50000
Less: Accumulated Depreciation (42000)
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Net Book Value 8000

Less: Sales Proceeds (5000)
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Loss on Disposal 3000

Case 2:
Cost 50000
Net Book Value 8000
Gain on Disposal (2000)
Case 3:
Cost 50000
Net Book Value 8000
No Gain / No Loss 0
1. If NBV > Sales Proceeds Loss on Disposal

2. If NBV < Sales Proceeds Gain on Disposal
3. If NBV = Sales Proceeds No Gain / No Loss
Question 1:
A company buys 2 machines worth $10000 each on 1st Jan 2010. The company’s policy is to
depreciate all its non-current assets at the end of each year at the rate of 20% per annum using
reducing balance method. At the end of the second year after allowing the second year’s
depreciation, the company decided to dispose off one of the assets for $5000. On the same day,
a new machine worth $13000 was bought. You are required to prepare showing all workings
clearly:
1) Machinery A/C 2) Provision for Depreciation A/C

3) Income Statement Extract 4) Disposal A/C
Question 2:
A company bought 2 machines worth $7000 each paying by cheque on 1st Jan 2012. The
company’s policy is to charge depreciation at the rate of 30% per annum using straight line
method. After allowing the 2 year’s depreciation, one of the assets is sold for $3000. On the same
date, another asset worth $10000 is bought by cheque. You are required to prepare showing all
workings clearly:
1) Machinery A/C 2) Provision for Depreciation A/C
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3) Income Statement Extract 4) Disposal A/C

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There are 3 policies with regards to charging of depreciation:
1. Full year’s depreciation in the year of purchase and no depreciation in the year of sale.
This means that whatever date we buy the asset, whether beginning of the year or at the
end of the year or during the year, we will charge full year’s depreciation. And whatever
date we sell the asset, no depreciation will be charged.
2. Full year’s depreciation in the year of sale and no depreciation in the year of purchase.
3. When the question is silent and does not mention any policy, then it means that
depreciation will be charged on Pro-Rata basis, i.e. monthly basis.
NOTE: There is a difference between accounting year and calendar year. Calendar year begins in
January and ends at December whereas Accounting year will be duration of 12 months starting
from any date. Depreciation is charged at the end of the accounting year (not at the end of the
calendar year).
Schedule of Non-Current Assets
It shows the details of the cost of the asset, purchase of asset during the year, sale of asset during
the year and the closing balance of asset. Moreover, it shows details of depreciation; opening
balance of depreciation, depreciation charge during the year, depreciation on disposal of asset,
and closing balance of depreciation. The schedule of asset also shows the closing net book value
obtained by deducting closing depreciation by closing value of asset.
Cost Vehicles Plant & Machinery Equipment Total
Opening balance xxx xxx xxx xxx
Purchase of asset xxx xxx xxx xxx
Sale of Asset (Cost) (xxx) (xxx) (xxx) (xxx)
Closing Balance xxx xxx xxx xxx
Depreciation
Opening balance xxx xxx xxx xxx
Charge for the year xxx xxx xxx xxx
Dep. charged on Disposed assets (xxx) (xxx) (xxx) (xxx)
Closing Balance xxx xxx xxx xxx
Net Book Value xxx xxx xxx xxx
Which method of depreciation is best suited for which assets?

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✓ Straight line method is best suited for those assets which loose their value slowly and
gradually and almost equally with the passage of time such as furniture, buildings and so
on.
✓ Reducing Balance method is best suited for high tech item which looses their value
rapidly such as plant and machinery, equipments, computers and so on.
✓ Revaluation method is best suited for those assets whose values cannot reliably be
measured and depends on market rates. Even those assets which do not have significant
value in isolation but as a whole many items have a significant worth such as loose tools,
even land is depreciated using reducing balance method.
✓ Units produced method is best suited for those assets which can only produce a certain
specified units over their entire life such as moulding machines, printing machines and
so on.
✓ Mileage method is best suited for vehicles such as trains, ships, cars, aero planes etc.
✓ Depletion method is best suited for natural resources such as oil wells and coal mines.
✓ Sum of year's digit method is best suited for those assets who have a short life and as
assets gets older its worth falls significantly such as any new product launched in the
market.
BAD DEBTS
If the customer who owes us money refuses to pay back the amount he owes, it is called ‘bad
debt’. Bad Debt is an actual loss and hence is an expense for the business. The double-entries to
record bad debt are:
Bad Debt Expense DR xxx
Trade Receivables CR xxx
Bad Debt Expense CR xxx
Reasons why a receivable becomes bad debt:
✓ He becomes bankrupt
✓ Receivable becomes mentally retarded
✓ The receivable dies
✓ Debtor runs away
✓ Refuses to pay
Provision for Bad Debts

Provision for bad debts is an expected loss. If we expect that the receivables will not pay us back
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the amount that they owe, than they will be considered as expected losses and as per Prudence
Concept, expected losses are to be recorded as expenses as soon as they are expected.
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Doubtful Debts is of two types:
1. Specific Provision is when a business feels that a particular customer will fail to pay back
the amount he owes then the business creates specific provision.
2. General Provision is when the business feels that amongst all customers a certain
percent will fail to payback then it will create general provision.
Provision for doubtful debt if given as a percentage is always charged on the net debt figure i.e.
receivables minus bad debts. Moreover if there are any specific provisions then general provision
will be charged on the net debt figure after specific provision has been deducted from it.
The total provision will be the sum of specific provision and general provision and the double
entries will be made by taking into consideration the total provision.
Double Entries to record Provision for Bad Debts:
Provision for Bad Debts CR xxx
What are the factors to be considered in deciding the rate of provision for bad debts?
✓ Past Experience
✓ Economic Conditions
✓ Credit worthiness of receivables
✓ Age of debts
✓ Industry averages
NOTE: Since provision for Bad Debt is Contra-asset therefore,
Increase in provision:
Provision for Bad Debts CR xxx
Decrease in provision:
Provision for Bad Debts DR xxx
Income Statement CR xxx
Bad Debts Recovered

The person who has previously been recorded as Bad Debt suddenly comes back and pays you
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back the amount he owes. Such a person is known as ‘Bad Debts Recovered’. Bad Debts
Recovered is the Revenue for the business and hence the double-entries to record bad debts
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recovered are as follows:

Trade Receivables DR xxx
Bad Debt Recovered CR xxx
Bank DR xxx
Trade Receivables CR xxx
Bad Debt Recovered DR xxx
Income Statement CR xxx
NOTE: If a debtor becomes bad debt and is recovered the same year, it is neither bad debt nor
bad debt recovered. Instead, it will be considered as normal treatment of debtor paying us back.
Example:
At the end of December 2011, receivables amounted to $12500 of which receivables worth
$1500 proved to be bad. It is the company’s policy to charge provision for bad debts at the rate
of 2% per annum. At the end of 31st December 2012, receivables amounted to $17500 of which
receivables worth $2500 proved to be bad. On 31st December 2013, receivables amounted to
$10500 of which receivables worth $500 proved to be bad. You are required to prepare, showing
all workings clearly, the following accounts:
1) Bad Debts A/C 2) Provision for Bad Debts A/C
3) Income Statement Extract
Provision for Discount Allowed
When our customers pay us within time, we allow them a discount for prompt payment which is
expense for the business, therefore if the business expects that some of its customers will pay
the business back on time to avail discounts, it has to prepare a provision for discount allowed,
which is an expected loss. The accounting treatment of provision for discount allowed is exactly
the same as provision for bad debt. Therefore, the double-entries to record provision for discount
allowed are as follows:
Provision for Discount Allowed CR xxx
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FINAL ACCOUNTS
IMPORTANT POINTS TO CONSIDER WHEN MAKING FINANCIAL STATEMENTS:
1) Closing Inventory is always ‘counted’ at the end of the accounting period. We do not
prepare the account of closing inventory instead closing inventory is counted by
techniques of inventory valuation. The amount of closing inventory is always part of
income statement and the statement of financial position.
2) If the adjustments to final accounts involve both opening and closing accruals and
prepayments, then in order to find the figure for expenses and revenues, we have to apply
PAAP (expenses) and APPA (revenues).
3) If adjustments to final accounts only involve closing prepayments, then closing

prepayments will be deducted from the expenses figure given in the trial balance. The
amount hence obtained will go to income statement as expenses and the amount of
prepayment will go to statement of financial position as current assets.
4) If only closing accrued income are given in adjustments to final accounts, then in order to
find the income figure, we will add accrued income to the income figure given in the trial
balance. The amount hence obtained will go to income statement as other incomes and
the amount of accrued income will go to statement of financial position as current assets.
5) If only closing accruals are given in adjustments to final accounts, then in order to find the
expenses figure, we will add accruals to the expense figure given in the trial balance. The
amount hence obtained will go to income statement as expenses and the amount of
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accruals will go to statement of financial position as current liability.

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6) If only closing pre-received income are given in adjustments to final accounts, then in
order to find the income figure, we will deduct pre-received income from the income
figure given in the trial balance. The amount hence obtained will go to income statement
as other incomes and the amount of pre-received income will go to statement of financial
position as current liability.
7) If the adjustment states that a certain percentage of depreciation is to be charged on the

non-current asset and no previous depreciation is given in the trial balance, then the rate
of depreciation will directly be charged on the cost of the asset and the amount hence
obtained will go to income statement as expenses and will be deducted from the cost of
the asset in the statement of financial position.
8) If the question states that depreciation is to be charged on cost, it indicates that straight-
line method of depreciation is to be charged. In order to do so, the rate of depreciation
will be charged on the cost of the asset. The amount hence obtained is depreciation for
the year and hence will be charged to the income statement as expense. Accumulated
depreciation (i.e. current year’s depreciation just found and the previous year’s
depreciation given in the trial balance) will be transferred to the statement of financial
position as a deduction from non-current assets.
9) If the adjustment states that depreciation is to be charged on the reduced cost or the net-
book value or written down value, it indicates that reducing balance method is to be
charged. In order to do so, we will first deduct the depreciation given in the trial balance
from the cost of the asset; the amount hence obtained is the net-book value and is subject
to the rate of depreciation. When this rate of depreciation will be charged on the net-
book value, the amount obtained will be depreciation for the year and will go to the
income statement as an expense. The accumulated depreciation will go to the statement
of financial position.
10) Whenever the owner withdraws anything from the business for his own use, it is
Drawings. If the owner withdraws cash, it is known as Cash Drawings and the double-
entries to record cash drawings is
Drawings DR
Cash CR
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✓ If the owner withdraws non-current assets, it is referred to as non-current assets

drawings and the double-entries to record this is
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Drawings DR
Non-Current Assets CR
✓ If the owner withdraws goods from the business for his own use, it is called Stock
Drawings and the double-entries to record stock drawings is
Drawings DR
Purchases CR
11) If the bad debt figure is given in the trial balance, it indicates that the receivable figure in
the trial balance is the net receivable figure and hence the percentage of provision will
directly be charged on this figure
✓ If the bad debt figure is given in the adjustments to final accounts, it means that
the receivable figure in trial balance is not the net receivable figure therefore in
order to achieve the net receivable figure, bad debt should be deducted from the
receivable figure given in the trial balance. The amount hence obtained will be
subject to provision for bad debts.
✓ Provision for bad debts will be charged on the amount of net receivable. The
amount hence obtained will go to statement of financial position as deduction
from receivables. If there is no provision for bad debts given in the trial balance,
the same amount will also go in the income statement as an expense.
✓ If previous provision for bad debts is given in the trial balance, then the current
year’s estimate will be deducted from it.
✓ If there is increase in provision, it will be treated as an expense and if there is
decrease in provision, it will be treated as revenue.
✓ If it is stated that provision for bad debt is to be ‘created’, it means that there will
be no previous estimate, hence the same amount will be charged in income
statement as an expense and statement of financial position as deduction from
receivables.
✓ Whether bad debts are given in trial balance or adjustments to final accounts,
they will always be treated as an expense.
12) If provision for discount allowed is given in adjustments, then the accounting treatment
of provision for discount allowed is exactly the same as provision for bad debt.
13) If a new business is commenced or started, then there will be no opening inventory.
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14) If premises are sub-let, it means that they have been given on rent and hence income
from such premises is the revenue of the business.
15) Whenever the question involves preparation of financial statements for the half-year
ended, all things remain intact except for current year’s depreciation. In questions
involving half-year, depreciation is to be halved.
16) If you are required to prepare income statement for the quarter ended, then all other
things will remain intact except for depreciation, which has to be divided by 4.
17) If you are required to prepare income statement for a month, then all other things will
remain intact except for depreciation which needs to be divided by 12.
18) Expenses are divided into 2 categories; Expenses associated to Purchases and expenses
associated to sales.
✓ Expenses which are associated to Purchases should be part of Cost of Goods Sold
and hence must be included in the trading account section of income statement.
Examples of expenses associated to purchases are Carriage Inwards, Freight
Charges, Custom Duties, Packaging, Wages and Salaries for preparation of goods
for sale and so on.
✓ Expenses which are associated to Sales are all those expenses which are part of
day to day running cost of the business and hence should be part of Profit and Loss
account of Income Statement and hence must be deducted from the gross profit
as expenses.
EXPENSES
Associated to Purchases Associated to Sales
Added to Cost of Goods

Added to Expenses
Sold
Part of Profit and Loss

Part of Trading Account
Account
19) Whenever goods are damaged, destroyed, lost or robbed and no insurance claim is
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accepted against it then it is an expense of the business, and the double entries are
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Income Statement DR
Purchases CR
✓ If goods are damaged, destroyed, lost or robbed and full insurance claim is accepted but
yet not received, then the insurance claim of the insurance company will be treated as
current assets and the double entries will be
Insurance claim DR
Purchases CR
✓ If partial claim is accepted but yet not received, then the amount accepted will be treated
as current assets and the amount not accepted will be treated as loss (expense) of the
business, and hence the double entries will be
Income Statement DR
Insurance claim DR
Purchases CR
20) If the rate of interest is given in adjustments to final accounts, it will be charged on the
amount of loan and the amount hence obtained is the interest expense for the year,
which will be charged to income statement as an expense. The amount of interest given
in the trial balance is the interest paid and the difference between interest incurred and
the interest paid are the accrued interest which will go to the Statement of Financial
Position as current liabilities.
21) If the amount of loan is given in trial balance it will be treated as non-current liability. If
the adjustment states that part of the loan is to be repaid within an accounting period
then the amount which is to be repaid will be treated as current liability. But the interest
will be charged on the whole outstanding amount whether it will be paid after an
accounting period or within an accounting period.
22) Stationery is the only thing in accounting which is current asset as well as expense of the
business. The amount of stationery used during the year is an expense while the amount
of stationery left unused is current asset.
23) If an asset is bought on hire purchase or lease then the total cost of asset will be treated
as non-current assets and the amount paid will already be deducted from bank and the
amount not yet paid will be treated as a liability.
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24) If disposal is written in the Trial Balance then we have to check whether it is written on
the Debit side or Credit side. If it is written on the debit side then it will be Loss on Disposal
(Expense) but if it is written on credit side then it is Gain on Disposal (Income).
25) Whenever the owner gives loan to the business it will not be treated as Capital instead it
will be treated just like any other non-current liability whose interest will be charged
normally as an expense. If it is included in error as Capital then we will deduct the amount
of loan from Capital and add it to the long-term liabilities.
26) If the business has given loan to the owner or an employee or anyone else then it is the
asset of the business and will be written in between the non-current asset and the current
asset.
27) If the assets disposal account is given in adjustments to final accounts then usually it is
made incorrectly `and we need to correct the errors in it. Usually gain or loss on disposal
is omitted from it because of which the value of asset is recorded incorrectly and hence
depreciation is calculated incorrectly.
RAJ INDUSTRIES
INCOME STATEMENT FOR THE YEAR ENDED 31 DEC 2013
$ $ $
Sales xxx
Less: Sales Returns (xx) xxx
Less: Cost of Goods Sold
Opening Inventory xxx
Purchases xxx
Less: Purchases Returns (xx) xxx
Carriage Inwards xxx
Cost of Goods Available for sale xxx
Less: Closing Inventory (xx) (xxx)
Gross Profit xxx
Add: Other Incomes

Discount Received xx
Gain on Disposal xx
Bad Debts Recovered xx
Decrease in provision xx
Commission Received xx
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Rent Received xx xxx

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xxx
Less: Expenses
Rent xx
Utility xx
Depreciation xx
Discount Allowed xx
Loss on Disposal xx
Increase in provision xx
Carriage outwards xx
Wages and Salaries xx
Interest xx (xxx)
Profit / (Loss) for the year xxx
RAJ INDUSTRIES
STATEMENT OF FINANCIAL POSITION AS AT 31 DEC 2013
$ $ $
Intangible Non-Current Assets
Goodwill xxx
Patent xxx xxx
Tangible Non-Current Assets
Equipment xxx (xxx) xxx
Land and Building xxx (xxx) xxx
xxx xxx xxx
Current Assets
Inventory xxx
Receivables (Net) xxx
Less: Provision for bad debts (xx)
Less: Provision for discount allowed (xx) xx
Prepayments xx
Bank xx
Cash xx xxx
Total Assets xxx
Equity and Liabilities
Equity
Opening Capital xxx
Add: Net Profit xxx xxx
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Less: Drawings (xx)

Closing Capital xxx
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Current Liabilities
Payables xxx
Accruals xxx
Bank Overdraft xxx
xxx
Non-Current Liabilities
Debentures xxx
Loan from XYZ xxx xxx
Total Equity and Liabilities xxx
WHAT IS AN INTANGIBLE ASSET?
Intangible Non-Current Assets are those assets which involve good reputation of the business
such as goodwill or some worthy asset such as patents.
(This is the most basic definition. We will go into further details later)
NOTE:
Current Assets must always be written in the reverse order of liquidity (ability of asset to turn
into cash) i.e.
Inventory
Receivables
Prepayments
Bank
Cash
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SOURCE DOCUMENTS
11) Receipt
9) Statement of Account
8) Credit Note
6) Statement of Account
4) Sales Invoice
2) Quotation
BUYER SELLER
1) Request for Quotation
3) Purchase order
5) Goods Received Note
7) Debit Note
10) Cheque Counterfoil
Source Documents are the accounting documents that all businesses keep in order to have a
proof that transaction between two parties takes place. From the source documents
transactions are made and then they are recorded for the whole accounting cycle to take place.
✓ Request for Quotation When the buyer is searching for the suppliers who would
provide them with the desired products they sent a request for quotation.
✓ Quotation is the document sent by the seller to the buyer providing details of all
products available their prices, colour, quality, model and so on. It also mentions
discount policies and payment methods.
✓ Purchase Order is sent by the buyer to the seller whose quotation has been accepted
indicating the products that are required and quantity needed.
✓ Sales Invoice is sent by the seller to the buyer along with the goods supplied indicating
the products that are sent, their quantity, price and discounts. The payment policy is
also mentioned.
✓ Goods received note is sent by the buyer to the seller indicating the goods that have
37
been received.
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✓ Statement of Account is the summary of transactions between the buyers and sellers
which is always sent by the seller to the buyer indicating the outstanding balance that
the buyer needs to pay and the summary of transactions between the buyer and the
seller.
✓ Debit Note is sent by the buyer to the seller if he wishes to return goods to the supplier
and informing him that the buyer has debited the account of the seller.
✓ Credit Note is sent by the seller to the buyer once he has accepted the goods returned
to him acknowledging his mistakes and informing the buyer that his account has been
credited.
✓ Cheque/Cheque counterfoil Cheque is a document sent by the buyer to the seller in
order to settle his outstanding balance and cheque counterfoil is kept as a proof by the
buyer that payment has been made.
✓ Receipt is the document sent by the seller to the buyer acknowledging that the
payment has been received.
Debit Note Issued: Returns Outwards

Debit Note Received: Returns Inwards
Credit Note Issued: Returns Inwards
Credit Note Received: Returns Outwards
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DEPARTMENTAL ACCOUNTING
Some businesses operate more than one department and hence it is very important to identify
how much profit has each department made so that it could be justified whether the department
should continue to exist or should shut down. Moreover, expenses of each department should
be identified in isolation so that it could be analyzed which department has how much share of
expenses. Even the performance of department managers is dependent upon the performance
of their respective departments as their commission is based on the performance of their
department.
The accounting treatment of questions involving departmental accounting comprises of
preparation of:
✓ Columnar Income Statement
✓ Statement of Financial Position
Columnar Income Statement means each department is allotted two columns and there is also
a column for total to reflect the overall performance of the business. The most important task of
questions involving departmental accounting is to distribute the expenses amongst the different
departments appropriately. Usually the question will provide the basis of distribution of expenses
but if the question is silent we will distribute rent in basis of floor area, wages and salaries on the
basis of number of employees, depreciation on the basis of cost of asset, utility bills on the basis
of floor area advertising and other selling expense on the basis on sales and so on.
Statement of Financial Position is made as normally and total profit is taken into consideration.
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VALENTINE GIFT SHOP
DEPARTMENTAL INCOME STATEMENT FOR THE YEAR ENDED ______
Fresh Flowers Cards Chocolates Total
Sales Xx xx xx Xx
Opening Inventory xx xx xx
Purchases xx xx xx
Costs Associated to Purchases x x x

Cost of Goods Available for sale xx Xx xx
Less: Closing Inventory (xx) (xx) (xx) (xx) (xx) (xx) (xx)
Gross Profit xxx xxx xxx Xxx
Add: Other Incomes
Discount Received xx xx - Xxx
Gain on Disposal xx xx xx xxx
xxx xxx xxx xxx
Less: Expenses
Rent xx xx xx
Wages and Salaries xx xx xx
Utility bills xx xx xx
Depreciation of Refrigerator - - xx
All other expenses to be distributed xx xx xx
as per department xx (xx) xx (xx) xx (xx) (xx)
Profit for the year xxx xxx xxx xxx

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BANK RECONCILIATION STATEMENT
Every month the business receives bank statement from the bank which is compared by the
business with the cash book that the business prepares. Officially the balance of the bank
statement at the end of the month should be equal to the balance of the cash book at the end of
the month but unfortunately this is not the case and there is a need to reconcile the cash book
with the bank statement so that the causes of the discrepancies could be identified and removed.
The causes of the discrepancies between the cash book and the bank statement are as follows:
STANDING ORDER:
When the business instructs the bank to transfer a fixed amount of money on a fixed date to a
fixed person’s account, it is called Standing Order. It is immediately recorded in the bank
statement but will be recorded in the cash book once the bank statement is received. It is also
known as Banker’s Order.
DIRECT DEBIT:
If a certain amount of money is transferred from the business bank account to some person’s
account on a particular date, it is known as Direct Debit. It is immediately taken into consideration
by the bank but will be recorded in the cash book once the bank statement is received.
CREDIT TRANSFER:
When someone transfers a certain amount of money directly into the business bank account
without informing the business, it is known as Credit Transfer, and it will be immediately recorded
by the bank but will be recorded in the cashbook when the bank statement is received. It is also
known as Bank Giro.
BANK CHARGES:
Bank charges are service charges for providing services to the business. These charges vary each
month depending on the services of the bank utilized and hence are not known by the business
till the bank statement is received, but are immediately taken into consideration by the bank.
INTEREST ON OVERDRAFT:
If bank overdraft facilities are availed by the business, the bank charges interest to the business
against the overdraft facilities. Interest on overdraft is an expense for the business which is
immediately taken into consideration by the bank, but will pass through business accounts once
the bank statement is received.
INTEREST ON DEPOSIT:
When business deposits a certain amount of money into the bank, it receives interest on it which
is an income for the business. Interest on deposit will be immediately taken into consideration
by the bank, but will be recorded in the cashbook once the bank statement is received.
DISHONOURED CHEQUES:
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Dishonored Cheques are the cheques which are returned unpaid. These are the Bounced
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Cheques which are immediately taken into consideration by the bank but will pass through the
business books once the business is informed by the bank or when the bank statement is
received.
All the above-mentioned causes of the discrepancies are those which are present in the bank
statement but are not there in the cash book and hence will impact the adjusted cash book. The
following are the causes of discrepancies which impact the bank statement and are already part
of cash book.
Why is a cheque dishonored?

Cheque is dishonored because of the following reasons:
➢ Insufficient funds in the account of the business/person who has issued the cheque.
➢ Amount in the words and amount in figures are different
➢ The signature on the cheque is of wrong specification
➢ The cheque is stale (if the cheque is more than 6 months old, it becomes stale)
➢ The cheque is mutilated/damaged
➢ The person who has issued the cheque dies
➢ The person who has issued the cheque becomes mentally retarded
UNPRESENTED CHEQUES:
When the cheques are issued by the business, they are immediately taken into consideration by
the business and are recorded in the cash book but they will only be taken into consideration by
the bank once the cheque is presented to the bank.
UNCREDITED DEPOSITS:
When a certain amount of money is deposited into the bank by means of cheque, it passes
through the process of clearing which takes 2-3 days. For this period of 2-3 days, the amount will
be shown in the cash book but will not appear in the bank statement. It is also known as Bank
Lodgments.
NOTE: Any error made or corrected by the bank might also cause difference in the amount of
cash book and the bank statement.
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HOW TO RECONCILE THE CASH BOOK AND THE BANK STATEMENT
There are 2 varieties of questions involved when reconciling the cash book with the bank
statement. In the first variety, you are provided with the cash book and the bank statement which
are not balancing with each other, thus creating a need to reconcile the cash book with the bank
statement.
In order to do so, we will open up adjusted cash book showing the bank column only, starting
with the incorrect closing balance given in the question. We need to remember that when we
deposit into the bank, it is an asset for the business but at the same time, it is liability for the
bank, hence when reconciling, we match the debit side of the cash book with the credit side of
the bank statement, and we match the credit side of the cash book with the debit side of the
bank statement.
When matching the debit side of the cash book with the credit side of the bank statement, all
those things that are common on both sides will be ignored. All those things that are present on
the credit side of the bank statement, but are not there on the debit side of the cash book will
be recorded on the debit side of the adjusted cash book. All those things that are present on the
debit side of the cash book, but are not there on the credit side of the bank statement will be
recorded in the bank reconciliation statement as Un-credited Deposits.
Then we will match the credit side of the cash book with the debit side of the bank statement,
all those things that are common on both sides, i.e. the credit side of the cash book and the debit
side of the bank statement will be ignored. All those things that are present on the debit side of
the bank statement, but are not there on the credit side of the cash book will be recorded on the
credit side of the adjusted cash book. All those things that are present on the credit side of the
cash book but are not there on the debit side of the bank statement will be recorded on the bank
reconciliation statement as Un-presented Cheques.
Finally, the adjusted cash book balance will match with the bank reconciliation statement
balance.
NOTE:
➢ When reconciling the cash book with the bank statement, any error made or corrected
by the bank will be ignored.
➢ If the cheque number in the bank statement is older than the cheque number in the cash
book, all such entries are to be ignored.
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In the 2nd variety of questions involving bank reconciliation statement, you will be provided with
the cash book balance and the bank statement. Instead you will only be given the closing balance
of cashbook and the bank statement which obviously will be different and hence there will be a
need to reconcile the cash book with the bank statement. The question will also provide the
causes of differences between the two, we will read those differences and identify whether they
are affecting the cash book or the bank statement. If they are affecting the cash book, the entry
will pass through the adjusted cash book. But if they are affecting the bank statement, we have
to realize whether they are Un-presented cheques or Un-credited Deposits, and hence they will
be incorporated in the bank reconciliation statement. Ideally, the adjusted cash book and the
bank reconciliation statement are made as follows:
ADJUSTED CASH BOOK

Balance b/d xxx Balance b/d xxx
Credit Transfer xxx Standing Order xxx
Interest on Deposits xxx Direct Debit xxx
Dividends xxx Bank Charges xxx
Dishonored Cheques xxx
Interest on Overdraft xxx
Balance c/d xxx Balance c/d xxx
xxx xxx
AQ INDUSTRIES
BANK RECONCILIATION STATEMENT AS AT 31st DEC 2016
Balance as per Bank Statement xxx
Add: Un-credited Deposits xxx
Less: Un-presented Cheques (xxx)
Balance as per Adjusted Cash Book xxx
OR
Balance as per Adjusted Cash Book xxx
Add: Un-presented Cheques xxx
Less: Un-credited Deposits (xxx)
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Balance as per Bank Statement xxx

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Points to Consider
➢ The Debit balance in the cashbook represents positive balance and it should be equal to
Credit balance in the bank statement which also represents positive balance.
➢ The Credit balance in the cashbook is negative balance and it should be equal to debit
balance in the bank statement.
➢ Bank is only thing in accounting which can either be an asset or a liability. If there is a
bank balance then it will be a debit balance and hence current asset. If there is a bank
overdraft it will be credit balance and hence current liabilities.
➢ The amount of bank balance/bank overdraft in the Statement of Financial Position is
always the adjusted cashbook balance.
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CONTROL ACCOUNTS
WHAT ARE CONTROL ACCOUNTS AND WHY ARE THEY PREPARED?

Control Accounts are divided into 2 categories:
Sales Ledger Control Account is also called the Total Receivables Account because it is the
account of total receivables. It is made in such a manner that whatever is recorded in the
individual receivable account will also be recorded in the total receivable account, i.e. sales ledger
control account.
Purchases Ledger Control Account is also called the Total Payables Account because it is the
account of total payables. It is made in such a manner that whatever is recorded in the individual
payable account will also be recorded in the total payable account, i.e. purchases ledger control
account.
The purpose of preparing the control accounts are:
➢ To identify the errors
➢ To detect frauds
➢ To find the values of total receivables and total payables
➢ To find the figures of credit sales and credit purchases
➢ To reconcile the control accounts with the individual accounts
HOW TO MAKE CONTROL ACCOUNTS:
In order to make control accounts, it must be kept in mind that whatever happens to an individual
receivables’ and payables’ account also impacts the control accounts. The only difference is that
while individual accounts are affected by daily transactions, control accounts are prepared from
Books of Original Entries so the accuracy of control accounts is dependent upon accuracy of
books of original entries.
CONTRA-SET OFF is always made with the MINOR of the two balances and will impact both Sales
Ledger Control Account and Purchase Ledger Control Account.
MINOR BALANCE: When the receivables overpays and does not adjust his account, he becomes
the payable for a very short period of time.
Why does minor balance exists?
➢ overpayment not settled by refund
➢ return on goods after payment
➢ allowance for overcharge
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➢ advance payment of goods to be bought later

➢ allowance for damaged goods after payment has been made
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SALES LEDGER CONTROL A/C (TOTAL RECEIVABLES A/C)
Balance b/d xxx Minor balance b/d xxx

Credit Sales xxx Sales returns xxx
Dishonored cheques xxx Bank/Cash xxx
Bad Debts Recovered xxx Bad Debts xxx
Interest on overdue account xxx Discount Allowed xxx
Cash refund xxx Bad Debts Recovered (bank) xxx
Contra set-off xxx
Minor balance c/d xxx Balance c/d xxx
xxx xxx
Balance b/d xxx Minor balance b/d xxx
PURCHASE LEDGER CONTROL A/C (TOTAL PAYABLES A/C)

Minor balance b/d xxx Balance b/d xxx
Purchases returns xxx Credit Purchases xxx
Discount Received xxx Interest on overdue account xxx
Bank/Cash xxx Cash refund xxx
Contra set-off xxx
Balance c/d xxx Minor balance c/d xxx
xxx xxx
Minor balance b/d xxx Balance b/d xxx
NOTE:
➢ When correcting accounts, if an entry is Understated, it will be corrected by making the
entry on the same side by the amount of understatement.
➢ When correcting accounts, if an entry is Overstated, it will be corrected by making the
entry on the opposite side by the amount of overstatement.
➢ When correcting accounts, if an entry is made on the wrong side, then it will be corrected
by making an entry on the correct side by the double amount.
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ERRORS AFFECTING AND NOT AFFECTING TRIAL BALANCE
Trial Balance is a list of balances, extracted from the ledgers to check the arithmetical accuracy
of the ledgers. If it does not balance, it has errors that affect trial balance. If it balances, it might
be correct or it might have balanced by the wrong amount. If it has balanced by the wrong
amount, it has errors not affecting trial balance.
ERRORS
Not affecting Trial Balance Affecting Trial Balance
Whether errors affect or do not affect trial balance, they need to be identified and corrected,
failure to do so will result in the financial statements being incorrect and will not reflect a true
and fair view of the business performance.
ERRORS NOT AFFECTING TRIAL BALANCE

➢ Error of Commission: If the double entry is complete with correct amounts being involved but
the entry has been made in the wrong person’s account, it is called Error of Commission. For
example, goods sold on credit to Ayesha worth $200 have been posted to Aisha’s Account.
➢ Error of Principle: If the double entry is complete with correct amounts being involved but the
entry has been made in the wrong type of account, it is called Error of Principle. For example,
furniture purchased paying by cash worth $500 have been posted to purchases account.
➢ Error of Omission: If the double entry is entirely omitted, it is referred to as Error of Omission,
because neither the debit entry nor the credit entry has been passed. For example, cash sales
$200 has been entirely omitted.
➢ Error of Original Entry: If the double entry is complete with correct accounts being involved but
the entry has been made by the wrong amount, it is referred to as Error of Original Entry. For
example, cash sales of $500 have been recorded as $5000.
➢ Transposition Error: If the double entry is complete with correct accounts being involved but the
entry has been made by the wrong amount in such a manner that the digits have been
interchanged, then it is referred to as Transposition Error. For example, cash sales of $360 have
been recorded as $630.
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➢ Casting Error: If the double entry is complete with correct accounts being involved but the entry
has been made by the wrong amount because of the totaling error in the invoice, it is referred to
as Casting Error.
➢ Error of Complete Reversal: If the double entry is complete with correct accounts and correct
amounts being involved but the entries have been made on the wrong side of accounts, then the
error is referred to as Error of Complete Reversal. For example, cash purchases $250 has been
posted on debit side of cash Account and credit side of purchases account.
➢ Compensating Error: If two or more errors that have no relationship with each other offset each
other’s mistakes, they are referred to as Compensating Errors. For example, cash sales $200
recorded as $20 in cash account, i.e.
Cash DR 20
Sales CR 200
And furniture bought on cash worth $200 recorded as $20 in cash account, i.e.
Furniture DR 200
Cash CR 20
Hence, overall both errors’ effect is nil.
COPCROCT
ERRORS AFFECTING TRIAL BALANCE

Whenever an error affects the trial balance, it needs to be corrected with the help of Suspense
Account. A Suspense Account is a temporary account which is opened when the errors are found
and closed when the errors are corrected. Until and unless the balance on the suspense account
is not nullified, it means that all errors are not yet found and the trial balance will still not balance.
If the final accounts are prepared before the correction of all errors, then the debit balance in
the suspense account will be treated as Current Assets and the credit balance in the suspense
account will be treated as Current Liabilities till all the errors are found and corrected.
Errors affecting trial balance can be broken down into 2 categories:
1) Errors to be corrected by double-entries
2) Errors to be corrected by just a single entry in the suspense account
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Errors to be corrected by Double-Entries are:
1) When the double-entry is not complete, i.e. either the debit entry or credit entry is made,
but not both.
2) The double-entries are made with different amounts, i.e. amount of debit and credit are
different
3) Both the double-entries are made on the same side, i.e. either both are debited or both
are credited
Errors to be corrected by Just Single Entry in Suspense Account:
If the error is such that there is no mistake in the ledger but instead the error is in the trial balance
or listing of some figures, then in order to correct these, only a single entry in the suspense
account will be required because when there is no error in the ledger, then no correction in the
ledger should be made.
1) Wrong amount is posted in the trial balance.
2) An item is omitted from the trial balance.
3) An item is recorded on the wrong side of the trial balance.
4) Something included in the trial balance should not be included, e.g. trade discount, closing
inventory
HOW TO SOLVE QUESTIONS INVOLVING SUSPENSE ACCOUNT

In order to solve questions involving suspense account, the question will provide us with either
an incorrect trial balance or the trial balance with different balances. The question will also
provide us with the errors that might have or might not have affected the trial balance. We will
read those errors and apply the following rules of correction:
1) What should have been done
2) What has been done
3) Identify the error
4) Correct the error
HOW TO CORRECT THE NET PROFIT WHEN ERRORS ARE INVOLVED
If an item affecting Income Statement, is being debited, it will decrease the profit, whereas if an
item affecting Income Statement is being credited, it will increase the profit.
HOW TO CORRECT THE WORKING CAPITAL
If an item affecting working capital i.e. either current assets or current liabilities is debited, it will
increase working capital, whereas if an item affecting working capital i.e. either current assets or
current liabilities is credited, it will decrease the working capital.
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MANUFACTURING ACCOUNTS
Some businesses do not involve only in trading activities instead, they also manufacture their
own products. Such businesses are called Manufacturing businesses. For such businesses,in order
to calculate profitability, we have to calculate the cost of production. Thus, it is very important
to understand the cost structure of the business, which comprises of the following:
1) FIXED COSTS: Fixed Costs are those costs which do not vary as output varies. Whether
output is zero or in large quantities, the fixed costs remain same. They are also known as ‘Indirect
Costs’ or ‘Factory Overheads’. For example, rent, supervisor salary, depreciation and so on.
It is very important to realize that as output increase, the ‘fixed cost per unit’ keeps on falling
(spreads over the output).
2) VARIABLE COSTS: Variable Costs are those costs which vary as output varies. When
output is zero, variable costs do not exist. But as output starts rising, variable costs starts
increasing. They are also known as ‘Direct Costs’ or ‘Prime Cost’. For example, cost of material,
wages of labor, etc.
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The ‘variable cost per unit’ is always fixed.

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3) SEMI-VARIABLE COSTS: Semi-Variable Costs are those costs which have a certain element
of variable cost and some portion of fixed cost. For example, Utility Bills in which line rent is fixed
and other cost depends on the units consumed. There are 3 situations in which semi-variable
costs can be applied:
Utility Bills Call packages Rent a car

4) STEPPED COSTS: Step Costs are those costs which are fixed over a range of output and
then fixed again over another range of output. Thus, the cost increases in the form of steps. For
example, Warehousing cost.
5) SUNK COSTS: Sunk Costs are those costs which are irrelevant from the decision-making
perspective, and hence are not drawn as a graph. For example, Market research cost which is
irrelevant to cost of production, but when making manufacturing account, our only concern is
the cost of production.
6) TOTAL COST: is the sum of fixed costs and

variable costs. When output is zero, total cost is
equals to the fixed costs because at that instant,
variable cost does not exist. But as output starts
increasing, total costs start increasing because of the
increase in variable costs.
The increase in total cost is because of the variable

cost and thus total costs’ graph and variable costs’
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graphs are always parallel and the vertical distance

between these two graphs is the fixed cost.
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WHY IS THERE A NEED TO MANUFACTURE GOODS?
➢ To earn higher profits
➢ To produce high-quality products
➢ To maintain brand image
➢ To remove dependency from suppliers
➢ Availability of raw materials (If raw material is available, then instead of buying finished
products, the business tries to convert those raw materials into finished goods itself)
NOTE:
When making manufacturing account, we try to identify what is the cost of production and
whether it is feasible to manufacture goods or to buy it from an outside vendor. If it is cheaper
to produce than to buy a product, then manufacturing should be done and the difference
between the manufacturing cost and the purchase price is manufacturing profit.
It is extremely important that manufacturing profit and trading profit should be calculated
separately, so that the performance of the manufacturing department and the trading
department could be identified individually. This is also important because of the fact that the
performance of each department manager is judged by the performance of his department.
The accounting treatment of questions involving manufacturing business comprise of

preparation of
➢ Manufacturing Account
➢ Income Statement
➢ Statement of Financial Position
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AQ INDUSTRIES
MANUFACTRING ACCOUNT FOR THE YEAR ENDED 31 DEC 2016
$ $ $
Cost of Raw Materials Consumed
Opening Inventory of Raw Materials xxx
Purchases of Raw Materials xxx
Less: Purchases Returns of Raw Materials (xx) xxx
Carriage Inwards of Raw Materials xx
Cost of Raw Materials Available for sale xxx
Less: Closing Inventory of Raw Materials (xx) xxx
Add: Other Direct Costs
Direct Labour xx
Variable Overheads xx
Royalties xx xxx
Prime Cost xxx
Add: Indirect Costs/ Factory Overheads
Depreciation xx
Rent and Rates xx
Supervisor Salary xx
Indirect Material xx
Indirect Labor xx xxx
Manufacturing Cost xxx
Add: Opening Inventory of Work-in-Process xx
Less: Closing Inventory of Work-in-Process (xx) xx
Cost of Production xxx
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AQ INDUSTRIES
$ $ $
Sales xxx
Opening Inventory of Finished Goods xxx
Transfer from Manufacturing Account xxx
Purchases of Finished Goods xxx
Less: Purchases Returns of Finished Goods (xx) xxx
Less: Closing Inventory of Finished Goods (xx) (xxx)
Gross Profit xxx
Add: Other Incomes
xxx
Less: Expenses
All expenses associated to trading department xx
for sale of goods xx
Bad Debts xx
Office expenses xx
Office salaries xx (xx)
Net Profit xxx
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AQ INDUSTRIES
$ $ $
Non-Current Assets
Machinery xxx (xxx) xxx
Premises xxx (xxx) xxx
Current Assets
Closing Inventory (RM + WIP + FG) xxx
Receivables (Net) xx
Less: Provision for bad debts (x)
Less: Provision for discount allowed (x) xx
Prepayments xx
Bank xx
Cash xx xxx
Total Assets xxx
Current Liabilities
Payables xxx
Accruals xxx
Total Current Liabilities xxx
Loan from XYZ xxx
Total Liabilities xxx
Equity
Opening Capital xxx
Add: Net Profit xxx xxx
Less: Drawings (xx)
Closing Capital xxx
Total Liabilities and Equity xxx
NOTE:
Manufacturing Royalties Direct Cost (Manufacturing Account)
Selling Royalties Expenses (Income Statement)
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NON-PROFIT ORGANISATIONS (NPO)
Some organizations come into existence not to make profits but to provide facilities to their
members. Such organizations do not have owners. They have members who choose one of the
members who is made responsible for running the NPO. Since there are no owners, there is no
concept of capital, drawings or profits. Such organizations exist in the form of clubs, or housing
societies and thus NPOs’ accounting is also referred to as Club Accounting.
Since in clubs, there is no concept of Capital, therefore instead of Capital Account, we make
‘Accumulated Funds Account’. Moreover, instead of Bank Account, we make ‘Receipts and
Payments Account’, and since there is no concept of profit and loss account, we make ‘Income
and Expenditure Account’ to find out whether the club has more incomes or expenses.
The major source of Income for the club is Subscriptions. Subscriptions are payments made by
the members to the NPO in order to avail the facilities of the club. Sometimes, club also involves
in trading activities and once again the motive is not profit making but instead facility of
members.
The accounting treatment of a NPO comprises of the following steps. If the requirement of the
question is to prepare Income and Expenditure Account and Statement of Financial Position, all
the following steps must be applied:
1) Preparation of Accumulated Funds

Accumulated Funds are similar to Capital Account and is achieved when opening liabilities are
deducted from opening assets.
ACCUMULATED FUNDS
Assets xxx Liabilities xxx
xxx xxx
xxx xxx
xxx xxx
xxx
Accumulated Funds xxx
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2) Preparation of Receipts and Payments Account
Receipts and Payments Account is similar to Bank Account and is based on cash concept. When
cash comes into the business, it is recorded as Receipts and when cash goes out of the business,
it is recorded as Payments. The Receipts and Payments Account can either have debit balance or
a credit balance. Debit balance of Receipts and Payments Account is Current Assets and Credit
balance of Receipts and Payments Account is Current Liabilities. Receipts and Payments Account
is made as follows:
RECEIPTS AND PAYMENTS ACCOUNT

Receipts Payments
xxx xxx
xxx xxx
xxx xxx
Balance c/d xxx Balance c/d xxx
3) Preparation of Trading Account

If clubs involve into trading activities, then we need to prepare Trading account. If receivables
and payables are given in the question, then we must prepare SLCA and PLCA to find out sales
and purchases. The terminology used for sales in questions involving NPO is ‘Takings’. The trading
account is made as follows:
TRADING ACCOUNT FOR THE YEAR ENDED 31 DEC 2013

$ $
Sales xxx
Purchases xxx
Gross Profit xxx
Less: Expenses associated to Trading only

Wages xx
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Other Expenses xx (xxx)

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Profit / (Loss) from trading xxx

4) Preparation of Subscription Account
Subscriptions are weekly, monthly or annual payments made by the members to the NPO in order
to avail the facilities of the club.
Subscriptions in Arrears:
Subscriptions in arrears means subscriptions earned but yet not received. They are accrued
subscriptions which are accrued incomes and hence current assets for the club.
Subscriptions in Advance:
Subscriptions in advance are the subscriptions received but yet not earned. They are unearned
income or pre-received income and hence current liabilities for the club.
The subscription account is made as follows:
SUBSCRIPTIONS ACCOUNT
Accrued b/d xxx Prepaid b/d xxx
Cash Refund xxx Receipts and Payments Account xxx
Income and Expenditure Account xxx Bad Debts xxx
Prepaid c/d xxx Accrued c/d xxx
xxx xxx
5) Adjustment of Expenses and Revenues

The revenues and expenses can be adjusted through PAAP and APPA. If the question is silent
regarding depreciation of NCA in questions involving NPO, then it does not mean that no
depreciation will be charged. Instead, it is an indication that revaluation method of depreciation
is to be applied, as follows:
Opening value of asset xxx

Add: Purchase of asset xxx
Less: Sale of Asset (xxx)
Less: Closing value of asset (xxx)
Depreciation for the year xxx
6) Preparation of Income and Expenditure Account
Income and Expenditure Account takes into consideration the earning capacity of the club as to
how much income is generated and through what sources and how much expenses are made
and by what means. If gift/donation/legacy received by the club is without any purpose, then it
is to be treated as an Income. Thus, Income and Expenditure Account is made as follows:
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INCOME AND EXPENDITURE ACCOUNT FOR THE YEAR ENDED 31st DEC 2016
Incomes $ $
Subscription xxx
Profit from Trading xxx
Gift/Donation/Legacy (Not for specific purposes) xxx
Gain on Disposal xxx
Entrance fees xxx xxx
Less: Expenses
Rent xxx
Loss from Trading xxx
Depreciation xxx
Loss on Disposal xxx
Wages xxx
Utility Bills xxx
Any other expense associated to club xxx (xxx)
SURPLUS / (DEFICIT) OF INCOME OVER EXPENDITURE xxx
7) Preparation of Statement of Financial Position

Statement of Financial Position will be made normally. The only important thing is to take into
consideration the ‘Capital Receipts’. Gift/donation/legacy for specific purpose are examples of
Capital Receipts, and hence are not to be included in Income and Expenditure Account; instead
are to be part of ‘Financed By’ section of Statement of Financial Position. Statement of Financial
Position is to be made as follows:
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STATEMENT OF FINANCIAL POSITION AS AT 31stDEC 2016
$ $ $
Non-Current Assets
Motor Vehicle xxx (xxx) xxx
Fixtures and Fittings xxx (xxx) xxx
Total Non-Current Assets xxx
Current Assets
Inventory xx
Receivables xx
Prepayments xx
Arrears (Subscriptions) xx
Receipts and Payments Account xx xxx
Total Assets xxx
Financed By:
Accumulated Funds xxx
Add: Surplus / (Deficit) xxx
Add: Life Membership xxx
Add: Gift/Donation/Legacy (for specific purposes) xxx xxx
Current Liabilities
Payables xx
Advance (Subscriptions) xx
Accruals xx
Receipts and Payments Account (Overdraft) xx
Loan from XYZ xxx
Total Liabilities and Accumulated Funds xxx
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GIFT/DONATION/LEGACY:
If gift/donation/legacy is not for specific purpose, it will be treated as Income, and will be
recorded in the Income and Expenditure Account. But if gift/donation/legacy is for a specific
purpose, then it will be recorded in the ‘Financed By’ section of the Balance Sheet.
WHAT IS LIFE MEMBERSHIP?
Some clubs provide the facility of life membership in which the members do not have to pay
monthly or annually. Instead they pay a lump sum amount at the time of joining the club. Life
membership is to be treated as Capital receipt and hence will go to the Equity section of the
Statement of Financial Position.
COMMON ERRORS MADE BY STUDENTS IN QUESTIONS INVOLVING NPO:

1. Students forget to write opening bank balance figure in accumulated funds, because it is
usually written separately.
2. Students always consider bank balance as debit balance whereas the bank balance can
also be a credit balance.
3. Students forget to make Control Accounts for calculation of sales and purchases.
4. Students do not calculate depreciation when question is silent regarding depreciation.
5. Students do not adjust other expenses and revenues for accruals and prepayments.
6. Gift/Donation/Legacy is not properly accounted for.
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INVENTORY VALUATION
What is Inventory?
Inventory is the stock of goods. These are those goods which are bought or manufactured with
an intention of resale, and are yet unsold.
How to value Inventory?
Inventory must be valued at lower of cost or Net Realizable Value (NRV), as per Prudence
Concept, using three cash-flow assumptions of valuing inventory and each cost-flow assumption
can be used using 2 methods. The 3 cash-flow assumptions are:
1) FIFO (First In First Out): FIFO means inventory which is bought first will be sold first
2) LIFO (Last In First Out): Inventory which is bought at the end will be sold first. As per
International Accounting Standards (IAS 2), LIFO method is no more applicable and hence
must not be used.
3) AVCO (Average Weighted Cost): The average cost of inventory is calculated after every
transaction.
Each of the above-mentioned cash-flow assumptions is applied either through
1) Perpetual Method
2) Periodic Method
The valuation of inventory must always be done on the last day of the accounting period because
when preparing the Income Statement and the Statement of Financial Position, the value of
inventory required is that of last day of accounting period without which it is practically
impossible to prepare Income Statement and the Statement of Financial Position.
If inventory is valued before or after the last day of the financial year, then in order to arrive at
the inventory figure that was in existence on the last day of the accounting period, we have to
do inventory valuation forwards or backwards.
25th December 31st December 20th January
Inventory Valuation Forwards Inventory Valuation Backwards
WHAT IS COST OF INVENTORY?

Cost of Inventory comprises of purchase price of goods add all costs associated to purchases.
Cost = Purchase Price + all costs associated to purchases
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WHAT IS NET REALIZABLE VALUE (NRV) OF INVENTORY?
NRV of Inventory is the selling price ‘less’ all cost associated to sales without which it is practically
impossible to sell the goods. Usually, this term appears in case of those goods which are damaged
and on which repair and maintenance cost is to be incurred.
NRV = Selling Price – All costs associated to sales
INVENTORY VALUATION FORWARDS
$
th
Inventory at Cost as at 25 December xxx
Add: Purchases xxx
Less: Purchases Returns (xxx)
Less: Sales (at Cost Price) (xxx)
Add: Sales Returns (at Cost Price) xxx
Less: Inventory Damaged (xxx)
Less: Stock Drawings (xxx)
Add: Goods Sold on Sale or Return basis (at Cost Price) xxx
Less: Goods bought/acquired on purchase or Return basis (xxx)
Less: Inventory Overvalued (xxx)
Add: Inventory Undervalued xxx
st
Inventory as at 31 December xxx
INVENTORY VALUATION BACKWARDS
$
Inventory at Cost as at 20th January xxx
Less: Purchases (xxx)
Add: Purchases Returns xxx
Add: Sales (at Cost Price) xxx
Less: Sales Returns (at Cost Price) (xxx)
Less: Inventory Damaged (xxx)
Add: Stock Drawings xxx
Add: Goods Sold on Sale or Return basis (at Cost Price) xxx
Less: Goods bought/acquired on purchase or Return basis (xxx)
Less: Inventory Overvalued (xxx)
Add: Inventory Undervalued xxx
Inventory as at 31st December xxx
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MARKUP MARGIN
Gross Profit as a percentage of Cost Gross Profit as a percentage of Sales
In markup, cost is always 100% In margin, sales is always 100%
Whether markup or margin,

Selling Price = Cost Price + Profit
Cost Price = Selling Price - Profit
Example, given that Example, Given that
Mark-up = 20% Margin = 20%
Cost = 100% ? S.P = 100% 2400
S.P = 120% 2400 Cost = 80% ?
Unknown Value = Unknown % x Known Value
Known %
Cost = 100 x 2400 = 2000 Cost = 80 x 2400 = 1920
120 100
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SINGLE ENTRY
When a business does not maintain any book of original entry, no accounting records are kept
and it is practically impossible to find each item of Income Statement such as sales, purchases
and expenses, then the question falls under the category of Single Entry.
In questions involving Single Entry, we cannot prepare full set of financial statements because of
unavailability of all financial information, thus we cannot make Income Statement at all,
therefore in order to find the profit that the business made, we will make ‘Statement of Profit or
Loss’ as follows:
STATEMENT OF PROFIT OR LOSS
$
Closing Capital xx
Add: Drawings xx
Less: Additional Capital (xx)
Less: Opening Capital (xx)
Net Profit/ (Net Loss) xx
Any business that does not keep any books of original entry or no accounting records is still in
the position to provide 4 details:
1) Closing Capital
2) Opening Capital
3) Additional Capital
4) Drawings
Opening Capital = Opening Assets – Opening Liabilities
Closing Capital = Closing Assets (with adjustments) – Closing Liabilities (with adjustments)
DRAWINGS
Cash Drawings Stock Drawings Fixed Asset Drawings
Weekly (52 weeks in a year)

DRAWINGS Monthly (12 months)
Quarterly (4 Quarters each year; each quarter has 3 months)
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Daily (365 days)

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Cash
ADDITIONAL CAPITAL Goods
Assets
Once Statement of Profit or Loss is made, it is possible to prepare the Statement of Financial
Position properly.
Statement of Affairs is another way of calculating opening and closing capital.
STATEMENT OF AFFAIRS (OPENING)

Assets xxx Liabilities xxx
xxx xxx
xxx xxx
xxx xxx
xxx
Opening Capital xxx
STATEMENT OF AFFAIRS (CLOSING)

Assets (with adjustment) xxx Liabilities (with adjustments) xxx
xxx xxx
xxx xxx
xxx xxx
xxx
Closing Capital xxx
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INCOMPLETE RECORDS
In questions involving Incomplete Records, the business keeps at least one book of original entry,
usually the cash book. Accounting records are maintained but in scattered form. We have to
accumulate all possible information so that we can prepare the Income Statement and the
Statement of Financial Position properly and completely and thus in order to do so, we will
prepare the following accounts:
➢ Opening Capital
➢ Sales Ledger Control Account
➢ Purchases Ledger Control Account
➢ Expenses (PAAP)
➢ Revenues (APPA)
➢ Inventory Valuation-Inventory
➢ Fixed Assets
➢ Current Assets
➢ Current Liabilities
➢ Long Term Liabilities
➢ Depreciation
➢ Markup, Margin
➢ Other Expenses (Bad Debts, Provision for Bad Debts etc.)
➢ Drawings
➢ Additional Capital
NOTE:
Whenever we are left with a debit balance while preparing cash account, it means that balance
is cash sales or receipts from debtors. If we are left with credit balance, it means it is Drawings.
If depreciation is not mentioned in the question, it does not mean depreciation will not be
charged; it means we will apply the Revaluation method of depreciation.
How to treat Inventory (Stock) loss?
In questions involving Incomplete Records sometimes it is stated that a certain amount of
inventory is damaged or robbed. In such instances we have to calculate the amount of inventory
lost and in order to do so we will calculate cost of goods sold using the formula:
Cost of Goods sold=Opening Inventory + Purchases – Purchase returns – Closing Inventory
And we will also calculate cost of goods sold using the mark-up or margin given in the question.
The difference between the two costs of sales will be the value of inventory lost.
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The double entries to record Inventory loss are
Income Statement DR
Purchases CR
How to treat Cash Stolen?

If the business suspects that cash is being stolen then in order to find the amount of cash stolen
we will calculate sales by following the normal procedure(SLCA, Cash A/C, Bank A/C) and you will
also calculate sales using markup or margin and the difference between the two sales will be
amount of cash lost.
The double entries to record cash stolen are
Income Statement DR
Cash CR
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RATIO ANALYSIS
Once the Income Statement and Statement of Financial Position are prepared, it is extremely
important to analyze the business performance so that it could be found whether the
performance of the business has improved, deteriorated or remained constant. Not only this, the
ratios also help in analyzing that what caused the changes in business performance. If the
performance improved, what caused the improvement? If the performance deteriorated, what
went wrong? And if the performance remained constant, why was there no improvement?
Moreover, with the help of ratios, it can also be analyzed as to what measures can be taken to
further improve the performance and what steps should be followed to avoid deterioration.
For the purpose of analysis, the ratios are divided into the following categories:
➢ Profitability Ratios
➢ Liquidity Ratios
➢ Resource Utilization Ratios (Not part of Syllabus)
➢ Investment Ratios (Not part of Syllabus)
➢ Cash Flow Ratios (Not part of Syllabus)
Profitability Ratios
Profitability ratios identify the earning capacity of the business, as to how much revenue is
earned and through what sources, and how much expenses are incurred and by what means and
thus what is the profitability. It helps in identifying whether the business is able to control its
expenses effectively and efficiently or not. Thus, the profitability ratios are as follows:
➢ Net Sales/ Turnover = Sales – Sales Returns
➢ Cost of Goods Sold = Opening Inventory + Net Purchases – Closing Inventory
➢ Owner’s Capital = Total Assets – Total Liabilities

= Capital Employed – Non-Current Liabilities
➢ Capital Employed = Net Assets

= Non Current Assets + Current Assets – Current Liabilities
= Non Current Assets + Working Capital
= Total Assets – Current Liabilities
= Owner’s Capital + Non-Current Liabilities
= Opening Capital + Net Profit – Drawings + Additional Capital +
Non Current Liabilities
➢ Gross Profit= Sales – Cost Of Goods Sold

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➢ Net Profit= Gross Profit – Expenses

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➢ Gross Profit Markup: Gross profit as a percentage of Cost
= Gross Profit x 100
Cost
➢ Gross Profit Margin: Gross profit as a percentage of Sales
= Gross Profit x 100
Sales
➢ Net Profit Margin: Gross profit as a percentage of Sales
= Net Profit x 100
Sales
➢ Expenses to Sales ratio: Expenses as a percentage of Sales
= Expenses x 100
Sales
➢ Expenses to Sales ratio = Gross Profit Margin - Net Profit Margin
➢ Return on Capital Employed (ROCE) = Net Profit before Interest and Tax x 100
Capital Employed
➢ Return on Net Assets (RONA) = Net Profit before Interest and Tax x 100
Net Assets
➢ Return on Total Assets (ROTA) = Net Profit before Interest and Tax x 100
Total Asset
➢ Return on Current Assets (ROCA) = Net Profit before Interest and Tax x 100
Current Assets
➢ Return on Equity (ROE) = Net Profit after Interest and Tax x 100
Equity
➢ Equity = Owner’s Capital
=Ordinary Share Capital + All Reserves
➢ Shareholder’s Fund = Ordinary Share Capital + Preference Share Capital + All Reserves
= Equity + Preference Share Capital

An increase in all Profitability ratios except for expenses to sales ratio depicts an improvement in
business performance and vice versa.
An increase in expense to sales ratio depicts deterioration as expenses have increased and
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business is unable to control them.

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Liquidity Ratios
Liquidity Ratios identifies how much cash is available within the business. It helps in identifying
whether the business has enough assets to pay off its debts and meet its obligations. It is the
ability of the business to convert its assets into cash. It must always be kept in mind that there is
a difference between profitability and liquidity of the business. If the business is earning good
profits, it does not necessarily mean that it is also generating good cash because when calculating
profits, we also take into consideration some cash and non-cash expenses whereas when
considering liquidity, we are only interested in cash inflows and outflows. Some non-cash
expenses and revenues taken into consideration are credit sales, credit purchases, discount
allowed, discount received, gain or loss on disposal, bad debts, depreciation and so on.
It is extremely important to realize that it is never the lack of profit which causes the company to
shut down. It is always the lack of liquidity or shortage of cash and inability to meet their
obligations and pay off the debts which causes the company to become bankrupt or to go into
liquidation. Thus, having a good liquidity is extremely essential for the survival or the going
concern of the business. Liquidity ratios are as follows:
➢ Working Capital = Current Assets – Current Liabilities

Working Capital should always be positive at any period in time because if working capital is
negative, it indicates that the business is unable to meet its obligations and is on the verge of the
bankruptcy.
Positive Working Capital is known as Net Current Assets.
Negative Working Capital is known as Net Current Liabilities.
➢ Current Ratio = Current Assets Ideal Ratio = 1.5:1 – 2:1
Current Liabilities
➢ Quick Ratio = Current Assets – Closing Inventory Ideal Ratio = 1:1

Current Liabilities
The current and quick ratio must be close to or equal to the ideal ratio because if they are less
than ideal ratio, it is an indication that the company is suffering from financial crunch and liquidity
crisis. Similarly, if the current and quick ratios are above the ideal ratio, it indicates that the
business is not utilizing resources appropriately and is in-efficient. The amount which should be
invested elsewhere is stuck into the business.
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➢ Average Inventory = Opening Inventory + Closing Inventory

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2
➢ Rate of Inventory Turnover = Cost of Goods Sold
Average Inventory
It indicates the number of times the business is able to sell its stock completely. The higher the
rate of inventory turnover, the better the performance is. It helps in finding the rapidity with
which inventory is sold.
➢ Inventory Turnover (Days): This indicates how many days the business takes to
completely sell the inventory.
= Average Inventory x 365
Cost of Goods Sold
= 1 x 365
Rate of Inventory Turnover
Unless otherwise states, we have to give answer in ‘days’.
➢ Receivables Collection Period (Days) = Receivables x 365
Credit Sales
It indicates how long the receivables take to pay back the amount that they owe.
➢ Payables PaymentPeriod (Days) = Payables x 365
Credit Purchases
It indicates how long the business takes to pay back the amount that is owed by them.
➢ Working Capital Cycle

= Inventory Turnover (Days) + Receivables Collection Period (Days) - Payables Payment
Period (Days)
Working Capital cycles indicate the number of days the business takes to recover the working
capital. The shorter the working capital cycle is, the better the liquidity of the business is. If we
delay payments to our creditors, then although working capital cycle will improve but at the
expense of adverse relationship with the payables and the discount which will have to be forgone
on early payments.
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Commenting on Ratios
Whenever we have to comment on ratios, we will never do so in a haphazard manner instead
whatever the sequence in which we calculated ratios, we will first comment on all profitability
ratios, then on liquidity ratios and finally we will give the conclusion. Not only this, it is extremely
important to realize that we are not supposed to tell whether the ratio has increased or
decreased, instead we have to identify whether the performance of the business has improved
or deteriorated and what caused the improvement or deterioration. We also need to suggest
what steps should be taken to further improve the performance. When some ratios increase,
they show improved performance. When some ratios decrease, it shows improved performance.
Sample Comment:
The gross profit margin of Najim has deteriorated by 3%. This could be because of the fact that
either his selling price has fallen or his cost of goods sold has increased. Despite a fall in the GP
margin, the NP margin has improved by more than 2% which is quite commendable. This is
because of the fact that Najim has been able to control his expenses in an amazing manner and
his expenses to sales ratio fell from 22.5% to 17.4% which is worth appreciating. This, in turn, has
caused the ROCE to increase by more than 2%. Overall, his profitability has improved.
The current and quick ratios of Najim are almost equal to the ideal ratios, with slight deterioration
in current ratio and slight improvement in quick ratio. The inventory turnover days has improved
by 3 days indicating that Najim is able to sell his inventory earlier and much easily. This could be
supported by the fact that he might have reduced his selling price in order to attract sales which
might have caused his GP margin to fall. Najim is facing difficulty in collecting money from his
receivables and they are paying 6 days late compared to last year. In turn, Najim is paying his
suppliers 6 days late which is not a good strategy. By paying 6 days late, he is deteriorating his
relationship with the suppliers and might be forgoing the discounts which he would have
otherwise achieved if he would have paid on time. Overall, his working capital cycle has improved
by 3 days indicating an improved liquidity in comparison to last year.
Overall, there is an improvement in Najim’s performance when comparing 2011 with 2010 as far
as profitability and liquidity ratios are concerned.
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PARTNERSHIP
Partnership is an agreement between two to twenty people who join together with an intention
of sharing profits and bearing losses. When the partnership is formed, a partnership agreement
is made in which it is decided how much will be the interest on capital, interest on drawings,
salary to partners, bonus or commissions and whether any partner will be a dormant partner or
not. And if the partner has provided loan how much will be the interest.
In absence of partnership agreement, Partnership Act 1890 will come under consideration and
the contents of Partnership Act 1890 are:
i. No interest on capital
ii. No interest on drawings
iii. No salary to partners
iv. No bonus to partners
v. No commission to partners
vi. No partner to be treated as dormant partner
vii. Interest on loan by the partner at the rate of 5%
viii. Residual profits to be distributed amongst partners equally.
INTEREST ON CAPITAL: It is given to the partner as an incentive to invest more into partnership.
Usually this interest rate is equal to the market rate of interest so as to attract the partners so
that by joining the partnership not only will they earn the normal interest but they will also reap
benefits of partnership.
INTEREST ON DRAWINGS: It is charged to the partners as a restriction to withdraw unnecessarily,
otherwise the partners will withdraw huge amounts causing liquidity crisis of partnership.
SALARY TO PARTNERS: It is given to the partners as a compensation for the services they have
performed for the partnership. Instead of hiring an employee the partner does the work and is
paid the salary.
BONUS TO PARTNERS: It is given to the partners against the organizations performance. The
better the partnership performs the higher the bonuses are distributed amongst the partners.
COMMISSION TO PARTNERS: It is given to the partners against their individual performance in
order to keep them motivated and perform even better.
INTEREST ON LOAN BY THE PARTNERS: When the partners provide loans to the partnership, they
are not considered to be the partner for that amount of loan. Instead, they are a liability of the
partnership and hence interest on loan is not the distribution of profit, instead it is an expense of
the business. If it is not pre-decided than loan interest would be 5%.
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RESIDUAL PROFITS: Once the profits are distributed in the forms of interest, salary, bonus and
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commission, the remaining profits are called residual profits which are to be distributed amongst
the partners in their predetermined rates decided in the partnership agreement. If no profit and
loss sharing ratio is given then in accordance to Partnership Act 1890 it is to be distributed
equally.
DORMANT PARTNER: It is also known as 'Sleeping Partner', such a partner is not actively involved
in the running of the partnership. His role is restricted to investing in the partnership but is not
part of decision making process. Since the dormant partner is not actively involved his liability is
limited.
LIMITED LIABILITY: it means that incase of bankruptcy or insolvency, the maximum amount that
can be snatched from a partner is his investment. His personal belongings will not be affected.
In a partnership, all partners cannot be sleeping partners there has to be at least one active
partner who will be responsible for the running of the business. The liability of the active partner
is unlimited. Unlimited liability means that incase of bankruptcy or insolvency, the personal
belongings of the partner will be at stake.
The accounting treatment of partnership involves preparation of:
I. Income statement
II. Profit and Loss Appropriation account
III. Partners' Current account
IV. Partners' Capital account
V. Statement of Financial Position
INCOME STATEMENT is made as normally like any other business. The only thing to be taken into
consideration is Interest on Loan by partners and it will be treated as an expense and hence is
not the distribution of profits.
PROFIT AND LOSS APPROPRIATION ACCOUNT shows the distribution of profits amongst the
partners in the form of interest, salary, bonus and commission. It also identifies the figure of
residual profits and the way it is distributed amongst the partners.
CURRENT ACCOUNTS are also known as Fluctuating Capital Account and shows movement in
Capital because of distribution of profits and drawings. The current account can have either a
credit or a debit balance. If the distribution of profits is more than drawings, the current account
will have a credit balance whereas if the drawings are more than the distribution of profits, the
current account will have debit balance. The credit balance in the current account is a positive
balance and the debit balance in the current account is a negative balance.
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PARTNERS’ CAPITAL ACCOUNT is also known as Fixed Capital Account because it usually does
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not change and the changes in the capital account only occurs when:
➢ The partner introduces additional capital
➢ When no separate current accounts are maintained (in this case, all entries regarding
current account are passed through the capital account)
STATEMENT OF FINANCIAL POSITION is made as normally except for the Financed By section in
which we have to take into consideration the closing capital and current account balances.
Moreover, if there is any goodwill maintained in the books, it has to be incorporated in the
Statement of Financial Position as Intangible Non-Current Asset.
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Page
SIMON, RAJ AND KULJEET
$ $ $
Sales xxx
Purchases xxx
Costs Associated to Purchases xxx
Gross Profit xxx
Add: Other Incomes
Gain on Disposal xx
Bad Debts Recovered xx
Decrease in provision xx
Commission Received xx
xxx
Less: Expenses
Rent xx
Utility xx
Depreciation xx
Discount Allowed xx
Loss on Disposal xx
Increase in provision xx
Carriage outwards xx
All Expenses associated to partnership xx
Interest on loan by partner xx (xxx)
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PROFIT AND LOSS APPROPRIATION ACCOUNT
$ $ $
Add: Interest on Drawings
Simon xx
Raj xx
Kuljeet xx xx xxx
Less: Interest on Capital
Simon xx
Raj xx
Kuljeet xx (xx)
Less: Salary
Simon xx
Raj xx (xx)
Less: Commission
Kuljeet (xx)
Less: Bonus
Simon xx
Raj xx
Kuljeet xx (xx) (xxx)
RESIDUAL PROFIT xxx

Less: Share of Profit
Simon xx
Raj xx
Kuljeet xx (xx)
-
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CURRENT ACCOUNT
SIMON RAJ KULJEET SIMON RAJ KULJEET
Balance b/d - - xx Balance b/d Xx Xx -
Share of Loss xx Xx xx Interest on Xx Xx xx

Capital
Drawings xx Xx xx Salary Xx Xx -
Interest on xx Xx xx Bonus Xx Xx xx
Drawings
Commission - - xx
Share of Xx Xx xx
Profit
Interest on Xx Xx xx
Loan *
Balance c/d xx xx - Balance c/d - - xx
xxx Xxx xxx Xxx Xxx xxx
Bal b/d - - xx Bal b/d Xx Xx -
*If interest on loan by the partner is already paid to the partner, then it will not be included in the
current account. If it is not yet paid, then only it will be part of Partner’s current account but will
not be part of Accruals, Current Liabilities in the Statement of Financial Position. Whatsoever, it
will be always part of Income Statement as an expense.
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CAPITAL ACCOUNT
SIMON RAJ KULJEET SIMON RAJ KULJEET
Goodwill xx Xx xx Balance b/d Xx Xx xx

written off
Loss on xx Xx xx Cash - Xx -
Revaluation
Loss on xx Xx xx Goodwill Xx Xx xx
Realization recorded
Balance c/d xx Xx xx Profit on Xx Xx xx

Revaluation
Profit on Xx Xx xx
Realization
xxx Xxx xxx Xxx Xxx xxx
Bal b/d Xx Xx xx
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SIMON, RAJ AND KULJEET
$ $ $

Goodwill xxx
Plant and Machinery xxx (xxx) xxx
xxx
Current Assets
Inventory xxx
Less: Provision for bad debts (x)
Less: Provision for discount allowed (x) xx
Prepayments xx
Bank xx
Cash xx xxx
Total Assets xxx
EQUITY AND LIABILITIES

Capital Accounts:
Simon xx
Raj xx
Kuljeet xx xxx
Current Accounts:
Simon xx
Raj xx
Kuljeet (x) xxx xxx
Current Liabilities
Payables xxx
Accruals xxx
Bank Overdraft xxx
Debentures xxx
Loan from Simon xxx
Total Non-Current Liabilities xxx

Total Equity and Liabilities xxx
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GOODWILL
Goodwill is the good reputation of the business. It is the worth of the business over and above
the fair value of its net assets and hence it is an Intangible Non-Current Asset.
Goodwill = Purchase Price – Fair Value of Net Assets Acquired
When there is any partnership change, it is a compulsion to value Goodwill so that the existing
partners can realize the true worth of the business and receive their due share. When at the time
of partnership change, goodwill is recorded, it is recorded amongst the old partners in their old
profit and loss sharing ratio, and hence the double-entries to record Goodwill are
Goodwill DR
Partners’ Capital Account CR:
A
B Amongst old partners in
C old profit and loss sharing ratio
If the question states that the Goodwill is to be maintained in the books, then it will be shown in
the books as Intangible Non-Current Assets, and each year we will have to check whether this
Goodwill is having any fall in its value. Fall in the value of Goodwill occurs either because of
Amortization (Depreciation of Goodwill) or Impairment (Drastic fall in the value of Goodwill) and
the fall in the value of Goodwill will be treated as an expense in the Income Statement, and the
double entries are
Income Statement DR (Expense)

Goodwill CR
If at the time of partnership change, the question indicates that Goodwill is not to be maintained
in the books, or Goodwill is to be written off, or Goodwill is not to be recorded, it all indicates
that Goodwill will be written off after recording it, and will not come in the Statement of Financial
Position. Goodwill is written off amongst new partners in their new Profit and Loss sharing ratio,
and hence the double-entries are:
Partners’ Capital Account DR:

A
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B Amongst new partners in their

C new profit and loss sharing ratio
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Goodwill Account CR
Example: A, B and C are partners sharing Profit and Loss equally. C retires and D is admitted and
now partners are sharing profit and loss in the ratio 3:2:1.
If goodwill which is not be maintained in the books is valued at $18000, pass double-entries and
make goodwill account.
Recording of GW: Writing-off Goodwill:

Goodwill DR 18000 A (3/6 * 18000) DR 9000
A CR 6000 B (2/6 * 18000) DR 6000
B CR 6000 D (1/6 * 18000) DR 3000
C CR 6000 Goodwill CR 18000
GOODWILL ACCOUNT
A 6000 A 9000
B 6000 B 6000
C 6000 D 3000
18000 18000
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LIMITED COMPANIES
Limited companies are incorporated businesses. They are owned by the shareholders and
controlled by the directors, appointed by the shareholders at the Annual General meeting. When
the company comes into existence, it has to be registered through the registrar of the company
which if accepted will be incorporated into Limited Liability Company. When the company comes
into existence it has to prepare two documents:
➢ Memorandum of association.
➢ Articles of association.
Memorandum of Association is the relation of the company to the outside world and the
contents of memorandum of association are as follows:
1) Name Clause: Name of the company ending either PLC or Ltd.
2) Liability Clause: A statement that the liability of the company is Ltd.
3) Capital Clause: The amount of Authorized Share Capital.
4) Address Clause: The address of registered office
5) Activity Clause: The principle activities that the company will involve in.
Articles of association are the internal rules governing the rights of the members and the
running of the company. The contents are as follows:
1) It defines rights and the duties of the shareholders.
2) It defines rights and the duties of the directors.
3) It contains the regulations as to how the meetings may be called.
4) It defines the rules regarding the voting rights.
5) It contains rules regarding the members who fail to pay the amount due upon them.
6) The minimum qualification to be a director.
7) The minimum number of share that a director must hold.
A company is divided into two categories:

➢ Private Limited companies.
➢ Public Limited companies.
Private Limited Companies are usually family owned business. They can't have Authorized Share
Capital of more than $ 50,000. They can't issue share to the general public, nor are their shares
traded in the stock exchange. Private Limited companies always have Ltd attached to its name.
Public Limited Companies can issue their share to the general public and their shares can be
traded in the stock exchange. Their Authorized Share Capital has to be more than $ 50,000. They
work under the policy of IAS Companies Act 2006 and Companies Act 1985. They usually have
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the word PLC attached to its name.

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The capital structure of a company comprises of Ordinary Share Capital, Preference Share Capital,
Debentures, Convertible Loan Stocks and Reserves.
Ordinary Shareholders are the real owners of the company and have a voting right with which
they take active part in the running of the business, by appointing the directors and hence they
are the risk bearers. At the time of distribution of dividends, the ordinary shareholders are given
the last priority and even in the case of insolvency they rank last after the payments have been
made to the creditors, long term liabilities and preference shareholders. The amount of dividends
that they receive is not fixed and varies as per the profitability of the company. In years of low or
no profit, they are not given any dividends at all.
The priorities in which the company distributes its assets in case of insolvency are as follows:
i) Short-term debts (creditors, accruals, bank overdraft)
ii) Secured Long-term debts
iii) Unsecured Long-term debts
iv) Preference Share Capital
v) Ordinary Share Capital
Preference Shareholders are given preference over ordinary shareholders both at the time of
distribution of dividends and incase of insolvency. They usually don’t have a voting right and they
receive a fixed rate of dividends and are divided into four categories:
➢ Cumulative Preference Shares.
➢ Non-cumulative Preference Shares.
➢ Participating Preference Shares.
➢ Non-participating Preference Shares
Cumulative Preference Shares are those shares who will receive the dividends whether the
company is making good profits or not. In case the company is not able to pay dividends in one
year because of low profitability, then the amount that is not paid is to be compensated in the
next year, and until it is compensated, it is treated as Current Liability.
Non-cumulative Preference Shares are those which will receive a fixed rate of dividends only in
the year when the company is making good profits. In years of low profits, they will only receive
the dividends which the company will be able to pay and the right over the remaining dividends
will be lapsed and will not be compensated in the future years.
Participating Preference Shares are those preference shares which have a voting right and they
take part in running of the business by choosing the directors at the Annual General Meeting
(AGM). Amongst the Preference Shares they rank last both at the time of distribution of dividends
and in case of insolvency.
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Non-participating Preference Shares are those preference shares who neither have voting rights
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nor are cumulative.

Besides the above-mentioned 4 categories, preference shares are broadly classified as
Redeemable and Non-Redeemable.
Debentures are the “I Owe You” certificates of the company, they are the long-term liabilities on
which a fixed rate of interest is given and the amount owed by the company is to be returned on
maturity. The interest on debentures are not the distribution of profits, instead are the expense
of the company.
Convertible Loan Stocks are the long-term liability of the company on which a fixed rate of
interest is to be given. On maturity, the convertible loan stock holders are given an option to
convert the loan into shares. Thus, the convertible loan stock holder becomes the shareholders
from the creditors of the company. The rate of conversion, the maturity date and the option to
convert are all pre-decided at the time when the convertible loan stocks are issued.
If the conversion is equal to the number of shares issued then the double entry is as follows:
Convertible Loan Stock DR
Ordinary Share Capital CR
If more amount of shares are issued compared to the amount of convertible loan stocks then the
double entry are as follows:
Share Premium DR
If less amount of shares are issued compared to the amount of convertible loan stocks, then it
indicates that the shares are issued at higher price or in other words shares are issued at
premium. The double entries are as follows:
Share Premium CR
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RESERVES
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There are two types of reserves,

➢ Revenue Reserves
➢ Capital Reserves
Revenue Reserves are the amounts set aside by the company from the trading activities of the
business, i.e. from the profits for the future prospects of the company. The revenue reserves of
the company comprise of:
1. General Reserves
2. Asset Replacement Reserves
3. Retained Profits
General Reserves are the amounts that the company set aside for the purpose of expansion or
to combat a problem that might arise in future.
Asset Replacement Reserves is the amount set aside by the company so that it has sufficient
funds to buy a new asset when the old one is disposed off.
Retained Profits are the left-over profits which are ploughed back into the company to finance
the running of the company in an effective manner.
Capital Reserves are those which are generated through non-trading activities and they comprise
of:
➢ Share Premium
➢ Revaluation Reserves
➢ Capital Redemption Reserves
➢ Debenture Redemption Reserve Fund
Share Premium is the amount that is generated by selling a share at higher price than its face
value.
Revaluation Reserve is the amount that is generated when the assets are revalued over and
above its Net Book Value.
Capital Redemption Reserves (Not part of syllabus) are the reserves which might be created
when the shares are redeemed.
Debentures Redemption Reserve Funds (Not part of syllabus) are the reserves which might be
created when the debentures are redeemed.
Limited companies are also called Limited Liability companies because the liability of the
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shareholders is limited, i.e. they are not personally liable for the debts of the company in case of
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insolvency or bankruptcy. In case of insolvency the maximum amount that can be snatched from
them is limited to their investment.
Authorized Share Capital is the maximum amount of shares that the company is allowed to issue.
Issued Share Capital is the part of authorized share capital which the company has already issued
to the general public.
Called-up Share Capital is the part of issued share capital that the company has asked to pay.
Uncalled-up Share Capital is that part of issued share capital that the company has yet not asked
to pay.
Paid-up Share Capital is that part of called-up share capital which has already been paid.
Unpaid Share Capital comprises of Uncalled Share Capital and the unpaid part of Called up Share
Capital.
Face Value is also known as nominal or par value. It is that amount of share which is written on
the face of the shares.
Issue Price is the amount of shares at which the shares are offered to the general public.
Share Premium is the difference between issue price and the face value of the share.Formula:
Share Premium = Issued Price – Face Value
Market Value is the price at which the share is being traded at the stock exchange.
Authorized Share Capital ($100000)
Issued Share Capital ($70000)
Called Up Share Capital Uncalled Share Capital

$0.6 $0.4
Paid up Share Capital $0.15

$0.45 Unpaid Share Capital
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DIVIDENDS
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Dividends are the distribution of profits which is paid to the shareholders if the dividends are
paid during the year, they are called Interim Dividends and if dividends are paid at the end of the
year then they are called Final Dividends. If the dividends are declared but yet not paid, they are
known as Proposed Dividends.
Proposed Preference Dividends are Current Liabilities of the business whereas Proposed Ordinary
Dividends are neither part of Income Statement nor Statement of Financial Position they are just
mentioned in Notes to Accounts. Preference Shares are always subject to fixed rate of dividends
whereas ordinary shares can receive varying amount of dividends each year either in the form of
dividend per share or a rate of dividend.
DIVIDENDS
Dividends per share (DPS) Rate of Dividends
DPS is applied on the ‘Number of Shares’ Rate of Dividends are applied on the ‘Amount
of Shares’
Example: If a company has 100000 Ordinary

shares of $0.5 each and it decided to pay a Amount = Number of Shares x Face Value
dividend of $0.05 per share, then the
dividends will be
Example: If a company has 100000 Ordinary
shares of $0.5 each and it decided to pay a
100000 x 0.05 = $5000 dividend of 10%, then
100000 x 0.5 = 50000
Rate 10% of 50000 = $5000
100000 Ordinary Shares of $0.5 each = $50000

80000 12% Preference Shares of $0.6 each = $48000
Number Fixed Rate Type of Share Face Value Amount of Shares

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of Shares of Dividend
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➢ Preference Dividends are only subject to Rate of Dividends because they receive fixed
rate of dividends which is applicable to the Amount of Shares.
Example: If a company has 80000 12% Preference Shares of $0.6 each, then the total dividends
applicable is
80000*0.6=48000
Rate of 12% = 12% of 48000 = $5760
Since preference shares receive fixed rate of dividend, if some amount is paid as Interim
Dividends them only the remaining amount is paid as Final.
INTERIM FINAL TOTAL
2000 3760 5760
2880 2880 5760
5000 760 5760
0 5760 5760
5760 0 5760
This is not applicable for ordinary shares because they are the real owners of the business and
can receive as much interim and as much final dividend as possible.
INTERIM FINAL TOTAL
5000 10000 15000
8000 12000 20000
0 0 0
0 8000 8000
7000 2000 9000
The accounting treatment of questions involving companies comprises of the preparation of:
I. Income statement
II. Statement of Changes in Equity
III. Statement of Financial Position
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IV. Notes to Accounts

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Income Statement is made as normally and shows the profitability position of the business. In
companies, it is compulsory to divide expenses into 3 categories:
1. Selling and Distribution Expenses: These include all those expenses which are associated
to promote sales. Example; Discount allowed, advertising, bad debts, provision for bad
debts, depreciation of delivery van, carriage outwards and so on.
2. Administrative Expenses: These include expenses which are incurred in managing the day
to day affairs of the business such as wages and salaries, rent, depreciation of
property/plant/equipment and utility bills.
Sum of Selling and Distribution expenses and Administrative expenses are called
Operating Expenses.
3. Financial Expenses: are those expenses that are associated to cost of financing a debt such
as interest and dividends on redeemable preference shares.
Moreover if taxes are incurred they will also be part of Income Statement of Companies,
so that distributable profits could be achieved.
Statement of Changes in Equity comprises of Ordinary share Capital, Preference Share Capital,
Revaluation Reserves, General Reserves, Asset-replacement reserve and Retained earnings. Any
movement in any of these things such as profits made, dividends paid, transfer to reserves, and
revaluation of assets and issue of shares are all part of Statement of Changes in Equity. Proposed
Preference dividends are although part of Statement of Changes in Equity but proposed Ordinary
Dividends are not part of Statement of Changes in Equity.
Statement of Financial Position is made as normally except for the fact that there is no Financed
By section in companies. Instead, there is a ‘Share Capital and Reserves Section’.
Notes to Accounts are the supplementary documents attached to financial statements in order
to make financial statements understandable in a better way.
NOTE: If the question is silent, the preference shares will be considered as Non-Redeemable
Preference Shares. 92
Page
TYPES OF SHARES
Ordinary Shares Preference Shares
Non-Redeemable Preference Redeemable Preference

Shares Shares
➢ are part of Shareholder’s

➢ IS NOT part of
Fund ➢ are part of Shareholder’s
Shareholder’s Funds;
➢ Their dividends are part of Fund
instead are Non-current
distribution of profits ➢ Their dividends are part of
liabilities of the company.
➢ Ordinary dividends paid distribution of profits
➢ Their dividends are NOT
only are part of Statement ➢ Preference dividends paid
the distribution of profits
of Changes in Equity and proposed are part of
➢ Dividends on Redeemable
➢ Proposed Ordinary Statement of Changes in
Preference Shares are
dividends are neither part Equity
part of Expenses of the
of Statement of Changes ➢ Proposed Preference
company
in Equity, nor are part of Dividends are Current
➢ Both dividends paid and
Current Liabilities Liabilities of the company.
proposed are part of
➢ Proposed Ordinary
financial expenses
dividends are mentioned
➢ Proposed preference
in the Notes to Accounts
dividends are Current
Liabilities of the company
93
Page
AQ LTD.
$ $ $
Sales xxx

Purchases xxx
Carriage Inwards xxx
Gross Profit xxx
Add: Other Incomes xx
Less: Selling and Distribution Expenses

Advertising xx
Bad Debts xx
Provision for Bad Debts xx
Discount Allowed xx
Commission xx
Depreciation of Delivery van xx
Carriage outwards xx xx
Less: Administrative Expenses
Wages and Salaries xx

Rent xx
Utility Bills xx
Depreciation xx
Loss on Disposal xx xx
Operating Expenses (xx)
Operating Profit/Profit before Interest and Tax xxx
Less: Financial Expenses
Interest xx
Dividends on Redeemable Preference Shares xx (xx)
Profit After Interest before Tax xxx
Less: Corporation Tax (xx)

94
Distributable Profits xxx

Page
AQ LTD
STATEMENT OF CHANGES IN EQUITY
Ordinary Preference Revaluation Share General Asset Retained Total
Share Share Reserve Premium Reserve Replacement Profit
Capital Capital Reserve
Opening x x X X x x x xx
Balance
Distributable - - - - - - xx xx
Profits
Transfer to - - - - xx xx (xx) -
any reserve
Issue of
shares at
xx xx - X - - - xx
premium
Preference
Dividends
- - - - - - (xx) (xx)
(Paid +
Proposed)
Ordinary
Dividends
- - - - - - (xx) (xx)
(Paid only)
Closing xx xx Xx Xx xx xx xx xxx
Balance
95
Page
AQ LTD.
$ $ $
Cost Depreciation NBV
Goodwill xxx
Property, Plant and Equipment xxx (xxx) xxx
xxx
Current Assets
Inventory xxx
Less: Provision for bad debts (x) xx
Prepayments xx
Cash and Cash Equivalents xx xxx
Total Assets xxx
Share Capital and Reserves

Ordinary Share Capital xxx
Preference Share Capital xxx
Revaluation Reserve xxx
Share Premium xxx
General Reserve xxx
Asset Replacement Reserve xxx
Retained Profits xxx xxx
Current Liabilities
Payables xxx
Accruals xxx
Proposed Taxation xxx
Proposed Preference Dividends xxx
Debentures xxx
Redeemable Preference Shares xxx
Convertible Loan Stock xxx
Total Non-Current Liabilities xxx
Total Liabilities and Equity xxx
96
NOTES TO ACCOUNTS
The company proposed ordinary dividends of $x/share or y% amounting to $____
Page
PAYROLL ACCOUNTING
Payroll Accounting refers to the remuneration policies of the organization. There are
different methods through which employees are compensated for their performance. A
complete salary package comprise of wages, allowances, perks, deductions and other
benefits.
There are different methods of calculating gross pay of the employees which are as
follows:
Fixed Salaries: Some employees are just entitled to daily, weekly, monthly or even
annual salaries with no other perks attached.
Commission only: Some employees are just entitled to commission on the basis of their
performance. This is usually true in case of sales staffs, who are given commission
against their sales.
Basic Pay + Commission: Some employees get a certain fixed salary and over and above
that they are entitled to commission on their performances.
Hourly Pay: Some employees are paid on the basis of number of hours worked. If they
work more than the specified number of hours they get overtime.
Piece meal: This indicates that the employees will be paid on the basis of number of
units they produce. Higher number of units they produce the higher the salary is.
Bonus Schemes: It is a method of remuneration according to which employees receive

a bonus if they meet specific target. It is also called incentive schemes and is usually for
the top executives and can comprise of share options in the company or any other
allowance.
The basic formula for time based system is as follows:

Total wages: (Hours worked × Basic rate of pay per hour) + (Overtime hours worked ×
overtime premium per hour)
The basic formula for a piece work system is as follows:

Total wages: Units produced × Rate of pay per unit
Net Pay is also called take home salary from the gross pay calculated through one of the above
97
techniques. Deductions are subtracted to achieve Net Pay and the formula is as follows:
Page
Net Pay: Gross Pay – Deductions

Deductions are broadly characterized as Statuary Deductions and Voluntary Deductions.
Statuary Deductions are mandatory by law and comprise of Income Tax and National Insurance
Contribution. Whereas Voluntary Deductions depends on the will of employees and comprise
of pension contribution, trade union subscription, and charitable donation.
➢ Income Tax: When an employee earns more than a specified amount, he has to pay tax
against their earnings. The more they earn, the higher the Income Tax. The tax rate
changes as per the change in Income bracket.
➢ National Insurance Contribution: It is deducted from all employees’ pay as a security that
if in future, the employee becomes unemployed or retired or dies, then the government
pays him or his family from the amount saved as NIC. Moreover, whatever deduction is
made from the employees’ salary, the same amount is matched by the employer and
deposited with the government so that the double amount is saved on behalf of the
employee.
➢ Pension Contribution: Some organizations have their own private pension scheme, which
is deducted from employees’ pay if the employee agrees so that when he retires or dies,
his family gets compensation. The amount saved as pension contribution can also be
withdrawn in time of need by the employee.
➢ Trade Union Subscription: Trade Unions are workers’ association which works for the
rights of employees so that the employees could get some benefit. Any employee who
wishes to be a pay of trade union must pay trade union subscriptions.
➢ Charitable Donations: If an employee wishes to pay charity to the specific charitable
organization, they can do so and hence also receive some tax exemptions.
✓ Different benefits and allowances that the employees get are medical
allowance, home allowance, travelling allowance, sick leaves, and casual leaves
and so on.
✓ The total cost of hiring an employee to the organization comprise of gross pay
plus the employer's share of national insurance contribution.
98
Page
Double entries to record payroll:
Income Statement DR
Cost of employing CR
Net Pay DR Payment to an employee
Bank CR
Deduction DR Payment to relevant authorities

Bank CR
Some basic Payroll terminologies:

Clock Card is used to note the time that an employee spent on a certain task. It is a time recorder
which is used to assist in tracking the hours work by an employee of the company.
Time Sheet is a method for recording the amount of a workers’ time spent on each job.
Pay slip is given to the employees at the end of each month to ensure that employees have
received the correct amount of pay. The pay slip contains details as to the number of hours
worked, the benefits received, gross pay, deductions, and net pay of the employee.
Payroll register is a document that records all details about employee’s pay during a period. It
provides details of the hours spent on each job, rate of pay, gross pay, deduction, net pay. It also
contains details of employee’s personal information.
Wages sheet is also known as Payroll sheet and it is a comprehensive list of all the workers, their
pay, rate of pay, deduction, benefits, and so on. The employee record should be kept updated so
any change in rate of pay or deduction could be incorporated in wage sheet.
99
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Accounting Notes (Ta 098)

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Accounting Notes (Ta 098)

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O LEVEL

DEPARTMENTAL ACCOUNTING ...................................................................................................................39

DEBIT SIDE (DR) CREDIT SIDE (CR)

RULES OF DEBIT AND CREDIT

DEBIT: Anything that comes into the business is debited.

+ - Decreases on Credit Side

- + Decreases on Debit Side

- + Decreases on Debit Side

+ - Decreases on Credit Side

- + Decreases on Debit Side

Purchases are goods bought with an intention of re-sale.

Goods are all those things that a business trades in.

Discount is of two types:

Invoice Price/List Price minus Trade discount is equal to Purchase Price

Purchase Price minus Cash discount is equal to Amount Paid.

Statement of Financial Position:

Rent Expense 2500

the same item might be an expense for a much larger business.

Depreciation Rate = Depreciation x 100

DEPRECIATION REPAIR AND MAINTENANCE TOTAL

YEAR 1 9000 0 9000

YEAR 2 9000 2000 11000

YEAR 3 9000 2500 11500

YEAR 4 9000 3500 12500

YEAR 5 9000 5000 14000

DEPRECIATION REPAIR AND MAINTENANCE TOTAL

YEAR 1 12000 0 12000

YEAR 2 10000 2000 12000

YEAR 3 9000 2500 11500

YEAR 4 8000 3500 11500

YEAR 5 6000 5000 11000

Depreciation = Natural resources extracted x Cost

Total natural resources available

Q - Apply all the depreciation methods on the given data:

Net Book Value 8000

Loss on Disposal 3000

1. If NBV > Sales Proceeds Loss on Disposal

1) Machinery A/C 2) Provision for Depreciation A/C

3) Income Statement Extract 4) Disposal A/C

Which method of depreciation is best suited for which assets?

Provision for Bad Debts

Bad Debts Recovered

recovered are as follows:

3) If adjustments to final accounts only involve closing prepayments, then closing

accruals will go to statement of financial position as current liability.

7) If the adjustment states that a certain percentage of depreciation is to be charged on the

✓ If the owner withdraws non-current assets, it is referred to as non-current assets

Associated to Purchases Associated to Sales

Added to Cost of Goods

Part of Profit and Loss

Gross Profit xxx

Add: Other Incomes

Rent Received xx xxx

Total Assets xxx

Equity and Liabilities

Less: Drawings (xx)

Total Equity and Liabilities xxx

WHAT IS AN INTANGIBLE ASSET?

Debit Note Issued: Returns Outwards

Fresh Flowers Cards Chocolates Total

Costs Associated to Purchases x x x

Add: Other Incomes

Discount Received xx xx - Xxx