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Maintaining Financial RecordsFA2FIA

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FA2 Maintaining Financial Records1. Financial statements, accounting principles and accounting standards 3

2. Recording business transactions within the accounting and double entry system 15

3. Sales Tax, The day books and Control Accounts 37

4. Cash 49

5. More on sales and receivables 63

6. Accruals and Prepayments 75

7. Accounting for Inventory 79

8. Non-Current Assets 89

9. Trial balances and correcting errors 97

10. Incomplete Records 111

11. Partnerships 119

Answers To Tests 127

Answers To Examples 139

FA2 Maintaining Financial Records (2019 Exams) 1




Chapter 1FINANCIAL STATEMENTS, ACCOUNTING PRINCIPLES AND ACCOUNTING STANDARDS

1. Introduction

The income statement and the statement of financial position are the key documents in the financial statements of any business.

You need to know how these are usually set out and the terminology that is used.

2. Types of business transaction

An organisation can be defined as:

A social arrangement which pursues collective goals, which controls its own performance and which has a boundary separating it from its environment.

Organisations can include businesses such as companies and partnerships, clubs, charities, government departments, hospitals and schools.

Even if not strictly a ‘business’ all organisations will have business transactions. Typically these will include:

๏ Purchasing goods and materials. Purchases can be for cash or credit. Cash purchases are paid for immediately and are fairly rare in most businesses. Credit purchases are paid for after some time, typically a month or so

๏ Purchasing services, for example, repair s to equipment, advertising, printing costs.

๏ Sales. Cash sales, for example in shops, are paid for immediately. Credit sales are paid for after some time.

๏ Paying wages and salaries.

๏ Purchase of non-current assets.

๏ Raising finance and paying rewards to the suppliers of finance. For example, owners putting in capital or loans being raised form banks. Owners of the business expect rewards based on a share of the profit; banks usually expect interest to be paid.

๏ Accounting for and paying tax.

๏ Movements of cash and money in the bank account. These movements usually arise from the transactions above.



3. Types of business documentation

Each type of business transaction has its own set of documentation. The documentation is needed to:

๏ Control the progress of the transaction

๏ Record the transaction

๏ Provide a history of how the transaction proceeded. This is sometimes known as an ‘audit trail’

Sometimes the documentation is purely internal; sometimes it arises externally or is sent outside the business. Nowadays, the term ‘documentation’ is not confined to paper documents only as many business transactions are mostly handled using computerised records.

Typical documentation is as follows:

Purchase of goods and materials: this will usually be initiated by someone in the warehouse or factory who can see that more materials will soon be needed. Often this person raises a purchase requisition which goes the buyers’ department. Buyers will then raise a purchase order to order goods from the most suitable supplier. Goods, accompanied by the supplier’s delivery note, will be received in the warehouse, where a goods received note will be raised. These must be checked back to the order to ensure that the correct goods are being received. Invoices from suppliers will be received and recorded by the accounting department first in a purchases day book (just a list of invoices received) and then in the payables ledger. Usually suppliers will send statements of account setting out the amounts still owed. Statements act as reminders and also they can be used to check that buyers agree with suppliers’ versions of events. Later the invoices will be paid and a remittance advice sent by the customer to indicate which invoices have been settled.

If goods are returned to suppliers (for example their quality was poor) then buyers will ask for a credit note. This acts like a negative invoice.

Purchasing services: often, these will be recurring items such as rent, electricity, telephone and insurance, and an invoice will be received Sometimes they will be once-off like paying for an advertisement in a newspaper or for the repair of a piece of equipment. These services should have a purchase order. The invoices will be processed by the accounting department who will make sure that the expenses look reasonable compared to previous amounts or who will ensure that the services have been properly ordered and received.

Sales: in a retail organisation sales will be initiated by customers either in a shop or through the internet. Payment will usually take place immediately and the customer given a till (cash register) receipt; a copy of the sales is also recorded by the cash register system. In businesses selling to other businesses, the sales representatives (sales men and sales women) will be responsible for encouraging customers to place sales orders. Once received, orders should result in goods despatch notes being raised and these act as authorisation to despatch the goods from the warehouse and for also sales invoices being created and sent to the customers by the accounting department. The accounting department will also record each invoice in a sales day book (just a list of invoices) and will then record what each customer owes in the receivables ledger.

Most businesses will send customers statements of account which set out the amounts still owed by customers. Statements act as reminders to customers about what needs to be paid and they also allow customers to check that they agree with the seller’s version of events. Payments by credit customers should be accompanied by remittance advices which detail what is being paid.

If goods are returned by customers (for example their quality was poor) then customers will ask for a credit note. This acts like a negative invoice.



Paying employees: large organisations will have a wages and salaries department which is responsible for calculating amounts owing, and dealing with employees who leave and with new joiners. Sometimes the payments are the same every week or month; sometimes they depend on time records (such as clock cards). In both cases employees will receive a wage or salary slip showing their pay and any deductions for tax etc. The amounts to be paid will usually be passed to the accounting department which will look after the cash transfers to employees.

Purchase of non-current assets: The purchase of these assets will often begin with en employee raising a purchase requisition, for example for a new printer, which is then authorised by a manager or by the company accountant. When the invoice is received, someone needs to ensure that the asset has been received and that it is working properly. These payments are handled in a similar way to purchases of goods and raw materials.

Finance. In companies, shares can be issued in exchange for new share capital. Loans will usually be accompanied by a loan agreement setting out the terms of the loan.

Tax will be paid in response to an assessment by the tax authorities.

Movements in cash and bank account amounts require careful documentation. Cash payments are usually small and usually made through the petty cash system where payments will be supported by petty cash vouchers. Payments from bank accounts will be by cheque or credit transfer. Credit transfers can be:

๏ Specially initiated by the company

๏ Automatic constant amounts (standing orders)

๏ Initiated by the person receiving the money (direct debits).

In all cases there should be documentation to back up the payments.

All to these transactions are recorded in the books of account (described in detail in a later chapter). The information is summarised at the end of accounting periods into two statements:

๏ Income statement

๏ Statement of financial position



4. Income statement

This shows the sales made and the costs incurred in a period. Sales less costs will show the profit made in the period (or if costs are greater than sales, the loss for the period). You might sometimes still hear this document referred to as the ‘Profit and loss account’, but that is no longer official terminology and you should try not to use it.

If the income statement is for a limited company its presentation is usually defined by statute, because limited companies are closely regulated. If it is for a sole trader or a partnership, then there can be more flexibility.

The typical layout is:

Notes1 ABC LimitedABC LimitedABC Limited2 Income statement for the year ended 31 December 2014Income statement for the year ended 31 December 2014Income statement for the year ended 31 December 2014

$ $3 Sales X4 Less: cost of sales (X)5 Gross profit X6 Selling costs X6 Distribution costs X6 Administration costs X

X7 Net profit X

Notes

1. The name of the entity must be stated.

2. Income statements are for periods. Typically they show income, expenses and profits for a period of a year. However, other periods are also possible.

3. Sales, or revenue, is what is sold in the period. This will exclude any sales tax that customers are charged because that is a tax passed onto the government, not a sale.

4. Cost of sales. The cost of sales is the direct costs of buying or making whatever is sold. Cost of sales is not generally the same as what was purchased because there can be opening and closing inventory.

Cost of sales = Opening inventory + Purchases – Closing inventory

The inventory adjustment ensures that sales are properly matched with the cost off the goods sold:

Opening inventory + Purchases equal all the items that were available for sale.

Closing inventory is what was not sold.

5. The gross profit is sales less cost of sales. Think of this as the main-spring of the business. If gross profit is poor, very poor profits will be made overall.

6. In a company’s income statement, typically other expenses are grouped and summarised as shown into selling, distribution and administration costs. This keeps the income statement relatively uncluttered. More details can be provided as notes to the financial statements.



7. The net profit is what’s left after all expenses. Out of this, companies will pay their corporation tax (for example a simple percentage of the new profit). Anything left can be kept in the business or paid out as dividends to reward shareholders) or taken as drawings in an unincorporated business).

The income statement of an unincorporated business (a sole trader for example) could look identical, but often the expenses will be listed in greater detail.

5. The statement of financial position

As the name of this document suggests the statement of financial position (“SOFP”) shows the financial position of a business at a point in time. You might sometimes hear this document referred to as a ‘balance sheet’, but this is old terminology and you should try to avoid it.

It shows:

๏ Assets (non-current assets and current assets)

๏ Liabilities (non-current liabilities and current liabilities)

๏ Capital

The typical layout is:

Notes1 ABC LimitedABC LimitedABC Limited2 Statement of financial position as at 31 December 2014Statement of financial position as at 31 December 2014Statement of financial position as at 31 December 2014

$ $3 Non current assets:

Land and buildings Machinery Vehicles

XXX

X4 Current assets

Inventory Receivables Cash at bank and in hand

XXX

X

XX

5 Capital Capital introduced Retained profits

XX

XNon-current liabilities Bank loan XCurrent liabilities Payables Overdraft

XX

XX



Notes

1. The name of the entity must be stated.

Statements of financial position are drafted for a point in time.

Non-current assets are used by the business to make profits and have a life of longer than one accounting period. They are not regularly bought and sold as trading goods are.

Current assets are either cash or expected to become cash within one year. They are presented in increasing order of liquidity. So, inventory has to be first sold and then the sales proceeds have to be collected. That could all take many months. Customers (receivables) are usually expected to pay within a month or so. Cash is already cash. So, the ‘bad news’ comes first because some inventory might never sell and might never become cash.

Capital arises from capital introduced by the owners of the business and from retained profits. Any withdrawal of profits by the owners will reduce the retained profit and therefore will reduce the capital of the business.

Non-current liabilities are liabilities that have to be settled after more than 12 months. For example, a bank loan being repaid over five years.

Current liabilities have to be settled in less than 12 months. Note that overdrafts are repayable on demand.

The figures marked by the arrows should be equal:

Assets = Liabilities + Capital (amounts owed to the owners)

In essence, the statement of financial position sets out the accounting equation covered in more detail in a later chapter).

6. The conceptual framework of accounting

There are certain principles which underpin accounting and accounts preparation. You need to know what these are:

1. Going concern: the assumption that the business will continue functioning in the foreseeable future. This can affect the valuation of many assets because if the business closes, assets might have to be disposed of at their scrap values.

2. Accruals: income and expenses should be matched on a time basis, not just when cash is received or paid.

3. Consistency: financial statements should be drawn up using the same approaches each year. If, for example, the way an amount is measured is altered, then profits could be affected or manipulated.

4. Double entry: every transaction has matching Debit and Credit entries in the bookkeeping system.

5. Business entity: accounting records record the transactions of the business entity, not the transactions of its owners.

6. Materiality: an item is material if its misstatement could alter the economic decisions of user of the financial statements. Immaterial items do not have to be disclosed – indeed too much information can be confusing.



7. Historical cost: transactions are recorded at their historical cost.

There are also certain qualitative characteristics of accounting, which you also need to know. These are:

1. Relevance: financial information is regarded as relevant if it is capable of influencing the decisions of users. Therefore, all relevant information should be included in financial statements.

2. Faithful representation: financial information must be complete, neutral and free from error otherwise it will mislead users of the financial statements.

3. Comparability: financial information should be capable of being compared over time and with similar information about other entities. If it is not comparable, then interpretation and understanding is difficult.

4. Verifiability: the accounting information should be capable of being verified through auditing procedures. This allows users to place more trust in the information.

5. Timeliness: information should be provided quickly enough to be of use in decision-making.

6. Understandability: information should be presented in a way that makes it understandable to users. This can be done, for example, by good layout, accurate descriptions and, where necessary, notes explaining the information.

7. Accounting standards

At one time accountants had an enormous amount of discretion when it came to producing financial statements. For example:

๏ There are many way in which inventory can be valued.

๏ There are different views on how money spent on research should be treated (is it an expense or an investment)

๏ How should profits be take on large construction contracts which last several years? Spread in some way or all taken at the very end of the contract?

Different accounting policies meant that it was hard to compare different entities because they might use different approaches to accounting. Also it meant that some financial statements were drawn up using approaches which might not be sufficiently prudent.

To bring consistency and prudence to the preparation of financial statements, there are now potentially three sources of rules for many accounting issues:

๏ National laws

๏ Local accounting standards

๏ International accounting standards (IAS) or International Financial Reporting Standards IFRS).

National laws take precedence, then local standards, then international standards, though many countries are adopting international standards.

IASs and IFRSs are developed by the International Accounting Standards Board in liaison with users of financial statements, academics, auditors, accounting bodies and industry.



You need to be aware of the main points covered by the following IASs:

๏ IAS 1 Presentation of financial statements

๏ IAS 2 Inventories

๏ IAS16 Property, plant and equipment

๏ IAS18 Revenue

๏ IAS 37 Provisions, contingent liabilities and contingent assets.

IAS 1 ! Presentation of financial statements

The objective of IAS 1 (2007) is to set out the basis for presentation of how general purpose financial statements should be presented to ensure comparability with both the entity's financial statements of previous periods and with the financial statements of other entities. IAS 1 sets out the overall requirements for the presentation of financial statements, guidelines for their structure and minimum requirements for their content.

IAS 2!Inventories

The fundamental principle of IAS 2 is that inventories (or stock) are must be stated at the lower of cost and net realisable value.

Cost should include all:

๏ Costs of purchase (including taxes, transport, and handling) net of trade discounts received.

๏ Costs of conversion (including fixed and variable manufacturing overheads)

๏ Other costs incurred in bringing the inventories to their present location and condition.

Net realisable value is the estimated selling price in the ordinary course of business, less the estimated cost of completion and the estimated costs necessary to make the sale.

IAS16! Property, plant and equipment

Items of property, plant, and equipment should be recognised as assets when:

๏ It is probable that the future economic benefits associated with the asset will flow to the entity, and

๏ The cost of the asset can be measured reliably.

An item of property, plant and equipment should initially be recorded at cost. Cost includes all costs necessary to bring the asset to working condition for its intended use. This would include not only its original purchase price but also costs of site preparation, delivery and handling, installation, related professional fees for architects and engineers, and the estimated cost of dismantling and removing the asset and restoring the site.

IAS 16 permits two accounting models:

๏ Cost model. The asset is carried at cost less accumulated depreciation and impairment.

๏ Revaluation model. The asset is carried at a revalued amount, being its fair value at the date of revaluation less subsequent depreciation and impairment, provided that fair value can be measured reliably.



IAS 18 ! Revenue

Revenue should be measured at the fair value of the consideration received or receivable. An exchange for goods or services of a similar nature and value is not regarded as a transaction that generates revenue. However, exchanges for dissimilar items are regarded as generating revenue.

Recognition of revenue can occur when:

๏ It is probable that any future economic benefit associated with the item of revenue will flow to the entity, and

๏ The amount of revenue can be measured with reliability

IAS 37! Provisions, contingent liabilities and contingent assets.

๏ Provision: - a liability of uncertain timing or amount.

๏ Liability: - present obligation as a result of past events

- settlement is expected to result in an outflow of resources (payment)

A contingent liability is a possible obligation arising from past events that depends on a future event. For example, damages that might have to be paid are contingent on the findings of a court.

Similarly, a contingent asset arises from past events but which is dependent on future events. For example, the amount of damages won can depend on the outcome of a court case.



Question 1 Which accounting principle says that income and expenditure should be matched on a time basis?

A Prudence

B Going concern

C Accruals

D Business entity

Question 2 IAS 2 states that inventories are must be stated at the lower of cost and net realisable value.

Which two accounting principles are in conflict if inventory is valued at net realisable value?

A Materiality and prudence

B Consistency and accruals

C Materiality and historical cost

D Prudence and accruals

Question 3 Going concern is the assumption that a business will:

A continue for the foreseeable future

B continue for the next 5 years

C be profitable in the future

D will shortly be closed down

Question 4 In its previous financial statements a business valued inventory using FIFO. In its current financial statements it has adopted the cumulative average approach.

Which accounting principle would this violate?

A Prudence

B Consistency

C Historical cost

D Understandability



Question 5

A business bought a machine for $10,000. Delivery cost $500 and installation cost $1,000.

What is the cost of the machine according to IAS 16?

A $10,000

B $10,500

C $11,000

D $11,500

Question 6

What do the following statements define according to IAS 37?

Present obligation as a result of past events

Settlement is expected to result in an outflow of resources (payment)

A A liability

B A contingent liability

C A provision

D A contingent asset.

Question 7 What is the purpose of a statement of account sent to a customer?

A It is a demand for payment

B It states to the customer what goods have been sent

C It tells the customer what is owed as a reminder and as a check

D It states the credit limit on the account.

Question 8 A remittance advice:

A Advises on what has to be paid

B Gives information about what is being paid

C Advises about goods being returned

D Gives information about wages being paid





Chapter 2RECORDING BUSINESS TRANSACTIONS WITHIN THE ACCOUNTING AND DOUBLE ENTRY SYSTEM

1. Introduction

This chapter gives a brief description of how transactions are recorded in accounting systems, including the use of codes to define information precisely.

2. Recording transactions.

Transactions are first recorded in the books of prime entry and then recorded on the ledger system.

A prime entry record (or book of prime entry) is where a transaction is first recorded.

These records consist of:

๏ The cash book: this records amounts paid into and out of the bank account

๏ The petty cash book: this records small amounts of cash paid for day to day expenses, such as buying postage stamps and teas or coffee for the office.

๏ The sales day book: sales invoices issued to credit customers

๏ The purchases day book: purchase invoices received from suppliers

๏ The journal: where adjustments, such as correcting errors, are first recorded.

Some businesses also have sales returns and purchases returns day books.

The books of prime entry serve to ‘capture’ transactions as soon as possible so that they are not subsequently lost or forgotten about.

The cash book and the petty cash book are part of the double entry system and record cash coming in and going out.

The day books and journal are not part of the ledger (double entry) system, and entries are made from there to the ledgers.



The word ‘ledger’ means a book. In accounting systems there are usually three ledgers:

๏ The general or nominal ledger, which records amounts such as wages, sales, purchases, sales, electricity, travel, advertising, rent, insurance, repairs, receivables, payables and non-current assets. The cash and bank accounts are technically part of this ledger but are usually physically kept in a separate book because cash and bank transactions are so numerous.

๏ The payables ledger (also known as the creditors’ ledger and sometime the purchase ledger). Although the total amount owed to suppliers is recorded in the general ledger, details of exactly what is owed to whom are also recorded here. There is a separate account for each supplier. The sum of the amounts owing in this ledger should agree with the payables balance in the general ledger.

๏ The receivables ledger (also known as the debtors’ ledger and sometimes the sales ledger). Although the total amount owed by customers is recorded in the general ledger, details of exactly what is owed from whom are also recorded here. There is a separate account for each credit customer. The sum of the amounts owing in this ledger should agree with the receivables balance in the general ledger.



3. The accounting system in diagrammatic form

The accounting system can be depicted as follows:

Receivables ledgerHolds detail of what makes up the total receivables.

An account for each credit customer:

Abramson xAhmad xBerry xBurton xCheridjian x.........

Total x

Sales day book

Lists credit sales.

From this the general ledger sales and receivable control accounts are updated together with the detailed receivables accounts in the receivables ledger

Purchases day book

Lists credit purchases.

From this the general ledger purchases and payables control accounts are updated together with the detailed payables accounts in the payables ledgerJournal

Makes adjustments to accounts in the double entry system

Payables ledgerHolds detail of what makes up the total payables.

An account for each credit supplier:

Adams xBoulez xClarke xDalziel xChun x.........

Total x

The double entry system

General (nominal) ledger

Assets (things owned)

Liabilities(things owed)

Equipment Payables (control)Machinery Bank loansPremisesInventory Owner’s capitalReceivables (control)

Income ExpensesSales Purchases for resaleInterest earned Rent

ElectricityInterest paid......etc

Cash Book

Dr! CrReceipts Payments

Petty cash Book


To recap:

The double entry system consists of the general ledger, the cash book and the petty cash book.

The receivables and payables ledgers provide details of the total receivables and payables that are recorded in the nominal ledger.

The books of prime entry are the cash book, the petty cash book, the sales day book, the purchases day book and the journal.



4. The accounting equation and the principles and practice of double-entry book-keeping

Bookkeeping relies on a number of linked principles:

1. The transactions of the business are separate from those of its owners

2. Every transaction gives rise to two effects (or two entries). One entry is known as a credit entry and the other a debit entry.

3. Things owned by the business equals things owed by the business.

The double entries are often displayed in ‘T’ accounts:

Account nameAccount nameAccount nameAccount name

Debit (DR) side Credit (CR) side

Means: Means:Increase in an asset Decrease in an assetIncrease in an expense Decrease in an expenseDecrease in a liability Increase in a liability(an amount owed) (an amount owed)

Increase in income

The accounts are collected together into ledgers. Remember ‘ledger’ just means ‘’book’ and it used to be that each account had its own page in the books.

Here are some simple, common transactions: remember every transaction has two effects: one debit, one credit. The amounts of debits must equal the amounts of credits.

Purchase of office stationery for cash:

Debit Office stationery (increase in an expense)

Credit Cash (decrease in an asset)

A cash sale:

Debit Cash (increase in an asset)

Credit Sales (increase in income)

A credit sale:

Debit Receivables (increase in an asset)

Credit Sales (increase in income)



Payment by a customer of an amount owing:

Debit Cash (increase in an asset)

Credit Receivables (decrease in an asset)

Purchase, on credit, of goods for resale:

Debit Purchases (increase in an expense. ‘Purchases’ is the name given to purchases for resale)

Credit Payables (increase in a liability).

You should understand that if the double entry as been carried out properly, then the sum of the debit entries should always equal the sum of the credit entries. This should be regularly checked by compiling a trial balance, which is simply all the accounts listed in debit and credit columns and the lists added up. The totals should always agree.

Question 1 What would be the double entry for the payment of wages to employees?

A Dr Employees Cr Wages

B Dr Wages Cr Cash

C Dr Cash Cr Wages

D Dr Cash Cr Employees

Question 2 What would be the double entry for the purchase of a car on credit?

A Dr Garage Cr Cars

B Dr Cars Cr Cash

C Dr Cars Cr Garage

D Dr Garage Cr Cash

Question 3 What would be the double entry for payment of an amount owing to a supplier?

A Dr Purchases Cr Cash

B Dr Supplier Cr Purchases

C Dr Purchases Cr Supplier

D Dr Supplier Cr Cash



5. Starting a business and its initial transactions

Transaction 1

The owner starts up the business in 1/1/2013 by putting $10,000 of cash in as capital.

From the business’s point of view, its cash has increased by $10,000 and its capital has increased by $10,000. Cash is an asset (something owned) and the capital is the amount owed by the business back to its owner.

The double entry would be:

Dr CashCashCashCash Cr

1/1/2013 Capital 10,000

Dr CapitalCapitalCapitalCapital Cr

1/1/2013 Cash 10,000

Notice the cross-referencing between the accounts. The entry in the Cash account is described as ‘Capital’, which is where the cash came from; the entry in the Capital account is described as ‘Cash’, the nature of the capital injected.

Accounting equation:

Things owned, cash $10,000 = Things owed, capital 10,000



Transaction 2

The business buys some equipment for $2,000 cash on 3/1/2013.

Cash has decreased $2,000 and the cost of equipment has increased by $2,000

Dr CashCashCashCash Cr

1/1/2013 Capital 10,000 3/1/2013 Equipment 2,000

Note the balance on this account is Dr 8,000, the net of the Dr and Cr sides

Dr EquipmentEquipmentEquipmentEquipment Cr

3/1/2013 Cash 2,000

The asset of cash decreases and that of equipment increases


1/1/2013 Cash 10,000


Things owned, cash $8,000 + equipment $2,000 = Things owed, capital $10,000



Transaction 3

On 10/1/2013, the business purchases goods for resale for $5,000 on credit.

Dr Cash Cash Cash Cash Cr



3/1/2013 Cash 2,000


1/1/2013 Cash 10,000

Dr InventoryInventoryInventoryInventory Cr

10/1/2013 Suppliers 5,000

Dr SuppliersSuppliersSuppliersSuppliers Cr

10/1/2013 Inventory 5,000

The asset of inventory increases and the liability to suppliers increases


Things owned, cash $8,000 + equipment $2,000 + inventory $5,000

= Things owed, capital $10,000 + suppliers $5,000



Transaction 4

On 15/1/2013, sells half the goods for $4,000 credit.

This will create a profit of 4,000 – 5,000/2 = $1,500. The profit is owed to the owners and is a liability of the business to its owners.

We can look at the sale in two parts: earning $4,000 for a cost of 5,000/2 = 2,500.




3/1/2013 Cash 2,000


1/1/2013 Cash 10,000


10/1/2013 Suppliers 5,000 15/1/2013 Cost of goods sold 2,500


10/1/2013 Inventory 5,000

Dr CustomersCustomersCustomersCustomers Cr

15/1/2013 Profit 4,000

Dr SalesSalesSalesSales Cr

10/1/2013 Customers 4,000

Dr Cost of goods soldCost of goods soldCost of goods soldCost of goods sold Cr

10/1/2013 Inventory 2,500




Things owned, cash $8,000 + equipment $2,000 + inventory $2,500 + due from customers $4,000 = $16,500

= Things owed, suppliers $5,000 capital $10,000 + profit [4,000 – 2,500] = $16,500

Transaction 5

On 31/1/2013, the suppliers are paid what they are owed and $100 is paid for rent.

The rent is an expense and decreases the profit. Paying suppliers what is owed to them has no effect on profits.



31/1/2013 Suppliers 5,000

31/1/2013 Rent 100


3/1/2013 Cash 2,000


1/1/2013 Cash 10,000


10/1/2013 Suppliers 5,000 15/1/2013 Cost of goods sold 2,500


31/1/2013 Cash 5,000 10/1/2013 Inventory 5,000

Dr CustomersCustomersCustomersCustomers Cr

15/1/2013 Profit 4,000



Dr SalesSalesSalesSales Cr

10/1/2013 Customers 4,000

Dr Cost of goods soldCost of goods soldCost of goods soldCost of goods sold Cr

10/1/2013 Inventory 2,500

Dr RentRentRentRent Cr

31/1/2013 Cash 100


Things owned, cash $2,900 + equipment $2,000 + inventory $2,500 + due from customers $4,000 = $11,400

= Things owed, capital $10,000 + profit [4,000- 2,500 – 100 (rent)] = $11,400

6. Trial balances

At any stage, the sums of debit balances and credit balances should be the same. This is because we were strict to always have equal debit and credit entries.

These totals are the trial balance

Example 1

Produce a trial balance for the above accounts: Dr balances Cr balances

Totals



7. Statements of financial position and statement of comprehensive income (income statement)

The accounts can also be used to produce a statement of financial position and an income statement.

๏ Statement of financial position: the assets and liabilities (things owned and things owed) at a point in time

๏ Income statements: income and expenses for the period.

Note that capital put in or taken out by the owners is neither income or expense. It is simply the owner changing his or her investment in the business.

The trial balance amounts can be marked up with SOFP or IS to show which document they form part of:

Dr CR

Cash 2,900 Asset: SOFP

Equipment 2,000 Asset: SOFP

Capital 10,000 Liability: SOFP

Inventory 2,500 Asset: SOFP

Suppliers – – Liability: SOFP

Customers 4,000 Asset: SOFP

Sales 4,000 Income: IS

Cost of goods sold 2,500 Expense: IS

Rent 100 Expense: IS

Total 14,000 14,000



Income statement for January 2013Sales 4,000

Cost of goods sold (2,500)

Gross profit 1,500

Rent (100)

Net profit 1,400

Statement of financial position as at 31 January 2013Assets

Equipment 2,000

Inventory 2,500

Cash 2,900

Due from customers 4,000

11,400

Liabilities

Capital introduced 10,000

Profit 1,400

11,400

Note that the profit made by the business is added to the liabilities in the SOFP. This is because profit is owed to the owners and becomes part of the capital of the business.

Profits taken out of the business are know as ‘Drawings’ (derived from ‘withdrawals’). If the owner removed $1,000 profits then cash would go down $1,000 and drawings up by $1,000. The liability side of the SOFP would then look like:

Liabilities Capital introduced 10,000

Profit 1,400

Drawings (1,000)

10,400



8. Carrying down balances

Look at this account:

CashCashCashCashCapital introduced 2,000 Wages 200

Sales 3,000 Purchases 1,400

Sales 100 Rent 200

Heating 100

To find out how much cash there is now, you have to find the balance on the account ie the net debit or credit amount.

Debits = 2,000 + 3,000 + 100 = 5,100

Credits = 200 + 1,400 + 200 + 100 = 1,900

Therefore balance = Dr 5,100 – Cr 1,900 = = Dr 3,200

This means that there is $3,200 cash i.e. and asset of $3,200.

In bookkeeping finding the balance is done in a very formal way:1. At the bottom of the Dr and Cr sides, enter the larger of the two totals. Here that would be 5,100.



Sales 100 Rent 200

Heating 100

5,100 5,100

2. To make the smaller column add up to that you have to enter the ‘balancing figure’. Here 3,200 needs to be entered on the credit side. This is marked with ‘Balance c/d’ (‘c/d’ meaning ‘carried down’).



Sales 100 Rent 200

Heating 100

Balance c/d 3,200

5,100 5,100



3. This figure is brought down below the totals on the other side. Here $3,200 would be brought down (b/d) on the debit side.



Sales 100 Rent 200

Heating 100

Balance c/d 3,200

5,100 5,100

Balance b/d 3,200

A balance brought down on the debit side of the cash account means that there is an asset of cash.

Example 2

Show how the balance would be carried down on this account:SalesSalesSalesSales

21/6/2013 Returns 550 1/6/2013 Cash 250

25/6/2013 Returns 32 3/6/2013 Credit sales 1,395

29/6/2013 Cash 49



Example 3

James started business as an art dealer in 1 January 2013. His transactions in January 2013 were:

1. Introduced $6,000 capital

2. Bought Picture A for $1,000 cash

3. Bought three identical prints for $1,500 in total, on credit, from V V Gogh

4. Sold Picture A for $1,900 cash [Hint: deal with the sale for $1,900 cash and also transfer the cost of the sale from inventory to the Cost of Goods Sold Account]

5. Sold one of the prints for $850 on credit to L D Vinci

6. Paid rent of $1,000

7. Paid electricity bill of $250

8. Paid V V Gogh half of what was owed.

9. Received the full amount owing from L D Vinci

10. Withdrew $500 from the business for personal living expenses

11. Received a bill for $300 for repairs, but didn’t pay it yet.

12. Bought a computer for $750.

You are required to

(a) write up the required ledger accounts for those transactions (there are accounts on the next page),

(b) calculate the balances on each account(c) produce a trial balance for the end of the period (d) state for each account on the trial balance whether it is an asset, liability, item of income or

item of expense.CashCashCashCash

CapitalCapitalCapitalCapital



InventoryInventoryInventoryInventory

SalesSalesSalesSales

Cost of goods soldCost of goods soldCost of goods soldCost of goods sold

V V GoghV V GoghV V GoghV V Gogh

L D VinciL D VinciL D VinciL D Vinci



ElectricityElectricityElectricityElectricity

RentRentRentRent

RepairsRepairsRepairsRepairs

Repair companyRepair companyRepair companyRepair company

ComputerComputerComputerComputer

DrawingsDrawingsDrawingsDrawings



13. The accounting equation and profit

You have seen how the accounting equation should always hold true:

Things owed = Things owned

If $10,000 cash in introduced as capital, then the equation is:

(1) Things owed $10,000 (Capital) = Things owned $10,000 (Cash)

If the business trades and makes profits of, say $6,000, then the business has become ‘richer’ by £6,000 and the owner’s stake in the business (capital) will have increased by $6,000.

(2) Things owed [$10,000 + $6,000] (Capital) = Things owned $16,000

If the business borrows $2,000, then cash will increase by that amount, but the business will also owe money to the bank:

(3) Things owed [$10,000 + $6,000] (Capital) + $2,000 = Things owned $18,000

or

(4) [$10,000 + $6,000] (Capital) = $18,000 – $2,000 [Loan] = Net assets $16,000

Comparing equations 1 and 4, Capital has increased by $6,000 because a profit has been made and this is reflected in the increase in net assets from $10,000 to $16,000.

Profit makes businesses richer.

However, profit and capital can be withdrawn from a business and this will reduce the net assets of the business. So, if the owner withdrew money to live on (made drawings) of $2,000, the assets would reduce by $2,000 and the equation would be:

(5) [$10,000 + $6,000 – 2,000] (Capital) = $16,000 –$2,000[Loan] = Net assets $14,000

So, comparing equations 1 and 5, we can say that:

Increase in net assets between two dates $(14,000 – 10,000) =

Capital introduced in the period ($Nil) + Profit ($6,000) – Drawings ($2,000) = $4,000.

Remember:

Increase in net assets = capital introduced + profit - drawings



Question 4 On 1 January 2013 a business had net assets of $15,000

On 31 January 2013, net assets amounted to £19,000.

No capital had been introduced in January, but the owner had made drawings of $750.

What profits were made in January?

A $4,000

B $4,750

C $3,250



Additional capital of $1,000 had been introduced in January, but the owner had made drawings of $400

What profits were made in January?

A $3,400

B $4,000

C $4,600

D $5,400



A loss of $7,000 had been made and the owner withdrew $1,000 to live on.

What additional capital was introduced to the business in January?

A $8,000

B $6,000

C $7,000

D $10,000



Question 7

On 1 January 2013 and 31 January 2013 a business had the following assets and liabilities:

1 January 31 January$ $

Cash 10,000 12,000Owed to suppliers 3,000 4,000Owed from customers 2,000 1,000Equipment 8,000 10,000Bank loan 2,000 5,000

No additional capital had been introduced, but the owner withdrew $800 to live on.

What profit or loss was made in January?

A $1,000 loss

B $5,800

C $200 loss

D $1,800





Chapter 3SALES TAX, THE DAY BOOKS AND CONTROL ACCOUNTS

1. Introduction

This chapter shows how the day books and journal are used to feed information into the double-entry system and into the receivables and payables ledgers.

2. Sales tax

Many countries have a sales tax where an amount is added to goods sold and this amount must later be paid over to the Government. In the UK, the sales tax is called VAT (value added tax). Usually businesses are required to register for sales tax once their turnover (sales) reaches a certain amount. Once registered, they have to charge sales tax to their customers on any taxable supplies they make.

The rates at which tax is charges can be complicated and varies from country to country. For example, in the UK there are:

๏ Exempt supplies. No tax is charged at any rate. Supplies include insurance and healthcare.

๏ Zero-rated supplies. Tax is levied at 0%. Supplies include most food (but not hot or restaurant food), books and newspapers, most travel.

๏ Standard-rated. Most goods have tax added at this rate. For example, hotel and restaurant bills, adult clothing, petrol etc.

๏ Reduced rate. For example, domestic electricity, gas and heating oil

The amount of the sales before the tax is added is called the net amount, and after tax is added is called the gross amount. Similarly, most purchases will include an amount of sales tax.

The tax on sales is called output tax.

The tax on purchases is called input tax.

Once registered, tax has to be charged on taxable supplies and this is periodically paid over the government. However, once registered, traders can reclaim input tax from the government. Only the net amount of input and output tax is paid to, or reclaimed from, the government.



Sales tax is accounted for in a sales tax account:

Sales TaxSales TaxSales TaxSales TaxInput tax X Output tax XCash – payment of net amount to government

X

It is vital to realise that for a registered trader, tax charged on sales is not part of sales or income and that tax charged on purchases is not part of expenses. The sales tax account shows the liability to or from the government.

Example 1

Sales tax is charged at 20%. In a period a business makes cash sales of $6,000 (net) on which sales tax is $1,200 and $7,200 is the gross amount.

In the same period cash purchases of $2,000 (net) were made on which sales tax was $400 and $2,400 is the gross amount.

At the end of the period the appropriate amount of tax was paid to the government.

Write up the following accounts:

SalesSalesSalesSales

PurchasesPurchasesPurchasesPurchases

Sales tax accountSales tax accountSales tax accountSales tax account



Cash accountCash accountCash accountCash account

3. Sales tax calculations

It is important to be able to work out gross and net amounts and the amount of tax, and this can best be done by a cost structure.

If sales tax is at 20%, then the cost structure would be:

Net amount + sales tax = Gross amount

100 20 120

Once that is established then you can easily move between any of the sales figures using proportions.

1 Net amount = 280: therefore


100 20 120

280 ? ?

sales tax = 280 x 20/100 = 56, and

gross amount = 280 x 120/100 = 336

2 Tax = 40: therefore


100 20 120

? 40 ?

net amount = 40 x100/20 = 200, and

gross amount = 40x 120/20 = 240

3 Gross amount = 840: therefore


100 20 120

sales tax = 840 x 20/120 = 140, and

net amount = 840 x 100/120 = 700



Note that this type of calculation was necessary in the petty cash voucher, above. $12 was charged, of which $2 was the VAT and $10 the net cost

If there are bulk or quantity discounts, the VAT is calculated on the amount after the discount.

The amount of sales tax charged on sales is known as output tax (a tax on goods leaving the business). Business suffer sales tax on their purchases as suppliers have to charge sales tax on their sales; that tax is known as input tax (it is the tax on goods coming into the business).

At the end of each tax accounting period, the net of the sales output and input taxes has is paid to or received form the government.

Question 1

Sales tax rate = 15%. Gross sales are $690.

What are the net sales and the sales tax?

A Net = $586.50. Sales tax = $103.5

B Net = $600. Sales tax = $90

C Net = $600. Sales tax = $103.5

D Net = $586.50. Sales tax = $90

Question 2

Sales tax rate = 16%. Full net price before any bulk discount = $3,000.

Bulk discount = 20%.

What are the gross sales and the sales tax?

A Gross = $2,784. Sales tax = $480

B Gross = $2,400 Sales tax = $384

C Gross = $3,480. Sales tax = $480

D Gross = $2,784. Sales tax = $384

Question 3

In a period a company charges $4,600 sales tax on its sales. Its purchases from its suppliers cost $6,000 including sales tax at 20%.

What payment/receipt will be made to/received from the government at the end of the period?

A 1,400 received from the government

B 1,400 to be paid to the government

C 3,600 to be paid to the government

D 3,600 to be received from the government



4. The day books

For convenience, the diagram of the accounting system is produced again:




Total x

Sales day book

Lists credit sales.


Purchases day book







Total x








Cash Book


Petty cash Book




The purchase day book (PDB)

This book records of all the invoices received by a business from its credit suppliers.

Before invoices are listed here, they should be approved for payment as the invoices will progress form here to the ledgers and eventual payment.

The PDB is simply a list. A simple PDB would be as follows:

Date Details Supplier’s account number

Net amount Sales tax amount

Gross amount

4/2/2013 ABC Ltd 123 1000 200 1200

8/2/2013 CDE Ltd 234 400 80 480

8/2/2013 FGH Ltd 332 1200 240 1440

9/2/2013 IJK Ltd 346 150 30 180

TOTALS 2750 550 3300

Notes

1. Despite its name the purchases day book does not have to be totalled every day.

2. The total of the net amount, sales tax amount and gross amount columns should add across (known as cross casting). If they don’t and error have been made somewhere.

3. The total of the gross amount column is how much extra we owe suppliers because of these invoices.

4. The total of the net amount column is the cost of how much extra has been purchased.

5. The total of the sales tax amount is simply the total of the sales tax relating to these invoices. This can be recovered from the government.

The posting that would be made to account for these purchases transactions are:

In the general ledger

Credit: Payables control account (total payables) 3,300Debit: Purchases account 2,750Debit: Sales tax account 550

3,300 3,300

These entries reflect that $3,300 is owed to suppliers for goods of $2,750 and sales tax of $550.

In addition, in the Payables Ledger, each of the suppliers is credited with the gross amount of their invoices



Supplier account number Supplier name Gross amount123 ABC Ltd 1200

234 CDE Ltd 480

332 FGH Ltd 1440

346 IJK Ltd 180

Note: the Payables Ledger is not part of the double entry system: it is a memorandum entry. If everything has been done properly, the sum of the detailed accounts in the payables ledger will agree with the payables Control Account in the general ledger.

This system fulfils the following functions:

1. The control account provides an instant answer as to what is owed to suppliers in total

2. The detailed ledger accounts in the Payables Ledger give information about exactly what is owed to whom

3. Ensuring the control account and the sum of the ledger balances agree will reduce the chance of an error having occurred in the postings.

The sales day book (SDB)

This book records of all the invoices issued by a business to its credit customers before they are sent out to customers.

The SDB is simply a list. A simple SDB would be as follows:

Date Details Customer’s account number


Gross amount

4/2/2013 PQR Ltd 378 400 80 480

8/2/2013 STU Ltd 388 300 60 360

8/2/2013 VWX Ltd 587 200 40 240

9/2/2013 YZA Ltd 775 120 24 144

TOTALS 1020 204 1224

Notes

1. Despite its name the sales day book does not have to be totalled every day.

2. The total of the net amount, sales tax amount and gross amount columns should add across (known as cross casting). If they don’t and error have been made somewhere.

3. The total of the gross amount column is how much extra we are owed by customers because of these invoices.

4. The total of the net amount column is the ore-tax sales value of the extra sales.

5. The total of the sales tax amount is simply the total of the sales tax relating to these invoices. This will be paid to the government (after off-setting any input sales tax).



The posting that would be made to account for these sales transactions are:

In the general ledger

Debit: Sales control account (total receivables) 1,224 3,300Credit: Sales account 1,020Credit: Sales tax account 204

1,224 1,224

These entries reflect that $1,224 is owed by customers for goods of $1,020 and sales tax of $204.

In addition, in the Receivables Ledger, each of the customers is debited with the gross amount of their invoices

Details Gross amountPQR Ltd 480

STU Ltd 360

VWX Ltd 240

YZA Ltd 144

Note: the Receivables Ledger is not part of the double entry system: it is a memorandum entry. If everything has been done properly, the sum of the detailed accounts in the receivables ledger will agree with the receivables Control Account in the general ledger.

This system fulfils the following functions:

1. The control account provides an instant answer as to what is owed by customers in total

2. The detailed ledger accounts in the Receivables Ledger give information about exactly who owes what.

3. Ensuring the control account and the sum of the ledger balances agree will reduce the chance of an error having occurred in the postings.



5. Control account reconciliations

The receivables and payables control accounts should always agree with the sum of the balances on the receivables and payables ledgers respectively. If they don’t, then an error must haven been made and needs to be corrected.

Correcting control account and ledger errors is a common exam requirement.

For example, a receivables control account balance is $3,825. The three receivable account balances in the receivables ledger are as follows:

Customer name Amount owingA Ltd 1,800

B Ltd 1,500

C Ltd 652

Total 3,952

Something must have gone wrong because the control account balance does not agree with the total of the individual balances.

Investigation of the entries shows the following errors:

1. An invoice for $425 in the day book was posted to C Ltd’s account as $452.

2. An invoice for $500 in the day book was posted as $200 to B’s account

3. The sales day book was under cast (ie added up by too little) by $400

Solution

List of balances b/fList of balances b/f 3,952

1 $452 – 425 = $27 too much debited to C Ltd (27)2 $500 – $200 = $300 too little posted to B Ltd 300Corrected listCorrected list 4,225

Control account balanceControl account balance 3,8253 Under casting error 400

4,225

It is vital to understand which entries come form where.

Individual lines in the day book affect postings to the receivables (or payables) ledger

Totals in the day book affect postings to the receivables (or payables) control account.



Question 4

The total columns in a purchases day book are as follows:

Date Details Supplier’s account number


Gross amount

.. .. ..

.. .. ..TOTALS 4,000 800 4,800

To where are these figures posted in the ledgers?

A Debit Purchases 4,800 Credit Suppliers 4,800

B Debit Purchases 4,000, Credit Sales tax 800 Credit suppliers 4,800

C Credit Purchases 4,000, Credit sales tax 800 Debit suppliers 4,800

D Debit Purchases 4,000, Debit sales tax 800 Credit suppliers 4,800

Question 5

The total columns in a sales day book are as follows:

Date Details Customer’s account number


Gross amount

.. .. ..

.. .. ..

TOTALS 6,000 1,200 7,200

To where are these figures posted in the ledgers?

A Credit Sales 7,200, Debit Customers 7,200

B Credit Sales 6,000, Debit Sales tax 1,200, Debit Customers 7,200

C Credit Sales 6,000, Credit sales tax 1,200, Debit Customers 7,200

D Credit Sales 6,000, Debit sales tax 1,200, Credit Customers 7,200

Question 6

A debit balance of $100 on an individual’s ledger account in the payables ledger has been listed as a credit balance when adding up the list of balances.

To correct the reconciliation of the control account with the list of balances:

Control account List of balances

A Cr 200 Increase by 100

B Cr 100 Increase by 200

C No effect Decrease by 200

D No effect Decrease by 100



Question 7

For the last week of the accounting period, purchases net of sales tax totalled $70,000. The sales tax amounted to $15,000. $85,000 has been credited to the suppliers’ control account as: $83,000.

To correct the reconciliation of the control account with the list of balances:

Control account List of balances

A Cr 2,000 No effect

B Cr 2,000 Increase by $2,000

C Dr 13,000 No effect

D Dr 15,000 No effect

Question 8 The sales day book has been overcast by $1,000. The effect of this error is to:

A Overstate sales, overstate the control account, overstate the total of the accounts in the receivables ledger

B Overstate sales, understate the control account, no effect on the total of the accounts in the receivables ledger.

C Overstate sales, overstate the control account, no effect on the total of the accounts in the receivables ledger.

D Understate sales, overstate the control account, no effect on the total of the accounts in the receivables ledger.

Question 9 An invoice to AGS Ltd of value $4,300 was listed in the sales day book as $3,400. To correct this error, which corrections are needed?

Control account AGS’s account in Sales account

the receivables ledger in the general ledger

A Dr 900 Dr 900 Cr 900

B Dr 900 No effect Cr 900

C Cr 900 Cr 900 Dr 900

D Dr 900 Dr 900 No effect



6. Returns day books

In addition to sales and purchases day books, some businesses sales returns day books and purchases returns day books. Credit notes issued to customers or received from suppliers are listed there.

They act as ‘negative’ day books. Therefore the following postings are made:

Sales returns day book:

Total: Dr Sales, Cr Receivables control account

Individual lines: Cr individual customers’ accounts

Purchase returns day books

Total: Cr Purchases, Dr Payables control account

Individual lines: Dr individual suppliers’ accounts



Chapter 4CASH

1. Introduction

This chapter shows the use of the cash book and petty cash book.

2. The cash books in the accounting system

The cash book and the petty cash book are books of prime entry and are part of the double entry system. The cash book records the flows of money in the bank account of the business; the petty cash book records relatively small amounts of cash expenditure on items like paying for coffee for the office, reimbursing employees for taxi fares, buying some pens for cash from the local stationery shop.




Total x

Sales day book

Lists credit sales.


Purchases day book







Total x








Cash Book


Petty cash Book




3. Types of payment from the bank

Payments can be made from a bank account in four main ways:

๏ Cheque. These are unconditional orders in writing given to a bank (the drawee) by the person paying out of his or her bank account (the drawer of the cheque) to pay an amount to the payee (the person receiving the money). When cheques are received and paid in to a bank account, they are provisionally credited immediately by the bank. However, it takes about three days for the cheque ‘to clear’ which is when the funds are transferred. Until then there is always a possibility that the cheque ‘bounces’ because the payer/drawer has no funds. If that happens the bank debits the recipient’s bank account to reverse the earlier, provisional credit, and sends the cheque back to the recipient. The cheque will be marked ‘Refer to drawer’ meaning that the person who hopes to receive money has to take the matter up with the person who should pay it.

Cheque details are entered into the business’s cash book as they are made out. However, it can be some time before that cheque arrives with the payee and who might delay paying it in. Until the money is taken from payer’s bank account the cheque is described as ‘unpresented’.

๏ Internet transfer: now very common. It is vitally important that account log-on details are kept secure. In addition to user-known passwords, some banks now issue devices that generate unique use-once codes. Access to the bank account is then possible only by someone who both knows the password and who possesses the device.

๏ Direct debit. Here the person receiving the funds has the right to extract them from the bank account. This is often used by institutions like insurance companies to collect insurance premiums from clients. The process can be completely automated.

๏ Standing order. Here the person paying instructs their bank to pay a regular amount to the recipient. This is often used to pay regular amounts like rent. The process can be completely automated.

In addition, banks can remove funds from accounts for interest and bank charges.

4. The cash book

The cash book is the cash account of the business and is where bank account receipts and payments are recorded. In a simple ‘T’ account it would look like;

Cash BookDr (Receipts) Cr (Payments)



Cash BookDr (Receipts) Cr (Payments)Balance b/d 1,200 Paid to C Clark 404Cash sales 240 Paid to D Drake 172Received from A Smith 360 Wages 1200Cash sales 120 Cash purchases 72Received from B Bodkin 600 Tax 300

Balance c/d 3722,520 2,520

Balance b/d 372



Notes:

1. At the start of the period there is cash of $1,200.

2. The receipts from Smith and Bodkin will be the settlement of sales invoices.

3. The payments to Clark and Drake will be the payment for purchases invoices.

4. At the end of the period there is cash of $372

Although the cash book would work perfectly well in this format, it does mean that every entry has to be posted individually to the other side of an account in the general ledger. A more efficient arrangement would be as follows:

Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments)

Total Cash sales

Receivables Total Cash purchases

Payables Wages Sundry

Balance b/d 1,200 Paid to C Clark

404 404

Cash sales 240 240 Paid to D Drake

172 172

Received from A Smith

360 360 Wages 1200 1200

Cash sales 120 120 Cash purchases

72 72

Received from B Bodkin

600 600 Tax 300 300Tax

Balance c/d 372

2,520 360 960 2,520 72 576 1200 300

Balance b/d 372

This is called an analysed cash book.

Remember, the cash book is part of the double entry, so the in debit entries in the cash book are debits in the double entry system. However, their corresponding credit entries for those items have not been. The entries required can be made from the total of each column:

Cr Sales 360

Cr Receivables ledger control account 960

In addition, the memoranda accounts of A Smith and B Bodkin in the Receivables ledger would have to be updated.

Similarly, the credit entries have been recorded in the double entry system, but the corresponding debit entries for those items have not been. The entries required can be made from the total of each column:

Dr Purchases 72

Dr Payables ledger control account 576

Dr Wages 1200

Dr Tax 300



In addition, the memoranda accounts of C Clark and D Drake in the Payables ledger would have to be updated.

5. Cash book with sales tax

Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments)

Total Sales tax

Cash sales

Receivables Total Sales tax

Cash purchases

Payables Wages Sundry

Balance b/d 1,200 Paid toC Clark

404 404

Cash sales 240 40 200 Paid toD Drake

172 172

Received from A Smith

360 360 Wages 1200 1200

Cash sales 120 20 100 Cash purchases 72 12 60Received from B Bodkin

600 600 Tax 300 300Tax

Balance c/d 3722520 60 300 960 2520 12 60 576 1200 300

Balance b/d 372

The introduction of sales tax alters the cells that are shaded.

Assume sales tax is at 20%

On the debit side, cash sales of $240 and $120 were made, but some of these amounts are the sales tax and some the net sales. These have to be accounted for separately.

Gross sales $240; net sales $200; sales tax $40

Gross sales $120; net sales $100; sales tax $20

Cash of $240 plus $120 was received and these amount are in the total column of the cash book.

$300, the total of the cash sale column would be credit to the Sales account

$60, the total of the sales tax column would be credited to the sales tax account.

There is no sales tax implication arising from the amounts received from A Smith and B Bodkin. These are not new sales and are merely these customers paying what they owe.

On the credit side, cash purchases of $72 were made and $72 was paid out. However, only $60 of this was the net purchases; the $12 was sales tax on these purchases.

$60 will be debited to the purchases account

$12 will be debited to the sales tax account

Wages and Tax are not subject to sales tax.

The payments to Clark and Drake are not new purchases so there is no sales tax implications. These payments are simply settling what is owed.



6. Bank reconciliations

The cash account (or cash book) records the movements of cash in the business’s bank account. Of course, there are usually many cash movements and it is easy for errors to be made. Fortunately, banks will normally send regular bank statements to their customers (or these can be downloaded or viewed over the Internet) and, by comparing the bank’s version with the cash book version, businesses have a very valuable way of checking that their bank account contains no errors.

However, often the cash book balance and the bank statement balance will differ because of timing and other differences. For example:

1. The bank might have made interest charges that have not yet been reflected in the cash book.

2. Cheques issued by the organisation and credited to their cash book, might not yet have reached the payee and not yet gone through the bank account (ie not yet cleared).

3. The organisation might have forgotten to enter standing orders or direct debits in its Cash Book, though these will have been paid by the bank.

4. Sometimes if an amount is paid at a different bank, it takes time to make its way to the bank account.

It is therefore necessary to carry out a bank reconciliation to ensure that any difference between the balance shown on the bank statement can be reconciled to (made to agree with) the balance in the cash book.

Bank reconciliations are in indispensable part of the internal control system of a business: cash has many movements and it is a very desirable asset so the accuracy of cash records has to be checked regularly

Here’s an example:

Dr(Receipts) Cash BookCash BookCash Book Cr

(Payments)Balance b/d 1 May 2013Balance b/d 1 May 2013 1,900 CN 1200 200

CN 1201 150

Paid in 31 May 2013Paid in 31 May 2013 360 CN 1202 388

CN1203 290

Balance c/d 31 May 2013 1,232

2,260 2,260

Balance b/d 1 June 2013Balance b/d 1 June 2013 1,232

[CN = cheque number]

Note CN = cheque number; DD = direct debit; SO = standing order.



Dr Bank Statement - Safe Bank IncBank Statement - Safe Bank IncBank Statement - Safe Bank Inc Cr

12011201 200 Balance b/d 1 May 2013 1,900

DDDD 50

Bank chargesBank charges 5

12021202 290

Balance c/d 31 May 2013Balance c/d 31 May 2013 1,355

1,900 1,900

Balance b/d 1 June 2013 1,355

Note that things seem to be reversed on the bank statement. This is the bank’s document showing its relationship with its customers. If the customer has $1,900 cash in the bank on 1 May then on that date the bank owes its customer $1,900. The customer is therefore a creditor of the bank and this will show a credit balance on the bank statement.

As cash leaves the account then the bank owes the customer less and debits these amounts from the account.

You will see that the closing balances do not agree here: $1,232 compared to $1,355. We have to see if the difference can be explained logically by performing a bank reconciliation.

First compare the two documents and mark off each item which appears on both: they cannot be the cause of any difference.


(Payments)Balance b/d 1 May 2013Balance b/d 1 May 2013 √ 1,900 CN 1200 √ 200

CN 1201 150

Paid in 31 May 2013Paid in 31 May 2013 360 CN 1202 388

CN1203 √ 290

Balance c/d 31 May 2013 1,232

2,260 2,260


Dr Bank Statement - Safe Bank IncBank Statement - Safe Bank IncBank Statement - Safe Bank Inc Cr

12011201 √ 200 Balance b/d 1 May 2013 √ 1,900DDDD 50Bank chargesBank charges 512021202 √ 290

Balance c/d 31 May 2013Balance c/d 31 May 2013 1,3551,900 1,900

Balance b/d 1 June 2013 1,355



Then bring each document up to date for the reconciling items

Bank statementBank statementBank statementBank statementOpening balance 1,355Less: cheques in cash book not yet on bank statement CN 1201 150

CN 1020 388(538)

Add: amount paid in but not yet on bank statement 360

Up-to-date balance 1,177


(Payments)


Direct debit 50

Bank charges 5

Correct bal c/d 1 June 2013 1,177

1,232 Balance b/d 1 June 2013 1,355

You will see that the two balances now agree.



Example 1

On 31 July 2013, the cash book of Pizazz Ltd showed a debit balance (ie cash at the bank) of $200. The bank statement showed a credit balance of (ie Pizazz had cash in the account) of $339.

The following errors and differences were found;

1. Cheques in the cash book of $500 had not been presented for payment (ie had this amount had not yet left the bank account).

2. An amount of $250 paid in had not yet been credited to the bank account.

3. The credit side of the cash book had been undercast by $70 (ie under-added) by $70 when working out the closing balance of $200

4. A payment of $40 by a customer had been sent directly to the bank and was not in the cash book.

5. Bank charges of $31 had been taken by the bank but were not in the cash book.

6. The bank had taken $50 out of the bank account because a cheque from a customer that had been credited to the bank account later ‘bounced’ ie was dishonoured. This was not reflected in the bank account.

Reconcile the bank account and the cash book, adjusting each as appropriate:Dr(Receipts) Cash BookCash BookCash Book Cr

(Payments)Balance b/d 31 July 2013Balance b/d 31 July 2013 200

Bank statementBank statementBank statementBank statementOpening balance 339

Up-to-date balance



7. Petty cash

The petty cash book will look similar to the main cash book and will usually have analysis columns. Usually the only source of funds will be when the petty cash is topped up by cash from the main bank account, though occasionally there will be small amounts received from staff as payment for personal photocopying, use of the firm’s postage and so on.

DebitDebitDebit CreditCreditCreditCreditCreditCreditCredit

Date Narrative Total$

Date Narrative Total$

Refreshments Post Fares Stationery

Petty cash is usually kept in a small locking box, the petty cash box.

As payments of cash are made, a petty cash voucher will be filled in showing the amount and purpose of the payment. Ideally, any receipts for the purchase will be stapled to the petty cash voucher and the voucher approved by a manager or supervisor.

Petty cash is usually kept on the imprest system as this prevents too much cash accumulating in the petty cash box. Under this system, on the presentation of the vouchers the balance is topped-up, back to an agreed amount (the petty cash float). The amount of the top-up should equal the sum of the vouchers and the vouchers are filed away.

At any stage, the total of the cash and the vouchers in the box should add back to the agreed maximum balance.

IllustrationPetty cash float = $100. During the week of 12 July, petty cash amounts paid out amounted to $68 and all amounts were supported by petty cash vouchers and receipts.

Just prior to reimbursement:

Cash in the box should be = 100 – 68 = $32; vouchers amount to $68

Cash + Vouchers = $100 (the agreed float)

The reimbursement process is:Petty cash float = 100Less: authorised expenditure (68)

32Petty cash reimbursement 68Re-established float 100



8. Control account reconciliations (again)

The previous chapter dealt with errors and inconsistencies that could arise from posting day book entries to control accounts and individual ledger accounts. Similar problems can occur when making posting form the cash book: the totals of the sales ledger and purchase ledger columns in the cash book are posted to control account whilst individual entries are posted to separate accounts in the receivables and payables ledgers,

Example 2

The sum of the balances in the receivables ledger amounted to $23,456.

The receivables control account balance was $23,742.

Investigation showed that:

1. A debit balance of $250 had been omitted from the list of balances

2. A receivables ledger column in the cash book that totalled $4,995 was posted as $4,959 to the receivables ledger.

Reconcile the control account balance and the sum of the sales ledger balances.

Question 1 A bank reconciliation can be best described as:

A Part of the double entry system

B Part of the books of prime entry

C A way of checking that the opening balance in the cash account can be reconciled to the closing balance on the bank statement

D An essential part of an organisation’s internal control system

Question 2 In the credit side of an analysed cash book there is a column headed Payables.

What double entries are made from this column?

A Dr Purchases with the total of the column; Cr Creditors control account with the total; Cr individual creditors with each entry in the column

B Dr Creditors control account with the total; Dr individual creditors with each entry in the column

C Cr Creditors control account with the total; Cr individual creditors with each entry in the column

D Dr Purchases with the total of the column



Question 3 The following information is to be used to prepare a bank reconciliation:

Balance per cash book 31/7/2013 5,700 Dr

Amounts paid in not yet appearing on the bank statement(uncredited lodgements) 1,367

Unpresented cheques 3,880

Bank charges not in cash book 70

Receipt from a customer sent to bank but not in cash book 403

What is the balance shown on the bank statement as at 31/7/2013?

A 8,213

B 6,033

C 3,520

D 8,546

Question 4 A bank a statement shows a balance of $750 overdrawn

The statement shows bank charges of $75 that have not been credited to the cash book.

There are also unpresented cheques totalling $800 and uncredited lodgements of $330

The bank overdraft on the balance sheet should be:

A 1,145

B 1,295

C 1,220

D 750

Question 5 The receivables column in debit side of a cash book has been added up by $100 too much.

When the list of receivables balances is being reconciled with the receivables ledger control account, what correction(s) will be needed?

A No correction is needed

B The receivables control account balance needs to be increased by $100

C The receivables control account balance needs to be decreased by $100

D The sum of the list of balances needs to be increased by $100



Question 6 Walton Ltd operates a petty cash imprest system. During the month an amount of $5 was received from a member of staff for private photocopying and petty cash vouchers amounting to $45 were approved.

If the agreed float is $100, how much will the petty cash need to be topped up by at the end of the month?

A $45

B $40

C $60

D $35

3. The journal

The journal is used as the book of prime entry for transactions or adjustments that are not initiated anywhere else. Examples include:

๏ Correction of errors

๏ Off set of amounts owed and owing. For example $1,400 is owed from ABC Ltd in the receivables ledger and $1,600 is owed to ABC Ltd in the payables ledger (ABC Ltd is both a customer and a supplier). The two amounts can be offset and only $200 needs to be paid.

๏ Dealing with depreciation (the reduction in the value of non-current assets)

The traditional way of setting out a journal is:

Journal number 1411 Dr CrDr ABC Ltd in the payables ledger 1,400 Cr ABC Ltd in the receivables ledger 1,400Being the offset of amounts payable and receivable 1,400 1,400Authorised by

Example 3

An amount of $350 paid for the repair of a machine was incorrectly treated as the purchase of a new machine.

What is the correcting journal?

Journal number Dr Cr

Authorised by



Example 4

An amount of $1789 received from XYZ in settlement of an invoice was incorrectly treated as a new sale.

What is the correcting journal?


Authorised by





Chapter 5MORE ON SALES AND RECEIVABLES

1. Introduction

This chapter looks in a little more detail at sales transactions and the receivables ledger

2. Recap of the receivables ledger system

Entries in the receivables ledger arise from two main sources:

๏ The sales day book (SDB), where new credit sales are first recorded.

๏ The cash book(CB) where receipts from credit customers are first recorded (in the receivables ledger column, on the debit side)

Additionally there will be occasional postings made from:

๏ The journal (eg the offset of debts to an account in the payables ledger)

The entries made from the sales day book will be:

๏ Dr Receivables control account with the total of the SDB gross amount column

๏ Cr Sales Account with the total of the SDB net amount column

๏ Cr Sales Tax Account with the total of the SDB sales tax amount column.

In addition, each line in the gross column of the SDB will be used to Debit individual accounts in the Receivables Ledger so as to record exactly who owes what.

The entries made from the cash book will be:

๏ Cr Receivables control account with the total of the Receivables Ledger column

In addition, each line in the Receivables column of the Cash Book will be used to Credit individual accounts in the Receivables Ledger so as to record exactly who has paid.

The accounting documents used are:1. When sales are made, invoices will be issued to customers

2. Statements will be sent regularly to customers, setting out what is owed and what has been paid.

3. Remittance advices will be received from customers when they pay to explain which invoices are being settled.



3. Credit control

Credit control is the name given to the process of trying to ensure that cash is eventually received for all credit sales.

The process starts with a new customer applying for credit and this should initiate some investigation, such as:

๏ Asking for the applicant’s recent financial statements.

๏ Enquiries to a credit reference agency to see if the applicant has any history of poor payments.

Based on these investigations, the applicant will be accepted or rejected. A credit limit should be set for all customers.

Once credit sales have been made, each customer should be encouraged to pay according to the terms of the contract. There are three ways of proceeding:

๏ Send statements. These often act as a gentle reminder about what’s due.

๏ Settlement discounts. For example, pay 5% less if paid within 30 days.

๏ Prepare aged receivables analyses and act accordingly on the information contained there.

4. Settlement discounts

For example, an invoice is issued to DFH Ltd for $700 on 2nd January 2013 with terms offering a settlement discount of 5% is settled within 30 days. The invoice was paid on 25th January 2013. Therefore, because it was paid on time the amount due will be $700 x 95% = $665.

The discount of $35 is an expense of the business. The customer has been ‘let off’ $35 for prompt payment.

The entries in the DFH’s account would be:

DFH LtdDFH LtdDFH LtdDFH Ltd2/1/2013 Sales day book 700 25/1/2013 Cash book 665

Settlement discount 35

700 700

The settlement discount is debited to the Discounts Allowed account in the general ledger. This is an expense account.

Occasionally there is a memorandum settlement discount column in the cash book so that, in the case above, $665 would be the amount of cash received and $35 would be entered in the memorandum column. The sum of the memorandum discount column would be debited to the Discounts Allowed account.

It is important to realise that the receivables control account should always reflect in total whatever happens the individual accounts. So, if a customer is given a settlement discount, this must also be credited to the control account.



For example, consider a company with just three customers:

ABC LtdABC LtdABC LtdABC LtdSales day book 700

DEF LtdDEF LtdDEF LtdDEF LtdSales day book 400

GHI LtdGHI LtdGHI LtdGHI LtdSales day book 200

Receivables control accountReceivables control accountReceivables control accountReceivables control accountB/f 1,300

You will see that, the control account balance agrees with the sum of the individual balances in the receivables ledger ($1,300 = $700 + $400 + $200)

Each is entitled to a settlement discount of 5% if the amounts are paid within 30 days. ABC Ltd and DEF Ltd pay within this time limit; GHI does not and pays only $100 of what is owed.

A cash book extract would be:

Cash book (Dr side)Cash book (Dr side)Cash book (Dr side)Cash book (Dr side)Cash book (Dr side)Narrative Total Discount Receivables

ledgerOther….

ABC Ltd 665 35 665DEF Ltd 380 20 380GHI Ltd 100 - 100

1,145 55 1,145

Dr Discounts allowed account $55Cr Receivables control account $55

Cr Receivables control account $1,145

Post to individual accounts in the

receivables ledger.



ABC LtdABC LtdABC LtdABC LtdSales day book 700 Cash 665

Discount 35

700 700

DEF LtdDEF LtdDEF LtdDEF LtdSales day book 400 Cash 380

Discount 20

400 400

GHI LtdGHI LtdGHI LtdGHI LtdSales day book 200 Cash 100

Bal c/d 100

200 200Bal b/d 100

Receivables control accountReceivables control accountReceivables control accountReceivables control accountB/f 1,300 Cash 1145

Discounts allowed 55Bal c/d 100

1,300 1300

Note that the sun of the individual balances (now GHI Ltd only) still equals the balance on the control account.

Note that a settlement discount is entirely different to a bulk or trade discount. The bulk or trade discount is to all intents and purposes a straight reduction in the selling price and the only amounts every invoiced or treated as a sale are after the discount has been removed.

With a settlement discount, the sales and the invoices are for the full amount (after the trade discount) and the discount is contingent upon prompt payment.



Question 1

A customer’s invoice and payment details are as follows:

Invoice date Invoice amount5 May 2013 $1,2008 May 2013 $40012 May 2013 $50025 May 2013 $1,000

All the invoices offered a 2.5% discount for payment at or before 30 days and all were settled by a payment on 9 June 2013.

How much should the payment be for and how much is the discount?

A Payment = $3,100; discount = $37.50

B Payment = $3,062.50; discount = $37.50

C Payment = $3,052.50; discount = $47.50

D Payment = $3,022.50; discount = $77.50

Question 2

The normal price of a purchase is $800, but a customer has negotiated a trade discount of 20%.

The invoice is dated 16 June 2013 and offers a 5% discount for payment within 45 days. Payment is received on 25 July 2013.

What amounts should be posted to the Sales account and to the Discount Allowed account in the general ledger?

(Ignore sales tax)

A Credit Sales account $800; debit discounts allowed account $192

B Credit Sales account $640; credit discounts allowed account $32

C Credit Sales account $640; debit discounts allowed account $32

D Credit Sales account $608; debit discounts allowed account $40



5. Aged receivables analysis

This looks at all the invoices still owed by customers and displays them in age categories.

Typically the age categories are something like:

≤ 30 days

30 to ≤ 60 days

60 to ≤ 90 days

90 to ≤ 180 days

> 180 days

Usually, the older an unpaid debt becomes, the less likely to be paid. Also, as debts become older more extreme action is likely to be taken to try to force payment. For example, final warnings, then taking customers to court.

The layout of an aged analysis is usually something along the lines of:

Customer Total ≤ 30 days 30 to ≤ 60 days

60 to ≤ 90 days

90 to ≤ 180 days

> 180 days

Aardvark 1,200 1,100 100Benson 900 600 300Chandos 100 100Draghi 600 500 100Ephram 500 100 200 200Fahrook 800 800: : : : : : :: : : : : : :Total 94,560 85,382 5,993 2,085 800 300% 100.0 90.3 6.3 2.2 0.9 0.3



6. Irrecoverable (bad) debts

Sometimes, despite all efforts to sell only to credit-worthy customers and to follow up old amounts carefully, it becomes clear that a debt is irrecoverable and no money will ever be received. Perhaps the customer has gone into liquidation (or simply disappeared!)

There is then no point in continuing to record the debt as a receivable (an asset) when it is worthless: the amount should be written off, ie reduced to zero. This is an expense to the business and will be recorded in an irrecoverable debts account (sometimes called a bad debts account).

As always, whatever adjustment you make to an individual debtor you must make to the receivables control account too. Writing off bad debts is one use of the journal.

Look at this example:

Total receivables account (control account) Total receivables account (control account) Total receivables account (control account) Total receivables account (control account) Bal b/d 1/1/2013 9,700 Total receipts 102,500Total sales 105,000

Bal c/d 31/12/2013 12,200114,700 114,700

One of the receivables accounts in the receivables ledger is:

Badone Ltd Badone Ltd Badone Ltd Badone Ltd Bal b/d 1/1/2013 1,300Sales 15/1/2013 2,500

Bal c/d 31/12/2013 3,8003,800 3,800

It has been decided that none of the $3,800 due from Badone Ltd will be recovered and that this amount should be written off.

The journal to do this is:

Journal number 1411 Dr CrDr Irrecoverable debts account 3,800 Cr Receivables control account 3,800Being the write-off of irrecoverable debts 3,800 3,800Authorised byAuthorised byAuthorised by



The accounts would then be:

Total receivables account (control account) Total receivables account (control account) Total receivables account (control account) Total receivables account (control account) Bal b/d 1/1/2013 9,700 Total receipts 102,500Total sales 105,000 Irrecoverable debts 3,800

Bal c/d 31/12/2013 8,400114,700 114,700

Bal b/d 31/12/2013 8,400

One of the receivables accounts in the receivables ledger is:

Badone Ltd Badone Ltd Badone Ltd Badone Ltd Bal b/d 1/1/2013 1,300 Written off 3,800Sales 15/1/2013 2,500

3,800 3,800

Irrecoverable debts Irrecoverable debts Irrecoverable debts Irrecoverable debts Total receivables account 3,800 Bal c/d 3,800

3,800 3,800

7. Irrecoverable (bad) debts and sales tax

Debts are not usually written off until all reasonable hope of recovery is gone and this usually takes time. Sales tax will probably have been charged on the sales giving rise to the debt, and will have been paid over to the government. Now it is clear that the sales tax will never be collected from the defaulting customer.

Sellers can get relief for the sales tax on debts written off, provided the debt written off was at least six months old.

So, if the $3,800 above contained sales tax at 20%, the sales tax content of that debt would be $3,800/6 = $633.33 and the net amount of the sale would be 3,166.67 (check: 3,166.67 x 20% = $633.33).

Therefore, the cost of the irrecoverable debt is reduced by the sales tax amount as follows:

Irrecoverable debts Irrecoverable debts Irrecoverable debts Irrecoverable debts Total receivables account 3,800.00 Sales tax account 633.33

Bal c/d 3,166.673,800.00 3,800.67

The debit to the sales tax account will reduce what has to be paid to the government in the future, so gives tax relief on the irrecoverable sales tax.



8. Allowances for irrecoverable debts

Once a write-off occurs the debt is, in effect, forgotten about and will not be pursued. However, before that stage is reached it will often begin to look unlikely that the debt will be recovered, but the company does not yet want to give up all hope and does not want to write off the debt. Nevertheless, to value the debt at its full amount would be over-optimistic.

In this case, an allowance can be made to reduce the value of the receivables. The allowance can be calculated using a combination off approaches:

๏ A specific debt is identified as ‘doubtful’. This will be a specific allowance for irrecoverable receivables.

๏ Historical experience might suggest that, say, 4% of debts generally have to be written off, though we do not know now which ones these will be. This might sometime be known as a general allowance for irrecoverable receivables.

The allowance will be a credit balance in an Allowance for Irrecoverable Debts Account and is netted off against the receivables amount in the statement of financial position. Setting up the allowance is an expense because the allowance reduces the value of an asset. The expense is debited to the Irrecoverable Debts Expense Account and hence to the Income Statement.

Example 1

On 31 December 2013, the total receivables are $125,000.

Of these:

1. An amount off $6,000 is to be written off as it is clearly no recoverable.

2. An amount of £12,000 is thought to be in danger of not being recoverable and a 100% allowance is to be made for that.

3. 4% of remaining receivables are to have an allowance.

Show the Receivables Control Account, the Allowance for Irrecoverable Debts Account, and the Irrecoverable Debts Expense Account and the value of receivables that will appear on the statement of financial position as at 31 December 2013

Say that at the end of the next period of account, receivables are $140,000. Of this, an amount of $10,000 is to be written off, there is to be a specific allowance for irrecoverable debts of $15,000 and a general allowance for irrecoverable debts of 5%.

Any change in the Allowance for Irrecoverable Debts Account is posted to the Irrecoverable Debts Expense Account.



Example 2

Show the Total Receivables Account, the Allowance for Irrecoverable Debts Account and the Allowance for Irrecoverable Debts Expense Account.

Total receivables accountTotal receivables accountTotal receivables accountTotal receivables accountBalance b/d 140,000

Allowance for Irrecoverable Debts AccountAllowance for Irrecoverable Debts AccountAllowance for Irrecoverable Debts AccountAllowance for Irrecoverable Debts AccountBalance b/d 140,000

Irrecoverable Debts Expense AccountIrrecoverable Debts Expense AccountIrrecoverable Debts Expense AccountIrrecoverable Debts Expense AccountBalance b/d 140,000

Question 3 At the start of a period a customer owed $12,345 and sales for the year were $11,346. During the year the customer paid $10,463 and was allowed discounts of $228.

It is though wise to make an allowance against irrecoverable debts in respect off this customer of 25%.

How much will the allowance against irrecoverable debts be?

A $228

B $3,307

C $3,364

D $3,250



Question 4 What does an aged receivables analysis show?

A The age of invoices

B The age of payments

C The age of sales

D The age of customers

Question 5 A debt of $34,615 has been written off. Sales tax is 15%.

What is the final cost of the write-off and how much sales tax can be recovered in respect to the write-off?

A Sales tax recoverable = $5,192.25; final cost of the write-off = $34,615

B Sales tax recoverable = $4,515; final cost of the write-off = $34,615

C Sales tax recoverable = $4,515; final cost of the write-off = $30,100

D Sales tax recoverable = $5,192.25; final cost of the write-off = $30,100

Question 6

The brought forward balance on the Allowance for Irrecoverable Debts Account is $12,000. In the period debts amounting to $5,000 are written off. At the end of the period the balance on the Allowance for Irrecoverable Debts Account is to be $14,000.

What is the amount taken to the Income Statement in respect of irrecoverable debts?

A $19,000

B $7,000

C $17,000

D $3,000

Question 7

The brought forward balance on the Allowance for Irrecoverable Debts Account is $10,000. In the period debts amounting to $4,000 are written off. In the period the total amount debited to the Income Statement in respect of irrecoverable debts is $2,500.

What is the carried forward balance on the Allowance for Irrecoverable Debts Account?

A $5,500

B $16,500

C $6,000

D $8,500





Chapter 6ACCRUALS AND PREPAYMENTS

1. Introduction

On of the fundamental accounting principles is the accruals principle. This states that income and expenses should be matched on a time basis. In particular they should not simply be matched on a cash basis as the receipts and payment of cash is too arbitrary and would not result in consistent or dependable results.

The problem is examined in two parts;

1. Accruals and prepayments in principle

2. Accruals and prepayments as handled in the double entry system.

2. Accruals and prepayments in principle

Example 1

Consider a business that started trading on 1 January 2014 and wants to work out its profits for its first month. Relevant transactions for that month are:

Sales: $5,000, of which cash collected from customers was $4,000.

Purchases: $3,000, of which $1,400 had been paid for. There was no opening or closing inventory.

Rent paid for 1/1/2014 to 31/3/2014 = $3,600

An electricity bill of $660 was received on 3/4/2014 for the period 1/1/2014 – 31/3/2014.

The correct treatment of these transactions using the accruals approach is to match income and expenditure on a time basis, not just on the basis of cash receipts and payments.

Draft the income statement for the month of January 2014:Income statement for the month of January 2014Income statement for the month of January 2014Income statement for the month of January 2014

Basis of calculation $

Sales

Purchases/cost of sales

Gross profitRent

Electricity

Net profit

It can sometimes be useful to show accruals and prepayments by way of a time-line diagram. For example:



In September 2013, insurance of $2,400 was paid for the year to 30/9/2014. In September 2014, insurance of $3,000 was paid for the year to 30/92015. What expense for insurance should be shown in the income statement for the year ended 31/12/2014, and what accrual or prepayment would be shown in the statements of financial position as at 31/12/2013 and 31/12/2014?

!1/10/2013 $2,400 30/9/2014 $3,000 30/9/2015

31/12/2013 31/12/2014

So, 9 months’ worth of the $2,400 rent to 30/9/2014 relates to the year to 31/12/2014 and 3 months of the rent to 30/9/2015 relates that year also.

Expense y/e 31/12/2014 = $2,400 x 9/12 + $3,000 x 3/12 = $1,800 + $750 = $2,550

Prepayment as at 31/12/2013 = 9/12 x 2,400 = $1,800

Prepayment as at 31/12/2014 = 9/12 x 3,000 = $2,250

Question 1

In October 2013, insurance of $2,400 was paid for the year to 30/11/2014. In October 2014, insurance of $3,000 was paid for the year to 30/11/2015.

What expense for insurance should be shown in the income statement for the year ended 31/12/2014, and what accrual or prepayment would be shown in the statements of financial position of 31/12/2013 and 31/12/2014?

A Expense $2,500; accrual 31/12/2013 = $2,000; accrual 31/12/2014 = $2,500

B Expense $2,450; prepayment 31/12/2013 = $2,200; prepayment 31/12/2014 = $2,750

C Expense $2,500; prepayment 31/12/2013 = $2,000; prepayment 31/12/2014 = $2,500

D Expense $2,450; accrual 31/12/2013 = $2,400; accrual 31/12/2014 = $2,750

Question 2

In February 2013 a company paid an electricity bill of $450 for the three months to 31/1/2013. In March 2014, the company paid an electricity bill of $600 for the three months to 31/1/2014.

Bills were also paid in May, August and November 2013 amounting to $2,000 for electricity from 1/2/2013 to 31/10/2013.

What electricity expenses should be shown in the income statement for the year ended 31/12/2013 and what is the accrual or prepayment as at 31/12/2013?

A Expense = $2,500; prepayment = $200

B Expense = $2,500; accrual = $200

C Expense = $2,550; prepayment = $400

D Expense = $2,550; accrual = $400



3. Accruals and prepayments in ‘T’ accounts.

Consider a business that starts on 1/10/2012 and which makes its first set of accounts up to 31/12/2012, and the next set of account up to 31/12/2013.

On 2/10/2012 it pays rent of $6,000 for the year ended 30/9/2013, and on 25/9/2012 pays rent of $7,200 for the year ended 30/9/2014.

The expenses and prepayments for rent are:

Three months to 31/12/2012: Expense = $6,000 x 3/12 = $1,500

Prepayment as at 31/12/2012 = $4,500

12 months to 31/12/2013: Expense = $6,000 x 9/12 + $7,200 x 3/12 = $6,300

Prepayment as at 31/12/2012 = $5,400

In the rent ‘T’ account, these results can be achieved as follows:

As at 31/12/2012, the correct expense is transferred to the income statement and this leaves $4,500 in the account. which is carries down as a balance on the debit side. This is an asset and is a prepayment.

Rent AccountRent AccountRent AccountRent Account2/10/2012 Cash 6,000 31/12/2012 – to income statement 1,500

Balance carried down 4,500

6,000 6,0001/1/2013 Balance b/d (prepayment) 4,500

During the following year, more rent is paid, the correct amount transferred to the income statement and a prepayment carried down.

Rent AccountRent AccountRent AccountRent Account2/10/2012 Cash 6,000 31/12/2012 – to income statement 1,500

Balance carried down 4,500

6,000 6,0001/1/2013 Balance b/d (prepayment) 4,500 31/12/2012 – to income statement 6,30029/9/2012 Cash 7,200 Balance carried down 5,400

11,700 11,7001/1/2013 Balance b/d (prepayment) 5,400

You can think of the 31/12/2012 expense of $6,300 as:

$4,500 (last time’s prepayment) + $7,200 (cash paid this time) - $5,400 (the prepaid amount within the $7,200) = $6,300.



Example 2

As at 31/12/2013 a company has an accrual for heating costs of $850. Payments during the year to 31/12/2014 are as follows:

12/3/2013 for the three months ending 28/2/2013 = $2,400




Heating costs for the month of December are estimated to be $975.

Write up the heating account from 1/1/2014 to 31/12/2014 showing accruals and the amount to be posted to the income statement for the year to 31/12/2014.

Question 3

A company’s rent is fixed for 5 years at $2,500 per month. As at 1/1/2014, the brought down balance on a rent account is $2,500 credit.

During 2014 14 rental payments are made.

Which of the following is correct?

A Rental expense for 2014 = $30,000; balance carried down to the credit side of the rental account on 1/1/2015 = $7,500.

B Rental expense for 2014 = $35,000; balance carried down to the credit side of the rental account on 1/1/2015 = $5,000

C Rental expense for 2014 = $30,000; balance carried down to the debit side of the rental account on 1/1/2015 = $2,500.

D Rental expense for 2014 = $30,000; balance carried down to the debit side of the rental account on 1/1/2015 = $5,000.



Chapter 7ACCOUNTING FOR INVENTORY

1. Introduction

This chapter looks at how inventory is accounted for.

2. What is inventory and why is it important?

Inventory can be any of the following:

Raw materials are purchased and then undergo further processing or are incorporated into products. Raw materials can be basic materials such as chemicals, flour, or lengths of wood. Or raw materials can be items which have been manufactured by the supplier, such as components and parts for use in production.

Work in progress refers to partly made products. They have progressed from the bought in stage (raw materials) but are not yet complete.

Finished goods are complete and are ready for sale.

When producing a set of financial statements, inventory has two effects:

The statement of financial position: closing inventory is an asset and must therefore appear on the statement of financial position. It will be included in current assets.

The income statement: an inventory adjustment is needed to match sales revenues with the cost of the goods sold. Not everything purchased in a period is necessarily sold in that period and to achieve proper matching inventory has to be taken into account.



3. The standard inventory adjustment

Example 1

Opening inventory = 2,000 units

Closing inventory = 2,300 units

Units purchased = 8,000 units

All units in inventory and those purchased cost $5 each. All are sold at $9 each.

Expenses amount to $3,700

Draft the income statement.Income statementIncome statementIncome statementIncome statementIncome statement

So, the standard inventory adjustment for the income statement is:

Cost of sales = opening inventory + purchases – closing inventory

4. The standard inventory adjustment in ‘T’ accounts

So, now we know the principle of the inventory adjustment, but how is this recorded in the books of account? Here again are the figures and the income statement:








Income statementIncome statementIncome statementIncome statementIncome statementUnits $/unit $ $

Sales 7,700 9 69,300

Opening inventory 2,000 5 10,000

Purchased 8,000 5 40,000

10,000 50,000

Closing inventory (2,300) 5 (11,500)

Cost of sales ie cost of units sold 7,700 5 38,500

Gross profit 30,800

Expenses (3,700)

Net profit 27,100

In ‘T’ accounts this would be recorded as follows:

The opening balance on the inventory account is the closing inventory from the last period. During the year, purchases are debited into the purchases account and sales credited into the sales account, as shown. The inventory account is not touched.

InventoryInventoryInventoryInventoryBalance brought down (opening inventory)

10,000

PurchasesPurchasesPurchasesPurchasesCash/supplier 40,000

SalesSalesSalesSalesCash/customer 69,300

At the end of the period, the amount of closing inventory is assessed and the inventory adjustments will be:

Dr Cost of sales account 10,000

Cr Inventory account 10,000

being the transfer of the opening inventory into cost of sales

Dr Inventory account 11,500

Cr Cost of sales 11,500



being the removal of the closing inventory from cost of sales and establishing it as an inventory asset.

Dr Cost of sales account 40,000

Cr Purchases 40,000

being the transfer of purchases to the cost off sales account.

After these adjustments the accounts will be:

InventoryInventoryInventoryInventoryBalance brought down (opening inventory)

10,000

To cost of sales 10,000Cost of sales (closing inventory) 11,500 Balance carried down

(closing inventory)11,500

21,500 21,500Balance brought down (closing inventory)

11,500

PurchasesPurchasesPurchasesPurchasesCash/supplier 40,000 To cost of sales 40,000

SalesSalesSalesSalesTo income statement 69,300 Cash/customer 69,300

Cost of SalesCost of SalesCost of SalesCost of SalesInventory (opening) 10,000 Inventory (closing) 11,500Purchases 40,000 To income statement (balance) 38,500

Note that the closing inventory adjustment is:

Dr Inventory account 11,500

Cr Cost of sales 11,500

A business could put any figure it wanted to into that adjustment and the financial statements would still balance. Every extra $ of closing inventory increases the inventory asset by $1 and decreases cost of sales (hence increasing profits) by $1. Therefore, inventory valuation is a very critical area in the preparation of financial statements – and for the audit of those statements.



5. Different methods used to price materials issued from inventory and to value closing inventory

In the examples above, all inventory, whether opening, purchases or in closing inventory had the same cost. In practice, the cost of purchases can fluctuate and this forces us to consider how to calculate the cost of the units sold and the cost of the units still in inventory.

Consider the following:

12 March 20X4: buy 1000 units at $5 each


31 March 20x4: sell 800 units at $12 each.

It is clear that revenue will be 800 x $12 = $9,600, but what is the cost of the units sold? Which have been sold?

What is their value and the value of the inventory left?

You have to know three approaches:

๏ FIFO

๏ Cumulative weighted average

๏ Periodic weighted average

FIFO (First-in, first out)

This method assumes that the goods that arrive first are the first to be used. It is only an assumption: apart from their price all goods of a given type are identical and therefore you don’t know, or care, how they are physically used.

So, in the above case, all 800 units sold would be assumed to be those delivered on 12 March. They would have a cost of 800 x $5 = $4,000 and the value of the inventory remaining would be 200 x $5 + 500 x $6 = $4,000.

Note that receipts and sales are handled on a strict time basis.



Cumulative weighted average

Every time units are added, a new average price is calculated. Any time goods are removed they are removed at the prevailing average.



31 March 20x4: sell 800 units at $12 each.

$12 March 20X4 1000 @ $5 5,00021 March 20X4 500 @ $6 3,000$5.33 = average cost 1,500 @ $5.33 8,00031 March 20X4 (800) @ $5.33 (4,267)Closing inventory 700 @$5.33 4,733

Note:

Sales do not alter the average cost.

Receipts and sales are handled on a strict time basis.

Periodic weighted average

Here, a new inventory value is calculated at the end of a set period. The cost of goods used is given by:

Cost of opening inventory + cost of purchases in the periodUnits in opening inventory + units purchased in the period

So, all units used in the period will have the same cost.

In the above simple example this method would give the same result as the cumulative weighted average approach



Example 2

Recent results of a division are:

Date Units Unit

price1 April Opening inventory 1,000 5.005 April Purchased 500 6.009 April Sold 200 N/a14 April Purchased 600 621 April Sold 1,200 N/a

Calculate the cost of inventory used each time and the cost of the inventory remaining at the end of the period using:(a) FIFO(b) Average cumulative cost(c) Periodic average cost

Advantages and disadvantages of the methods:

FIFO

Advantages

๏ Permitted by accounting standards as an acceptable approach to inventory valuation

๏ closing inventory has a value close to its replacement value

๏ might reflect physical use of stock

Disadvantages

๏ Requires care to get it right

Average stock values

Advantages

๏ Averages out stock price fluctuations

๏ Relatively easy to work out.

๏ Permitted by Financial Reporting Standards



6. Other inventory valuation issues: cost and net realisable value

The fundamental principle of IAS 2 is that inventories (or stock) are must be stated at the lower of cost and net realisable value. This valuation rule ensures a prudent approach to inventory accounting: profits are not recognised until earned (ie the inventory is sold at above cost), but losses would be taken as soon as foreseen (because inventory is values at net realisable value if lower than cost).

Cost should include all:

๏ Costs of purchase (including taxes, transport, and handling) net of trade discounts received.

๏ Costs of conversion (including fixed and variable manufacturing overheads)

๏ Other costs incurred in bringing the inventories to their present location and condition.

Net realisable value is the estimated selling price in the ordinary course of business, less the estimated cost of completion and the estimated costs necessary to make the sale.

Each line of inventory has to have its cost/NRV comparison carried out separately. The comparison is not performed on total inventory figures.

Example 3

Value the inventory items shown below:Product Number

Number of units

Purchase price of

goods/unit

Carriage inwards/unit (delivery cost

paid by purchaser)

Selling price of goods/unit

Costs of packing and

delivering goods/unit

(carriage outwards)

Inventory valuation for the financial statements

$ $ $ $ $1435 400 10 1 20 21567 120 20 2 15 21577 300 15 1 18 31601 200 20 2 40 21733 150 30 2 10 1



Question 1 Opening inventory = $12,400

Cost of sales = $93,000

Closing inventory = $16,600

What were purchases?

A $88,800

B $122,000

C $97,200

D $64,000

Question 2 Which of the following are the proper journal entries for inventory when financial statements are to be prepared?

A Dr Inventory Account with opening inventory

Cr Cost of sales with opening inventory

Dr Cost of sales with closing inventory

Cr Inventory Account with closing inventory

B Cr Inventory Account with opening inventory

Dr Cost of sales with opening inventory

Cr Cost of sales with closing inventory

Dr Inventory Account with closing inventory

C Dr Inventory Account with opening inventory

Cr Purchases with opening inventory

Dr Purchases with closing inventory

Cr Inventory Account with closing inventory

D Cr Inventory Account with opening inventory

Dr Cost of sales with opening inventory

Cr Purchases with closing inventory

Dr Inventory Account with closing inventory



Question 3

The items in closing inventory cost $15,000 to purchase. In addition there was carriage inwards of $1,000.

The goods would cost $2,500 to clean, packing and distribute and they would then sell for $12,000.

At what amount should the goods be values in the financial statements?

What were purchases?

A $16,000

B $14,000

C $14,500

D $9,500

Question 4 Purchases and sales of an item of inventory were as follows:

Date Purchase / sale Units Purchase / sale price per unit

12/1/2014 Purchase 1,000 12.0020/1/2104 Purchase 500 13.0021/1/2014 Sale 1200 20.0025/1/2014 Purchase 700 14.0031/1/2014 Sale 100 21.00

If the FIFO method of valuing inventory is used, what is the value of the goods remaining?

A $12,400

B $12,600

C $12,150

D $12,000



Chapter 8NON-CURRENT ASSETS

1. Introduction

Non-current assets refer to items such as machinery, equipment, premises and motor vehicles. These assets usually last for several accounting periods. They are not frequently bought and sold (like inventory is) but are used by the business to carry on its operations and to make profits.

You might hear people refer to non-current assets as ‘fixed assets’. Technically this term is out of date, but it is still commonly used informally. Financial statements should use the term ‘non-current assets’

2. Capital and revenue expenditure

Revenue expenditure is expenditure incurred for the purposes of the trade of the business or for maintaining the earning ability of non-current assets. Examples include: wages, rent, repairs, purchases of goods for resale, interest, electricity, fuel. Revenue expenditure is another term for business expenses and will appear on the income statement

Capital expenditure is the purchase on non-current assets or expenditure to enhance their earning ability. Examples include: purchase of a computer, purchase of factory machinery, purchase of a leasehold or freehold office, upgrading a computer by adding a larger hard disk. Capital expenditure results in non-current assets and these will appear in the statement of financial position.

3. Depreciation

Although non-current assets last for several accounting periods, most wear out. The only exception is freehold land (ie land that is owned for ever). Cars, machines, office equipment all wear out and will eventually by scrapped or sold for a (usually low) second hand value. Leases gradually ‘wear out’ over the period of a lease.

If you have ever owned a car you will be familiar with the idea that it loses value as it gets older and the term given to this process is depreciation.

For leases, the term amortisation is used instead of depreciation.

When working out profits depreciation should be taken into account. The asset loses value as it is used and losing value is an expense. To get a fair view of profit, the amount of depreciation in each period should be treated as an expense of the period. Note that it is not the purpose of depreciation to value the asset at its net realisable value as it wears out: its purpose is to spread the initial cost less residual value over the asset’s estimated useful life and to match that to income on a time basis.

Usually the rate of depreciation is determined in advance by reference to the assets estimated useful life.

As time passes, each year more depreciation will be charged. The accumulated depreciation keeps increasing and the net book value of the asset (cost less accumulated depreciation) keeps falling.



4. Methods of depreciation

There are two main methods of depreciation used in financial statements:

๏ Straight line

๏ Reducing balance

Straight line

This is the easiest approach: the asset is written down from cost to residual value over its estimated useful life.

Example 1

Cost = $24,000; scrap (residual) value at end of life $4,000; estimated useful life = 5 years.

Show the depreciation charge (expense) for each year, the accumulated depreciation and the net book value at the end of each of the four years.

Reducing balance method

Each year’s depreciation is based on the brought forward written down value

Example 2

Cost = $24,000 to be depreciated at 25% pa on the written down basis.

Note that most companies have a depreciation policy that charges a full year’s depreciation in the year of acquisition irrespective of when during the year the asset was bought, and no depreciation charged in the year of disposal irrespective of when during the year the asset was disposed of.

Note that there is much estimation in depreciation calculations: useful life, residual value, straight-line or reducing balance method.

Question 1

On 1 October 2013 a machine was bought for $25,000. The depreciation policy for this class of asset is 20% WDV (written down value). What are the amounts for depreciation expense in respect of this machine for the year ended 31 December 2013, 31 December 2014?

A $5,000 for each year

B 2013: $1,250, 2014: $4,750, 2015: $4,300

C 2013: $5,000, 2014: $4,000, 2015: $3,200

D 2013: $1,250, 2014: $5,000, 2015: $4,000



5. Accounting for non-current assets and depreciation

There are four ‘T’ accounts needed when accounting for non-current assets and depreciation:

1. The non-current asset cost account. This simply holds the cost of non-current assets. It is of vital importance to realise that this is not affected by depreciation; it is an account that simply records the acquisition of non-current assets.

2. The accumulated depreciation account (this might sometimes be referred to as the depreciation provision account). The cumulative depreciation is build up in this account.

3. The depreciation expense account. Each year’s depreciation expense is posted to this account and then transferred to that year’s income statement.

4. The non-current assets disposal account. Used to account for the disposal of non-current assets.

Example 3

A machine cost = $26,000 on 1/7/2013 and is to be depreciated at 25% pa on a straight line basis. Residual value estimated to be $6,000.

Write up the Machine Cost Account, the Machine Accumulated Depreciation Account, and the Depreciation Expense Account

Machine Cost AccountMachine Cost AccountMachine Cost AccountMachine Cost Account

Machine Accumulated Depreciation AccountMachine Accumulated Depreciation AccountMachine Accumulated Depreciation AccountMachine Accumulated Depreciation Account



Machine Depreciation Expense AccountMachine Depreciation Expense AccountMachine Depreciation Expense AccountMachine Depreciation Expense Account

6. Accounting for non-current assets disposal

On 12 January 2017, the machine is sold for $7,500. To handle this transaction correctly you must ensure that:

1. No trace of the machine’s cost remains in the cost account: if the company no longer has the asset it cannot be recording its cost. The cost is therefore transferred to the disposal account.

2. No trace of the machine’s accumulated depreciation remains in the accumulated depreciation account: if the company no longer has the asset it cannot be recording its depreciation. The accumulated depreciation is therefore transferred to the disposal account.

3. Cash is debited with the disposal proceeds and credited to the disposal account

4. The balance on the disposals account is a profit or loss on disposal.

At the start of 2017, the accounts are:

Machine Cost AccountMachine Cost AccountMachine Cost AccountMachine Cost Account1/1/2017 Bal b/d 26,000

Machine Accumulated Depreciation AccountMachine Accumulated Depreciation AccountMachine Accumulated Depreciation AccountMachine Accumulated Depreciation Account1/1/2017 Bal b/d 20,000



These balances are transferred out of these accounts into the disposals account and the cash credited to the disposals account also:

Machine Cost AccountMachine Cost AccountMachine Cost AccountMachine Cost Account1/1/2017 Bal b/d 26,000 12/1/2017 To disposals account 26,000

Machine Accumulated Depreciation AccountMachine Accumulated Depreciation AccountMachine Accumulated Depreciation AccountMachine Accumulated Depreciation Account12/1/2017 To disposals account 20,000 1/1/2017 Bal b/d 20,000

Machine Disposals AccountMachine Disposals AccountMachine Disposals AccountMachine Disposals Account12/1/2017 From Machine Cost account

26,00012/1/2017 From accumulated depreciation account 20,000

Profit on disposal (balancing figure) 1,500 12/1/2017 Cash proceeds 7,500

27,500 27,500

The Profit on Disposal amount of $1,500 is credited to the Income Statement (usually be reducing the total depreciation charge). The profit arises because the company has disposed of an item of net book value $6,000 (ie $26,000 – 20,000) for $7,500.

7. Accounting for part exchange (or trade-in) of non-current assets

A business owns a delivery van that cost $25,000 some years ago. The accumulated depreciation on the van is $15,000. The van is traded in for a new one. There was a trade–in allowance of $13,000 on the old van and the balance of $22,000 was paid in cash.

To treat this correctly you have to:

1. For the old asset, remove the cost and accumulated depreciation by transferring these to the disposals account.

2. Understand that a trade in allowance of $13,000 is equivalent to sale proceeds of $13,000 (though not received in cash. The trade-in allowance will be posted to the disposals account

3. Understand that the new van’s cost is $35,000 ie the trade-in value of $13,000 plus the cash paid of $22,000.



Example 4

Write up the above transactions in the following accounts:Machine Cost AccountMachine Cost AccountMachine Cost AccountMachine Cost Account

Bal b/d 25,000

Machine Accumulated Depreciation AccountMachine Accumulated Depreciation AccountMachine Accumulated Depreciation AccountMachine Accumulated Depreciation AccountBal b/d 15,000

Machine Disposals AccountMachine Disposals AccountMachine Disposals AccountMachine Disposals Account

Question 2

A machine which cost $40,000 has accumulated depreciation of $28,000. Its expected residual value was $8,000. The machine is traded in for a new model. A cash payment of $50,000 was required to buy the new machine and the rest was a trade-in allowance of $10,000 for the old machine.

Which of the following is correct?

A Cost of new machine = $60,000; profit on disposal of old machine = $2,000

B Cost of new machine = $50,000; profit on disposal of old machine = $2,000

C Cost of new machine = $50,000; loss on disposal of old machine = $2,000

D Cost of new machine = $60,000; loss on disposal of old machine = $2,000

Question 3 A non current asset is being disposed off. What entries would appear in the disposal account?

A Dr Disposal Account: Accumulated depreciation; Cr Disposal Account: Cost of asset; Cr Disposal account: Proceeds of sale

B Cr Disposal Account: Accumulated depreciation; Dr Disposal Account: Cost of asset; Dr Disposal account: Proceeds of sale

C Dr Disposal Account: Accumulated depreciation; Cr Disposal Account: Cost of asset; Dr Disposal account: Proceeds of sale

D Cr Disposal Account: Accumulated depreciation; Dr Disposal Account: Cost of asset; Cr Disposal account: Proceeds of sale



8. The non-current assets register

In its nominal ledger, a business will typically have accounts for the cost of: premises, vehicles, office equipment and machinery. There will also be accounts for the accumulated depreciation for each class of non-current asset.

Every time a new item is bought, its cost will be debited to the appropriate cost account. For example, if a piece of office equipment is bought, its cost will be debited to the office equipment account. The cost accounts therefore keep track of the total cost of each type of non-current asset and similarly the accumulated depreciation accounts keep track of the total accumulated depreciation of each type of asset.

However, more detailed information is also required. For example, when an asset is sold its depreciation to date has to be transferred to the disposals account, so records are needed of how much depreciation attaches to each individual asset. Similarly, if an asset is fully written down to zero net book value, no more depreciation should be applied to it or NBV will become negative. Therefore, depreciation cannot simply be calculated as, for example, 25% of the balance on a fixed asset cost account, because some of the assets in that figure might have been fully depreciated.

The more detailed information needed is recorded in a non-current asset register; this is a memorandum record and is not part of the double entry system

The situation is rather similar to that of the total receivables account (receivables control account) and the receivables ledger. The total receivables account holds the total summary information, but the receivables ledger holds details about each customer and exactly what is owed by whom.

The non-current assets register has a page for each non-current asset. Typically it will list out:

Information Reason for the information

Cost Basic accounting information. Needed for depreciation calculations and on the disposal of the asset. The sum of the costs of the assets should agree to the amount in the cost account in the general ledger.

Date purchased Might be needed for depreciation calculations or the identification of old assets.

Accumulated depreciation Basic accounting information. Needed for depreciation calculations and on the disposal of the asset. The sum of the accumulated depreciation of the assets should agree to the amount in the accumulated depreciation account in the general ledger.

Depreciation method Needed for depreciation calculations

Estimated residual value Needed for depreciation calculations

Manufacturer’s name address and the item’s serial number

Needed for maintenance and renewal of assets

Location of the asset Required for physical inspection of the asset or for routine maintenance checks.

Date asset last inspected Needed for auditing, maintenance and safety procedures

Date asset scrapped or sold Needed for auditing purposes



9. The purchase and disposal of non-current assets

The purchase of non-current assets will often begin with an employee raising a purchase requisition, for example for a new printer, which is then authorised by a manager or by the company accountant. When the invoice is received, someone needs to ensure that the asset has been received and that it is working properly. These payments are handled in a similar way to purchases of goods and raw materials.

Non-current asset purchase is often very closely monitored because every asset bought removes cash from the business. Once a non-current asset has been bought, the transaction is difficult to reverse without incurring large losses on disposal. A successful company hoping to expand can find that it his spent so much on buying non-current assets that it then has difficulty paying its rent, wages and interest on loans.

The disposal of non-current assets should also be carefully controlled. Apart form the asset being potentially valuable, its disposal could damage the company’s ability to make profits.

Major acquisitions and disposals would normally be approved at board level.

Regular physical inspection of non-current assets should be carried out to ensure that the assets still exist, still work and that they are still used. If assets are no longer in use they should be written down to nil book value because if a non-current asset is of no use, it can’t really still be regarded as an asset with any value.

It is very important that the purchase of non-current assets is correctly recorded. Possible material errors are:

1. The purchase is treated as revenue expenditure rather than capital expenditure. That would mean that all of the cost of the non-current asset is expensed in the year of acquisition rather than its cost being spread over the life of the asset through the depreciation mechanism. Profits would therefore be understated in that year and overstated in subsequent years.

2. Revenue expenditure is treated as capital expenditure. This would cause profits to be overstated because instead of being expensed in the period of purchase, the expense is spread and the expenditure is treated as the acquisition of an asset.

3. Posting the acquisition to the wrong non-current asset account. This could lead to incorrect depreciation rates being used.



Chapter 9TRIAL BALANCES AND CORRECTING ERRORS

1. Introduction

This chapter describes the process of extracting trial balances, investigating and correcting any errors the errors that might be discovered, making other adjustments and setting up accruals and prepayments.

2. Recording transactions and the trial balance

The double entry system consists of:

๏ The cash book: this records amounts paid into and out of the bank account

๏ The petty cash book: this records small amounts of cash paid for day to day expenses, such as buying postage stamps and teas or coffee for the office.

๏ The general or nominal ledger, which records amounts such as wages, sales, purchases, sales, electricity, travel, advertising, rent, insurance, repairs, receivables, payables and non-current assets.

In addition there were two detailed memoranda ledgers

๏ The payables ledger which details of exactly what is owed to whom are also recorded here. The sum of the amounts owing in this ledger should agree with the payables balance in the general ledger.

๏ The receivables ledger which details of exactly what is owed from whom are also recorded here. There is a separate account for each credit customer. The sum of the amounts owing in this ledger should agree with the receivables balance in the general ledger.

If double entry had been carried out correctly then the values of all credits made should equal the value of all debits made, and when balances on each account are worked out, the sum of the debit balances should equal the sum of the credit balances. The document showing this is the trial balance.



For example:

Dr CR Type of account

Cash 2,900 AssetEquipment 2,000 AssetCapital 10000 Liability (to owners)Inventory 2,500 AssetSuppliers – – LiabilityCustomers 4,000 AssetSales 4000 IncomeCost of goods sold 2,500 ExpenseRent 100 ExpenseTotal 14,000 14000

Example 1

Produce a trial balance for the following accounts by listing each amount as appropriate in the Dr or Cr columns, and label each asset, liability, income or expense:

Balance Dr Cr

Cash (in credit at the bank) 8,175Petty cash 24Sales 123,758Purchases 84,758Wages 15,893Equipment 38,600Rent 3,340Electricity 254Receivables 10,392Payables 5,678Bank loan 12,000Capital 20,000

Trial balances should be taken out regularly (at least monthly) to see if something has gone wrong with the maintenance of double entry. It is much easier finding an error in one month’s postings than a whole year’s.

However, trial balances will not detect all errors: they only detect errors where the debit does not equal the credit entry, or where the trial balance has been taken out incorrectly.

Errors not found by trial balance can be categorised as:

Errors of commission

Example: an expense of rent was incorrectly debited to the wages account.



Example: the purchases day book had been added up to be $8,900 when the correct total was $9,800. Both purchases and the payables control account would then have $900 (ie $9,800 - £8,900) to little posted to them, but the double entry would have been maintained.

Errors of omission

Example: an invoice form a supplier is not entered into the purchases day book at all, so no entry is made for that transaction.

Compensating errors

Example: rent paid of $210 is debited to the rent account as £120 (error = $90 too little debited) and cash sales of $540 are credited to the sales account as $450 (error = $90 too little credited).

Errors of principle

Example: the expense of rent of £350 was incorrectly posted to a receivables account. This error is worse than the error of commission above because it will affect the profit of the business. Instead of adding to an expense, the value of an asset has increased.

A common cause of errors, rather than a type of error is a transposition error, such as writing 1234 instead of 1324. A way to try to see if transposition has been a cause of an error is to see if the error is evenly divisible by 9. For example 1324 – 1234 = 90 which can obviously be divided by nine without a remainder.

Any of the types errors described above will not cause a trial balance not to balance. The errors once found are easy to correct by journal.

Example 2

What would be the correcting journals for the error of commission and the error of principle set out above?Journal number Dr Cr

Authorised by


Authorised by



If a trial balance does not balance then:

1. A one sided error must have occurred (Such as Credit cash $120, Debit Purchases $100 and forgetting about the sales tax of $20).

2. The production of the trial balance is incorrect. For example, leaving out an account or listing it in the wrong side of the trial balance.

Non-balancing trial balances often use a suspense account to indicate the amount by which the two sides differ, and as errors are found, the suspense account can be brought back to zero, indicating that the two columns of the trial balance agree.

For example: if the trial balance produced was this:

Dr CR

Cash 6,700Equipment 1,800Capital 10,000Inventory 2,500Suppliers – 2,700Customers 4,000Sales 8,000Cost of goods sold 2,500Rent 100Wages 2,456

Total 20,056 20,700

Then a suspense account would be introduced to make it balance:

Dr CR

Cash 6,700Equipment 1,800Capital 10,000Inventory 2,500Suppliers – 2,700Customers 4,000Sales 8,000Cost of goods sold 2,500Rent 100Wages 2,456Suspense account 644Total 20,700 20,700

This suspense account indicates that there was originally more on the credit side than on the debit side so that more debits are needed.



An investigation of the differences then needs to be carries out. Let’s say that the following errors were found:

1. Rent of £400 had been charged to wages.

2. Cash received of £200 had been assumed to be a customer paying an invoice in the receivables ledger. In fact it was a new sale.

3. Petty cash of $44 has been left out of the trial balance

4. A sales day book total of $820 had been debited to receivables (customers) as $280, though had been correctly posted to the sales account.

5. Discounts allowed to customer of $30 had been credited to the sales account rather then debited to the discounts allowed account.

Now look at each error and decide how to correct it. Also think carefully if it would have caused the trial balance not to balance: if so, the suspense account will be affected.

Example 3

Errors 1 and 2 would not cause the trial balance to be out of balance. They are errors of commission and principle.

Adjust the trial balance to correct these errors:AdjustmentAdjustment

Dr Cr Dr Cr Dr CrCash 6,700Equipment 1,800Capital 10,000Inventory 2,500Suppliers – 2,700Customers 4,000Sales 8,000Cost of goods sold 2,500Rent 100Wages 2,456Suspense account 644Total 20,700 20,700



The trial balance will now be as follows:

AdjustmentAdjustmentDr Cr Dr Cr Dr Cr

Cash 6,700Equipment 1,800Capital 10,000Inventory 2,500Suppliers – 2,700Customers 4,200Sales 8,200Cost of goods sold 2,500Rent 500Wages 2,056Suspense account 644Total 20,900 20,900

The remaining errors are all of a one-sided nature, and as they are corrected, the suspense account can be updated. [Note the suspense account is not a real ‘T’ account; it is just a way of tracking the errors].

It is easy to make the wrong adjustments in the suspense account. The key is to think:

1. How are the accounts or trial balance to be corrected? What side is to be adjusted and by how much?

2. Having worked that out, the suspense account entry is always on the other side.

Continuing with the example;

Error 3

$44 has been left out of the trial balance. $44 needs to be introduced on the debit side of the trial balance so the suspense account will be credited $44.

Error 4

Receivables were debited by $280 when they should have been debited by $820. The size of the error is therefore $540 and this needs to be an extra debit to receivables. Therefore, credit the suspense account by $540.

Error 5

$30 had been credited to sales rather than debited to discounts allowed. The size of the error is $30 x 2 = $60. $30 has to be debited (ie come out of) to the sales account and $30 debited into the discount account.



The memorandum suspense account ‘T’ account would therefore be:

Suspense accountSuspense accountSuspense accountSuspense accountBalance b/f 644 Error 3 $44 petty cash put into the trial

balance44

Error 4 Extra $540 into receivables (customers)

540

Error 5 $30 out of sales and into discounts

60

644 644

The trial balance would be:


Cash 6,700 6,700Petty cash 44 44Equipment 1,800 1,800Capital 10,000 10,000Inventory 2,500 2,500Suppliers – 2,700 – 2,700Customers 4,200 540 4,740Sales 8,200 30 8,170Discounts allowed 30 30Cost of goods sold 2,500 2,500Rent 500 500Wages 2,056 2,056Suspense account 644 644Total 20,900 20,900 20,870 20,870

Question 1Which of the following errors would cause a trial balance not to balance?

1. Debiting the purchase of a car to the Purchases account instead of the Motor Vehicles account.

2. Debiting cash received to the cash book and crediting payables instead of Receivables

3. Listing discounts allowed to customers as a credit balance

4. Listing petty cash as a debit balance.

A 1, 2, 3 and 4

B 2, 3 and 4 only

C 3 only

D 3 and 4 only



Question 2 A debit balance in the general ledger of £1123 was listed in the trial balance as $2123 credit. By how much does this cause the trial balance not to balance?

A 3,246

B 1,000

C 3,266

D 1,633

Question 3 The trial balance of Mazar Ltd does not balance and a suspense account has been created. Cash paid to a credit card account of $5,641 has been posted to the credit card account as $5,146.

Which of the following entries is the correct adjustment?

A Dr Credit card company 990 Cr Suspense account 990

B Dr Credit card company 495 Cr Suspense account 495

C Dr Suspense account 495 Cr Credit card account 495

D Dr Suspense account 990 Cr Credit card account 990

Question 4 A trial balance does not balance. One of the errors discovered was made in writing off a bad debt of $500. The receivables ledger entry handled correctly, but the Irrecoverable Debts Account was credited with $500.

The correcting entry would be to;

A Dr Irrecoverable Debts 500 Cr Suspense Account 500

B Dr Irrecoverable Debts 1,000 Cr Suspense Account 1,000

C Dr Suspense Account 1,000 Cr Irrecoverable Debts 1,000

D Dr Suspense Account 500 Cr Irrecoverable Debts 500

Question 5 A company made sales of $2,950 inclusive of sales tax at 18%.

The company debited the Receivables account $2,950, credited sales $2,950 and credited the Sales Tax account $531.

What corrections are required?

A Dr Sales $450; Dr Sales tax $81; Cr Suspense account $531

B Dr Sales $531; Cr Suspense account $531

C Dr Receivables account $450; Cr Suspense account $450

D Cr Sales $531; Cr Sales tax $450; Cr Suspense account $81



Question 6 A sales order from a customer slips down the back of a desk before goods are despatched or invoiced.

Which of the following errors in the accounting system has been committed?

A An error of omission

B An error of commission

C An error of principle

D None of the above

Question 7 A company was owed $4,300 by a customer and there was to be a 5% settlement discount if the amount was paid within 30 days. The amount net of the discount was received after 25 days and this was debited to the cash book. $4,300 was credited to the memorandum receivables account and to the receivables control account to indicate that the debt had been fully settled in accordance with the terms offered.

When a trial balance is extracted, what will be the suspense account that is needed initially?

A $4,085 Dr

B $4,085 Cr

C $215 Cr

D $215 Dr

Question 8 An amount of $1,239 paid to a supplier to settle an invoice was treated as a new purchase.

What adjustment is needed to correct this error?

A Dr Supplier $1,239 Cr Suspense account $1,239

B Dr Supplier $1,239 Cr Purchases $1,239

C Cr Suspense account $1,239 Dr Supplier $1,239

D Dr Purchases $1,239 Cr Supplier $1,239

Question 9 A company was owed $500 by ABC Ltd and owed $600 to ABC Ltd. It was decided to offset these amounts to the fullest extent so as to leave a net balance of $100. The company debited Receivables $500 and credited Payables $500.

Which of the following statements is true?

A These are the correct entries to carry out the offset.

B This will cause the trial balance not to balance by $100

C These are not the correct entries, but the trial balance will still balance.

D This will cause the trial balance not to balance by $500



Question 10 Petty cash amounting to $56 was listed on the wrong side of the trial balance.

What adjustment is needed to correct this error?

A Dr Trial balance petty cash line $56; Cr suspense account $56

B Cr Trial balance petty cash line $56; Dr suspense account $56

C Dr Trial balance petty cash line $112; Cr suspense account $112

D Cr Trial balance petty cash line $112; Dr suspense account $112

3. Extending the trial balance

The trial balance lists all accounts in the general ledger plus the cash book and petty cash book balances. Each account will either end up on the income statement (incomes and expense accounts) or the statement of financial position (assets, liabilities and capital accounts).

However, before the accounts are finalised some adjustments might be needed. These include:

๏ Depreciation charges

๏ Writing-off irrecoverable debts

๏ Inventory adjustments

In addition, accruals and prepayments might need to be set up:

Accruals: increase the expenses recorded in the expenses ‘T’ accounts and also feature as liabilities (amounts still owed in respect of the expense)

Prepayments: decrease the expenses recorded in the expenses ‘T’ accounts and also feature as assets (amounts paid in advance to suppliers).

All these matters can be incorporated in an extended trial balance:

Initial trial balance


AdjustmentsAdjustments Accruals and prepaymentsAccruals and prepayments Income statement

Income statement

Statement of financial position


Dr Cr Dr Cr Accruals Prepayments Dr Cr Dr Cr

Profit X X Y Y Total accruals Total prepmnts



The extended trial balance works as follows:

1. Start with the initial, balancing trial balance. There’s no point going on unless this balances as there must be an error.

2. The adjustments columns are journal entries and these must balance. So, to put through depreciation of $3,000 on office equipment, $3,000 would be placed in the Debit column at the depreciation expense row, and $3,000 also in the Credit column in the Office Equipment Accumulated Depreciation row. The sum of the DR and Cr columns must be equal.

3. If rent of $1,000 had to be accrued, then $1,000 would be placed in the Accrual column at the Rent Account row. If a prepayment were needed it would be placed in the appropriate row in the Prepayments column. The sum of the Accruals and Prepayments columns do not need to balance. However, the totals of these columns are carried across to the Statement of Financial Position – but they ‘change column’. Thus the rent accrual that started in the left hand column of the Accruals and Prepayments pair will end up in the Cr column (right hand) of the SOFP. This recognises that an accrual is a liability on the SOFP. Similarly, the total of the prepayments column will be carried to the debit side of the SOFP, representing an asset.

4. The first three pairs of columns are added across adding to end up with the final figures after adjustments, accruals and prepayments. Each account ends up either in the Income Statement or the Statement of Financial Position. Any profit made will be carried across to the credit of side of the SOFP, to be added to capital.



Example 4



AdjustmentsAdjustments Accruals and prepaymentsAccruals and prepayments

Income statement

Income statement



Dr Cr Dr Cr Accruals Prepmnts Dr Cr Dr Cr

Cash 6,700

Petty cash 44

Equipment 1,800

Capital 10,000

Inventory 2,500

Suppliers – 2,700

Customers 4,740

Sales 8,170

Disc allowed 30

Cost of goods sold 2,500

Rent 500

Wages 2,056

Depreciation expense

Accumulated depreciation

Irrecoverable debts expense

Electricity

Accruals

Prepayment

Profit

Total 20,870 20,870

The following adjustments are needed for the preparation of the financial statements:

1. A depreciation charge of $500 is to be made.

2. Irrecoverable debts of $400 are to be written off

3. Wages of $600 and electricity of $200 are to be accrued. Rent has been prepaid by £100

Extend the trial balance and prepare the income statement and statement of financial position in a manner suitable for presentation.



Question 11 Here is an extended trial balance extract:




Income statement

Income statement




Cell 1 Cell 2 Cell 3 Cell 4

AT PT

AT = accruals total

PT = prepayments total

To where should AT and PT be transferred?

A AT to Cell 3; PT to Cell 4

B AT to Cell 1; PT to Cell 2

C AT to Cell 4; PT to Cell 4

D AT to Cell 4; PT to Cell 3

Question 12

In the income statement columns of an extended trial balance, the total of the credit column adds up to $134,000 and the total of the debit balances add up to $110,000.

What does this indicate?

A An error has been made

B A profit has been made

C A loss has been made

D The difference should be transferred to the debit side of the statement of financial position.





Chapter 10INCOMPLETE RECORDS

1. Introduction

Many traders do not keep good accounting records, and certainly not a ledger system. Typically, they will keep invoices received and copies of invoices issued. Usually they will know what has been paid to suppliers and received from customers. They are often hazy about the amount of cash sales and perhaps cash purchases. In particular, there is a danger that cash sales are deliberately omitted so that income is under-declared and tax fraudulently reduced. In your questions almost any figure could be missing and you have to try to piece together what’s happened so that you can make estimates of profit or other amounts.

This chapter looks at the techniques available.

2. Overview

It is essential to understand the accounting pathway from purchases through to the collection of cash as solving incomplete records problems involves moving up and down pathway, trying to work out any missing figures.

Stage 1 – purchases

Purchases, payables and payments can all be summarised on the Payables Ledger Control Account (or Total Payables Account):

Payables Ledger Control AccountPayables Ledger Control AccountPayables Ledger Control AccountPayables Ledger Control AccountPayments to suppliers X Balance brought forward XBalance c/f X Credit purchases X

X XBalance brought forward X

If any one of these figures is missing, it can be found by drawing up the control account and making it balance by inserting the missing figure.

If there are also cash purchases, they will have to be added to the control account purchases figure.

Stage 2 – Cost of sales

Cost of sales = Opening inventory + Purchases – Closing inventory

Again, any single missing figure can be worked out easily.

If all purchases are on credit, then the purchases figure will be the Credit purchases figure from the control account. Remember, in general the purchases figure will not be the same as the amount paid to suppliers. That’s why the control account is important.



Stage 3 – Sales

Credit sales, cash receipts, opening and closing receivables are linked up the Receivables Ledger Control Account (or Total Receivables account):

Receivables Ledger Control AccountReceivables Ledger Control AccountReceivables Ledger Control AccountReceivables Ledger Control AccountBalance brought forward X Receipts from debtors XCredit sales Balance c/f X

X XBalance brought forward X

If any one of these figures is missing, it can be found by drawing up the control account and making it balance by inserting the missing figure.

If there are also cash sales, they will have to be added to the control account sales figure.

It would, of course be quite possible for two item in the control account to be missing, for example, sales and receipts from debtors. That would mean that the control account is of limited use, in which case, another method might also have to be employed. This is where gross profit percentages and mark-ups can be very useful as these link cost of sales and sales.

Question 1 Opening payables balance = $4,000

Closing payables balance = $6,000

Payments to credit suppliers = $12,000

Cash purchases = $1,000

What is the total purchases figure?

A 7,000

B 10,000

C 11,000

D 15,000

Question 2 Opening receivables balance = $5,000

Closing receivables balance = $4,000

Sales on credit = $12,000

Cash sales = $2,000

What amount of cash has been collected from credit customers?

A 11,000

B 12,000

C 13,000

D 14,000



Question 3 Opening inventory = $5,000



What are purchases?

A 15,000

B 12,000

C 28,000

D 18,000

3. Gross profit percentages and mark-ups

A gross profit percentage (or gross margin) is always defined with respect to the sales value. So a gross profit percentage of 20% means that gross profit is 20% of sales. It can be very useful to set out this information in the form of a ‘cost structure’:

Cost of sales + Gross profit = Sales

80 20 100

It is vital to get the proportions correct. If you are told that the gross profit percentage is 20%, then that means gross profit is 20% of sales. Therefore put sales at 100, the profit at 20 and the cost of sales at 80 (100 – 20).

If you were told that Cost of Sales = $1,600, then using the proportions in the cost structure:

Gross profit = $1,600 x 20/80 = $400

Sales = $1,600 x 100/80 = $2,000

[or Sales = GP + Cost = 400 + 1,600 = 2,000]

A mark-up percentage is always defined with respect to cost of sales. So a mark-up of 25% would mean that 25% is added to cost to give the selling price. Profits are 25% of costs.

One again a cost structure is very useful:

Cost of sales + Gross profit = Sales

100 25 125

It is vital to get the proportions correct. If you are told that the mark-up percentage is 25%, then that means gross profit is 25% of cost of sales. Therefore put cost of sales at 100, the profit at 25 and the sales at 125 (100 + 25).

If you were told that sales = $6,000, then using the proportions in the cost structure:

Gross profit = $6,000 x 25/125 = $1,200

Cost of sales = $6,000 x 100/125 = $4,800

[or Cost = Sales – GP = $6,000 – $1,200 = $4,800]



Question 4

A company earns a mark-up of 33⅓ % on all sales. Sales amount to $12,000.

What are the profits and cost of sales?

A Cost of sales = $9,000; profit = $4,000

B Cost of sales = $9,000; profit = $3,000

C Cost of sales = $8,000; profit = $3,000

D Cost of sales = $8,000; profit = $4,000

Question 5 A company earns gross margin of 30% on all sales.

The gross profit amounts to $21,000.

What are cost of sales and sales?

A Cost of sales = $70,000; sales = $91,000

B Cost of sales = $49,000; sales = $56,000

C Cost of sales = $49,000; sales = $70,000

D Cost of sales = $70,000; sales = $100,000

4. Bringing it together

So, we have looked at the use of control accounts, and mark-ups and gross profit percentages. Now we have to bring these elements together.

Example 1

A trader provided you with the following information:

Payables at the start of the period = $5,000 and at the end of the period = $6,000

$28,000 was paid to suppliers during the period.

Opening inventory was $7,000 but there is no figure available for closing inventory.

Receivables at the start of the period = $10,000 and at the end of the period = $8,000

$40,000 was received from debtors during the period.

The trader is operating in a business where the typical gross margin is 40%

Prepare a trading account showing sales, opening and closing inventories, purchases, cost of sales and gross profit.



Question 6 A trader provided the following information:

Payables: opening balance = $4,000; closing balance = $5,000. Payments made = $20,000

Receivables: opening balance = $7,000; closing balance = $9,000. All sales are on credit.

Inventory: opening balance = $5,500; closing balance = $2,500.

Gross profit percentage = 25%

How much cash has been collected for from customers?

A $30,000

B $32,000

C $28,000

D $26,000

Question 7 A trader provided the following information:

Payables: opening balance = $6,000; closing balance = $3,000. Payments made = $40,000

Receivables: opening balance = $9,000; closing balance = $8,000. There was a bad debt written off of $1,000. Receipts from customers = $45,000. All sales are on credit.

The inventory at the start of the year was $7,500, but immediately after year end a fire destroyed all closing inventory before it could be counted.

Mark-up = 50%

What was the cost of closing inventory just before the fire?

A $500

B $15,167

C $11,250

D $14,500



5. The cash account

The last piece of the jigsaw is often to work out certain cash amounts, such as how much the owner has withdrawn form the business (drawings). Drawing up a cash account can allow you to find missing items by balance. However, if you don’t know how much cash has come in from customers and how much the owner has taken out in drawings then you will have to do some detective work.

Example 2



A file of purchases invoices added up to $45,000

Opening inventory was $9,000 and closing inventory $10,000


A file of copy invoices issued in the period added up to $55,000

Cash sales were also made, but no record was kept of them or of the owner’s drawings.

$100 was paid in cash each week for casual labour. Other expense amounts paid from the bank account amount to $13,000, and $2,300 was spent on a new computer.


Opening cash was $100 as cash and £12,000 in the bank; closing balances were $80 as cash and $10,500 in the bank

Prepare a trading account showing sales, opening and closing inventories, purchases, cost of sales and gross profit, net profit and drawings.

Question 8 Opening cash = $4,321; closing cash = $4,567.


Gross profit = 40%

Paid to suppliers from cash = $85,393

Other expenses payments from cash= $59,952

All sales were for cash and those were the only amounts paid into the account. Apart from drawings, no other amounts were paid from cash

What were the profit and the drawings?

A Profit = $64,240; drawings = $15,255

B Profit = $62,240; drawings = $10,609

C Profit = $64,240; drawings = $15,009

D Profit = $62,240; drawings = $10,855



6. Another approach - the accounting equation

Sometimes records are so scarce that there is next to no information about sales, purchases, costs and drawings. This can easily arise when a trader is almost entirely cash-based so that there is no information available from any bank transactions.

However, if the net assets at the start and end of a period can be listed, then there is a way available to estimate profits.

The accounting equation states that:

Increase in net assets over a period = Capital introduced – Drawings + Profits

Example 3


Statement of financial position 31/12/2013:

Non-current assets 45,000Current assets: Inventory 14,000 Receivables 9,000 Cash 1,200

24,20069,200

Owner’s capital 59,200Bank loan 8,000Trade creditors 2,000

69,200

During the year ended 31/12/2014:

1. The owner estimates that drawings of $2,000 per month were taken.

2. The bank loan has decreased to $5,000

3. New non-current assets were bought for $20,000 and a depreciation charge of 20% was made on all non-current assets.

4. Closing balances: inventory = $12,000; receivables = $10,000; cash = $2,000; trade creditors =$3,000.

What profits did the business make for the year ended 31/12/2014?



Question 9 Net assets at the start of the period = $56,265.

At the end of the period, non-current assets were $10,500 higher and net current assets were $2,345 lower long term bank loans had increased by $6,000. Drawings of $8,000 were taken out of the business and additional owner’s capital of $2,000 introduced.

What profit or loss was made in the period?

A $3,845 loss

B $8,155 profit

C $3,845 profit

D $2,155 profit



Chapter 11PARTNERSHIPS

1. Introduction

A sole trader is when a person sets up an unincorporated business himself or herself. The sole trader is responsible for introducing proprietor’s capital and can enjoy all of the profits and can withdraw money from the business (drawings). There is a single capital account showing how much the trader is owed by the business.

By contrast, a partnership is where several people trade together with a view to making profits. All the partners can introduce capital and they will have a share of the profits. Each will have their own capital account and can make their own drawings.

2. Definition

A partnership is when two or more people carry on a business in common with a view to making profits.

The personal liability of the partners in most partnerships is unlimited, though some countries do have legislation permitting limited partnerships. In general all of the partners participate in the management of the business.

No formal agreement is needed to form a partner. Simply by carrying on a business together two people can find themselves regarded as partners by the operation of the law.

3. Capital and current accounts

Each partner will have a capital account and often a current account. These accounts keep track of how much capital a partner has introduced, earned or withdrawn from the business. There is no fundamental difference between capital and current accounts: both record partners’ capital. However, amounts in the capital account tend to be relatively stable and constant whilst amounts in the current account are liable to be more volatile. The current accounts will usually contain the partners’ share of profits and any drawings that have been made.



Amounts of capital added will be posted as:Amounts of capital added will be posted as:Dr Cash total capital addedDr Cash total capital added X

Cr Partner A Capital account with amount introduced by Partner A XCr Partner B Capital account with amount introduced by Partner B X X

Partners’ shares of profits will be posted as:Partners’ shares of profits will be posted as:Dr Net profitDr Net profit X

Cr Partner A Current account with Partner A’s share of profits XCr Partner B Current account with Partner B’s share of profits X

X XPartners’ drawings will be posted as:Partners’ drawings will be posted as:Dr Partner A Current account with Partner A’s drawingsDr Partner A Current account with Partner A’s drawings XDr Partner B Current account with Partner B’s drawingsDr Partner B Current account with Partner B’s drawings X

Cr Cash XX X

Note that these entries are in principle no different from those of a sole trader. Profits increase capital, drawings decrease capital, introducing more capital obviously increases capital

Remember also that the current accounts are simply subsidiary capital accounts

4. Profit shares

The partners are the owners of the business. Any money they receive from the business is a share of profits. Sometimes sole traders and partners will refer to themselves as receiving a salary or a wage but this only means a regular withdrawal of profits to live on. These amounts are not expenses of the business because sole traders and partners are not employees. They are drawings and are simply one way in which profits can be appropriated.

Remember also that profits and drawings are not linked. Profits can be made, yet no drawings need be made and all profits can be left in the business. Alternatively, drawings can be made even if no profits are made. This will reduce the capital of the business.

Partnership profits can be appropriates in three ways:

1. Partners can be entitled to salaries (remember, not real salaries)

2. Partners can be entitled to interest on their capital (again, this is not a real interest expense, it is simply part of the appropriate formula)

3. Profits left after (1) and (2) above are then shared out in an agreed profit sharing ratio.

If there is a partnership agreement, the salaries, interest and profit sharing ratios will be stipulated there.

If there is no partnership agreement and the partners have just drifted into a partnership agreement then there will be no salaried, no interest on capital, and profits or losses will be shared equally.



Example 1

A partnership makes profits of $118,000. The partnership agreement stipulates that:

- Partner A receives a salary of £30,000 and interest on capital account of 10% pa

- Partner B receives a salary of $20,000 and interest on capital account of 10% pa

- Capital accounts: Partner A = $200,000; Partner B = £120,000

Profit sharing ratio A:B = 3:2

Show the appropriation of the profits to the two partners.

Note that the profit appropriation formula (salary, interest and profit sharing ratio) is followed even if a loss has been made, or there are not enough profits to cover the salaries and interest.

Example 2


- Partner A receives a salary of £35,000 and interest on capital account of 8% pa

- Partner B receives a salary of $25,000 and interest on capital account of 8% pa

- Capital accounts: Partner A = $100,000; Partner B = £80,000

Profit sharing ratio A:B = 1:1

Show the appropriation of the profits to the two partners.

5. Loan interest

Occasionally a partner will make a loan to a partnership in addition to investing capital.

Such loans will usually earn interest, but that interest is an expense of the business and will have to be deducted from profits before they are appropriated to the partners. All that’s happened is that the business has borrowed form a partner rather than borrowing form a bank. Bank interest would be an expense, so interest paid on loans form partners is an expense.

Note carefully the two types of interest and their treatment:

Interest on partners’ capital: not an expense and not deducted from profits. This is part of the appropriation of profits.

Interest on loans from partners: an expense of the business that has to be deducted to find the profits. Then appropriation can begin.



6. Admission of a new partner

When a new partner is admitted to a partnership, that person gets immediate access to the profit earning ability of the partnership. Assuming the partnership is successful, that profit earning ability will be much greater than would be found in a new business starting from scratch.

This is because a successful and established business will have a reputation, knowhow, a customer list and loyal customers. Collectively these qualities give rise to goodwill.

When the new partner is admitted, the old partners are essentially sharing some of this goodwill with the new partner: they are giving up some of that goodwill to the new partner. It is only fair that the new partner should pay for access to goodwill and the benefits it brings, and that the old partners should be compensated for giving some of it up to the new partner. A goodwill adjustment is therefore needed.

You do not have to calculate the value of the goodwill. In practice this is a matter for negotiation between the people involved. Because the value of goodwill is therefore arbitrary, it is usually not left in the books and will not appear as an asset in the statement of financial position.

The adjustment needed can be thought of as being in two parts:

1. Establish the goodwill belonging to the old partners, This is done by:

Dr Goodwill to the goodwill account Cr Goodwill to the old partners’ capital accounts in their old profit sharing ratio

2. Admit the new partner then write-off the goodwill in the new profit sharing ratio

Dr Goodwill to the new partners’ capital accounts in their new profit sharing ratio Cr Goodwill to the goodwill account

The goodwill account can be ignored here and the two journal entries merged to give:

Cr Goodwill to the old partners’ capital accounts in their old profit sharing ratioDr Goodwill to the new partners’ capital accounts in their new profit sharing ratio

Remember: credit in the old; debit in the new



Example 3

Partners A and B share profits and losses in the ratio A: B, 2:3

They decide to admit Partner C, and they will then share profits in the ratio A:B:C, 3:4:1

Goodwill has been agreed as $160,000.

Show the goodwill entries in the partners’ capital accounts.

Partners’ capital accountsPartners’ capital accountsPartners’ capital accountsPartners’ capital accountsPartners’ capital accountsPartners’ capital accountsPartners’ capital accountsPartners’ capital accountsPartner

APartner

BPartner

CPartner

APartner

BPartner

C

The net effects of these adjustments are:


APartner

BPartner

CPartner

APartner

BPartner

CCredit in the old 2:3 64,000 96,000

Debit in the new3:4:1 60,000 80,000 20,000

Partner A

Capital net increased by $4,000 ($64,000 - $60,000).

Partner A had enjoyed profit benefits arising from 2/5 of the goodwill and now enjoys only 3/8. This is a decrease of 16/40 – 15/40 = 1/40th.

The $4,000 net credit is equivalent to 1/40 x $160,000. The adjustment therefore compensates A for giving up part of the benefit arising from goodwill.

Partner B

Capital net increased by $16,000 ($96,000 - $80,000).

Partner B had enjoyed profit benefits arising from 3/5 of the goodwill and now enjoys only 4/8. This is a decrease of 6/10 – 5/10 = 1/10th.

The $16,000 net credit is equivalent to 1/10 x $160,000. The adjustment therefore compensates B for giving up part of the benefit arising from goodwill.

Partner C

Capital has been charged with $20,000.

Partner C now enjoys access to profits arising from 1/8 of the goodwill and this is worth $160,000/8 = $20,000. So C has been charged for gaining access to goodwill.



7. Pro forma partnership accounts

Income statement

Sales XCost of sales (X)Gross profit XLess: expenses including interest on loans for partners (X)Net profit for appropriation X

Partners’ salaries Partner A X Partner B X

(X)Interest on capital Partner A X Partner B X

(X)X

Partners’ share of the balance in profit sharing ratio Partner A X Partner B X

(X)–


Non-current assets - cost XNon-current assets – accumulated depreciation (X)Non-current assets - NBV XCurrent assets: inventory, receivables, cash X

X

Partners’ capital accounts Partner A X Partner B X

XPartners’ current accounts Partner A X Partner B X

XX

Loans XCurrent liabilities X

X



Question 1 A partnership has a partnership agreement which stipulates:

Partners’ salaries: A $10,000; B $8,000; C $12,000

Profit sharing ratio: A:B:C 2:3:4

Profits for a year were $12,000.

What is the total amount of these appropriated to partner B?

A $2,000

B $14,000

C $4,000

D $(6,000)

Question 2 A partnership has a partnership agreement which stipulates:

Interest on capital = 5% pa

Partners’ capital: A $100,000; B $80,000; C $120,000

Profit sharing ratio: A:B:C 2:3:4

Additionally partner A had made a loan of $50,000 to the partnership of $50,000 on which interest of 6% would be charged.

Profits for a year before any interest $90,000.

What is the total amount of profits appropriated to partner A?

A $19,000

B $16,000

C $24,000

D $21,000

Question 3 A partnership with three partners shares profits in the ratio W:X:Y 3:2:4. A new partner Z is to be admitted and the four partners will share profits in the ratio W:X:Y:Z 3:3:3:1.

What will be the net effect of the goodwill adjustment on Y’s capital account if goodwill is valued at $180,000 but is not to remain in the books of account?

A Net Cr = $80,000

B Net Cr = $26,000

C Net Dr = $26,000

D Net Dr = $80,000





ANSWERS TO TESTS

Chapter 1

Question 1

C

Question 2

D Accruals would suggest that if a loss has not been made in a period, it shouldn’t be included in that period’s results. However, prudence says that losses should be recognised as soon as foreseen.

Question 3

A

Question 4

B

Question 5

D

Question 6

A

Question 7

C

Question 8

B

Chapter 2Question 1

B The asset of cash decreases; the expense of wages increases

Question 2

C The asset of cars increases as does the liability to the garage.

Question 3

D Cash decreases as does the liability to the supplier



Question 4

B Increase in net assets = 19,000 – 15,000 = 4,000.Had there been no drawings nor capital introduced this would be the profit. However, net assets have increased by $4,000 despite drawings of $750, so profit must have been $4,750.

Or:

Increase in net assets = Capital introduced + Profit – Drawings

4,000 Nil P - 750

So, P = 4,000 + 750 = 4,750

Question 5

A Increase in net assets = Capital introduced + Profit – Drawings

4,000 1,000 + P – 400

So, P = 4,000 + 400 – 1000 = 3,400

Question 6

B Increase in net assets = Capital introduced + Profit – Drawings

–2,000 C – 7,000 – 1,000

So, C = 7,000 + 1,000 - 2,000 = 6,000

$7,000 loss and $1000 drawings have flowed out of the business. This would have reduced the net assets by $8,000, but they fell by only $2,000. Therefore $6,000 must have been injected as new capital.

Question 7

C

Net assets 1 January 31 January$ $

Cash 10,000 12,000Owed from customers 2,000 1,000Equipment 8,000 10,000Assets 20,000 23,000Owed to suppliers (3,000) (4,000)Bank loan (2,000) (5,000)Net assets 15,000 14,000

Decrease in net assets = $1,000 and the owner withdrew $800, so the loss must have been $200



Chapter 3

Question 1

B 690 x 100/115 = 600; 690 x 15/115 = 90

Question 2

D 3000 x 80% x 1.16 = 2784; 3000 x 80% x 16% = 384

Question 3

C Output tax = $4,600; input tax = $1,000 ie 6,000 x 20/120. So, $3,600 has to be paid

Question 4

D Remember, total debits must equal total credits in the double entry system.

Question 5

C Remember, total debits must equal total credits in the double entry system

Question 6

C The control account is not affected by errors in extracting and adding up the list of balances from the payables ledger. Had the $100 been treated correctly it would have been like a negative figure; it was treated as positive so the error is $200.

Question 7

A Totals are posted to control accounts and an extra $2,000 has to be posted to correct it. The list of balances does not depend on total postings from the day book

Question 8

C Totals in the sales day book are posted to the receivables control account and the sales account, not to the individual accounts in the receivables ledger.

Question 9

A The error is in the initial recording of the invoice so everything flowing form that will be wrong.

Chapter 4

Question 1

D

Question 2

B The double entry is CR Cash (already in the cash book) DR Payables (in total ant the individual accounts).



Question 3

D


(Payments)

Balance b/d 31 July 2013Balance b/d 31 July 2013 5,700

Receipt not recordedReceipt not recorded 403

Bank charges not recorded 70

Balance c/d 31 July 2013 6,033

6,103 6,103

Balance b/d 1 August 2013Balance b/d 1 August 2013 6,033

Bank statementBalance 31 July 2013 ?Less: amount paid in but not yet on bank statement 1,367Add: cheques in cash book not yet on bank statement (3,880)Up-to-date balance 6,033

X must be 6033 + 3880 – 1,367 = 8,546

Question 4

C


(Payments)

Balance b/d 1,145

Receipt not recordedReceipt not recorded

Bank charges not recorded 75

Balance c/dBalance c/d 1,220

1,220 1,220

Balance b/d 1 August 2013 1,220

Bank statement

Opening balance o/d (750)

Less: amount paid in but not yet on bank statement 330

Add: cheques in cash book not yet on bank statement (800)

Up-to-date balance (1220)

X must be 6033 + 3880 – 1,367 = 8,546



Question 5

B $100 too much will have been credited to the receivables control account form the cash book column total.

Question 6

B Net expenditure = 45 – 5 = $40, so that will be the amount of reimbursement needed.

Chapter 5

Question 1

B Discounts of 2.5% are available on the debts of $500 and $1,000: $1,500 x 2.5% = $37.50.

The total payment should therefore be: $3,100 - $37.50 = $3,062.50

Question 2

C Sales = 800 x 80% = $640; settlement discount = 5% x 640 = $32.

The settlement discount is debited to the discounts allowed account.

Question 3

D Amount owing at period end before discount = $12,345 +11,346 – 10,463 – 228 = $13,000. 25% of $13,000 = $3,250

Question 4

A Note that C is wrong. The age of debts begins running from the date of the invoice

Question 5

C Sales tax content = $34,615 x 15/115 = 4,515. The net amount of the sale = $30,100

Question 6

B Increasing the allowance from $12,000 to $14,000 costs $2,000. Writing off the debt costs $5,000. Therefore, the total cost = $7,000.

Question 7

D If debts of $4,000 are written off yet the amount debited to the Income Statement in respect of irrecoverable debts is only $2,500, the allowance must have decreased by $1,500. Therefore the new balance is $10,000 - $1,500 = $8,500.



Chapter 6

Question 1

B Expense = 11/12 x 2,400 + 1/12 x 3,000 = $2,450

Prepayment 31/12/2013 = $2,200

Prepayment 31/12/2014 = $2,750

Question 2

D Expense = $2,000 + $450 x 1/3 + $600 x 2/3 = $2,550

Accrual = $400

Question 3

C

Rent AccountRent AccountRent AccountRent Account

Cash 14 x 2,500 35,000 Bal b/d 1/1/2014 2,500

To Income statement 12 x $2,500 30,000

Bal c/d 31/12/2014 2,500

35,000 35,000

1/1/2015 Balance b/d (prepayment) 2,500

Chapter 7Question 1

C Cost of sales = opening inventory + purchases – closing inventory

Therefore:

Purchases = Cost of sales + closing inventory – opening inventory

Question 2

B

Question 3

D Cost = $15,000 + $1,000 = $16,000

NRV = $12,000 - $2,500 = $9,500 [estimated selling price less costs of completion, distribution etc]

Question 4

A Sale on 21/1 uses up all 12/1 purchases and 200 of 20/1, leaving 300 of 20/1 purchases.

Sale of 31/1 uses 100 of 20/1 purchases and leaves 200 of 20/1 purchases.

Stock value = 700 x $14 + 200 x $13 = 12,400



Chapter 8

Question 1

C 2013 25,000 x 20% = 5,000 (charge for depreciation):

WDV = 25,000 – 5,000 = 20,000

2014 20,000 x 20% = 4,000 (charge for depreciation):

WDV = 20,000 – 4,000 = 16,000

2015 16,000 x 20% = 3,200 (charge for depreciation):

WDV = 16,000 – 3,200 = 12,800

Question 2

D Cost = $50,000 + $10,000 = $60,000;

Loss on disposal = (40,000 – 28,000) – 10,000 = $2,000

Question 3

D

Chapter 9

Question 1

C In 1 and 2 the double entry is arithmetically complete, though wrong in principle. In 4, petty cash should be, and is, listed as a debit.

Question 2

A 1123 is missing from the debit side and 2123 has been arbitrarily introduced to the credit side. The error is therefore 1123 + 2123 = 3246

Question 3

B There had been too few debits made by $5,641 - $5,146 = $495. The adjustment is to debit the credit card company with $495 more and to credit the suspense account with $495.

Question 4

B $500 was not just left out, it was posted to the wrong side making the Irrecoverable Debts account $1,000 too little.

Question 5

A Entries should have been:

Dr Receivables 2950 Cr Sales 2500 Cr Sales tax 450

Entries were:

Dr Receivables 2950 Cr Sales 2950 Cr Sales tax 531

Differences Over 450 Over 81



Question 6

D This is not an error in the accounting system. No goods have been despatched and no transactions have been updated and the accounting records are correct

An error of omission would have occurred if the goods had been despatched and invoice for them had not been recoded anywhere

Question 7

D At present the Dr to cash is $4,300 x 95% = $4,085 and the credit to the customer is $4,300. There is a difference of $215 which is $215 too much to credits. The Suspense account will be $215 Debit to make the trial balance balance.

Question 8

B

Question 9

C The double entry was complete, but the wrong way round

Question 10

C Petty cash should be a debit entry, but was placed on the wrong side of the trial balance: 2 x 56 = 112

Question 11

D Accruals appear as a credit balance (liability) on the SOFP and prepayments as a debit balance (asset) on the SOFP

Question 12

B If credits exceed debits, income exceeds expenses and a profit has therefore been made. This will be transferred to the credit side of the SOFP to add to capital.

Chapter 10Question 1

D Opening payables balance = $4,000

Closing payables balance = $6,000

Payments to credit suppliers = $12,000

Cash purchases = $1,000

Payables Ledger Control AccountPayables Ledger Control AccountPayables Ledger Control AccountPayables Ledger Control Account

Payments to suppliers 12,000 Balance brought forward 4,000

Balance c/f 6,000 Credit purchases (balancing figure) 14,000

18,000 18,000

Balance brought forward 6,000

Total purchases = $14,000 (on credit) + $1,000 (cash) = $15,000



Question 2

C Opening receivables balance = $5,000

Closing receivables balance = $4,000

Sales on credit = $12,000

Cash sales = $2,000

Receivables Ledger Control AccountReceivables Ledger Control AccountReceivables Ledger Control AccountReceivables Ledger Control Account

Balance brought forward 5,000 Receipts from debtors 13,000

Credit sales 12,000 Balance c/f 4,000

17,000 17,000


Cash sales are irrelevant to receipts from credit customers.

Question 3

D Cost of sales = Opening inventory + Purchases – Closing inventory

15,000 5,000 + Purchases - 8,000

Purchases = 15,000 + 8,000 – 5,000 = $18,000

Question 4

B Cost + Profit = Sales

100 + 33 ⅓ = 133⅓

9,000 + 3,000 = 12,000

Question 5

C Cost + Profit = Sales

70 + 30 = 100

49,000 + 21,000 = 70,000

Question 6

A Payables: opening balance = $4,000; closing balance = $5,000.

Payments made = $20,000

Receivables: opening balance = $7,000; closing balance = $9,000.

All sales are on credit.

Inventory: opening balance = $5,500; closing balance = $2,500.

Gross profit percentage = 25%





Balance c/f 5,000 Credit purchases (balancing figure) 21,000

25,000 25,000


Cost of sales = 5,500 + 21,000 – 2,500 = $24,000

Cost + Profit = Sales

75 + 25 = 100

24,000 + 8,000 = 32,000


Balance brought forward 7,000 Receipts from debtors 30,000


39,000 39,000


Question 7

D Payables: opening balance = $6,000; closing balance = $3,000. Payments made = $40,000

Receivables: opening balance = $9,000; closing balance = $8,000.

There was a bad debt written off of $1,000. All sales are on credit.

The inventory at the start of the year was $7,500, but immediately after year end a fire destroyed all closing inventory before it could be counted.

Mark-up = 50%



Balance c/f 3,000 Purchases (balancing figure) 37,000

43,000 43,000



Balance brought forward 9,000 Receipts from customers 45,000

Bad debt write-off 1,000


54,000 54,000




Cost + Profit = Sales

100 + 50 = 150

30,000 + 15,000 = 45,000

Cost of sales = opening stock + purchases – closing stock

30,000 = 7,500 + 37,000 – closing stock

Closing stock = opening stock + purchases – cost of sales

Closing stock = 7,500 + 37,000 – 30,000 = 14,500

Question 8

C Opening cash = $4,321; closing cash = $4,567.


Opening inventory = $12,000; closing inventory = $15,000

Gross profit = 40%

Paid to suppliers from cash = $85,393

Other expenses payments from cash = $59,952

All sales were for cash and those were the only amounts paid into the account. Apart from drawings, no other amounts were paid from cash

Cost of sales + Profit = Sales

60 + 40 = 100

Profit = 96,360 x 40/60 = 64,240

Sales = 96,360 x 100/60 = 160,600 [or 96,460 + 64,240]

CashCashCashCash

Balance brought forward 4,321 Paid to suppliers 85,393

Other expenses 59,952

Drawings (balance) 15,009

Cash sales 160,600 Balance c/f 4,567

164,921 164,921




Question 9

B Net assets at the start of the period = $56,265.

At the end of the period, non-current assets were $10,500 higher and net current assets were $2,345 lower long term bank loans had increased by $6,000. Drawings of $8,000 were taken out of the business and additional owner’s capital of $2,000 introduced.

Net assets at the end of the period = $56,265 + $10,500 – 2,345 – 6,000 = $58,420.

Increase in net assets = 58,420 – 56,265 = $2,155

Increase in net assets = Capital introduced – drawings + Profits

2,155 = 2,000 – 8,000 + Profits

Profits = $8,155

Chapter 11Question 1

A Residual loss after appropriation of salaries = $12,000 - $10,000 - $8,000 - $12,000 = ($18,000).

Of this B will have 3/9th apportioned = 18,000 x 3/9 = $6,000 loss

Net amount apportioned to B = $8,000 - $6,000 = $2,000.

Question 2

D Profits for a year before any interest $90,000.

Profits after interest on loan = $90,000 – 6% x $50,000 = $87,000

Residual profits after interest on capital = 87,000 – 5,000 – 4,000 – 6,000 = $72,000

Of this 2/9 is apportioned to A = 2/9 x $72,000 = $16,000

Total appropriated to A = $16,000 + $5,000 = $21,000

Note: interest on the loan is not an appropriation of profits

Question 3

B A partnership with three partners shares profits in the ratio W:X:Y 3:2:4. A new partner Z is to be admitted and the four partners will share profits in the ratio W:X:Y:Z 3:3:3:1.

Goodwill - $180,000

Cr Y in old PSR 180,000 x 4/9 = $80,000

Dr Y in new PSR 180,000 x 3/10 = $54,000

Net Cr = $26,000



ANSWERS TO EXAMPLES

Chapter 1

Example 1

Chapter 2Example 1

Dr CRCash 2,900Equipment 2,000Capital 10,000Inventory 2,500Suppliers – –Customers 4,000Sales 4,000Cost of goods sold 2,500Rent 100Total 14,000 14,000

Example 2

SalesSalesSalesSales21/6/2103 Returns 550 1/6/2013 Cash 25025/6/2013 Returns 32 3/6/2013 Credit sales 1,395Balance carried down 1,112 29/6/2013 Cash 49

1,694 1,694

Balance brought down 1,112



Example 3

CashCashCashCash1 Capital 6,000 2 Inventory 1,0004 Sales 1,900 6 Rent 1,0009 LD Vinci 850 7 Electricity 250

8 VV Gogh 75010 Drawings 50012 Cash 750Balance c/d 4,500

8,750 8,750Balance b/d 4,500

CapitalCapitalCapitalCapitalBalance c/d 6,000 1 Cash 6,000

6,000 6,000Balance b/d 6,000

InventoryInventoryInventoryInventory2 Cash 1,000 4 Cost of goods sold 1,0003 V V Gogh 1,500 5 Cost of goods sold 500

Balance c/d 1,0002,500 2,500

Balance b/d 1,000

SalesSalesSalesSales4 Cash 1,900

Balance c/d 2,750 5 L D Vinci 8502,750 2,750

Balance c/d 2,750

Cost of goods soldCost of goods soldCost of goods soldCost of goods sold4 Inventory 1,0005 Inventory 500 Balance c/d 1,500

1,500 1,500Balance b/d 1,500

V V GoghV V GoghV V GoghV V Gogh8 Cash 750 3 Inventory 1,500Balance c/d 750

1,500 1,500Balance c/d 750



L D VinciL D VinciL D VinciL D Vinci5 Sales 850 9 Cash 850

850 850

ElectricityElectricityElectricityElectricity7 Cash 250 Balance c/d 250

250 250Balance b/d 250

RentRentRentRent6 Rent 1,000 Balance c/d 1,000

1,000 1,000Balance b/d 1,000

RepairsRepairsRepairsRepairs11 Repair company 300 Balance c/d 300


Repair companyRepair companyRepair companyRepair companyBalance c/d 300 11 Repairs 300


ComputerComputerComputerComputer12 Computer 750 Balance c/d 750


DrawingsDrawingsDrawingsDrawings10 Cash 500 Balance c/d 500




Trial balance

Account Dr CrCash 4,500 AssetCapital 6,000 LiabilityInventory 1,000 AssetSales 2,750 IncomeCost of goods sold 1,500 ExpenseV V Gogh 750 LiabilityL D Vinci – –Electricity 250 ExpenseRent 1,000 ExpenseRepairs 300 ExpenseRepair company 300 LiabilityComputer 750 AssetDrawings 500 Reduction in a liability

9,800 9,800

Chapter 3

Example 1

Sales tax is charged at 20%. In a period a business makes cash sales of $6,000 (net) on which sales tax is $1,200 and $7,200 is the gross amount.

In the same period cash purchases of $2,000 (net) were made on which sales tax was $400 and $2,400 is the gross amount.

At the end of the period the appropriate amount of tax was paid to the government.

Write up the following accounts:

SalesSalesSalesSalesCash 6,000

PurchasesPurchasesPurchasesPurchasesCash 2,000



Sales tax accountSales tax accountSales tax accountSales tax accountCash 400 Cash 1,200Cash (to government) 800

1,200 1,200

Sales tax accountSales tax accountSales tax accountSales tax accountCash from sales and tax 7,200 Cash for purchases and tax 2,400

To government 800

Chapter 4Example 1Dr(Receipts) Cash BookCash BookCash Book Cr

(Payments)

Balance b/d 31 July 2013Balance b/d 31 July 2013 200

4 Receipt not recorded4 Receipt not recorded 40 3 Undercast correction 70

5 Bank charges not recorded 31

6 Bounced cheque 50

Balance c/d 31 July 2013 89

240 240

Balance b/d 1 August 2013Balance b/d 1 August 2013 89

Bank statementBank statementOpening balance 339Less: 1 cheques in cash book not yet on bank statement (500)Add: 2 amount paid in but not yet on bank statement 250

Up-to-date balance 89



Example 2

The sum of the balances in the receivables ledger amounted to $23,456.

The receivables control account balance was $23,742.

Investigation showed that:

๏ A debit balance of $250 had been omitted from the list of balances

๏ A receivables ledger column in the cash book that totalled $4,995 was posted as $4,959 to the receivables ledger.

List of balances $ Initial list of balances 23,456Balance omitted 250Correct list of balances 23,706

$4,959 was credited to the receivables account; $4,995 should have been credited. Therefore $4,995 - $4,959 = $36 needs to be credited to correct the error

Receivables ledger control accountReceivables ledger control accountReceivables ledger control accountReceivables ledger control accountBal b/d 23,742 Error in posting from cash book 36

Bal c/d 23,706

Example 3

Journal number Dr CrDr Repairs 350 Cr Machinery cost account 350Being the correction of the treatment of a repair invoice as an addition to machinery

350 350

Authorised by

Example 4

Journal number Dr CrDr Sales 1789 Cr XYZ Ltd 1789Being the correction of an amount treated as a new sale but which was the settlement off a debt.

1789 1789

Authorised by



Chapter 5

Example 1

Working $Initial amount of receivables 125,000Written off (6,000)

119,000Allowances – specific 12,000 – general 4% x (119,000 – 12,000) 4,280

(16,280)

102,720

Working $Initial amount of receivables 125,000Written off (6,000)

119,000Allowances – specific 12,000

- general 4% x (119,000 – 12,000) 4,280(16,280)102,720

Allowance for Irrecoverable Debts AccountAllowance for Irrecoverable Debts AccountAllowance for Irrecoverable Debts AccountAllowance for Irrecoverable Debts AccountBalance carried down

16,280

Allowance for irrecoverable debts – debit to the Allowance for Irrecoverable debts expense account 16,280

16,280 16,280Balance brought down 16,280

Irrecoverable Debts Expense AccountIrrecoverable Debts Expense AccountIrrecoverable Debts Expense AccountIrrecoverable Debts Expense AccountDebts written off 6,000Allowance for irrecoverable debts 16,280 To income statement at period

end [an expense]22,280

22,280 22,280

On the statement of financial position, receivables will be shown as $102,720, the figure after any write-offs and after netting-off the allowance. The allowance is not disclosed separately.



Example 2

Total receivables accountTotal receivables accountTotal receivables accountTotal receivables accountBalance b/d

140,000Irrecoverable Debts Expense Account 10,000Balance carried down 130,000

140,000 140,000

Working: after the write-off, the total allowance needed is: $15,000 + ($140,000 – 10,000 – 15,000) x 5% = $20,750

Allowance for Irrecoverable Debts AccountAllowance for Irrecoverable Debts AccountAllowance for Irrecoverable Debts AccountAllowance for Irrecoverable Debts AccountBalance brought down 16,280

Balance carried down 20,750 Amount needed to increase the allowance – DR the expense account

4,470


Irrecoverable Debts Expense AccountIrrecoverable Debts Expense AccountIrrecoverable Debts Expense AccountIrrecoverable Debts Expense AccountWritten off 10,000Increase in allowance 4,470 To Income Statement [an expense] 14,470


Chapter 6Example 1

Income statement for the month of January 2014Income statement for the month of January 2014Income statement for the month of January 2014Basis of calculation $

Sales Sales made, not just cash collected 5,000

Purchases/cost of sales Purchases made, not just what was paid for (3,000)

Gross profit 2,000

Rent For the month of January $3,600/3The remaining $2,400 is known as a prepayment

(1,200)

Electricity For the month of January $660/3$220 is known as an accrual

(220)

Net profit 580



The prepayment (or payment in advance) of $2,400 is an asset: an amount has been paid to the landlord for which the business has not yet enjoyed any benefit. It’s as though the landlord owes the business this money. Prepayments are often grouped with receivables.

The accrual of $220 is a liability: the business has used electricity for which it hasn’t yet paid. Accruals are often grouped with payables.

Example 2

As at 31/12/2013 a company has an accrual for heating costs of $850.

Payments during the year to 31/12/2014 are as follows:





Heating costs for the month of December are estimated to be $975.

Write up the heating account from 1/1/2014 to 31/12/2014 showing accruals and the amount to be posted to the income statement for the year to 31/12/2014.

Heating AccountHeating AccountHeating AccountHeating Account12/3/2014 Cash 2,400 1/12/2014 balance b/d 85011/6/2014 Cash 1,80015/9/2014 Cash 1,500 To income statement y/e/

31/12/20147,425

8/12/2014 Cash 1,600Balance c/d 31/12/2014 975

8,275 8,275Bal b/d 1/1/2015 975

The amount taken to the income statement is equivalent to the sum of the four payments made in the year (2,400 + 1,800 + 1,500 + 1,600 = 7,300) less $850, the amount of these payments estimated to relate to 31/12/2013, plus $975, the amount for December 2014 that is not reflected in the payments.



Chapter 7

Example 1






Note:

Available units for sale = 2,000 (opening) + 8,000 (purchased) = 10,000.

Of these, the 2,300 units in closing inventory were not sold, so 10,000 – 2,300 = 7,700 units must have been sold.

Income statementIncome statementIncome statementIncome statementIncome statementUnits $/unit $ $

Sales 7,700 9 69,300Opening inventory 2,000 5 10,000Purchased 8,000 5 40,000

10,000 50,000Closing inventory (2,300) 5 (11,500)

Cost of sales ie cost of units sold 7,700 5 38,500

Gross profit 30,800Expenses (3,700)Net profit 27,100

Example 2

Date Units Unit price1 April Opening inventory 1,000 5.005 April Purchased 500 6.009 April Sold 200 N/a14 April Purchased 600 5.5021 April Sold 1,200 N/a

FIFO

Sale of 200 on 9 April: assumed to be units from opening inventory: 200 @ $5 = $1,000

Sale of 1,200 on 21 April: assumed to be the 800 remaining from opening stock plus 400 from the purchase on 5 April: 800 @ $5 + 400 @ $6 = $6,400



Closing inventory will be all the 600 purchased on 14 April plus 100 left from the 5 April purchase = 600 @ $5.50 + 100 @ $6.00 = 3,900.

Cumulative weighted average

Date Units Unit price

Cumulative weighted

average

1 April Opening inventory 1,000 5.00 5,000

5 April Purchased 500 6.00 3,000

1,500 @5.333 [8.000/1,500 = 5.3333] 8,000

9 April Sold (200) @5.333 (1,067)

1,300 @5.333 6,933

14 April Purchased 600 5.50 3,300

1,900 @5.386 10,233

21 April Sold (1,200) @5.386 (6,463)

Closing stock 700 @5.386 3,770

Cost of sales = $1,067 + $6,463 = 7,530


Periodic weighted average

Value of purchases plus opening stock = $5,000 + $3,000 + $3,300 = $11,300

Units purchased plus in opening stock = 1,000 + 500 + 600 = 2,100

Periodic average = 11,300/2,100 = 5.381

Cost of sales = (200 + 1,200) x 5.381 = 7,533

Value of inventory = 700 x 5.381 = 3,767



Example 3

Valuation of the inventory items shown below:

Product Number

Number of units

Purchase price of

goods/unit

Carriage inwards/

unit (delivery

cost paid by purchaser)

Selling price of

goods/unit

Costs of packing

and delivering

goods/unit (carriage

outwards)

Inventory valuation

for the financial

statements

Basis

$ $ $ $ $

1435 400 10 1.00 20.00 2 4,400 Cost10 + 1 = 11

1567 120 20 2.00 15.00 2 1,560NRV

15 – 2 = 13

1577 300 15 1.00 18.00 3 4,500 NRV 18 – 3 = 15

1601 200 20 2.00 40.00 2 4,400Cost

20+2 = 22

1733 150 30 2.00 10.00 1 1,350NRV

10 – 1 = 9

Chapter 8

Example 1

Straight line

Cost = $24,000; scrap (residual) value at end of life $4,000;

estimated useful life = 5 years.

($24,000 - $4,000)/5 = $4,000 per year

Year Accumulated depreciation Net book value

1 4,000 20,000

2 8,000 16,000

3 12,000 12,000

4 16,000 8,000

5 20,000 4,000



Example 2

Reducing balance method

Cost = $24,000; scrap (residual) value at end of life $4,000;

estimated useful life = 5 years.

Year Cost/written down value

Accumulated depreciation

24,000

1 25% charge 6,000 6,000

18,000

2 25% charge 4,500 10,500

13,500

3 25% charge 3,375 13,875

10,125

Etc...

This method never gets to zero

Example 3

Machine Cost AccountMachine Cost AccountMachine Cost AccountMachine Cost Account1/7/2013 Cash/creditor 26,000 31/12/2013 Bal c/d 26,0001/1/2014 Bal b/d 26,000 31/12/2014 Bal c/d 26,0001/1/2015 Bal b/d 26,000 31/12/2015 Bal c/d 26,0001/1/2016 Bal b/d 26,000 31/12/2016 Bal c/d 26,000

Machine Accumulated Depreciation AccountMachine Accumulated Depreciation AccountMachine Accumulated Depreciation AccountMachine Accumulated Depreciation Account31/12/2013 Bal c/d 5,000 31/12/2013 Depreciation expense 5,000

1/1/2014 Balance b/d 5,00031/12/2014 Bal c/d 10,000 31/12/2014 Depreciation expense 5,000

10,000 10,0001/1/2015 Balance b/d 10,000

31/12/2015 Bal c/d 15,000 31/12/2015 Depreciation expense 5,000

15,000 15,0001/1/2016 Balance b/d 15,000

31/12/2016 Bal c/d 20,000 31/12/2016 Depreciation expense 5,000

12,000 20,000



Machine Depreciation Expense AccountMachine Depreciation Expense AccountMachine Depreciation Expense AccountMachine Depreciation Expense Account31/12/2013 Accumulated depreciation account 5,000

Income statement period ended 31/12/2013 5,000

31/12/2014 Accumulated depreciation account 5,000






Example 4

Write up the above transactions in the following accounts:

Machine Cost AccountMachine Cost AccountMachine Cost AccountMachine Cost AccountBal b/d 25,000 To disposals account 25,000Trade-in value: Cr to disposals account 13,000Cash 22,000 Bal c/d 35,000

60,000 60,000

Machine Accumulated Depreciation AccountMachine Accumulated Depreciation AccountMachine Accumulated Depreciation AccountMachine Accumulated Depreciation AccountTo disposals account 15,000 Bal b/d 15,000

Machine Disposals AccountMachine Disposals AccountMachine Disposals AccountMachine Disposals AccountMachine Cost account 25,000 From accumulated depreciation

account15,000

Profit on disposal (balancing figure)3,000

Trade-in value: Dr to Machine cost account

13,000

28,000 28.000



Chapter 9

Example 1

Balance Dr CR Type of account

Cash (in credit at the bank) 8,175 8,175 AssetPetty cash 24 24 AssetSales 123,758 123,758 IncomePurchases 84,758 84,758 ExpenseWages 15,893 15,893 ExpenseEquipment 38,600 38,600 AssetRent 3,340 3,340 ExpenseElectricity 254 254 ExpenseReceivables 10,392 10,392 AssetPayables 5,678 5,678 LiabilityBank loan 12,000 12,000 LiabilityCapital 20,000 20,000 Liability to owners

161,436 161436

Example 2

Journal number Dr CrDr Purchases 90 Cr Payables control account 90Being the correction of under cast purchases day bookAuthorised by

Journal number Dr CrDr Rent 350 Cr Receivables control account 350Being the correction of a rental paymentAuthorised by



Example 3


Cash 6,700 6,700Equipment 1,800 1,800Capital 10,000 10,000Inventory 2,500 2,500Suppliers – 2,700 – 2,700Customers 4,000 200 4,200Sales 8,000 200 8,200Cost of goods sold 2,500 2,500Rent 100 400 500Wages 2,456 400 2,056Suspense account 644 644Total 20,700 20,700 20,900 20,900

Example 4




Income statement

Income statement




Cash 6,700 6,700

Petty cash 44 44

Equipment 1,800 1,800

Capital 10,000 10,000

Inventory 2,500 2,500

Suppliers – 2,700 400 3,100

Customers 4,740 4,740

Sales 8,170 8,170

Disc allowed 30 30

Cost of goods sold 2,500 2,500

Rent 500 100 400

Wages 2,056 600 2,656

Depreciation expense 500 500

Accumulated depreciation 500 500

Irrecoverable debts expense

400 400

Electricity 200 200

Accruals 800

Prepayment 100

Profit 1,484 1,484

Total 20,870 20,870 900 900 800 100 8,170 15,884 15,884



Income statement for the period

$Sales 8,170Cost of sales 2,500

Gross profit 5,670Expenses: Discounts allowed 30 Rent 400 Wages 2,656 Depreciation 500 Irrecoverable debts 400 Electricity 200

4,186Net profit 1,484

Statement of financial position at the end of the period

$Equipment cost 1,800Accumulated depreciation 500

Net book value 1,300

Current assets Inventory 2,500 Receivables (inc prepayment) 4,840

Cash 6,74414,08415,384

Capital brought forward 10,000Profit for the year 1,484

Capital carried forward 11,484

Current liabilities (including accruals) 3,90015,384



Chapter 10

Example 1


$28,000 was paid to suppliers during the period. There were no cash purchases.

Opening inventory was $7,000 but there is no figure available for closing inventory.


$40,000 was received from debtors during the period. There were no cash sales.


Prepare a trading account showing sales, opening and closing inventories, purchases, cost of sales and gross profit.

Payables Ledger Control AccountPayables Ledger Control AccountPayables Ledger Control AccountPayables Ledger Control AccountPayments to suppliers 28,000 Balance brought forward 5,000Balance c/f 6,000 Credit purchases (balancing figure) 29,000

34,000 34,000Balance brought forward 6,000

Receivables Ledger Control AccountReceivables Ledger Control AccountReceivables Ledger Control AccountReceivables Ledger Control AccountBalance brought forward 10,000 Receipts from debtors 40,000Credit sales (balancing figure) 38,000 Balance c/f 8,000


Cost structure:


60 40 100

38,000 (from Receivables ledger control account)

Profit = 38,000 x 40/100 = $15,200

Cost of sales = $38,000 - $15,200 = $22,800

Cost of sales = opening inventory + purchases – closing inventory

22,800 = $7,000 + 29,000 – closing inventory

Closing inventory = $29,000 + $7,000 - $22,800 = $13,200



Trading account:

$ $Sales 38,000Opening inventory 7,000Purchases 29,000Less: closing inventory (13,200)

Cost of sales (22,800)

Gross profit 15,200

Example 2



A file of purchases invoices added up to $45,000. All purchases were on credit.

Opening inventory was $9,000 and closing inventory $10,000


A file of copy invoices issued in the period added up to $55,000.

Cash sales were also made, but no record was kept of them or of the owner’s drawings.

$100 was paid in cash each week for casual labour. Other expense amounts paid from the bank account amount to $13,000, and $2,300 was spent on a new computer.

The trader is operating in a business where the typical mark-up is 50%

Opening cash was $100 as cash and £12,000 in the bank; closing balances were $80 as cash and $10,500 in the bank

Prepare a trading account showing sales, opening and closing inventories, purchases, cost of sales and gross profit, net profit and drawings.

Payables Ledger Control AccountPayables Ledger Control AccountPayables Ledger Control AccountPayables Ledger Control AccountPayments to suppliers (balancing figure) 43,000 Balance brought forward 5,000Balance c/f 7,000 Credit purchases 45,000


Receivables Ledger Control AccountReceivables Ledger Control AccountReceivables Ledger Control AccountReceivables Ledger Control AccountBalance brought forward 10,000 Receipts from debtors (balancing figure) 57,000Credit sales 55,000 Balance c/f 8,000




CashCashCashCash

Balances brought forward 10012,000

Payments to suppliers 43,000

From credit customers 57,000 Casual labour 5,200

From cash sales ? Other expenses 13,000

` New computer 2,300

Drawings ?

Balances c/f 80 10,500

? ?


A figure is missing on each side of the cash book.

Using the mark-up, it should be possible to estimate total sales as follows:

Cost structure:


100 50 150

Cost of sales = Opening stock + Purchases –- Closing stock = 9,000 + 45,000 – 10,000 = 44,000

Therefore, total sales = 44,000 x 150/100 = $66,000

Credit sales = $55,000

Therefore, cash sales = 66,000 – 55,000 = 11,000



CashCashCashCash


Payments to suppliers 43,000

From credit customers 57,000 Casual labour 5,200

From cash sales 11,000 Other expenses 13,000

` New computer 2,300

Drawings (Balance) 6,020

Balances c/f 80 10,500

80,100 80,100


Trading and profit and loss account:

$ $Sales 66,000Opening inventory 9,000Purchases 45,000Less: closing inventory (10,000)

Cost of sales (44,000)

Gross profit 22,000Labour 5200Other expenses 13,000

(18,200)Net profit 3,800

Note: Purchase of the computer and the drawings are not expenses



Example 3


Statement of financial position 31/12/2013:

$ $Non-current assets 45,000Current assets: Inventory 14,000 Receivables 9,000 Cash 1,200.00

24,20069,200

Owner’s capital 59,200Bank loan 8,000Trade creditors 2,000

69,200

During the year ended 31/12/2014:

(a) The owner estimates that drawings of $2,000 per month were taken.

(b) The bank loan has decreased to $5,000

(c) New non-current assets were bought for $20,000 and a depreciation charge of 20% was made on all non-current assets.

(d) Closing balances: inventory = $12,000; receivables = $10,000; cash = $2,000; trade creditors =$3,000.

Opening net assets = 45,000 + 24,200 – 8,000 – 2,000 = 59,200 [Owner’s capital]

Closing net assets = (45,000 + 20,000) x 80% + 12,000 + 10,000 + 2,000 – 3,000 – 5,000 =$68,000

Increase in net assets = 68,000 – 59,200 = $8,800

Drawings = 12 x 2,000 = 24,000

Therefore, as we know:

Increase in net assets over a period = Capital introduced – Drawings + Profits

$8,800 = Nil – $24,000 + Profits

Profits = $8,800 + $24,000 = $32,800



Chapter 11

Example 1


Partner A receives a salary of £30,000 and interest on capital account of 10% pa

Partner B receives a salary of $20,000 and interest on capital account of 10% pa

Capital accounts: Partner A = $200,000; Partner B = £120,000

Profit sharing ratio 3:2

$ $ $Partner A Partner B Profit 118,000

Salary 30,000 20,000 (50,000)Interest on capital 20,000 12,000 (32,000)

Residual profits 36,000Profit sharing ratio 3:2 21,600 14,400 (36,000)

Final appropriations 71,600 46,400

Note: the final appropriations of $71,600 and $46,400 add up to $118,000, the initial profits.

Example 2


Partner A receives a salary of £35,000 and interest on capital account of 8% pa

Partner B receives a salary of $25,000 and interest on capital account of 8% pa

Capital accounts: Partner A = $100,000; Partner B = £80,000

Profit sharing ratio = 1:1

$ $ $Partner A Partner B Profit 40,000

Salary 35,000 25,000 (60,000)Interest on capital 8,000 6,400 (14,400)

Residual loss (34,400)Profit sharing ratio 3:2 (17,200) (17,200) 34,400

Final appropriations 25,800 14,200

Note: the final appropriations of $25,800 and $14,200 add up to $40,000 the initial profits.



Example 3

Partners A and B share profits and losses in the ratio A: B, 2:3

They decide to admit Partner C, and they will then share profits in the ratio A:B:C, 3:4:1

Goodwill has been agreed as $160,000.

Show the goodwill entries in the partners’ capital accounts.


APartner

BPartner

CPartner

APartner

BPartner

CCredit in the old 2:3 64,000 96,000

Debit in the new3:4:1 60,000 80,000 20,000


Documents

FIA FA2 2019opentuition.com/files/securepdfs/2019/01/FIA-FA2-2019.pdfFIA FA2 Financial Records Please spread the word about OpenTuition, so that all ACCA students can bene!t. ONLY