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  ACCOUNTING	
  CYCLE	
  
	
  
	
  
The	
  Accounting	
  Cycle	
  is	
  a	
  series	
  of	
  steps,	
  which	
  are	
  repeated	
  every	
  reporting	
  period.	
  
The	
  process	
  starts	
  with	
  making	
  accounting	
  entries	
  for	
  each	
  transaction	
  and	
  goes	
  
through	
  closing	
  the	
  books.	
  This	
  Involves	
  recording	
  transactions	
  in	
  the	
  daybooks,	
  
posting	
  them	
  to	
  ledger,	
  extracting	
  a	
  trial	
  balance	
  and	
  finally	
  drawing	
  up	
  financial	
  
statements.	
  
	
  
Step	
  1:	
  	
  Recording	
  Transactions	
  in	
  Daybooks	
  
	
  
Each	
  transaction	
  is	
  recorded	
  first	
  in	
  one	
  of	
  the	
  following	
  daybook	
  (	
  book	
  of	
  original	
  
entry)	
  according	
  to	
  the	
  nature	
  of	
  the	
  transaction.	
  
	
  
1.	
  All	
  goods	
  sold	
  on	
  Credit	
  (	
  Credit	
  Sales)	
  	
  	
  	
  	
  ….>	
  Sales	
  Daybook	
  
2.	
  All	
  goods	
  purchased	
  on	
  Credit	
  (Credit	
  Purchases)	
  ….>	
  Purchases	
  Daybook	
  
3.	
  All	
  goods	
  sold	
  on	
  credit	
  but	
  now	
  returned	
  by	
  costumers	
  ..>	
  Sales	
  Return	
  (Inwards)	
  
Daybook	
  
4.	
  All	
  goods	
  purchased	
  on	
  credit	
  but	
  now	
  returned	
  to	
  suppliers…>	
  Purchases	
  Return	
  
Daybook	
  
	
  
The	
  above	
  four	
  daybooks	
  only	
  record	
  credit	
  transactions	
  related	
  to	
  movement	
  in	
  
inventory.	
  There	
  are	
  no	
  accounts	
  maintained	
  inside	
  the	
  daybooks.	
  It	
  Just	
  contains	
  
Date,	
  Name,	
  Source	
  document	
  number	
  and	
  Amount.	
  
	
  
5.	
  All	
  transactions	
  which	
  relate	
  to	
  receipts	
  and	
  payments	
  through	
  cash	
  or	
  cheque	
  ..>	
  
Cashbook	
  
	
  
Cash	
  and	
  Bank	
  accounts	
  are	
  made	
  inside	
  the	
  cashbook	
  hence	
  it	
  also	
  serves	
  the	
  
purpose	
  of	
  ledger.	
  
	
  
6.	
  All	
  other	
  transactions	
  …..>	
  General	
  Journal	
  
	
  
	
  	
  	
  In	
  this	
  we	
  actually	
  write	
  the	
  double	
  entry	
  of	
  only	
  those	
  transactions	
  which	
  cannot	
  be	
  
recorded	
  in	
  the	
  above	
  five	
  daybooks.	
  To	
  name	
  a	
  few	
  
-­‐ Non	
  Current	
  Assets	
  Purchased	
  or	
  Sold	
  on	
  Credit	
  
-­‐ Writing	
  off	
  Bad	
  debts	
  
-­‐ Entries	
  for	
  Provisions	
  of	
  doubtful	
  debts	
  and	
  depreciation	
  
-­‐ Adjustments	
  for	
  Prepaid	
  and	
  Owings	
  
-­‐ Correction	
  of	
  Errors	
  
	
  
 
	
  
	
  
	
  
Step	
  2:	
  Posting	
  Transactions	
  In	
  Ledgers	
  
	
  
A	
  ledger	
  is	
  a	
  book	
  which	
  contains	
  accounts	
  (	
  the	
  actual	
  T	
  Accounts	
  guys).	
  There	
  are	
  three	
  
types	
  of	
  Ledgers.	
  In	
  each	
  type	
  we	
  have	
  different	
  type	
  of	
  accounts.	
  
	
  
Advantages	
  Of	
  Dividing	
  The	
  Ledger:	
  
1. It	
  facilitates	
  division	
  of	
  labour	
  in	
  the	
  maintenance	
  of	
  ledger.	
  	
  
2. It	
  becomes	
  easy	
  to	
  locate	
  errors	
  in	
  ledger	
  accounts.	
  	
  
3. It	
  helps	
  the	
  ledger	
  clerks	
  to	
  complete	
  their	
  respective	
  work	
  in	
  time	
  with	
  	
  perfection.	
  	
  
4. It	
  becomes	
  easy	
  to	
  refer	
  to	
  any	
  particular	
  account.	
  	
  
	
  
	
  
Sales	
  Ledger:	
  This	
  contains	
  accounts	
  of	
  credit	
  costumers	
  (	
  people	
  to	
  who	
  we	
  sell	
  goods	
  on	
  
credit)	
  –	
  Trader	
  Receivables	
  	
  
	
  
	
  At	
  the	
  end	
  of	
  the	
  year	
  all	
  the	
  account	
  balances	
  in	
  the	
  sales	
  ledger	
  are	
  listed	
  in	
  a	
  schedule	
  
which	
  is	
  called	
  list	
  of	
  Trade	
  receivables.	
  This	
  shows	
  the	
  individual	
  account	
  balances(	
  
closing)	
  and	
  also	
  the	
  total	
  debtors	
  which	
  goes	
  into	
  the	
  trail	
  balance.	
  
	
  
	
  	
  Purchase	
  Ledger:	
  This	
  contains	
  accounts	
  of	
  credit	
  suppliers	
  (	
  people	
  from	
  whom	
  we	
  buy	
  
goods	
  on	
  credit)	
  –	
  Trader	
  Payables	
  
	
  
At	
  the	
  end	
  of	
  the	
  year	
  all	
  the	
  account	
  balances	
  in	
  the	
  purchase	
  ledger	
  are	
  listed	
  in	
  a	
  schedule	
  
which	
  is	
  called	
  list	
  of	
  Trade	
  Payables.	
  This	
  shows	
  the	
  individual	
  account	
  balances(	
  closing)	
  
and	
  also	
  the	
  total	
  creditors	
  which	
  goes	
  into	
  the	
  trail	
  balance.	
  
	
  
	
  	
  
General	
  Ledger:	
  This	
  contains	
  all	
  the	
  other	
  accounts.	
  Like	
  all	
  expenses	
  ,incomes	
  ,provisions	
  
(literally	
  all	
  other	
  accounts)	
  
	
  
Please	
  remember	
  Sales	
  and	
  Purchases	
  accounts	
  are	
  in	
  the	
  General	
  Ledger	
  cause	
  they	
  are	
  not	
  
our	
  costumers	
  or	
  suppliers	
  .	
  	
  
	
  
Once	
  all	
  the	
  transactions	
  are	
  posted	
  all	
  the	
  accounts	
  are	
  balanced	
  via	
  inserting	
  a	
  balance	
  C/d	
  
in	
  all	
  accounts.	
  
 
Step	
  3	
  :	
  Extracting	
  a	
  Trial	
  Balance	
  
	
  
All	
  the	
  closing	
  balances	
  in	
  the	
  General	
  Ledger	
  along	
  with	
  the	
  figure	
  of	
  total	
  trade	
  receivables	
  
and	
  payables	
  are	
  listed	
  in	
  a	
  trail	
  balance.	
  Debit	
  balances	
  and	
  Credit	
  Balances	
  are	
  listed	
  
separately	
  side	
  by	
  side.	
  The	
  Sum	
  of	
  all	
  Debits	
  should	
  be	
  equal	
  to	
  sum	
  of	
  all	
  credit	
  balances.	
  
The	
  trail	
  balances	
  is	
  used	
  to	
  check	
  the	
  completion	
  of	
  the	
  double	
  entry.	
  The	
  trail	
  balance	
  will	
  
balance	
  because	
  	
  
-­‐ For	
  each	
  debit	
  entry	
  there	
  is	
  a	
  credit	
  entry	
  (	
  vice	
  versa)	
  
-­‐ The	
  sum	
  of	
  all	
  debit	
  entries	
  is	
  equal	
  to	
  the	
  sum	
  of	
  credit	
  entries	
  	
  
	
  
	
  
	
  
	
  
Step	
  4:	
  Closing	
  Entries	
  with	
  Year	
  end	
  Adjustments	
  (	
  Details	
  in	
  following	
  pages)	
  
	
  
After	
  making	
  the	
  trail	
  balance	
  we	
  also	
  have	
  to	
  adjust	
  for	
  certain	
  items.	
  Remember	
  only	
  
Incomes	
  and	
  Expenses	
  are	
  taken	
  into	
  account	
  while	
  calculating	
  profit.	
  These	
  accounts	
  are	
  
closed	
  by	
  transferring	
  them	
  to	
  the	
  income	
  statement	
  (	
  the	
  Profit	
  and	
  Loss	
  Account).	
  This	
  
process	
  is	
  called	
  Closing	
  Entries.	
  
Some	
  common	
  adjustments	
  are	
  
-­‐ Expenses	
  and	
  Incomes	
  are	
  adjusted	
  for	
  prepaid	
  (advance)	
  and	
  accruals(Owings)	
  
-­‐ Non	
  Current	
  Assets	
  are	
  depreciated	
  	
  
-­‐ Provision	
  for	
  doubtful	
  debt	
  is	
  adjusted	
  
-­‐ Closing	
  inventory	
  is	
  valued	
  by	
  physical	
  stock	
  take	
  and	
  it	
  is	
  adjusted	
  in	
  
calculating	
  cost	
  of	
  goods	
  sold	
  and	
  also	
  for	
  Balance	
  Sheet	
  
-­‐ Adjustments	
  for	
  goods	
  withdrawn	
  by	
  owner	
  or	
  Stock	
  Losses	
  
	
  
Step	
  5	
  :	
  Final	
  Accounts:	
  
An	
  income	
  statement	
  	
  (	
  Trading	
  Account	
  till	
  Gross	
  Profit	
  and	
  Profit	
  and	
  Loss	
  Account	
  tiill	
  Net	
  
Profit)	
  and	
  Balance	
  Sheet	
  is	
  drawn	
  which	
  ends	
  the	
  Accounting	
  Cycle.	
  Now	
  by	
  looking	
  at	
  
Income	
  Statement	
  owner	
  can	
  check	
  his	
  Profit	
  and	
  by	
  looking	
  at	
  the	
  Balance	
  Sheet	
  he	
  can	
  
check	
  his	
  Net	
  worth	
  of	
  the	
  Business.	
  
	
  
BUSINESS	
  DOCUMENTS	
  	
  
1.	
  Invoice:	
  Whenever	
  there	
  is	
  a	
  credit	
  sale,	
  the	
  selling	
  business	
  will	
  send	
  a	
  document	
  to	
  
buyer	
  showing	
  full	
  details	
  of	
  the	
  goods	
  sold.	
  This	
  document	
  is	
  called	
  as	
  Invoice.	
  It	
  is	
  known	
  
to	
  the	
  buyer	
  as	
  a	
  “Purchases	
  invoice”.	
  And	
  to	
  the	
  seller	
  as	
  a	
  “Sales	
  invoice”.	
  
Note:	
  Entries	
  in	
  the	
  sales	
  book	
  and	
  the	
  purchases	
  Book	
  are	
  made	
  with	
  the	
  help	
  of	
  an	
  
invoice.	
  
 
	
  	
  	
  2.	
  Debit	
  Note:	
  This	
  document	
  is	
  prepared	
  by	
  the	
  purchaser	
  and	
  it	
  is	
  sent	
  to	
  the	
  
supplier	
  to	
  report	
  him	
  if	
  any	
  faulty	
  goods	
  are	
  been	
  sent	
  or	
  shortages	
  or	
  overcharges	
  are	
  
been	
  made.	
  
3.	
  Credit	
  Note:	
  When	
  goods	
  are	
  returned,	
  or	
  there	
  has	
  been	
  an	
  over-­‐charge,	
  a	
  supplier	
  may	
  
issue	
  a	
  credit	
  note	
  to	
  the	
  buyer.	
  This	
  reduces	
  the	
  amount	
  owed	
  by	
  the	
  customer.	
  Note:	
  This	
  
document	
  is	
  used	
  to	
  make	
  the	
  entries	
  in	
  both	
  the	
  purchases	
  returns	
  Book	
  and	
  the	
  sales	
  
returns	
  Book.	
  
4.	
  Statement	
  of	
  Account:	
  This	
  document	
  is	
  prepared	
  and	
  sent	
  to	
  the	
  customer	
  by	
  the	
  
supplier.	
  It	
  is	
  issued	
  to	
  remind	
  the	
  customer	
  about	
  his	
  due	
  amount.	
  It	
  is	
  basically	
  a	
  
summary	
  of	
  the	
  transaction	
  of	
  a	
  customer	
  during	
  the	
  month	
  like	
  sales	
  made,	
  Returns	
  
received	
  and	
  Cash	
  received	
  
	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  DISCOUNTS	
  
1. Trade Discount: It is an allowance or deduction given by the supplier to the retailer on the
catalogue price or list price.
It is given to encourage him to buy in bulk.
It is given so that retailer could make some profit.
Note: It is not recorded in the books either by the seller or the buyer.
2. Cash Discount: It is an allowance or deduction given by the receiver of cash to the payer of
cash for prompt payment. It is of two types discount allowed and discount received.
i. It is given to encourage the payer to pay on or before the due date.
ii. Note: This discount is recorded in the Cash Book. Discount allowed is recorded at the debit
side and discount received on the credit side.
iii. Note: Discount columns are never balanced. It is just totalled.
	
  
	
  
	
  
	
  
	
  
	
  
	
  
	
  
	
  	
  	
  
 	
  ADJUSTMENTS	
  IN	
  DETAIL	
  
	
  
BAD	
  DEBTS	
  AND	
  PROVISION	
  FOR	
  DOUBTFUL(BAD)	
  DEBTS	
  
	
  
What	
  is	
  a	
  bad	
  debt?	
  
	
  
When	
  a	
  costumer	
  to	
  whom	
  goods	
  were	
  sold	
  on	
  credit	
  basis,	
  is	
  unable	
  to	
  pay	
  his	
  debt	
  then	
  it	
  
results	
  into	
  an	
  expense	
  for	
  the	
  business.	
  Selling	
  goods	
  on	
  credit	
  basis	
  involves	
  this	
  risk	
  of	
  
bad	
  debt.	
  Any	
  amount	
  of	
  debt	
  which	
  becomes	
  irrecoverable	
  should	
  be	
  written	
  off	
  as	
  bad	
  
debt.	
  
	
  
	
  	
  	
  	
  	
  Debit:	
  Bad	
  Debts	
  
	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  Credit	
  :	
  Person	
  Who	
  is	
  Bad	
  :>/Trade	
  receivable	
  	
  
	
  
What	
  is	
  a	
  Provision	
  for	
  bad	
  debt?	
  
A	
  business	
  must	
  consider	
  that	
  some	
  costumers	
  might	
  not	
  pay	
  the	
  amount	
  owed	
  by	
  them;	
  
these	
  debts	
  are	
  considered	
  to	
  be	
  doubtful.	
  Since	
  the	
  business	
  does	
  not	
  know	
  the	
  exact	
  
amount	
  of	
  the	
  doubtful	
  debts(	
  and	
  also	
  which	
  costumer	
  might	
  not	
  pay),	
  an	
  estimate	
  for	
  such	
  
amount	
  is	
  kept	
  in	
  a	
  provision	
  for	
  doubtful	
  debt	
  account	
  (	
  this	
  account	
  is	
  not	
  an	
  expense	
  
account,	
  it’s	
  a	
  reduction	
  in	
  asset	
  from	
  the	
  balance	
  sheet).	
  Provision	
  is	
  created	
  to	
  reduce	
  
profit	
  now	
  for	
  an	
  expense	
  which	
  might	
  happen	
  in	
  future.	
  This	
  is	
  done	
  to	
  be	
  pessimistic	
  ,	
  in	
  
Accounting	
  we	
  call	
  this	
  being	
  prudent	
  or	
  the	
  Prudence	
  Concept.	
  
	
  
How	
  is	
  the	
  amount	
  of	
  provision	
  estimated?	
  (	
  Factors	
  effecting	
  it)	
  
	
  
-­‐ Age	
  of	
  Debts	
  (	
  Since	
  how	
  long	
  they	
  owe	
  us),	
  higher	
  the	
  age	
  more	
  likely	
  bad	
  debts	
  
(	
  so	
  high	
  provision	
  is	
  kept	
  If	
  majority	
  of	
  the	
  debts	
  are	
  owed	
  for	
  long)	
  
-­‐ Historical	
  percentage	
  of	
  actual	
  bad	
  debts	
  from	
  previous	
  years	
  
-­‐ Reputation	
  of	
  people	
  who	
  us	
  money	
  in	
  the	
  market	
  
-­‐ Nature	
  of	
  Business	
  
	
  
What	
  is	
  the	
  difference	
  between	
  accounting	
  treatment	
  of	
  Provision	
  for	
  doubtful	
  debts	
  and	
  the	
  
actual	
  Bad	
  debts?	
  
	
  
The	
  Journal	
  entry	
  for	
  provision:	
  
	
  
To	
  create	
  /	
  Increase	
  
	
  	
  	
  	
  	
  	
  	
  	
  	
  Debit	
  :	
  Profit	
  and	
  Loss	
  	
  
	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  Credit	
  :	
  Provision	
  for	
  doubtful	
  Debts	
  
	
  
To	
  Decrease	
  
	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  Debit	
  :	
  Provision	
  for	
  doubtful	
  debts	
  
	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  Credit	
  :	
  Profit	
  and	
  Loss	
  
 
The	
  difference	
  in	
  accounting	
  treatment	
  is	
  that	
  the	
  whole	
  of	
  bad	
  debt	
  is	
  treated	
  as	
  an	
  expense	
  
but	
  only	
  the	
  change	
  in	
  provision	
  is	
  treated	
  as	
  either	
  an	
  expense	
  (if	
  increasing)	
  or	
  an	
  income	
  (	
  
if	
  decreasing).	
  When	
  we	
  write	
  off	
  a	
  bad	
  debt,	
  we	
  remove	
  the	
  debtor	
  from	
  our	
  books	
  but	
  in	
  
case	
  of	
  a	
  provision	
  we	
  don’t	
  adjust	
  the	
  debtor	
  account	
  as	
  a	
  separate	
  account	
  is	
  maintained.	
  
	
  
	
  
	
  
	
  
ACCOUNTING	
  FOR	
  NON	
  CURRENT	
  ASSETS	
  
	
  
Whenever	
  we	
  spend	
  money	
  we	
  call	
  it	
  expenditure.	
  The	
  expenditure	
  can	
  be	
  divided	
  in	
  two	
  	
  
	
  
Capital	
  Expenditure	
  	
   Revenue	
  Expenditure	
  
Any	
  expenditure	
  incurred	
  on	
  buying	
  
new	
  non-­‐current	
  asset.	
  We	
  take	
  this	
  to	
  
balance	
  Sheet	
  
Any	
  day	
  to	
  day	
  expense	
  to	
  run	
  the	
  
business.	
  We	
  take	
  this	
  to	
  income	
  
statement	
  
Usually	
  one	
  off	
  (doesn’t	
  happen	
  on	
  
daily	
  basis)	
  
Its	
  recurring	
  in	
  nature	
  (	
  we	
  have	
  to	
  do	
  
it	
  again	
  and	
  again)	
  
Includes	
  initial	
  expenses	
  incurred	
  till	
  
we	
  start	
  using	
  the	
  asset	
  e.g.	
  
Installation,	
  delivery	
  charges	
  
Usually	
  occurs	
  after	
  we	
  start	
  using	
  the	
  
asset	
  
Increases	
  the	
  value	
  of	
  earning	
  
capability	
  of	
  the	
  asset	
  e.g.	
  Adding	
  a	
  
Safety	
  device	
  
Maintains	
  the	
  value	
  or	
  earning	
  
capability	
  of	
  the	
  asset.	
  E.g.	
  Repainting	
  
or	
  Repair	
  
	
  
In	
  the	
  same	
  way	
  we	
  can	
  have	
  Capital	
  receipts	
  and	
  Revenue	
  Receipts	
  .	
  
	
  
Capital	
  Receipts	
  would	
  include	
  money	
  received	
  from	
  capital	
  transactions	
  e.g.	
  	
  taking	
  a	
  bank	
  
loan	
  ,	
  selling	
  a	
  non	
  current	
  asset	
  or	
  additional	
  capital	
  introduced	
  by	
  the	
  owners	
  (	
  note	
  this	
  
money	
  coming	
  in	
  not	
  earned	
  by	
  the	
  business	
  from	
  profits)	
  	
  
Revenue	
  Receipts	
  are	
  incomes	
  generated	
  from	
  day	
  to	
  day	
  operations	
  of	
  a	
  business	
  (	
  taken	
  to	
  
income	
  statement)	
  e.g.	
  Sale	
  of	
  goods	
  ,	
  Interest	
  received	
  rent	
  received	
  	
  
	
  
	
  
If	
  these	
  expenditures	
  and	
  receipts	
  are	
  treated	
  in	
  the	
  wrong	
  way	
  then	
  both	
  income	
  statement	
  
and	
  balance	
  sheet	
  will	
  be	
  wrong.	
  
	
  
Depreciation	
  
	
  
This	
  is	
  an	
  expense	
  recorded	
  to	
  allocate	
  a	
  non	
  current	
  asset	
  cost	
  over	
  its	
  useful	
  life.	
  
Deprecation	
  is	
  used	
  in	
  accounting	
  to	
  try	
  to	
  match	
  the	
  expense	
  of	
  an	
  asset	
  to	
  the	
  income	
  that	
  
the	
  asset	
  helps	
  the	
  business	
  to	
  earn.	
  For	
  example	
  if	
  a	
  business	
  buys	
  a	
  piece	
  of	
  equipment	
  for	
  
$1	
  million	
  and	
  expects	
  to	
  use	
  it	
  over	
  a	
  life	
  of	
  10	
  years,	
  it	
  will	
  be	
  depreciated	
  over	
  10	
  years	
  .	
  	
  
Every	
  accounting	
  year,	
  the	
  company	
  will	
  expense	
  $100000	
  (assuming	
  straight	
  line	
  ,	
  which	
  
will	
  be	
  matched	
  with	
  the	
  money	
  that	
  the	
  equipment	
  helps	
  to	
  make	
  each	
  year.	
  	
  
	
  
The	
  Double	
  Entry	
  for	
  Depreciation	
  is	
  :	
  
	
  
	
  Debit	
  :	
  Profit	
  and	
  Loss	
  Account	
  (	
  Income	
  Statement)	
  
	
  	
  	
  	
  	
  	
  	
  	
  	
  Credit	
  :	
  Provision	
  for	
  Depreciation	
  	
  
	
  
Methods	
  of	
  Depreciation:	
  
	
  
1. Straight	
  Line	
  :	
  	
  
	
  	
  	
  	
  	
  	
  	
  	
  	
  An	
  equal	
  amount	
  of	
  deprecation	
  is	
  charged	
  every	
  year.	
  It	
  is	
  always	
  calculated	
  on	
  cost	
  .	
  In	
  
case	
  of	
  scrap	
  value	
  (residual	
  value)	
  	
  and	
  life	
  given	
  use	
  :	
  Cost	
  –Scrap/Life	
  	
  
	
  
2. Reducing	
  Balance	
  Method:	
  
In	
  this	
  deprecation	
  for	
  initial	
  years	
  in	
  always	
  higher	
  then	
  the	
  later	
  years.	
  It	
  is	
  simply	
  a	
  
percentage	
  on	
  net	
  book	
  value	
  (written	
  down	
  value)	
  .	
  Net	
  Book	
  value	
  represents	
  cost	
  minus	
  
total	
  deprecation	
  till	
  date.	
  
	
  
3. Revaluation	
  Method:	
  
	
  	
  	
  	
  	
  	
  	
  	
  This	
  is	
  usually	
  used	
  for	
  loose	
  tools	
  (	
  or	
  any	
  asset	
  which	
  can	
  only	
  be	
  valued	
  collectively)	
  .	
  
In	
  this	
  method	
  at	
  the	
  end	
  of	
  the	
  year	
  the	
  market	
  value	
  is	
  estimated.	
  A	
  numerical	
  example	
  
best	
  explains	
  this	
  	
  
	
  
	
  	
  	
  	
  	
  At	
  the	
  start	
  of	
  the	
  year	
  Loose	
  Tools	
  Valued	
  at	
  $5000	
  
	
  	
  	
  	
  	
  During	
  the	
  year	
  Loose	
  Tools	
  purchased	
  	
  =	
  $2000	
  
	
  	
  	
  	
  	
  Loose	
  Tools	
  Sold	
  =	
  $300	
  
	
  	
  	
  	
  At	
  the	
  End	
  Loose	
  tools	
  are	
  worth	
  $4500	
  
Deprecation	
  =	
  5000	
  +	
  2000	
  –	
  300-­‐	
  4500	
  =	
  2200	
  
Opening	
  Value+	
  Purchased	
  –Sold	
  –	
  Closing	
  Value	
  
	
  
	
  
	
  
Which	
  Method	
  is	
  best	
  to	
  use?	
  
It	
  depends	
  on	
  the	
  nature	
  of	
  Non	
  Current	
  Asset	
  
 
Straight	
  Line	
  method	
  is	
  appropriate	
  for	
  assets	
  like	
  office	
  furniture	
  and	
  fittings	
  (which	
  are	
  
used	
  evenly	
  through	
  out	
  the	
  year	
  useful	
  life,	
  and	
  the	
  efficiency	
  of	
  them	
  doesn’t	
  fall	
  by	
  great	
  
amount	
  in	
  initial	
  years)	
  
	
  
Reducing	
  Balance	
  Method	
  is	
  appropriate	
  for	
  assets	
  like	
  machinery	
  or	
  van.	
  Since	
  these	
  assets	
  
are	
  more	
  efficient	
  when	
  new,	
  more	
  depreciation	
  is	
  charged	
  in	
  initial	
  years.	
  As	
  the	
  asset	
  gets	
  
old	
  it	
  looses	
  efficiency	
  and	
  so	
  we	
  charge	
  less	
  deprecation.	
  Another	
  way	
  to	
  look	
  at	
  it	
  is	
  that	
  the	
  
maintenance	
  and	
  repairs	
  of	
  asset	
  will	
  increase	
  in	
  later	
  years	
  so	
  to	
  maintain	
  the	
  overall	
  
expense	
  it	
  makes	
  sense	
  to	
  charge	
  more	
  depreciation	
  in	
  initial	
  years	
  when	
  maintenance	
  is	
  
low	
  and	
  then	
  reduce	
  it	
  as	
  maintenance	
  increases.	
  
	
  
How	
  to	
  record	
  disposal	
  of	
  Asset:	
  
Disposal	
  of	
  means	
  getting	
  ride	
  of	
  the	
  fixed	
  asset	
  .	
  it	
  can	
  be	
  sold	
  or	
  may	
  be	
  stolen	
  or	
  just	
  
discarded.	
  Usually	
  there	
  are	
  4	
  entries	
  to	
  record	
  sale	
  of	
  asset	
  
	
  
1. Remove	
  the	
  Cost	
  of	
  the	
  Asset	
  Sold	
  
Debit	
  :	
  Disposal	
  	
  	
  	
  	
  	
  Credit:	
  Asset	
  	
  
	
  
2. 	
  Remove	
  the	
  Total	
  Deprecation	
  	
  
Debit	
  :	
  Provision	
  for	
  Depreciation	
  	
  	
  	
  Credit	
  :	
  Disposal	
  
	
  
3. Record	
  the	
  Selling	
  Price	
  
Debit:	
  Bank	
  	
  	
  	
  	
  Credit	
  :	
  Disposal	
  
	
  
If	
  exchanged	
  then	
  	
  
	
  	
  	
  	
  	
  	
  	
  	
  Debit	
  :	
  Asset	
  	
  	
  Credit	
  Disposal	
  
	
  	
  
4. Close	
  the	
  Disposal	
  Account	
  
	
  	
  	
  	
  	
  Close	
  with	
  income	
  statement	
  	
  
	
  
	
  
	
  
BANK	
  RECONCILIATION	
  STATEMENTS	
  
	
  
Cashbook	
  is	
  owner’s	
  record	
  (Debit	
  means	
  +	
  balance,	
  Credit	
  means	
  –	
  balance)	
  
Bank	
  statement	
  is	
  bank’s	
  record	
  (Credit	
  means	
  +	
  balance,	
  Debit	
  means	
  –	
  balance)	
  
	
  
Some	
  entries	
  which	
  are	
  recorded	
  in	
  the	
  bank	
  statement	
  but	
  not	
  in	
  the	
  cashbook:	
  
For	
  these,	
  we	
  will	
  have	
  to	
  correct	
  the	
  cashbook	
  
	
  
1. Credit	
  transfer	
  (Bank	
  Giro):	
  Money	
  deposited	
  by	
  customer	
  directly	
  in	
  the	
  bank	
  
account	
  (We	
  should	
  add	
  it	
  to	
  cashbook	
  balance)	
  
2. Standing	
  order/	
  Direct	
  Debit:	
  Money	
  paid	
  to	
  supplier	
  directly	
  by	
  the	
  bank.	
  
(We	
  should	
  subtract	
  this	
  from	
  cashbook	
  balance)	
  
3. Bank	
  Charges/	
  Interest	
  Charged:	
  Money	
  deducted	
  directly	
  by	
  the	
  Bank.	
  
(We	
  should	
  subtract	
  this	
  from	
  cashbook	
  balance)	
  
4. Interest	
  Received/	
  Dividends	
  Received:	
  Money	
  added	
  to	
  the	
  bank	
  account	
  in	
  form	
  of	
  
interest	
  or	
  dividend	
  (We	
  should	
  ad	
  it	
  to	
  the	
  cashbook	
  balance)	
  
5. Dishonored	
  Cheque:	
  A	
  cheque	
  received	
  from	
  customer	
  but	
  not	
  acknowledged	
  by	
  the	
  
bank	
  (We	
  should	
  subtract	
  this	
  from	
  cashbook	
  balance	
  because	
  we	
  need	
  to	
  cancel	
  the	
  
entry	
  made	
  when	
  the	
  cheque	
  was	
  received).	
  
	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  Some	
  entries	
  which	
  are	
  recorded	
  in	
  the	
  cashbook	
  but	
  not	
  on	
  the	
  bank	
  statement.	
  
	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  For	
  this,	
  we	
  will	
  have	
  to	
  correct	
  the	
  bank	
  statement:	
  
	
  
1. Unpresented	
  Cheque:	
  Cheques	
  written	
  by	
  us	
  to	
  a	
  creditor	
  but	
  not	
  yet	
  presented	
  to	
  
the	
  bank	
  for	
  payment,	
  so	
  the	
  bank	
  has	
  not	
  deducted	
  money	
  from	
  our	
  account.	
  
(We	
  should	
  subtract	
  this	
  from	
  bank	
  statement	
  balance)	
  
2. Uncredited	
  Cheque	
  (Lodgments):	
  Cheques	
  received	
  by	
  us	
  but	
  not	
  yet	
  deposited	
  in	
  
the	
  bank,	
  so	
  the	
  bank	
  has	
  not	
  increased	
  the	
  bank	
  balance.	
  (We	
  should	
  add	
  this	
  to	
  the	
  
bank	
  statement	
  balance)	
  
	
  
FOR	
  MCQ’s	
  remember	
  
	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  Balance	
  as	
  per	
  Bank	
  statement	
  +	
  Uncredited	
  Cheques	
  –	
  Unpresented	
  Cheques	
  =	
  Balance	
  as	
  	
  	
  	
  
per	
  corrected	
  Cashbook.	
  
	
  
If	
  balance	
  as	
  per	
  corrected	
  cashbook	
  is	
  given	
  in	
  the	
  question,	
  simply	
  ignores	
  the	
  entries	
  
which	
  will	
  affect	
  the	
  cashbook	
  balance.	
  	
  
	
  
If	
  there	
  is	
  an	
  overdraft	
  (for	
  either	
  cashbook	
  or	
  bank	
  statement),	
  take	
  it	
  as	
  a	
  negative	
  
figure	
  in	
  the	
  equation.	
  
	
  
Reasons	
  For	
  Preparing	
  bank	
  Reconciliation	
  Statement:	
  
To	
  ensure	
  that	
  the	
  cash	
  book	
  entries	
  are	
  complete.	
  	
  
To	
  discover	
  bank	
  errors.	
  	
  
To	
  discover	
  errors	
  in	
  cash	
  book.	
  	
  
To	
  check	
  Fraud	
  and	
  embezzlement.	
  	
  
	
  	
  	
  	
  	
  	
  	
  To	
  discover	
  dishonoured	
  cheques.	
  	
  
 
	
  
	
  
CONTROL	
  ACCOUNTS	
  
	
  
What	
  is	
  the	
  difference	
  between	
  Sales	
  Ledger	
  and	
  Salas	
  Ledger	
  Control	
  Account?	
  
	
  
Sales	
  ledger	
  is	
  where	
  we	
  make	
  individual	
  accounts	
  of	
  credit	
  customers.	
  It	
  is	
  part	
  of	
  double	
  entry	
  
system	
  and	
  it	
  gives	
  details	
  of	
  amounts	
  owing	
  by	
  each	
  customer.	
  A	
  list	
  of	
  debtors	
  is	
  extracted	
  from	
  
the	
  sales	
  ledger,	
  which	
  gives	
  the	
  figure	
  of	
  debtors	
  for	
  the	
  trial	
  balance.	
  
Sales	
  ledger	
  control	
  account	
  on	
  the	
  other	
  hand	
  is	
  the	
  total	
  debtors	
  account	
  in	
  the	
  general	
  ledger.	
  It	
  
is	
  not	
  part	
  of	
  the	
  double	
  entry	
  system.	
  It	
  I	
  often	
  referred	
  as	
  total	
  debtors	
  account.	
  All	
  the	
  entries	
  
recorded	
  here	
  are	
  totals	
  taken	
  from	
  daybooks	
  e.g.	
  Sales	
  figure	
  is	
  the	
  total	
  of	
  the	
  sales	
  daybook,	
  
discount	
  allowed	
  is	
  total	
  discount	
  allowed	
  from	
  the	
  discount	
  allowed	
  account	
  or	
  the	
  column	
  in	
  the	
  
cashbook.	
  
	
  
USES	
  OF	
  CONTROL	
  ACCOUNT	
  
1. Helps	
  to	
  prevent	
  fraud	
  
2. Helps	
  to	
  detect	
  errors	
  
3. Quickly	
  provide	
  figures	
  of	
  total	
  debtors	
  and	
  creditor.	
  
LIMITATIONS	
  OF	
  CONTROL	
  ACCOUNT	
  
1. Cant	
  trace	
  error	
  of	
  omission	
  	
  
2. Cant	
  trace	
  error	
  of	
  original	
  entry	
  
	
  
Note:	
  Sometimes	
  it	
  can	
  happen	
  that	
  there	
  is	
  a	
  small	
  opening	
  Debit	
  balance	
  on	
  a	
  purchases	
  
ledger	
  control	
  account	
  in	
  addition	
  to	
  the	
  usual	
  credit	
  balance.	
  It	
  happens	
  when	
  the	
  business	
  
has	
  overpaid	
  a	
  creditor,	
  or	
  has	
  returned	
  the	
  goods	
  after	
  paying	
  the	
  due	
  amount.	
  
Note:	
  Sometimes	
  sales	
  ledger	
  control	
  account	
  too	
  also	
  has	
  small	
  opening	
  credit	
  balance	
  b/d	
  
on	
  a	
  sales	
  ledger	
  control	
  account,	
  in	
  addition	
  to	
  the	
  usual	
  opening	
  debit	
  balance.	
  It	
  happens	
  
when	
  a	
  debtor	
  has	
  over	
  paid	
  his	
  account	
  or	
  has	
  returned	
  goods	
  after	
  paying	
  his	
  account	
  or	
  
due	
  amount.	
  
	
  
	
  
	
  
	
  
 
	
  
	
  
ERRORS	
  AND	
  SUSPENSE	
  
Error	
  not	
  affecting	
  the	
  Trial	
  Balance:	
  	
  
1. Error	
  of	
  complete	
  omission:	
  When	
  nothing	
  has	
  been	
  recorded	
  in	
  the	
  books.	
  To	
  correct	
  this,	
  
simply	
  record	
  the	
  transaction.	
  
2. Error	
  of	
  original	
  entry:	
  Where	
  correct	
  double	
  entry	
  is	
  passed	
  but	
  with	
  the	
  wrong	
  amount.	
  
To	
  correct	
  this,	
  adjust	
  for	
  the	
  difference.	
  
3. Error	
  of	
  principal:	
  Where	
  a	
  wrong	
  type	
  of	
  account	
  has	
  been	
  debited	
  or	
  credited	
  instead.	
  For	
  
example,	
  we	
  have	
  debited	
  Rent	
  instead	
  of	
  Motor	
  Van.	
  
4. Error	
  of	
  commission:	
  Where	
  a	
  wrong	
  account	
  but	
  of	
  same	
  type	
  (usually	
  debtors	
  or	
  
creditors)	
  has	
  been	
  debited	
  or	
  credited	
  instead.	
  For	
  example,	
  we	
  have	
  credited	
  Mr.	
  A	
  
instead	
  of	
  Mr.	
  B.	
  
5. Error	
  of	
  complete	
  reversal:	
  Where	
  a	
  completely	
  opposite	
  entry	
  is	
  passed	
  with	
  the	
  right	
  
amount.	
  To	
  correct	
  this,	
  pass	
  the	
  correct	
  entry	
  with	
  double	
  amounts.	
  
6. Compensating	
  error:	
  Where	
  one	
  error	
  compensates	
  for	
  other.	
  Like	
  a	
  debit	
  item	
  (say	
  
purchase)	
  and	
  a	
  credit	
  item	
  (say	
  sales)	
  are	
  both	
  undercast	
  with	
  same	
  amounts.	
  (don’t	
  worry	
  
about	
  this	
  too	
  much	
  :P)	
  
	
  
All	
  the	
  above	
  errors	
  do	
  not	
  affect	
  the	
  Trial	
  Balance	
  because	
  in	
  all	
  situations	
  the	
  total	
  debits	
  are	
  
equal	
  to	
  total	
  credits.	
  
	
  
Errors	
  can	
  be	
  made	
  which	
  can	
  lead	
  to	
  disagreement	
  of	
  the	
  trial	
  balance.	
  
This	
  is	
  when	
  either	
  we	
  have	
  only	
  debited	
  something	
  and	
  forgot	
  to	
  credit	
  (Incomplete	
  double	
  entry)	
  
or	
  we	
  have	
  debited	
  something	
  with	
  a	
  correct	
  amount	
  and	
  credited	
  the	
  other	
  with	
  the	
  wrong	
  
amount	
  (Incorrect	
  double	
  entry).	
  And	
  it	
  can	
  also	
  happen	
  if	
  any	
  daybook	
  is	
  over	
  or	
  under	
  cast.	
  E.g.	
  
Sales	
  daybook	
  is	
  undercast.	
  In	
  these	
  situations	
  Suspense	
  account	
  comes	
  into	
  the	
  picture.	
  Since	
  sales	
  
daybook	
  is	
  undercast,	
  this	
  means	
  only	
  the	
  total	
  sales	
  were	
  wrong	
  (understated),	
  so	
  we	
  need	
  to	
  
amend	
  the	
  sales	
  accounts.	
  
	
   	
   	
   	
   Debit:	
  Suspense	
  
	
   	
   	
   	
   	
   Credit:	
  Sales	
  
	
  
Errors	
  affecting	
  Profit	
  or	
  Loss	
  
These	
  errors	
  affect	
  those	
  accounts	
  which	
  are	
  included	
  in	
  the	
  Trading	
  and	
  Profit	
  and	
  Loss	
  
Account	
  eg	
  purchases,	
  sales,	
  expenses	
  etc.	
  We	
  must	
  ask	
  the	
  following	
  questions:	
  
1)	
  Does	
  the	
  error	
  affect	
  the	
  gross	
  profit,	
  the	
  net	
  profit	
  or	
  both?	
  (a)	
  Errors	
  which	
  affect	
  items	
  
that	
  go	
  into	
  the	
  trading	
  account	
  affect	
  gross	
  profitand	
  net	
  profit	
  to	
  the	
  same	
  extent	
  and	
  in	
  
the	
  same	
  direction.	
  Such	
  items	
  aresales,	
  purchases,	
  returns,	
  stock,	
  carriage	
  inwards	
  etc.	
  (b)	
  
Errors	
  which	
  affect	
  items	
  that	
  are	
  entered	
  in	
  the	
  profit	
  and	
  loss	
  section	
  of	
  theaccount,	
  i.e.	
  
operating	
  expenses,	
  affect	
  only	
  net	
  profit.	
  Purchases	
  of	
  fixed	
  assets	
  affect	
  profit	
  only	
  
indirectly	
  through	
  provisions	
  for	
  depreciation.	
  
2)	
  In	
  what	
  direction	
  is	
  profit	
  affected?	
  
(a)	
  If	
  sales	
  are	
  overstated	
  or	
  purchases	
  understated,	
  both	
  gross	
  profit	
  and	
  netprofit	
  are	
  too	
  
high	
  and	
  must	
  be	
  reduced	
  by	
  the	
  relevant	
  amount.	
  The	
  sameapplies	
  if	
  sales	
  returns	
  are	
  
understated	
  or	
  purchases	
  returns	
  overstated.	
  	
  
(b)If	
  sales	
  are	
  understated	
  or	
  purchases	
  overstated,	
  both	
  gross	
  profit	
  and	
  net	
  profit	
  are	
  too	
  
low	
  and	
  must	
  be	
  increased	
  by	
  the	
  relevant	
  amount.	
  The	
  sameapplies	
  if	
  sales	
  returns	
  are	
  
overstated	
  or	
  purchases	
  returns	
  understated.	
  	
  
(c)	
  If	
  miscellaneous	
  receipts	
  are	
  overstated	
  or	
  if	
  expenses	
  are	
  understated,	
  gross	
  profit	
  is	
  
not	
  affected	
  but	
  net	
  profit	
  will	
  be	
  high	
  and	
  must	
  be	
  reduced.	
  
(d)	
  	
  If	
  miscellaneous	
  receipts	
  are	
  understated	
  or	
  if	
  expenses	
  are	
  overstated,	
  again	
  	
  gross	
  
profit	
  is	
  not	
  affected	
  but	
  net	
  profit	
  is	
  too	
  low	
  and	
  must	
  be	
  increased.	
  	
  
(e)	
  	
  If	
  capital	
  expenditure	
  is	
  wrongly	
  treated	
  as	
  revenue	
  expenditure,	
  eg	
  if	
  the	
  purchase	
  of	
  a	
  
fixed	
  asset	
  is	
  treated	
  as	
  an	
  expense,	
  then	
  net	
  profit	
  will	
  be	
  too	
  low	
  and	
  must	
  be	
  increased.	
  
The	
  opposite	
  applies	
  if	
  revenue	
  expenditure	
  is	
  	
  treated	
  as	
  capital	
  expenditure.	
  	
  
3)	
  Does	
  the	
  errors	
  that	
  affect	
  items	
  in	
  the	
  balance	
  sheet	
  affect	
  profit	
  as	
  well?	
  	
  
The	
  answer	
  is	
  only	
  those	
  that	
  were	
  adjusted	
  after	
  the	
  trial	
  balance	
  was	
  prepared.	
  Errors	
  
affecting	
  fixed	
  assets,	
  current	
  assets	
  and	
  liabilities	
  do	
  not	
  normally	
  affect	
  profit	
  but	
  if	
  one	
  of	
  
these	
  items	
  has	
  changed	
  as	
  a	
  result	
  of	
  an	
  adjustment,	
  then	
  profit	
  is	
  affected.	
  For	
  example:	
  
. (a)	
  	
  If	
  the	
  closing	
  stock	
  has	
  been	
  overvalued,	
  the	
  stock	
  figure	
  in	
  the	
  balance	
  sheet	
  is	
  too	
  
high	
  and	
  so	
  are	
  the	
  gross	
  profit	
  and	
  the	
  net	
  profit.	
  The	
  opposite	
  is	
  true	
  of	
  a	
  closing	
  
stock	
  which	
  is	
  undervalued.	
  Remember	
  that	
  closing	
  stock	
  adds	
  on	
  to	
  gross	
  profit	
  
and	
  opening	
  stock	
  takes	
  away	
  from	
  it.	
  	
  
. (b)	
  	
  If	
  an	
  accrued	
  or	
  prepaid	
  expense	
  is	
  the	
  wrong	
  amount,	
  both	
  profit	
  and	
  the	
  item	
  in	
  the	
  
balance	
  sheet	
  are	
  wrong.	
  If	
  an	
  amount	
  owing	
  is	
  overstated	
  or	
  a	
  prepayment	
  is	
  
understated,	
  profit	
  is	
  too	
  low	
  and	
  must	
  be	
  increased,	
  and	
  vice	
  versa.	
  	
  
. (c)	
  	
  The	
  opposite	
  to	
  (b)	
  applies	
  in	
  the	
  case	
  of	
  accrued	
  or	
  prepaid	
  receipts.	
  	
  
Estimating	
  the	
  effects	
  of	
  errors	
  can	
  be	
  confusing	
  and	
  you	
  must	
  keep	
  a	
  clear	
  mind.	
  Think	
  
how	
  the	
  original	
  figure	
  has	
  affected	
  profit	
  and	
  then	
  try	
  to	
  see	
  in	
  which	
  direction	
  the	
  error	
  is	
  
affecting	
  the	
  profit.	
  
	
  
 
	
  
INCOMPLETE	
  RECORDS:	
  
	
  
Remember	
  Net	
  profit	
  can	
  be	
  calculated	
  using	
  the	
  following	
  formula.	
  If	
  a	
  question	
  says	
  make	
  a	
  
trading	
  profit	
  and	
  loss	
  account,	
  than	
  this	
  doesn’t	
  apply.	
  Only	
  when	
  it	
  says	
  to	
  calculate	
  net	
  profit	
  or	
  
make	
  a	
  statement	
  showing	
  net	
  profit.	
  
	
  
	
   Opening	
  Capital	
  +	
  Additional	
  Capital	
  +	
  Net	
  profit	
  –	
  Drawings	
  =	
  Closing	
  Capital	
  
	
  
(I	
  really	
  hope	
  you	
  can	
  solve	
  for	
  net	
  profit),	
  don’t	
  memorize	
  the	
  formula,	
  it’s	
  the	
  financed	
  by	
  section.	
  
J	
  
	
  
For	
  the	
  final	
  account	
  questions	
  (where	
  the	
  trading,	
  profit	
  and	
  loss	
  account	
  and	
  a	
  balance	
  sheet	
  is	
  
required),	
  always	
  make	
  the	
  following	
  accounts.	
  (By	
  always,	
  I	
  mean	
  always).	
  
	
  
1. Sales	
  ledger	
  control	
  account	
  (If	
  business	
  only	
  deals	
  in	
  cash	
  sales,	
  then	
  don’t)	
  
2. Purchase	
  ledger	
  control	
  account	
  
3. Bank	
  account	
  (if	
  it	
  is	
  already	
  given	
  in	
  the	
  question,	
  then	
  it’s	
  okay)	
  
	
  
Once	
  you	
  have	
  filled	
  in	
  your	
  accounts,	
  and	
  then	
  move	
  to	
  the	
  Final	
  accounts.	
  Don’t	
  panic	
  if	
  it	
  doesn’t	
  
balance,	
  because	
  marks	
  are	
  for	
  working.	
  Don’t	
  spend	
  your	
  entire	
  lifetime	
  on	
  this	
  question.	
  
	
  
NEVER	
  NEVER	
  NEVER	
  forget	
  depreciation.	
  They	
  will	
  usually	
  give	
  you	
  net	
  book	
  values	
  at	
  start	
  and	
  
end.	
  
Depreciation	
  =	
  	
  
	
  
	
   Opening	
  NBV	
  +	
  Purchase	
  of	
  assets	
  –	
  Sale	
  of	
  assets	
  (at	
  NBV)	
  –	
  Closing	
  NBV	
  
	
  
Also	
  make	
  expense	
  accounts	
  or	
  adjust	
  for	
  prepaid	
  and	
  owings	
  directly.	
  But	
  show	
  all	
  working.	
  
	
  
In	
  your	
  financed	
  by	
  section,	
  you	
  will	
  need	
  opening	
  capital.	
  This	
  will	
  come	
  from	
  Opening	
  Assets	
  –	
  
Opening	
  Liabilities.	
  Don’t	
  forget	
  to	
  include	
  the	
  opening	
  balance	
  of	
  the	
  bank	
  account	
  in	
  your	
  
calculation	
  (like	
  other	
  idiots).	
  
	
  
	
  
	
  
	
  
	
  
 
	
  
	
  
	
  
MARGINS	
  AND	
  MARK-­‐UPS	
  
	
  
These	
  are	
  tools	
  used	
  in	
  conjunction	
  with	
  trading	
  account	
  to	
  compute	
  the	
  missing	
  figures	
  of	
  sales,	
  
figures	
  or	
  stocks.	
  If	
  either	
  of	
  these	
  percentages	
  is	
  given,	
  it	
  is	
  a	
  sign	
  that	
  we	
  are	
  expected	
  to	
  compute	
  
the	
  missing	
  figures	
  by	
  using	
  the	
  trading	
  account	
  technique.	
  
	
  
MARGINS	
  
Represent	
  Gross	
  Profit	
  as	
  a	
  percentage	
  of	
  selling	
  price.	
  
	
  
Example:	
  
A	
  company	
  sells	
  its	
  goods	
  at	
  a	
  selling	
  price	
  of	
  $80.	
  Its	
  profits	
  are	
  set	
  at	
  20%	
  no	
  selling	
  price.	
  
Profits	
  will	
  be	
  $80	
  x	
  20%	
  =	
  $16	
  
By	
  using	
  trading	
  account	
  format,	
  we	
  can	
  determine	
  the	
  cost	
  of	
  goods	
  sold	
  as:	
  
	
   $	
  
Sales	
   	
  80	
  
Less:	
  Cost	
  of	
  goods	
  sold	
  (balancing	
  figure)	
   	
  (64)	
  
Profit	
   	
  	
  16_	
  
	
  
MARK-­‐UP	
  
Represent	
  Gross	
  profit	
  as	
  a	
  percentage	
  of	
  cost.	
  Its	
  application	
  is	
  like	
  margin,	
  that	
  if	
  we	
  get	
  one	
  of	
  the	
  
trading	
  figures,	
  we	
  will	
  be	
  able	
  to	
  compute	
  the	
  others.	
  
	
  
Let	
  us	
  assume	
  that	
  the	
  information	
  we	
  have	
  from	
  the	
  above	
  example	
  is	
  that	
  a	
  company	
  sells	
  goods,	
  
which	
  cost	
  $64.	
  Its	
  profit	
  on	
  cost	
  is	
  25%.	
  Profits	
  would	
  be	
  computed	
  as	
  follows:	
  
Profits	
  	
  =	
  $64	
  x	
  25%	
  
	
   =	
  $16.	
  
By	
  using	
  trading	
  account	
  format,	
  we	
  can	
  determine	
  sales	
  as:	
  
	
   $	
  
Sales	
  (balancing	
  figure)	
   	
  80	
  
Less:	
  Cost	
  of	
  goods	
  sold	
   	
  (64)	
  
Profit	
   	
  	
  16_	
  
	
  
 
Try	
  to	
  use	
  	
  
Sales	
  –	
  Cost	
  =	
  Profit	
  
	
  
If	
  Mark	
  up	
  if	
  given	
  Profit	
  is	
  a	
  %	
  of	
  Cost	
  and	
  IF	
  margin	
  is	
  given	
  Profit	
  is	
  a	
  %	
  of	
  Sales	
  
	
  
For	
  eg.	
  
	
  
Sales	
  =	
  80000	
  
Cost	
  =	
  ?	
  
Margin	
  =	
  25%	
  
	
  
Sales	
  –	
  Cost	
  =	
  Profit	
  
80000-­‐	
  x	
  =	
  25	
  %	
  of	
  80000	
  
	
  
Cost	
  =	
  60000	
  
But	
  if	
  	
  	
  
Sales	
  =	
  80000	
  
Cost	
  =	
  ?	
  
Markup	
  =25%	
  
	
  
Sales	
  –	
  Cost	
  =	
  Profit	
  
80000-­‐	
  x	
  =	
  25	
  %	
  of	
  X	
  
	
  
Cost	
  =	
  64000	
  
	
  
NON-­‐PROFIT	
  ORGANIZATION	
  (CLUBS	
  AND	
  
SOCITIES)	
  
	
  
The	
  non-­‐profit	
  organization	
  is	
  with	
  a	
  view	
  of	
  providing	
  services	
  to	
  its	
  members.	
  The	
  aim	
  is	
  not	
  to	
  
make	
  profits	
  out	
  of	
  trading	
  activities,	
  but	
  to	
  increase	
  to	
  welfare	
  of	
  members	
  through	
  social	
  
interaction	
  and	
  other	
  activities.	
  A	
  club	
  is	
  owned	
  by	
  all	
  the	
  members	
  collectively	
  and	
  since	
  there	
  is	
  
no	
  single	
  owner,	
  there	
  are	
  no	
  DRAWINGS.	
  
	
  
TERMINOLOGY	
  DIFFERENCE	
  
Non-­‐profit	
  organizations	
   Normal	
  trading	
  Businesses	
  
Receipts	
  and	
  Payments	
  Account	
   Bank	
  Account	
  
Income	
  and	
  Expenditure	
  Account	
   Trading,	
  Profit	
  and	
  Loss	
  Account	
  
Surplus	
   Profit	
  
Deficit	
   Loss	
  
Accumulated	
  Funds	
   Capital	
  
	
  
Why	
  is	
  a	
  Receipts	
  and	
  Payments	
  Account	
  unsatisfactory	
  for	
  the	
  members?	
  
	
  
The	
  receipts	
  and	
  Payments	
  account	
  does	
  not	
  provide	
  information	
  to	
  the	
  members	
  relating	
  to	
  
1. Assets	
  owned	
  by	
  the	
  club	
  
2. Liabilities	
  owed	
  by	
  the	
  club	
  
3. Surplus	
  or	
  Deficit	
  
4. Depreciation	
  of	
  fixed	
  assets	
  
5. Performance	
  of	
  the	
  club	
  
6. Financial	
  position	
  of	
  the	
  club.	
  
	
  
In	
  order	
  to	
  make	
  the	
  income	
  and	
  expenditure	
  account,	
  you	
  will	
  need	
  to	
  determine	
  the	
  incomes	
  
separately.	
  Incomes	
  may	
  include:	
  
-­‐ Refreshment	
  Profit/Bar	
  profit	
  (make	
  a	
  separate	
  account	
  to	
  calculate	
  net	
  profit	
  from	
  this)	
  
-­‐ Annual	
  subscription	
  (separate	
  subscription	
  account	
  for	
  this)	
  
-­‐ Gain	
  on	
  disposal.	
  
-­‐ Interest	
  on	
  deposit	
  account	
  or	
  investment	
  account.	
  
-­‐ Profits	
  from	
  different	
  events	
  (say	
  Dinner	
  dance)	
  
-­‐ Donations	
  (only	
  day	
  to	
  day)	
  
	
  
Check	
  debit	
  side	
  of	
  Receipts	
  and	
  Payments	
  account	
  for	
  anything	
  else.	
  
	
  
What	
  is	
  the	
  difference	
  between	
  receipts	
  and	
  payments	
  account	
  and	
  Income	
  and	
  Expenditure	
  
account?	
  
	
  
Receipts	
  and	
  Payment	
  account	
   Income	
  and	
  Expenditure	
  account	
  
It	
  shows	
  balance	
  of	
  bank	
  at	
  start	
  and	
  end	
   It	
  shows	
  Surplus	
  of	
  Deficit	
  for	
  the	
  year	
  
It	
  records	
  money	
  coming	
  in	
  and	
  going	
  out	
   It	
  records	
  Incomes	
  and	
  expenses	
  incurred	
  
It	
  considers	
  all	
  type	
  of	
  money	
  coming	
  including	
  
capital	
  receipts,	
  e.g.	
  Long	
  term	
  donations	
  and	
  
all	
  type	
  of	
  money	
  going	
  out,	
  e.g.	
  Purchase	
  of	
  
fixed	
  asset	
  
It	
  considers	
  only	
  revenue	
  incomes	
  and	
  
expenditure.	
  
It	
  is	
  an	
  alternative	
  name	
  for	
  cashbook	
   It	
  is	
  an	
  alternative	
  name	
  for	
  profit	
  and	
  Loss	
  
	
  
What	
  is	
  a	
  donation	
  and	
  what	
  are	
  two	
  accounting	
  treatments	
  for	
  it?	
  
An	
  amount	
  received	
  by	
  a	
  club	
  which	
  the	
  club	
  does	
  not	
  have	
  to	
  pay	
  back.	
  This	
  includes	
  donations,	
  
gifts,	
  legacy	
  and	
  grants.	
  
	
  
If	
  donation	
  is	
  for	
  a	
  day	
  to	
  day	
  expenditure	
  or	
  will	
  remain	
  with	
  the	
  club	
  only	
  for	
  a	
  short	
  period	
  then	
  
it	
  should	
  be	
  treated	
  as	
  an	
  income	
  in	
  the	
  income	
  and	
  expenditure	
  account.	
  
	
  
If	
  donation	
  is	
  for	
  purpose	
  of	
  capital	
  expenditure	
  on	
  long	
  term	
  assets,	
  then	
  it	
  is	
  shown	
  as	
  a	
  special	
  
fund	
  in	
  the	
  balance	
  sheet.	
  (Financed	
  by	
  section	
  added	
  it	
  to	
  accumulated	
  funds).	
  
	
  
PARTNERSHIP	
  ACCOUNTS	
  
	
  
A	
  partnership	
  is	
  defined	
  by	
  the	
  Partnership	
  Act	
  1890	
  as	
  a	
  relationship,	
  which	
  exists	
  between	
  two	
  or	
  
more	
  persons	
  who	
  carry	
  business	
  with	
  a	
  view	
  of	
  profit.	
  
	
  
CHARACTERISTICS	
  OF	
  PARTNERSHIP	
  
• Partners	
  are	
  jointly	
  and	
  severally	
  liable	
  for	
  the	
  debts	
  of	
  the	
  partnership.	
  They	
  have	
  
unlimited	
  liabilities	
  for	
  the	
  debts	
  of	
  the	
  partnership.	
  
• The	
  minimum	
  number	
  of	
  partners	
  is	
  usually	
  two	
  and	
  maximum	
  number	
  is	
  twenty,	
  
with	
  exception	
  of	
  banks,	
  where	
  the	
  maximum	
  number	
  is	
  fixed	
  at	
  ten	
  and	
  some	
  
professional	
  practices	
  where	
  there	
  is	
  no	
  maximum	
  number.	
  
• All	
  partners	
  usually	
  participate	
  in	
  the	
  running	
  of	
  their	
  business.	
  
• There	
  is	
  usually	
  a	
  written	
  partnership	
  agreement.	
  
	
  
THE	
  PARTNERSHIP	
  AGREEMENT	
  
	
  
The	
  partnership	
  agreement	
  is	
  a	
  written	
  agreement	
  which	
  sets	
  up	
  the	
  terms	
  of	
  the	
  partnership,	
  
especially	
  the	
  financial	
  arrangements	
  between	
  the	
  partners.	
  
	
  
The	
  contents	
  of	
  the	
  partnership	
  agreement	
  can	
  vary	
  from	
  one	
  partnership	
  to	
  another.	
  A	
  standard	
  
Partnership	
  Agreement	
  may	
  include	
  the	
  following	
  items:	
  
1. The	
  name	
  of	
  the	
  firm,	
  business	
  type	
  and	
  duration	
  
2. Capital	
  contribution.	
  
3. Profit	
  sharing	
  ratios.	
  
4. Interest	
  on	
  Capital.	
  
5. Partners’	
  salaries.	
  
6. Drawings.	
  
7. Interest	
  on	
  drawings.	
  
8. Arrangements	
  in	
  case	
  of	
  dissolution,	
  death	
  or	
  retirement	
  of	
  partners.	
  
9. Arrangement	
  for	
  settling	
  disputes.	
  
	
  
In	
  absence	
  of	
  a	
  formal	
  agreement	
  between	
  the	
  partners,	
  certain	
  rules	
  laid	
  down	
  by	
  the	
  Partnership	
  
Act	
  1890	
  are	
  presumed	
  to	
  apply.	
  These	
  are:	
  
1. Residual	
  profits	
  are	
  shared	
  equally	
  between	
  the	
  partners.	
  
2. There	
  are	
  no	
  partners’	
  salaries.	
  
3. No	
  interest	
  is	
  charged	
  on	
  drawings	
  made	
  by	
  the	
  partners	
  
4. Partners	
  receive	
  no	
  interest	
  on	
  capital	
  invested	
  in	
  the	
  business.	
  
5. Partners	
  are	
  entitled	
  to	
  interest	
  of	
  5%	
  per	
  annum	
  on	
  any	
  loans	
  they	
  advance	
  to	
  the	
  business	
  
in	
  excess	
  of	
  their	
  agreed	
  capital.	
  
	
  
ADVANTAGES	
  OF	
  PARTNERSHIP	
  OVER	
  SOLE	
  TRADER	
  
	
  
1. Additional	
  capital	
  from	
  other	
  partners,	
  and	
  also	
  easier	
  to	
  get	
  loans.	
  
2. Additional	
  expertise.	
  
3. Additional	
  management	
  time.	
  
4. Risk	
  (losses)	
  is	
  shared.	
  
	
  
	
  
DISADVANTAGES	
  OF	
  PARTNERSHIOP	
  OVER	
  A	
  SOLE	
  TRADER	
  
	
  
1. Profit	
  are	
  shared	
  
2. Possibility	
  of	
  disputes	
  
3. Loss	
  of	
  control	
  
	
  
What	
  is	
  a	
  current	
  account?	
  
	
  
Majority	
  of	
  partnership	
  keep	
  a	
  fixed	
  capital	
  account,	
  whenever	
  they	
  have	
  fixed	
  capital	
  accounts,	
  
they	
  will	
  have	
  to	
  maintain	
  a	
  current	
  account	
  for	
  each	
  partner.	
  By	
  fixed	
  capital	
  account,	
  we	
  mean	
  
that	
  all	
  the	
  appropriation	
  and	
  drawings	
  will	
  pass	
  through	
  a	
  temporary	
  capital	
  account	
  (current	
  
account),	
  only	
  additional	
  investment	
  by	
  a	
  partner	
  will	
  be	
  recorded	
  in	
  the	
  capital	
  account.	
  This	
  gives	
  
information	
  relating	
  to	
  long	
  term	
  and	
  short	
  term	
  aspects	
  separately.	
  This	
  also	
  helps	
  to	
  determine	
  
the	
  investment	
  made	
  by	
  partner	
  in	
  the	
  business.	
  
Some	
  partnerships	
  also	
  maintain	
  a	
  fluctuating	
  capital	
  account;	
  in	
  this	
  case	
  they	
  will	
  not	
  maintain	
  a	
  
current	
  account.	
  All	
  the	
  transactions	
  will	
  pass	
  through	
  the	
  capital	
  account.	
  
	
  
	
  
	
  
	
  
	
  
	
  
	
  
	
  
	
  
 
	
  
LIMITED	
  COMPANIES	
  
	
  
Limited	
  companies	
  are	
  business	
  organizations,	
  whose	
  owners’	
  liabilities	
  are	
  limited	
  to	
  their	
  capital	
  
contributed	
  or	
  guarantees	
  made.	
  
	
  
CHARACTERISTICS	
  OF	
  LIMITED	
  COMPANIES	
  
1. Separate	
  legal	
  entity:	
   A	
  company	
  is	
  regarded	
  as	
  a	
  separate	
  person	
  from	
  its	
  owners	
  
and	
  managers.	
  As	
  a	
  result,	
  it	
  can	
  sue	
  or	
  be	
  sued,	
  it	
  can	
  own	
  
property.	
  This	
  concept	
  is	
  often	
  referred	
  to	
  as	
  veil	
  of	
  
incorporation.	
  
2. Limited	
  liability:	
   Shareholders’	
  liability	
  is	
  limited	
  to	
  what	
  they	
  have	
  paid	
  for	
  
shares.	
  
3. Perpetual	
  succession:	
   Unlike	
  partnership	
  and	
  sole	
  trader,	
  a	
  company	
  does	
  not	
  cease	
  
to	
  exist	
  on	
  the	
  death	
  or	
  retirement	
  of	
  any	
  of	
  the	
  owners.	
  
Owners	
  can	
  buy	
  and	
  sell	
  their	
  shares	
  without	
  affecting	
  the	
  
running	
  of	
  the	
  business.	
  
4. Number	
  of	
  members:	
   There	
  is	
  no	
  limit	
  as	
  to	
  the	
  number	
  of	
  members	
  
5. Capital:	
   Company’s	
  capital	
  is	
  raised	
  through	
  the	
  issuance	
  of	
  shares	
  
6. Profit	
  distribution:	
   Profits	
  are	
  distributed	
  to	
  members	
  through	
  dividends.	
  
7. Retained	
  profits:	
   The	
  retained	
  profits	
  are	
  capitalized	
  are	
  reserves.	
  
8. Legislation:	
   Companies	
  are	
  highly	
  regulated.	
  They	
  are	
  required	
  to	
  comply	
  
with	
  the	
  requirements	
  of	
  Company’s	
  ACT	
  as	
  well	
  as	
  Financial	
  
Reporting	
  Standards.	
  
	
  
ADVANTAGES	
  OF	
  OPERATING	
  AS	
  A	
  LIMITED	
  COMPANY:	
  
1. The	
  liability	
  of	
  the	
  shareholders	
  is	
  limited.	
  Therefore,	
  in	
  case	
  of	
  company	
  going	
  bankrupt,	
  
the	
  individual	
  assets	
  of	
  the	
  owners	
  will	
  not	
  be	
  used	
  to	
  meet	
  the	
  company’s	
  debts.	
  Only	
  
shareholders	
  who	
  have	
  only	
  partly	
  paid	
  for	
  their	
  shares	
  can	
  be	
  forced	
  to	
  pay	
  the	
  balance	
  
owing	
  on	
  the	
  shares,	
  but	
  nothing	
  else.	
  
2. There	
  is	
  a	
  formal	
  separation	
  between	
  the	
  ownership	
  and	
  management	
  of	
  the	
  business.	
  This	
  
helps	
  in	
  clearly	
  identifying	
  the	
  responsible	
  persons.	
  
3. Ownership	
  is	
  vastly	
  shared	
  by	
  many	
  people,	
  hence	
  diversifying	
  risk,	
  and	
  funds	
  become	
  
available	
  is	
  substantial	
  amounts.	
  
4. Shares	
  in	
  the	
  business	
  can	
  be	
  transferred	
  relatively	
  easily.	
  
	
  
	
  
DISADVANTAGES:	
  
1. Formation	
  costs	
  are	
  normally	
  very	
  high.	
  
2. Companies	
  are	
  highly	
  regulated.	
  
3. Running	
  costs	
  are	
  also	
  very	
  high	
  i.e.	
  preparation	
  and	
  submission	
  of	
  annual	
  returns,	
  audit	
  
fees	
  etc.	
  
4. Profit	
  distribution	
  is	
  also	
  subject	
  to	
  some	
  restrictions.	
  Not	
  all	
  surpluses	
  from	
  the	
  business	
  
transactions	
  can	
  be	
  distributed	
  back	
  to	
  the	
  shareholders.	
  
5. Company	
  accounts	
  must	
  be	
  available	
  for	
  inspection	
  to	
  the	
  public.	
  
There	
  are	
  two	
  types	
  of	
  limited	
  companies:	
  
1. Public	
  limited	
  companies:	
  
a-­‐ They	
  have	
  the	
  abbreviation	
  Plc	
  of	
  public	
  limited	
  company	
  at	
  the	
  end	
  of	
  their	
  names	
  
b-­‐ Their	
  minimum	
  allotted	
  share	
  is	
  required	
  to	
  be	
  £50	
  000.	
  
c-­‐ They	
  can	
  invite	
  the	
  general	
  public	
  to	
  subscribe	
  for	
  their	
  shares	
  
d-­‐ Their	
  shares	
  may	
  be	
  traded	
  in	
  the	
  stock	
  exchange	
  i.e.	
  they	
  can	
  be	
  quoted	
  with	
  the	
  stock	
  
exchange.	
  
2. Private	
  limited	
  companies:	
  
a-­‐ They	
  have	
  the	
  abbreviation	
  ‘Ltd’	
  for	
  limited	
  at	
  the	
  end	
  of	
  their	
  names.	
  
b-­‐ They	
  are	
  not	
  allowed	
  to	
  invite	
  general	
  public	
  for	
  the	
  subscription	
  of	
  their	
  share	
  capital.	
  
	
  
COMPANY	
  FINANCE	
  
	
  
As	
  is	
  a	
  case	
  with	
  sole	
  traders	
  and	
  partnerships,	
  companies	
  also	
  have	
  two	
  main	
  sources	
  of	
  finance,	
  
namely;	
  capital	
  and	
  liabilities.	
  The	
  difference	
  is	
  on	
  naming	
  and	
  classification	
  of	
  these	
  terms.	
  
	
  
When	
  the	
  company	
  is	
  formed,	
  it	
  normally	
  issues	
  shares	
  to	
  be	
  subscribed	
  by	
  the	
  potential	
  members.	
  
People	
  who	
  subscribe	
  and	
  buy	
  company’s	
  shares	
  are	
  known	
  as	
  shareholders,	
  and	
  they	
  become	
  the	
  
legal	
  owners	
  of	
  the	
  company	
  depending	
  in	
  the	
  proportion	
  and	
  type	
  of	
  shares	
  they	
  hold.	
  They	
  receive	
  
dividends	
  as	
  return	
  on	
  their	
  invested	
  capital.	
  Dividends	
  are,	
  therefore,	
  appropriations	
  of	
  the	
  profits.	
  
	
  
On	
  the	
  other	
  hand,	
  the	
  company	
  can	
  borrow	
  funds	
  from	
  other	
  people	
  who	
  are	
  not	
  owners.	
  The	
  
main	
  form	
  of	
  company	
  borrowings	
  is	
  by	
  issuing	
  debenture,	
  which	
  is	
  a	
  written	
  acknowledgement	
  of	
  
a	
  loan	
  to	
  a	
  company,	
  given	
  under	
  the	
  company’s	
  seal.	
  The	
  debenture	
  holders	
  are	
  not	
  owners	
  of	
  the	
  
company	
  but	
  they	
  are	
  liabilities.	
  Debenture	
  holders	
  receive	
  a	
  fixed	
  percentage	
  of	
  interest	
  on	
  the	
  loan	
  
amount.	
  Debenture	
  interest	
  is	
  a	
  business	
  expense,	
  which	
  must	
  be	
  paid	
  when	
  is	
  due.	
  Other	
  forms	
  of	
  
borrowings	
  include	
  trade	
  creditors	
  and	
  bank	
  overdrafts.	
  
	
  
The	
  difference	
  between	
  shareholders	
  and	
  debenture	
  holders	
  can	
  be	
  analyzed	
  in	
  terms	
  of:	
  
1. Ownership;	
  and	
  
2. Return	
  on	
  investment	
  (Debenture	
  holders	
  will	
  get	
  it	
  even	
  if	
  the	
  company	
  makes	
  losses)	
  
	
  
SHARE	
  CAPITAL	
  
Share	
  capital	
  is	
  normally	
  of	
  two	
  types:	
  
1. Ordinary	
  share	
  capital;	
  and	
  
2. Preference	
  share	
  capital	
  
	
  
	
  
	
  
	
  
	
  
Their	
  difference	
  is	
  summarized	
  in	
  the	
  table	
  below:	
  
	
  
Aspect	
   Ordinary	
  shares	
   Preference	
  shares	
  
Voting	
  power	
   Carry	
  a	
  vote	
   Limited	
  or	
  no	
  voting	
  power	
  
Dividends	
   1. Vary	
  between	
  one	
  year	
  to	
  
another,	
  depending	
  on	
  the	
  
profit	
  for	
  the	
  period.	
  
2. Rank	
  after	
  preference	
  
shareholders.	
  
3. Not	
  cumulative.	
  
1. Fixed	
  percentage	
  of	
  the	
  nominal	
  
value.	
  
2. Cumulative.	
  If	
  not	
  paid	
  in	
  the	
  
year	
  of	
  low	
  or	
  no	
  profits,	
  it	
  is	
  
carried	
  forward	
  to	
  the	
  next	
  
years.	
  
3. They	
  may	
  be	
  non-­‐cumulative.	
  
Liquidation	
  
(Company	
  closing	
  
down)	
  
Entitled	
  to	
  surplus	
  assets	
  on	
  
liquidation,	
  after	
  all	
  liabilities	
  and	
  
preference	
  shareholders	
  have	
  
been	
  paid.	
  Whatever	
  is	
  left,	
  go	
  to	
  
Ordinary	
  shareholders.	
  
1. Priority	
  of	
  payment	
  before	
  
ordinary	
  shareholders,	
  but	
  after	
  
all	
  other	
  liabilities.	
  
2. Not	
  entitled	
  to	
  surplus	
  assets	
  on	
  
liquidation.	
  
	
  
SHARE	
  CAPITAL	
  STRUCTURE	
  
	
  
Authorized	
  share	
  capital:	
   the	
  maximum	
  share	
  capital	
  that	
  the	
  company	
  is	
  empowered	
  to	
  issue	
  
per	
  its	
  memorandum	
  of	
  association.	
  It	
  is	
  sometimes	
  called	
  as	
  
registered	
  capital.	
  
	
  
Issued	
  share	
  capital:	
   The	
  total	
  nominal	
  value	
  of	
  share	
  capital	
  that	
  has	
  actually	
  been	
  issued	
  
to	
  the	
  shareholders.	
  
	
  
Called-­‐up	
  capital:	
   This	
  is	
  a	
  part	
  of	
  issued	
  capital	
  that	
  the	
  company	
  has	
  already	
  asked	
  
the	
  shareholders	
  to	
  pay.	
  Normally	
  when	
  the	
  company	
  issues	
  shares,	
  
it	
  does	
  not	
  require	
  its	
  shareholders	
  to	
  pay	
  the	
  full	
  price	
  on	
  spot.	
  
Rather	
  it	
  calls	
  the	
  installments	
  from	
  time	
  to	
  time.	
  It	
  is	
  the	
  amount	
  
that	
  is	
  included	
  in	
  the	
  balance	
  sheet.	
  
 
Paid-­‐up	
  capital:	
   This	
  is	
  the	
  total	
  amount	
  of	
  the	
  money	
  already	
  collected	
  from	
  the	
  
shareholders	
  to	
  date.	
  Dividend	
  is	
  paid	
  on	
  this.	
  
	
  
Uncalled	
  capital:	
  	
   This	
  is	
  the	
  part	
  of	
  issued	
  capital,	
  which	
  the	
  company	
  has	
  not	
  yet	
  
requested	
  its	
  shareholders	
  to	
  pay	
  for.	
  
	
  
Dividends:	
   According	
  to	
  the	
  new	
  law,	
  we	
  only	
  subtract	
  the	
  amount	
  of	
  dividends	
  
paid	
  from	
  profit.	
  Dividends	
  which	
  are	
  announced	
  are	
  ignored.	
  
	
  
What	
  is	
  a	
  Debenture?	
  
	
  
A	
  debenture	
  is	
  a	
  document	
  containing	
  details	
  of	
  a	
  loan	
  made	
  to	
  a	
  company.	
  Debentures	
  carry	
  the	
  
right	
  to	
  a	
  fixed	
  rate	
  of	
  interest	
  .	
  They	
  are	
  just	
  treated	
  like	
  long	
  term	
  loans.	
  
	
  
What	
  are	
  the	
  different	
  Types	
  of	
  Preference	
  Shares?	
  
	
  
1. Non-­‐cumulative	
  Preference	
  shares:	
  In	
  case	
  company	
  doesn’t	
  pay	
  enough	
  profits,	
  these	
  
shareholders	
  will	
  get	
  no	
  dividends	
  in	
  the	
  year	
  and	
  that	
  amount	
  of	
  dividend	
  will	
  never	
  be	
  
given.	
  
2. Cumulative	
  Preference	
  Shares:	
  In	
  case	
  company	
  doesn’t	
  have	
  enough	
  profits,	
  these	
  
shareholders	
  will	
  get	
  no	
  dividend	
  in	
  the	
  year	
  and	
  that	
  amount	
  of	
  dividend	
  will	
  be	
  carried	
  
forward	
  to	
  next	
  year,	
  when	
  the	
  company	
  makes	
  enough	
  profit,	
  the	
  entire	
  amount	
  will	
  be	
  
payable	
  as	
  dividend.	
  
3. Participating	
  Preference	
  Shares:	
  These	
  shareholders	
  have	
  limited	
  voting	
  right,	
  i.e.	
  they	
  
can	
  participate	
  in	
  the	
  decision	
  making.	
  
	
  
What	
  is	
  the	
  difference	
  between	
  Debentures	
  and	
  Prefrence	
  Shares?	
  	
  
Debenture	
  is	
  Loan	
  and	
  Prefrence	
  Shares	
  are	
  Capital	
  (Owner)	
  of	
  the	
  Business.	
  Both	
  get	
  fixed	
  rate	
  of	
  
return(	
  that	
  is	
  a	
  similarity)	
  but	
  when	
  no	
  profits	
  are	
  available	
  debenture	
  interest	
  still	
  has	
  to	
  be	
  paid	
  
whereas	
  preference	
  dividend	
  can	
  be	
  saved	
  or	
  carried	
  forward	
  to	
  next	
  year.	
  
	
  
	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  
	
  
	
  
	
  
	
  
	
  
	
  
 	
  	
  GOODWILL	
  
	
  
Goodwill	
  at	
  time	
  of	
  purchasing	
  A	
  business:	
  
This	
  is	
  calculated	
  whenever	
  a	
  business	
  is	
  purchased	
  .	
  The	
  difference	
  between	
  purchase	
  
price	
  and	
  the	
  market	
  value	
  of	
  net	
  assets	
  (assets	
  minus	
  liabilities)	
  acquired.	
  It	
  is	
  the	
  extra	
  
amount	
  which	
  business	
  	
  pays	
  for	
  an	
  existing	
  reputation	
  of	
  the	
  business.	
  It	
  is	
  treated	
  as	
  an	
  
intangible	
  asset	
  (	
  Non	
  current)	
  in	
  the	
  Balance	
  Sheet	
  
Goodwill	
  =	
  Purchase	
  Price	
  	
  minus	
  Net	
  Assets	
  (	
  at	
  market	
  Value)	
  
	
  
Goodwill	
  at	
  the	
  time	
  of	
  merger	
  (	
  formation	
  of	
  partnership)	
  
When	
  two	
  sole	
  traders	
  combine	
  to	
  form	
  a	
  partnership	
  business	
  we	
  also	
  have	
  to	
  treat	
  
goodwill.	
  The	
  partnership	
  will	
  buy	
  both	
  individual	
  sole	
  trader	
  businesses.	
  	
  Any	
  extra	
  
amount	
  placed	
  on	
  their	
  businesses	
  is	
  treated	
  as	
  goodwill	
  they	
  bring	
  into	
  the	
  business.	
  
	
  There	
  are	
  two	
  methods	
  to	
  treat	
  this	
  situation	
  	
  
	
  
Goodwill	
  is	
  kept	
  in	
  the	
  books:	
  The	
  individual	
  goodwill	
  is	
  recorded	
  on	
  the	
  credit	
  side	
  of	
  
partner’s	
  capital	
  account.	
  	
  The	
  total	
  value	
  is	
  then	
  shown	
  in	
  the	
  balance	
  sheet	
  as	
  intangible	
  
non	
  current	
  assets.	
  
	
  
Goodwill	
  is	
  written	
  off:	
  The	
  individual	
  goodwill	
  is	
  recorded	
  on	
  the	
  credit	
  side	
  of	
  partner’s	
  
capital	
  account.	
  	
  The	
  total	
  value	
  is	
  then	
  debited	
  to	
  partners	
  capital	
  accounts	
  in	
  the	
  profit	
  
sharing	
  ratio,	
  this	
  is	
  done	
  to	
  remove	
  goodwill	
  from	
  the	
  balance	
  sheet.	
  	
  
	
  
INVENTORY	
  (WHAT	
  IS	
  NET	
  REALIZABLE	
  VALUE)	
  
This	
  is	
  simply	
  the	
  current	
  market	
  value	
  of	
  goods	
  
The	
  amount	
  of	
  goods	
  left	
  unsold	
  at	
  the	
  end	
  of	
  the	
  year	
  is	
  known	
  as	
  Inventory.	
  When	
  
calculating	
  the	
  value	
  of	
  inventory	
  there	
  is	
  a	
  special	
  rule.	
  If	
  the	
  market	
  value	
  of	
  the	
  inventory	
  
is	
  higher	
  then	
  the	
  price	
  at	
  which	
  we	
  bought	
  it	
  (cost)	
  then	
  we	
  should	
  record	
  inventory	
  at	
  
cost	
  price.	
  But	
  if	
  the	
  market	
  value	
  is	
  lower	
  than	
  the	
  cost	
  price	
  then	
  we	
  should	
  use	
  the	
  
market	
  value.	
  
For	
  Example	
  :	
  I	
  bought	
  an	
  Iphone	
  4	
  with	
  an	
  intention	
  to	
  sell	
  at	
  $400.	
  This	
  is	
  my	
  cost	
  price.	
  If	
  
the	
  phone	
  can	
  be	
  sold	
  in	
  the	
  market	
  for	
  $500	
  in	
  my	
  balance	
  sheet	
  I	
  will	
  still	
  record	
  my	
  
closing	
  inventory	
  at	
  $400	
  cause	
  I	
  bought	
  it	
  for	
  $400	
  and	
  it	
  is	
  still	
  not	
  sold.	
  If	
  I	
  record	
  it	
  at	
  
$500	
  then	
  I	
  would	
  be	
  counting	
  $100	
  profit	
  which	
  I	
  have	
  still	
  not	
  earn.	
  	
  Now	
  consider	
  the	
  
market	
  value	
  of	
  the	
  same	
  phone	
  was	
  $300	
  (	
  because	
  probably	
  iphone	
  5	
  came	
  out),	
  now	
  
whenever	
  I	
  sell	
  it	
  I	
  will	
  have	
  a	
  loss	
  of	
  $100	
  ,	
  this	
  should	
  be	
  reflected	
  in	
  my	
  accounts	
  and	
  I	
  
would	
  show	
  the	
  stock	
  at	
  $300.	
  	
  
So	
  a	
  general	
  rule	
  is	
  whichever	
  is	
  lower	
  (	
  the	
  cost	
  price	
  or	
  market	
  value)	
  stock	
  should	
  be	
  
recorded	
  at	
  that	
  price.	
  
 
ACCOUNTING	
  CONCEPTS	
  
	
  
TABLE/SUMMARY/SNAPSHOT	
  OF	
  ACCOUNTING	
  CONCEPTS/CONVENTION	
  
	
  
Accounting	
  period	
  
Concept	
  
	
  
Also	
  known	
  as	
  Time	
  Period	
  where	
  business	
  operation	
  can	
  be	
  
divided	
  into	
  specific	
  period	
  of	
  time	
  such	
  as	
  month,	
  a	
  quarter	
  or	
  
a	
  year	
  (accounting	
  period)	
  
	
  
Final	
  accounts	
  are	
  prepared	
  at	
  the	
  end	
  of	
  the	
  accounting	
  period,	
  
i.e.	
  one	
  year.	
  Internal	
  accounts	
  can	
  be	
  prepared	
  monthly,	
  
quarterly	
  or	
  half	
  yearly.	
  
	
  
	
  
Accrual	
  Concept	
  /	
  
Matching	
  
	
  
Requires	
  all	
  revenues	
  and	
  expenses	
  to	
  be	
  taken	
  into	
  account	
  for	
  
the	
  period	
  in	
  which	
  they	
  are	
  earned	
  and	
  incurred	
  when	
  
determining	
  the	
  profit	
  /	
  (loss)	
  of	
  the	
  business.	
  The	
  net	
  profit	
  /	
  
(loss)	
  is	
  the	
  difference	
  between	
  the	
  revenue	
  EARNED	
  and	
  the	
  
expenses	
  INCURRED	
  and	
  not	
  the	
  difference	
  between	
  the	
  
revenue	
  RECEIVED	
  and	
  expenses	
  PAID.	
  
	
  
	
  
Business	
  
Entity/Separate	
  Entity	
  
	
  
Also	
  known	
  as	
  Accounting	
  Entity	
  convention	
  which	
  states	
  that	
  
the	
  business	
  is	
  an	
  entity	
  or	
  body	
  separate	
  from	
  its	
  owner.	
  
Therefore	
  business	
  records	
  should	
  be	
  separated	
  and	
  distinct	
  
from	
  personal	
  records	
  of	
  business	
  owner.	
  
	
  
	
  
Consistency	
  Concept	
  
	
  
According	
  to	
  this	
  convention,	
  accounting	
  practices	
  should	
  
remain	
  unchanged	
  from	
  one	
  period	
  to	
  another.	
  For	
  example,	
  if	
  
depreciation	
  is	
  charged	
  on	
  fixed	
  assets	
  according	
  to	
  a	
  particular	
  
method,	
  it	
  should	
  be	
  done	
  year	
  after	
  year.	
  This	
  is	
  necessary	
  for	
  
purpose	
  of	
  comparison.	
  
 
	
  
Dual	
  Aspect	
  Concept	
  
	
  
Double	
  entry	
  system.	
  For	
  every	
  debit,	
  there	
  is	
  a	
  credit	
  entry	
  of	
  
an	
  equal	
  amount.	
  
	
  
	
  
Going	
  Concern	
  Concept	
  
	
  
The	
  business	
  will	
  follow	
  accounting	
  concepts	
  and	
  methods	
  on	
  
the	
  assumption	
  that	
  business	
  will	
  continue	
  its	
  operation	
  to	
  the	
  
foreseeable	
  future	
  or	
  for	
  an	
  indefinite	
  period	
  of	
  time.	
  
	
  
	
  
Historical	
  Cost	
  Concept	
  
	
  
Business	
  should	
  report	
  its	
  activities	
  or	
  economic	
  events	
  at	
  their	
  
actual	
  costs.	
  For	
  example,	
  fixed	
  assets	
  are	
  recorded	
  at	
  their	
  cost	
  
in	
  account	
  except	
  for	
  land	
  which	
  can	
  be	
  revalued	
  due	
  to	
  
appreciation	
  
	
  
	
  
Materiality	
  Concept	
  
	
  
The	
  accountant	
  should	
  attach	
  importance	
  to	
  material	
  details	
  
and	
  ignore	
  insignificant	
  details	
  otherwise	
  accounting	
  will	
  be	
  
burdened	
  with	
  minute	
  details.	
  Only	
  items	
  that	
  are	
  deemed	
  
significant	
  for	
  a	
  given	
  size	
  of	
  operation.	
  
	
  
	
  
Money	
  Measurement	
  
Concept	
  
	
  
Also	
  known	
  as	
  Monetary	
  unit.	
  Transactions	
  related	
  to	
  the	
  
business,	
  and	
  having	
  money	
  value	
  are	
  recorded	
  in	
  the	
  books	
  of	
  
accounts.	
  Events	
  or	
  transactions	
  which	
  cannot	
  be	
  expressed	
  in	
  
term	
  of	
  money	
  do	
  not	
  find	
  a	
  place	
  in	
  the	
  books	
  of	
  accounts.	
  
	
  
	
  
Prudence	
  /	
  
Conservatism	
  Concept	
  
	
  
Take	
  into	
  account	
  unrealized	
  losses,	
  not	
  unrealized	
  
profits/gains.	
  Assets	
  should	
  not	
  be	
  over-­‐valued,	
  liabilities	
  
under-­‐valued.	
  Provisions	
  are	
  example	
  of	
  prudence	
  or	
  
conservatism	
  concept.	
  Also	
  under	
  this	
  prudence/conservatism	
  
concept,	
  stock/inventory	
  is	
  value	
  at	
  lower	
  of	
  cost	
  or	
  market	
  
value.	
  This	
  concept	
  guides	
  accountants	
  to	
  choose	
  option	
  that	
  
minimize	
  the	
  possibility	
  of	
  overstating	
  an	
  asset	
  or	
  income.	
  
	
  
	
  
	
  
	
  
	
  
	
  
	
  
	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  WORKING	
  CAPITAL	
  
	
  
	
  
What	
  is	
  meant	
  by	
  working	
  capital?	
  
It	
  is	
  the	
  money	
  required	
  to	
  meet	
  its	
  every	
  day	
  expenses.	
  It	
  can	
  be	
  calculated	
  by	
  taking	
  the	
  
difference	
  between	
  current	
  assets	
  and	
  current	
  liabilities.	
  	
  It	
  is	
  very	
  important	
  to	
  have	
  
enough	
  working	
  capital	
  to	
  survive	
  in	
  the	
  short	
  run.	
  
	
  
What	
  are	
  the	
  effects	
  of	
  not	
  having	
  enough	
  working	
  capital?	
  
(i)	
  	
  Problems	
  in	
  meeting	
  debts	
  as	
  they	
  fall	
  due.	
  	
  
(ii)	
  	
  Inability	
  to	
  take	
  advantage	
  of	
  cash	
  discount.	
  	
  
(iii)	
  	
  Difficulty	
  in	
  obtaining	
  further	
  supplies.	
  	
  
	
  	
  	
  	
  	
  	
  	
  (iv)	
  	
  Inability	
  to	
  take	
  advantage	
  of	
  business	
  opportunity	
  	
  	
  as	
  they	
  arise.	
  	
  
	
  
What	
  are	
  	
  ways	
  of	
  improving	
  working	
  capital.	
  
	
  	
  	
  	
  	
  	
  	
  	
  (i)Introduction	
  of	
  further	
  capital.	
  
(ii)	
  	
  Obtaining	
  long-­‐term	
  loan.	
  	
  
(iii)	
  	
  Reducing	
  owners	
  drawings.	
  	
  
(iv)	
  	
  Selling	
  out	
  useless	
  fixed	
  assets.	
  	
  
 
RATIOS	
  
	
  
PROFITABILITY	
  
	
  
GROSS	
  PROFIT	
  MARGIN	
   	
   	
   (	
   Gross	
  Profit	
  x	
  	
  	
  100	
   )	
  
	
   	
   	
   	
   	
   	
   	
   	
  	
  Net	
  Sales	
  
While	
  the	
  gross	
  profit	
  is	
  a	
  dollar	
  amount,	
  the	
  gross	
  profit	
  margin	
  is	
  expressed	
  as	
  a	
  percentage	
  of	
  net	
  
sales.	
  The	
  Gross	
  Profit	
  Margin	
  illustrates	
  the	
  profit	
  a	
  company	
  makes	
  after	
  paying	
  off	
  its	
  Cost	
  of	
  
Goods	
  sold.	
  The	
  Gross	
  Profit	
  Margin	
  shows	
  how	
  efficient	
  the	
  management	
  is	
  in	
  using	
  its	
  labour	
  and	
  
raw	
  materials	
  in	
  the	
  process	
  of	
  production	
  (In	
  case	
  of	
  a	
  trader,	
  how	
  efficient	
  the	
  management	
  is	
  in	
  
purchasing	
  the	
  good).	
  There	
  are	
  two	
  key	
  ways	
  for	
  you	
  to	
  improve	
  your	
  gross	
  profit	
  margin.	
  First,	
  
you	
  can	
  increase	
  your	
  process.	
  Second,	
  you	
  can	
  decrease	
  the	
  costs	
  of	
  the	
  goods.	
  Once	
  you	
  calculate	
  
the	
  gross	
  profit	
  margin	
  of	
  a	
  firm,	
  compare	
  it	
  with	
  industry	
  standards	
  or	
  with	
  the	
  ratio	
  of	
  last	
  year.	
  
For	
  example,	
  it	
  does	
  not	
  make	
  sense	
  to	
  compare	
  the	
  profit	
  margin	
  of	
  a	
  software	
  company	
  (typically	
  
90%)	
  with	
  that	
  of	
  an	
  airline	
  company	
  (5%).	
  
	
  
Reasons	
  for	
  this	
  ratio	
  to	
  go	
  UP	
  (opposite	
  for	
  down)	
  
1. Increase	
  in	
  selling	
  price	
  per	
  unit	
  
2. Decrease	
  in	
  purchase	
  price	
  per	
  unit	
  due	
  to	
  lower	
  quality	
  of	
  goods	
  or	
  a	
  different	
  supplier.	
  
3. Decrease	
  in	
  purchase	
  price	
  per	
  unit	
  due	
  to	
  bulk	
  (trade)	
  discounts.	
  
4. Extensive	
  advertising	
  raising	
  sales	
  volume	
  (units)	
  along	
  with	
  selling	
  price.	
  
5. Understatement	
  of	
  opening	
  stock.	
  
6. Overstatement	
  of	
  closing	
  stock.	
  
7. Decrease	
  in	
  carriage	
  inwards/Duties	
  (trading	
  expenses)	
  
8. Change	
  in	
  Sales	
  Mix	
  (maybe	
  we	
  are	
  selling	
  some	
  new	
  products	
  which	
  give	
  a	
  higher	
  margin).	
  
	
  
NET	
  PROFIT	
  MARGIN	
   	
   	
   (	
   Net	
  Profit	
   x	
  	
  	
  100	
   )	
  
	
   	
   	
   	
   	
   	
   	
   	
  Net	
  Sales	
  
Net	
  profit	
  margin	
  tells	
  you	
  exactly	
  how	
  the	
  management	
  and	
  operations	
  of	
  a	
  business	
  are	
  
performing.	
  Net	
  Profit	
  Margin	
  compares	
  the	
  net	
  profit	
  of	
  a	
  firm	
  with	
  total	
  sales	
  achieved.	
  The	
  main	
  
difference	
  between	
  GP	
  Margin	
  and	
  NP	
  Margin	
  are	
  the	
  overhead	
  expenses	
  (Expenses	
  and	
  loss).	
  In	
  
some	
  businesses	
  Gross	
  Margin	
  is	
  very	
  high	
  but	
  Net	
  Margin	
  is	
  low	
  due	
  to	
  high	
  expenses,	
  e.g.	
  
Software	
  Company	
  will	
  have	
  high	
  Research	
  expenses.	
  
	
  
Reasons	
  for	
  this	
  ratio	
  to	
  go	
  UP	
  (opposite	
  for	
  down)	
  
All	
  the	
  reasons	
  for	
  GP	
  margin	
  apply	
  here.	
  Additionally	
  
1. Increase	
  in	
  cash	
  discounts	
  from	
  suppliers	
  
2. A	
  decrease	
  in	
  overhead	
  expenses	
  
3. Increase	
  in	
  other	
  incomes	
  like	
  gain	
  on	
  disposal,	
  Rent	
  Received	
  etc.	
  
 
Return	
  on	
  Capital	
  Employed	
  (ROCE)	
  	
  
	
  
This	
  is	
  the	
  key	
  profitability	
  ratio	
  since	
  it	
  calculates	
  return	
  on	
  amount	
  invested	
  in	
  the	
  business.	
  If	
  this	
  
ratio	
  is	
  high,	
  this	
  means	
  more	
  profitability	
  (In	
  exam	
  if	
  ROCE	
  is	
  higher	
  for	
  any	
  firm	
  it	
  is	
  better	
  than	
  
the	
  other	
  firm	
  irrespective	
  of	
  GP	
  and	
  NP	
  Margin).	
  This	
  return	
  is	
  important	
  as	
  it	
  can	
  be	
  compared	
  to	
  
other	
  businesses	
  and	
  potential	
  investment	
  or	
  even	
  the	
  Interest	
  rate	
  offered	
  by	
  the	
  bank.	
  If	
  ROCE	
  is	
  
lower	
  than	
  the	
  bank	
  interest	
  then	
  the	
  owner	
  should	
  shoot	
  himself.	
  This	
  ratio	
  can	
  go	
  up	
  if	
  profits	
  
increase	
  and	
  capital	
  employed	
  remains	
  the	
  same.	
  Also	
  if	
  Capital	
  employed	
  decreases,	
  this	
  ratio	
  
might	
  go	
  up.	
  
	
  
	
   	
  	
  Net	
  Profit	
  	
  	
  x	
   100	
  
	
   	
  Capital	
  Employed	
  
	
   	
   	
   	
   	
  	
  
	
  
	
  
	
   Capital	
  Employed	
  	
   =	
  Fixed	
  Assets	
  +	
  Current	
  Assets	
  –	
  Current	
  
Liabilities	
  
	
  
	
   OR	
  
	
  
=	
  Ordinary	
  Share	
  Capital	
  +	
  Preference	
  Share	
  Capital	
  +	
  
	
   Reserves	
  +	
  Long-­‐term	
  Liabilities	
  
	
  
LIQUIDITY	
  	
  
	
  
As	
  we	
  know	
  a	
  firm	
  has	
  to	
  have	
  different	
  liquidity.	
  In	
  other	
  words	
  they	
  have	
  to	
  be	
  able	
  to	
  meet	
  their	
  
day	
  to	
  day	
  payments.	
  It	
  is	
  no	
  good	
  having	
  your	
  money	
  tied	
  up	
  or	
  invested	
  so	
  that	
  you	
  haven’t	
  
enough	
  money	
  to	
  meet	
  your	
  bills!	
  Current	
  assets	
  and	
  liabilities	
  are	
  an	
  important	
  part	
  of	
  this	
  
liquidity	
  and	
  so	
  to	
  measure	
  the	
  firms	
  liquidity	
  situation	
  we	
  can	
  work	
  out	
  a	
  ratio.	
  The	
  current	
  ratio	
  is	
  
worked	
  out	
  by	
  dividing	
  the	
  current	
  assets	
  by	
  the	
  current	
  liabilities.	
  
	
  
CURRENT	
  RATIO	
   =	
   	
  	
  	
  Current	
  assets	
  _	
  
	
   	
   	
   	
   Current	
  liabilities	
  
	
  
The	
  figure	
  should	
  always	
  be	
  above	
  1	
  or	
  the	
  form	
  does	
  not	
  have	
  enough	
  assets	
  to	
  meet	
  its	
  liabilities	
  
and	
  is	
  therefore	
  technically	
  insolvent.	
  However,	
  a	
  figure	
  close	
  to	
  1	
  would	
  be	
  a	
  little	
  close	
  for	
  a	
  firm	
  
as	
  they	
  would	
  only	
  just	
  be	
  able	
  to	
  meet	
  their	
  liabilities	
  and	
  so	
  a	
  figure	
  of	
  between	
  1.5	
  and	
  2	
  is	
  
generally	
  considered	
  being	
  desirable.	
  A	
  figure	
  of	
  2	
  means	
  that	
  they	
  can	
  meet	
  their	
  liabilities	
  twice	
  
over	
  and	
  so	
  is	
  safe	
  for	
  them.	
  If	
  the	
  figure	
  is	
  any	
  bigger	
  than	
  this	
  then	
  the	
  firm	
  may	
  be	
  tying	
  too	
  much	
  
of	
  their	
  money	
  in	
  a	
  form	
  that	
  is	
  not	
  earning	
  them	
  anything.	
  If	
  the	
  current	
  ratio	
  is	
  bigger	
  than	
  2	
  they	
  
should	
  therefore	
  perhaps	
  consider	
  investing	
  some	
  for	
  a	
  longer	
  period	
  to	
  earn	
  them	
  more.	
  
	
  
However,	
  the	
  current	
  assets	
  also	
  include	
  the	
  firm’s	
  stock.	
  If	
  the	
  firm	
  has	
  a	
  high	
  level	
  of	
  stock,	
  it	
  may	
  
mean	
  one	
  of	
  the	
  two	
  things,	
  
1. Sales	
  are	
  booming	
  and	
  they’re	
  producing	
  a	
  lot	
  to	
  keep	
  up	
  with	
  demand.	
  
2. They	
  can’t	
  sell	
  all	
  they’re	
  producing	
  and	
  it’s	
  piling	
  up	
  in	
  the	
  warehouse!	
  
	
  
If	
  the	
  second	
  of	
  these	
  is	
  true	
  then	
  stock	
  may	
  not	
  be	
  a	
  very	
  useful	
  current	
  asset,	
  and	
  even	
  if	
  they	
  
could	
  sell	
  it	
  isn’t	
  as	
  liquid	
  as	
  cash	
  in	
  the	
  bank,	
  and	
  so	
  a	
  better	
  measure	
  of	
  liquidity	
  is	
  the	
  ACID	
  
TEST	
  (or	
  QUICK)	
  RATIO.	
  This	
  excludes	
  stock	
  from	
  the	
  current	
  assets,	
  but	
  is	
  otherwise	
  the	
  same	
  
as	
  the	
  current	
  ratio.	
  
	
  
ACID	
  TEST	
  RATIO	
   =	
   Current	
  assets	
  –	
  stock	
  
	
   	
   	
   	
   	
  	
  	
  	
  Current	
  liabilities	
  
	
  
Ideally	
  this	
  figure	
  should	
  also	
  be	
  above	
  1	
  for	
  the	
  firm	
  to	
  be	
  comfortable.	
  That	
  would	
  mean	
  that	
  they	
  
can	
  meet	
  all	
  their	
  liabilities	
  without	
  having	
  to	
  pay	
  any	
  of	
  their	
  stock.	
  This	
  would	
  make	
  potential	
  
investors	
  feel	
  more	
  comfortable	
  about	
  their	
  liquidity.	
  If	
  the	
  figure	
  is	
  far	
  below	
  1,	
  they	
  may	
  begin	
  to	
  
get	
  worried	
  about	
  their	
  firm’s	
  ability	
  to	
  meet	
  its	
  debts.	
  
	
  
	
  
Rate	
  of	
  Stock	
  Turnover	
  
	
  
It	
  shows	
  the	
  number	
  of	
  times,	
  on	
  average,	
  that	
  the	
  business	
  will	
  sell	
  its	
  stock	
  in	
  a	
  given	
  period	
  of	
  
time.	
  It	
  basically	
  gives	
  an	
  indication	
  of	
  how	
  well	
  the	
  stock	
  has	
  been	
  managed.	
  A	
  high	
  ratio	
  is	
  
desirable	
  because	
  the	
  quicker	
  the	
  stock	
  is	
  turned	
  over,	
  more	
  profit	
  can	
  be	
  generated.	
  A	
  low	
  ratio	
  
indicates	
  that	
  stocks	
  are	
  kept	
  for	
  a	
  longer	
  period	
  of	
  time	
  (which	
  is	
  not	
  good).	
  
	
  
	
   	
   Cost	
  of	
  Goods	
  Sold	
   	
   =	
   ____	
  Times	
  
	
   	
   	
  	
  	
  	
  Average	
  Stock	
  
	
  
	
  
Advantages	
  of	
  Ratios	
  
1. Shows	
  a	
  trend	
  
2. Helps	
  to	
  compare	
  a	
  single	
  firm	
  over	
  a	
  two	
  years	
  (time	
  –	
  series)	
  
3. Helps	
  to	
  compare	
  to	
  similar	
  firms	
  over	
  a	
  particular	
  year.	
  
4. Helps	
  in	
  making	
  decisions	
  
	
  
Disadvantages	
  (Limitations):	
  
1. A	
  ratio	
  on	
  its	
  own	
  is	
  isolated	
  (We	
  need	
  to	
  compare	
  it	
  with	
  some	
  figures)	
  
2. Depends	
  upon	
  the	
  reliability	
  of	
  the	
  information	
  from	
  which	
  ratios	
  are	
  calculated.	
  
3. Different	
  industries	
  will	
  have	
  different	
  ideal	
  ratios.	
  
4. Different	
  companies	
  have	
  different	
  accounting	
  policies.	
  E.g.	
  Method	
  of	
  depreciation	
  used.	
  
5. Ratios	
  do	
  not	
  take	
  inflation	
  into	
  account.	
  
6. Ratios	
  can	
  ever	
  simplify	
  a	
  situation	
  so	
  can	
  be	
  misleading.	
  
7. Outside	
  influences	
  can	
  affect	
  ratios	
  e.g.	
  world	
  economy,	
  trade	
  cycles.	
  
8. After	
  calculating	
  ratios	
  we	
  still	
  have	
  to	
  analyze	
  them	
  in	
  order	
  to	
  derive	
  a	
  conclusion.	
  
	
  
How	
  to	
  Comment:	
  
Usually	
  in	
  CIE	
  they	
  assign	
  2	
  marks	
  for	
  comment	
  on	
  each	
  ratio.	
  One	
  mark	
  is	
  for	
  indicating	
  if	
  the	
  ratio	
  
is	
  better	
  or	
  worse	
  (not	
  higher	
  or	
  lower).	
  The	
  second	
  mark	
  is	
  to	
  explain	
  the	
  importance	
  or	
  the	
  
reason	
  of	
  the	
  change	
  in	
  ratio.	
  For	
  e.g.	
  If	
  Gross	
  Profit	
  Margin	
  was	
  40%	
  and	
  now	
  its	
  50%,	
  you	
  should	
  
say	
  that	
  the	
  Gross	
  profit	
  Margin	
  has	
  improved	
  (rather	
  than	
  increased)	
  and	
  this	
  may	
  be	
  due	
  to	
  an	
  
increase	
  in	
  selling	
  price	
  or	
  a	
  decrease	
  in	
  cost	
  of	
  goods	
  sold	
  (depending	
  upon	
  the	
  question).	
  
	
  
Also	
  remember	
  that	
  the	
  liquidity	
  ratios	
  should	
  be	
  close	
  to	
  industry	
  average.	
  Too	
  less	
  or	
  too	
  much	
  
liquidity	
  is	
  bad!	
  
	
  
At	
  the	
  end	
  of	
  your	
  answer,	
  always	
  give	
  a	
  conclusion	
  
• When	
  comparing	
  a	
  single	
  firm	
  over	
  two	
  years	
  then	
  do	
  mention	
  performance	
  of	
  which	
  year	
  
is	
  better.	
  (In	
  terms	
  of	
  profitability	
  and	
  liquidity)	
  
• When	
  comparing	
  two	
  different	
  firms	
  over	
  the	
  same	
  year	
  do	
  mention	
  performance	
  of	
  which	
  
firm	
  is	
  better.	
  (In	
  terms	
  of	
  profitability	
  and	
  liquidity).	
  
	
  
	
  
If	
  the	
  question	
  says	
  evaluate	
  profitability	
  then	
  use	
  (GP	
  Margin,	
  NP	
  Margin	
  and	
  ROCE)	
  
	
  
If	
  the	
  question	
  says	
  evaluate	
  liquidity,	
  use	
  (Current	
  Ratio,	
  Acid	
  Test	
  and	
  Rate	
  of	
  Stock	
  Turnover)	
  	
  
	
  
If	
  the	
  question	
  says	
  evaluate	
  the	
  performance	
  it	
  means	
  both	
  profitability	
  and	
  liquidity.	
  
	
  
	
  
	
  
	
  	
  	
  
	
  
	
  
DEPARTMENTAL	
  ACCOUNTS	
  
Departmental	
  Accounts	
  are	
  the	
  accounts	
  that	
  through	
  light	
  not	
  only	
  on	
  the	
  trading	
  result	
  of	
  the	
  
business	
  as	
  a	
  whole	
  but	
  also	
  on	
  the	
  trading	
  result	
  of	
  each	
  department	
  individually.	
  
Reasons	
  Or	
  Advantages	
  Of	
  Making	
  Departmental	
  Accounts:	
  OR	
  
Reasons	
  To	
  Know	
  The	
  Result	
  Of	
  Each	
  Department:	
  
It	
  lets	
  us	
  know	
  the	
  expenses	
  and	
  incomes	
  of	
  each	
  department	
  clearly	
  at	
  one	
  place.	
  	
  
It	
  helps	
  us	
  to	
  compare	
  the	
  results	
  i.e.	
  G.P	
  or	
  N.P	
  of	
  one	
  department	
  with	
  the	
  other.	
  	
  
It	
  helps	
  us	
  to	
  formulate	
  policies	
  in	
  order	
  to	
  develop	
  the	
  business	
  on	
  proper	
  lines.	
  	
  
	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  To	
  decide	
  whether	
  to	
  drop	
  or	
  start	
  a	
  new	
  department.	
  	
  
	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  It	
  helps	
  us	
  to	
  reward	
  the	
  departmental	
  managers.	
  	
  
Things	
  to	
  be	
  considered	
  before	
  closing	
  a	
  department:	
  
. Consider	
  all	
  possible	
  means	
  to	
  improve	
  the	
  department.	
  	
  
. The	
  methods	
  used	
  to	
  apportion	
  the	
  expenses	
  should	
  be	
  studied	
  to	
  see	
  if	
  they	
  are	
  	
  in	
  fact	
  the	
  
fairest	
  methods.	
  	
  
. The	
  effect	
  of	
  the	
  closure	
  of	
  one	
  department	
  on	
  the	
  other	
  department	
  should	
  be	
  
	
  investigated.	
  	
  
. The	
  attractive	
  uses	
  of	
  the	
  space	
  becoming	
  available	
  need	
  to	
  be	
  considered.	
  	
  
. Non-­‐Monetary	
  factors	
  such	
  as	
  staff	
  morale	
  and	
  the	
  effect	
  on	
  supplies	
  and	
  	
  customers	
  faith	
  is	
  
also	
  to	
  be	
  considered.	
  	
  
MANUFACTURING ACCOUNT
. Manufacturing businesses prepare manufacturing account in addition to the usual final
Accounts. Manufacturing account shows how much does it cost the business to
manufacture the goods in a financial year.
. Cost Of Raw Material Consumed: It is the value of Raw material used in production. It
consist of net purchases of Raw Material, carriage on raw material opening stock of raw
material closing stock of Raw material.
. Prime Cost: It is the basic cost of manufacturing the goods. It consists of direct raw
material direct labour and direct expenses.
. Production Cost: It is the total cost of manufacturing the goods. It consist of prime cost
plus factory expenses, and it is after any adjustment for work-in- progress.
. Work-in-progress: These are the goods which are partly made, but which are not yet
completed are known as work-in-progress.
	
  
	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  
	
  
	
  
	
  
	
  
	
  
	
  
	
  
	
  
The	
  Impact	
  of	
  ICT	
  in	
  Accounting:	
  
ICT	
  can	
  be	
  used	
  in	
  accounting	
  for	
  keeping	
  and	
  updating	
  the	
  double	
  entry	
  system,	
  stock	
  
records,	
  debtor	
  analysis	
  and	
  the	
  preparation	
  of	
  budgets.	
  
Benefits:	
  
·	
  	
  Greater	
  accuracy-­‐automatic	
  and	
  error	
  free	
  	
  
·	
  	
  Greater	
  speed	
  	
  
·	
  	
  Improved	
  accessibility	
  	
  
More	
  information	
  available	
  	
  
·	
  	
  Cuts	
  in	
  staff	
  costs	
  	
  
	
  Drawbacks:	
  	
  
	
  	
  Capital	
  expenditure-­‐cost	
  of	
  machines	
  and	
  software.	
  Economic	
  life	
  can	
  be	
  quite	
  short	
  	
  
. ·	
  	
  Training	
  costs-­‐of	
  training	
  the	
  staff	
  to	
  use	
  the	
  equipment	
  	
  
. 	
  Staff	
  morale	
  could	
  be	
  lowered	
  	
  
·	
  	
  Risk	
  of	
  data	
  loss	
  and	
  security	
  breaches	
  can	
  be	
  vulnerable	
  to	
  crashes,	
  	
  viruses	
  and	
  hacking.	
  
	
  
	
  
	
  
	
  
	
  
	
  
	
  
	
  
	
  
	
  
 	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  PAYROLL	
  DOCUMENTATION	
  
PAYE	
  SYSTEM:	
  
The	
  Pay	
  As	
  you	
  Earn	
  system	
  means	
  tax	
  and	
  other	
  deductions	
  are	
  subtracted	
  by	
  the	
  
employer	
  at	
  source	
  	
  and	
  only	
  net	
  pay	
  is	
  paid	
  to	
  the	
  worker.	
  	
  
CLOCK	
  CARD	
  
• Employee	
  inserts	
  a	
  card	
  into	
  a	
  time	
  recording	
  clock	
  to	
  record	
  the	
  start	
  and	
  finish	
  
time	
  for	
  each	
  working	
  session	
  
• Payroll	
   department	
   can	
   calculate	
   the	
   number	
   of	
   basic	
   hours	
   and	
   the	
   number	
   of	
  
overtime	
  hours	
  for	
  each	
  day	
  
• Payroll	
  department	
  can	
  calculate	
  the	
  total	
  basic	
  hours	
  and	
  total	
  overtime	
  hours	
  for	
  
each	
  week	
  
• Payroll	
  department	
  can	
  calculate	
  total	
  gross	
  pay	
  
	
  
TIME	
  SHEET	
  
The	
  sheet	
  contains	
  a	
  breakdown	
  of	
  working	
  details	
  for	
  each	
  day,	
  the	
  employee	
  manually	
  
records	
  the	
  start	
  and	
  finish	
  time	
  for	
  each	
  session,	
  including	
  a	
  reference	
  to	
  the	
  time	
  spend	
  
on	
  each	
  job	
  
Payroll	
  department	
  can	
  calculate	
  the	
  same	
  as	
  above.	
  
The	
  payroll	
  department	
  can	
  cost	
  labour	
  hours	
  to	
  be	
  charged	
  to	
  specific	
  job	
  
PAYSLIPS	
  
An	
  employee	
  has	
  a	
  legal	
  right	
  to	
  receive	
  a	
  payslip.	
  It	
  is	
  given	
  to	
  the	
  employee	
  when	
  wages	
  
are	
  received,	
  or	
  sent	
  to	
  employee	
  if	
  wages	
  are	
  paid	
  by	
  direct	
  debit.	
  
The	
  payslip	
  is	
  used	
  to	
  inform	
  the	
  employee	
  of	
  pay	
  details,	
  including:	
  
• Gross	
  pay	
  
	
  
• Details	
  of	
  deductions	
  made	
  
	
  
• Net	
  pay	
  
	
  
• Employee	
  number	
  
	
  
• Tax	
  code	
  number/	
  National	
  insurance	
  number	
  
	
  
 
PAYROLL	
  REGISTER	
  
	
  
List	
  of	
  all	
  employees	
  kept	
  by	
  the	
  payroll	
  department,	
  containing	
  personal	
  data	
  and	
  pay	
  
details	
  which	
  included:	
  
Employee	
  number	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  Salary	
  
	
  
Job	
  title	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  Tax	
  code	
  
	
  
Employee	
  name	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  National	
  insurance	
  number	
  
	
  
Address	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  Voluntary	
  deductions	
  
	
  
Telephone	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  Starting	
  date	
  
	
  
Date	
  of	
  birth	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  Leaving	
  date	
  
	
  
The	
  information	
  is	
  for	
  reference,	
  and	
  details	
  may	
  be	
  kept	
  on	
  individual	
  employee	
  record	
  
card.	
  
WAGES	
  SHEET	
  	
  (also	
  wages	
  book,	
  and	
  weekly	
  payroll)	
  
nformation	
  from	
  each	
  employee’s	
  individual	
  payslip	
  is	
  listed	
  on	
  a	
  sheet,	
  showing	
  the	
  gross	
  
pay,	
  tax	
  and	
  NIC,	
  other	
  deductions	
  and	
  net	
  pay	
  
Each	
  column	
  is	
  totalled	
  for	
  the	
  week	
  
Is	
  used	
  to	
  reconcile	
  the	
  gross	
  pay	
  and	
  the	
  net	
  pay	
  paid	
  
	
  
	
  
	
  
Olevel Accounting Notes
Olevel Accounting Notes
Olevel Accounting Notes
Olevel Accounting Notes

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Olevel Accounting Notes

  • 1.                                                    ACCOUNTING  CYCLE       The  Accounting  Cycle  is  a  series  of  steps,  which  are  repeated  every  reporting  period.   The  process  starts  with  making  accounting  entries  for  each  transaction  and  goes   through  closing  the  books.  This  Involves  recording  transactions  in  the  daybooks,   posting  them  to  ledger,  extracting  a  trial  balance  and  finally  drawing  up  financial   statements.     Step  1:    Recording  Transactions  in  Daybooks     Each  transaction  is  recorded  first  in  one  of  the  following  daybook  (  book  of  original   entry)  according  to  the  nature  of  the  transaction.     1.  All  goods  sold  on  Credit  (  Credit  Sales)          ….>  Sales  Daybook   2.  All  goods  purchased  on  Credit  (Credit  Purchases)  ….>  Purchases  Daybook   3.  All  goods  sold  on  credit  but  now  returned  by  costumers  ..>  Sales  Return  (Inwards)   Daybook   4.  All  goods  purchased  on  credit  but  now  returned  to  suppliers…>  Purchases  Return   Daybook     The  above  four  daybooks  only  record  credit  transactions  related  to  movement  in   inventory.  There  are  no  accounts  maintained  inside  the  daybooks.  It  Just  contains   Date,  Name,  Source  document  number  and  Amount.     5.  All  transactions  which  relate  to  receipts  and  payments  through  cash  or  cheque  ..>   Cashbook     Cash  and  Bank  accounts  are  made  inside  the  cashbook  hence  it  also  serves  the   purpose  of  ledger.     6.  All  other  transactions  …..>  General  Journal          In  this  we  actually  write  the  double  entry  of  only  those  transactions  which  cannot  be   recorded  in  the  above  five  daybooks.  To  name  a  few   -­‐ Non  Current  Assets  Purchased  or  Sold  on  Credit   -­‐ Writing  off  Bad  debts   -­‐ Entries  for  Provisions  of  doubtful  debts  and  depreciation   -­‐ Adjustments  for  Prepaid  and  Owings   -­‐ Correction  of  Errors    
  • 2.         Step  2:  Posting  Transactions  In  Ledgers     A  ledger  is  a  book  which  contains  accounts  (  the  actual  T  Accounts  guys).  There  are  three   types  of  Ledgers.  In  each  type  we  have  different  type  of  accounts.     Advantages  Of  Dividing  The  Ledger:   1. It  facilitates  division  of  labour  in  the  maintenance  of  ledger.     2. It  becomes  easy  to  locate  errors  in  ledger  accounts.     3. It  helps  the  ledger  clerks  to  complete  their  respective  work  in  time  with    perfection.     4. It  becomes  easy  to  refer  to  any  particular  account.         Sales  Ledger:  This  contains  accounts  of  credit  costumers  (  people  to  who  we  sell  goods  on   credit)  –  Trader  Receivables        At  the  end  of  the  year  all  the  account  balances  in  the  sales  ledger  are  listed  in  a  schedule   which  is  called  list  of  Trade  receivables.  This  shows  the  individual  account  balances(   closing)  and  also  the  total  debtors  which  goes  into  the  trail  balance.        Purchase  Ledger:  This  contains  accounts  of  credit  suppliers  (  people  from  whom  we  buy   goods  on  credit)  –  Trader  Payables     At  the  end  of  the  year  all  the  account  balances  in  the  purchase  ledger  are  listed  in  a  schedule   which  is  called  list  of  Trade  Payables.  This  shows  the  individual  account  balances(  closing)   and  also  the  total  creditors  which  goes  into  the  trail  balance.         General  Ledger:  This  contains  all  the  other  accounts.  Like  all  expenses  ,incomes  ,provisions   (literally  all  other  accounts)     Please  remember  Sales  and  Purchases  accounts  are  in  the  General  Ledger  cause  they  are  not   our  costumers  or  suppliers  .       Once  all  the  transactions  are  posted  all  the  accounts  are  balanced  via  inserting  a  balance  C/d   in  all  accounts.  
  • 3.   Step  3  :  Extracting  a  Trial  Balance     All  the  closing  balances  in  the  General  Ledger  along  with  the  figure  of  total  trade  receivables   and  payables  are  listed  in  a  trail  balance.  Debit  balances  and  Credit  Balances  are  listed   separately  side  by  side.  The  Sum  of  all  Debits  should  be  equal  to  sum  of  all  credit  balances.   The  trail  balances  is  used  to  check  the  completion  of  the  double  entry.  The  trail  balance  will   balance  because     -­‐ For  each  debit  entry  there  is  a  credit  entry  (  vice  versa)   -­‐ The  sum  of  all  debit  entries  is  equal  to  the  sum  of  credit  entries             Step  4:  Closing  Entries  with  Year  end  Adjustments  (  Details  in  following  pages)     After  making  the  trail  balance  we  also  have  to  adjust  for  certain  items.  Remember  only   Incomes  and  Expenses  are  taken  into  account  while  calculating  profit.  These  accounts  are   closed  by  transferring  them  to  the  income  statement  (  the  Profit  and  Loss  Account).  This   process  is  called  Closing  Entries.   Some  common  adjustments  are   -­‐ Expenses  and  Incomes  are  adjusted  for  prepaid  (advance)  and  accruals(Owings)   -­‐ Non  Current  Assets  are  depreciated     -­‐ Provision  for  doubtful  debt  is  adjusted   -­‐ Closing  inventory  is  valued  by  physical  stock  take  and  it  is  adjusted  in   calculating  cost  of  goods  sold  and  also  for  Balance  Sheet   -­‐ Adjustments  for  goods  withdrawn  by  owner  or  Stock  Losses     Step  5  :  Final  Accounts:   An  income  statement    (  Trading  Account  till  Gross  Profit  and  Profit  and  Loss  Account  tiill  Net   Profit)  and  Balance  Sheet  is  drawn  which  ends  the  Accounting  Cycle.  Now  by  looking  at   Income  Statement  owner  can  check  his  Profit  and  by  looking  at  the  Balance  Sheet  he  can   check  his  Net  worth  of  the  Business.     BUSINESS  DOCUMENTS     1.  Invoice:  Whenever  there  is  a  credit  sale,  the  selling  business  will  send  a  document  to   buyer  showing  full  details  of  the  goods  sold.  This  document  is  called  as  Invoice.  It  is  known   to  the  buyer  as  a  “Purchases  invoice”.  And  to  the  seller  as  a  “Sales  invoice”.   Note:  Entries  in  the  sales  book  and  the  purchases  Book  are  made  with  the  help  of  an   invoice.  
  • 4.        2.  Debit  Note:  This  document  is  prepared  by  the  purchaser  and  it  is  sent  to  the   supplier  to  report  him  if  any  faulty  goods  are  been  sent  or  shortages  or  overcharges  are   been  made.   3.  Credit  Note:  When  goods  are  returned,  or  there  has  been  an  over-­‐charge,  a  supplier  may   issue  a  credit  note  to  the  buyer.  This  reduces  the  amount  owed  by  the  customer.  Note:  This   document  is  used  to  make  the  entries  in  both  the  purchases  returns  Book  and  the  sales   returns  Book.   4.  Statement  of  Account:  This  document  is  prepared  and  sent  to  the  customer  by  the   supplier.  It  is  issued  to  remind  the  customer  about  his  due  amount.  It  is  basically  a   summary  of  the  transaction  of  a  customer  during  the  month  like  sales  made,  Returns   received  and  Cash  received                                                                                              DISCOUNTS   1. Trade Discount: It is an allowance or deduction given by the supplier to the retailer on the catalogue price or list price. It is given to encourage him to buy in bulk. It is given so that retailer could make some profit. Note: It is not recorded in the books either by the seller or the buyer. 2. Cash Discount: It is an allowance or deduction given by the receiver of cash to the payer of cash for prompt payment. It is of two types discount allowed and discount received. i. It is given to encourage the payer to pay on or before the due date. ii. Note: This discount is recorded in the Cash Book. Discount allowed is recorded at the debit side and discount received on the credit side. iii. Note: Discount columns are never balanced. It is just totalled.                      
  • 5.    ADJUSTMENTS  IN  DETAIL     BAD  DEBTS  AND  PROVISION  FOR  DOUBTFUL(BAD)  DEBTS     What  is  a  bad  debt?     When  a  costumer  to  whom  goods  were  sold  on  credit  basis,  is  unable  to  pay  his  debt  then  it   results  into  an  expense  for  the  business.  Selling  goods  on  credit  basis  involves  this  risk  of   bad  debt.  Any  amount  of  debt  which  becomes  irrecoverable  should  be  written  off  as  bad   debt.              Debit:  Bad  Debts                        Credit  :  Person  Who  is  Bad  :>/Trade  receivable       What  is  a  Provision  for  bad  debt?   A  business  must  consider  that  some  costumers  might  not  pay  the  amount  owed  by  them;   these  debts  are  considered  to  be  doubtful.  Since  the  business  does  not  know  the  exact   amount  of  the  doubtful  debts(  and  also  which  costumer  might  not  pay),  an  estimate  for  such   amount  is  kept  in  a  provision  for  doubtful  debt  account  (  this  account  is  not  an  expense   account,  it’s  a  reduction  in  asset  from  the  balance  sheet).  Provision  is  created  to  reduce   profit  now  for  an  expense  which  might  happen  in  future.  This  is  done  to  be  pessimistic  ,  in   Accounting  we  call  this  being  prudent  or  the  Prudence  Concept.     How  is  the  amount  of  provision  estimated?  (  Factors  effecting  it)     -­‐ Age  of  Debts  (  Since  how  long  they  owe  us),  higher  the  age  more  likely  bad  debts   (  so  high  provision  is  kept  If  majority  of  the  debts  are  owed  for  long)   -­‐ Historical  percentage  of  actual  bad  debts  from  previous  years   -­‐ Reputation  of  people  who  us  money  in  the  market   -­‐ Nature  of  Business     What  is  the  difference  between  accounting  treatment  of  Provision  for  doubtful  debts  and  the   actual  Bad  debts?     The  Journal  entry  for  provision:     To  create  /  Increase                    Debit  :  Profit  and  Loss                                Credit  :  Provision  for  doubtful  Debts     To  Decrease                            Debit  :  Provision  for  doubtful  debts                                      Credit  :  Profit  and  Loss  
  • 6.   The  difference  in  accounting  treatment  is  that  the  whole  of  bad  debt  is  treated  as  an  expense   but  only  the  change  in  provision  is  treated  as  either  an  expense  (if  increasing)  or  an  income  (   if  decreasing).  When  we  write  off  a  bad  debt,  we  remove  the  debtor  from  our  books  but  in   case  of  a  provision  we  don’t  adjust  the  debtor  account  as  a  separate  account  is  maintained.           ACCOUNTING  FOR  NON  CURRENT  ASSETS     Whenever  we  spend  money  we  call  it  expenditure.  The  expenditure  can  be  divided  in  two       Capital  Expenditure     Revenue  Expenditure   Any  expenditure  incurred  on  buying   new  non-­‐current  asset.  We  take  this  to   balance  Sheet   Any  day  to  day  expense  to  run  the   business.  We  take  this  to  income   statement   Usually  one  off  (doesn’t  happen  on   daily  basis)   Its  recurring  in  nature  (  we  have  to  do   it  again  and  again)   Includes  initial  expenses  incurred  till   we  start  using  the  asset  e.g.   Installation,  delivery  charges   Usually  occurs  after  we  start  using  the   asset   Increases  the  value  of  earning   capability  of  the  asset  e.g.  Adding  a   Safety  device   Maintains  the  value  or  earning   capability  of  the  asset.  E.g.  Repainting   or  Repair     In  the  same  way  we  can  have  Capital  receipts  and  Revenue  Receipts  .     Capital  Receipts  would  include  money  received  from  capital  transactions  e.g.    taking  a  bank   loan  ,  selling  a  non  current  asset  or  additional  capital  introduced  by  the  owners  (  note  this   money  coming  in  not  earned  by  the  business  from  profits)     Revenue  Receipts  are  incomes  generated  from  day  to  day  operations  of  a  business  (  taken  to   income  statement)  e.g.  Sale  of  goods  ,  Interest  received  rent  received         If  these  expenditures  and  receipts  are  treated  in  the  wrong  way  then  both  income  statement   and  balance  sheet  will  be  wrong.    
  • 7. Depreciation     This  is  an  expense  recorded  to  allocate  a  non  current  asset  cost  over  its  useful  life.   Deprecation  is  used  in  accounting  to  try  to  match  the  expense  of  an  asset  to  the  income  that   the  asset  helps  the  business  to  earn.  For  example  if  a  business  buys  a  piece  of  equipment  for   $1  million  and  expects  to  use  it  over  a  life  of  10  years,  it  will  be  depreciated  over  10  years  .     Every  accounting  year,  the  company  will  expense  $100000  (assuming  straight  line  ,  which   will  be  matched  with  the  money  that  the  equipment  helps  to  make  each  year.       The  Double  Entry  for  Depreciation  is  :      Debit  :  Profit  and  Loss  Account  (  Income  Statement)                    Credit  :  Provision  for  Depreciation       Methods  of  Depreciation:     1. Straight  Line  :                      An  equal  amount  of  deprecation  is  charged  every  year.  It  is  always  calculated  on  cost  .  In   case  of  scrap  value  (residual  value)    and  life  given  use  :  Cost  –Scrap/Life       2. Reducing  Balance  Method:   In  this  deprecation  for  initial  years  in  always  higher  then  the  later  years.  It  is  simply  a   percentage  on  net  book  value  (written  down  value)  .  Net  Book  value  represents  cost  minus   total  deprecation  till  date.     3. Revaluation  Method:                  This  is  usually  used  for  loose  tools  (  or  any  asset  which  can  only  be  valued  collectively)  .   In  this  method  at  the  end  of  the  year  the  market  value  is  estimated.  A  numerical  example   best  explains  this                At  the  start  of  the  year  Loose  Tools  Valued  at  $5000            During  the  year  Loose  Tools  purchased    =  $2000            Loose  Tools  Sold  =  $300          At  the  End  Loose  tools  are  worth  $4500   Deprecation  =  5000  +  2000  –  300-­‐  4500  =  2200   Opening  Value+  Purchased  –Sold  –  Closing  Value         Which  Method  is  best  to  use?   It  depends  on  the  nature  of  Non  Current  Asset  
  • 8.   Straight  Line  method  is  appropriate  for  assets  like  office  furniture  and  fittings  (which  are   used  evenly  through  out  the  year  useful  life,  and  the  efficiency  of  them  doesn’t  fall  by  great   amount  in  initial  years)     Reducing  Balance  Method  is  appropriate  for  assets  like  machinery  or  van.  Since  these  assets   are  more  efficient  when  new,  more  depreciation  is  charged  in  initial  years.  As  the  asset  gets   old  it  looses  efficiency  and  so  we  charge  less  deprecation.  Another  way  to  look  at  it  is  that  the   maintenance  and  repairs  of  asset  will  increase  in  later  years  so  to  maintain  the  overall   expense  it  makes  sense  to  charge  more  depreciation  in  initial  years  when  maintenance  is   low  and  then  reduce  it  as  maintenance  increases.     How  to  record  disposal  of  Asset:   Disposal  of  means  getting  ride  of  the  fixed  asset  .  it  can  be  sold  or  may  be  stolen  or  just   discarded.  Usually  there  are  4  entries  to  record  sale  of  asset     1. Remove  the  Cost  of  the  Asset  Sold   Debit  :  Disposal            Credit:  Asset       2.  Remove  the  Total  Deprecation     Debit  :  Provision  for  Depreciation        Credit  :  Disposal     3. Record  the  Selling  Price   Debit:  Bank          Credit  :  Disposal     If  exchanged  then                    Debit  :  Asset      Credit  Disposal       4. Close  the  Disposal  Account            Close  with  income  statement           BANK  RECONCILIATION  STATEMENTS     Cashbook  is  owner’s  record  (Debit  means  +  balance,  Credit  means  –  balance)   Bank  statement  is  bank’s  record  (Credit  means  +  balance,  Debit  means  –  balance)     Some  entries  which  are  recorded  in  the  bank  statement  but  not  in  the  cashbook:   For  these,  we  will  have  to  correct  the  cashbook    
  • 9. 1. Credit  transfer  (Bank  Giro):  Money  deposited  by  customer  directly  in  the  bank   account  (We  should  add  it  to  cashbook  balance)   2. Standing  order/  Direct  Debit:  Money  paid  to  supplier  directly  by  the  bank.   (We  should  subtract  this  from  cashbook  balance)   3. Bank  Charges/  Interest  Charged:  Money  deducted  directly  by  the  Bank.   (We  should  subtract  this  from  cashbook  balance)   4. Interest  Received/  Dividends  Received:  Money  added  to  the  bank  account  in  form  of   interest  or  dividend  (We  should  ad  it  to  the  cashbook  balance)   5. Dishonored  Cheque:  A  cheque  received  from  customer  but  not  acknowledged  by  the   bank  (We  should  subtract  this  from  cashbook  balance  because  we  need  to  cancel  the   entry  made  when  the  cheque  was  received).                                            Some  entries  which  are  recorded  in  the  cashbook  but  not  on  the  bank  statement.                                              For  this,  we  will  have  to  correct  the  bank  statement:     1. Unpresented  Cheque:  Cheques  written  by  us  to  a  creditor  but  not  yet  presented  to   the  bank  for  payment,  so  the  bank  has  not  deducted  money  from  our  account.   (We  should  subtract  this  from  bank  statement  balance)   2. Uncredited  Cheque  (Lodgments):  Cheques  received  by  us  but  not  yet  deposited  in   the  bank,  so  the  bank  has  not  increased  the  bank  balance.  (We  should  add  this  to  the   bank  statement  balance)     FOR  MCQ’s  remember                          Balance  as  per  Bank  statement  +  Uncredited  Cheques  –  Unpresented  Cheques  =  Balance  as         per  corrected  Cashbook.     If  balance  as  per  corrected  cashbook  is  given  in  the  question,  simply  ignores  the  entries   which  will  affect  the  cashbook  balance.       If  there  is  an  overdraft  (for  either  cashbook  or  bank  statement),  take  it  as  a  negative   figure  in  the  equation.     Reasons  For  Preparing  bank  Reconciliation  Statement:   To  ensure  that  the  cash  book  entries  are  complete.     To  discover  bank  errors.     To  discover  errors  in  cash  book.     To  check  Fraud  and  embezzlement.                  To  discover  dishonoured  cheques.    
  • 10.       CONTROL  ACCOUNTS     What  is  the  difference  between  Sales  Ledger  and  Salas  Ledger  Control  Account?     Sales  ledger  is  where  we  make  individual  accounts  of  credit  customers.  It  is  part  of  double  entry   system  and  it  gives  details  of  amounts  owing  by  each  customer.  A  list  of  debtors  is  extracted  from   the  sales  ledger,  which  gives  the  figure  of  debtors  for  the  trial  balance.   Sales  ledger  control  account  on  the  other  hand  is  the  total  debtors  account  in  the  general  ledger.  It   is  not  part  of  the  double  entry  system.  It  I  often  referred  as  total  debtors  account.  All  the  entries   recorded  here  are  totals  taken  from  daybooks  e.g.  Sales  figure  is  the  total  of  the  sales  daybook,   discount  allowed  is  total  discount  allowed  from  the  discount  allowed  account  or  the  column  in  the   cashbook.     USES  OF  CONTROL  ACCOUNT   1. Helps  to  prevent  fraud   2. Helps  to  detect  errors   3. Quickly  provide  figures  of  total  debtors  and  creditor.   LIMITATIONS  OF  CONTROL  ACCOUNT   1. Cant  trace  error  of  omission     2. Cant  trace  error  of  original  entry     Note:  Sometimes  it  can  happen  that  there  is  a  small  opening  Debit  balance  on  a  purchases   ledger  control  account  in  addition  to  the  usual  credit  balance.  It  happens  when  the  business   has  overpaid  a  creditor,  or  has  returned  the  goods  after  paying  the  due  amount.   Note:  Sometimes  sales  ledger  control  account  too  also  has  small  opening  credit  balance  b/d   on  a  sales  ledger  control  account,  in  addition  to  the  usual  opening  debit  balance.  It  happens   when  a  debtor  has  over  paid  his  account  or  has  returned  goods  after  paying  his  account  or   due  amount.          
  • 11.       ERRORS  AND  SUSPENSE   Error  not  affecting  the  Trial  Balance:     1. Error  of  complete  omission:  When  nothing  has  been  recorded  in  the  books.  To  correct  this,   simply  record  the  transaction.   2. Error  of  original  entry:  Where  correct  double  entry  is  passed  but  with  the  wrong  amount.   To  correct  this,  adjust  for  the  difference.   3. Error  of  principal:  Where  a  wrong  type  of  account  has  been  debited  or  credited  instead.  For   example,  we  have  debited  Rent  instead  of  Motor  Van.   4. Error  of  commission:  Where  a  wrong  account  but  of  same  type  (usually  debtors  or   creditors)  has  been  debited  or  credited  instead.  For  example,  we  have  credited  Mr.  A   instead  of  Mr.  B.   5. Error  of  complete  reversal:  Where  a  completely  opposite  entry  is  passed  with  the  right   amount.  To  correct  this,  pass  the  correct  entry  with  double  amounts.   6. Compensating  error:  Where  one  error  compensates  for  other.  Like  a  debit  item  (say   purchase)  and  a  credit  item  (say  sales)  are  both  undercast  with  same  amounts.  (don’t  worry   about  this  too  much  :P)     All  the  above  errors  do  not  affect  the  Trial  Balance  because  in  all  situations  the  total  debits  are   equal  to  total  credits.     Errors  can  be  made  which  can  lead  to  disagreement  of  the  trial  balance.   This  is  when  either  we  have  only  debited  something  and  forgot  to  credit  (Incomplete  double  entry)   or  we  have  debited  something  with  a  correct  amount  and  credited  the  other  with  the  wrong   amount  (Incorrect  double  entry).  And  it  can  also  happen  if  any  daybook  is  over  or  under  cast.  E.g.   Sales  daybook  is  undercast.  In  these  situations  Suspense  account  comes  into  the  picture.  Since  sales   daybook  is  undercast,  this  means  only  the  total  sales  were  wrong  (understated),  so  we  need  to   amend  the  sales  accounts.           Debit:  Suspense             Credit:  Sales     Errors  affecting  Profit  or  Loss   These  errors  affect  those  accounts  which  are  included  in  the  Trading  and  Profit  and  Loss   Account  eg  purchases,  sales,  expenses  etc.  We  must  ask  the  following  questions:   1)  Does  the  error  affect  the  gross  profit,  the  net  profit  or  both?  (a)  Errors  which  affect  items   that  go  into  the  trading  account  affect  gross  profitand  net  profit  to  the  same  extent  and  in  
  • 12. the  same  direction.  Such  items  aresales,  purchases,  returns,  stock,  carriage  inwards  etc.  (b)   Errors  which  affect  items  that  are  entered  in  the  profit  and  loss  section  of  theaccount,  i.e.   operating  expenses,  affect  only  net  profit.  Purchases  of  fixed  assets  affect  profit  only   indirectly  through  provisions  for  depreciation.   2)  In  what  direction  is  profit  affected?   (a)  If  sales  are  overstated  or  purchases  understated,  both  gross  profit  and  netprofit  are  too   high  and  must  be  reduced  by  the  relevant  amount.  The  sameapplies  if  sales  returns  are   understated  or  purchases  returns  overstated.     (b)If  sales  are  understated  or  purchases  overstated,  both  gross  profit  and  net  profit  are  too   low  and  must  be  increased  by  the  relevant  amount.  The  sameapplies  if  sales  returns  are   overstated  or  purchases  returns  understated.     (c)  If  miscellaneous  receipts  are  overstated  or  if  expenses  are  understated,  gross  profit  is   not  affected  but  net  profit  will  be  high  and  must  be  reduced.   (d)    If  miscellaneous  receipts  are  understated  or  if  expenses  are  overstated,  again    gross   profit  is  not  affected  but  net  profit  is  too  low  and  must  be  increased.     (e)    If  capital  expenditure  is  wrongly  treated  as  revenue  expenditure,  eg  if  the  purchase  of  a   fixed  asset  is  treated  as  an  expense,  then  net  profit  will  be  too  low  and  must  be  increased.   The  opposite  applies  if  revenue  expenditure  is    treated  as  capital  expenditure.     3)  Does  the  errors  that  affect  items  in  the  balance  sheet  affect  profit  as  well?     The  answer  is  only  those  that  were  adjusted  after  the  trial  balance  was  prepared.  Errors   affecting  fixed  assets,  current  assets  and  liabilities  do  not  normally  affect  profit  but  if  one  of   these  items  has  changed  as  a  result  of  an  adjustment,  then  profit  is  affected.  For  example:   . (a)    If  the  closing  stock  has  been  overvalued,  the  stock  figure  in  the  balance  sheet  is  too   high  and  so  are  the  gross  profit  and  the  net  profit.  The  opposite  is  true  of  a  closing   stock  which  is  undervalued.  Remember  that  closing  stock  adds  on  to  gross  profit   and  opening  stock  takes  away  from  it.     . (b)    If  an  accrued  or  prepaid  expense  is  the  wrong  amount,  both  profit  and  the  item  in  the   balance  sheet  are  wrong.  If  an  amount  owing  is  overstated  or  a  prepayment  is   understated,  profit  is  too  low  and  must  be  increased,  and  vice  versa.     . (c)    The  opposite  to  (b)  applies  in  the  case  of  accrued  or  prepaid  receipts.     Estimating  the  effects  of  errors  can  be  confusing  and  you  must  keep  a  clear  mind.  Think   how  the  original  figure  has  affected  profit  and  then  try  to  see  in  which  direction  the  error  is   affecting  the  profit.    
  • 13.     INCOMPLETE  RECORDS:     Remember  Net  profit  can  be  calculated  using  the  following  formula.  If  a  question  says  make  a   trading  profit  and  loss  account,  than  this  doesn’t  apply.  Only  when  it  says  to  calculate  net  profit  or   make  a  statement  showing  net  profit.       Opening  Capital  +  Additional  Capital  +  Net  profit  –  Drawings  =  Closing  Capital     (I  really  hope  you  can  solve  for  net  profit),  don’t  memorize  the  formula,  it’s  the  financed  by  section.   J     For  the  final  account  questions  (where  the  trading,  profit  and  loss  account  and  a  balance  sheet  is   required),  always  make  the  following  accounts.  (By  always,  I  mean  always).     1. Sales  ledger  control  account  (If  business  only  deals  in  cash  sales,  then  don’t)   2. Purchase  ledger  control  account   3. Bank  account  (if  it  is  already  given  in  the  question,  then  it’s  okay)     Once  you  have  filled  in  your  accounts,  and  then  move  to  the  Final  accounts.  Don’t  panic  if  it  doesn’t   balance,  because  marks  are  for  working.  Don’t  spend  your  entire  lifetime  on  this  question.     NEVER  NEVER  NEVER  forget  depreciation.  They  will  usually  give  you  net  book  values  at  start  and   end.   Depreciation  =         Opening  NBV  +  Purchase  of  assets  –  Sale  of  assets  (at  NBV)  –  Closing  NBV     Also  make  expense  accounts  or  adjust  for  prepaid  and  owings  directly.  But  show  all  working.     In  your  financed  by  section,  you  will  need  opening  capital.  This  will  come  from  Opening  Assets  –   Opening  Liabilities.  Don’t  forget  to  include  the  opening  balance  of  the  bank  account  in  your   calculation  (like  other  idiots).            
  • 14.         MARGINS  AND  MARK-­‐UPS     These  are  tools  used  in  conjunction  with  trading  account  to  compute  the  missing  figures  of  sales,   figures  or  stocks.  If  either  of  these  percentages  is  given,  it  is  a  sign  that  we  are  expected  to  compute   the  missing  figures  by  using  the  trading  account  technique.     MARGINS   Represent  Gross  Profit  as  a  percentage  of  selling  price.     Example:   A  company  sells  its  goods  at  a  selling  price  of  $80.  Its  profits  are  set  at  20%  no  selling  price.   Profits  will  be  $80  x  20%  =  $16   By  using  trading  account  format,  we  can  determine  the  cost  of  goods  sold  as:     $   Sales    80   Less:  Cost  of  goods  sold  (balancing  figure)    (64)   Profit      16_     MARK-­‐UP   Represent  Gross  profit  as  a  percentage  of  cost.  Its  application  is  like  margin,  that  if  we  get  one  of  the   trading  figures,  we  will  be  able  to  compute  the  others.     Let  us  assume  that  the  information  we  have  from  the  above  example  is  that  a  company  sells  goods,   which  cost  $64.  Its  profit  on  cost  is  25%.  Profits  would  be  computed  as  follows:   Profits    =  $64  x  25%     =  $16.   By  using  trading  account  format,  we  can  determine  sales  as:     $   Sales  (balancing  figure)    80   Less:  Cost  of  goods  sold    (64)   Profit      16_    
  • 15.   Try  to  use     Sales  –  Cost  =  Profit     If  Mark  up  if  given  Profit  is  a  %  of  Cost  and  IF  margin  is  given  Profit  is  a  %  of  Sales     For  eg.     Sales  =  80000   Cost  =  ?   Margin  =  25%     Sales  –  Cost  =  Profit   80000-­‐  x  =  25  %  of  80000     Cost  =  60000   But  if       Sales  =  80000   Cost  =  ?   Markup  =25%     Sales  –  Cost  =  Profit   80000-­‐  x  =  25  %  of  X     Cost  =  64000     NON-­‐PROFIT  ORGANIZATION  (CLUBS  AND   SOCITIES)     The  non-­‐profit  organization  is  with  a  view  of  providing  services  to  its  members.  The  aim  is  not  to   make  profits  out  of  trading  activities,  but  to  increase  to  welfare  of  members  through  social   interaction  and  other  activities.  A  club  is  owned  by  all  the  members  collectively  and  since  there  is   no  single  owner,  there  are  no  DRAWINGS.     TERMINOLOGY  DIFFERENCE   Non-­‐profit  organizations   Normal  trading  Businesses   Receipts  and  Payments  Account   Bank  Account   Income  and  Expenditure  Account   Trading,  Profit  and  Loss  Account  
  • 16. Surplus   Profit   Deficit   Loss   Accumulated  Funds   Capital     Why  is  a  Receipts  and  Payments  Account  unsatisfactory  for  the  members?     The  receipts  and  Payments  account  does  not  provide  information  to  the  members  relating  to   1. Assets  owned  by  the  club   2. Liabilities  owed  by  the  club   3. Surplus  or  Deficit   4. Depreciation  of  fixed  assets   5. Performance  of  the  club   6. Financial  position  of  the  club.     In  order  to  make  the  income  and  expenditure  account,  you  will  need  to  determine  the  incomes   separately.  Incomes  may  include:   -­‐ Refreshment  Profit/Bar  profit  (make  a  separate  account  to  calculate  net  profit  from  this)   -­‐ Annual  subscription  (separate  subscription  account  for  this)   -­‐ Gain  on  disposal.   -­‐ Interest  on  deposit  account  or  investment  account.   -­‐ Profits  from  different  events  (say  Dinner  dance)   -­‐ Donations  (only  day  to  day)     Check  debit  side  of  Receipts  and  Payments  account  for  anything  else.     What  is  the  difference  between  receipts  and  payments  account  and  Income  and  Expenditure   account?     Receipts  and  Payment  account   Income  and  Expenditure  account   It  shows  balance  of  bank  at  start  and  end   It  shows  Surplus  of  Deficit  for  the  year   It  records  money  coming  in  and  going  out   It  records  Incomes  and  expenses  incurred   It  considers  all  type  of  money  coming  including   capital  receipts,  e.g.  Long  term  donations  and   all  type  of  money  going  out,  e.g.  Purchase  of   fixed  asset   It  considers  only  revenue  incomes  and   expenditure.   It  is  an  alternative  name  for  cashbook   It  is  an  alternative  name  for  profit  and  Loss     What  is  a  donation  and  what  are  two  accounting  treatments  for  it?  
  • 17. An  amount  received  by  a  club  which  the  club  does  not  have  to  pay  back.  This  includes  donations,   gifts,  legacy  and  grants.     If  donation  is  for  a  day  to  day  expenditure  or  will  remain  with  the  club  only  for  a  short  period  then   it  should  be  treated  as  an  income  in  the  income  and  expenditure  account.     If  donation  is  for  purpose  of  capital  expenditure  on  long  term  assets,  then  it  is  shown  as  a  special   fund  in  the  balance  sheet.  (Financed  by  section  added  it  to  accumulated  funds).     PARTNERSHIP  ACCOUNTS     A  partnership  is  defined  by  the  Partnership  Act  1890  as  a  relationship,  which  exists  between  two  or   more  persons  who  carry  business  with  a  view  of  profit.     CHARACTERISTICS  OF  PARTNERSHIP   • Partners  are  jointly  and  severally  liable  for  the  debts  of  the  partnership.  They  have   unlimited  liabilities  for  the  debts  of  the  partnership.   • The  minimum  number  of  partners  is  usually  two  and  maximum  number  is  twenty,   with  exception  of  banks,  where  the  maximum  number  is  fixed  at  ten  and  some   professional  practices  where  there  is  no  maximum  number.   • All  partners  usually  participate  in  the  running  of  their  business.   • There  is  usually  a  written  partnership  agreement.     THE  PARTNERSHIP  AGREEMENT     The  partnership  agreement  is  a  written  agreement  which  sets  up  the  terms  of  the  partnership,   especially  the  financial  arrangements  between  the  partners.     The  contents  of  the  partnership  agreement  can  vary  from  one  partnership  to  another.  A  standard   Partnership  Agreement  may  include  the  following  items:   1. The  name  of  the  firm,  business  type  and  duration   2. Capital  contribution.   3. Profit  sharing  ratios.   4. Interest  on  Capital.   5. Partners’  salaries.   6. Drawings.   7. Interest  on  drawings.   8. Arrangements  in  case  of  dissolution,  death  or  retirement  of  partners.   9. Arrangement  for  settling  disputes.    
  • 18. In  absence  of  a  formal  agreement  between  the  partners,  certain  rules  laid  down  by  the  Partnership   Act  1890  are  presumed  to  apply.  These  are:   1. Residual  profits  are  shared  equally  between  the  partners.   2. There  are  no  partners’  salaries.   3. No  interest  is  charged  on  drawings  made  by  the  partners   4. Partners  receive  no  interest  on  capital  invested  in  the  business.   5. Partners  are  entitled  to  interest  of  5%  per  annum  on  any  loans  they  advance  to  the  business   in  excess  of  their  agreed  capital.     ADVANTAGES  OF  PARTNERSHIP  OVER  SOLE  TRADER     1. Additional  capital  from  other  partners,  and  also  easier  to  get  loans.   2. Additional  expertise.   3. Additional  management  time.   4. Risk  (losses)  is  shared.       DISADVANTAGES  OF  PARTNERSHIOP  OVER  A  SOLE  TRADER     1. Profit  are  shared   2. Possibility  of  disputes   3. Loss  of  control     What  is  a  current  account?     Majority  of  partnership  keep  a  fixed  capital  account,  whenever  they  have  fixed  capital  accounts,   they  will  have  to  maintain  a  current  account  for  each  partner.  By  fixed  capital  account,  we  mean   that  all  the  appropriation  and  drawings  will  pass  through  a  temporary  capital  account  (current   account),  only  additional  investment  by  a  partner  will  be  recorded  in  the  capital  account.  This  gives   information  relating  to  long  term  and  short  term  aspects  separately.  This  also  helps  to  determine   the  investment  made  by  partner  in  the  business.   Some  partnerships  also  maintain  a  fluctuating  capital  account;  in  this  case  they  will  not  maintain  a   current  account.  All  the  transactions  will  pass  through  the  capital  account.                    
  • 19.     LIMITED  COMPANIES     Limited  companies  are  business  organizations,  whose  owners’  liabilities  are  limited  to  their  capital   contributed  or  guarantees  made.     CHARACTERISTICS  OF  LIMITED  COMPANIES   1. Separate  legal  entity:   A  company  is  regarded  as  a  separate  person  from  its  owners   and  managers.  As  a  result,  it  can  sue  or  be  sued,  it  can  own   property.  This  concept  is  often  referred  to  as  veil  of   incorporation.   2. Limited  liability:   Shareholders’  liability  is  limited  to  what  they  have  paid  for   shares.   3. Perpetual  succession:   Unlike  partnership  and  sole  trader,  a  company  does  not  cease   to  exist  on  the  death  or  retirement  of  any  of  the  owners.   Owners  can  buy  and  sell  their  shares  without  affecting  the   running  of  the  business.   4. Number  of  members:   There  is  no  limit  as  to  the  number  of  members   5. Capital:   Company’s  capital  is  raised  through  the  issuance  of  shares   6. Profit  distribution:   Profits  are  distributed  to  members  through  dividends.   7. Retained  profits:   The  retained  profits  are  capitalized  are  reserves.   8. Legislation:   Companies  are  highly  regulated.  They  are  required  to  comply   with  the  requirements  of  Company’s  ACT  as  well  as  Financial   Reporting  Standards.     ADVANTAGES  OF  OPERATING  AS  A  LIMITED  COMPANY:   1. The  liability  of  the  shareholders  is  limited.  Therefore,  in  case  of  company  going  bankrupt,   the  individual  assets  of  the  owners  will  not  be  used  to  meet  the  company’s  debts.  Only   shareholders  who  have  only  partly  paid  for  their  shares  can  be  forced  to  pay  the  balance   owing  on  the  shares,  but  nothing  else.   2. There  is  a  formal  separation  between  the  ownership  and  management  of  the  business.  This   helps  in  clearly  identifying  the  responsible  persons.  
  • 20. 3. Ownership  is  vastly  shared  by  many  people,  hence  diversifying  risk,  and  funds  become   available  is  substantial  amounts.   4. Shares  in  the  business  can  be  transferred  relatively  easily.       DISADVANTAGES:   1. Formation  costs  are  normally  very  high.   2. Companies  are  highly  regulated.   3. Running  costs  are  also  very  high  i.e.  preparation  and  submission  of  annual  returns,  audit   fees  etc.   4. Profit  distribution  is  also  subject  to  some  restrictions.  Not  all  surpluses  from  the  business   transactions  can  be  distributed  back  to  the  shareholders.   5. Company  accounts  must  be  available  for  inspection  to  the  public.   There  are  two  types  of  limited  companies:   1. Public  limited  companies:   a-­‐ They  have  the  abbreviation  Plc  of  public  limited  company  at  the  end  of  their  names   b-­‐ Their  minimum  allotted  share  is  required  to  be  £50  000.   c-­‐ They  can  invite  the  general  public  to  subscribe  for  their  shares   d-­‐ Their  shares  may  be  traded  in  the  stock  exchange  i.e.  they  can  be  quoted  with  the  stock   exchange.   2. Private  limited  companies:   a-­‐ They  have  the  abbreviation  ‘Ltd’  for  limited  at  the  end  of  their  names.   b-­‐ They  are  not  allowed  to  invite  general  public  for  the  subscription  of  their  share  capital.     COMPANY  FINANCE     As  is  a  case  with  sole  traders  and  partnerships,  companies  also  have  two  main  sources  of  finance,   namely;  capital  and  liabilities.  The  difference  is  on  naming  and  classification  of  these  terms.     When  the  company  is  formed,  it  normally  issues  shares  to  be  subscribed  by  the  potential  members.   People  who  subscribe  and  buy  company’s  shares  are  known  as  shareholders,  and  they  become  the   legal  owners  of  the  company  depending  in  the  proportion  and  type  of  shares  they  hold.  They  receive   dividends  as  return  on  their  invested  capital.  Dividends  are,  therefore,  appropriations  of  the  profits.     On  the  other  hand,  the  company  can  borrow  funds  from  other  people  who  are  not  owners.  The   main  form  of  company  borrowings  is  by  issuing  debenture,  which  is  a  written  acknowledgement  of   a  loan  to  a  company,  given  under  the  company’s  seal.  The  debenture  holders  are  not  owners  of  the   company  but  they  are  liabilities.  Debenture  holders  receive  a  fixed  percentage  of  interest  on  the  loan   amount.  Debenture  interest  is  a  business  expense,  which  must  be  paid  when  is  due.  Other  forms  of   borrowings  include  trade  creditors  and  bank  overdrafts.     The  difference  between  shareholders  and  debenture  holders  can  be  analyzed  in  terms  of:   1. Ownership;  and  
  • 21. 2. Return  on  investment  (Debenture  holders  will  get  it  even  if  the  company  makes  losses)     SHARE  CAPITAL   Share  capital  is  normally  of  two  types:   1. Ordinary  share  capital;  and   2. Preference  share  capital             Their  difference  is  summarized  in  the  table  below:     Aspect   Ordinary  shares   Preference  shares   Voting  power   Carry  a  vote   Limited  or  no  voting  power   Dividends   1. Vary  between  one  year  to   another,  depending  on  the   profit  for  the  period.   2. Rank  after  preference   shareholders.   3. Not  cumulative.   1. Fixed  percentage  of  the  nominal   value.   2. Cumulative.  If  not  paid  in  the   year  of  low  or  no  profits,  it  is   carried  forward  to  the  next   years.   3. They  may  be  non-­‐cumulative.   Liquidation   (Company  closing   down)   Entitled  to  surplus  assets  on   liquidation,  after  all  liabilities  and   preference  shareholders  have   been  paid.  Whatever  is  left,  go  to   Ordinary  shareholders.   1. Priority  of  payment  before   ordinary  shareholders,  but  after   all  other  liabilities.   2. Not  entitled  to  surplus  assets  on   liquidation.     SHARE  CAPITAL  STRUCTURE     Authorized  share  capital:   the  maximum  share  capital  that  the  company  is  empowered  to  issue   per  its  memorandum  of  association.  It  is  sometimes  called  as   registered  capital.     Issued  share  capital:   The  total  nominal  value  of  share  capital  that  has  actually  been  issued   to  the  shareholders.     Called-­‐up  capital:   This  is  a  part  of  issued  capital  that  the  company  has  already  asked   the  shareholders  to  pay.  Normally  when  the  company  issues  shares,   it  does  not  require  its  shareholders  to  pay  the  full  price  on  spot.   Rather  it  calls  the  installments  from  time  to  time.  It  is  the  amount   that  is  included  in  the  balance  sheet.  
  • 22.   Paid-­‐up  capital:   This  is  the  total  amount  of  the  money  already  collected  from  the   shareholders  to  date.  Dividend  is  paid  on  this.     Uncalled  capital:     This  is  the  part  of  issued  capital,  which  the  company  has  not  yet   requested  its  shareholders  to  pay  for.     Dividends:   According  to  the  new  law,  we  only  subtract  the  amount  of  dividends   paid  from  profit.  Dividends  which  are  announced  are  ignored.     What  is  a  Debenture?     A  debenture  is  a  document  containing  details  of  a  loan  made  to  a  company.  Debentures  carry  the   right  to  a  fixed  rate  of  interest  .  They  are  just  treated  like  long  term  loans.     What  are  the  different  Types  of  Preference  Shares?     1. Non-­‐cumulative  Preference  shares:  In  case  company  doesn’t  pay  enough  profits,  these   shareholders  will  get  no  dividends  in  the  year  and  that  amount  of  dividend  will  never  be   given.   2. Cumulative  Preference  Shares:  In  case  company  doesn’t  have  enough  profits,  these   shareholders  will  get  no  dividend  in  the  year  and  that  amount  of  dividend  will  be  carried   forward  to  next  year,  when  the  company  makes  enough  profit,  the  entire  amount  will  be   payable  as  dividend.   3. Participating  Preference  Shares:  These  shareholders  have  limited  voting  right,  i.e.  they   can  participate  in  the  decision  making.     What  is  the  difference  between  Debentures  and  Prefrence  Shares?     Debenture  is  Loan  and  Prefrence  Shares  are  Capital  (Owner)  of  the  Business.  Both  get  fixed  rate  of   return(  that  is  a  similarity)  but  when  no  profits  are  available  debenture  interest  still  has  to  be  paid   whereas  preference  dividend  can  be  saved  or  carried  forward  to  next  year.                                                                                    
  • 23.      GOODWILL     Goodwill  at  time  of  purchasing  A  business:   This  is  calculated  whenever  a  business  is  purchased  .  The  difference  between  purchase   price  and  the  market  value  of  net  assets  (assets  minus  liabilities)  acquired.  It  is  the  extra   amount  which  business    pays  for  an  existing  reputation  of  the  business.  It  is  treated  as  an   intangible  asset  (  Non  current)  in  the  Balance  Sheet   Goodwill  =  Purchase  Price    minus  Net  Assets  (  at  market  Value)     Goodwill  at  the  time  of  merger  (  formation  of  partnership)   When  two  sole  traders  combine  to  form  a  partnership  business  we  also  have  to  treat   goodwill.  The  partnership  will  buy  both  individual  sole  trader  businesses.    Any  extra   amount  placed  on  their  businesses  is  treated  as  goodwill  they  bring  into  the  business.    There  are  two  methods  to  treat  this  situation       Goodwill  is  kept  in  the  books:  The  individual  goodwill  is  recorded  on  the  credit  side  of   partner’s  capital  account.    The  total  value  is  then  shown  in  the  balance  sheet  as  intangible   non  current  assets.     Goodwill  is  written  off:  The  individual  goodwill  is  recorded  on  the  credit  side  of  partner’s   capital  account.    The  total  value  is  then  debited  to  partners  capital  accounts  in  the  profit   sharing  ratio,  this  is  done  to  remove  goodwill  from  the  balance  sheet.       INVENTORY  (WHAT  IS  NET  REALIZABLE  VALUE)   This  is  simply  the  current  market  value  of  goods   The  amount  of  goods  left  unsold  at  the  end  of  the  year  is  known  as  Inventory.  When   calculating  the  value  of  inventory  there  is  a  special  rule.  If  the  market  value  of  the  inventory   is  higher  then  the  price  at  which  we  bought  it  (cost)  then  we  should  record  inventory  at   cost  price.  But  if  the  market  value  is  lower  than  the  cost  price  then  we  should  use  the   market  value.   For  Example  :  I  bought  an  Iphone  4  with  an  intention  to  sell  at  $400.  This  is  my  cost  price.  If   the  phone  can  be  sold  in  the  market  for  $500  in  my  balance  sheet  I  will  still  record  my   closing  inventory  at  $400  cause  I  bought  it  for  $400  and  it  is  still  not  sold.  If  I  record  it  at   $500  then  I  would  be  counting  $100  profit  which  I  have  still  not  earn.    Now  consider  the   market  value  of  the  same  phone  was  $300  (  because  probably  iphone  5  came  out),  now   whenever  I  sell  it  I  will  have  a  loss  of  $100  ,  this  should  be  reflected  in  my  accounts  and  I   would  show  the  stock  at  $300.     So  a  general  rule  is  whichever  is  lower  (  the  cost  price  or  market  value)  stock  should  be   recorded  at  that  price.  
  • 24.   ACCOUNTING  CONCEPTS     TABLE/SUMMARY/SNAPSHOT  OF  ACCOUNTING  CONCEPTS/CONVENTION     Accounting  period   Concept     Also  known  as  Time  Period  where  business  operation  can  be   divided  into  specific  period  of  time  such  as  month,  a  quarter  or   a  year  (accounting  period)     Final  accounts  are  prepared  at  the  end  of  the  accounting  period,   i.e.  one  year.  Internal  accounts  can  be  prepared  monthly,   quarterly  or  half  yearly.       Accrual  Concept  /   Matching     Requires  all  revenues  and  expenses  to  be  taken  into  account  for   the  period  in  which  they  are  earned  and  incurred  when   determining  the  profit  /  (loss)  of  the  business.  The  net  profit  /   (loss)  is  the  difference  between  the  revenue  EARNED  and  the   expenses  INCURRED  and  not  the  difference  between  the   revenue  RECEIVED  and  expenses  PAID.       Business   Entity/Separate  Entity     Also  known  as  Accounting  Entity  convention  which  states  that   the  business  is  an  entity  or  body  separate  from  its  owner.   Therefore  business  records  should  be  separated  and  distinct   from  personal  records  of  business  owner.       Consistency  Concept     According  to  this  convention,  accounting  practices  should   remain  unchanged  from  one  period  to  another.  For  example,  if   depreciation  is  charged  on  fixed  assets  according  to  a  particular   method,  it  should  be  done  year  after  year.  This  is  necessary  for   purpose  of  comparison.  
  • 25.     Dual  Aspect  Concept     Double  entry  system.  For  every  debit,  there  is  a  credit  entry  of   an  equal  amount.       Going  Concern  Concept     The  business  will  follow  accounting  concepts  and  methods  on   the  assumption  that  business  will  continue  its  operation  to  the   foreseeable  future  or  for  an  indefinite  period  of  time.       Historical  Cost  Concept     Business  should  report  its  activities  or  economic  events  at  their   actual  costs.  For  example,  fixed  assets  are  recorded  at  their  cost   in  account  except  for  land  which  can  be  revalued  due  to   appreciation       Materiality  Concept     The  accountant  should  attach  importance  to  material  details   and  ignore  insignificant  details  otherwise  accounting  will  be   burdened  with  minute  details.  Only  items  that  are  deemed   significant  for  a  given  size  of  operation.       Money  Measurement   Concept     Also  known  as  Monetary  unit.  Transactions  related  to  the   business,  and  having  money  value  are  recorded  in  the  books  of   accounts.  Events  or  transactions  which  cannot  be  expressed  in   term  of  money  do  not  find  a  place  in  the  books  of  accounts.       Prudence  /   Conservatism  Concept     Take  into  account  unrealized  losses,  not  unrealized   profits/gains.  Assets  should  not  be  over-­‐valued,  liabilities   under-­‐valued.  Provisions  are  example  of  prudence  or  
  • 26. conservatism  concept.  Also  under  this  prudence/conservatism   concept,  stock/inventory  is  value  at  lower  of  cost  or  market   value.  This  concept  guides  accountants  to  choose  option  that   minimize  the  possibility  of  overstating  an  asset  or  income.                                                                                                    WORKING  CAPITAL       What  is  meant  by  working  capital?   It  is  the  money  required  to  meet  its  every  day  expenses.  It  can  be  calculated  by  taking  the   difference  between  current  assets  and  current  liabilities.    It  is  very  important  to  have   enough  working  capital  to  survive  in  the  short  run.     What  are  the  effects  of  not  having  enough  working  capital?   (i)    Problems  in  meeting  debts  as  they  fall  due.     (ii)    Inability  to  take  advantage  of  cash  discount.     (iii)    Difficulty  in  obtaining  further  supplies.                  (iv)    Inability  to  take  advantage  of  business  opportunity      as  they  arise.       What  are    ways  of  improving  working  capital.                  (i)Introduction  of  further  capital.   (ii)    Obtaining  long-­‐term  loan.     (iii)    Reducing  owners  drawings.     (iv)    Selling  out  useless  fixed  assets.    
  • 27.   RATIOS     PROFITABILITY     GROSS  PROFIT  MARGIN       (   Gross  Profit  x      100   )                    Net  Sales   While  the  gross  profit  is  a  dollar  amount,  the  gross  profit  margin  is  expressed  as  a  percentage  of  net   sales.  The  Gross  Profit  Margin  illustrates  the  profit  a  company  makes  after  paying  off  its  Cost  of   Goods  sold.  The  Gross  Profit  Margin  shows  how  efficient  the  management  is  in  using  its  labour  and   raw  materials  in  the  process  of  production  (In  case  of  a  trader,  how  efficient  the  management  is  in   purchasing  the  good).  There  are  two  key  ways  for  you  to  improve  your  gross  profit  margin.  First,   you  can  increase  your  process.  Second,  you  can  decrease  the  costs  of  the  goods.  Once  you  calculate   the  gross  profit  margin  of  a  firm,  compare  it  with  industry  standards  or  with  the  ratio  of  last  year.   For  example,  it  does  not  make  sense  to  compare  the  profit  margin  of  a  software  company  (typically   90%)  with  that  of  an  airline  company  (5%).     Reasons  for  this  ratio  to  go  UP  (opposite  for  down)   1. Increase  in  selling  price  per  unit   2. Decrease  in  purchase  price  per  unit  due  to  lower  quality  of  goods  or  a  different  supplier.   3. Decrease  in  purchase  price  per  unit  due  to  bulk  (trade)  discounts.   4. Extensive  advertising  raising  sales  volume  (units)  along  with  selling  price.   5. Understatement  of  opening  stock.   6. Overstatement  of  closing  stock.   7. Decrease  in  carriage  inwards/Duties  (trading  expenses)   8. Change  in  Sales  Mix  (maybe  we  are  selling  some  new  products  which  give  a  higher  margin).     NET  PROFIT  MARGIN       (   Net  Profit   x      100   )                  Net  Sales   Net  profit  margin  tells  you  exactly  how  the  management  and  operations  of  a  business  are   performing.  Net  Profit  Margin  compares  the  net  profit  of  a  firm  with  total  sales  achieved.  The  main   difference  between  GP  Margin  and  NP  Margin  are  the  overhead  expenses  (Expenses  and  loss).  In   some  businesses  Gross  Margin  is  very  high  but  Net  Margin  is  low  due  to  high  expenses,  e.g.   Software  Company  will  have  high  Research  expenses.     Reasons  for  this  ratio  to  go  UP  (opposite  for  down)   All  the  reasons  for  GP  margin  apply  here.  Additionally   1. Increase  in  cash  discounts  from  suppliers   2. A  decrease  in  overhead  expenses   3. Increase  in  other  incomes  like  gain  on  disposal,  Rent  Received  etc.  
  • 28.   Return  on  Capital  Employed  (ROCE)       This  is  the  key  profitability  ratio  since  it  calculates  return  on  amount  invested  in  the  business.  If  this   ratio  is  high,  this  means  more  profitability  (In  exam  if  ROCE  is  higher  for  any  firm  it  is  better  than   the  other  firm  irrespective  of  GP  and  NP  Margin).  This  return  is  important  as  it  can  be  compared  to   other  businesses  and  potential  investment  or  even  the  Interest  rate  offered  by  the  bank.  If  ROCE  is   lower  than  the  bank  interest  then  the  owner  should  shoot  himself.  This  ratio  can  go  up  if  profits   increase  and  capital  employed  remains  the  same.  Also  if  Capital  employed  decreases,  this  ratio   might  go  up.          Net  Profit      x   100      Capital  Employed                     Capital  Employed     =  Fixed  Assets  +  Current  Assets  –  Current   Liabilities       OR     =  Ordinary  Share  Capital  +  Preference  Share  Capital  +     Reserves  +  Long-­‐term  Liabilities     LIQUIDITY       As  we  know  a  firm  has  to  have  different  liquidity.  In  other  words  they  have  to  be  able  to  meet  their   day  to  day  payments.  It  is  no  good  having  your  money  tied  up  or  invested  so  that  you  haven’t   enough  money  to  meet  your  bills!  Current  assets  and  liabilities  are  an  important  part  of  this   liquidity  and  so  to  measure  the  firms  liquidity  situation  we  can  work  out  a  ratio.  The  current  ratio  is   worked  out  by  dividing  the  current  assets  by  the  current  liabilities.     CURRENT  RATIO   =        Current  assets  _           Current  liabilities     The  figure  should  always  be  above  1  or  the  form  does  not  have  enough  assets  to  meet  its  liabilities   and  is  therefore  technically  insolvent.  However,  a  figure  close  to  1  would  be  a  little  close  for  a  firm   as  they  would  only  just  be  able  to  meet  their  liabilities  and  so  a  figure  of  between  1.5  and  2  is   generally  considered  being  desirable.  A  figure  of  2  means  that  they  can  meet  their  liabilities  twice  
  • 29. over  and  so  is  safe  for  them.  If  the  figure  is  any  bigger  than  this  then  the  firm  may  be  tying  too  much   of  their  money  in  a  form  that  is  not  earning  them  anything.  If  the  current  ratio  is  bigger  than  2  they   should  therefore  perhaps  consider  investing  some  for  a  longer  period  to  earn  them  more.     However,  the  current  assets  also  include  the  firm’s  stock.  If  the  firm  has  a  high  level  of  stock,  it  may   mean  one  of  the  two  things,   1. Sales  are  booming  and  they’re  producing  a  lot  to  keep  up  with  demand.   2. They  can’t  sell  all  they’re  producing  and  it’s  piling  up  in  the  warehouse!     If  the  second  of  these  is  true  then  stock  may  not  be  a  very  useful  current  asset,  and  even  if  they   could  sell  it  isn’t  as  liquid  as  cash  in  the  bank,  and  so  a  better  measure  of  liquidity  is  the  ACID   TEST  (or  QUICK)  RATIO.  This  excludes  stock  from  the  current  assets,  but  is  otherwise  the  same   as  the  current  ratio.     ACID  TEST  RATIO   =   Current  assets  –  stock                  Current  liabilities     Ideally  this  figure  should  also  be  above  1  for  the  firm  to  be  comfortable.  That  would  mean  that  they   can  meet  all  their  liabilities  without  having  to  pay  any  of  their  stock.  This  would  make  potential   investors  feel  more  comfortable  about  their  liquidity.  If  the  figure  is  far  below  1,  they  may  begin  to   get  worried  about  their  firm’s  ability  to  meet  its  debts.       Rate  of  Stock  Turnover     It  shows  the  number  of  times,  on  average,  that  the  business  will  sell  its  stock  in  a  given  period  of   time.  It  basically  gives  an  indication  of  how  well  the  stock  has  been  managed.  A  high  ratio  is   desirable  because  the  quicker  the  stock  is  turned  over,  more  profit  can  be  generated.  A  low  ratio   indicates  that  stocks  are  kept  for  a  longer  period  of  time  (which  is  not  good).         Cost  of  Goods  Sold     =   ____  Times              Average  Stock       Advantages  of  Ratios   1. Shows  a  trend   2. Helps  to  compare  a  single  firm  over  a  two  years  (time  –  series)   3. Helps  to  compare  to  similar  firms  over  a  particular  year.   4. Helps  in  making  decisions     Disadvantages  (Limitations):   1. A  ratio  on  its  own  is  isolated  (We  need  to  compare  it  with  some  figures)  
  • 30. 2. Depends  upon  the  reliability  of  the  information  from  which  ratios  are  calculated.   3. Different  industries  will  have  different  ideal  ratios.   4. Different  companies  have  different  accounting  policies.  E.g.  Method  of  depreciation  used.   5. Ratios  do  not  take  inflation  into  account.   6. Ratios  can  ever  simplify  a  situation  so  can  be  misleading.   7. Outside  influences  can  affect  ratios  e.g.  world  economy,  trade  cycles.   8. After  calculating  ratios  we  still  have  to  analyze  them  in  order  to  derive  a  conclusion.     How  to  Comment:   Usually  in  CIE  they  assign  2  marks  for  comment  on  each  ratio.  One  mark  is  for  indicating  if  the  ratio   is  better  or  worse  (not  higher  or  lower).  The  second  mark  is  to  explain  the  importance  or  the   reason  of  the  change  in  ratio.  For  e.g.  If  Gross  Profit  Margin  was  40%  and  now  its  50%,  you  should   say  that  the  Gross  profit  Margin  has  improved  (rather  than  increased)  and  this  may  be  due  to  an   increase  in  selling  price  or  a  decrease  in  cost  of  goods  sold  (depending  upon  the  question).     Also  remember  that  the  liquidity  ratios  should  be  close  to  industry  average.  Too  less  or  too  much   liquidity  is  bad!     At  the  end  of  your  answer,  always  give  a  conclusion   • When  comparing  a  single  firm  over  two  years  then  do  mention  performance  of  which  year   is  better.  (In  terms  of  profitability  and  liquidity)   • When  comparing  two  different  firms  over  the  same  year  do  mention  performance  of  which   firm  is  better.  (In  terms  of  profitability  and  liquidity).       If  the  question  says  evaluate  profitability  then  use  (GP  Margin,  NP  Margin  and  ROCE)     If  the  question  says  evaluate  liquidity,  use  (Current  Ratio,  Acid  Test  and  Rate  of  Stock  Turnover)       If  the  question  says  evaluate  the  performance  it  means  both  profitability  and  liquidity.                  
  • 31. DEPARTMENTAL  ACCOUNTS   Departmental  Accounts  are  the  accounts  that  through  light  not  only  on  the  trading  result  of  the   business  as  a  whole  but  also  on  the  trading  result  of  each  department  individually.   Reasons  Or  Advantages  Of  Making  Departmental  Accounts:  OR   Reasons  To  Know  The  Result  Of  Each  Department:   It  lets  us  know  the  expenses  and  incomes  of  each  department  clearly  at  one  place.     It  helps  us  to  compare  the  results  i.e.  G.P  or  N.P  of  one  department  with  the  other.     It  helps  us  to  formulate  policies  in  order  to  develop  the  business  on  proper  lines.                            To  decide  whether  to  drop  or  start  a  new  department.                            It  helps  us  to  reward  the  departmental  managers.     Things  to  be  considered  before  closing  a  department:   . Consider  all  possible  means  to  improve  the  department.     . The  methods  used  to  apportion  the  expenses  should  be  studied  to  see  if  they  are    in  fact  the   fairest  methods.     . The  effect  of  the  closure  of  one  department  on  the  other  department  should  be    investigated.     . The  attractive  uses  of  the  space  becoming  available  need  to  be  considered.     . Non-­‐Monetary  factors  such  as  staff  morale  and  the  effect  on  supplies  and    customers  faith  is   also  to  be  considered.    
  • 32. MANUFACTURING ACCOUNT . Manufacturing businesses prepare manufacturing account in addition to the usual final Accounts. Manufacturing account shows how much does it cost the business to manufacture the goods in a financial year. . Cost Of Raw Material Consumed: It is the value of Raw material used in production. It consist of net purchases of Raw Material, carriage on raw material opening stock of raw material closing stock of Raw material. . Prime Cost: It is the basic cost of manufacturing the goods. It consists of direct raw material direct labour and direct expenses. . Production Cost: It is the total cost of manufacturing the goods. It consist of prime cost plus factory expenses, and it is after any adjustment for work-in- progress. . Work-in-progress: These are the goods which are partly made, but which are not yet completed are known as work-in-progress.                                                                                
  • 33. The  Impact  of  ICT  in  Accounting:   ICT  can  be  used  in  accounting  for  keeping  and  updating  the  double  entry  system,  stock   records,  debtor  analysis  and  the  preparation  of  budgets.   Benefits:   ·    Greater  accuracy-­‐automatic  and  error  free     ·    Greater  speed     ·    Improved  accessibility     More  information  available     ·    Cuts  in  staff  costs      Drawbacks:        Capital  expenditure-­‐cost  of  machines  and  software.  Economic  life  can  be  quite  short     . ·    Training  costs-­‐of  training  the  staff  to  use  the  equipment     .  Staff  morale  could  be  lowered     ·    Risk  of  data  loss  and  security  breaches  can  be  vulnerable  to  crashes,    viruses  and  hacking.                      
  • 34.                                  PAYROLL  DOCUMENTATION   PAYE  SYSTEM:   The  Pay  As  you  Earn  system  means  tax  and  other  deductions  are  subtracted  by  the   employer  at  source    and  only  net  pay  is  paid  to  the  worker.     CLOCK  CARD   • Employee  inserts  a  card  into  a  time  recording  clock  to  record  the  start  and  finish   time  for  each  working  session   • Payroll   department   can   calculate   the   number   of   basic   hours   and   the   number   of   overtime  hours  for  each  day   • Payroll  department  can  calculate  the  total  basic  hours  and  total  overtime  hours  for   each  week   • Payroll  department  can  calculate  total  gross  pay     TIME  SHEET   The  sheet  contains  a  breakdown  of  working  details  for  each  day,  the  employee  manually   records  the  start  and  finish  time  for  each  session,  including  a  reference  to  the  time  spend   on  each  job   Payroll  department  can  calculate  the  same  as  above.   The  payroll  department  can  cost  labour  hours  to  be  charged  to  specific  job   PAYSLIPS   An  employee  has  a  legal  right  to  receive  a  payslip.  It  is  given  to  the  employee  when  wages   are  received,  or  sent  to  employee  if  wages  are  paid  by  direct  debit.   The  payslip  is  used  to  inform  the  employee  of  pay  details,  including:   • Gross  pay     • Details  of  deductions  made     • Net  pay     • Employee  number     • Tax  code  number/  National  insurance  number    
  • 35.   PAYROLL  REGISTER     List  of  all  employees  kept  by  the  payroll  department,  containing  personal  data  and  pay   details  which  included:   Employee  number                            Salary     Job  title                                                              Tax  code     Employee  name                                      National  insurance  number     Address                                                                Voluntary  deductions     Telephone                                                          Starting  date     Date  of  birth                                                  Leaving  date     The  information  is  for  reference,  and  details  may  be  kept  on  individual  employee  record   card.   WAGES  SHEET    (also  wages  book,  and  weekly  payroll)   nformation  from  each  employee’s  individual  payslip  is  listed  on  a  sheet,  showing  the  gross   pay,  tax  and  NIC,  other  deductions  and  net  pay   Each  column  is  totalled  for  the  week   Is  used  to  reconcile  the  gross  pay  and  the  net  pay  paid