Preparation of financial statements for a business which has not maintained proper records(Double Entry records)
Profit Equation method or Converting incomplete records to complete records.
2. Incomplete Records
* Introduction
* Statement of Affairs
* Calculation of profit using basic accounting equation
* Calculation of profit using the capital account
* Calculation of opening capital, sales, purchases and
closing bank balance.
* Important Ratios
* Margin
* Mark-up
* Stock Turnover
* Summary
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3. Introduction
When a full set of accounting records is maintained the owner of the business
has all the information available about the assets, liabilities, revenues and
expenses of the business. This makes the preparation of final accounts
relatively easy.
Sometimes businesses, small businesses in particular, do not maintain a full
set of accounting records. This means that a trial balance cannot be drawn up
and the final accounts cannot be prepared until a certain amount of
preparatory calculations have been carried out.
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4. Statement of Affairs
When a list of assets and liabilities is prepared without the use of a
set of double entry records it is known as a statement of affairs rather
than a balance sheet.
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5. Calculation of profit using basic accounting equation.
If the assets, liabilities and capital of the business are known and no further
information is available, the only way in which the profit can be measured is to
compare the change in the capital over the financial period.
* Capital increases when a profit is made and decreases when a loss is
incurred.
The basic formula for calculating profit is:
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Profit = Closing capital – Opening capital.
7. If drawings have taken place during the period, the formula must be modified
to:
If additional capital has been introduced during the period, the formula must
be modified to:
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Profit = Closing capital – Opening capital + Drawings
Profit = Closing capital – Opening capital + Drawings – Capital introduced
8. Profit for the period can be calculated using capital account as follows:
(Calculation of profit using the capital account)
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Date Details Folio $ Date Details Folio $
Year 1
Dec.31
Drawings ×××× Year 1
Jan. 1
Balance b/d ××××
Balance c/d ×××× Dec.31 Bank ××××
Net profit ?
×××× ××××
Year 2
Jan. 1
Balance b/d ××××
Capital Account
9. Calculation of opening capital, sales, purchases and closing bank balance.
Calculating credit sales.
1st method
2nd method
Total Debtors account
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Opening Capital = Assets as at year beginning – Liabilities as at year beginning.
Credit Sales for the year = Receipts from debtors – Debtors as at year beginning .
+ Debtors as at year end.
Date Details Folio $ Date Details Folio $
Year 1 – Jan. 1 Balance b/d ××× Year 1-Dec.31 Bank ×××
Year 1-Dec.31 Sales ××× Balance c/d ×××
××× ×××
Year 2- Jan. 1 Balance b/d ×××
10. Calculating credit purchases.
1st Method
2nd Method
Total Creditors Account
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Total Sales = Credit sales + Cash sales
Credit Purchases for the year = Payments for creditors – Creditors as at year beginning
+ Creditors as at year end.
Date Details Folio $ Date Details Folio $
Year 1-Dec.31 Bank ××× Year 1 –Jan. 1 Balance b/d ×××
Balance c/d ××× Year 1-Dec.31 Purchases ×××
××× ×××
Year 2- Jan. 1 b/d ×××
11. Calculating bank balance
Bank Account
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Total Purchases = Credit Purchases + Cash Purchases
Date Details Folio $ Date Details Folio $
Year 1 –Jan. 1 Balance b/d ×××× Year 1-Dec.31 Total
payments
××××
Year 1-Dec.31 Total receipts ×××× Balance c/d ×××
×××× ××××
Year 2- Jan. 1 Balance b/d ×××
12. Important Ratios
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Margin = Gross profit/Sales
Mark-up = Gross profit/Cost of sales
Stock Turnover = Cost of goods sold/Average stock
13. Summary
* A statement of affairs is similar to a Statement of Financial Position and is
prepared when full set of accounting records is not maintained.
* Profit can be measured from the change in the capital over a period of time,
taking into consideration drawings and capital introduced.
* The amount received from debtors does not necessarily equal the credit sales:
the amount paid to creditors does not necessarily equal the credit purchases.
* When a record of money paid and received is available as well as the assets
and liabilities, it is possible to prepare a set of final accounts after calculating
sales and purchases.
* Gross profit can be expressed as margin (on selling price) and as mark-up (on
cost price)
* The rate of stock turnover is the number of times a business replaces its stock
in a given period of time.
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14. I wish you an enjoyable learning…..!
Sanjaya Jayasundara
“The best investment is education.”