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ACCT 111 FINANCIAL ACCOUNTING NOTES
Definition of Accounting
Accounting is a process of three activities, namely
1
...

2
...
Recording consists of keeping a chronological
diary of measured events in an orderly and systematic manner
...

3
...
The information is communicated through the preparation of and distribution of
accounting reports, the most common of which are known as financial statements
...

Users of Accounting information
Accounting in the modern world is very important to the extent that even the smallest business entity
needs it
...
Managers
These are the day to day decision makers, they need to know how well things are progressing
financially and about the financial status of the business
...
Owners of the business (shareholders)
They want to be able to see whether the business is thriving or not
...

3
...

4
...

5
...

6
...

7
...

8
...


Types of accountants
One way to classify different types of accountants is to identify the kinds of organizations for which
they work for
...

1
...
A large business
might employ a hundred or more private accountants
...
Public accountant
Public accountants provide their services to many different clients
...

3
...
Some
government accountants perform accounting services for their employers
...

Another way to classify accountants is to identify the kind of work they do
...
These fields involve providing different kinds of information to various
types of users
...
Financial accounting
Financial accounting provides information to decision makers who are not involved in the
day-to-day operations of an organization
...
The information is distributed primarily through general purpose financial
statements
...
Financial accounting is governed by Generally Accepted
Accounting Principles (GAAP), which consists of external standards which must be adhered
to
...

2
...
Managers use this information in their decision making, which leads to the
attainment of the objectives of the entity
...
However, managerial accounting
reports include information for internal use only
...


Tax accounting
The field of tax accounting deals mainly with tax issues
...
Tax regulations are written by accountants
practising in this field and hence, they also investigate any violation of tax laws
...
Types of accountants and the fields in which they practice in
...

While bookkeeping is critical to accounting, it is only the clerical part of the accounting process
...


3

Accounting on the other hand, is concerned with identifying how transactions and events should be
described in financial reports
...

Thus the work of the accountant is much broader than bookkeeping
...


FINANCIAL STATEMENTS
Financial statements communicate accounting information to managers and other decision makers
...


Types of financial statements
The main purpose of financial statements is to provide information to a wide range of users
...
Income statement
The statement of comprehensive income provides information on the performance of a
business
...
Net income
is earned if the company revenues exceeds it expenditure
...

Income


Income consists of both revenue and gains
...
g sales, legal fees, tuition fees etc
...
g salaries, wages, rent etc

4

2
...


The balance sheet shows the financial position of a business on a specific date by listing the assets,
liabilities and owner’s equity
...

Assets definition 2: A resource controlled by the entity as a result of past events and from which
future economic benefits are expected to flow to the entity’
Assets are divided into non-current assets and current assets
...
e
...

Current assets
These are assets that are owned by an entity for one year or less
...
g cash, stock, debtors,
prepayments etc
...

OR
These are amounts owed by the business to other firms
...

Liabilities are divided into two:
Non-current liabilities
Current liabilities
Equity: residual interest in the assets that remain after deducting its liabilities
...
Statement of changes in owners’ equity
The statement of changes in equity provides information about how the equity of a
company has changed over the period
...

4
...


Legal forms of business
a) sole proprietorship- owned by one person and is not organised under state or federal laws as a
corporation legally a single proprietorship does not have a separate existence apart from its owners
...
All
that is required is for the partners to agree to operate a business together
...

c) Corporation- a separate legal entity formed /incorporated under the laws of a state or federal
governments
...
You may well ask “Why?
Accounting is supposed to be a practical subject”
...

The techniques used in the practice of accounting are based on conceptual and theoretical ideas
...

Accounting policy
Situations often occur in our everyday life which are repetitive (ie they are always the same) but they would
each have a different outcome if we acted differently each time
...
Our friends would think we were
unreliable
...

We encounter precisely the same situation in accounting
...
Accounting policy is thus a set of decisions about how the entity will treat
the same type of transactions in order to achieve a consistent result
...
For example, an entity has to indicate
what basis it has used to deal with the depreciation of property, plant and equipment
...

How It Works/Example:
GAAP principles, which are updated regularly to reflect the latest accounting methodologies,
are the definitive source of accounting guidelines that companies rely on when preparing
their financial statements
...

GAAP rules and procedures are what govern corporate accountants when they present the
details of a company's financial operations
...
However, GAAP
rules are sometimes subject to different interpretations, and unscrupulous companies often
find a way to bend or manipulate them to their advantage
...
balance sheets or income statements or
annual reports
...
A widely accepted set of rules, conventions, standards,
and procedures for reporting financial information, as established by the Financial Accounting
Standards Board
...
Official sources for these principles began with American Institute
of Certified Public Accounts (AICPA), whose Accounting Principles Board issued 31 formal
opinions
...
Strongly
independent accounting professionals from public, governmental, industrial and educational sectors,
FASB has issued many statements of Financial Accounting Standards
...
Both official standards
and practices generally followed by the profession are summarized below:

ACCOUNTING ENTITY CONCEPT
An economic unit, which may be a person, business, government, organization, or part thereof, is
being accounted for
...
Liquidation value may be ignored
...


COST PRINCIPLE
Income Statement and Balance Sheet accounts must be recorded at cost, as evidenced by their
objective fair market value at time of acquisition, called historical costs, these figures, to the dismay
of some, are generally not adjusted to current market value
...
For
a retailing business, point of sale easily establishes when earned, for manufacturing construction
businesses, the process is more complicated
...
it is realized
2
...
it is earned
Revenues are realized when goods and services are exchanged for cash or claims to cash (receivables)
Revenues are realizable when assets received in exchange are readily convertible to known amounts
of cash or claims to cash (short-term investments)
...
e when the earnings process is complete or virtually complete
...


OBJECTIVITY PRINCIPLE
To be reliable, accounting information must be objective
...

MATERIALITY
Accounting principles need not be followed when the effect of this action is immaterial and would not
affect the reader’s interpretation of the accounting information
...
Some information, such as
contingent liability, is easily communicated with a footnote, while other information, such as the
effect of inflation, requires more complex procedures
...

CONSERVATISM
Estimates requiring subjective analysis should not overstate revenue and asset values or understate
expenses and liabilities
...
Because the dollar is not stable, larger corporations, at
FASB’s request, voluntarily prepare information on the effects of inflation on their financial
statements
...

The IASB’s conceptual framework is known as the Conceptual Framework for Financial
Reporting 2010 (‘the Framework’)
...


Framework for the preparation and presentation of financial statements
The framework represents the main ideas, concepts and principles upon which all International
Financial Reporting Standards, and therefore financial statements, are based
...

These are:
1
...
The going concern

9

Qualitative characteristic of financial statements

The four main qualitative characteristics are:
1
...
The readers of the information
should be able to follow the presentations easily
...
Relevance
Accounting information should be relevant
...
Predictive value helps users forecast future events
...

3
...
To be reliable, accounting information must be verifiable – we must
be able to prove that it is free of error and bias
...

4
...

Consistency means that a company uses the same accounting principles and methods from
year to year
...

The global nature of business creates a major accounting problem
The problem is that each country has its own unique accounting standards
...

International standards consist of the following:
International Financial Reporting Standards (IFRSs)
o These are issued by the International Accounting Standards Board
...

o When the IASB was formed it adopted the IAS’s created by the IASC
...


The IFRS Foundation (‘the Foundation’
•
•
•

The IFRS Foundation is an independent not-for profit foundation based in the US
...

They are also responsible for setting and approving the budgets of the various bodies,
determining strategic direction and promoting IFRS
...

The IASB’s objectives are:
- to develop a single set of high quality, global accounting standards that
require transparent and comparable information in general purpose
financial statements
- to promote the use and rigorous application of those standards; and
- to work actively with national standard setters to bring about convergence of national
accounting standards and IFRSs
...

• They provide timely guidance on:
- newly identified financial reporting issues not specifically covered by an
accounting standard
- unsatisfactory interpretations that have developed or may develop
...


Their overall objectives are:
- to give advice to the IASB on agenda decisions and priorities
- to inform the IASB of the views of organisations and individuals, and
- to give other advice to the IASB or the Trustees
...

The accounting equation forms the basis on which financial accounting lies
...
It reviews the assets of the business:
i
...


From the point of view of their value
...


Where there is no external borrowing capital should be equal to the assets of the business
...


Show the effect of each transaction on assets, liabilities and capital
...
Owner pays capital into the bank
b
...
Buy inventory on credit
d
...
Sale of inventory for cash
f
...
Debtor pays money owing by cheque
h
...
Owner pays creditor private money outside the firm

Effect

2
...

Cash
=
$ 10 000
Debtors
=
30 000
Buildings
=
200 000
Fixtures and fittings
=
80 000
Creditors
=
50 000
Capital
=
?

3
...
Tambo is the owner of Ara Services which offers a carpet cleaning service
...
Clients owe $40 000 for services rendered and
Ara Services owes $20 000 for parts purchased
...

Calculate the equity
...

Accounting Process


Business
Transactions
Business
are comp
 transactions
Other (internal
events)

End result
Analyzing
economic events
and recording
their effects

Classifying and
summarizing the
recorded effects

Financial statement & other
reports presented to
economic decision makers
...

Some economic events affect an entity’s accounting equation even though they are not transactions with outside
parties e
...
e the
economic benefit of the machine is partially used out
...
g receipts and
invoices, debit and credit note, bank statement, cheque requisition, purchase order, employee’s earning record
...
Objectivity
adds to the reliability of accounting information
...
These locations
in the accounting system are called ACCOUNTS
...
A separate account is used for each revenue and expense item that appears on the
income statements
...
e customers and suppliers)
...

Real accounts – accounts in which possessions are recorded
...
g buildings, machinery, fixtures and inventory
...


Double entry system



States that every transaction should be recorded twice (once Dr entry and once Cr entry)
...

This follows from the fact that all business transaction affect two accounts simultaneously, where one
account can be seen as a giver and the other as a receiver
...

Cr the giver, Dr the receiver



When a business fails to maintain double entry, its records are recorded as incomplete and they don’t
balance
...





Sales ledger
...
This is for suppliers’ personal accounts
...
This contains the remaining double entry accounts, such as those relating to
expenses, non-current assets and capital
...


Using a T account
Place the name of the item recorded
Dr side






Cr side

In accounting the left side is called the Debit side and the right side is called the Credit side
...
When amounts are entered on the right side they are called credits and the account is said
to be credited
...

It is a debit balance when the sum of the debits exceeds the sum of the credits
...


Double entry system for capital, liabilities and assets
In the books if accounts of a business, liabilities are represented by a Cr balance and assets by a Dr balance
...

To come up with a journal (format):
1
...
Name of the accounts involved
3
...
An explanation of the transaction

What is posting?


It is the process of copying journal entry information from a journal to a legder
...


a
...

c
...

e
...

g
...

i
...


Complete the following table

Bought lorry for cash
Paid creditor, T lake, by cheque
Repaid P Logan’s loan by cash
Sold lorry for cash
Bought office machinery on credit from Ultra Ltd
A debtor, A Hill, pays us by cash
A, debtor J Cross, pays us by cheque
Proprietor puts a further amount into the business by cheque
A loan of $200 in cash is received from L Lowe
Paid creditor, D Lords, by cash

19

Account to
“be Debited

Account to
“be Credited”

---------------------------------------------------------------------------------------------------------------------------------------------

-------------------------------------------------------------------------------------------------------------------------------------------------------

2
...

1
2
5
6
10
11
12
19
21
22
30
31

Bought goods on credit $220 from D Small
...

Sold goods on credit to D Hughes for $60
...
Spencer for $45
...
Small
...

Goods bought for cash $150
...
Spencer returned $16 worth of goods to Spink Ltd
...

Paid cash to D
...

D
...

Bought goods on credit for $214 from A
...


Required:
Journalize the above transactions, post them to the general ledger and extract a trial balance as at 31 May 2012
...

- It is a list of accounts and their balances at any given time
...

2
...

4
...

6
...

8
...
They are however some errors
which when done the trail balance agreement will still be observed
...

Error of omission
This exists when a transaction is completely omitted from the books of accounts of the business
...
g
...
Smart on 5January 2010 were neither recorded in J
...


20

Error of commission
This occurs when a transaction is recorded or posted to the wrong personal account but of the same category as
the correct account
...
Webster $120 but instead recorded the
transaction is G
...

Error of principle
This is an error which is committed as a result of failure to observe the correct principle of accounts
...
Instead of opening up a fixtures account / in case of buying a
fixed asset / one opens a purchase account
...
e
...
On 7 January 2011, X Company made sales of $560 cash but instead recorded this in the
sales account as $500
...
Jones but
recorded this in the purchase account as $830
...
i
...
when an account that was supposed to be debited
is credited and an account that was supposed to be credited is debited
...
g
...

Transposition error
This occurs when wrong sequence of the individual characters within a number was entered, e
...


Procedures in correcting the above errors
1
...

3
...


EXAMPLES
Error of commission
A sale of goods worth $678 to J Harris had been entered to J
...

Error of Omission
The sale of $59 worth of goods to R
...

Error of Commission
A purchase of $44 worth of goods from C
...
Munda’s
account
...

Error of Principle
The purchase of a machine for $200 is debited to purchases account instead of being debited to machinery
account
...


21

Error of original entry
A sale of $38 to A Smiles was entered in the books as $28
...
Mcloud costing $56 was entered in the books as $65
...


PREPERATION OF FINANCIAL STATEMENTS
-

Every firm likes to measure the performance of its operations in terms of profits or loss
...

In order to ascertain its income and also access the position of assets and liabilities, financial
statements are prepared,
Financial statements are also known with the traditional name as final accounts
...

Dr
Cash
Merchandise Inventory
Office supplies expense
Store equipment expense
Prepaid insurance expense
Office equipment
Accumulated depreciation – office equipment
Accounts Payable
Store equipment
Accumulated Depreciation – Store equipment
Capital: D
...
Walker
Sales
Sales returns & allowances
Sales discount (discount allowed)
Purchases
Purchases returns & allowances
Purchases discount (discount received)
Transportation in (carriage inwards)
Sales salaries expense
Rent expense – Selling spares
Advertising expense
Office salaries expense
Rent expense – Office

Cr

2 400
61 152
438
1 410
3 276
10 644
3 840
8 766
38 178
15 372
72 540
32 400
342 774
2 094
3 816
205 650
1 332
5 292
1 158
38 304
23 220
684
22 356
2 736
449 916

Additional information
i
...

ii
...

iii
...


22

449 916

Required:
1
...

3
...

Prepare a statement of changes in owner’s equity as at 31 December 2011
...


The Window Store
Trading, Profit & Loss Account
for the year ended 31 December 2011
Sales
Less: Sales returns & allowances
Turnover
Less: Cost of Goods Sold
Opening stock
Add: Purchases
Less: Purchases returns
Add: Carriage inwards
Goods available for sale
Less: Closing stock
Gross profit
Add: Discount received

$342 774
2 094
340 680

$ 61 152
$205 650
1 332
204 318
1 158

Less: Expenses
Office supplies
Store supplies
Prepaid insurance
Depreciation – Store equipment
Depreciation – Office equipment
Discount allowed
Sales salaries expense
Rent expenses: Selling spares
Office
Advertising
Office salaries expense
Net Profit

205 476
266 628
62 784

438
1 410
3 276
3 816
690
3 816
38 304
23 220
2 736
684
22 356

23

203 844
136 836
5 292
142 128

100 746
41 382

Opening capital
Add: Net profit
Less: Drawings
Closing capital

Statement of changes in Owner’s Equity
$72 540
41 382
113 922
32 400
81 522

Window Store
Balance Sheet
As at 31 December 2011

Non - Current Assets
Office equipment
Store equipment

Cost

Accumulated
Depreciation

Net Book Value

$10 644
38 178
48 822

$ 4 530
19 188
23 718

$ 6 114
18 990
25 104

Current Assets
Closing stock
Cash

62 784
2 400
65 184

Current Liabilities
Accounts payable
Working capital

8 766
56 418
81 522

Equity
Financed by: D
...

However the financial progress of a firm needs to be determined at any time
...
To accomplish this, the
accounting process is based on a time period principle
...

Since the division of the life of a business into time periods is done for accounting purposes, the time
periods are called accounting periods
...
The specific
12month period that a business adopts as its annual period is called a fiscal year
...


Accruals
These are the expenses attributable to the current accounting period but which have not yet been paid
...
Such expenses should be accounted for in the period when they are incurred
...

Example 1
The financial year of ABC Company is from January to December
...
At the beginning of the financial period, the office supplies account had a debit balance of $2 000
...
At the end of the year, the physical count of
office supplies revealed that there was $2 500 worth of supplies still on hand
...
At the beginning ABC received $3 000 from a client before supplying The Great Hope books the
client needed
...
No adjustment has
been done
...
The prepaid insurance account had a $1 760 debit balance at the end of the accounting period before
adjustments for expired insurance
...

4
...

5
...

Required: Prepare adjusting entries for the above transactions
...
Expired insurance $800
...
Unused framing supplies $5 100
...
Estimated depreciation of framing equipment $1 300
...
Earned but unpaid salaries $500
...

Among the different assets we have covered cash is more liquid than the other assets
...

All assets can be evaluated in terms of their relevant liquidity

Current assets
cash/bank
debtors
stock
prepayments

26



Assets such as cash are the most liquid assets because they can be easily converted into other types of
assets or used to buy services or pay liabilities
...
e
...
he or she commonly buys all the assets and services used
in the business
...

However, as the business grows it becomes increasingly difficult to maintain this close personal contact
...

The procedures that control the operations of a business make up its internal control system
...

ii
...


Advantages of an internal control system
A properly designed internal control system encourages adherence to prescribed managerial policies
...


Specific internal control procedures vary from company to company and depend on such factors as the nature of
the business and the size
...
The
broad principles are:

1
...
When responsibility is not clearly spelled out, it is difficult to determine who is at
fault when something goes wrong
...
g when two sales clerks share access to the same cash register and there is
a shortage, it may not be possible to tell which clerk is at fault
...

The problem may be solved by having different cash registers for each operator
...
Maintain adequate records
A good record keeping system helps protect assets and ensures that employees follow prescribed procedures
...
E
...

Numerous pre-printed forms and internal business papers shall be designed and properly used to maintain good
eternal control
...
g if sales slips are properly designed, sales personnel can record the needed information
efficiently without errors or delays to customers
...
As a result a salesperson is not able
to pocket cash by making a sale and destroying the sales slip
...
Insure assets and bond key employees
Assets should be covered by adequate casualty insurance, and employees who handle cash and negotiable assets
should be bonded
...
Bonding clearly reduces the loss suffered by theft
...
Separate record keeping and custody over assets
A fundamental principle of internal control is that the person who has access to or is otherwise responsible for
an asset should not maintain the accounting record for the asset
...
g the fixed asset register is kept in the
accounts office rather than by the maintenance department
...
Divide responsibility for a transactions
Responsibility for a transaction or a series of related transactions should be divided between individuals or
departments so that the work of one acts as a check on the other
...
Each employee or department should perform an unduplicated portion
...
g responsibility
for placing orders, receiving the merchandise, and paying the vendors should not be given to one individual or
department
...

And, designating a third person to approve the payment of the invoice offers additional protection
against error and fraud
...


6
...

A time clock registers the exact time an employee arrives on the job and the exact time the employee
departs
...


7
...
E
...
by internal auditors
...
Petty cash might be used, for
example, to pay for bus fares, taxi fares, tea and coffee for the office, and so on
...
A system is needed to keep
strict control over spending of petty cash, and to make sure that the amount of money held in petty cash is
always correct, and that no money is missing
...
The box, and the locked box is kept in an office safe or possibly in a locked drawer of the
office supervisor’s desk
...
All cash withdrawals from the bank to ‘top
up’ the petty cash must be recorded
...
The voucher must be properly authorised by a manager,
and should state the date of the expense
...

The person using the petty cash should obtain (if possible) a receipt for the item when it is purchased
...
If the unused cash is returned, the petty cash voucher should be amended to record the actual
amount of cash spent
...


Petty cash: imprest system
When petty cash is controlled by an imprest system, the amount of notes and coins in petty cash is ‘topped up’
from time to time, so that the total cash in petty cash is exactly equal to a specified limit
...
From time to time, the amount of cash held in petty cash
will be restored to $300, by making another cash withdrawal from the bank
...
The total of the vouchers for petty
cash expenses should equal the total amount of cash required to top up the petty cash to its limit
...
By checking the total of petty cash vouchers and
cash withdrawals from the bank, it should be possible to identify errors or fraud, where cash has been stolen or
is missing, or where petty cash vouchers appear to be incorrect or incomplete
...

The petty cash book will normally contain columns for analysing petty cash transactions into different types of
expense
...

EXAMPLE: PETTY CASH BOOK
A petty cash system is operated on the imprest system with a limit of $100
...
During March, payments out of petty cash totalled $64
...
At the end of March, the petty cash box is topped up to $100 by withdrawing $64 in cash from
the bank account
...

Accounting for petty cash in the main ledger
A petty cash account is an account in the main ledger
...

EXAMPLE: Using the example above record the accounting entries of the expenses in the main ledger and
record the reimbursement of the petty cash
...
For example it might be a business’s policy to withdraw $50 each Monday morning
in cash to deal with petty cash claims during the week
...
Alternatively if claims are very low then if $50 is added to petty
cash each Monday the amount of cash held will be accumulating
...
Petty cash is therefore topped up whenever it becomes necessary
...


Bank Reconciliation Statements





For purposes of safe keeping money is deposited at a bank
...
Every entity that entrusts its money to a bank is a creditor of the bank
...

Every business keeps a record of its transaction with the bank and the bank does the same for every
client
...
e
...
a cash receipt journal
...

The following will be reflected on the bank statement:
- The opening balance (beginning of the month)\
- Deposits credited during the month
- Cheques paid (debited) during the month
- Bank charges for the month
- Interest charged (debt) on overdraft or paid on a favourable (credit) bank balance
- Debit and stop orders for the month
- Dishonoured cheques for the month (cheques deposited, but not paid by the drawer’s bank
- Correction of errors made by the bank in the previous month

Example of a cashbook and bank statement

20XX
Dec 1 Bal b/f
20 S
...
Frank

20XX
Dec 1 Bal b/f
8 008910
21 Deposit

cash book before balance 31/12/20xx
$ 20XX
2 500
Dec 5
K
...
Francis
1 900
Bank statement
Withdrawal

Deposit

650
1 000

30

$
650
1 750

Balance
2 500
1 850
2 850

28 Deposit
29 008911
30 Bank Giro credit:G Jones
31 Bank charges

1 900
1 750
700
500

4750
3 000
3 700
3 200

*008910 and 008911 refer to the serial numbers on the cheques paid out
*with the above information it is possible to see that the two items not shown in the Company’s cash book:
- bank giro credit G Jones
$700
- bank charges
$500


G Jones had paid $700 but instead of sending a cheque he had paid the money direct into the
company’s bank account, using the bank services
...
The bank had charged the company $500 for keeping
the bank account and all the work connected with it
...

as we have identified the items missing from the cask book, we can now complete writing it up by entering the
two items we have identified:

20XX
Dec 1 Bal b/f
20 S
...
Frank
G
...


Where closing balances differ:
Although a cash book may be written up to date by a business, it obviously cannot alter the bank’s own records
...


20X2
Jan 1 Bal b/f
16 R Lomes
24 V Verity
31 J Soames
31 R Johnson
Bal b/d

Cash book before balance 31/12/20xx
$ 20X2
320
Jan 10 C Morgan
160
20 M McCarthy
140
28 Cheshire C rates
470
30 M Peck
90
31 Bal c/d
1 180
600

31

$
110
90
180
200
600
1 180

20XX
Jan 1 Bal b/f
12 10627
16 Deposit
23 10628
24 Deposit
28 Direct debit: Cheshire CC
31 Bank Giro credit: R Johnson

Bank statement
Withdrawal

Deposit

110
160
90
140
180
90

Balance
320
210
370
280
420
240
330

*identify which items are causing the two balances to differ even after the bank statement has been checked
against the cash book and the necessary additional entries have been made in the cash book
...
These are:
i
...
Peck on January 30
...
This is known as an
unpresented cheuque
...

Although a cheque for $470 was received from J Soames on 31 January and the business deposited it
with the bank on that date, the bank did not receive funds from Soames’ bank until February
...

-

The cash book balance on January 31 was $600, whereas the bank statement shows a balance of $330
...
e
...

It will either start with the bank statement balance or then reconcile it to the cash book balance, or it
will start with the cash book balance and then reconcile it to the bank statement balance
...
This will have to be
located and then corrected
...


-

It does not calculate what the bank account figure in the balance sheet should be because it starts with
the balance in the cash book after adjusting for items revealed in the bank statement
...
g
...
12
...

NB* in reconciling cash book and bank statement always start with the balance as per cash book
Other terms used in banking
1
...
e
...
you may ask your bank to pay $2million a month to a building society to repay a mortgage
...


Direct debits- these are payments which have to be made such as electricity bills, telephone bills, rates
and insurance premiums
...
This is particularly

33

useful if the amounts payable may vary from time to time, as it is the creditor who changes the
payments, not you
...

The cash book balance will be a credit:


An overdraft is often shown with the letters O/D following the amount



Alternatively, some banks use Dr or Cr after every balance entry to indicate whether the account is
overdrawn
...
i
...
negative number
...


Balance /overdraft per cash book
Normal Balance
Adjustments: unpresented cheques
bank lodgement not on bank statement
balance/overdraft per bank statement

Over drawn

plus
less
xxx

less
add
xxx

Adjusting entries in the case of an overdraft are the same as those you make when it is positive
...


stale cheques

2
...


variance in the amount in words and amount in figures

4
...


Alterations that are not counter signed for
...


If the owner of the account dies
...


From the following draw up a bank reconciliation statement from details as on 31 December 2006
$

34

Cash at bank as per bank column of the cash book
Unpresented cheques
Cheques received &paid into the bank but not yet entered on the bank statement
Credit transfers entered as banked on the bank statement but not entered in the cash book
Cash at hand as per bank statement

2
...
Write the cash book up to date
b
...

The person or business owing money to an enterprise which originates from a credit sale is known as a
trade debtor
...

The period is known as a credit term and is predetermined in accordance with the credit policy of the
enterprise making the sale
...
How debtors are encouraged to pay their accounts on time
2
...
Creation and adjustment of the provision for bad debts
Discount allowed
Discount is often offered to debtors in order to encourage a quick settlement of their debts within the stated
credit term
...


35

Example: A client purchased $550 worth of goods on credit on 1 March 2011
...
If the client pays before 31 March 2011 a discount of 2% will be
allowed
...

Interest charged
Many enterprises charge interest on the outstanding debt if an account is not paid within the credit term
...
g
...

If the client does not pay the account of $550 before 31 March 2011, but only pays it at the end of April
2011 he will be charged 18% per annum interest (for 1month) on $550
...

The interest increases the outstanding balance on the individual debtors account
...
Circumstances that
may lead to the occurrence of bad debts include:
1
...
Unethical business practises by customers
3
...

These debts which are never paid are known as bad debts or irrecoverable debts
...

The treatment for bad debts/Accounting for bad debts
Bad debts i
...

Writing off bad debts
Accounting for such bad debts is done following the procedures summarized below:
1
...

2
...

3
...

Example ;G T Z had the following balances in its debtors account ;
Jones
$400
Ketty
1000
Chandi
2000
At the end of the trading period 31/12/11 these debts proved to be bad
...


Providing for bad debts
 It is customary for enterprises selling goods on credit to create a provision for bad debts
...


36




The principle of conservatism is applied when there is uncertainty about whether income or a current
asset will be realised i
...

The prospect of not realising all debts is typical of this type of uncertainty
...

The financial manager decided to create a provision for bad debts of 4% of the outstanding trade
debtors
...


When a provision is created the only accounts which are affected are the :
 Bad debts
 Provision for bad debts (a contra asset a/c)
In the general ledger the balance on the debtors account T Ltd remains as $20 000
...

2
...
The $19 200 is shown in
the balance sheet as current assets under trade and other receivables
...
The $800 bad debts are closed off to the P&L account
...
Then a change in the amount of outstanding debtors will mean a change in the provision between one
year and the next
...

Example
On 30 June 2011 the outstanding trade debtors of Trio Ltd amounted to $30 000
...
The
assumption is that the existing provision is $800
...


400

$
1 200
800
400

New provision ($30 000 X 4%)
Existing provision
Amount needed for adjustment
Debtors account
2011
June 30 Bal b/d

Bal c/d

2011
Jun 30 Bal b/d
Provision for bad debts

30 000

Provision for bad debts account
2010
Jul 1 Bal b/d
2011
1 200
Jun 30 Bad debts
1 200
Bal b/d

Bad debts
2011
730
Jun 30 P&L
400
1 130

800
400
1 200
1 200

1 130
1 130

Summary
1
...

2
...

3
...
Only the
difference is debited to bad debts and credited to the provision for bad debts
...
Remember that the debtors control account is an asset account and provision for bad debts is a contra
asset account
...

5
...
($1 130)

Decreasing the provision for bad debts
If we assume once again that the provision for bad debts is based on a fixed % of outstanding debtors
...


Example
On 30 June 2012 the outstanding trade debtors of T Ltd amounted to $25 000 (bad debts already written off
during the year amounted to $960 )
...


38

The following accounting entries are necessary to adjust the provision for bad debts:
2012
June 30
Provision for bad debts
Bad debts
Being decrease of provision of bad debts

DR

CR

200
200

$
1 200
1 000
200

Existing provision
New provision (25 000 X 4%)
Amount in excess

Debtors account
2012
Jun 30 Bal b/d

2012
Jun 30 Bad debts
Bal c/d

2012
Jun 30 Bal b/d

25 000

Provision for bad debts account
2011
200
Jul 1 Bal b/d
1 000
1 200
Bal b/d

960

1 200
1 200
1 000

Bad debts
2012
Jun 30 Provision for bad debts
P&L

960

200
760
960

Recovery of bad debts written off
 when money is recovered that was previously written off as irrecoverable it must be recorded and
disclosed separately
...
The money recovered will be
debited against the bank account and the bad debts recovered account will be credited
...
This is to cancel the expense written off previously
...
The required accounts
for these recoveries :
DR
CR
Bank: Jones
400
Ketty
1000
Bad debts recovery a/c : Jones
400
Ketty
1000
Being bad debts recovered

DR

39

CR

Bad debt recovered
P&L a/c
Being bad debt recovered a/c closed to the P&L a/c

1400
1400

Provision for discount allowed
Provision for discount allowed is treated like provision for bad debts
...


Exercise 1
The balance sheet as at 31 May 2011 of Forest Traders Ltd included a provision for doubtful debts of $23 000
...
The company’s policy now is
to relate the provision for doubtful debts to the age of debts outstanding
...
It is now proposed to
make a provision for discounts to be allowed in the company’s accounts for the year ended 31 May 2011
...
Show the provision for doubtful debt account
...
Show the provision for discount allowed
...
Show a balance sheet extract as at 31 May 2011
...
On the following April 10 2013, management decided that the $500 account of
Sam Baker was uncollectible and wrote it off as a bad debt
...


Required:
Record the appropriate general journal entries for these events
...
A primary issue in
accounting for inventories is the amount of cost to be recognised as an asset and carried forward until the related
revenues are recognised
...
It also provides guidance on the cost formulas that are used to
assign costs to inventories
...

 The cost of inventories shall comprise costs of purchase, cost of conversion and other costs incurred in
bringing the inventories to their present location and condition
...
It has
dealt in only one type of good
...


First In First Out Method (FIFO)
This method assumes that the first units purchased are the first units to be sold
...

Last In First Out ( LIFO)

41

This methods assumes that goods which were bought last are the first to be sold
...


Average Cost Method (AVCO)
This involves valuing stocks at an average price
...
e
...
Further uses of goods are then at that figure until another
receipt of goods means that another recalculation is needed
...
It is therefore important that the
method chosen is the one that is closest in its assumption to the nature of the business
...
e
...
This is a example of the application of the prudence concept (accountants
should always exercise caution when dealing with uncertainty, while at the same time ensuring that the
financial statements are neutral- that gains and losses are neither overstated nor understated)
...

 To check that stock is not overvalued accountants calculate its net realisable value
...
e
...


Net realisable value
Net realisable value is the amount that can be obtained from disposing of the inventory in normal course of
business, less any further costs that will be incurred in getting it ready for sale or disposal
...
Inventory is therefore usually valued at cost
...

The cost and net realisable value should be compared for each separately-identifiable item of inventory, or
group of similar inventories, rather than for inventory in total
...
You may prefer to think of this as a ‘valuation’ of
inventory
...

Example
In year 2010 a business has four items of inventory
...
The inventory of item A1 could be disposed off for $7 800 less selling cost of $500
...

Required: What should be the value for inventory in the statement of financial position?
Lower of cost and NRV: events after the end of the accounting period
Inventory must be valued at the lower of cost and net realisable value, but it might not become apparent that
NRV is less than cost until after the end of the financial period
...
The units might be sold in January
2011, but only for $15 each net of selling expenses
...
Since the units were sold for only
$15in January, it is clear that their net realisable value at 31 December was only $15, even though this only
became apparent later
...

Cost of inventories
IAS 2states that ‘the cost of inventories shall comprise all cost purchase, cost of conversion and other costs
incurred in bringing the inventories to their present location and condition
...

The purchase price excludes any trade discounts, and is the cosr after deduction of trade discounts
...
Conversion costs must be
included in the cost of finished goods and unfinished work in progress
...
e
...
(fixed production overheads must be allocated to costs of finished output and
closing inventories on the basis of the normal production capacity in the period)
 Other costs incurred in bringing the inventories to their present location and condition
...


Other costs
Other costs can be included in the cost of inventories only to the extent that they are incurred in bringing the
inventory to its present location and condition
...

Administrative costs and selling and distribution costs must not be included in the cost of inventory
...
Even though they are
both expenses they are reportedly differently in the income statement
...
Sometimes the
supplier may pay any delivery costs but if the business has to pay its own delivery cists it records these costs as
carriage inwards
...
The
cost is usually added to the purchase cost of the goods and so this cost included in the cost of sales and the
calculation of gross profit
...
This is a normal selling expense, which is
treated as an expense in the income statement
...

Non- current assets are acquired with the intention of carrying out, supporting or facilitating operations
Non-current assets have an operating life span of more than a year and can be used over and over again
Non-current assets may be tangible, non-tangible or financial assets
Tangible non-current assets are assets such as buildings, machinery, vehicles and furniture
...
They are shown in the balance sheet under the heading Property
Plant and Equipment

Because property, plant and equipment become obsolete after several years, they must be written over their
expected economic life
...
This is to give
effect in the matching principle
When an asset can no longer operate economically
...
The proceeds on the realisation (sale)
of the asset are normally used to partly finance the new asset
...

IAS 16
The objective of this standard is to prescribe the accounting treatment for property plant and equipment so that
users of financial statements can discern information about an entity’s investment in its property plant and
equipment and the changes in such investments
...
The same
applies to maintenance costs
...
The following
important information regarding the asset register is recorded:
 Location
 Serial number
 Cost price
 Date of acquisition
 Expected lifespan
 Carrying amount
 Current year’s depreciation
 Accumulated depreciation

Recording the purchase of property plant and equipment
The purchase of property plant and equipment is recorded in the applicable asset account
...
g
...

The totals of the costs prices in the asset register with regard to a specific asset account must be equal to the
balance of that asset account in the general ledger
...





Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life
...

The method decided on for allocating depreciation must represent a fair allocation of the cost of
owning the asset each year
...


accumulated depreciation

Depreciation (expense account)
xxxx

45

under the double entry system, another account has to be credited with the same amount
...

Accumulated Depreciation account)
Depreciation

xxxx

The difference between the debit balance on the asset account and the credit balance on the accumulated
depreciation account is the net carrying amount of the asset
...

Methods of calculating depreciation
There are various methods of determining the amount of annual depreciation to be written off
...
g
...
The depreciatiable cost price of the machine is:
$500 000
( 60 000)
440 000
15 000
5 000
$460 000
The estimated lifespan is 5years
...

We now examine the 3 methods using this information
...

Depreciation = cost – RV
No
...

- This assumption is that the asset will be more productive when it is still new and less productive when
old
...

- This method does not use the depreciation amount (cost less residual value) as the basis for calculation
but is based on the cost price less accumulated depreciation, or the carrying amount
...
Usage
can be in the form of mileage (vehicles), production (machinery and equipment) and time (machinery and
equipment)
...


46

Formulae: Ds = ( Cost – RV) X Use
Total use
-

If there is no residual value : Cost X
Units produced during the year
No
...
Garages or engineering works
will have a lot of spanners, screwdrivers and other small tools
...

With these small non-current assets it would be difficult to follow the procedure followed for expensive noncurrent assets, i
...
Find its cost
...
Estimate its years of use to the business
...
Calculate and provide depreciation
...
Make the adjustments when the asset is disposed of
...
Calculate profit or loss on disposal
...
The method is not difficult to use
...
These are not sold but are used by the business
...


Depletion unit method
With non-current assets such as a quarry from which raw materials are dug out to be sold to the building
industry, a different method is needed, the depletion method
...
of units taken in a period

Machine hour method
With a machine the depreciation provision may be based on the number of hours that the machine was operated
during the period compared with the total expected running hours during the machine’s life with the business
...

Sum of year’s digits method

47

This method provides for higher depreciation to be charged early in the life of an asset with lower depreciation
in later years
...
The provision for depreciation for the first
year must be determined for the portion of the year which in this case is 6/12 or 50%
...


There are different ways to dispose of an asset:
1
...
Selling it outright
3
...

Scrapping an asset that has been written off entirely
This means there are no proceeds
...

Selling of the asset
The following 6steps should be followed when dealing with the disposal of an asset:
1
...
Transfer the total accumulated depreciation of the disposed asset to the realisation account
Debit : accumulated depreciation
Credit : realisation account
3
...


5
...


Record the amount earned on the realisation (note that the realisation account is credited in all three
cases)
Sold for cash
Debit : bank
Credit : realisation a/c
Sold on credit
Debit : debtor
Credit : realisation a/c
Asset traded in
Debit : asset a/c
Credit realisation a/c
Determine the profit or loss on the disposed asset:
 If the total of the debit side of the realisation account is bigger than that of the credit side, the
asset was disposed of at a loss
...

Transfer the profit or loss to the profit or lose account on disposal of that types of assets
Profit
Debit : realisation a/c
Credit : profit on disposal of
...
a/c
Credit : realisation a/c

Example:
Suppose that in the Braform Ltd’s example the machine costing $460 000 was bought on 30 November 2011
...

Required:
Account for the sale of the asset
...

1
...
Disclose if the land and buildings are classified as investment properties and are depreciated or not
...
Carrying amounts of the assets
Other non-current assets
Intangible assets
Are identifiable, non-monetary assets without physical substance held for use in the production or supply of
goods and services, for rental to others or administrative purposes, which are controlled by an enterprise as a
result of past events and from which future economic benefits are expected to flow to the enterprise
...


49

-

Amortisation is the systematic allocation of the depreciable amount of an intangible asset over its
useful life
...

Amortization is similar to depreciation and the accounting entry for amortisation of an intangible asset
would be as follows:
Dr : amortization
Cr : accumulative amortization

Other financial assets
Other financial assets include investments in banks or other institutions, loans granted and shares in listed and or
unlisted companies
...

Loans granted
Loans granted by an enterprise to other institutions and individuals may vary from long term to short term loans
...
The interest
earned may be calculated on a monthly basis or annual basis and may e
debited to the loan account or recurred in cash
...


Answer to Window Store Example
The Window Store
Trading, Profit & Loss Account
for the year ended 31 December 2011
Sales
Less: Sales returns & allowances
Turnover

$342 774
2 094
340 680

Less: Cost of Goods Sold
Opening stock
Add: Purchases
Less: Purchases returns

$ 61 152
$205 650
1 332
204 318
1 158

Add: Carriage inwards
Goods available for sale
Less: Closing stock
Gross profit
Add: Discount received

Less: Expenses
50

205 476
266 628
62 784

203 844
136 836
5 292
142 128

Office supplies
Store supplies
Prepaid insurance
Depreciation – Store equipment
Depreciation – Office equipment
Discount allowed
Sales salaries expense
Rent expenses: Selling spares
Office
Advertising
Office salaries expense
Net Profit

Opening capital
Add: Net profit
Less: Drawings
Closing capital

438
1 410
3 276
3 816
690
3 816
38 304
23 220
2 736
684
22 356

100 746
41382

Statement of changes in Owner’s Equity
$72 540
41 382
113 922
32 400
81 522

Window Store
Balance Sheet
As at 31 December 2011

Non - Current Assets
Office equipment
Store equipment

Cost

Accumulated
Depreciation

10 644
38 178
48 822

$ 4 530
19 188
23 718
51

Net Book Value

$ 6 114
18 990
25104

Current Assets
Closing stock
Cash

62 784
2 400
65 184

Current Liabilities
Accounts payable
Working capital

8 766
56 418
81 522

Equity
Financed by: D
...

Show the workings
...
Sales
$ 333 000
Beginning Inventory 117 000
Purchases

?

Ending Inventory

135 000

COGS

144 000

Gross Profit

?

Expenses

99 000

Net income or loss

90 000

B
...
Lane is as follows after his first year’s trading:
Trial balance as at 30 June 2012
DR
$
Sales
Purchases

154 870

Rent

4 200

Lighting and heating expenses
Salaries and wages

530
51 400

Insurance

2 100

Buildings

85 000

Fixtures

1 100

Accounts receivable

CR
$
265 900

31 300

Sundry expense

412

Accounts payable

15 910

Cash at bank

14 590

Drawings

30 000

Vans

16 400

Motor running expenses

4 110

Capital

114 202
396 012

396 012

Additional information:
Inventory at 30 June 2012 was $16 280
...
An income statement for the year ending 30 June 2012
...
A Balance Sheet as at 30 June 2012
...


DR
$
Sales
Purchases

CR
$
37 910

25 112

Stock 01
...
09

7 552

Salaries and wages

4 894

Motor expenses

1 328

Rent

912

Rates

240

Insurances

1 330

Light and heating expenses

292

Stationery

552

Sundry expenses

230

Motor vehicles

4 800

Fixture and Fittings

1 200

Debtors

9 154

Creditors

6 090

Cash at bank

7 752

Cash at hand

240

Drawings

4 100

Capital

25 688
69 688

55

69 688

Additional Information:
a
...

b
...

c
...

d
...


Required:
1
...

2
...

Question Four
The unadjusted trial balance for Lisa Garza, a sole proprietor as at 31 December 2009 is as
follows:
Dr
Cr
$
Cash

27 400

Surveying Supplies

19 300

Prepayments

35 000

Surveying Equipment

$

853 650

Accumulated depreciation – Surveying Equipment

354 600

Accounts payable

9 000

Long-term notes payable

120 000

Lisa Garza (capital)

346 800

Lisa Garza (withdrawals)

210 000

Surveying fees earned

584 000

Wages expense

168 200

56

Interest expense

7 200

Rent expense

54 000

Property taxes expense

24 700

Utilities expense

9 600

Repairs expense

5 350

1 414 400

a
...

c
...

e
...

g
...


1 414 400

Additional information:
Used supplies in 2009 $10 900
...

Insurance expense of $16 000 for the year of 2009
...

Earned but unpaid wages $2 100
...

Outstanding property taxes $6 200
...


Required:
1
...

2
...

3
...

4
...

Question Five
The following list of balance appeared in the books of Brotherhood, a sole proprietorship for
the year ended 31 December 2009
...
Estimated depreciation for the vehicle in 2009 was $9 100
...
Estimated depreciation for the equipment in 2009 was $1 950
...
On 31 December 2009, a stock count found the inventory to be $8 000
...
Prepare a trial balance as at 31 December 2009
...
Prepare an income statement for the year ended 31 December 2009
...
Prepare a statement of changes in owner’s equity for the year ended 31
December 2009
...
Prepare a balance sheet as at 31 December 2009
...
Capital: T
...
Stationary on hand at 28 February 2010 $ 150
...
A provision for bad debts at 5% on outstanding trade debtors balances must be
created
...
Rent income amounts to $1 500 per month and the rental has been charged for the full
financial year
...
Provide for depreciation on furniture and fittings at 5% per annum on cost price
...
Provide for interest still outstanding on mortgage bond
...
Land and buildings are not depreciated because they are classified as investment
properties
...
Prepare an income statement of Tafuma Fitz for the year ended 28 February 2010
...
Prepare a statement of changes in owner’s equity of Tafuma Fitz for the year ended
28 February 2010
...
Prepare a balance sheet of Tafuma Fitz as at 28 February 2010
...
The machine can be
used for a total of 20 000hours over an estimated life of 49 months
...
The financial year of
the business ends on 31 December each year
...

b) Suppose that during the financial year ended 31 December 2007 the machine was
used for only 1 500 hours before being sold for $800 000 on 30 June
...

ii
...


The Machine account
The provision for depreciation account
The assets disposal account

61



---