Income Statement Format

Name of company….. Limited

Income Statement of the period ended .

$ $ $
Revenue/Sales XX
Less Return Inwards/Sales return (X)

Net Sales XX

Cost of Sales: (Heading)

Opening Inventory XX
Purchases XX
Less: Return Outwards/Purchases (X)
Returns
Carriage Inwards XX

Net Purchases XX
Less: Closing Inventory (X)

Cost of Sales (X)

Gross Profit XX

Add Revenue:
Discount Received XX

Decrease in provision for doubtful XX XX

debts
XX
Total Expenses

Less Expenses: (Heading)

Directors’ remuneration XX
Debenture interest XX
Auditors’ remuneration XX
Salaries XX
Rent XX

Total Expenses (XXX)

Net Profit/Profit for the Year XXX

1
2
Balance Sheet Format

Name of Company Limited

Statement of Financial Position as at ,

$ $ $
Cost Acc. Pepr. NBV
Current Assets
(Heading)

In Tangible assets
Goodwill XX
Premises XX (X) XX
Machinery XX (X) XX

XXX XX XXX

Current Assets
(Heading)
Closing Inventory XX
Accounts Receivables XX
Bank XX

Total Current Assets XX

Less Current Liabilities

(Heading)

A.P account XX
Dividends XX
Debenture interest XX
owing

Total Current Liabilities X

3
4
Appropriation Account Format

Appropriation Account

$ $ $

Net Profit XX
Add Retained XXX
earnings b/d
XX

Less Appropriations:
Transfers:
General reserves XX
Replacement reserves XX

(XX)

Interim Dividends
Paid:
Preference shares XX

Ordinary shares XX

(XX)

Retained earnings c/f (XX)

XXX

5
 Introduction to Principles of Accounting – Chapter 1 (Done)

What is accounting?

Accounting is a process by which certain methods are used to prepare,

classify, analyze and summarize the financial records of a
business.

The accountant is expected to prepare financial statements to

interpret their efforts, on the affairs, of the business and to use the
information as a basis for decision making in the financial planning of
the business.

The concept and purpose of accounting

It is important for those individuals' response for the success of the

business to know....

 Whether profit is being made, because this is the main reason of

having a business.

 Whether there are sufficient funds to meet all the commitments of the
business on time.

 That they are making the best use of funds that has been invested into
the business.

The Users of Accounting Information

Internal Users

Owners - will have invested personal savings in a business and be

dependent on the success of the business of his/her livelihood.

Manager - will be concerned about the performance of the business and

will wish to identify any weakness and problems so that steps can be
taken to rectify these and to capitalize on business opportunities.

Employes - dependent on the success of the business for job’s security,

increases in pay and promotion opportunities.

External Users

Customers - dependent on the success of the business to ensure that

they goods or services they wish to buy are of good quality and available
when they are needed.

External Users

6
Customers - dependent on the success of the business to ensure that
they goods or services they wish to buy are of good quality and available
when they are needed.

7
Suppliers - will be concerned that the business can pay for goods and
services on time and also about the possibility of repeat and growing
orders.

Banks - may have lent funds to a business and will therefore wish to
ensure that interested payments and loan repayments can be made when
due.

Potential Investors – will carefully consider the possible returns on any

investment made and the risk involved.

Governments - will want to know the profit being made by the business
so that accurate tax assessments can be made.

Competitors - will wish to compare their own results with those of the
business.

Local Community - will consider the impact of the business on the

environment, the contribution made to the local economy and the
possibility of employment opportunities.

Fundamental Principles of Ethical Behaviour

Ethics is about moral principles and standards of behavior. It is vital that

clients can have complete trust in their accountant. Accountants have
access to information that is both confidential and sensitive and as such
they are requires to abide by certain ethical principles to demonstrate
honesty and fairness and to ensure public trust is maintained.

Ethical Principles - (Code of Ethics)

Integrity - being straight-forward and honest in all professional and

business relationships.

Objectivity - avoiding bias, conflicts of interest or the undue influence of

others when making professional judgements.

Professional competence and due care keeping – keeping knowledge

and skills at the appropriate level in order to deliver the services to clients
diligently.

Confidentiality - avoiding the disclosure of information to others without

expressed permission; not using a client's information for personal
advantage or gain.

Professional Behavior - taking personal responsibility for adopting the

highest standards of profession by complying with legal requirements and
regulation and avoiding any action that may discredit the profession.

8
9
Application of the Ethical Principles

The following ethical principles should be adhered to in the workplace.

 Treat people with respect and curtesy.

 Act responsible and honestly.

 Ensure Confidentiality.

 Be accountable for your actions.

 Be trustworthy.

 Apply Technical skills and competence.

 Comply with legal requirements and the organization’s laws and

regulations.

 Avoid conflicts of interests.

Inappropriate Applications of (The Ethical Principle)

Unacceptable behavior in the workplace would include in the following:

 Not working in the best interest of your employer

 Being dishonest and untrustworthy

 Disregarding confidentiality

 Undermining colleagues causing conflict

 Intimidation or harassment of colleagues to gain an advantage in a

particular area

 Accepting bribes or gifts in return for a favor

Appropriate Applications of Accounting Principles

Employees should comply in the following principles:

 Competency

 Willingness

 Communication

 Continuous training

 Confidentiality

10
  Openness

 Trust

 Accountability

 Honesty

Inappropriate Application of Accounting Principles

Not all employes comply and work within the accounting principles and
some may resort to unacceptable behavior, such as:

 Fraudulent financial reporting

 Failure to record all sales

 Theft of inventory

 Misappropriation of funds (standing funds)

 Entering non-existing employes on the payroll

 Tax evasion

Results of Inappropriate Application of Accounting Principles

Maintaining ethical principles requires strength of character and courage.

Where there is a failure to apply ethical principles the following
consequences conflict arise:

 Lawsuits

 Loss of jobs

 Loss of integrity/reputation

 Fines

 Imprisonments

11
Accounting Cycle

In order to prepare accounting records, it is essential that a particular

sequence of events and processes are followed. This sequence is
often referred to as the “Accounting Cycle”. The term cycle is used
because the sequence of activities is continuous.

The accounting cycle is a set of procedures which are followed in the

same sequence in each accounting period. The accounting period or
trading period, is the period which is covered by the final accounts. It is
usually one year in the most.

Source Documents – Thes are documents which are collected by the

business when financial transactions take place.

Journalizing – Recording transactions in the books of original entry.

12
Posting to the ledger – Transferring all debit and credit entries from the
books of original entry to the ledger.

Trial Balance – Making a list of all credit and debit balances in the ledger.

Financial Statements – Accounting to account principles, adjusts must

be made to certain accounts to allow for accruals, prepayments, etc.
before final accounts are paypared. Expenses and revenue of accounts
must also be closed off and transferred to the trading and profit and loss
account. Then the trading and profit and loss account and balance sheet
can be prepared.

13
The Business Cycle

The transitions that take place in a business from day to day, month to
month and year to year follows a certain cycle:

14
Types of Business Organizations

Business are organizations that provide goods and or services in order

to make a profit. There are a number of ways to classifying business.
Business can be classified by what they do:

 Provide raw material through mining, farming, fishing, etc.

 Manufacture goods, farming raw materials into finished products

etc.

 Sell goods to the general, public (retailers) or to other businesses

(wholesalers) etc.

 Provides services for business and the general public etc.

It is also possible to think about businesses in terms of who owns them

for, e.g.:

1. Sole Trader - one individual owns and controls the business. If

successful, the profit made by the business belong to the individual.
If unsuccessful the individual can lose whatever has been invested
as well as private resources.

2. Partnerships - several individuals own the business. Parties

jointly control the business, sharing profit between them. They are
also jointly responsible for the debts of the business, and can lose
their private resources if the partnership is unsuccessful.

3. Limited Liability Companies (Cooperations) - Owned by

shareholders who:

 Contribute the funds needed to establish and run the company.

 Are rewarded with some of the profits made by the company if

successful.

 Carry a responsibility for the debts of the company that is limited to

the amount they have invested.

 Are not at risk of losing their private funds if things go wrong, unlike
sole traders and partners.

15
 4. Cooperatives - these are organizations that are formed and
controlled by members. They are run to provide their members with
goods and services rather than to make a profit. When successful,
co-operations may reward their

16
 members in a number of ways including some share of any surplus
made, but usually surpluses are reinvested in the organization.

5. Non-Profit Organization's - these include clubs and societies

that are former by their members so that they can meet for
particular activities, perhaps social and or sporting activities. These
but have to be financially viable in order to provide a service.

Financial Statements (Definitions)

The main financial statements produced by business organizations are as

followed:

Income Statement - This reports the profits or loss made by a sole

trader, partnership or limited company, comparing revenue (income) with
costs. In the case of partnerships and limited liability companies, the
income statement is accompanied by an appropriation account showing
how profits are to be distributed.

Income and Expenditure Account - This records the surplus or deficit

made by a cooperation society.

Statements of Financial Position (Balance Sheet) - This sets out for

all organization, details of resources owned by the organization, its
liabilities and its net value. It helps identify the organization's ability to
meet its commitments on time, and also whether its resources are being
used efficient.

Cash How Statement - This provides summarized details of the inflows

of cash and out flows of cash during a financial period. The statement
gives users information about some of the important decisions made by
the owners of a business and how they would affect the business cash
funds during a financial period.

Technology and Accounting

In modern days accounting records usually produced using electronic

systems and the specialized accounting software packages. A wide variety
of these packages are available: Including;

Sage, quick books, and Microsoft dynamics.

17
Features of Technology in Accounting;

Automatic Processing - The computer operator extracts information

from source documents and inputs the relevant data into the software
programme. The other accounting processes are automatic: Ledger
accounts are updated instantly and trail balances and other financial
statements can be produced on demand.

Integration of Functions - As well as the main financial records, most

software packages will also produce inventory records generate
documents such as invoices and credit notes and, in some cases,
produces payroll records.

Management Information – Managers can often be provided with

additional information to help run the business, such as details of amounts
due from credit customers, analyzed according to the age of the debt, that
is the length of time it has been.

Advantages of Computerization

1. Greater accuracy due to automation of processes.

2. Greater speed because updating and calculations are carried out

virtually simultaneously.

3. Easier access to information using computer software to find

particular details.

4. Reduction in staffing cost or expenses may be possible because

record keeping is mainly automative.

5. More information available to help with management and decision

making.

Disadvantages of Computerization

Capital Expenditure - There could be a heavy initial outlay or cost on

computer equipment and software programmes. There is also likely to be
three need to update software at frequent interbuls.

Training Cost - Staff will need support in using new equipment and
software programmes and skills will need updating from time to time.
18
Risk of Data Lost - Systems can crash and security of data can be a
serious issue.

19
Maintenance and Support Cost - Businesses has to invest in technical
support to ensure systems provide continual service.

Period of Transition - it is sensible to operate / run old or manual

systems alongside new computerized systems at least for a time to
ensure that everything works as it should.

Computerized Accounting Systems can include some useful additional

functions such as;

Inventory Control - inventory records can be automatically updated

every time there is a purchase of goods, a sale of goods, returns of goods.
etc.

Credit Control - computerized records of accounts receivable can show

how much is owed by each customer and the amounts owed to credit
suppliers can be provided which makes it easier.

Payroll - computer software are programmes produce all the necessary

detailed information about wage and salary calculations, pay slips, payroll
registers. Etc.

Management Reports - Software Programs can automatically provide

trail balance income statements, balance sheets, ratio analysis and audit
traits. Statement of Financial Position.

Statement of Financial Position

A balance sheet is a financial statement that gives some important

information about a business to its owner, manager or other interested
individuals. It can be prepared at any point in time, but the balance sheet
is always prepared for the end of the financial period of the business. It
gives details of;

 Assets - The resources owned by the business.

 Liabilities - The amounts owned by the business to other

individuals, business or organizations.

 Capital - The net value of the business, also represents the owner’s
investments in the business.

20
21
Typical aspects for a small business include:

Cash at Bank

Cash in Bank

Equipment

Fixtures and Fittings

Inventory / Goods / Stock

Land

Premises / Building

Accounts Receivable

Vehicles

Typical Liabilities for a small business include:

Bank Loan

Bank Overdraft

Accounts Payable

The Accounting Equations

The link between the assets, liability and capital of a business is referred
to as the accounting equation.

Assets are equals to Capital plus Liability

Assets = Capital + Liability

This concept states that whatever assets are owned by the business must
have been purchased with finance supplied by the owner (Capital) and by
external parties (Liabilities).

22
Example - Isac opened a business called the ‘Village Stores’ on the first of
May 2019. On this data, he invested $40,000 (Capital) and borrowed
$10,000 from the bank (Liability). At this data the business would have
total assets of $50,000

Assets= Capital + Liabilities

$40,000 + $10,000 = $50,000

The Village Stores

Statement of Financial Position

as at 1st May 2019

Furniture and
fittings
17,000

Vehicle
15,000

Equipment
8,000

Inventory
7,500

Cash at
Bank
2,000

Cash in
Bank
500

50,000

Capital
40,000

23
Liabilities
10,000

Bank
Loan
50,000

24
Sequence of Balance Sheet:

Assets > Total (Double Entry) > Capital > Liabilities > Total (Double
Entry)

Types of Assets

Assets can be divided into 2 categories:

Non-Current Assets - those assets that a business intends to keep and

make use of for a long period (More than 1 year).

Typical examples of non-current assets are: Premises, Machinery,

Equipment, Furniture, Fixtures and Fitting and Vehicles.

Current Assets - those assets that are frequently changing in value they
are assets that are quickly turned into cash and are a benefit to the
business for a short period of time (Less than one year).

Typical examples of current assets include: Inventory, Accounts

Receivable, Cash at Bank, Cash in Hand.

Types of Liabilities

Liabilities can be divided into two categories:

Non-Current Liabilities - amounts owned that will be settled in the

longer terms (More than one year).

A typical example of a long-term liability is a Bank Loan, a Mortgage. Etc.

Current Liabilities - amounts owed that will be settled in the shorter

term (Less than one year).

A typical example of current of current liabilities include; Accounts Payable

and Banks Overdraft.

Order of Permanence

In a classified balance sheet details are set out to show the different
categories of assets and liabilities. Assets are normally shown in an order
that reflects how long each asset is expected to benefit the business.

25
This is called the order of Permanence. The order of permanence list items
on a balance sheet beginning with items likely to be used by the business
for the longest period. In the order if Permanence.

A. The first part of the balance sheet, non-current assets are recorded
first starting with premises.

B. Current assets are recorded next in the order: inventory, accounts

receivable, cash at bank, cash in hand.

C. In the second part of the balance sheet capital comes before non-
current liabilities and current liabilities are placed last.

26
 Hightown Retail Store

Statement of Financial Position as at 30th September 2019

Non-Current
Assets
$ $

Shop
Premises
50,000

Fixtures and
Fittings
9,000

Equipment
7,000 66,000

Current Assets

Inventories
6,000

Account
Receivable
700

Cash at
Bank
3,400

Cash in
Hand
200 10,500

76,500

Capital
62,000
27
Non-Current Liability

Bank
Loan
10,000

28
Sequence of Permanence:

Non-Current Assets > Current Assets > Total (Double Entry) > Capital >
Non-Current Liabilities > Current Liabilities > Total (Double Entry)

Order of Liquidity

This is the sequence used to list items on a balance sheet beginning

with cash and ending with the items least likely to be turned into
cash.

This is where assets that are already in the form of money in the near
future are placed last. For instance, current assets will come before or
proceed non-current assets and should start with, cash in hand and finish
with inventories. In the second part current liabilities come before non-
current liabilities; capital is placed last. In other words, the complete
reverse of the order of permanence.

29
 Hightown Retail Store

Statement of Financial Position as at 30th September 2019

$ $

Current Assets

Cash in Hand
200

Cash at Bank
3,400

Accounts Receivable
700

Inventories
6,200 10,500

Non-Current Assets

Equipment
7,000

Fixtures and Fittings

9,000

Shop Premises
50,000 66,000

76,500

Current Liability

Accounts Payable
4,500

Non-Current Liability

30
Bank Loan
10,000

Capital
62,000

76,500

31
Sequence of Liquidity:

Current Assets > Non-Current Assets > Total (Double Entry) > Current
Liabilities > Non-Current Liabilities > Capital > Total (Double Entry)

The effect of a transaction on the balance sheet.

A transaction is a financial activity event. Each transaction has 2 effects

and this idea is the foundation of what is usually called “The Double Entry
Accounting System”. Every time a transaction occurs if it is possible to
work out its effects on the balance sheet of a business. This process is the
simplest way of reading transactions.

It is important to realizes:

 Each transaction affects 2 balance sheet items.

 After the transaction has been recorded, the accounting

equation should still hold true,

A=C+L

Preparing Ledger Accounts - (Classes of Accounts)

Ledge accounts can be divided into three different classes:

Nominal Accounts

Are those in which expenses and income are recorded:

Sales, Purchases, Wages, Electricity, Commissions Received etc.

Real Accounts

Are those which deal with possessions of the business:

Building, Machinery, Computer, Equipment, Fixtures and Fittings, Stock

etc.

32
Personal Accounts

Accounts that deal with people and firms e.g.:

Accounts Receivables and Accounts Payable

Types of ledgers

In a double entry system, the accounts are kept in a ledger. Ledger

accounts are grouped together in three different ledgers.

Transactions and the Double Entry Principle

Any transaction has two effects on items in the balance sheet. Two effects
of the balance sheet. Two effects of the balance sheet and income
statement of the business.

The system of double entry book. Keeping is a method of recording

transactions in the books of account of a business. The information for
every item that is entered into the books of account, is obtained from a
source document, that is an invoice, credit note, cheque stub, etc.

This is the book keeping stage of accounting and the process used is
called Double Entry.

33
Rules of Double Entry or Double-Entry Principles

Preparing Simple Ledger Accounts

A Ledger Account is a record of transactions affecting a particular aspect

of the affairs of the business.

Leger accounts make use of a two-sided form that corresponds to a shape

“T”, and ledger accounts are sometimes referred to as “T” accounts.

Accounts have columns to record the data of each entry, details of the
transactions being recorded, a folio column for cross referring to the
sources of the information and money columns to record the amount
involved in the transaction.

The title of each account is written across the top of the account at the
center. In any account:

The left-hand side is referred to as the debit side, abbreviated as

“Dr”.

The right-hand side is referred to as credit side, abbreviated as

“Cr”.

Example - Paid cash $2,000.00 to buy machinery – 15 June 2019

Two accounts being affected:

Cash (asset) in hand – decreasing – credit

34
Machinery (asset) - increasing – debit

35
Dr Cash in
Hand Cr

Date Details Folio Amount Date Details Folio Amount

2019

June Machinery $2,000

15

Dr
Machinery Cr

Date Details Folio Amount Date Details Folio Amount

2019

June Cash in $2,000

15 Hand

Inventory Movements

To keep a check on the movements of inventory various accounts are

opened as shown below:

Purchase Account – This account is used for the purchase of goods /

inventory.

Sales Accounts – This account is used for the sale of goods / inventory.

Return Inwards / Sale Return Accounts – This account is used for

goods returned to the firm by its customers.

Return Outwards / Purchase Return Account – This account is used

for good related by the firm to its supplier.

36
Sales and Purchases -

Purchases

In accounting this means the purchase of those goods that the firm buys
with the prime intention of selling / for the purpose of resale.

Sales

This refers to the sale of those goods in which the firm normally deals and
which were bought with the prime intention of resale / prime intention of
selling.

Inventory / Stock / Goods are those items which the business purchases or

manufactures for the purpose of re-sale.

37
Inventory Movements

To keep a check on the movements of inventory various accounts are

opened as shown below:

a) Purchases Account –

This account is used for the purchase of goods / inventory

b) Sales Accounts –

This account is used for the sales of goods / inventory

c) Return Inwards / Sales Return Account –

This account is used for goods returned to the firm by its customers

d) Return Outwards / Purchases Return Account –

This account is used for goods returned by the firm to its supplier

Sales & Purchases

1) Purchases

In Accounting this means the purchase of those goods that the firm buys
with the prime intention of selling / for the purpose of resale.

2) Sales

This refers to the slae of those goods in which the firm normally deals and
which were bought with the prime intention of resale / prime intention of
selling

 Inventory / Stock / Goods are those which the business purchases /

manufactures for the purpose of resale.

3) Return Inwards or Sales Return –

These represent goods sold which have subsequently been returned by a

customer. This would be for various reasons such as:

a) The goods have been damaged in transit

b) The goods are of poor quality
c) The goods sent to the customer are of the incorrect size, colour or
model

38
4) Return Outwards or Purchases Returns –

These represent goods that were purchases, and are now being returned
to the supplier.

Drawings –

The owner may want to take cash out of the business for his / her private
use. This is known as drawings. Money taken out as Drawings will reduce
Capital. Each amount taken out as drawings will be debited to a drawings
account and at the year this is transferred to the capital account.

Revenues –

The term ‘Revenues’ means the value of goods and services that have
been supplied to customers.

Expenses –

The term ‘Expenses’ means the value of the assets that have used up to
obtain those revenues.

Balancing Accounts

The Balancing Process

At the end of an Accounting / Financial period, it is necessary to find the

balance on each ledger account in order that a trial balance can be
extracted as part of the accounting cycle. The process is referred to as
balancing off accounts or balancing the ledger.

The balancing process follows the basic rule of Double – Entry. There must
be a matching Debit and Credit Entry.

And it includes three (3) steps;

Step 1 – Calculating the balance at the end of the period and recording
this on which ever side of the account has the lowest total (This is referred
as the balance carried down or balanced c/d.)

39
Step 2 – Recording totals on the next available blank line.

Step 3 – Making a second record of balance below the totals on the

opposite side to complete the Double – Entry (This is referred to as the
balance brought down or balanced b/d.)

Interpretating Entries and Preparing A Trial Balance

It is a valuable skill to be able explain the entries made in any ledger

account. This means stating the following:

a) The Date of the Transaction (year, month and day)

b) The Nature of the Transaction
c) The Amount of the Transaction

The purpose of A Trial Balance

The trial balance is designed to check the accuracy of the double entry
records. The trial balance list all the accounts in the accounting system, it
is also a very useful summary to refer to when preparing financial
statements such as the income statement and the balance sheet.

However, the trial balance does have limitations. There are several types
of errors which are not revealed by a trial balance.

How Does A Trial Balance Work?

The trial balance is based on the principle that for every transaction there
should be a matching debit and credit entry, so that the total of debit
entries should equal the total of all credit entries.

40
To produce a Trial Balce the following steps are necessary:

Step One –

List all the accounts in the accounting system

Step Two –

For each account record its balance in either the Debit column or Credit
column of the Trial Balance according to the side on which the balance
appears in the account.

Step Three –

Total the debit and credit columns of the Trial Balance, the totals should
agree.

Example

Trial Balance as at 31 December 2019

$ $

Accounts Payable: Ox Manufacturer

4,130

Accounts Receivable: E. Jones

2,080

Capital
27,940

Cash in Hand
390

Cas in Bank
2,740

Fixtures and Fittings

20,100

General Expenses
5,800

41
Purchase
39,900

Sales
57,700

Wages
18,7600

89,770 89,770

42
43
 Introduction to financial statements and ratios – Chapter 2 (nearly done)

Sole Trader Financial Statements

Financial Statements are designed to inform a wide range of users of

important aspects of the performance of a business. In the case of a sole
trader, the owner will need to know how profitable the business is and
also whether it is generating enough funds to pay its financial obligations.

The Components of Financial Statements

A sole Trader’s Financial Statements, prepared at the end of each financial

year, consist of an income statement, and a statement of financial
position (balance sheet).

The income statement of a trading business is divided into two (2)

sections:

a) A Trading Account Section - Comparing the sales of the business for the
period to the cost of goods sold, to give a figure for gross profit /
income.
b) A Profit and Loss Section – comparing the gross profit made by the
business to all the day-to-day running cost (expenses) of the business
giving a figure for the net profit for the year (or net loss for the year.)

A Statement of Financial Position (Balance Sheet) is a formal document

setting out details of the assets, liabilities and capital of a business. It
provides the information required to enable users to judge the success or
otherwise of a business in terms of profitability and solvency (the ability to
pay it debts).

Both the income statements and balance sheet are usually set out in a
vertical style. This format is now in common use because it has greater
flexibility and is more easily understood by all users of financial
statements.

 Gross Profit – The profit made by buying and selling goods

 Profit for the year – The profit made by a business in a financial year
taking account of operational expenses. Profit for the year is sometime
referred to as Net Profit / Income.

44
Preparing The Income Statement of a Sole Trader

In income statement (sometimes called a Trading and Profit and Loss

account) set out a detailed calculation of the Profit or Loss for the year of
the business. Account is taking of the value of unsold goods (inventory)
when calculating the profit.

Here is the format for a Simple Income Statement of a business selling

goods using the vertical style:

 Revenue is the term used in an income statement for the income

received for Sale of Goods of a business.
 It is recommended that any figures that are to be deducted in an
income statement are shown in brackets.

45
Here is the format for the vertical method of the balance sheet:

46
Double Entry for Inventory

The valuation of unsold goods (inventory) is taken into account at the end
of each financial year. Often the figure is found by actually counting the
items in the stock room and working out the value using the price paid for
the items when they were purchased. It is now becoming much more
common for inventory records to be kept electronically using software that
can produce figures for the valuation of inventory.

Once the closing inventory has been valued, general journal entries will be
prepared as follows:

1. Debited the inventory account in the General Ledger.

2. Deducted from the value of goods available for sale during the year in
the Income Statement.

Recording Returns in the Trading Section of an Income Statement

Goods returned are recording in the Trading Section as shown below.

1. Returns Inwards (Sales Returns) – These are deducted form Sales /

Revenue to slow a Net figure for the year under Review.
2. Returns Outwards (Purchases Returns) – These are deducted from
purchases to show a Net figure for the year under Review.

Carriages Charges and The Income Statement

Carriage is the term used to describe the expense of having goods

delivered. In other words, Delivery Expense

1. Carriage Inwards – refers to the changes paid to have purchases

delivered or it is the cost of transporting goods purchased by a
business. Carriage Inwards is recorded in the Trading Section and is
added to purchases.
2.

47
3. Carriage Outwards – refers to the charges paid by a business to have
its goods delivered to customers or it is the cost of transporting to
customers. Carriage Outwards is recorded in the Profit and Loss Section
of the Income Statement as an expense.

48
From here is where I copied

Introduction to Financial Statements and Ratios – Chapter 2

Ratios

Ratios can be used under the following headings when reporting in a

business’s performance.

Profitability-

These ratios led us if the owners and managers of a business are

successful in measuring the business’s value over time through lending of
providing a service. The profitability ratios are:

 Return on Capital Employed

 Gross Profit Margin

 Net Profit Margin

 Mark up

Liquidity-

These ratios tell us if the business’s resources are well managed so that
debts are settled on time and so that the owner can receive a reuseable
income. The liquidity ratios are:

 Working Capital / Current Ratio

 Acid Test / Liquid Capital Ratios

Efficiency-

These ratios tell us of the owners and the managers of the business are
controlling the resources so that the maximum benefit is derived from the
funds tied up in them. The efficiency ratios:

 Ratio of Inventory Turnover

Working Capital Ratio

This measures the funds available to meet the business’s debt.

Acid Test Ratio

This ratio indicates the funds more immediately available to meet the
business’s debt.
49
Return on Capital Employed

This measures how much profit is being made compared to the owner’s
investment in the business.

Formulas;

Ratio of Inventory Turnover

Return of Capital Employed

Trade payable Payment

Trade Receivable Collection

Working Capital Ratio ******************

50
Income Statement Ratio

In order to find out the key aspects of a business performance it is usual

to calculate ratios using some of the key figures contained in financial
statements ratios can be used to make comparisons of results for;

a) 1 Year compared to previous years

b) 1 Business compared to a similar business

 When these comparisons are made it will be possible to have a better

idea of improvements that have improved, or of any weakening
imperformance.

There are four (4) income performance ratios which can be used to
analyze the income statement.

1. Gross Profit Margin / Percentage of Gross Profit to Revenue

2. Mark-Up

3. Rate of Inventory Turn Over

4. Profit Margin / Percentage of Profit to Revenue

51
 Income Statement for the year ended

31 December 2012

$ $

Revenue
400,000

Less: opening inventory

27,000

Purchases
296,000

323,000

Less: closing inventory

(23,000)

Cost of
Sales
(300,000)

Gross
Profit
100,000

Less: general expense

9,000

Rent
17,000

Salaries
44,000 (70,000)

Profit of the
year
30,000

Calculations: have to get from phone

1. Gross Profit Margin

52
Gross Profit x 100RevenueGross Profit x 100Revenue

100,000 x 100400,000100,000 x 100400,000

25% 25%

53
 2. Mark-Up

Gross Profit x 100Cost of SalesGross Pr⁡ofit x 100Cost of Sales

100,000 x 100300,000100,000 x 100300,000

3313%3313%

3. Rate of Inventory Turn Over

Costs of SalesAverage InventoryCosts of SalesAverage Inventory

Average Inventory =27,000 + 23,0002Average Inventory =27,000 +

23,0002

50,0002=25,00050,0002=25,000

300,00025,000300,00025,000

12 times 12 times

4. Net Profit Margin

Profit of the Year x 100RevenuePr⁡ofit of the Year x 100Revenue

30,000 x 100400,00030,000 x 100400,000

75% 75%

54
 Interpreting The Results:

1. Gross Profit Margin

This percentage shows how much Gross Profit is made for every $1 of
Revenue. In this example every $1 of Sales provides 25¢ for Gross Profit.

2. Mark-Up

This percentage shows how much Gross profit is made for every $1 spent
on buying goods for resale. In the example, every $1 of cost of sales
provides 33.33¢ of Gross Profit.

3. Rate of Inventory Turn Over

This shows how many times during the year the business manage to sell
the typical amount of inventory it has for sale at one time. In this
example, the businesses average inventory was sold 12times during the
year, that is an average of the month.

4. Net Profit Margin

This percentage shows how much profit is made for every $1 for Revenue.
In this example, every $1 of sales produced a profit of 7.5¢.

Positive Performance and Income Statement Ratios

It is possible to make comments on a business’s performance however, it

is important to have equivalent ratios for a previous year/s and for a
similar business.

55
Analyzing Income Statement Ratios:

1. Gross Profit Margin and Mark-Up

If these figures are increasing this is usually seen as good news for a
business, because it means more Gross Profit is being made in relation to
sales of Cost of Sales.

2. Rate of Inventory Turn Over

An increase in this ratio should be welcomed news for the owner of a

business because it could result from selling gained more quickly so profit
is being made on a greater volume of sales. It could also result from
holding a smaller average inventory.

3. Net Profit Margin

An increase in this percentage will mean that a business is making more

profit on each item sold.

Balance Sheets Ratios

There are five (5) ratios which can be used to analyze a balance sheet.

1. The Working Capital / Current Ratio

Your answer should be written as; a ratio 2:1

2. Liquid Capital / Acid Test Ratio

Your result should be written as; a ratio 2:1

56
57
3. Return on Capital Employed / Return on Investment

It is possible to use the opening, closing or an average capital figure.

4. Trade Receivables Collection Period

The answer is expressed in days and always rounded up.

5. Trade Payable Payment Period

The answer is expressed in days and always rounded up.

58
 Calculating Balance Sheet Ratios

Balance Sheet as at 31 December 2013

$ $ $

Non-current assets
330,000

Current Assets

Inventory
15,000

Trade Receivable 12,000

Cost at Bank
13,000 40,000

Less current Liabilities

Trade
Payable
(20,000)

Working Capital (Net Current

Assets)
20,000

350,000

Capital

Opening
balance
300,000

Profit of the
year
70,000

370,000
59
Less
Drawings
(20,000)

350,000

60
The business had a total Credit Sales of $136,875 and total Credit
Purchases were $243,333.

1. Working Capital Ratio

Formula: Current AssetsCurrent LiabilitiesFormula: Current AssetsCurrent

Liabilities

=40,00020,000=40,00020,000

=2:1 =2:1

2. Liquid Capital Ratio

Formula: Current Asset−(Inventory+Prepayment)Current

LiabilitiesFormula: Current Asset−Inventory+Pr⁡epaymentCurrent Liabilities

=40,000−(15,000+0)20,000=40,000−15,000+020,000

=1.25:1 =1.25:1

3. Return on Capital Employed

Formula: Profit of the Year x 100Opening Balance (Opening, Closing or

On Average of Both)Formula: Pr⁡ofit of the Year x 100Opening Balance
Opening, Closin⁡g or On Average of Both

=70,000 x 100300,000=70,000 x 100300,000

=23% =23%

4. Trade Receivable collection Period

=Trade Receiable x 365Credit Sales=Trade Receiable x 365Credit Sales

61
=12,000 x 365136,875=12,000 x 365136,875

=32 days =32 days

5. Trade Payable Payment Period

=Trade Payable x 365Credit Purchases=Trade Payable x 365Credit

Purchases

=20,000 x 365243,333=20,000 x 365243,333

=30 days =30 days

62
Interpretating The Results

1. Working Capital Ratio -

This measures the funds available to meet the business’s debt.

2. Acid Test Ratio -

This ratio indicates the funds more immediately available to meet the
business’s debt.

3. Return on Capital Employed -

This measures how much profit is being made compared to owner’s

investment in the business.

4. Trade Receivables Collection Period -

This measures how quickly credit customers pay their accounts.

5. Trade payables Payment Period -

This measures how quickly credit suppliers are paid.

Positive Performance and Balance Sheet Ratios

1. Working Capital Ratio

If this ratio is in line with the norm for the type of business being
reviewed, it means that the business is well placed to meet its
commitments and has just the right amount of Net Currents Assets.

2. Acid Test Ratio

If this Ratio is in line with the norm for the type of business being
reviewed, it means the business is well-placed to meet its commitments in
the short term and has just the right amount of liquid assets.

63
3. Return on Capital Employed

If the percentage is increasing this would signal an improving performance

and a more effective use of all the business’s resources.

4. Collections Period and Payables Period

For most business credit terms are normally 30 days. When these ratios
are bought within 30 days, it means credit terms are being met by the
business and by its customers and that money flowing out of the business
is matched by money flowing into the business.

Year End December 31, 2012

Average
Inventory
48,000

Cost of
Sales
576,000

Credit
Purchases
547,500

Credit
Sales
334,458

Gross
Profit
144,000

Profit of the
year
72,000

Revenue (Cash and Credit

Sales)
720,000

64
Capital
Employed
900,000

Current
Assets
90,000

Current
Liabilities
45,000

Inventory
46,000

Trade
Payables
45,000

Trade
Receivables
33,000

65
 Foster Company

Reporting an Business Performance

2011 2012

Gross Profit Margin

23% 20%

Acid Test Ratio

0.7:1 0.98:1

Mark-up
30% 25%

Net Profit Margin

14% 10%

Rate of Inventory Turnover 11

times 12 times

Return on Capital Employed

7% 8%

Trade Payable Payment 30

days 30 days

Trade Receivable Collections 30 days

36 days

Working Capital
Ratio 1.8:1
2:1

Revenue
740,000 720,000

1. Gross Profit Margin

Gross Profit x 100RevenueGross Pr⁡ofit x 100Revenue

=144,000 x 100720,000=144,000 x 100720,000

=20% =20%

66
 2. Mark-up

Gross Profit x 100Cost of SalesGross Pr⁡ofit x 100Cost of Sales

=144,000 x 100576,000=144,000 x 100576,000

=25% =25%

3. Rate of Inventory Turnover

Cost of SalesAverage IventoryCost of SalesAverage Iventory

=576,00048,000=576,00048,000

=12 times =12 times

4. Net Profit Margin

Profit of the Year x 100RevenuePr⁡ofit of the Year x 100Revenue

=72,000 x 100720,000=72,000 x 100720,000

=10% =10%

67
Ratios can be viewed under the following headings when reporting on a
business's performance.

A. Profitability

These ratios tell us if the owners and managers of a business are

successful in increasing the business’s overtime through trading or
providing a service. The profitability ratios are:

1. The Return on Capital Employed

2. Gross Profit Margin

3. Net Profit Margin

4. Mark-up

B. Liquidity

Thes ratios tell us if the business’s resources are well managed so that
debts are settled on time and so that the owner can receive a reasonable
income. The liquidity ratios are:

1. Working Capital / Current Ratio

2. Acid Test / Liquid Capital Ratio

C. Efficiency

These ratios tell us if the owners and managers of the business are
controlling key recourses so that the maximum benefit is derived from the
funds tied up in them. The efficiency ratios are:

1. Rate of Inventory Turn Over

2. Trade Receivables Collection Period

3. Trade Payable Payment Period

68
 Foster Company

Report on the Results of the 2012 Ratios

Vs the 2011 Ratios

It can be seen the Revenue has fallen since 2011 by $20,000.

Profitability:

Improvements:

The Return on Capital Employed has improved by 1% meaning that more

profit is being earned per $1 of capital invested by the owner so resources
are being used more effectively.

Weaknesses:

The Gross Profit Margin and Mark-up are lower than in 2011 meaning that
less profit is being made on each $1 of Sales or $1 of Cost of Sales. The
net profit margin has decreased by 4% since 2011 meaning that less profit
is being made per $1 of Sales.

Liquidity:

Improvements:

The working capital ratio has improved since 2011 which means that the
business should be able to pay its debts more easily. The liquid capital
ratio has improved since 2011 which means that the business should be
able to pay its immediate debts more easily.

Weaknesses:

None

69
Efficiency;

Improvements:

The Rate of Inventory Turn Over has increased since 2011 which could
mean that a possibly smaller average in inventory is being sold more
quickly in 2012. The Trade Payable Period has been constant at 30 days.

Weaknesses:

Trade Receivables are paying less quickly than in 2011 and less quickly
than would be expected, which could cause liquidity problems.

Overall Performance

Liquidity has improved since 2011, but in some respects profitability and
efficiency have weakened.

Possible Recommendations:

1. Increase Sales by considering changing selling prices, advertising more

effectively, or making changes to the product lines that are currently
being sold.

2. Improve the Gross Profit Margin and Mark-up by either increasing prices
and finding cheaper suppliers.

3. Increase the Profit Margin by having a stricter control of expenses.

4. Encourage credit customers to pay more promptly by sending more

reminders and / or possibly offering cash discounts

70
 Books of original entry – Chapter 3

Source Documents Related to Books of Original Entry

Source Documents need to be stored carefully as they provide evidence

that a transaction has occurred when a source document is received /
issued, key information is extracted from the document and recorded in
one of the books of original entry.

Books of Original Entry

In the double entry system of book-keeping all transactions must first be

recorded in books of original entry, there are 7 books of original entry and
detail about transactions are listed in these books in date order. The books
of original entry are then used as the source for all details shown in the
ledger accounts.

71
Cash Transactions – these transactions involve the immediate receipt or
payment of money. They could make use of cash, cheques, debit and or
credit cards and can take place online.

Credit Transactions – these transactions are those where the receipt or

payments is delayed. The business has to keep a record of the amount
owing to the – the accounts payable. The safe of goods on credit means
that goods are sent to a customer but the customer pays at a later date.

The business will as such keep a record of the amount owed by the
customer – the account receivable.

72
Terms

List Price – A reference to the normal selling price of a product. It is the

price before deducting any trade discount.

Trade Discount – This is a reduction in the unit price of items purchased

for resale. Trade Discount are not normally available to private individuals.
It is a price given as a reward to businesses for buying in large quantities.

Cash Discounts – This is an incentive that a seller offers to a buyer for

setting the invoice immediately on delivery for paying a bill owed before
the scheduled due date.

Discount Allowed – These are cash discounts given to a credit discount

given to a credit customer for setting their account within an agreed time-
limit. These discounts are given to induce those who owe money to settle
within a time specified by the company.

Discount Received – This is a cash discount given by a credit supplier

whose account has been settled within an agreed time-limit.

Purchases Book

This book is a record of credit purchases of goods / inventory. The source

documents for these entries are the purchases invoices received from
suppliers. This book is maintained in date order and is totaled at
appropriate intervals (weekly / monthly).

 Cash purchases are recorded in the cash book.

 Purchases non-current (fixed) assets on credit are recorded in the
general journal.

Example; During June 2019, the business received the following purchases
invoices from their suppliers.

June 7 – Speed Cycles Ltd, invoices number 7459 for goods total value
$1,4800.00

June 19 – J. Manufactory Ltd, invoice number 84963 for goods at list price
$3,200.00 less 25% trade discount.

($3,200-25%) =$2,400.00

73
 Purchases Book

Date Supplier Invoice Number Folio Amount Due

2019

June 7 Speed Cycles Ltd 74536 $1,480

June 19 J. Manufactory Ltd 84962 $2,400

Total Purchases $3,880

Sales Book

A sales book is a record of credit sales of goods / inventory. The source

documents for these entries are the sales invoices issued by the business
and sent to its credit customers. It is maintained in date order and totaled
at appropriate intervals.

 Cash sales are recorded in the cash book.

 Sales of non-current assets on credit are recorded in the general
journal.

Examples: During June 2019 the business issued the following invoices to
credit customers:

June 11 – Best Buy Stores, Sales Invoice No.2771, for goods at list price
$1,240.00, less 15% trade discount.

June 23 – Bike In, Sales Invoice No.2772, for goods at list price $2,280.00,
less 20% trade discount.

Sales Book

Date Customer Invoice Number Folio Amount Due

2019

June 11 Best Buy Stores 2771 $1,054

June 23 Bike In 2772 $1,824

Total Sales $2,878

74
($1240-15%) =$1054

($2280-20%) =$1824

Where a trade discount has been given by a supplier or to a customer,

only the net amount due is recorded in the book of original entry. It is the
amount due / to be paid that matters.

The details shown in the purchases and sales book are used to make the
double entry records in the ledger accounts. It is when these double entry
records, are made that entries are made in the folio column of the journal.

Return Outwards and Return Inwards Book

Goods are returned to their supplier for a number of reasons:

1. Goods were found to be damaged on receipt / receiving the goods.

2. The wrong goods were sent out by the supplier

3. Goods were received too late so that the sale by date had been
exceeded (expired goods)

Credit Notes

The most commonly used source document for returns are credit notes.
This document is used to record the amount to be deducted when goods
are returned. Credit Notes are used for the followings:

Return Outwards Book – This book of original entry lists all the goods
returned on credit to suppliers. Credit notes received are used to prepare
the return outwards book.

Return Inwards Book – This book of original entry lists all goods returned
by a customer that were previously sold one credit. Copies of the credit
notes sent are used to prepare the return inwards book.

 If a trade discount had been applied to the goods that are being
returned the same rate of trade discount will be deducted when
preparing the credit note.

 Credit Notes are also issued an amount charged on an invoice is

overstated in error and needs to be reduced.
75
Debits Notes
This is a document used to record details of goods being returned to a
supplier and the amount to be deducted from the total due. However, no
entries are made in the books of account of the business until a credit
note is received from the supplier.

Example: Sofia owns a wholesale business. During March 2019 the

following transaction occurred:

March 8 – Returned damaged goods to a supplier. BTL Manufacturing and

received a Credit Note #473 for $780.00.

March 13 – Issued a credit note #B83 to Rockport Ltd for goods returned
by this customer for $370.00.

March 20 – Return Faulty goods to PCP Ltd, which had a list price of $600,
a trade discount of 25% which be deducted and received a Credit Number
T1007 for $450.

(600-25%) =$450

March 27 – Issued a Credit Note #B84 to Trent Stored Limited for goods
that had been sold at a list price of $960 less a Trade Discount of 20%.

(960-20%) =$768

Return Outwards Book

Date Supplier Credit Note Number Folio Amount Due

2019

March 8 BTL Manufacturing 473 $780

PCP Ltd T1007 $450
Total Return $1,230
Outwards

Return Inwards Book

Date Customer Credit Note Number Folio Amount Due

2019

March Rockport Ltd B83 $370

13
March Trent Stores Ltd B84 $768

76
27
Total Return $1,138 00
Inwards
Only returns on goods previously purchased or sold on credit are recorded.

77
The Three Column Cash Book

The books of original entry used for recording cash transactions is called
the cash book. A three-column cash book includes columns to record
receipts and payments affecting the cash and bank accounts of the
business, as well as additional columns to record cash discounts. The
discounts column is not part of the double entry record of cash discounts.

 A cash book is both a book of original entry and also a ledger for the
two accounts – the cash account and bank account.
 Contra – entry – the record in the cash book of cash transferred to the
bank, or cash withdrawn from the bank. Contra – entries are indicated
by a letter “C” in the Folio column.

The cash book consists of the cash account and the bank account put
together in one book. Initially there were 2 ledger accounts (bank account
and cash account), now it is to put the two sets of accounts columns
together. As such we can record all money received and paid out on a
particular date on the same page.

Bank overdraft and The Cash Book

A business may borrow money from a bank by means of a bank overdraft.

This means that the business is allowed to pay more out of the bank
account, by writing out cheques than the total amount available in the
account.

Example; Anita offers her suppliers a cash discount for prompt payments
and she offers her credit customers a cash discounts if they settle their
accounts properly.

On 1 September 2019, page 2 of Cash Book showed balances of $635.00

cash in hand and $4838.00 cash at bank. During the 1 st week of
September, the following transactions occurred:

78
Sept 1 – Cheque counterfoil - Payment of supplier, MNH Supplier
$1,140.00 in full settlement of the amount due, $1200.00.

Sept 2 – Paying-in -slip - Cheque received from credit customer, K Anson,

for $780.00 settlement of the amount due, $800.00

Sept 3 – Cash receipt in respect - Payments for general expenses, of

sundry purchases $82.00

Sept 4 – Bank Statement - Bank charges for the month totalling, $73.00

Sept 5 – Bank Statement – Bank charges for the month totalling, $73

Sept 6 – Paying-slip - Cheque received from credit customer, Leo Adams.

Leo Adams owed $1,200.00 at this date. The cheque was in full settlement
of the amount less of a 2.5% cash discount.

Sept 7 – Cheque counterfoil – Payment of supplier, Island Trader Ltd. This

company was owed $2,600.00 on this date. The account was settled in full
less a 5% cash discount.

Sept 8 – Paying-in-slip counterfoil – Cash in bank $1,500.00

79
From Here****

The Petty Cash Book

Some businesses we a separate book of original entry to record small

payments in cash. This is done so that the main cash book is not
overburdened with small transactions.

Source Documents For Petty Cash Transactions.

The responsibility for keeping the petty cash book is given to a more
junior member of staff. Many businesses operate what is called the
imprest system, which works as follows:

The Petty Cashier is given responsibility for a maximum amount of petty

cash at any time. The maximum amount is called The Petty Cash Float or
Imprest. The imprest is set at a level sufficient to cover petty cash
payments for an agreed period of time, often a month.

There is often an agreement that petty cash will be used to cover

expenditure below a particular amount for example $25. Payments higher
than this amount will be made by the cashier and recorded in the Three
Column Cash Book rather than being recorded by the Petty Cashier.

For many transactions the Petty Cashier will be required to repay an

employee for cash spent on behalf of the business. The cashier will ensure
that a Petty Cash Voucher is competed and that a receipt is either proof of
repayment is attached to the voucher.

80
General Journal

Why is a General Journal is Needed?

The other 6 books of Original Entry are the first record of all money
transactions and all credit transactions in volving the purchase and sales
of goods in which a business trades. A seventh book of original entry, the
General Journal, is required to make a first record of a small group of
transactions that cannot be recorded in the other six journal books – Here
are some examples of these transactions:

a. The Purchase and / or Sale of a non-current asset on credit

b. Cancelling entries and correcting errors in accounts
c. Transferring information from one account to another
d. Opening a new set of books of accounts

Source Documents and The General Journal

Many different source documents are used for entries in the General
Journal, for example;

1. A Purchase Invoice for a new non-current asset

2. Letters and Emails received from other businesses
3. Emails and Notes written by owners and managers

Preparing A General Journal

An entry in a general journal consists of the following elements:

A. The data
B. Account To Be Debited and the Amount
C. Account to Be Credited and the Amount
D. The Brief Explanation of the Nature of the Transaction (often called The
Narrative)
E. Folio References which are completed when the journal entry is posted
in the ledger

 Each entry is set out so that the debit entries are recorded first and
credit entries second (credit entries are slightly indented.)

 Usually there is only1 account to debit and 1 account to credit,

occasionally it is possible to have several accounts debited or credited
in one journal entry.
81
82
The Treatment of Totals From Books of Original Entry

At regular intervals the totals shown in the books of original entry will be
posted to ledger accounts. The following table summarizes how total are
treated:

Totals in the Book of Original Treatment

Entry
1) Purchase Book Posted to the debit side of the
purchases the account in the
general ledger
2) Sales Book
Posted to the credit side of the
sales account in the general ledger
3) Return Outwards Book
Posted to the credit side of the
return outwards account in the
4) Return Inwards Book general ledger

Posted to the debit side of the

5) Discount Columns in the return inwards account in the
Cash Book general ledger

a) The total of the discount

allowed column is posted to the
debit side of the discount
allowed account in the general
ledger

b) The total of the discount

6) Petty Cash Book Analyse received account is posted to
Columns the credit side of the discount
received account of the general
ledger

Totals of the expense columns are

posted to the relevant expense
accounts in the general ledger.
Entries in a column for payments
to accounts payable are posted to
the individual accounts payable
accounts in the purchase ledger.

83
Roslyn example

84
 Accounting adjustments – Chapter 4 (Done)

Accounting Concepts and Adjustments

A number of adjustments have to be made to financial position to

enhance the quality of the information they obtain to make it more useful.
These adjustments are made to satisfy a number of key accounting
concepts.

The Accruals / Matching Concepts -

This establishes that when calculating profits and loses for a certain
period, only the Revenue and other income for that period should be
included and it should be matched to the expenses for the same period,
whether or not all the amounts concerned have actually or paid.

e.g.

Adjustments have to be made for expenses and income for the period that
are not yet paid and expenses and income relating to the next period that
have been paid in advance. In addition, Provisions for doubtful debts and
Depreciation must be considered.

The Prudence Concept -

This concept requires asset values and profits, where there is doubt to be
understand rather than overstated, it also states that expenses and
liabilities should be recognized as soon as possible where there is
uncertainty while revenues and assets are only recognized when they
assured of being received.

e.g.

Bad debts are written off promptly and accounts receivables are adjusted
to make a provision for doubtful debts.

Consistency Concepts -

The rule that accounting policies should be carried out in the same way
year after year. As a result, the users of financial statements can make
valid comparisons of performance.

e.g.

85
A business should apply the same depreciation method each year and the
same percentage provision for doubtful debts each year.

86
The True and Fair Principle –

The idea that is not acceptable to manipulate figures in the financial

statement in order the finances of the business in the financial statement
in order the finances of the business in a false light to gain some kind of
advantage. The records must be accurate or at least present a reasonable
estimate of the position.

e.g.

It is expected that some accounts receivables will not be paid, therefore a

provision should be made for this to reduce the income recorded.

**************************************************start review from here

Expense Adjustments

Expense Accruals -

This is the used when an expense is not fully paid at the year end, leaving
an amount that is due but unpaid.

 At the year end the amount of an Expense Accrual is Added to find the
correct amount to be charged to the income statement for that
expense.
 An Accrual is recorded as a credit balance in an expense account as it
is a Current Liability

Example - During the year ended 31st December 2018 as business has
paid Wages of $27,300. At 31st December 2018, $400 remains due for
wages for the last part of the year.

Journal

Date Details
Dr Cr

2018
$ $

Dec 31 Income
Statement 27,700

Wages
27,700

Transfer of wages for the year

87
 To the income statement

88
Dr
Wages Cr

2018 2018
$ $

Dec 31 Cash Dec 31 Income Statement

27,300 27,700

31 Bal c/d
400

27,700 27,700

2019

Jan 1 Bal b/d

400

Expense Prepayments -

When a payment for an expense covers more than the year under review,
i.e. part if the payment made for an expense covers the business at the
beginning of the next financial year, it is called a Prepayment.

 The amount of any prepayment must be deducted to find the correct

value of the expense to be charged to the income statement.
 A prepayment is recorded as a debit balance on an expense account as
it represents a current asset

Example - During the year ended, 31st December 2018 a business has
paid Insurance of $9,500. However, this includes $1,500 which is related
to Insurance for January 2019.

Journal

Date Details
Dr Cr

2018
$ $

Dec 31 Income Statement

8,000

89
 Insurance
8,000

Transfer of wages for the year

to the income statement

2018 2018
$ $

Dec 31 Cash Dec 31 Income Statement

9,500 8,000

31 Bal c/d
1,500

9,500
9,500
2019

Jan 1 Bal b/d

1500

90
Income Adjustments

Sometimes businesses receive income not just from sales but also from
activities, such as rent received when a business rents out part of its
premises to a tenant and interest received on investments and savings.
Other income items are added to Gross Profit in the second part of the
Income Statement.

Income Due -

This is the income that has yet to be received at year end.

 The amount of any income due at the year-end is added to find the
correct amount of income to be shown in an income statement.
 Income due is recorded as a Debit Balance, in an Income Account as it
is a current asset.

Example - A business has received interest of $1,450 on an investment

during, the year ended 31st December 2018. At 31st December, interest of
$350 is due but not yet received.

Journal

Date Details
Dr Cr

2018
$ $

Dec 31st Interest received

1,800

Income Statement
1,800

Transfer of interest received for

the year to the income statement

91
Dr Interest
Derived Cr

2018 2018
$ $

Dec 31 Income Statements Dec 31 Income Statement

1,800 1,450

31 Bal c/d
350

1,800
1,800
2019

Jan 1 Bal c/d

350

Advanced Income / Prepaid Income -

This is the amount of any income received the covers more than the year
under review e.g. part of the amount received covers the beginning of the
next financial year. It is necessary to deduct the amount of any income
received in advance at the year end to find the correct value of income to
be shown in an income statement.

 Advanced income is recorded as a credit balance on an income account

as it represents a current liability.

Example – The business has also received rent form a tenant of $3,900,
however, this includes rent of $300 for the amount of January 2019.

Journal

Date Details
Dr Cr

2018
$ $

92
Dec 31st Rent received
3,600

Income Statement
3,600

Transfer of rent received for

the year to the income statement

93
Dr Rent
Received Cr

2018 2018
$ $

Dec 31 Income Statement Dec 31 Bank

3,600 3,900

31 Bal c/d
300

3,900
3,900
Jan 1 Bal c/d
300

Expense and Income Adjustments are designed to implement the Accruals

Concept when preparing Financial statements.

Balance Sheet Treatment

Adjustment Shown under

Expense accrual Current liabilities
Prepaid expense Current assets
Income due Current assets
Advanced Income Current liabilities

94
 Expense & Income Adjustments and financial Statements

Income Statements (extracted) 31 December 2018

$
$

Gross Profit
XX

Add : Interest received 1,800

Rent Received 3,600

5,400

Less Expenses

Insurance 8,000

Wages 27,700

Other Expenses XX
XX

Profit for the year

XX

Balance Sheet (extract) 31 December 2018

$
$ $

Current Assets

Income due 350

Prepaid rent 1,500

Cash at bank XX
XX

Current Liabilities

Income received in advance (rent) 300

95
Accrued Wages 400

Accounts payable XX
(XX)

Working capital
XX

96
Bad Debts and Income Statement

When a credit customer is unable or unwilling to pay a business the

amount due, it is necessary to write off this loss as a bad debt. Writing off
a bad debt demonstrates the prudence concept.

Writing off a bad debit ensures:

 The Profit for the year is not shown at an unrealistically high figure.

 The figure for accounts receivables on the balance sheet represents

the balance sheet represents the true and fair figure.

Writing off a Bad Debt:

1. Prepare an entry in the General, debiting the Bad Debit Account and
crediting the Account Receivable.

2. Debit the Bad Debt account in the General Ledger.

3. Credit the Accounts receivable in the Sales Ledger.

3. At the year end, transfer the balance of the Bad Debt account to the
Income Statement.

Example – The Sales Ledger of a business included the account of

S.Wright who owed $1,220. It has become necessary to write off the
account as the amount has outstanding for over 10 months and the
customer cannot be found.

Journal

Date Details Dr Cr
Bad debt 1220 1220
Accounts Receivable
S.Wright
Account of Customer
Written of as a bad debt

DR S.Wright
Cr

$ $

97
 Sales Bad debt
1,220 1,220
Dr Bad Debt
Cr

$ $
S.Wright Income Statement
1,220 1,220

Profit & Loss (extract)

$
$

Gross Profit
XX

Less Expenses

Bad Debt 1,220

Creating a Provision for Doubtful Debts

Business experience bad debts during a course of a year. As the Accounts

Receivable amount of on the Balance sheet could easily be overstated
versus the amount that will actually be received. To avoid this
overstatement, we record the total of accounts receivable less on
estimate for future bad debts. This estimate is called a provision for
doubtful debts. This adjustment is a good example of the Accruals and
Prudence Concept.

Setting Up a Provision for Doubtful Debts

The amount of a provision for Doubtful Debts is usually based on the

passed past experience of bad debts of the business compared to the
total amount owed by credit customers. When it is necessary to create a
provision for doubtful debts the following entries are required:

a) General Journal – Recording the amount of the provision and the entries
to be made in the provision for doubtful debt account and income
statement.

98
b) General Ledger – A provision for doubtful debt account is credited with
the amount of the provision.

c) Income Statement – The provision is included in the list of expenses.

99
 d) Balance Sheet – The provision is shown as a deduction from the
Accounts Receivable.

Example – At 31st December a business has totaled Account Receivable of

$44,000. A provision for doubtful debts for 5% of accounts receivables is
to be created.

Journal

Date Details Dr Cr
Dec 31 Income Statement 2,200
Provision for 2,200
Doubtful debts
Entries to create a
provision for doubtful
debts

Dr Provision for Doubtful Debts

Cr

$
Dec 31 Income statement
2,200

Profit & loss (extract)

$
$

Gross Profit
XX

Less Expenses

Provision for doubtful debts 2,200

Balance Sheet (extract)

$
$ $

100
Current Assets

Accounts Receivable 44,000

Less: Provision of doubtful debts (2,200)

41,800

Cash at bank
XX XX

Increasing a Provision of Doubtful Debts

Once a business has created a provision for doubtful debts it is necessary

to review the figure at the end of each financial year to bring it in line with
the accounts receivables. If the total of the accounts receivable has
increased, it will be necessary to increase the provision for doubtful
debts. Creating a Provision for Doubtful Debts.

Example – At December 31st 2018 the provision for doubtful debit was
$2,200. At the end of December 31st 2019, the business has total accounts
receivable of $50,000 and a provision of 5% is to be made. The owner
makes entries to increase the provision to $2,500 (5% of $50,000). This
represents an increase of $300 since December 31st 2018.

Journal

Date Details Dr Cr
2019 Income Statement 300
Dec 31 Provision for doubtful debt 300
Entries to increase the
provision for doubtful debts

Dr Provision for doubtful debts

Cr

2019 2018
$ $
Dec 31 Bal c/d Dec 31 Income Statement
2,800 2,200

2019
2,500 Dec 31 Income Statement
300

2,500
2020

101
 Jan 1 Bal b/d
2,500

102
 Income Statement (extract)

31 Dec 2020

$
$

Gross Profit
XX

Less Expenses:

Income in provision for

doubtful debts 300

Balance Sheet (extract)

31 Dec 2020

$
$

Accounts Receivable 50,000

Less: Provision for doubtful debts (2,500)

47,500

Decreasing Provision for doubtful Debts

If the total of accounts receivable decreases the provision for doubtful

debts should be reduced.

Example – At the end of 2022 the business has total accounts receivables
of $40,000, so the owner makes entries to decrease the provision to
$2,000 (5% of 40,000). This represents a decrease of $500 since 32st
December 2019.

103
 Journal

Date Details Dr Cr
2020 Dec 31 Provision for 500
doubtful debts 500
Income Statement
Entries to decrease the
provision for doubtful
debts

Dr Provision for doubtful debts

Cr

2019 2018
$ $
Dec 31 Bal c/d Dec 31 Income Statement
2,500 2,200

2019
Dec 31 Income Statement
300
2,500
2020 2,500
Dec 31 Income Statement
500
31 Bal c/d 2,500
2000 2021
Jan 1 Bal b/d
2,500 2,000

Income Statement (extract)

31 Dec 2020

$
$

Gross Profit
XX

Add: Decrease in provision for

doubtful debts 500

Interest received XX

Adjusted; Gross profit

XX

104
 Balance Sheet (extract)

31 Dec 2020

$
$

Accounts Payable 40,000

Less: Provision for doubtful debts (2,000)

38,000

105
Depreciation here

Depreciation is the term used for the less in the value of the non-current
assets (fixed assets) of a business over their working life due to wear and
tear. It is the original purchase cost of a non-current asset consumed
during its period of use by the business. It is an expense for the services
consumed.

Causes of Depreciation

1. Physical Deterioration –

This can come in two basic forms:

 Wear and tear

 Erosion, rust, rot, and decay

Example;

When a motor vehicle, machinery or fixtures and fittings are used they
eventually wear out. Land may be eroded or wasted away by the action of
wind, rain, sun and other elements of nature. Similarly, the metal in motor
vehicles or machinery will rust or eroded.

2. Economic-Factor/Technological Change-

Some non-current assets can become out of date very quickly and so
cease to meet the needs of a business. Some fixed assets may be
obsolete by becoming out of date due to advanced technology or a
change in processes. Some fixed assets may become inadequate and can
no longer be used because of growth and changes in the size of the
business.

Example;

High tech equipment such as computers, mobile phones, printer, etc.

106
3. Time Factor-

The life of some non-current assets is limited legally; at the end of the
assets life the asset will have no value.

Example;

You may agree to rent some buildings for ten years (lease), when the
lease expires the building would no longer have value to the business.

4. Depletion-

Other assets are of wasting character as a result of raw materials being

extracted from them.

Example;

Natural resources such as mines, quarries and oil wells come under this
heading.

Factors in determining depreciation expense

1. Cost of the non - current asset

2. The useful life - The number of years the asset is expected to be

economically useful to the business.

3. The residual value/scrap value/ disposal vale – The best estimate of the
worth of the asset at the end of its useful life.

Methods of Calculation Depreciation Expense

Depreciation is usually calculated using one of the following two (2)

methods:

1) The Straight-Line method

2) The Reducing Balance Method

107
The Straight-Line Method

This is where the non-current asset is depreciated equally over its usual
life. This method is also called the fixed or equal instalment method of
depreciation.

Cost−Residual Value
formula;
Useful Life
Or

Cost of Non – Current Assets

of Depreciation

1) Example – A business some new machinery costing $38,000. The

owner believes the machinery will have a useful life of 4 years and
have a residual value of $2,000. Calculate the Depreciation charged.
$ 38,000−$ 2,000
4 years

= $9,000

The annual Depreciation expense is $9,000

2) Example – A business has purchased new equipment costing $100,00,

the depreciation rate is 10% per annum over the equipment useful life.
Calculate the Depreciation expense.

$100,00 x 10% = $10,000

The depreciation expense is $10,000 per annum

108
Reducing Balance Method

This is where the non-current asset is depreciated by a agreed percentage

based on the assets Net Book Value at the beginning of the year.

Net Book Value means the original cost – all the accumulative
Depreciation

(Depreciation Expense to date)

Example – A business has purchased a delivery van costing $24,000. It

has been decided to depreciate this asset by 25% per annum. The usual
life of this delivery van is 4 years. Calculate the depreciation / charge of
every year of the asset’s useful life.

Year 1 –

Cost x Percentage %

$24,000 x 25% = $6,000 Depreciation expense

(Depreciation)

Year Cost / NBA Depreciation Accumulated Net Book

1 (25%) Depreciation Value
$24,000 Expense / Charge $6,000 $18,000
2 $6,000 (6000+4500)
$18,000 (18,000x25%) $13,500
3 $10,500
$13,500 $4,500 (10,500+3,75) $10,125
4 (13,500x25%)
$10,125 $13,875 $7593.75
$3,375 (13,875+2,531.2
(10,125x25%) 5)

$2,531.25 $16,406.25

 This method is sometimes referred to as the diminishing balance

method of depreciation.
 In accordance, with the accruals concept it is important to take account
of this expense every year.

109
110
 Financial statements of other organisations – Chapter 5

Accounting for Partnerships

A partnership is a form of business ownership where 2 or more individuals

work together with the intention of making a profit.

Types of Partners

Unlimited Partner / Liability –

Where the owner/s of a business are responsible for all the debits of the
business and may lose all their investment in the business. Their private
possessions as well may be lost in order to pay off the debts of the
business.

Limited Partners –

One or more partners have limited liability for the debts of the business,
meaning they can only lose the amount they invested in the business if it
should fail. Limited partners can not take part in the day – to – day
decision making of the partnership.

Feature of a Partnership

Unless it is a Limited Partnership, each partner will have unlimited liability

for the debts of the business.

A partnership is a voluntary association, that is a business where a group

of individuals join together on the basis of common objectives.

All the partners are jointly responsible for the debts for the partnership,
even if an individual partner played no direct part in incurring the debt.

Mutual agency exists, where by each partner has the power to make
contracts on behalf of the partnership and is bound by the other partners
actions in the normal running of the partnership.

Advantages of a partnership

They can raise more capital because several owners can contribute.

They can share ideas and expertise.

They can share the work load involved in running a business.

111
Disadvantages of a partnership

Unlimited liability.

Decision making can be more difficult because every partner must agree
to important proposals about how to run a business.

Each partner must follow any agreements made by the partner.

Each partner is jointly responsible for the debts of the partnership.

Partnership businesses can be short – lived, because they may have to

close on the retirement or death of a partner.

There is always the risk that partners will disagree and that relationship
may breakdown, possibly bring the partnership to an end.

Features of a Partnership Agreement

Agreement often includes.

How much capital is to be contributed by each partner.

Responsibilities of each partner in running the business.

A limit on each partner’s drawings.

How profits and loses are to be stored.

Where parted do not have a formal agreement about sharing profits and
losses, the law requires profits and losses, the law requires profits and
losses to be shared equally.

The Deed of Partnership

Partners usually make a formal agreement when the partnership is

established. The agreement may be merely spoken or may be written
down in the form of the Deed of Partnership.

Sharing Profits and Losses

Partner may receive a share of profits based on his/her capital

contribution, this is referred to as interest on capital. A rate of interest per
annum will be agreed.

112
One or some of the partners may receive a partnership salary, a share of
the profits awarded taking special responsibility for some aspect of
managing the business.

Profits or losses remaining after these awards (interest on capital and

partnership) may be shared equally or in some other ratio.

Some agreements may also provide for interest on drawings, a penalty

based on the amount of a partner’s drawings.

Partner Capital Account

Partners agree to contribute a fixed amount of capital that cannot be

changed except by agreement of all partners, this is called the Fixed
Capital Account.

Where there is a fixed capital account in a partnership, separate accounts

called Current Accounts are maintained to record day – to – day changes
in the partners investment/capital.

Alternatively, in some partnerships all these records are kept in what are
called Fluctuating Capital Accounts.

Entries To Record to Capital Introduced By Partners

Examples

The Partnership Appropriation Account

A Partnership’s Financial Statements will include an Appropriation Account

to show how profits or losses have been shared in accordance with the
Partnership Agreement.

Accounting for Limited Liability Companies, Cooperatives or Non-Profit

Organizations.

Features of a Limited Liability Company

113
A Limited Company is a form of business organization whose capital is
divided into units called shares. Those who invest in a company owns
shares and are referred to as and are referred to as shareholder. Some
features of Limited Liability Companies include;

a) Each shareholder / Owner has responsibility for the debts of the

organization and these debts are limited to the amount they have
invested into the company. The correct for this special privilege
enjoyed by shareholders is limited liability.
b) Individuals are most likely to be inclined to invest in a company as a
result of limited liability.
c) Companies can be very large organizations with many shareholders.
d) Shareholders elect directors to the running of the company.

Limited Liability Companies are also known as Cooperations

Shareholders – The owners of the share capital of a limited company

called members.

Advantages of Limited Liability Companies:

a) They raise large amount of finance / capital because there is there is

the potential to have many shareholders.
b) They call upon the expertise of a wider group of individuals to help
manage and help manage and help develop the company.
c) They can continue the operate, despite the individuals who own the
shares.

Disadvantages of Limited Liability Companies:

1) They are subject to many legal requirements.

2) They are subject to changes in control, dependent on the number of
shares and voting rights some shareholders may acquire.

Principles of Limited Liability Companies

Shares are freely transferrable, such shareholder can sell their shares at
any times. Insolvency of debt of a member does not affect the existence
of the company.

There are Two Types of Limited Liability Companies.

114
1) Private Limited Companies
2) Public Limited Companies

Private Limited Companies Features:

a) Owners of shares are restricted to members of a family, friends and

possibly employs,
b) They are small usually small organization with few shareholders.
c) Members cannot invest in a private limited company.
d) Shares are bought and sold privately and only with the correct of
existing shareholders.
e) They could just have one shareholder.
f) The abbreviation “LTD” appears in the title / name of a private limited
company.

Public Limited Companies Features:

a) The general public can invest.

b) Shares are traded on the stock exchange.
c) They are larger organizations with hundreds or thousands of
shareholders.
d) The abbreviation “PLC” appears in the name title of a public limited
company.

The Capital of a Limited Company

A decision has to be made as to the maximum amount of capital that can

be raised. This amount of capital that can be raised. This amount is known
as the authorized share capital. The total of a companies shares that are
hold by shareholders is called issued share capital. Share can be divided
into two types;

1) Ordinary Shares
2) Preferences Shares

Ordinary Shares

a) Ordinary shares are also called equity shares / common shares.

b) These shares have a face value of nominal value, for example; $1, $2,
$3.50.

115
c)

116
d) Ordinary shares holders are rewarded for investing in the company by
receiving and annually payment called a dividend.
e) Ordinary shareholders have voting rights which can be used at the
company’s annual general meeting (AGM).

Preference Shares

a) These also have a normal value and shareholders also receive a

dividend.
b) Dividends are used calculated using a fixed percentage of the amount
invested. They are always entitled to receive a dividend once the
company makes a profit.
c) Preference shareholders are allocated their dividends before ordinary
shareholders and in event the company is closing down. They would
their investment before ordinary shareholders.
d) The shareholders normally don’t have any voting rights.

Authorised Share Capital - The maximum amount of share capital that a

limited company may issue.

Issued Share Capital – The amount of share capital that actually issued by
a limited company.

Directors – An individual who is appointed by share-holders to manage the

company on their behalf.

“AGM” – A yearly meeting of shareholders where directors report on the

performance of the company.

Debentures

A debenture is a long-term loan that a company can take, which should be

repaid at a certain date. It shows has borrowed an amount of money
which it promises to repay. Debentures holders are the for creditors of the
company. Debentures have a fixed rate of interest and this interest is
payable yearly / by annually. Debenture interest is a expense

117
an is charged to the income statement. They are regarded as a non-
current liability under the balance sheet.

The Issue of Shares

The amount the company can raise in the from of capital depends on;

The number of shares issued.

The face value of the shares – per value.

Whether the company is able to issue the shares at a value about the per
value.

If shares are issued for a price above the face values the additional
amount received is called the share premium.

Example – On January 2019 a company issued 500,000 ordinary shares

with a face value of $1 each and 100,000 6% preference shares of $1
each. The ordinary was issued at a market price of $1 and 50 cents per
share prepare the journal entries to show the issued of the shares.

118
Company / Cooperations

Journal Entries (General Journal Format)

1) When shares are issued or sold

Date Details Dr $ Cr $
2024
Jan 01 Cash / Bank XX
Ordinary Shares XX
To record the
issue of
Ordinary shares

2) When debentures are issued / sold.

Date Details Dr $ Cr $
2024
Mar 28 Cash / Bank XX
10% debenture XX
To record the
issue of 10%
Debenture

3) To record interest expense on debenture

Date Details Dr $ Cr $
2024
Dec 31 Debenture XX
interest exp
Cash / Bank XX
To record
payment of
debenture
interest

4) When debentures are repaid

Date Details Dr $ Cr $
2027
Dec 31 10% Debenture XX
Cask / Bank XX
To receive the
repayment
Of 10%
Debenture

119