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Acorn Q2022 AAT L3 Financial Accounting Preparing

Financial Statements Mock Exam One
Association of Accounting Technicians (Botswana Accountancy College)

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MarZar

Mock Exam One

AAT L3 Financial Accounting:
Preparing Financial Statements

Contents Page
Mock practice assessment 3
Revision Notes 25
Solutions to mock practice assessment 63

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Mock Exam One

1 AAT L3 Financial Accounting:
Preparing Financial Statements

Assessment information:
You have 2 hours and 30 minutes to complete this practice assessment.

• This assessment contains 6 tasks and you should attempt to complete every
task.
• Each task is independent. You will not need to refer to your answers to previous
tasks.
• The total number of marks for this assessment is 120.
• Read every task carefully to make sure you understand what is required.
• Where the date is relevant, it is given in the task data.
• Both minus signs and brackets can be used to indicate negative numbers unless
task instructions state otherwise.
• You must use a full stop to indicate a decimal point. For example, write 100.57
not 100,57 or 10057.
• You may use a comma to indicate a number in the thousands, but you don’t have
to. For example, 10000 and 10,000 are both acceptable.

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Task 1 (28 marks)

This task is about using daybooks, and accounting for and monitoring non-current
assets.

(a) Complete the following sentences about using daybooks.

(3 marks)
A sales invoice for £3,600 issued to a customer for the sale of goods on credit would be
recorded in the
A small transaction of £3.40 paid in cash for postage stamps would be recorded in the

A credit note received from a supplier for a prompt payment discount would be recorded
in the

Picklist: Sales Day Book, Sales Returns Day Book, Discounts Allowed Day Book,
Purchase Day Book, Purchase Returns Day Book, Discounts Received Day Book, Petty
Cash Book.

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You are working on the accounting records of A. Business. A. Business is a VAT

registered business.
The business part-exchanged an old item of machinery for a new machine in its factory.
The following is the relevant purchase invoice for the new machine.

From: ZAR Traders

To: A. Business Date: 1 Sept 20X6
Invoice number: 1123
Item Details £
Machine AZ50 AZ50 19,000.00
Software for AZ50 1,290.00
2 x PC Monitors (screens) @ £150 each for AZ50 300.00
Delivery and installation for AZ50 800.00
Net total 21,390.00
VAT 20% 4,278.00
Total 25,668.00

All VAT can be reclaimed on the purchase cost for the items above.
The following details relate to the old item of machinery replaced by the business.
Item description Machine AX56
Date of purchase 01/09/X4
Date of sale 24/07/X7
Part-exchange value £2,000.00 plus VAT

• The business has a policy of capitalising expenditure over £200.

• Plant and machinery is depreciated at 25% per annum on a diminishing balance
basis.
• Motor vehicles are depreciated at 35% per annum on a diminishing balance
basis.
• A full year’s depreciation is charged in the year of acquisition and none in the
year of disposal.
(b)(i) For the year ended 31 August 20X7, record the following in the extract from
a non-current asset register shown below.
• Any acquisitions of non-current assets
• Any disposals of non-current assets
• Depreciation
(12 marks)
Enter answers where a grey picklist is required and insert numerical answers in
the highlighted grey cells only. Show all numerical answers to TWO decimal
places.

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Depreciation Carrying Disposal

Description/ Acquisition Cost Funding Disposal
charges amount proceeds
Serial number date £ method date
£ £ £

Plant and machinery

Machine AX56 01/09/X4 13000.00 Loan

Year ended 31/08/X5 3250.00 9750.00

Year ended 31/08/X6 2437.50 7312.50

Year ended 31/08/X7 2000.00 24/07/X7

01/09/X6 Part Exchange

Year ended 31/08/X7

Motor vehicles

Car EN65 RBV 23/01/X6 6700.00 Loan

Year ended 31/08/X6 2345.00 4355.00

Year ended 31/08/X7

Car BN60 DFV 26/08/X5 7800.00 Finance lease

Year ended 31/08/X5 2730.00 5070.00

Year ended 31/08/X6 1774.50 3295.50

Year ended 31/08/X7 1153.43 2142.07

0.00 9750.00 Machine AX56

2031.25 7312.50 Car BN60 DFV
1828.13 0.00 Car EN65 RBV
1523.44 13000.00 Machine AZ50

(b)(ii) Complete the following calculation (3 marks)

Calculate the gain or loss on disposal of Machine AX56 for the year ended 31 August
20X7. Show your answer rounded to TWO decimal places. Use a minus sign or
brackets to indicate a loss on disposal.

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A business is registered for VAT.

(c) Drag and drop two items that are included as capital expenditure and two
items that are excluded from capital expenditure.
(2 marks)

VAT

Site preparation costs Costs included Costs excluded

Delivery cost

Revenue expenditure

You are working on the accounting records of a business for the year ended 31 August
20X7. VAT can be ignored. A new machine has been acquired, the cost was
£18,930 and the amount was paid from the business bank account. The business plans
to sell the new machine after 5 years when its residual value is expected to be £2,000.
Machines are depreciated using the straight-line method. A full year’s depreciation is
charged in the year of acquisition. Depreciation has already been entered in the
accounting records of the business for existing machines and the amounts are shown in
the ledger accounts below.

(d)(i) Calculate the depreciation charge of the new machine for the year ended 31
August 20X7
(2 marks)

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Make entries in the ledger accounts below for the acquisition and depreciation charges
for the new machine for the year ended 31 August 20X7. For each ledger account
show clearly the balance to be carried down or transferred to the statement of profit or
loss, as appropriate.
(d)(ii) Make entries in the accounts below for:

• The acquisition of the new machine

• The depreciation charges for the new machine
(6 marks)
Picklist: Bank, Depreciation charges, Disposals, Machinery accumulated depreciation,
Machinery at cost, Profit or loss account, Balance c/d.

Machinery at cost
£ £
Balance b/d 84900

84900 0

Machinery accumulated depreciation

£ £
Balance b/d 49200

0 49200

Depreciation charges
£ £
Balance b/d 22600

22600 0

End of Task

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Task 2 (14 marks)

This task is about recording period end adjustments.

You are working on the accounting records of a business for the year ended 31
December 20X7. In this task you are to ignore VAT.

Business policy: accounting for accruals and prepayments

An entry is made to the income or expense account and an opposite entry to the
relevant asset or liability account. In the following period, asset or liability entries are
reversed.
You are looking at motor vehicle expenses for the year.
• The cash book for the year shows payments for motor vehicle expenses of
£8,042. This amount includes £1,467 for the following payments relating to motor
vehicle insurance.

Insurance Car EN15 RBV Insurance Car SG67 EEF

Insurance for the period Insurance for the period

1 May 20X7 to 30 April 20X8. 1 January 20X7 to
£900 for the period. 31 December 20X7.
£567 for the period.

(a)(i) Complete the following statement. Do NOT use a minus sign or brackets.
(4 marks)
The motor vehicle expense account needs an adjustment for

of £ dated

Picklist Picklist
Accrued expenses 31/12/X8
Accrued income 31/12/X7
Prepaid expenses 30/04/X8
Prepaid income 01/01/X7

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(a)(ii) Update the motor vehicle expenses account

Show clearly:
• the cash book figure
• the year-end adjustment
• the transfer to the statement of profit or loss for the year. (6 marks)

Motor vehicle expenses

£ £

0 0

Picklist: Motor vehicle expenses, Bank, Accrued expenses, Accrued expenses

(reversal), Accrued income, Accrued income (reversal), Prepaid income, Prepaid
income (reversal), Prepaid expenses, Prepaid expenses (reversal), Statement of
financial position, Profit or loss account, Balance b/d, Balance c/d.

(b) Show the journal entries that will be required to adjust for closing inventory of
£13,422 for the year ended 31 December 20X7.
(4 marks)
Dr Cr
Account
£ £

Picklist: Bank, Purchases, Closing inventory (statement of profit or loss account),

Balance b/d, Balance c/d, Closing inventory (statement of financial position).

End of Task

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Task 3 (24 marks)

This task is about producing, adjusting, checking and extending the trial balance.

(a) Enter the figures in the table shown below to the appropriate trial balance
debit or credit columns. Do not enter zeros in unused column cells. Do NOT use
minus signs or brackets.
(2 marks)
Extract from the trial balance

Ledger
Trial balance
balance
Account £ £ DR £CR
Prepaid income 1000
Drawings 8900
Carriage inwards 1029
Accrued income 1504

A trial balance shown below has been drawn up and balanced using a suspense
account. You now need to make some corrections and adjustments for the year ended
31 December 20X7. You may ignore VAT in this task.
The general allowance for doubtful debts needs to be adjusted to 2% of outstanding
trade receivables.
(b)(i) Refer to the extract from the extended trial balance below. Calculate the
value of the adjustment required (to the nearest £).
(2 marks)

(b)(ii) Record the adjustment in (b)(i) and the following adjustments in the extract
from the extended trial balance below.
(8 marks)
• Office expenses of £90 have been correctly posted to the cashbook but no
corresponding debit entry was made to office expenses.
• The payables ledger control account in the general ledger has been extracted
and included in the trial balance incorrectly as £5,999. The correct balance
should be £6,739.
• Staff wages of £1,080 were posted in error to office expenses.

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Ledger account Ledger balances Adjustments

Dr £ Cr £ Dr £ Cr £
Bank 21932
Opening inventory 6781
Irrecoverable debts 750
Capital 24976
Office expenses 4200
Staff wages 16339
Allowance for
Allowance for doubtful
doubtfuldebts
receivables 400
Allowance for
Allowance for doubtful
doubtfuldebts
receivables adjustment
- adjustment
Depreciation charges 2952
Van at cost 17400
Van accumulated depreciation 6090
Purchases 45688
Payables ledger
Purchase ledger control
control account 5999
Sales 79991
Receivables
Sales ledger ledger
controlcontrol
account 24090
Suspense 650

You are preparing a payables ledger control account reconciliation for the year ended
31 December 20X7. The current balance showing in the payables ledger control
account is a credit balance of £27,042 and the total amount outstanding in the payables
ledger is a credit balance of £22,044.
The payables ledger has been compared to the payables ledger control account and the
following errors or omissions have been identified:

1. The total column in the purchases daybook was undercast by £1,000. The amount
posted to the payables ledger control account was £131,673 but the correct
amount should have been £132,673.
2. Purchases returns of £5,640 have been credited to the payables ledger control
account in error. The correct entries have been made in the payables ledger
accounts for suppliers.
3. A purchase invoice of £240 from Streets Ltd was omitted from purchases daybook.
The correct entry was made in the payables ledger account of the supplier.
4. A set-off entry of £5,042 was omitted from the payables ledger account of M.
Smith. The correct entry was made in payables ledger control account.
5. Purchase returns of £120 were debited in error to the payables ledger account of
Winkle Traders Ltd instead of the payables ledger account of Traders RUS Ltd.
6. A purchase invoice was sent by a supplier for £360 in error, the correct amount
should have been £3,600. The incorrect amount of £360 was posted to both the
payables ledger and payables ledger control account.

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(c) Using the table below show THREE adjustments that should appear in the
payables ledger control account. Enter only ONE figure for each line. Do not
enter zeros in unused cells. Do NOT use minus signs or brackets.
(6 marks)

Dr Cr
Account
£ £

Picklist: Adjustment 1, Adjustment 2, Adjustment 3, Adjustment 4, Adjustment 5,

Adjustment 6

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(d) You are to compete the extended trial balance shown below. Ensure you
calculate the profit or loss and complete in the appropriate space in the first
column whether it is a profit or a loss.
(6 marks)

Extended Trial Balance

Statement of Statement of
Ledger balances Adjustments
Ledger account profit or loss financial position
Dr £ Cr £ Dr £ Cr £ Dr £ Cr £ Dr £ Cr £
Bank 18,533 800 17,733
Opening inventory 4,500 4,500
Capital 22,622 22,622
Drawings 8,000 8,000
Office expenses 4,589 4,589
Van expenses 12,320 360
Staff wages 13,239 13,239
Discounts allowed 471 471
Discounts received 579 579
Carriage outwards 540 540
Loan 20,000 20,000
Closing inventory 3,300 3,300 3,300 3,300
Advertising expenses 8,000 800
Depreciation charges 6,234 6,234
Vans at cost 27,400 27,400
Vans - accumulated depreciation 9,590 6,234 15,824
Purchases 19,680 19,680
Payables ledger control 1,009 550
Accrued expenses 360 360
Irrecoverable debts 240 240
Sales 68,612 68,612
Receivables ledger control 3,090 240 2,850
Loan interest paid 1,500 1,500
Suspense 550 550
Pick list
Total 122,412 122,412 11,484 11,484 Autosum Autosum Autosum Autosum

Pick list: Profit for the year, Loss for the year, Suspense, Balance b/d, Balance c/d.

End of Task

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Task 4 (24 marks)

This task is about producing financial statements for sole traders and partnerships.
You have been given the following information about a partnership business.
• The partners are Albert and Brenda.
• The financial year end is the 31 March.
• There is no interest on capital or interest on drawings for the partners.
Figures relating to the year ended 31 March 20X7 were as follows:
S
Albert Brenda
S
Profit share 70% 30% D
Drawings for the year £25,000 £60,000 C
Salary (per month) £1,500 £2,000
Sales commission earned for the year £7,560 £3,450

Profits earned by the partnership for the year ended 31 March 20X7 were £97,000.
(a)(i) Prepare a partnership appropriation account for the year ended 31 March
20X7. Use a minus sign for deductions or where there is a loss to be distributed.
(10 marks)
Picklist: Share of residual profit – A, Share of residual profit – B, Share of residual loss
– A, Share of residual loss – B, Drawings – A, Drawings – B, Salary – A, Salary – B,
Sales commission – A, Sales commission – B.
Partnership appropriation account for the year ended 31 March 20X7
£
Profit for appropriation

Residual profit available for distribution

Share of residual profit or loss:

Total residual profit or loss distributed

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Brenda had a current account balance of £340 in debit on the 1 April 20X6. Brenda has
taken drawings of £60,000 from the partnership business during the year ended 31
March 20X7.
(a)(ii) Complete the following sentences about Brenda’s current account:
(5 marks)

Brenda’s current account will be shown in the

Picklist: Statement of financial position, Statement of profit or loss.

Brenda’s current account as at 31 March 20X7 would be a

balance of £
Picklist : Debit, Credit.

You have the following information about a sole trader:

• The sole trader had taken business goods valued at £1,300 during the year for
personal use.
• Profit for the year ended 31 March 20X7 was £13,228.

(b) Complete the capital account for the year ended 31 March 20X7. Show clearly
the balance carried down to the next financial year.
(6 marks)
Picklist: Balance b/d, Balance c/d, Bank, Capital, Drawings, Expenses, Profit for the
year, Loss for the year, Statement of financial position, Suspense.
Capital
£ £
Balance b/d 19228

0 19228

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(c) Show whether the following statements are TRUE or FALSE

(3 marks)

TRUE FALSE

The calculation of cost of sales in a statement of

profit or loss account is equal to opening inventory
plus net purchases less closing inventory.

Capital injections and profits earned during a period

are both credit entries in the capital account of a
partner.

A bank overdraft and the payables ledger control

account are presented as non-current liabilities in the
statement of financial position.

End of Task

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Task 5 (18 marks)

This task is about accounting principles, qualities of useful financial information and
interpreting financial statements using profitability ratios.
(a) Reconciliation of a cash book balance to the bank statements, or a payables
ledger account balance to a supplier statement received, is more likely to support
which one of the following qualitative characteristics of useful financial
information. Choose ONE answer only.
(2 marks)
Verifiability
Timeliness
Comparability
Relevance

(b) Show whether the following is TRUE or FALSE.

(2 marks)
Gross profit
Mark-up precentage maybe calculated as:
x 100%
Sales

True

False

You are working as a finance assistant to a management accountant. The

management accountant has asked you to post a journal of £5,900 from motor vehicle
expenses to motor vehicles (a non-current asset). You have checked the details of the
invoice paid and feel there is no justification to make such a posting.

(c) Which ONE of the following is NOT a likely response given to the management
accountants request.
(2 marks)
Seek guidance from your practice manager regarding the posting of this journal.

You are
Discuss givenwith
the matter thethefollowing
management information
accountant to seeabout aabusiness.
if there is valid case for posting this journal.

Post the journal without question as the management accountant is your client.

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The following information exists for a business.

Statement of profit or loss extract £

Sales 53,508
Cost of sales 31,802
Gross profit 21,706
Expenses 12,900
Net profit 8,806

Statement of financial position extract £

Non-current assets 30,500
Current assets 3,080
Current liabilities 550
Non-current liabilities 14,000
Capital 19,030

(d) Calculate the following ratios based on the information above. Answers
should be rounded to two decimal places.
(6 marks)

Return on capital employed (%)

Sales margin (%)

Expenses as a percentage of sales (%)

(e) Show whether the following statements are TRUE or FALSE

(3 marks)
TRUE FALSE

The return on capital employed ratio could be improved if a

business repays a 5 year bank loan.

Whether a ratio is better or worse requires a comparison to

be made with another organisation, or to a different time
period.

The sales margin ratio could be improved if a business

repays its 5 year bank loan.

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(f) Complete the following sentences about accounting principles.

(3 marks)
The concept is an accounting rule that exercises conservatism
and caution when making judgements about accounting transactions under conditions
of uncertainty.

The concept means to recognise the business can continue to

operate and remain in business for the foreseeable future.

The concept states that business transactions and the personal

transactions of its owner are different for accounting purposes.

Picklist: Materiality, Going concern, Consistency, Separate entity, Money

measurement, Prudence.

End of Task

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Task 6 (12 marks)

This task is about preparing accounting records from incomplete information.

You are working on the accounting records of a sole trader to the year ended 31 August
20X8.
You have the following information:
Day book summaries Goods £ VAT £ Total £
Sales 299,751 59,950 359,701
Sales returns None
Purchases 68,900 13,780 82,680
Purchase returns not available

VAT on discounts have been correctly adjusted in the sales and purchase daybooks.
• Cash sales of £32,600 were recorded plus 20% VAT.
• The owner of the business took drawings from cash sales for personal use and
any amount remaining was banked.
• All purchases were on credit terms.
• A contra entry of £1,200 was made between the receivables ledger and payables
ledger during the year.
31 August 20X7 31 August 20X8
Balances as at
£ £
Trade receivables 55,769 424,537
Trade payables 29,522 35,672
Closing inventory 11,000 22,000
Bank 4,549 debit not available
Cash 2,300 5,430
VAT 3,344 credit not available

Receipts and payments recorded in the bank account include:

Amounts to suppliers 69,627
Amounts from credit customers 334,990
Amounts banked from cash sales 15,000
HMRC - VAT paid 24,990
Premises expenses 18,990
Wages 15,000
Loan repayment 12,336
Motor vehicle expenses 10,680
Bank charges and interest 2562

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(a)(i) Find the total purchase returns figure including VAT by completing the
payables ledger control account for the year ended 31 August 20X8.
(5 marks)
Payables ledger control

Amount Amount
Details Details
£ £

Balance b/d 29522

Total Autosum Total Autosum

Picklist: Receivables ledger control, Balance c/d, Bank, Cash purchases, Purchase
daybook, Purchase returns daybook, Discounts received.

(a)(ii) Find the missing drawings figure the owner has taken for personal use by
completing the cash account for the year ended 31 August 20X8.
(4 marks)
Cash account

Amount Amount
Details Details
£ £

Balance b/d 2300

Total Autosum Total Autosum

Picklist: Balance c/d, Bank, Cash sales, Drawings.

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A trader is allowed by its suppliers to settle its accounts 60 days after purchases are
made. Purchases were £60,000 during the accounting year.
(b) Which of the following is most likely to be the total balance in the payables
ledger control account at the year end.
(2 marks)

£15,000

£10,000

£5,000

The following details exist for a business.

• Costs of sales for the year were £170,000

• Mark up is 30%
(c) Using the information above calculate sale income earned for the year ended.

(1 mark)
£

End of Task

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1 Revision Notes

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The day books (also called books of ‘original’ or ‘prime entry’)

Day books keep a record of a business's past transactions. In a manual bookkeeping
system the day books will complete the first entries in the accounting system for
transactions such as invoices, credit notes, bank receipts and payments.
At the end of each accounting period the total amounts are added up from the day
books and these summary amounts are posted to general ledger accounts using a
double entry system. Transactions recorded in the day books are also used to update
the receivables ledger (customer account balances owing for the sale of goods on
credit) and the payables ledger (supplier account balances owed for the purchase of
goods on credit).
The day books (also called books of ‘original’ or ‘prime entry’)
• Sales Day Book (SDB records sales invoices issued to credit customers).
• Sales Returns Day Book (SRDB records credit notes to reverse sales invoices
issued to credit customers, due to goods returned or disputes with customers).
• Discounts Allowed Day Book (DADB records credit notes to reverse sales
invoices, due to prompt payment discounts allowed for customers, if settling
sales invoices early).
• Purchase Day Book (PDB records purchase invoices issued from credit
suppliers).
• Purchase Returns Day Book (PRDB records credit notes received from suppliers
to reverse purchase invoices issued from credit suppliers, due to goods returned
or disputes with suppliers).
• Discounts Received Day Book (DRDB records credit notes received from
suppliers to reverse purchase invoices, due to prompt payment discounts
received from suppliers, if settling purchase invoices early).
• Cash Book (CB records all cash and bank transactions for the business).
• Petty Cash Book (PCB records very small cash transactions for the business).
• Journal Book (JN records any postings made to the general ledger for accounting
adjustments that are not recorded in any other day book, such as to correct
errors and omissions).

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The general ledger

The general ledger is a double-entry accounting system, whereby ledger accounts are
kept to record all the financial balances required to produce a statement of profit or loss
(reporting general ledger account balances for ‘income’ and ‘expenses’) and a
statement of financial position (reporting general ledger account balances for ‘assets’,
‘liabilities’ and ‘capital’).

The receivables ledger

When a significant amount of detailed information is needed for credit sales transactions
made to customers of a business, then a subsidiary ledger is commonly used.
Subsidiary ledgers are kept when there is a large amount of transaction information that
needs to be recorded, a subsidiary ledger avoids large volumes of transactions that
would otherwise be recorded in the general ledger.
The ‘receivables ledger' is also called the ‘sales ledger’ and also called ‘trade
receivables’, it represents ledgers kept for each customer account, including the total
balance owed by each customer to be ‘received’ by the business. The accounts
receivables subsidiary ledger is a breakdown of the total amount of receivables that
would be included in the general ledger.
The receivables ledger is not part of the double entry general ledger system, it is
maintained separately and independently. The receivables ledger records the detailed
transaction history for all credit customers of the business, which would include sales
invoices, credit notes and money received from each credit customer.

The payables ledger

When a significant amount of detailed information is needed for credit purchases made
from suppliers to a business, then a subsidiary ledger is commonly used. Subsidiary
ledgers are kept when there is a large amount of transaction information that needs to
be recorded, a subsidiary ledger avoids large volumes of transactions that would
otherwise be recorded in the general ledger.
The ‘payables ledger' is also called the ‘purchases ledger’ and also called ‘trade
payables’, it represents ledgers kept for each supplier account, including the total
balance owed to each supplier to be ‘payable’ by the business. The accounts payables
subsidiary ledger is a breakdown of the total amount of payables that would be included
in the general ledger.
The payables ledger is not part of the double entry general ledger system, it is
maintained separately and independently. The payables ledger records the detailed
transaction history for all credit suppliers to a business, which would include purchase
invoices, credit notes and money paid to each credit supplier.

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Total amounts posted from the day books to the general ledger
Sale of goods on credit

Credit Customers Total Amount VAT Amount Net Amount

DR
CR CR
Sales Day Book (SDB) Receivables Ledger
VAT Sales
Control
CR
DR DR
Sales Returns Day Book (SRDB) Receivables Ledger
VAT Sales Returns
Control
CR
DR DR
Discounts Allowed Day Book (DADB) Receivables Ledger
VAT Discounts Allowed
Control

The sale of goods on credit to customers are recorded in the sales day book and
receivables ledger. Cash sales are sales earned from customers that were not on credit
and are recorded in the cash book.
Purchase of goods on credit

Credit Suppliers Total Amount VAT Amount Net Amount

CR
DR DR
Purchases Day Book (PDB) Payables Ledger
VAT Purchases
Control
DR
CR CR
Purchases Returns Day Book (PRDB) Payables Ledger
VAT Purchases Returns
Control
DR
CR CR
Discounts Received Day Book (DRDB) Payables Ledger
VAT Discounts Received
Control

The purchase of goods on credit from suppliers are recorded in the purchases day book
and payables ledger. Cash purchases are purchases made from suppliers that were not
on credit and are recorded in the cash book.
Money received and paid

Total Amount in the cash and VAT and Net Amounts in the
Transaction
bank columns of a cash book analysis columns of a cash book

Money received DR Bank or DR Cash CR VAT and Net amounts

Money paid CR Bank or CR Cash DR VAT and Net amounts

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DEAD CLIC
Don’t get clouded in the double entry logic, ledgers are just balances kept for the five
financial elements and you are either increasing or decreasing these balances
according to the rules of double entry.
Important double entry terminology
DEAD CLIC defines what is the ‘normal balance’ or the natural state for a T account.
DEAD CLIC is an acronym that defines elements of the financial statements and
indicates whether each element would be overall a debit or credit balance. It can be
used for determining the correct debit or credit balance that would exist in a ledger
account, but the element must be determined first. It can also be used to determine the
correct double entry to increase or decrease a ledger account balance.
DEAD CLIC
Debit Credit
Expenses Liabilities
Assets Income
Drawings Capital
Increase balance Decrease balance
The elements Natural state (as per the (opposite to
natural state) natural state)
Income Credit Credit Debit
Expenses Debit Debit Credit
Assets Debit Debit Credit
Liabilities Credit Credit Debit
Capital Credit Credit Debit

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The elements of final accounts

Five elements make up the final accounts for a business and these are assets,
liabilities, capital (equity), income and expenses.
• Assets, liabilities and capital are presented in the statement of financial position
(SFP) which reports about the wealth and liquidity (cash) position of the
business.
• Income and expenses are presented in the statement of profit or loss (SPL)
which reports the profit earned (or loss incurred) by the business.
Assets
Resources controlled by the business as a result of past events and from which future
benefits (money) are expected to flow to the business.
Non-current assets are assets consumed or used by a business beyond a period of one
year, they are long-term investments and used to generate products, services or cash
for a business.
Examples of non-current assets
• Land and buildings.
• Manufacturing plant and equipment.
• Equipment and tools.
• Computer equipment.
• Office equipment.
• Furniture, fixtures and fittings.
• Motor vehicles.
An accumulated depreciation account in the general ledger is a credit balance and
represents an amount provided as depreciation charges in previous accounting periods
for non-current assets. This contra account (a credit balance) is normally netted against
the original cost of the non-current asset (a debit balance) to show ‘the carrying value’ in
the statement of financial position.
Current assets are assets expected to be converted quickly into cash within a period of
one year or less.
Examples of current assets
• Closing inventory the business currently holds for resale.
• Trade receivables (money to be ‘received’ and owed from credit customers). Also
called the receivables ledger control account.
• Prepaid expenses (expenses paid but not yet consumed).
• Accrued income (income earned but not yet received).
• VAT owed from HMRC.
• Money in the bank account.
• Cash in hand (physical notes and coins).

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The allowance for doubtful receivables account in the general ledger is a credit balance
and represents an amount provided for doubtful debts in the receivables ledger control
account. This contra account (a credit balance) is normally netted against the amount
in the receivables ledger control account (a debit balance) to show ‘net trade
receivables’ in the statement of financial position.

Liabilities
Present obligations of the business arising from past events and in future money will be
paid out by the business to settle outstanding balances.
Non-current liabilities are obligations expected to be settled (paid) by the business
beyond a period of one year
Examples of non-current liabilities
• Bank loans.
• Hire purchase agreements.
• Lease agreements.
Current liabilities are obligations expected to be settled (paid) by the business within a
period of one year or less.

Examples of current liabilities

• VAT owed to HMRC.
• Wages owed to staff.
• Accrued expenses (expenses consumed but not yet paid).
• Prepaid income (income received but not yet earned).
• Bank overdraft (money owed to the bank).
• Trade payables (money to be ‘paid’ and owed to credit suppliers). Also called
the payables ledger control account.

Capital
Capital (equity) simply means the value of ownership. Capital is the residual interest
(whatever is left) from the assets of the business after deducting all liabilities. The
balance of assets less liabilities (‘net assets’) represent what is owed by the business to
the owner of the business. A drawings account also records any money taken from the
business by the owner. A drawings account is kept separate to the capital account
because it provides more information.
Any profit shown in a statement of profit or loss is owed to the owner of the business
(increasing their capital balance) and any losses shown in a statement of profit or loss
reduce what is owed to the owner of the business (decreasing their capital balance).
Assets, liabilities and capital are presented in the statement of financial position for a
business, which reports about the wealth and liquidity (cash) position of the business.

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Income
Money earned or received by the business from the sale of goods or services, or from
other investments and income sources.
• Cash sales (sales that were for cash, not on credit).
• Credit sales (sales that were on credit).
• Rent received from rental of business premises.
• Bank interest received.
• Discounts received (prompt payment discounts) from suppliers.
• Gain on disposal of non-current assets.
The sales returns account in the general ledger is a debit balance and represents sales
returns by customers. This contra account (a debit balance) is normally netted against
sales (a credit balance) to show ‘net sales’ in a statement of profit or loss.
Expenses
Costs incurred or paid for by the business in the normal course of trade, such as the
cost of goods purchased for resale and other expenses consumed.
• Cash purchases (purchases that were for cash, not on credit).
• Credit purchases (purchases that were on credit).
• Rent payments for business premises.
• Premises insurance, light and heat.
• Staff wages.
• Motor vehicle running costs.
• Advertising and marketing.
• Depreciation charges (an expense for the wear and tear, fall in value or
obsolescence of non-current assets).
• Loss on disposal of non-current assets.
• Bank interest and bank charges.
• Irrecoverable debts (bad debts written off in the receivables ledger control).
• Allowance for doubtful receivables adjustment.
• Discounts allowed (prompt payment discounts) to credit customers.
• Accountancy and legal services.
• Carriage inwards.
• Carriage outwards.
The purchase returns account in the general ledger is a credit balance and represents
purchase returns to suppliers. This account is normally netted against purchases (a
debit balance) to show ‘net purchases’ in a statement of profit or loss. Carriage inwards
represent an expense for delivery charges made by suppliers and normally treated as
part of cost of goods sold. Exam tasks may expect you to include purchases as one
single figure within the trading account section (see later) of a statement of profit or loss,
after adding carriage inwards and deducting purchase returns. Exam task instructions
would be given wherever relevant. Carriage outwards represents delivery charges
incurred by the business to transport goods sold to customers, these expenses are
included below the trading account in a statement of profit or loss (see later).

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The initial trial balance

An initial ‘trial balance’ (a ‘trial of balances’) as the name suggests is an accounting
statement where all debit and credit balances from the general ledger (a double-entry
system) are shown together to test their equality. The receivables and payables ledgers
are independent from the general ledger and are not included in a trial balance.
The purpose of a trial balance is to ensure that all entries made in the general ledger
have been properly balanced and to check the accuracy of entries made before a final
set of financial statements are constructed for a business.

The accounting equation

The accounting equation states that the sum of the business’s total assets less its total
liabilities (net assets) would be equal to the capital (equity) owed to the owner of the
business. Capital is the residual interest (whatever is left for the owner).
Total Assets (debits) - Total Liabilities (credits) = Capital (a ‘credit’ balance remaining).
Types of errors not disclosed by the trial balance
Errors and omissions occur in the general ledger that do not cause an imbalance
between the total of all debit and credit balances in a trial balance. This makes these
types of error more difficult to detect. These types of error can be remembered using
the acronym ‘TOPCROC’. You do not need to memorise the different types of error but
exam tasks can require you to prepare adjustments to an extended trial balance or
produce journal entries required to correct errors.

• T Transposition
A digit (number) for an amount posted is reversed incorrectly for both a debit and
credit entry made.
• O Original entry
Documents such as invoices or credit notes are prepared incorrectly or the wrong
amounts are posted incorrectly to the day books.
• P Principle
An amount incorrectly posted to the wrong general ledger account and the wrong
financial element.
• C Commission
An amount incorrectly posted to the wrong general ledger account but the right
financial element.
• R Reversal of entries
Debit and credit entries are incorrectly posted the wrong way round.
• O Omission
No entry has been made in the general ledger (a transaction is not recorded).
• C Compensating
Very rare but can happen, two independent errors create an imbalance between
debit and credit amounts, but each error compensates and cancels out the other
(so no imbalance would exist in the trial balance).

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Types of errors disclosed by the trial balance

Errors and omissions occur in the general ledger that do cause an imbalance between
the total of all debit and credit balances in a trial balance. This makes these types of
error easier to detect because the trial balance will not balance.
These types of error can be remembered using the acronym ‘TESCOS’. You do not
need to memorise the different types of error but exam tasks can require you to prepare
adjustments to an extended trial balance or produce journal entries required to correct
errors.

• T Transposition
A digit (number) for an amount posted is reversed incorrectly for a debit amount
posted but the credit amount is correctly posted, or vice versa.
• E Extraction
A general ledger balance in error is balanced incorrectly. The incorrect balance is
‘extracted’ and shown incorrectly in a trial balance.
• S Single entry
A debit entry is posted without any corresponding credit entry, or vice versa.
• C Casting
A column in a day book is added up (‘casted’) incorrectly and the incorrect
amount posted from a day book to the general ledger.
• O Omission
A general ledger balance in error is missed out altogether from a trial balance.
• S Same sided
Two debit entries are posted in error without any corresponding credit entry, or
vice versa.
Suspense accounts
A suspense account balance is opened each time an imbalance exists between the total
of all debits and credits in a trial balance. A balance is opened in a suspense account
to ensure equality between the total of all debits and credits in a trial balance, it is a
temporary account and will be closed whenever the errors can be found and corrected.
A suspense account can also temporarily store financial transactions until they can be
verified and the correct general ledger accounts for the posting is determined.
Practice example 1
Trial Balance (totals before the suspense account opened) 154,896 155,279
Suspense account opened (debit balance) 383
Trial balance totals agree but errors need to be found 155,279 155,279
In the example above the total debit amounts and total credit amounts in a trial balance
do not agree and a suspense account is temporarily opened to hold the amount of any
imbalance. An amount of £383 is missing on the debit side (£155,279 - £154,896) which
becomes a suspense account balance to ensure the trial balance debit and credit totals
do agree.

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The extended trial balance (ETB)

An ETB is a workings paper in a manual book-keeping system used to prepare the final
debit and credit balances for the statement of profit and loss account (SPL) and the
statement of financial position (SFP). You must be able to transfer balances from ledger
accounts, a list of balances or written data into the correct debit or credit columns of an
initial trial balance. You must be able to place the following period adjustments correctly
into the adjustment columns of an adjusted trial balance so that it balances:
• Closing inventory
• Accruals of income or expenses
• Prepayments of income or expenses
• Depreciation
• Irrecoverable debts
• Allowances for doubtful receivables
• Disposals of non-current assets (NCA) including part-exchange.
You must be able to correct errors that are not shown by an initial trial balance and
correct errors that are shown by an initial trial balance by the use and clearing of a
suspense account.
You must be able to complete the SPL and SFP columns of an ETB by extending
figures from the ledger balances and adjustment columns to the relevant statement of
profit or loss (SPL) and statement of financial position (SFP) columns. You must be
able to balance off the ETB by calculating the profit or loss amount and enter the
relevant figure in the SPL and SFP columns. The completion of an ETB for partnerships
is excluded from your syllabus. An example of a fully completed ETB is shown below.
Extended Trial Balance

Statement of Statement of
Ledger balances Adjustments
Ledger account profit or loss financial position
Dr £ Cr £ Dr £ Cr £ Dr £ Cr £ Dr £ Cr £
Bank 1,299 1,299
Opening inventory 4,200 4,200
Capital 7,928 7,928
Drawings 22,000 22,000
Premises expenses 16,931 16,931
Bank charges and interest 320 320
Staff wages 12,480 12,480
Sales returns 2,400 2,400
Purchases returns 480 480
Carriage inwards 940 940
Bank loan 15,900 15,900
Closing inventory 3,200 3,200 3,200 3,200
Administration expenses 6,600 6,600
Depreciation charges 2,740 2,740
Office equipment at cost 27,400 27,400
Office equipment - accumulated depreciation 5,480 2,740 8,220
Purchases 25,420 25,420
Payables ledger control account 5,725 5,725
Allowance for doubtful receivables 300 39 339
Allowance for doubtful receivables - adjustment 39 39
Sales 86,400 86,400
Receivables ledger control account 3,390 3,390
Loan interest paid 1,431 1,431
Profit for the year 16,579 16,579
Totals 123,512 123,512 5,979 5,979 90,080 90,080 55,990 55,990

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The purpose of a bank reconciliation

A bank reconciliation is the process of agreeing a closing cash book balance recorded
by the business to the closing balance shown on the bank statements. A bank
reconciliation is an important internal control to help a business identify any errors or
omissions from its cash receipts or payments recorded. It also helps to discover any
cash fraud in a more timely manner.
Reasons for performing a bank reconciliation
• Detecting errors
• Identifying fraudulent transactions and theft
• Keeping track of trade receivables and trade payables

The process for a bank reconciliation

1. Compare and match receipts recorded in the cash book (receipts are ‘debits’ in
the cash book) to receipts recorded on the bank statements (receipts are ‘credits’
on a bank statement) AND Compare and match payments recorded in the cash
book (payments are ‘credits’ in the cash book) to payments recorded on the bank
statements (payments are ‘debits’ on a bank statement).

The end result of step 1 is to discover unmatched receipts and payments from
comparing both sets of records.

2. Revise the cash book by making entries in the cash book for items that appear
on the bank statements but are not recorded in the cash book. Examples of such
items include bank interest received, bank charges and interest paid, automated
payments or receipts (such as BACS and faster payments) that have been
omitted (missed) from the cash book.

An exam task may provide a cash book and expect you to enter missing items not in the
cash book, as well as total and balance the cash book. An exam task alternatively
could ask for the debit or credit entries to revise a cash book. The end result of step 2 is
to have an accurate and up-to-date closing balance for the cash book.
3. Complete a bank reconciliation statement that will agree the closing balance in
the revised cash book to the closing balance shown on the bank statements. A
bank reconciliation statement adjusts the closing balance shown on the bank
statement for ‘timing differences’ to agree this closing balance to the cash book.

Earlier timing differences are items recorded in the cash book in the previous month and
are now clearing ‘early’ on the bank statements in the following month. Earlier timing
differences are not reconciling items for the current month and these items should be
ignored when completing step 2 above.

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The receivables ledger control account (RLCA)

The general ledger account that represents the total amount owed by credit customers
is the receivables ledger control account (RLCA). An example of a receivables ledger
control account (RLCA) is shown below. Using the principle of DEAD CLIC, the balance
brought down (b/d) is on the debit side because the receivables ledger control account
is an asset (customers owe money to the business). All entries within this account
would include VAT.
• Debit entries are made for sales invoices which increase the balance owed by
credit customers.
• Credit entries are made for customer payments, discounts allowed, sales returns,
and irrecoverable debts, which decrease the balance owed by credit customers.
Example of a receivables ledger control account

Receivables ledger control account

Amount Amount
Date Details Date Details
£ £
1 Apr Balance b/d 12,900 30 Apr Bank 24,060

30 Apr Sales 31,200 30 Apr Sales returns 500

30 Apr Discounts allowed 624

30 Apr Set off entries to PLCA 1,200
30 Apr Irrecoverable debts 680
30 Apr Balance c/d 17,036
Total 44,100 Total 44,100
1 May Balance b/d 17,036

All amounts entered in the RLCA would be inclusive of VAT. Cash sales are not
recorded in the receivables ledger or receivables ledger control account. A set-off
(contra) entry occurs in a situation when you have a customer who orders goods on
credit but also supplies goods on credit to the same business. In such cases
agreements can be made to set-off balances between the receivables and payables
ledger without any payment.
Purpose of the receivables ledger control account
• Checks the accuracy of the total customer balances in the receivables ledger.
• Provides a quick total for customer balances in the receivables ledger.
• Helps to identify any errors or missing figures.

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Types of error that are common in the receivables ledger control and receivables ledger
include sales invoices, credit notes or bank receipts that have been duplicated or
omitted. In a manual book keeping system mistakes may happen in one ledger system
but not the other and the balances from each ledger may not agree at the end of a
period.
Summary for the effect of duplications and omissions

Error made in the

Error made in the
Type of error Transaction receivables ledger
receivables ledger
control account (RLCA)

RLCA balance higher Receivables ledger

Sales invoice
than the receivables balance higher than
(debit entry)
ledger balance the RLCA balance
Duplication
e.g. same
transaction
entered twice Credit notes, payments,
RLCA balance lower Receivables ledger
set off entries and
than the receivables balance lower than
irrecoverable debts
ledger balance the RLCA balance
(credit entry)

RLCA balance lower Receivables ledger

Sales invoice
than the receivables balance lower than
(debit entry)
ledger balance the RLCA balance
Omission
e.g. transaction
not recorded
Credit notes, payments,
RLCA balance higher Receivables ledger
set off entries and
than the receivables balance higher than
irrecoverable debts
ledger balance the RLCA balance
(credit entry)

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The payables ledger control account (PLCA)

The general ledger account that represents the total amount owed to credit suppliers is
the payables ledger control account (PLCA), the entries in this account are the
summarised total amounts entered from the day books. An example of a payables
ledger control account (PLCA) is shown below. Using the principle of DEAD CLIC, the
balance brought down (b/d) is on the credit side because the payables ledger control
account is a liability (the business owes money to suppliers). All entries within this
account would include VAT.
• Credit entries are made for purchase invoices which increase the balance owed
to credit suppliers.
• Debit entries are made for supplier payments, discounts received and purchase
returns which decrease the balance owed to credit suppliers.
Example of a payables ledger control account

Payables ledger control account

Amount Amount
Date Details Date Details
£ £
30 Apr Discounts received 249 1 Apr Balance b/d 6,590

30 Apr Purchase returns 360 30 Apr Purchases 24,895

30 Apr Bank 15,296

30 Apr Set off entries to RLCA 1,200

30 Apr Balance c/d 14,380

Total 31,485 Total 31,485

1 May Balance b/d 14,380

All amounts entered in the PLCA would be inclusive of VAT. Cash purchases are not
recorded in the payables ledger or payables ledger control account. A set-off (contra)
entry occurs in a situation when you have a customer who orders goods on credit but
also supplies goods on credit to the same business. In such cases agreements can be
made to set-off balances between the receivables and payables ledger without any
payment.
Purpose of the payables ledger control account
• Checks the accuracy of the total supplier balances in the payables ledger.
• Provides a quick total for supplier balances in the payables ledger.
• Helps to identify any errors or missing figures.

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Types of error that are common in the payables ledger control and payables ledger
include purchase invoices, credit notes or bank payments that have been duplicated or
omitted. In a manual book keeping system mistakes may happen in one ledger system
but not the other and the balances from each ledger may not agree at the end of a
period.
Summary for the effect of duplications and omissions

Error made in the

Error made in the
Type of error Transaction Payables ledger control
Payables ledger
account (PLCA)

PLCA balance higher Payables ledger

Purchase invoice
than the payables balance higher than
(credit entry)
ledger balance the PLCA balance
Duplication
e.g. same
transaction
entered twice
Credit note or PLCA balance lower Payables ledger
payment than the payables balance lower than
(debit entry) ledger balance the PLCA balance

PLCA balance lower Payables ledger

Purchase invoice
than the payables balance lower than
(credit entry)
ledger balance the PLCA balance
Omission
e.g. transaction
not recorded
Credit note or PLCA balance higher Payables ledger
payment than the payables balance higher than
(debit entry) ledger balance the PLCA balance

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Incomplete records
Incomplete records is an accounting situation, where a business does not maintain a
double-entry bookkeeping system and does not produce a trial balance. The accountant
has minimal records to prepare final accounts, such as a cash book only, or no actual
accounting records exist at all.
The receivables and payables ledger control accounts are useful accounting tools for
incomplete records, they can be used to estimate and calculate missing figures and
help prepare the final accounts. General ledger accounts such as bank and cash can
also help identify missing items such as money or goods taken or stolen, or the
drawings a sole trader has taken from the business but did not record.
The VAT control account
The purpose of a VAT control account is to accurately record VAT collected from sales
(outputs of the business) and VAT to be reclaimed from purchases and expenses
(inputs to the business). It provides the necessary details for a VAT return to be
prepared and submitted to HMRC.
An example of a VAT control account is shown below. Using the principle of DEAD
CLIC, the balance brought down (b/d) is on the credit side because the VAT control
account is normally a liability (VAT is owed to HMRC).
In some cases VAT is owed from HMRC (a refund of VAT is due to the business). This
can happen when a business reclaims more input VAT on its purchases and expenses
compared to output VAT it owes on its sales. The balance brought down (b/d) in this
case would be on the debit side and indicates an ’asset’ as VAT is owed from HMRC.
Example of a VAT control account
VAT control account

Amount Amount
Date Details Date Details
£ £

30 Apr Cash purchases 635 1 Apr Balance b/d 2391

30 Apr Credit purchases 3450 30 Apr Cash sales 6780

30 Apr Discounts allowed 54 30 Apr Credit sales 13667

30 Apr Sales returns 120 30 Apr Purchase returns 468

30 Apr Bank (payment of VAT) 2391 30 Apr Discounts received 23

30 Apr Balance c/d 16679

Total 23329 Total 23329

1 May Balance b/d 16679

Calculating VAT amounts

• 1/5 x the net amount (excluding VAT) = the VAT amount.
• 1/6 x the total amount (including VAT) = the VAT amount.

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The wages control account

A wages control account is a ‘liability’ account representing net salaries (money) owed
to employees, it also records the total summary from payroll reports such as amounts
owed to HMRC (income tax and national insurance), pension contributions and trade
union subscriptions.
The wages control account keeps a record of the total (summary) of payroll transactions
for a period. The control account acts as a 'check' for wages paid to employees and
ensures the correct payroll liabilities have been recorded.

The exam will not require tax and national insurance to be calculated. According to the
logic of DEAD CLIC a credit entry will increase the balance for a liability and a debit
entry will decrease a balance for a liability.
A proforma wages control account is shown below. A tip to learn payroll entries would
be that all payroll entries will always be a debit or credit entry to the wages control
account, so if you are familiar with these entries in the wages control then you can work
out the other side of the double entry required for a journal entry.

Wages control account

Amount Amount
Details Details
£ £

HMRC liability 1157 Wages expenses 4103

Pensions liability 780

TU liability 26

Bank (net salaries paid) 2140

Total 4103 Total 4103

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Period end adjustments

The reason for period end adjustments to the final accounts is because of the accruals
(or matching) concept. The accruals (or matching) concept is an accounting principle
that recognises revenues such as sales income and all its related expenses in the same
accounting period.
Irrecoverable (bad) debts
An irrecoverable debt is a debt that ‘definitely will not be paid’ and cannot be
collected because a customer is unable to pay the amount owed. The business is also
not willing to take any action to collect it. The debt must be removed from the
receivables ledger control account (RLCA) in the general ledger and from the
customer’s account in the receivables ledger.
Journal entry for irrecoverable debts (no VAT charged on sales)
• Debit Irrecoverable debts (expenses increase)
• Credit Receivables ledger control account (the ‘asset’ decreases)
Journal entry for irrecoverable debts (VAT charged on sales)
• Debit Irrecoverable debts (expenses increase)
• Debit VAT control account (liability to pay VAT to HMRC decreases)
• Credit Receivables ledger control account (the ‘asset’ decreases)
Bad debt recovery
A bad (irrecoverable debt) may have been written off and subsequently the money
owed is then recovered from the customer in a future accounting period. The
accounting adjustment would be the reverse of the accounting entries shown above.
Allowances for doubtful receivables
A doubtful receivable is a debt that is ‘unlikely, or uncertain to be paid’. Allowances
for doubtful receivables are matched as expenses against the sales income earned in
the same accounting period.
Specific allowances for doubtful receivables may be set aside for money owed by
certain customers because of the customers position, such as a long overdue account
or an on-going trade dispute.
General allowances for doubtful receivables may be set aside that anticipate that
some customers in the future may become uncollectible, but without knowing any
specific customer names. History and experience may suggest that a certain
percentage of the receivables ledger balance owed may not pay due to unforeseen
circumstances.

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Accounting for doubtful receivables

• The percentage for a general allowance is calculated after deducting
irrecoverable debts and specific allowances for doubtful receivables from the
RLCA. This avoids double counting.
• Specific and general allowances are added together and compared to the total
credit balance for allowances for doubtful receivables at the beginning of the
accounting year.
• The credit balance for allowances for doubtful receivables is increased or
decreased at the end of each accounting year.
Increasing allowances for doubtful receivables.
• DEBIT ALLOWANCE FOR DOUBTFUL RECEIVABLES: ADJUSTMENT
(statement of profit or loss)
• CREDIT ALLOWANCE FOR DOUBTFUL RECEIVABLES
(statement of financial position)
Decreasing allowances for doubtful receivables.
• DEBIT ALLOWANCE FOR DOUBTFUL RECEIVABLES
(statement of financial position)
• CREDIT ALLOWANCE FOR DOUBTFUL RECEIVABLES: ADJUSTMENT
(statement of profit or loss)
Summary of irrecoverable debts and doubtful receivables

Statement of Statement of
Nature Action
financial position profit or loss

Customer Write off the debt from

Irrecoverable amounts owed the RLCA and close the Irrecoverable
RLCA
debts that definitely will receivables ledger debts
not be paid. account of the customer.

Specific
Specific
allowances for Record an allowance for
customers that are
doubtful doubtful receivables.
unlikely to pay.
receivables
Allowance for
Allowance for
doubtful
doubtful
receivables
receivables
adjustment
General General
allowances for percentage for Record an allowance for
doubtful customers that are doubtful receivables.
receivables unlikely to pay.

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Closing inventory
Closing inventory is the cost of ‘unsold goods for resale’ (purchases) at the end of an
accounting period. At the end of an accounting period the cost of closing inventory
(unsold goods) is removed from cost of sales in a profit or loss account and recognised
as an asset in the statement of financial position.
Journal entries for closing inventory
• DEBIT Closing inventory
(increase assets in the statement of financial position)
• CREDIT Closing inventory
(decrease cost of sales in the statement of profit or loss)

Valuing closing inventory

The accounting standard that regulates the accounting treatment of inventory is
international accounting standard (IAS) 2 Inventory. IAS 2 defines inventories as assets
which are held for sale in the ordinary course of business.
Inventory must be valued at the lower of purchase cost or net realisable value (NRV).
Net realisable value (NRV) means the estimated selling price of the inventory less any
costs to complete the sale. Obsolescence, damage or falling market prices are likely
reasons why inventory can be worth less than its purchase cost.

What can be included in the value of closing inventory

• Purchase cost (less any trade or bulk discount).
• Delivery cost (also called carriage inwards).
• Import duties paid on the goods.
What cannot be included in the value of closing inventory
• Storage (warehouse) costs.
• Administrative costs.
• Selling costs e.g. advertising and marketing.
• VAT (if the business is registered for VAT).

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Accruals and prepayments of income and expenditure

Exam tasks may require you to account for period end adjustments for accruals and
prepayments, including the reversal of these entries at the beginning of the accounting
year. The general ledger accounts examined include accrued expenses, accrued
income, prepaid expenses and prepaid income.

A period end adjustment for accruals and prepayments will be made on the last day of
an accounting period. The double entry is shown below.

Account Nature Debit Credit

Accrued Expenses consumed

Accrued
Expenses but not paid for in an Expenses
Expenses
(Liability) accounting period.

Prepaid Expenses paid for

Prepaid
Expenses but not consumed in Expenses
Expenses
(Asset) an accounting period.

Accrued Income earned but not

Accrued
Income received in an Income
Income
(Asset) accounting period.

Prepaid Income received but

Prepaid
Income not earned in an Income
Income
(Liability) accounting period.

The reversal of accruals and prepayments on the first day of the next accounting year
would be the opposite to the double entry shown above.

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Capital expenditure
International Accounting Standard (IAS) 16 is the accounting standard that regulates the
accounting treatment of property, plant and equipment. IAS 16 defines tangible non-
current assets as ‘assets with physical substance and held for a continual (long-term)
purpose’. Examples include land, buildings, machines, furniture, computers and motor
vehicles. Current assets (rather than non-current assets) are assets that are quickly
converted into cash typically within one year e.g. closing inventory, trade receivables,
prepaid expenses, accrued income, money in the bank and cash in hand.
Costs included as capital expenditure
• Purchase price of the non-current asset.
• Delivery cost.
• Installation, assembly and fitting costs.
• Site preparation costs.
Costs excluded as capital expenditure
• VAT if the amount is reclaimed.
• Revenue expenditure.
• Non-current assets costing less than a materiality threshold.
Capital v revenue expenditure
• Capital expenditure means acquiring non-current assets that are permanent,
long-lasting and used in a business beyond one year. Capital expenditure will be
recorded as a ‘non-current asset’ in a statement of financial position at the end of
the year.
• Revenue expenditure is an expense that is consumed quickly and the benefit of
consumption is short-lived (within one year or less) e.g. rent, staff wages and
advertising expenses. Revenue expenditure is matched as an ‘expense’ with
sales income earned in a statement of profit or loss for the year.

Journal entries for the purchase (acquisition) of non-current assets

• DEBIT Non-current assets - at cost
(increase assets in the statement of financial position)
• CREDIT Bank
(decrease assets in the statement of financial position)
Alternatively, if the purchase was funded by a bank loan then credit bank loan (increase
liability) rather than credit bank (decrease asset).

Business policies
Formal organisational policies can help control non-current assets and include
authorisation of capital expenditure prior to purchase, materiality limits for accounting
treatment of capital expenditure, maintaining a non-current asset register and regular
physical inspection of assets for wear and tear, obsolesce, damage, or theft.

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Materiality limits
Materiality limits may exist as policy to govern the accounting treatment of capital
expenditure. Materiality disregards ‘trivial’ or ‘small’ matters and materiality thresholds
are common as business policy to determine the accounting treatment for new assets.
If the amount spent on an asset is below a certain materiality (trivial) threshold then
expenditure is treated as a revenue ‘expense’ rather than a ‘non-current asset’.
Exam instructions will always explain the materiality policy of a business.

Depreciation
When a non-current asset is used over time it will generally lose value due to wear and
tear, obsolescence or damage. The matching (accruals) concept would account for this
loss of value (depreciation) during an assets lifetime and match this ‘expense’ to sales
income earned in each accounting year.
Different methods exist to calculate the amount for depreciation charges to be
recognised as an expense in the statement of profit or loss for each accounting year.
The straight-line method
Depreciation charge each year = (Cost - Residual Value) ÷ Useful Life (Years).
The diminishing (reducing) balance method
Depreciation charge each year = Carrying value of NCA x Rate of depreciation (%).
This method calculates a depreciation amount for each year by multiplying a constant
percentage rate by the carrying value of a non-current asset at the beginning of the
accounting year. The carrying value is the original cost of the asset less any
accumulated depreciation. The percentage rate already accounts for any residual
(resale) value of the NCA at the end of its useful economic life and is therefore excluded
from the depreciation calculation.
Journal entries for depreciation charges
• DEBIT Depreciation charges
(increase expenses in the statement of profit or loss account)
• CREDIT Accumulated depreciation
(decrease carrying value of the NCA in the statement of financial position)
Accumulated depreciation is a credit balance to represent the amount of depreciation
charges accumulated to date for a non-current asset. Accumulated depreciation (a
credit balance) is often referred to as a ‘contra asset’ account because its credit balance
is netted off against the original cost of an NCA (a debit balance) to calculate the
carrying value of the asset in the statement of financial position.

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Terminology to learn

Original cost The purchase price of a non-current asset, including

installation, assembly, fitting, site preparation and
delivery costs.

Accumulated depreciation The total amount of depreciation charged to date for

a non-current asset.

Carrying (value) amount The original cost of the non-current asset less any
accumulated depreciation. Carrying value may also
be called ‘net book value’.

Useful economic life The period of time a non-current asset is expected

to be used by the business.

Residual (resale) value The estimated sale value of a non-current asset at

the end of its useful economic life.

Depreciable amount The original cost of a non-current asset less any

residual value.

Depreciation charge The amount charged as an expense in the

statement of profit or loss, to recognise a fall in
value for a non-current asset.

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Recording the disposal (sale) of non-current assets

A disposal (sale) account is a general ledger account used to calculate a gain or loss on
the sale of a non-current asset. The disposal account records the proceeds received
from the sale (disposal) of the asset and the carrying value of the asset sold (its original
cost - accumulated depreciation). The difference between sale proceeds and the
carrying value of the asset is the gain or loss arising on disposal. An example of a
disposal account is shown below.

Disposal account

Amount Amount
Details Details
£ £
Forklift truck - at cost 20,000 Forklift truck - accum depn 6,000
Profit or loss account 1,000 Bank 15,000
21,000 21,000

Journal to remove the original cost of an NCA

• Debit Disposals
• Credit Non-current asset - at cost
Journal to remove accumulated depreciation for an NCA
• Debit Accumulated depreciation
• Credit Disposals
Journal to record the sale proceeds (money) received
• Debit Bank
• Credit Disposals
The disposals account is closed at the end of the accounting year and any balance
remaining is transferred as a gain (income) or loss (expense) to the statement of profit
or loss account.
• A gain means that the sale proceeds received were more than the carrying value
of the asset sold - Debit Disposals and Credit Profit or loss (income).
• A loss means that the sale proceeds received were less than the carrying value
of the asset sold - Debit Profit or loss (expense) and Credit Disposals.
Recording a part exchange value for the disposal of a non-current asset
A part-exchange is when an existing asset owned by the business is ‘traded in’ to fund
the purchase cost for a new asset.
Journal to record a part-exchange value received
• Debit Non-current assets - at cost
• Credit Disposals

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The non-current asset register

The general ledger provides only a summarised total balance for the original cost and
accumulated depreciation for all assets owned by the business. A non-current asset (or
fixed asset) register keeps a detailed record of all the individual non-current assets
owned by a business. Details include a description of each asset, its acquisition date,
original cost (£), accumulated depreciation (£), carrying value (£) and method of
funding.
Example of a non-current asset register
Depreciation Carrying Disposal
Description Acquisition Cost Funding Disposal
charges amount proceeds
/Serial number date £ method date
£ £ £
Computer equipment

PC ZX100 01/09/X4 1300.00 Cash

Year ended 31/01/X5 250.00 1050.00

Year ended 31/01/X6 250.00 800.00

Year ended 31/01/X7 250.00 550.00

PC ZX200 01/09/X4 1800.00 Cash

Year ended 31/01/X5 375.00 1425.00

Year ended 31/01/X6 375.00 1050.00

Year ended 31/01/X7 0.00 0.00 200.00 31/01/X7

Office equipment

Furniture and printer 01/12/X6 2638.00 Cash

Year ended 31/01/X7 395.70 2242.30

Motor vehicles

Car RBV007 23/01/X6 16700.00 Hire Purchase

Year ended 31/01/X6 3340.00 13360.00

Year ended 31/01/X7 2672.00 10688.00

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Preparing final accounts for a sole trader

The layout for a statement of profit or loss and statement of financial position would be
provided in the exam task if you are required to construct a set of final accounts.
Picklists would be provided for you to make your text entries and boxes provided in the
layout for you to enter amounts.
Statement of profit or loss for the year ended 30 April 20X8
£ £
Sales revenue
revenue (£98,500 - £2,400) 96,100
Opening inventory 5,500
Purchases (£26,900 - £3,250)
Purchases 23,650
Closing inventory -4,100

Cost of goods sold 25,050

Gross profit 71,050
Add:
Discounts received 500
Interest received 650

1,150
Less:
Depreciation charges 8,000
Discounts allowed 5,560
Irrecoverable debts 5,000
Light and heat 1,870
Advertising 3,000
Telephone expenses 1,340
Motor vehicle expenses 5,920
Staff wages 10,200
Rent 12,000

Total expenses 52,890

Net
Net profit
profit or loss 19,310
Terminology to learn
• Sales revenue = sales - sales returns.
• Net purchases = purchases - purchases returns + carriage inwards.
• Cost of sales = opening inventory + net purchases - closing inventory.

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Statement of financial position as at 30 April 20X8

Accumulated Carrying
Cost
depreciation amount
£
£ £

Non-current assets
Office equipment 18,000 4,500 13,500
Motor vehicles 14,500 3,500 11,000
24,500

Current assets
Closing inventory 4,100
Trade receivables 22,300
Cash at bank 14,600

41,000
Current liabilities
HMRC liability 1,500
VAT owed to HMRC 5,410
Trade payables 13,400

20,310
Net current assets 20,690
Net assets 45,190

Financed by
Opening capital 49,880
Add: Profit for the year 19,310
Less: Drawings 24,000
Closing capital 45,190

The capital account

Exam tasks can expect you to complete ledger entries for a sole traders capital account.
The amounts included in the statement of financial position above are entered in the
capital account shown below.
Capital account

Amount Amount
Details Details
£ £
Drawings 24,000 Balance b/d 49,880

Balance c/d 45,190 Profit or loss account 19,310

Total 69,190 Total 69,190

Balance b/d 45,190

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Preparing final accounts for a partnership

1. The statement of profit or loss is prepared for a partnership in exactly the same
way as a sole trader.
2. The appropriation account is then prepared to allocate the net profit (or net loss)
to each partner.
3. The current accounts for each partner are then updated using the appropriation
account and each partners drawings figure for the year.
4. A financial position is prepared in a similar way to a sole trader. The ‘financed by’
section shows the closing capital and current account balances for each partner.
The key components of a partnership agreement
The Partnership Act 1890 defines a partnership as persons carrying on a business in
common with a view of profit. It is advisable in a partnership to have a partnership
agreement which sets out the rights, duties and obligations of each partner. If a
partnership agreement does not exist, the Partnership Act 1890 states simply that
‘profits or losses will be shared equally’ between each partner.
Example of an appropriation account
The profit or loss for appropriation would be the net profit or net loss figure taken from
the statement of profit or loss account.
£
Profit or loss for appropriation 45,160
Add:
Interest on drawings – A 1,000
Interest on drawings – B 600
Deduct:
Interest on capital – A -1,500
Interest on capital – B -1,000
Salary
Salary –- A
A 0
Salary
Salary –- B
B (£500 x 12 months) -6,000
Sales commission – A -3,450
Sales commission – B -2,900
Residual profit or loss available for distribution 31,910
Share of residual profit or loss:
Share
Share of
of residual
residual profit
profitor
- Aloss – A (£31,910 ÷ 100% x 60%) 19,146
Share
Share of
of residual
residual profit
profitloss
- B – B (£31,910 ÷ 100% x 40%) 12,764
residual profit
Total residual profitor
distributed
loss distributed 31,910

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Interest of drawings
Partners maybe penalised for taking drawings from the business and interest on
drawings charged to each partner. The amounts are added to the net profit or loss
available for appropriation.
Interest of capital
Partners maybe allocated interest on their capital invested in the partnership business.
Interest on capital is deducted from the net profit or loss for appropriation.
Salaries
Partners maybe entitled to a salary. Salaries are deducted from the net profit or loss for
appropriation.
Sales commission
Partners maybe entitled to sales commission on their sales results achieved. Sales
commission is deducted from the net profit or loss for appropriation.
The ‘residual’ profit or loss
The net profit or loss after adjustment for salaries, sales commission, interest on capital
and interest on drawings, is the ‘residual’ profit or loss. Residual means ‘whatever is
remaining’. The residual profit or loss will be shared according to the profit or loss
sharing agreement of each partner (by ratio, fraction or percentage).
Partnership capital and current accounts
Partners would normally keep two accounts for their private transactions which is a
capital account and current account. Capital accounts record the permanent (fixed)
capital invested by each partner in the business. Current accounts record the current
balance that each partner can withdraw from the business at any time they choose. The
balance in a current account will fluctuate from year to year and is kept separate from
the capital account of each partner. A balance for a current account can also be
overdrawn (debit balance) when a partner takes more drawings than their share of
profits allocated.
Drawings taken by each partner each year is also debited to their current account which
decreases the current account balance available for each partner. Drawings is not an
entry in an appropriation account because it is not an appropriation of profit, it is money
taken by a partner after profits have been appropriated.
A sole trader only needs to keep one capital account to record their profits (or losses)
and drawings taken for each accounting year because 100% of the net assets of the
business belong wholly to the sole trader. Sole traders do not keep a current account.

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Example of current accounts for a partnership

Current accounts

Anne Burt Anne Burt

Details Details
£ £ £ £

Balance b/d 2,420 Balance b/d 9,450

Interest on drawings 1,000 600 Interest on capital 1,500 1,000

Drawings 20,000 12,000 Salaries 0 6,000

Balance c/d 12,546 7,644 Sales commission 3,450 2,900

Share of profit or loss 19,146 12,764

Total 33,546 22,664 Total 33,546 22,664

Accounting entries for current accounts

Interest on drawings or a share of a residual loss.
• Debit Current account (decrease balance owed to partner)
• Credit Appropriation account
Interest on capital, salaries, sales commission or a share of a residual profit.
• Debit Appropriation account
• Credit Current account (increase balance owed to partner)

REMEMBER! Drawings are never included in an appropriation account.

Drawings taken by each partner.
• Debit Current account (decrease balance owed to partner)
• Credit Drawings (decrease drawings to close the account)

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Example of a statement of financial position for a partnership

The statement of financial position for a partnership is prepared in exactly the same way
as a sole trader. The only difference is how the ‘financed by’ section would be
completed. A partnership would show the closing capital and closing current account
balances of each partner for the end of the year.

Statement of financial position as at 31 March 20X5

Accumulated Carrying
Cost
depreciation amount
£
£ £

Non-current assets
Office equipment 18,000 4,500 13,500
Motor vehicles 14,500 3,500 11,000
24,500

Current assets
Closing inventory 4,100
Trade receivables 22,300
Cash at bank 14,600
41,000
Current liabilities
HMRC liability 1,500
VAT owed to HMRC 5,410
Trade payables 13,400
20,310
Net current assets 20,690
Net assets 45,190

Financed by Anne Burt Total

Capital accounts 15,000 10,000 25,000
Current accounts 12,546 7,644 20,190
27,546 17,644 45,190

An overdrawn current account would be represented as a negative figure in a statement

of financial position. Neither partner has an overdrawn current account balance.

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The financial statements

• The statement of profit or loss (SPL) inform users about the ability of the
business to generate profits. It also shows information about sales and the nature
of expenses incurred.
• The statement of financial position (SFP) inform users about the current status of
the business which include its net assets, liquidity, debt levels and funding.
The primary users of financial statements
The primary (most important) users of final accounts are investors, lenders and other
creditors of the business.

Users Reasons why final accounts are needed

To assess how much profit has been generated by the business

and the value of its net assets. To assess whether the business
Owner will be able to pay dividends (or drawings) in the future. To assess
the risk and return from their investment and whether they should
continue to invest.

To assess current debt levels of the business and its ability to meet
Bank
future loan repayments and interest.

To assess any risk of supplying goods or services on credit to the

Supplier
business and whether the supplier will get paid.

To assess how well the business is being managed in terms of

Management
utilising assets and resources to generate cash-flows and profit.

To assess the security of their employment and the continuing

Employee profitability of the business. Interested in employment prospects,
pension funding and the security of their retirement benefits.

To assess any going concern problems of the business and its

Customer
ability to continue to supply goods or services in the future.

HMRC, Companies House and the Office for National Statistics

are examples of government agents that are interested in
Government
accounting information. HMRC needs to know the amount
of tax that should be paid by the business.

Individuals and groups in society may have varied interests in the

General public activities and performance of a business. Especially if the business
is well-known in the media.

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The qualitative characteristics of useful financial information

Qualitative characteristics are the attributes that make financial information useful to the
users of final accounts. Each characteristic can be remembered using the acronym
VCRUFT.
• Verifiability.
• Comparability.
• Relevance.
• Understandability.
• Faithful representation.
• Timeliness.
The ‘fundamental’ qualitative characteristics of useful financial information is relevance
and faithful representation. There are four ‘enhancing’ qualitative characteristics, which
include comparability, verifiability, timeliness and understandability.
Relevance
Financial information must be capable of influencing and making a difference to the
decisions of users. Relevance means information that is both material and useful to
users of the final accounts.
Faithful representation
Financial information must be complete and free from material error and omission.
The final accounts need to paint an objective, transparent and honest financial picture of
what really happened.
Comparability
Information about a business is more useful if it can be compared with similar
information to a previous year, or to another business in the same industry.
Verifiability
Verifiability gives assurance to the user that the information provided is faithfully
represented. Auditing accounts using an independent and external auditor can lend
more credibility for information contained within the final accounts.
Timeliness
Timeliness means that the information is available and capable of influencing users to
make economic decisions in a timely manner.
Understandability
Presenting information clearly and concisely makes it more understandable. Final
accounts are prepared for users who should have reasonable knowledge of the
business and its economic activities.

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Accounting concepts that govern the financial statements

The materiality concept
The materiality concept is an accounting rule that dictates that any transaction that
significantly has an impact on the final accounts must be recognised.
The prudence concept
The prudence concept is an accounting rule that exercises conservatism and caution
when making judgements about accounting transactions under conditions of
uncertainty.
The accruals (matching) concept
The accruals (matching) concept recognises sales income and all related expenses
which belong to the same accounting period.
The going concern concept
The going concern concept means to recognise the business can continue to operate
and remain in business for the foreseeable future.
The business (separate) entity concept
The separate entity concept states that business transactions and the personal
transactions of its owners must be kept separate for accounting purposes.
The consistency concept
The consistency concept states that, once a business has adopted an accounting policy
then it must continue to follow it consistently in future accounting years. This ensures
that results reported from one year to another are comparable.
The money measurement concept
The money measurement concept states that a business should only record an
accounting transaction, if it can be reliably measured and expressed in terms of money.

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Calculating and interpreting profitability ratios

The objective of the financial statements is to provide information to all users of
accounts to help make decisions. A ratio is a measure of the relationship between two
quantities, normally expressed as one figure divided by the other, it is an effective way
of analysing the financial statements and for comparing performance.
A single ratio on its own is meaningless unless:
• Results compared to another period of time.
• Results compared to another organisation.
• Results compared to an industry average (or standard).
Limitations of ratio analysis
• Historical information is not necessarily a guide for predicting the future.
• Different accounting policies may significantly effect comparison.
• Business and product changes over time may significantly effect comparison.
• Non-financial performance is not understood e.g. customer satisfaction.
• Manipulation of financial statements may significantly effect comparison.
Examinable profitability ratios
• Sales (also called gross profit) margin = gross profit / sales revenue × 100.
• Mark-up = gross profit / cost of goods sold × 100.
• Net profit margin = net profit for the year / sales revenue × 100.
• Expense/sales revenue percentage (a ‘specified expense’ including cost of
sales as a % of sales revenue) = ‘specified expense’ / sales revenue × 100.
Exam task instructions would state which expense to measure as a percentage
of sales.
• ROCE (return on capital employed) = net profit for the year / capital employed ×
100 (where capital employed = capital + non-current liabilities).

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Principles of ethics for professional accountants

The code of ethics establishes the fundamental principles of ethics for professional
accountants and can be remembered using the acronym PIPCO.
• Professional competence and due care
• Integrity
• Professional behaviour
• Confidentiality
• Objectivity
Professional behaviour
Members should comply with relevant laws and regulations and should avoid any action
that discredits the profession.
Integrity
Members should be straightforward and honest in all professional and business
relationships.
Professional competence and due care
Members have a continuing duty to maintain professional knowledge and skill at a level
required to ensure competent professional services based on current developments in
practice, legislation and techniques. Members should act diligently and in accordance
with applicable technical and professional standards when providing professional
services.
Confidentiality
Members should respect the confidentiality of information acquired as a result of
professional and business relationships and should not disclose any such information to
third parties without proper and specific authority or unless there is a legal or
professional right or duty to disclose.
Objectivity
Members should not allow bias, conflicts of interest or undue influence of others to
override professional or business judgements.

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Mock Exam One

1 - Solutions
AAT L3 Financial Accounting:
Preparing Financial Statements

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Task 1 - Solutions (28 marks)

This task is about using daybooks, and accounting for and monitoring non-current
assets.
(a) Complete the following sentences about using daybooks.
(3 marks)
A sales invoice for £3,600 issued to a customer for the sale of goods on credit would be
recorded in the Sales Day Book.
A small transaction of £3.40 paid in cash for postage stamps would be recorded in the
Petty Cash Book.
A credit note received from a supplier for a prompt payment discount would be recorded
in the Discounts Received Day Book.
(b)(i) For the year ended 31 August 20X7, record the following in the extract from
a non-current asset register below.
• Any acquisitions of non-current assets
• Any disposals of non-current assets
• Depreciation
(12 marks)
Depreciation Carrying Disposal
Description Acquisition Cost Funding Disposal
charges amount proceeds
/Serial number date £ method date
£ £ £
Plant and machinery

Machine AX56 01/09/X4 13000.00 Loan

Year ended 31/08/X5 3250.00 9750.00

Year ended 31/08/X6 2437.50 7312.50

Year ended 31/08/X7 0.00 0.00 2000.00 24/07/X7

Machine AZ50 01/09/X6 21390.00 Part Exchange

Year ended 31/08/X7 5347.50 16042.50

Motor vehicles

Car EN65 RBV 23/01/X6 6700.00 Loan

Year ended 31/08/X6 2345.00 4355.00

Year ended 31/08/X7 1524.25 2830.75

Car BN60 DFV 26/08/X5 7800.00 Finance lease

Year ended 31/08/X5 2730.00 5070.00

Year ended 31/08/X6 1774.50 3295.50

Year ended 31/08/X7 1153.43 2142.07

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Workings:
From: ZAR Traders
To: A. Business Date: 1 Sept 20X6
Invoice number: 1123
Item Details £
Machine AZ50 AZ50 19,000.00
Software for AZ50 1,290.00
2 x PC Monitors (screens) @ £150 each for AZ50 300.00
Delivery and installation for AZ50 800.00
Net total 21,390.00
VAT 20% 4,278.00
Total 25,668.00

Machine AX56 (sold)

• This machine would be removed from the accounting records of the business by
posting both its original cost and accumulated depreciation to a disposal account.
The carrying value would therefore always be zero when an asset has been
removed. 1 mark for the correct amount.
• Depreciation charged is 0.00 because the accounting policy of the business is to
apply none in the year of disposal. 1 mark for the correct amount.
Machine AZ50 (purchased)
Capitalisation of cost for this machine
• Machine AZ50 £19000 is capital expenditure.
• The software and 2 monitors are also capital expenditure. Even the though the
monitors are below the cost of £200 each (the accounting policy for not
capitalising expenditure), machine AZ50 (in total) costs more than £200 for all
items relating to this machine ‘in aggregate’. The entire purchase cost should be
capitalised.
• Delivery and installation cost is always treated as capital expenditure if an asset
is capitalised.
• VAT should be ignored as the business will reclaim all VAT from the purchase
cost of the asset. The VAT on the transaction would be posted to a VAT control
account.
• The total cost that should be capitalised (items highlighted in bold on the invoice
above) is £21390.00. 3 marks for the correct amount. 1 mark for the picklist
‘Machine AZ50’.

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Depreciation charges for machine AZ50

• Plant and machinery is depreciated at 25% per annum on a diminishing balance
basis.
• A full year’s depreciation is applied in the year of acquisition.
• £21390 is the carrying value (the asset has just been acquired) x 25% =
£5347.50 depreciation charged. 2 marks for the correct amount.
• The carrying value at the year-end would be the original cost £21390.00 less
accumulated depreciation £5347.50 = £16042.50. 1 mark for the correct
amount.
Car EN65 RBV
• Motor vehicles are depreciated at 35% per annum on a diminishing balance
basis.
• The carrying value of the car at the beginning of the year was £4355.00 x 35%
depreciation rate = £1524.25 depreciation charges. 2 marks for the correct
amount.
• The carrying value at the beginning of the year was £4355.00 less depreciation
charged for the year £1524.25 = £2830.75 carrying value for the car at the end of
the year. 1 mark for the correct amount.

(b)(ii) Complete the following calculation (3 marks)

Calculate the gain or loss on disposal of Machine AX56 for the year ended 31 August
20X7. Show your answer rounded to TWO decimal places. Use a minus sign or
brackets to indicate a loss on disposal.
Answer -5312.50
Workings
Carrying value at the beginning of the year 7312.50
Part exchange value 2000.00
Loss on disposal -5312.50
The original cost of the old machine was £13000.00. Accumulated depreciation for the
old machine sold was £5687.50 (depreciation charges recorded in the NCA register was
£3250.00 + £2437.50). The carrying value of the old machine sold was £13000.00 -
£5687.50 = £7312.50. The part exchange value of £2,000 given was lower compared to
the carrying value of £7312.50 for the old machine. Whenever the sale proceeds (cash,
or part exchange value) are less than the carrying value, then a loss on disposal would
arise. A disposal account is provided below to help improve your understanding of the
ledger entries required.

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Disposals (Statement of profit or loss)

Amount Amount
Details Details
£ £
Old machine - at cost 13,000.00 Old machine - accumulated depreciation 5,687.50
New machine - at cost 2,000.00
Profit or loss account 5,312.50
Total 13,000.00 Total 13,000.00

(c) Drag and drop two items that are included as capital expenditure and two
items that are excluded from capital expenditure.
(2 marks)

Costs included Costs excluded

Site preparation costs VAT

Delivery cost Revenue expenditure

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(d)(i) Calculate the depreciation charge of the new machine for the year ended 31
August 20X7
(2 marks)
The straight-line method calculates a constant amount of depreciation for each year.

Straight Line Depreciation per annum = (Cost - Residual Value) / Useful Life of Asset.
Straight Line Depreciation per annum = (£18,930 - £2,000) / 5 years = £3,386 every
year.
(d)(ii) Make entries in the accounts below for:
• The acquisition of the new machine
• The depreciation charges for the new machine
(6 marks)
Machinery at cost
£ £
Balance b/d 84900 Balance c/d 103830
Bank 18930

103830 103830

Machinery accumulated depreciation

£ £
Balance c/d 52586 Balance b/d 49200
Deprciation charges 3386

52586 52586

Depreciation charges
£ £
Balance b/d 22600 Profit or loss account 25986
Machinery accumulated depreciation 3386

25986 25986

The balance b/d was already entered in the task information for all three ledger
accounts. 1 mark is given for each correct entry and correct amount entered on the
debit or credit side.

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Task 2 - Solutions (14 marks)

This task is about recording period end adjustments.

(a)(i) Complete the following statement.
(4 marks)

Prepaid expenses of £ 300 dated 31/12/X7

1 mark is given for each correct picklist and 2 marks are given for the correct amount of
£300. The amount paid of £900 for 12 months of insurance. 8 months of this payment
relates to this accounting period (1/5/X7 to 31/12/X7) and 4 months of this payment
relates to the next accounting period (1/1/X8 to 30/4/X8). 4 months insurance has been
prepaid in advance for the year ended 31 December 20X7. £900 ÷ 12 months = £75
per month x 4 months = £300 prepaid expenses. A prepaid expense is an asset
because the business has paid for expenses which have not yet been consumed.
Accruals and prepayments are period end adjustments and entries would be made in
the general ledger on the year-end date of 31 December 20X7.
The amount paid of £567 wholly relates to the accounting year ended 31 December
20X7 and no period end adjustment is required.

(a)(ii) Update the motor vehicle expenses account

(6 marks)
Motor vehicle expenses
£ £
Bank 8042 Prepaid expenses 300
Profit or loss account 7742

8042 8042

The cash book for the year shows payments for motor vehicle expenses of £8,042. The
double entry would be:
• Debit £8,042 Motor vehicle expenses (increase expenses)
• Credit £8,042 Bank (decrease asset)
Prepaid expenses is an asset in the statement of financial position. The double entry at
the year ended would be:
• Debit £300 Prepaid expenses (increase asset)
• Credit £300 Motor vehicle expenses (decrease expenses)
The balance of £7,742 at the year-end for motor vehicle expenses would be transferred
as an expense to the statement of profit or loss account.

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(b) Show the journal entries that will be required to adjust for closing inventory of
£13,422 for the year ended 31 December 20X7.
(4 marks)

Dr Cr
Account
£ £
Closing inventory (statement of financial position) 13422
Closing inventory (statement of profit or loss account) 13422

Closing inventory is a reduction in cost of sales (expenses) for the year in the statement
of profit or loss, and an asset in the statement of financial position because it is
something that the business owns. A journal entry is made to increase (debit) assets
and decrease (credit) expenses.

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Task 3 - Solutions (24 marks)

(a) Enter the figures in the table shown below to the appropriate trial balance
debit or credit columns. Do not enter zeros in unused column cells. Do NOT use
minus signs or brackets.
(2 marks)
Extract from the trial balance
Ledger
Trial balance
balance
Account £ £ DR £CR
Prepaid income (liability) 1000 1000
Drawings (see DEADCLIC) drawings a DR 8900 8900
Carriage inwards (expense) 1029 1029
Accrued income (asset) 1504 1504

(b)(i) Refer to the extract from the extended trial balance below. Calculate the
value of the adjustment required (to the nearest £).
(2 marks)

£ 82

The allowance for doubtful debts account is a contra account (credit balance) to the
receivables ledger control account (debit balance), to work out net trade receivables in
the statement of financial position. The general allowance for the year ended should be
compared to the total credit balance brought forward at the beginning of the accounting
year, and the allowance for doubtful receivables credit balance is either increased or
decreased by the adjustment required.
The general allowance for doubtful debts needs to be adjusted to 2% of outstanding
trade receivables. In the ETB the receivables ledger control account is £24,090.
£24,090 x 2% = £482 allowance for doubtful receivables for the year ended. The
current balance in the allowance for doubtful receivables account is a credit balance of
£400. The credit balance of £400 needs to be increased to a £482 credit balance, so
the double entry would be to credit £82 to increase the allowance for doubtful
receivables balance and debit the allowance for doubtful debts - adjustment (an
expense) in the profit or loss account.

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General ledger accounts are shown below to improve logic and understanding of the
double entry.
Allowance for doubtful receivables (statement of financial position)
Amount Amount
Details Details
£ £
Balance c/d 482 Balance b/d 400
Allowance for doubtful receivables adjustment 82

Total 482 Total 482

Allowance for doubtful receivables adjustment (statement of profit or loss)

Amount Amount
Details Details
£ £
Allowance for doubtful receivables 82 Profit and loss account 82

Total 82 Total 82

(b)(ii) Record the adjustment in (b)(i) and the following adjustments in the extract
from the extended trial balance below.
(8 marks)

Ledger account Ledger balances Adjustments

Dr £ Cr £ Dr £ Cr £
Bank 21932
Opening inventory 6781
Irrecoverable debts 750
Capital 24976
Office expenses 4200 90 1080
Staff wages 16339 1080
Allowance for doubtful receivables
debts 400 82
Allowance for doubtful receivables - adjustment
debts - adjustment 82
Depreciation charges 2952
Van at cost 17400
Van accumulated depreciation 6090
Purchases 45688
Payables
Purchase ledger control
control account 5999 740
Sales 79991
Receivables
Sales ledger ledger
controlcontrol
account 24090
Suspense 650 740 90

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Workings
• Office expenses of £90 have been correctly posted to the cashbook but no
corresponding debit entry was made to office expenses. This is a single sided
error where a credit to the cash book was made but no debit entry. A debit entry
is required to increase office expenses by £90 and a credit entry made to the
suspense account of £90. If only £90 was credited to the bank then a £90 debit
entry would be required in a suspense account to ensure the trial balance will
balance. The credit entry of £90 to the suspense account would help clear the
suspense account balance.
• The payables ledger control account in the general ledger has been extracted
and included in the trial balance incorrectly as £5,999. This is an extraction error.
The correct balance to be included was £6,739. The PLCA balance is £6,739 -
£5,999 = £740 understated on the credit side. An entry is required to increase
(credit) the PLCA balance by £740. A debit entry is also required to the
suspense account of £740. If only £5,999 was included as a credit balance in the
trial balance, then a £740 credit entry would be required in a suspense account
to ensure the trial balance will balance. The debit entry of £740 to the suspense
account would help clear the suspense account balance.
• Staff wages of £1,080 were posted in error to office expenses. This is an error of
commission. Decrease (credit) office expenses by £1,080 and increase (debit)
staff wages by £1,080. No imbalance between debits and credits exist with this
type of error, so no suspense account entry is required.
(c) Using the table below show THREE adjustments that should appear in the
payables ledger control account. Enter only ONE figure for each line. Do not
enter zeros in unused cells. Do NOT use minus signs or brackets. (6 marks)

Dr Cr
Account
£ £
Adjustment 1 1000
Adjustment 2 11280
Adjustment 3 240
1. The total column in the purchases daybook was undercast by £1,000. The amount
posted to the payables ledger control account was £131,673 but the correct
amount should have been £132,673. The total column of a purchase daybook
would be credited to the PLCA. Given the total was undercast (under added)
by £1,000 then we need to post another £1,000 more to the PLCA. A credit
entry is made to the PLCA of £1,000 to increase liability to suppliers.
2. Purchases returns of £5,640 have been credited to the payables ledger control
account in error. The correct entries have been made in the payables ledger
accounts for suppliers. Purchase returns should be a debit, not a credit entry
to the PLCA because credit notes for goods returned reduce the liability to
pay suppliers. We need to debit the PLCA by £5,640 to cancel the credit
error and then debit the PLCA again by £5,640 to record the correct entry (2 x
£5,640) = £11,280 debit entry is made to the PLCA.

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3. A purchase invoice of £240 from Streets Ltd was omitted from purchases daybook.
The correct entry was made in the payables ledger account of the supplier.
A purchase daybook would be used to credit the PLCA by the total for all
supplier invoices. Given £240 was omitted in the PLCA a credit entry of £240
is required to be made to the PLCA to increase liability to suppliers.
4. A set-off entry of £5,042 was omitted from the payables ledger account of M.
Smith. The correct entry was made in payables ledger control account. The PLCA
has been correctly updated, but the purchase ledger account of the supplier
needs to be reduced by £5,042.
5. Purchase returns of £120 were debited in error to the payables ledger account of
Winkle Traders Ltd instead of the payables ledger account of Traders RUS Ltd. An
entry was made to the wrong supplier account in the payables ledger but a
correct debit posting was made to the payables ledger and PLCA. Both the
PLCA and payables ledger balance would still agree.
6. A purchase invoice was sent by a supplier for £360 in error, the correct amount
should have been £3,600. The incorrect amount of £360 was posted to both the
payables ledger and payables ledger control account. This is a supplier error
and both the PLCA and payables ledger were updated by only £360. When
the correct invoice is received, both ledgers will be adjusted but currently
both balances still agree because they contain an entry for the same amount.
A payables ledger control account (PLCA) showing the error adjustments and a
reconciliation (agreement) to the total of all balances in the payables ledger accounts is
shown below to further the logic and understanding.
PLCA (Trade Payables)
£ £

Adjustment 2 11280 Balance b/d 27042

Balance c/d 17002 Adjustment 1 1000

Adjustment 3 240

28282 28282

Adjustmentsto
Adjustment tothe
purchase ledger
payables accounts
ledger accounts
£

Total balances
Total balancesfrom
in the payables
purchase ledger
ledger accounts 22044
accounts
Adjustment 4 -5042

Revised (corrected) balance from PLCA 17002

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(d) You are to compete the extended trial balance shown below. Ensure you
calculate the profit or loss and specify in the appropriate space in the first
column whether it is a profit or a loss.
(6 marks)
Extended Trial Balance

Statement of Statement of
Ledger balances Adjustments
Ledger account profit or loss financial position
Dr £ Cr £ Dr £ Cr £ Dr £ Cr £ Dr £ Cr £
Bank 18,533 800 17,733
Opening inventory 4,500 4,500
Capital 22,622 22,622
Drawings 8,000 8,000
Office expenses 4,589 4,589
Van expenses 12,320 360 12,680
Staff wages 13,239 13,239
Discounts allowed 471 471
Discounts received 579 579
Carriage outwards 540 540
Loan 20,000 20,000
Closing inventory 3,300 3,300 3,300 3,300
Advertising expenses 8,000 800 8,800
Depreciation charges 6,234 6,234
Vans at cost 27,400 27,400
Vans - accumulated depreciation 9,590 6,234 15,824
Purchases 19,680 19,680
Payables ledger control 1,009 550 459
Accrued expenses 360 360
Irrecoverable debts 240 240
Sales 68,612 68,612
Receivables ledger control 3,090 240 2,850
Loan interest paid 1,500 1,500
Suspense 550 550
Profit for the year 18 18
Total 122,412 122,412 11,484 11,484 72,491 72,491 59,283 59,283

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Task 4 - Solutions (24 marks)

This task is about producing financial statements for sole traders and partnerships.
(a)(i) Prepare a partnership appropriation account for the year ended 31 March
20X7. Use a minus sign for deductions or where there is a loss to be distributed.
You must enter zeros where appropriate in order to obtain full marks.
(10 marks)

£
Profit for appropriation 97,000
Salary - A -18,000
Salary - B -24,000
Sales commission - A -7,560
Sales commission - B -3,450

Residual profit available for distribution 43,990

Share of residual profit or loss:
Share of residual profit - A 30,793
Share of residual profit - B 13,197

Total residual profit or loss distributed 43,990

Workings
• 2 marks for the correct entry of profit for appropriation £97,000.
• 1 mark for each correct entry for sales commission.
• Salaries were paid each month: Albert £1,500 x 12 months = £18,000. Brenda
£2,000 per month x 12 months = £24,000. 1 mark for each correct entry.
• After salary and commission has been appropriated, the residual profit is
£43,990. The share agreement is Albert gets 70% and Brenda gets 30%.
£43,990 residual profit ÷ 100% x 70% = Alberts residual profit share £30,793.
£43,990 residual profit ÷ 100% x 30% = Brenda’s residual profit share £13,197.
2 marks for each correct entry.
• Drawings you never include in an appropriation account (only interest on
drawings). Drawings is money taken by each partner from the business after
profits have been appropriated and the amount is posted to the current account
of each partner.

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(a)(ii) Complete the following sentences about Brenda’s current account:

(5 marks)

Brenda’s current account will be shown in the Statement of financial position.

Brenda’s current account as at 31 March 20X7 would be a Debit balance of £19,963.

1 mark is given for selecting ‘Debit’ balance and ‘Statement of financial position’.
3 marks are given for calculating the correct balance of £19,963.

A current account for Brenda has been constructed below to help with the logic and
understanding. When the entries for the accounting year are made and the account is
totalled and balanced, the balance c/d is on the credit side. At the start of the next
accounting year the balance b/d will be on the debit side (her current account is
overdrawn and is a debit balance).
Current account (Brenda)
£ £
Balance b/d 340 Salary 24000
Drawings 60000 Sales commission 3450
Share of residual profit 13197
Balance c/d 19693
60340 60340

(b) Complete the capital account for the year ended 31 March 20X7. Show clearly
the balance carried down to the next financial year.
(6 marks)
Capital
£ £
Drawings 1300 Balance b/d 19228
Balance c/d 31156 Profit for the year 13228

32456 32456

1 mark is given for the drawings picklist and 1 mark given for the amount of £1,300
entered on the debit side. 1 mark is given for the profit for the year picklist and 1 mark
given for the amount of £13,228 entered on the credit side. 1 mark is given for the
balance b/d and balance c/d only if the correct picklist and correct amount is entered.
Assets, goods or money taken by a sole trader is a debit entry to the drawings account
of a sole trader. Drawings are posted to the capital account at the end of the
accounting year, and the entry would be Debit Capital £1,300 (decrease money owed
by the business to its owner) and Credit Drawings (to close the account). Profits for the
year are a Credit entry to capital (increase money owed by the business to its owner)
and a Debit entry to the statement of profit or loss (to close the account).

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(c) Show whether the following statements are TRUE or FALSE

(3 marks)

TRUE FALSE

The calculation of cost of sales in a statement of

profit or loss account is equal to opening inventory
plus net purchases less closing inventory.

Capital injections and profits earned during a period

are both credit entries in the capital account of a
partner.

A bank overdraft and the payables ledger control

account are presented as non-current liabilities in the
statement of financial position.

• TRUE. The calculation of cost of sales in a statement of profit or loss account is

equal to opening inventory plus net purchases less closing inventory.
• FALSE. Capital injections and profits earned during a period are both credit
entries in the capital account of a partner. Capital injections would be a credit
entry in a partners capital account but any share of profits would be a credit to
the current account (not the capital account) of a partner.
• FALSE. A bank overdraft and the payables ledger control account are presented
as non-current liabilities in the statement of financial position. Non-current
liabilities are obligations expected to be settled (paid) by the business beyond a
period of one year. A bank overdraft and a payables ledger control account are
presented as current liabilities, which are obligations expected to be settled
(paid) by the business within a period of one year or less.

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Task 5 - Solutions (18 marks)

This task is about accounting principles, qualities of useful financial information and
interpreting financial statements using profitability ratios.

(a) Reconciliation of a cash book balance to the bank statements, or a payables

ledger account balance to a supplier statement received, is more likely to support
which one of the following qualitative characteristics of useful financial
information. Choose ONE answer only.
(2 marks)
Verifiability
Timeliness
Comparability
Relevance
Verifiability gives ‘assurance for information’. Timeliness would mean to receive
information on time to make effective decisions. Comparability would mean the
information can be compared with other years or to other businesses. Relevance means
information is both material and useful for its users.
(b) Show whether the following is TRUE or FALSE.
(2 marks)

True

False

The above ratio is for sales margin (not mark-up).

(c) Which ONE of the following is NOT a likely response given to the management
accountants request.
(2 marks)

Seek guidance from your practice manager regarding the posting of this journal.

Discuss the matter with the management accountant to see if there is a valid case for posting this journal.

Post the journal without question as the management accountant is your client.

To post the journal without question would be breaching the ethical principle of
objectivity (scepticism is to question and not just accept someone else’s opinion).

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(d) Calculate the following ratios based on the information above. Answers
should be rounded to two decimal places.
(6 marks)
• ROCE (return on capital employed) = net profit for the year £8,806 / capital
employed × 100 (where capital employed = capital £19,030 + non-current
liabilities £14,000). £8,806 / £33,030 × 100 = 26.66%.
• Sales margin = gross profit £21,706 / sales revenue £53,508 × 100 = 40.57%.
• Expenses as a percentage of sales = expense £12,900 / sales revenue
£53,508 × 100 = 24.11%.

(e) Show whether the following statements are TRUE or FALSE

(3 marks)
TRUE FALSE

The return on capital employed ratio could be improved if a

business repays a 5 year bank loan.

Whether a ratio is better or worse requires a comparison to

be made with another organisation, or to a different time
period.

The sales margin ratio could be improved if a business

repays its 5 year bank loan.

• TRUE. ROCE (return on capital employed) is calculated as net profit divided by

capital employed (capital + non-current liabilities). Therefore either an increase
in net profit or a decrease in capital employed would improve the ratio. The
repayment of a long-term bank loan would reduce non-current liabilities and
therefore the amount of capital employed, the ratio is therefore likely to improve.
• TRUE. Whether a ratio is better or worse requires a comparison to be made with
a different organisation, or to a different time period or to an industry standard.
• FALSE. Sales margin is gross profit divided by sales. The repayment of a long-
term bank loan would reduce non-current liabilities, but gross profit and sales
would remain unchanged. The ratio is therefore likely to remain the same.

(f) Complete the following sentences about accounting principles.

(3 marks)
The prudence concept is an accounting rule that exercises conservatism and caution
when making judgements about accounting transactions under conditions of
uncertainty.
The going concern concept means to recognise the business can continue to operate
and remain in business for the foreseeable future.
The separate entity concept states that business transactions and the personal
transactions of its owner are different for accounting purposes.

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Task 6 - Solutions (12 marks)

This task is about preparing accounting records from incomplete information.

(a)(i) Find the total purchase returns figure including VAT by completing the
payables ledger control account for the year ended 31 August 20X8.
(5 marks)
Payables
Purchaseledger
ledgercontrol
control account
£ £
Receivables ledger control
Set off (contra) 1200 Balance b/d 29522
Bank 69627 Purchase daybook 82680
Purchase returns daybook 5703
Balance c/d 35672
112202 112202

The missing figure for purchase returns is £5,703. This is calculated by totalling and
balancing the control account, once all items including the balance b/d and balance c/d
has been entered in the control account. Exam tasks would normally provide an
autosum function for calculating the debit and credit totals (£112,202). Cash purchases
are not included in a payables ledger control.

(a)(ii) Find the missing drawings figure the owner has taken for personal use by
completing the cash account for the year ended 31 August 20X8.
(4 marks)
Cash account
£ £
Balance b/d 2300 Bank 15000
Cash sales (£32,600 plus VAT at 20%) = 39120 Drawings (missing figure) 20990
Balance c/d 5430
41420 41420

A cash account follows the same principle as the bank (an asset). You would debit
receipts (including VAT) to increase the cash balance (total cash sales) and credit
payments (including VAT) to decrease the cash balance (amounts banked, or taken as
drawings). The missing figure for drawings is £20,990. This is calculated by totalling
and balancing the cash account, once all items including the balance b/d and balance
c/d has been entered in the cash account. Exam tasks would normally provide an
autosum function for calculating the debit and credit totals (£41,420).

(b) Which of the following is most likely to be the total balance in the payables
ledger control account at the year end.
(2 marks)
£15,000

£10,000

£5,000

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The trader is allowed by its suppliers to settle its accounts 60 days after purchase, so on
average it owes 60 days of purchases. Purchases were £60,000. The balance in the
payables ledger control account on ‘average’ would be £60,000 (purchases for the year)
÷ 365 days = £164 of purchases per day x 60 days owed to suppliers = £9,863 PLCA
balance (an ‘average’). The figure closest to £10,000 would be the answer.

(c) Using the information above calculate sale income earned for the year ended.
(1 mark)

£170,000 x 30% = GP £51,000

£170,000 COS + £51,000 GP = £221,000
SALES = £221,000.

Mark-up is calculated as Gross profit / Cost of sales × 100. If mark-up is 30%, then
30% of cost of sales is gross profit (£51,000 gross profit is calculated above). If
£51,000 of gross profit is added to cost of sales (£170,000), the total amount would be
sales income earned of £221,000 for the year ended.

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