Accounts Definitions:
1) Accounting involves:
The recording of business transactions in financial terms.
Reporting and presenting financial information to the owner of the business and
other interested parties.
Advising the owner and other parties how to use the financial reports to assess the
business past performance.
To help the owner and accountant for decision making.
2) Possible users of Accounting can be:
Owner/s of business;
Prospective buyer/s;
Commercial Banks;
Tax Departments – Inland Revenue Department;
A prospective partner;
Shareholders;
Managers.
3) The most common documents used in an Accounting system are:
Invoice: When a business buys goods it receives a purchases invoices. When the
business sells goods it receives sales invoices. An invoice contains the following
information – the amount owing, when it should be paid, and details of goods sold
or services provided.
Credit Note: When the buyer (customer/debtor) returns goods to the business
(faulty/damaged). The seller (business) will prepare a credit note, which is sent to
the buyer, reducing the amount of money owed.
Debit Note: When goods are returned by the business to the supplier (creditor)
due to goods being damaged or faulty. The debit note shows that the account of
the creditor is being debited, reducing the amount owed.
Vouchers: When a petty cashier makes a payment to someone, then that person
will have to fill in a voucher showing exactly what the payment was for (petty
cash voucher).
Other documents that are used are: cheque counterfoils, paying in slips, bank
statements etc.
4. Current Accounts: this is used for regular payments. The bank will give a
chequebook to the holder of such an account. This is used to make payments to people
to whom the account holder owes money. The account holder can pay (deposit)
money into his current account. For deposits the holder is given a paying – in book.
No interest is given and money can be withdrawn without any notice.
Pg.1 A.Craus Paper 1 Matsec Notes
Deposit Accounts: A deposit with a bank which requires notice for withdrawal, and
where interest is paid.
Bank Overdrafts: When the bank gives permission to the business to withdraw more
money than the balance at bank or when we have paid more out of our account than
we have paid into it.
Bank Statement: A copy of our account as kept by the bank is known as the bank
statement. It is presented in a three column format (computerised) showing columns
for withdrawals (debit column), deposits (credit column) and Balance.
5. Bank Reconciliation Statements: Is used to reconcile (agree) the balance as
shown by the columns of the Cash Book with that shown by the bank statement.
When closing balances differ, this is due to:
• Cheques not credited: This is shown on the debit side of the cash book but not
in the bank statement. When a cheque is received by the business but it is not yet
deposited in a commercial bank.
• Unpresented Cheques: These are shown on the credit side of the cash book but
not in the bank statement. Cheques issued by the business but were not yet
presented to the bank for payment.
• Standing Order: When we instruct our bank to pay regular fixed amounts of
money at stated dates to persons or firms. This is shown only on the debit side of
the bank statement. E.g Car Insurance, Rent
• Direct Debits: When we instruct our bank to pay regular variable amounts of
money at stated dates to persons or firms. This is shown only on the debit side of
the bank statement. E.g telephone bills, light and heat, creditors etc
• Credit Transfers: These are payments made by debtors (customers) directly into
our bank account. This is shown only on the credit side of the bank statement.
• Bank Charges: These are charges for services rendered by the bank. This is
shown only on the debit side of the bank statement.
• Dishonoured Cheques: This is when the bank fails to honour the cheque due to
1) the drawer has no money in his account, 2) figures and written words do not
agree, 3) an incorrect date. This is shown only on the debit side of the bank
statement.
6. While the firm is very small, all the double entry accounts can be kept in the ledger.
As the firm grows it would be impossible just to use one book, therefore more books
are needed. These are known as Books of Original Entry, also known as Subsidiary
Books. These are:
• Cash Book: for the receipts and payments of cash and cheques.
• Sales Day Book (Sales Journal): for all the credit sales.
• Purchases Day Book (Purchases Journal): for all the credit purchases.
• Returns In Day Book (Returns In Journal) for all the returns of goods by
customers to the business
Pg.2 A.Craus Paper 1 Matsec Notes
• Returns Out Day Book ( Returns Out Journal) for all the returns of goods by the
business to suppliers.
• Journal: This book records all the transactions that are not recorded in ither books
of original entry. It is used for: the opening of a business on a double entry
system, correction of errors, buying and selling of fixed assets on credit, writing
off bad debts, transfers at year end and for other transactions.
There are three types of ledgers:
• Sales ledger: For all the personal accounts of Debtors.
• Purchases Ledger: For all the personal accounts of Creditors:
• General Ledger : For all the other accounts.
7. Trade Discount: This is allowed (given) as a reduction when goods are supplied to
other businesses when they buy in large quantities. Trade discounts are never shown
in the ledger accounts, they are simply deducted from the original amounts.
E.g. Bought goods Lm1,000 from XYZ Ltd, a 10% trade discount is being deducted.
Therefore, the trade discount is 10% x 1,000 = 100. Only the Lm900 is recorded in
the ledger accounts. The trade discount is just deducted.
8. Cash Discount: This is a discount given to encourage quick and immediate
payments. There are two types of Cash Discounts, these are discount allowed (a
discount given by the business to customers) and discount received (a discount
received by the business from suppliers). Discount allowed is an expense and discount
received is a gain.
9. Trial Balance: A Trial Balance is a list of every account opened in the ledgers,
distinguishing those accounts which have debit balances from those which have credit
balances. A Trial Balance is extracted to check the arithmetical accuracy of the
ledgers, i.e. the debit entries must be equal to the credit entries. It is also extracted
before the preparation of the Final Accounts.
10. Errors: Although the Trial Balance’s totals agree there might be errors, which do
not affect the Trial Balance totals. These are:
A. Error of Omission – When a transaction is completely left out. E.g Bought goods
on credit from A.Muscat Lm200 was left out.
B. Error of Commission – When the correct amount is entered in the wrong
personal account. E.g. Paid D.Camilleri Lm200 in cash entered in D.Callus.
C. Error of Principle – When the correct amount is entered in the wrong type of
account. Bought machinery Lm1,000 entered in the purchases account.
D. Error of Original Entry – When the Incorrect amounts (numbers) is entered in
the accounts. Paid Rent Lm29 by cheque entered as Lm92.
E. Compensation Errors - Two Errors cancel out each other. E.g. Sales and wages
both undercasted by Lm25.
F. Complete Reversal of Entries – When the correct amount is entered in the
correct accounts but on the wrong sides.
E.g. Received a cheque Lm200 from A.Bartolo entered on the cr side of the Bank
account and debit side of A. Bartolo Account.
Suspense Account: This account is used to eliminate the difference in the trial
balance. All errors that affect the trial balance are included in such account.
Pg.3 A.Craus Paper 1 Matsec Notes
11. Contra Entries are transactions that affect the debit side and credit side of the
cashbook. Example: Withdrew Lm110 cash from the bank for business use (Bank -;
Cash +) ; Took Lm230 from the cash and paid it into the bank (cash - ; bank +)
12. The Petty Cash Book is a book used to record all the small cash payments for
expenses such as cleaning, stationery, postage, bus fares etc. The Imprest System is
used in such book. This states that: A sum of money is fixed as a petty cash float and
at the end of the month the total amount of expenses paid is reimbursed i.e. refunded.
All expenses in the petty cashbook are transferred to the General ledger.
13. VAT i.e. Value added Tax is an expenditure tax. It is charged when ever goods
are sold/bought.
Exempted Firms and Zero Rated Firms are those which do not have to add VAT on
their prices.
If you want to find the amount paid as VAT you should use the following formula:
% rate of VAT x Gross Amount
100 + % rate of VAT
Example you paid Lm150 for product Z. The VAT rate is 15%. ∴
15 x 150 = Lm19.56
100 + 15
The Lm19.56 is the amount of VAT paid.
When a VAT account is opened, if it has a debit balance it means that the amount
shown is to be refunded (paid) to the business and this must be listed as a current
asset. If it is a credit balance it means that the business owes the VAT department, it
will be listed as a Current Liability.
14. Capital Expenditure is made when a firm spends money either to buy fixed
assets or add to the value of an existing one.
Revenue Expenditure is made when expenses are paid to run the business on a day –
to day basis.
Capital Expenses are related to the Balance Sheet (Bought Premises) while the
Revenue are related to the Profit and Loss (Paid Rent).
If by mistake a capital expenditure is treated as revenue or vice versa the Gross Profit,
Net Profit and Fixed Assets figures will be incorrectly calculated.
If for example car maintenance were treated as new vehicle the Net Profit and Motor
Vehicles in the Final Account would be incorrect.
Capital Expenditure = Bought motor van, premises extension, installation of new
computers, new computers.
Revenue Expenditue = Fuel, Rent and rates, light and heat, floppy discs.
15. Depreciation is the decrease in the value of fixed assets over a period of time.
Factors, which cause fixed assets to depreciate, are:
A. Wear and tear through use;
B. Obsolete – out dated;
C. Inadequacy – no longer used.
There are two main methods used in the calculation of depreciation:
Pg.4 A.Craus Paper 1 Matsec Notes
Straight Line Method : Percentage on Cost.
Reducing Balance Method: Percentage on the Net Value (Cost – Depreciation
Provision).
Depreciation Provision: this is the total depreciation accumulated throughout the
years.
Depreciation: is the depreciation of one particular year.
16. A disposal account is opened to find the profit or loss from the sale of fixed
assets.
The amount received for
the asset sold
Dr Disposal Account Cr
Cost of Fixed Asset xxxx Depreciation Provision xxxx
Bank xxxx
Loss on sale of fixed asset xxxx
xxxx xxxx
If the cost of the fixed asset is less than the depreciation provision and the bank, a
profit on the sale of the fixed asset will be registered and it will be debited.
17. Accrued, Owing, In arrears, Outstanding and Due. If it is an expense due it
means not yet paid (Current Liability), if it is gain due it means not yet received
(Current Asset). EXPENSES AND GAINS DUE ARE ALWAYS ADDED IN
THE PROFIT AND LOSS ACCOUNT.
18. Expenses Prepaid or paid in advance is when something is paid for the next
year. It is a Current Asset. Gains received in advance is when something is
received for the next year, it is treated as a Current Liability. EXPENSES AND
GAINS PAID or RECEIVED IN ADVANCE ARE ALWAYS DEDUCTED IN
THE PROFIT AND LOSS ACCOUNT.
19. Bad Debts are debtors who are bankrupt and so they are written off because they
are unable to pay us 9the business). Actual loss on debtors.
Bad Debts Provision: This is a percentage on debtors who might become
bankrupt in the future.
Bad debts Recovered: These are debts written off in the previous years being
recovered (received) in this financial year.
In the Profit and Loss Account In the Balance Sheet
a) Expense : Bad Debts Not Included
b) Expense:
Creation of Bad Debts Provision Deducted from debtors
Increase of Bad debts Provision Deducted from debtors
C) Gains:
Decrease in Bad Debts Provision Deducted from debtors
Note that when we have an increase or decrease in BDP always take the difference in
the Profit and loss Account. In the Balance Sheet take the new adjusted amount.
Pg.5 A.Craus Paper 1 Matsec Notes
20. Assets (Possessions): Items owned by the business. Fixed Assets are assets that
provide service to the business. They are listed in increasing order of liquidity i.e.
the most permanent assets are listed first. Premises being the first, vehicles the
last. These are also known as tangible fixed assets (having material substance).
Intangible fixed assets those which do not have material substance, but belong to
the business and have money value, such as Goodwill (reputation, good location,
experience), Patents and Trademarks.
Current Assets: Items owned by the business that can be converted into money.
They are listed in order of liquidity i.e. Stock of goods, the most difficult to turn it
into money, is listed first.
21. Liabilities are debts and loans owed by the business. Current Liabilities are
amounts owing and are due for repayment within 12 months or less. E.g. are
Creditors, bank overdrafts, Expenses due and Gains Prepaid. Long Term Liabilities
are borrowings/loans where repayment is due in more than 12 months.
21. Capital is what the owner invests in the business. The obligation of the business
to the owner.
22. Working Capital / Net Current Assets: This is the excess of Current Assets
over Current Liabilities. Without it a business cannot continue to operate. It is
found by: Current Assets minus Current Liabilities.
23. Net assets or Capital Employed = Fixed assets + Working Capital (Net Current
Assets). This shows the business worth.
24. Drawings are the amount of cash or goods taken by the owner for his own
personal use. Drawings are deducted from the amount of Capital in the Financed
By section in the Balance Sheet.
25. Concepts are rules, which the accountant has to follow when preparing final
accounts.
(a) Business Entity: Only transactions concerning the business are recorded in the
business accounts.
(b) Cost Concept: That assets and Liabilities are recorded at Cost Price i.e. the actual
amount of the transaction.
(c) Accruals Concept: This means that expenses and gains/revenues in the Profit and
Loss Account should always show the amount should have been incurred (paid).
That is the expenditure for the year whether or not it has been paid. In fact
expenses and gains due are added in the profit and loss account.
(d) Prudence Concept: Provide for losses as soon as they are anticipated. This is
why bad debts provision is included in the profit and loss account because it is an
anticipated (estimated) loss.
(e) Consistency Concept: When adopting a particular accounting method, one
should continue to use such method. This refers to depreciation. If an accountant
chooses the straight-line method he must continue to use that method and not
change to the reducing balance.
Pg.6 A.Craus Paper 1 Matsec Notes
(f) Materiality Concept: Some items in accounts have such a low value. It is not
worth it to open a separate account for them. They are grouped under the title of
Sundry expenses. E.g. window cleaning, pencils, donation to charity etc.
(g) Going Concern Concept: Business will be operating for a long time. Final
Accounts are prepared on the basis that there is no intention to reduce the size of
the business or liquidate it.
26. Control Accounts are those which control a number of accounts in the Sales and
Purchases Ledger. There are two control accounts, The Purchases Ledger Control
Account and The Sales Ledger Control account. These are an aid to management:
(a) in giving information on debtors and creditors; (b) by making fraud more difficult;
(b) in helping to locate errors.
27. Set Off occurs when one person has an account in both the sales and purchases
ledger (he is both a debtor and a creditor). It is agreed to set-off on balance
against the other to leave a net balance. That is if J.Agius owes the business
Lm100 (he is a debtor) and at the same time we owe him Lm150 (he is a
creditor), the balance in his account would be Lm50 on the credit side in the
Purchases Ledger. In other words we still owe him Lm50.
28. Incomplete Records is the term used where the bookkeeping system does not
use double-entry principles and no trial balance is available. Another term used is
Single Entry.
29. The differences between businesses and non-profit making organisations, such as
clubs and societies.
Business Non Profit Making
Organisations
Objective : To make a profit To provide facilities and services to members
Main Accounting Trading and Profit Bar Trading and Income
Statements : Loss account and Expenditure Account
Balance Sheet Balance Sheet
Financial Gross and Net Profit Bar Profit and Surplus of Income over Expenditure
Performance : or Net Loss or Deficit
Funding: Capital Accumulated Fund
30. Partners means two to twenty persons carrying on a business in common with a
view of profit. Deed of Partnership: This is an agreement which states: (a) How
profits and losses are to be shared; (b) whether any partner is entitled to extra salaries
and/or commissions; (c) whether interest is to be allowed on capital, and at what rate;
(4) whether interest is to be charged on partners’ drawings, and at what rate.
Pg.7 A.Craus Paper 1 Matsec Notes
If the partners do no have an agreement the Partnership Act of 1890 is applied and
this states that: (a) no partner is given a salary, (b) no interest on capital, (c) no
(c) interest on drawings partners is charged; (d) and that profits are shared equally.
The profit and Loss Appropriation Account is prepared after the Profit and Loss
Account. This shows how net profit is to be divided amongst the partners according
the partnership agreement. The main aim is to calculate the share of profits or losses.
The Partners’ Current Account shows profits not taken by the partner (credit
balance) or excessive profits taken by the partner (debit balance). If it is a credit
balance the partners’ investments in the business increases and if it is a debit balance
the partners’ investments in the business decreases.
Partners Capital Account is normally fixed and only alters if there is an increase or
decrease in capital contributed by the partner. If in the current account the partners’
have a credit balance it increases capital and if it is a debit balance, decreases capital.
31. A limited Company is a business owned by shareholders. Shareholders are
people who buy shares in a company. The liability of shareholders is limited to the
amount of shares they own, no personal possessions are at risk. A Company may
become a Public Limited Company if it has: a) Issued Share Capital of over
Lm50,000 b) at least two shareholders and two directors c) The company may raise
capital by issuing shares to the general public, d) Public limited companies are quoted
at the stock exchange if they conform with all the rules and regulations of the
department of trade and the stock exchange. (e) their accounts must be made public
and published in news papers.
On must also say that there are the Private Limited companies and these are family
concern companies. The share are not traded publicly, but are transferred between
individuals.
The Authorised Share Capital is the maximum share capital that the company is
allowed to issue. Also known as the ‘Registered Capital’ or ‘Nominal Capital’.
The Issued Share Capital is the total of the share capital actually issued to
shareholders.
Dividends (imghaxx) are amounts given to shareholders as their share of the profits of
the company.
Preference Shares are those which usually carry a fixed percentage rate of dividend.
Their dividends are paid before to those given to ordinary shareholders. Dividends are
only given when profits are registered. In the event the company ceases to trade, the
preference shareholders are given the money back before the ordinary shareholders,
but after debenture holders.
Participating Preference Shares are shares that carry a fixed dividend but are entitled
to extra dividends when the company registers high profits.
Cumulative Preference Shares are shares that carry a fixed dividend but do not loose
that dividend not given in a particular year.
Ordinary Shares are the most commonly issued class of shares. They carry the main
risk and rewards of the business. The riskiest type of share because there is the risk of
loosing part or all of the value of the shares if the business loses money or becomes
insolvent (ifalli) and that no dividend is paid when low profits are registered. The
rewards are that when the company registers large profits, large dividends are
Pg.8 A.Craus Paper 1 Matsec Notes
received. They have the voting right in the Annual General Meeting, so they are
considered as very influential in the board of directors’ elections and when important
decisions have to be taken. Note that these are the last to be paid after the loan.
interest, taxation, debenture interest and preference shareholders’ dividend have all
been paid.
Debentures are loans received by the company from the general public. They are
issued the same way as shares. Debenture holders are given a debenture interest. They
are paid before shareholders, even if the company registers low or no profits.
Directors’ Remuneration is salaries given to the directors. They are listed in the Profit
and Loss Account as an expense.
Nominal Value or Face value of shares is the value of the share when it was first
issued. Market Value of the share is the value of the share that is being traded at the
stock exchange.
Share Premium. When a company issues shares to the public at a higher price than the
nominal value. Ex Share with nominal value of Lm1 are issued at Lm1.50. The extra
50c is the share premium.
Reserves. A Company rarely distributes all its profits to its shareholders. Instead, it
will often keep part of the profits earned each year in the form of reserves. There are
two types:
1) Capital Reserves: which are created as a result of non-trading profits. Ex
Revaluation reserve and Share Premium.
2) Revenue Reserves which are retained (undistributed) profits from the Profit and
Loss Appropriation Account
The Profit and Loss Appropriation Account of companies shows how the net profit is
to be distributed and used.
Shareholders Funds represent the amount of Issued Share Capital (Ordinary and
Preference) plus Reserves (Capital plus Revenue).
32. A Manufacturing Account includes all the Costs involved in the production of a
product.
The Prime Costs: These are all the direct costs that vary directly with output. These
are Direct Material, Direct Labour and Direct Expenses (Royalties).
Direct Material = Opening Stock of Raw Material + Net Purchases of Raw Material +
Carriage In – Closing Stock of Raw Material.
The Factory Overheads All the other indirect costs incurred in the production process.
These are known as Fixed Costs because they do not vary with output. Examples are
factory cleaners, depreciation and maintenance of machinery, factory power etc.
Production Cost is the Total Cost of Production, which is equal to Prime Cost
(variable costs) plus Factory Overheads (fixed costs).
Pg.9 A.Craus Paper 1 Matsec Notes
There are three types of stocks. These are:
Stocks of Raw Material, Stocks of Finished Goods and Stocks of Work In Progress
(Semi Finished Products).
33. Accounting Ratios are useful ratios and percentages to assess the strengths and
weaknesses of a business in terms of Liquidity and Profitability. Interpretation of
accounts is important for the following people: general managers, bank managers,
creditors, shareholders, prospective buyers, Inland Revenue department.
One of the objectives of a business is to make a profit. Profitability Ratios examine
the relationship between profit and sales, assets and capital employed. These are:
(1) Margin = Gross Profit ÷Sales; (2) Mark-Up = Gross Profit ÷ Cost of Sales; (3) Net
Profit ÷ Sales; (3) Net Profit ÷Capital Employed (Return On Capital Employed);
Capital Employed (Net Assets) = Fixed Assets + Working Capital (Current Assets –
Current Liabilities).
Liquidity Ratios measure the financial stability of the business i.e. the ability of the
business to pay short term debts (current liabilities). These are:
Working Capital Ratio / Current Ratio = Current Assets ÷ Current Liabilities.
Acid Test ratio/ Liquid Ratio = Current Assets – Closing Stock
Current Liabilities
Rate of Turnover of Stock = Cost of Sales
Average Stock
Average Stock = (Opening Stock + Closing Stock) ÷ 2
Debtors’ Collection Period = Debtors x 365 days
Credit Sales
Creditors’ Collection Period = Creditors x 365 days
Credit Purchases
Pg.10 A.Craus Paper 1 Matsec Notes
