Account

Accounting Topical Revision Notes
For Cambridge iGCSE and O Level (7707)
Preface
This revision book is written according to the latest Accounting syllabus for the
Cambridge iGCSE and O Level (7707) examinations from Year 2020 to 2022.
This electronic book is created to complement students' study needs for quick reference
during their course of study and revision. Students are able to obtain the required
information whenever and wherever needed. This minimise hindrance to their revision
progress and schedule.
Author's years of experience coaching students through the Cambridge GCE O Level
(Singapore) examinations allows her to understand the stumbling blocks that students
face while studying the Accounting subject. This is manifested in this book where:
knotty concepts that students struggles with are simplified
related topics are logically grouped to enhance understanding
illustrative examples are provided to refresh memories
ISBN: 978-981-14-2372-7
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All rights reserved. Art Of Maths LLP, 2019
About Author
The eBook is written by Adelina Loo, owner cum tutor at Art of Maths LLP which
specialises in secondary school mathematics and accounting. Adelina coaches secondary
school students in Singapore in the Principles of Accounts subject.
Adelina majored in Accounting and was a Chartered Accountant with the Institute of
Singapore Chartered Accountants (ISCA). Prior to becoming a private tutor, she worked
as an accountant in corporations of various industries. Her last appointment was as
Head of Accounts department of a US MNC. She has also provided consulting services to
Singapore's small-medium enterprises (SMEs) on accounting matters including the
computerisation of their accounting processes.
Full profile of author can be found at www.artofpoa.com.
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Table of Contents
Chapter 1. Accounting Principles and Policies ....................................................... 1

1.1 Accounting Principles ........................................................................................................................... 1
1.2 Accounting Policies ................................................................................................................................ 6
Chapter 2. Business Documents and Books of Prime Entry ............................. 7

2.1 Business Documents .............................................................................................................................. 7
2.2 Books of Prime Entry ............................................................................................................................ 8
2.2.1 Trade discounts and Cash discounts ................................................................... 9
2.2.2 General Journal ........................................................................................................... 10
2.2.3 Special Journals........................................................................................................... 10
2.2.4 Cash book ....................................................................................................................... 11
2.2.5 Petty Cash Book .......................................................................................................... 12
Chapter 3. Trial Balance ................................................................................................. 14

3.1 List of Errors Not Affecting Trial Balance................................................................................ 15
Chapter 4. Correction of Errors .................................................................................. 16

4.1 Suspense Account ................................................................................................................................ 16
4.2 Correcting Profit for the year ........................................................................................................ 17
Chapter 5. Bank Reconciliation ................................................................................... 18
Chapter 6. Trade receivables and Trade payables ............................................. 21

6.1 Control Accounts .................................................................................................................................. 21
6.2 Trade receivables and Sales Ledger Control Account......................................................... 22
6.3 Trade payables and Purchases Ledger Control Account ................................................... 24
Chapter 7. Capital and Revenue Expenditure and Receipts .......................... 26

7.1 Capital expenditure ............................................................................................................................ 26
7.2 Revenue expenditure.......................................................................................................................... 27
7.2.1 Exception to capital expenditure rule .............................................................. 27
7.3 Capital receipts ..................................................................................................................................... 28
7.4 Revenue receipts .................................................................................................................................. 28
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Chapter 8. Accounting for Depreciation ................................................................. 29

8.1 Depreciation .......................................................................................................................................... 29
8.1.1 Depreciation policy ................................................................................................... 30
8.1.2 Straight-line method of depreciation ............................................................... 31
8.1.3 Reducing-balance method of depreciation .................................................... 33
8.1.4 Revaluation method of depreciation................................................................. 35
8.2 Sales of non-current assets.............................................................................................................. 36
Chapter 9. Other Payables and Other Receivables ............................................. 38

9.1 Recording Accrued and Prepaid Expenses ............................................................................... 38
9.2 Recording Accrued and Prepaid Income .................................................................................. 39
Chapter 10. Irrecoverable Debts and Provision for doubtful debts .......... 40
10.1 Irrecoverable debts ............................................................................................................................. 40
10.2 Recovery of irrecoverable debts.................................................................................................... 41
10.3 Provision for doubtful debts ........................................................................................................... 42
Chapter 11. Valuation of Inventory .......................................................................... 45
Chapter 12. Sole Traders............................................................................................... 46

12.1 Advantages and Disadvantages of Sole Traders ................................................................... 46
12.2 Difference between Trading Business and Service Business............................................ 46
12.3 Income Statement ............................................................................................................................... 47
12.3.1 Trading business......................................................................................................... 47
12.3.2 Service business........................................................................................................... 48
12.4 Statement of Financial Position.................................................................................................... 49
12.5 Equity Accounts .................................................................................................................................... 50
12.5.1 Drawings accounts .................................................................................................... 50
12.5.2 Capital accounts ......................................................................................................... 50
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Chapter 13. Partnerships .............................................................................................. 52

13.1 Advantages and Disadvantages of Partnership .................................................................... 52
13.2 Partnership Agreement .................................................................................................................... 52
13.3 Accounting for Partners' Transactions ..................................................................................... 53
13.3.1 Interest on Capital ..................................................................................................... 53
13.3.2 Interest on Drawings ................................................................................................ 53
13.3.3 Partners' Salary / Bonuses / Commissions .................................................... 54
13.3.4 Loan from Partners ................................................................................................... 54
13.3.5 Interest on Loan from Partners ........................................................................... 55
13.4 Appropriation account...................................................................................................................... 56
13.5 Capital account..................................................................................................................................... 58
13.6 Current account ................................................................................................................................... 59
13.7 Presentation of Partners' Equity in Statement of Financial Position .......................... 60
Chapter 14. Limited Company .................................................................................... 61

14.1 Advantages and Disadvantages .................................................................................................... 61
14.2 Types of Capital .................................................................................................................................... 61
14.2.1 Issued, Called-up, Paid-up Share Capital......................................................... 61
14.2.2 Preference Shares Capital ...................................................................................... 62
14.2.3 Ordinary Shares Capital.......................................................................................... 63
14.2.4 General Reserves......................................................................................................... 63
14.2.5 Retained Earnings ..................................................................................................... 64
14.2.6 Debentures (Loan Capital) .................................................................................... 64
14.3 Income Statement of Limited Company .................................................................................... 65
14.4 Statement of Changes in Equity .................................................................................................... 65
14.5 Statement of Financial Position.................................................................................................... 65
Chapter 15. Clubs and Societies ................................................................................. 66

15.1 Receipts and Payments Accounts ................................................................................................. 66
15.2 Income and Expenditure Accounts .............................................................................................. 67
15.3 Statements of Financial Position .................................................................................................. 68
15.3.1 Accumulated Fund ..................................................................................................... 68
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Chapter 16. Manufacturing Accounts ...................................................................... 69

16.1 Direct And Indirect Costs ................................................................................................................. 69
16.2 Manufacturing Account .................................................................................................................... 70
16.3 Income statement ................................................................................................................................ 72
16.4 Statements of financial position ................................................................................................... 72
Chapter 17. Incomplete Records ............................................................................... 73

17.1 Changes in Capital Method ............................................................................................................. 73
17.2 Statement of Affairs............................................................................................................................ 75
17.3 Account Analysis Method ................................................................................................................. 77
17.3.1 Determining Sales ...................................................................................................... 77
17.3.2 Determining Total Purchases ............................................................................... 77
17.3.3 Determining Cost of Sales....................................................................................... 77
17.3.4 Determining Depreciation ..................................................................................... 78
17.3.5 Determining Operating Expenses ....................................................................... 78
17.3.6 Determining Other Income .................................................................................... 78
17.4 Ratio Analysis Method ....................................................................................................................... 81
Chapter 18. Analysis and Interpretation ............................................................... 82

18.1 Liquidity Analysis ................................................................................................................................ 82
18.2 Profitability Analysis.......................................................................................................................... 86
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Chapter 1. Accounting Principles and Policies

1.1 Accounting Principles
1. Duality principle states that all aspects of an accounting transaction are recognised. It
is the fundamental of accounting and underlying basis for double entry
accounting system.
2. Money Measurement principle states that only transactions measured in monetary

terms are recorded.
Good business
relationship with
Good business
customer and
location
supplier
Hardworking staffs
Unable to measure in dollar ($) value

Therefore, cannot be recorded in business books
3. Business Entity principles states that owner and business are separate entities.
Therefore,
Business transactions are recorded in business books
Transactions between business and owner are recorded in Equity accounts:
Capital account: Owner contributes assets Business
Drawings account: Owner withdraws assets Business
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4. Consistency principle states that a business is to use the same accounting methods
and procedures from period to period to enable meaningful comparison
over time.
Example where concept is applied:

Depreciation of non-current assets. Assuming a business decides to adopt
reducing-balance method for depreciating Motor Vehicles.
Year 1 Year 2 Year 3 Year ∞
Depreciation Reducing- Reducing- Reducing- Reducing-

method balance balance balance balance
5. Prudence principle states that a business must not overstate its profits / assets and
understate its losses / liabilities when choosing alternatives accounting
treatments.
Topic Application
Depreciation of Non-current assets are reported at net book value in the

Non-current assets Statement of Financial Position.
.... must not overstate its non-current asset and understate

its depreciation expenses .....
Provision for Trade receivables are reported at net trade receivables in

Doubtful Debts the Statement of Financial Position.
.... must not overstate its trade receivables and understate

its debts that are deemed uncollectible.....
Inventory Inventory are valued at lower of cost and net realisable

value.

6. Matching principle states that expenses incurred must be matched against income
earned within the same period to determine the profit or loss for that
period.
Topic Application
Depreciation of Depreciation is recorded as an expense in Income

Non-current assets Statement.
.... depreciation expense must be matched against income

that non-current assets helped to generate .....
Provision for Doubtful debts are recorded as an expense in Income

Doubtful Debts Statement.
.... loss from debts estimated to be uncollectible must be

matched against sales earned from trade receivables .....
Other payables & All income and expenses are adjusted for any prepayment
Other receivables or accrual.
.... all business expenses must be matched against all

income generated by the business .....
7. Historic Cost principle states that transactions are to be recorded at the original
purchase price based on source documents.
NOW 5 YEARS LATER

Purchase car at $80,000 Car is worth $40,000
Statement of financial position Statement of financial position

Non-current asset Cost Non-current asset Cost
Motor vehicles $80,000 Motor vehicles $80,000

8. Materiality principle states that a transaction or an item is considered material if it

makes a difference to decision-making.
The value of a transaction or an item is compared to the size and nature of the
business to determine if it is material.
Value of business
$1,000,000
Cost of basket
$10 Cost of basket is
Revenue
not material to
expenditure
decision-making
This concept is asked in conjunction with questions on Capital and Revenue

Expenditure.
Example:
Transaction Type of expenditure
Purchase motor vehicle Capital
Pay for road tax Revenue
9. Going Concern principle states that a business is assumed to operate indefinitely.
Examples where concept is applied:

Credit transactions:
Suppliers are confident that the business will continue to exist after goods
are delivered though money has yet to be received.
Long-term borrowings:
Bank is confident that the business continues to exist in the future to repay
the loan.
10. Realisation principle states that business incomes should be regarded as earned
when the legal title to goods or services are passed from the seller to the
buyer.

11. Accounting Period principle states that the life of a business is divided into equal
time periods known as financial period or accounting period.
This explains the need to prepare Income Statement and Statement of financial
position at the end of every accounting period.
12 months 12 months 12 months 12 months 12 months
Prepare Prepare Prepare

final final final The cycle continues.....
statements statements statements

1.2 Accounting Policies

1. Comparability
financial information is comparable with similar information with same business
or another accounting period
2. Relevance
Financial information
must be provided in time for financial decisions to be made
can be used to confirm or correct prior expectations about past events
is able to help form, revise or confirm expectations about the future
3. Reliability
Financial statements are
depended upon by users as being a true representation of the underlying
transactions and events
independently verifiable
free from bias
free from significant errors
prepared with suitable caution on judgements and estimates
4. Understandability
financial statements provides clear information that can be understood by the
users

Chapter 2. Business Documents and Books of Prime Entry

2.1 Business Documents
Business documents are sources of information which proofs that a transaction
occurred.
Transactions Business documents
Business documents Transactions / Uses
1. Invoices Credit purchases and sales
2. Credit note Returning of goods by credit customers or to credit supplier
3. Debit note When an original invoice to a credit customer or from a credit

supplier is undercharged
4. Receipt Cash purchases and sales; acknowledgement of payment
5. Payment voucher Record payment to creditors
6. Petty cash voucher Record payment through petty cash
7. Cheque counterfoil Portion of cheques that are kept by the payers
8. Bank statement Deposits or payments through the business bank account
9. Paying-in slip Deposit slip for depositing cheques or cash into the bank

2.2 Books of Prime Entry

Also known as Day Books / Books of Original Entry / Journals
The first books of entry where a business records its transactions
Transactions Business documents Journals
Types of Books of Prime Entry:
Books of prime entry Transactions recorded
1. Sales Journal Credit sales of goods
2. Sales Return Journal Returning of goods by credit customers
3. Purchase Journal Credit purchase of goods
4. Purchase Return Journal Returning of goods to credit suppliers
5. Cash Book Cash and Bank transactions
6. Petty Cash Book Petty cash transactions
7. General Journal All transactions not recorded in the above journals

2.2.1 Trade discounts and Cash discounts

Trade discounts
Discounts given to encourage customers to buy in bulk
No double-entry for trade discounts
Example:
Company Y sold goods on credit to customer Z at a list price of $500 less 10% trade
discounts.
*Common error
Debit trade receivables $450
Answer:
Debit discount $50
Net price of goods sold = 500 x 90% = $450 Credit sales $500
Debit Trade receivables - customer Z $450
Credit Sales $450
Cash discounts
Discounts given to encourage customers to pay promptly
Cash discounts are recorded as follows:
Discount given to trade receivables:
Debit Discount allowed
Credit Trade receivables
Example:
Trade receivables X paid $500 owing by cheque after deducting 5% cash
discount.
Answer:
Debit Discount allowed (500 x 5%) $25
Debit Bank (500 - 25) $475
Credit Trade receivables X $500
Discount received from trade payables:

Debit Trade payables
Credit Discount received
Example:
Paid $800 owed to trade payables Y by cheque after 10% cash discount.
Answer:
Debit Trade payables Y $800
Credit Discount received (800 x 10%) $80
Credit Bank (800 - 80) $720

2.2.2 General Journal

Format:
General Journal
Date Particulars Debit Credit
Transaction Account to debit Amount

Date Account to credit Amount
[ Narration ]
Notes:
A transaction can have more than one debit account or credit account
Total amount debited must be equal to total amount credited
Narration is a short description of the transaction
2.2.3 Special Journals

Features:
Transactions of similar nature are recorded together
Only total amount in a special journal is posted to the General Ledger
Advantages / Purposes:
Enable easy retrieval of information
Avoids overcrowding in the General Ledger
Increase efficiency and productivity
Types Double-entry
1. Sales Journal Debit Sales ledger control

Credit Sales
2. Sales Return Journal Debit Sales Return

Credit Sales ledger control
3. Purchase Journal Debit Purchases

Credit Purchase ledger control
4. Purchase Return Journal Debit Purchase ledger control

Credit Purchase Return

2.2.4 Cash book

Interpreting 3-column Cash Book
Debit Cash Book Credit
Discount Discount
Date Particulars Cash Bank Date Particulars Cash Bank
Allowed Received
20X1 $ $ $ 20X1 $ $ $
Jan 1 Bal b/d 100 500 Jan 8 Ace Ltd 20 260
6 Sales 50 15 Drawing 80
20 Mac Ltd 15 60 20 Purchases 130
28 Bank 200 28 Cash 200
31 Bal c/d 30 31 Bal c/d 270

15 350 590 20 350 590
Feb 1 Bal b/d 270 Feb 1 Bal b/d 30
Cash discount given Cash discount received from

to trade receivable trade payables
Debit Discount allowed Debit Trade payable
Credit Trade receivable Credit Discount received
To calculate cash discount in percentage,

15
Mac Ltd: × 100 =20%
(15 + 60 )
On Jan 28, $200 was debited to Cash account and credited from Bank account. This
represent withdrawal of funds from bank account for office use.
Balance b/d on Feb 1,
Cash account $270 Dr [ Current asset ]
Bank account $30 Cr [ Current liability - Bank overdraft ]
Only Bank account can have a credit balance.

2.2.5 Petty Cash Book

Petty cash are small amount of cash kept in the office to pay for minor recurring
expenditures.
Petty Cash Book is used to record transactions involving petty cash funds.
Imprest System is a system for maintaining the petty cash fund.

Key features:
a fixed sum called imprest amount or float is maintained
petty cash fund is reimbursed after making approved payments
Advantages
provides internal control
avoid overcrowding of the Cash Book
Double- entry:
Set up petty cash fund: Debit Petty cash
Credit Bank or Cash
Reimburse petty cash funds: Debit Expenses

Credit Bank or Cash

Interpreting Petty Cash Book:

Petty Cash Book
Analysis of payments
Total Total
Receipts Date Particulars Payments Stationery Travel Postage Sundry
$ 20X1 $ $ $ $ $
100 Jan 1 Cash
5 Newspaper 10 10
15 Pens 15 15
18 Eraser 2 2
20 Stamps 3 3
25 Cab fare 16 16
28 Drinks 25 25
71 17 16 3 35
31 Balance c/d 29
100 100
29 Feb 1 Balance b/d
71 Bank
Amount paid = $(17 + 16 + 3 + 35) = $71
Bal b/d + Amount reimbursed Amount paid = Amount Reimbursed

= Imprest amount
Double-entry for reimbursement of petty cash fund on 1 February 20X1:

Debit Stationery expenses $17
Travel expenses $16
Postage expenses $3
Sundry expenses $35
Credit Bank $71

Chapter 3. Trial Balance
Business Trial
Transactions Journals Ledger
documents Balance
Definition:
Trial Balance is a list of the ending balances of all accounts at a given date.
Purpose:
Check arithmetic accuracy of the accounts
Aid in preparation of the financial statements, namely Income Statement and
Statement of Financial Position
Limitation:
A balanced trial balance does not mean that the entries in the accounts contains no
errors. There are errors that are not revealed by a trial balance.
Format:
Trial Balance as at "state the date here"
Particulars Debit Credit
$ $
Asset accounts X
Liabilities accounts X
Expenses accounts X
Income accounts X
Drawings X
Capital X
Purchases X
Purchases Returns X
Sales X
Sales Returns X
Provision for depreciation X
Provision for doubtful debts X
Irrecoverable debts X
Irrecoverable debts recovered X
XXX XXX

3.1 List of Errors Not Affecting Trial Balance
Type of Errors Interpretation Example
Error of Omission Transaction not recorded Paid rent $500 by cheque.

This was not recorded in the
books.
Error of Original Entry Wrong amount was recorded Payment of rent $500 by
cheque was recorded in the
books as $50.
Error of Commission Recorded in wrong accounts Payment of rent $500 was

within the same account type recorded to the wages
account.
Error of Principle Recorded in wrong accounts Purchase of stationery $300

under different account type was recorded to the fixtures
account.
Compensating error An error on the debit side of Both sales and discount
an account is offset by an allowed accounts are overcast
error of the same amount on by $150.
the credit side of another
account
Error of Recorded on the wrong side Payment of rent $500 by

Complete Reversal of both accounts cheque was wrongly credited
(Amount must multiply by 2) to the rent account and
debited to the bank account.

Chapter 4. Correction of Errors

4.1 Suspense Account
Purpose:
To temporarily balance a trial balance until the errors are discovered and corrected.
To facilitate the preparation of draft financial statements
Recording in Suspense Account

Only errors affecting the balancing of the trial balance are corrected in the
Suspense account
Balances in Suspense account:
Debit balance: Asset
Credit balance: Liability
Example:
The totals of Company K's trial balance on 30 June 20X2 did not agree. There was a
shortage of $500 on the credit side. This was entered in a suspense account.
The following errors were later discovered.
(a) Goods of $250 returned by customer was omitted from the sales return account.
(b) Payment of $1,000 for wages was erroneously recorded to the stationery account.
(c) Interest of $120 received from the bank was debited to the interest account.
(d) Purchase of a printer for $500 was debited to the general expense account.
(e) A sales of $690 was recorded in the sales account as $960.
(f) Purchases of goods amounting to $80 was not recorded.
Answer:
Suspense A/C
Date Details Debit Date Details Credit
20X2 $ 20X2 $
Jun 30 Sales return (a) 250 Jun 30 Bal b/d 500
Sales (e) 270 Interest (c) 240
Purchases (f) 80
Bal c/d 140
740 740
July 1 Bal b/d 140

4.2 Correcting Profit for the year

Statement of Corrected Profit or Loss:
Statement of corrected profit or loss for the year ended “state the date here”
$
Profit / Loss for the year before correction XX
Add: Errors that understate profit X
Expense overstated or income understated
Less: Errors that overstate profit (X)
Expense understated or income overstated
Corrected profit / loss for the year XX
Example:
Continuing from previous example, the following errors were discovered:
(a) Goods of $250 returned by customer was omitted from the sales return account.
(b) Payment of $1,000 for wages was erroneously recorded to the stationery account.
(c) Interest of $120 received from the bank was debited to the interest account.
(d) Purchase of a printer for $500 was debited to the general expense account.
(e) A sales of $690 was recorded in the sales account as $960.
(f) Purchases of goods amounting to $80 was not recorded.
Profit for the year ended 30 June 20X2 was $6 000.
Answer:
Statement of corrected profit for the year ended 30 June 20X2
$ $
Profit for the year before correction 6,000
Add:
(c) Interest income understated [ 120 x 2 ] 240
(d) General expense overstated 500 740
Less:
(a) Sales return understated 250
(e) Sales overstated [ 960 - 690 ] 270
(f) Purchases understated 80 600
Corrected profit for the year 6,140

Chapter 5. Bank Reconciliation

Purpose:
Determine accurate bank balance
Identify errors in the bank statement and Bank account
Deterrence against fraud
Difference between Bank Account and Bank Statement:
Bank account Bank statement
Prepared by business Prepared by bank
represents money own represents money owing

by business to business by bank
Asset Liability
Debit (+) Credit (-) Debit (-) Credit (+)
As such, a debit balance in the Bank account is represented by a credit balance in the
bank statement.
Steps to bank reconciliation:

1. Cancel similar transactions in the Bank account and bank statement.
Debit in Bank account cancel against Credit in bank statement
Credit in Bank account cancel against Debit in bank statement
Bank A/C
Date Details Cheque Debit Date Details Cheque Credit
$ $
Bank Statement
Date Particulars Debit Credit Balance
$ $ $
(Payment) (Deposit)

2. Update Bank account

(a) Correct any errors found in Bank account
(b) Record transactions not cancelled in bank statement
Example:
Bank A/C
July $ July $
6 Fence Ltd 2,100 1 Bal b/d 730
16 Max Print (a) 10 5 Rent 0023 600
30 Sales error 300 9 Purchases 0024 1,400
31 Bal c/d 1,070 17 Drawings 0025 150
28 Mary's Cafe 0026 600
3,480 3,480
Aug
1 Bal b/d 1,070
Starting balance in updated Bank account
Bank Statement
Date Particulars Debit Credit Balance
July belongs to previous months$ $ $
1 Bal b/d IGNORE!! 200 Dr
2 Cheque 0020 530 730 Dr
7 Cheque 0023 600 1 330 Dr
8 Cash 2 100 770 Cr
12 Cheque 0024 1 400 630 Dr
(b)
13 Returned cheque 2 100 2 730 Dr
18 Deposit 100 2 630 Dr
20 Cheque 0025 (b) 150 2 780 Dr
31 Bank charges 160 (b) 2 940 Dr
31 Credit transfer: Dividends 500 2 440 Dr
Note:
Amount received from Max Printing is correctly recorded in the bank statement.
Answer:
Updated Bank A/C
July $ July $
31 Max Print (a) 90 31 Bal b/d 1,070
Dividend (b) 500 Fence Ltd (b) 2,100
Bal c/d 2,740 Bank charge (b) 160
3,330 3,330
Aug
1 Bal b/d 2,740

3. Prepare bank reconciliation statement

(a) Record any errors found in bank statement
(b) Record transactions not cancelled in Bank account
Bank A/C
$ $
Deposits not credited Cheques not presented
Continue from the previous example:

Bank reconciliation statement as at 31 July 20XX
$
Balance per updated Bank account 2,740 Cr
Add cheques not yet presented:
Mary's Cafe 600
2,140
Less deposit not yet credited:
Sales 300
Balance per bank statement 2,440 Dr
Alternative presentation of bank reconciliation statement
Bank reconciliation statement as at 31 July 20XX

$
Balance per bank statement 2,440 Dr
Less cheques not yet presented:
Mary's Cafe 600
3,040
Add deposit not yet credited:
Sales 300
Balance per updated Bank account 2,740 Cr

Chapter 6. Trade receivables and Trade payables

6.1 Control Accounts
Sales ledger control account (also known as Trade receivable control account) is a
summary of the sales ledger.
Purchase ledger control account (also known as Trade payable control account) is a
summary of the purchase ledger.
Purpose / Advantages
Independent check on the accuracy of postings in the sales and purchases ledgers
Avoid overcrowding in the General Ledger with voluminous details
Deter and detect errors
Provide total amount of trade receivables and trade payables
Contra or Offset transaction

refers to a transfer of amount owing between a trade receivables who is also a
trade payable.
Double-entry:
Debit Purchases ledger control
Credit Sales ledger control

6.2 Trade receivables and Sales Ledger Control Account

Trade receivables are customers who bought goods from the business on credit.
Recorded in Recorded in
Sales Ledger General Ledger
Trade receivables
account
Trade receivables Sales ledger

account control
account
Trade receivables
account
Format for Trade receivables account AND Sales Ledger control account:
Trade receivables A/C OR Sales Ledger Control A/C
$ $
Bal b/d XX Sales returns X
Sales X Cash / Bank X
Bank (dishonoured cheque) X Discount allowed X
Discount allowed (withdrawn) X Irrecoverable debts X
Other charges - interest; X Purchase ledger control X
delivery (contra)
Bal c/d XX
XXX XXX

Transactions affecting trade receivables accounts:
Books of Business
Transactions Account
Prime Entry Document
Credit sales Sales Journal Invoice Sales
Undercharging General Journal Debit note Sales
Sales Return
Return of goods Credit note Sales return
Journal
Payment received Cash Book Receipt Cash / Bank
Discount given Cash Book Receipt Discount allowed
Court papers /
Write off debts General Journal Irrecoverable debts
lawyer's letter
Returned cheque Cash Book Bank statement Bank
Discount withdrawn Cash Book Bank statement Discount allowed
Other charges General Journal Invoice Depends on the charges
Contra General Journal Receipt Purchases ledger control

6.3 Trade payables and Purchases Ledger Control Account

Trade payables are suppliers who supply goods to the business on credit.
Recorded in Recorded in
Purchase Ledger General Ledger
Trade payables
account
Purchases
Trade payables ledger
account control
account
Trade payables
account
Format for Trade payables account AND Purchases ledger control account:
Trade payable A/C OR Purchases Ledger Control A/C
$ $
Purchases Returns X Bal b/d XX
Cash / Bank X Purchases X
Discount received X Other charges - interest; X
delivery
Sales ledger control (contra) X
Bal c/d XX
XXX XXX

Transactions affecting trade payables accounts:

Books of Business
Transactions Account
Prime Entry Document
Credit purchases Purchase Journal Invoice Purchases
Undercharging General Journal Debit note Purchases
Purchase Return
Return of goods Credit note Purchases Returns
Journal
Payment Cash Book Payment voucher Cash / Bank
Discount received Cash Book Payment voucher Discount received
*Depends on the
Other charges General Journal Invoice
charges
Contra General Journal Receipt Sales ledger control

Chapter 7. Capital and Revenue Expenditure and Receipts

7.1 Capital expenditure
Definition:
is the cost of acquiring asset and improving or extending non-current asset
benefit will last for more than one accounting period
recorded as non-current assets
Cost of Asset:
Original purchase price + all cost required to bring asset to usable state
Double-entry:
Debit Non-current asset
Credit Cash / Bank / Other payable
Example:
Company X purchase a piece of machinery from Great Machinery Ltd on credit at list
price of $50,000 less 10% discount. Also included in the invoice were the following costs:
Installation of machinery $2,000
2 years warranty $450
Yearly maintenance $1,200
Answer:
Cost of asset = ( 50,000 x 90% ) + 2,000 = $47,000
Original Expense required to bring

purchase price asset to usable state
Debit Plant & machinery $47,000

Credit Other payable - Great Machinery Ltd $47,000

7.2 Revenue expenditure

Definition:
is the purchase of goods for resale or services to run a business on a daily basis
benefit last less than one accounting period
recorded as current asset or expenses
Cost of expenditure = Original amount incurred
Double-entry:
Debit Expense
Credit Cash / Bank / Other payable
Example:
Continued from the above scenario for capital expenditure...
Answer:
Warranty and maintenance are considered yearly expenditure, therefore
Cost of expenditure = 450 + 1,200 = $1,650
Debit Maintenance expense $1,650

Credit Other payable - Great Machinery Ltd $1,650
7.2.1 Exception to capital expenditure rule

Materiality concept states that a transaction or an item is considered material if it
makes a difference to decision-making.
Example:
Company X has a capital of $1 million. Recently, it paid $6 for a waste paper basket for
office use.
Answer:
Though the waste paper basket can last the business for more than one accounting
period, the amount of $6 is insignificant compared to the overall worth of the business.
Instead of being considered as a capital expenditure, the waste paper basket
is considered as revenue expenditure.

7.3 Capital receipts

Definition:
income obtained from investment and financing activities of the business
benefit will last for more than one accounting period
recorded as non-current liabilities or capital
Examples:
Issuance of shares
Capital contribution from owner
Loan from financial institutions / banks
Government grants
7.4 Revenue receipts

Definition:
income obtained through normal business operations
benefit last within one accounting period
recorded as income
Examples:
Sales of goods
Discount received
Interest income
Dividend income

Chapter 8. Accounting for Depreciation

8.1 Depreciation
Definition:
Depreciation:
Allocation of the original cost of a non-current asset over its useful life
Represent the loss of value of a non-current asset for each accounting period
Provision for depreciation or Accumulated depreciation:

Total depreciation of a non-current asset to-date
Contra asset
Credit account
Book value:
Original cost of a non-current asset less its accumulated depreciation
Non-current assets are valued at net book value according to the Prudence concept
Cause of depreciation:
1. Wear and tear
2. Obsolescence
3. Passage of time
4. Legal limit
5. Depletion

8.1.1 Depreciation policy
Calculation of depreciation in
Depreciation policy
Year of Purchase Year of Sale
Full year depreciation in the

year of purchase and none 12 months No depreciation
in the year of sale
Full year depreciation in the

year of purchase and year 12 months 12 months
of sale
No depreciation in the year From start of accounting

No depreciation
of purchase period to date of sale
Depreciation is charged From date of purchase to From start of accounting

from date of transaction end of accounting period period to date of sale
Question did not specify From date of purchase to From start of accounting
any of the above end of accounting period period to date of sale

8.1.2 Straight-line method of depreciation

Formula:
( Cost - Scrap value)
OR Cost × Rate of depreciation (%)
Useful life
Effect on Profit for the year:

Depreciation expenses remains constant over the asset's useful life
Effect on profit for the year is constant
Example:
Company Z bought some cupboards for $8,000 on 1 March 20X1 and paid by cheque.
The scrap value of these cupboards is estimated at $500 after 5 years of usage.
On 1 May 20X2, the company bought a new set of tables for $3,600 by cheque. These
tables will be depreciated at 20% per annum on cost.
Prepare the Fixtures & Fittings account and Provision for depreciation of fixtures &
fittings account for the years ended 30 June 20X1 and 20X2.
Answer:
Fixtures & Fittings A/C
20X1 $ 20X1 $
Mar 1 Bank 8,000 Jun 30 Bal c/d 8,000
July 1 Bal b/d 8,000
20X2 20X2
May 1 Bank 3,600 Jun 30 Bal c/d 11,600
11,600 11,600
 ( 8000 − 500 )  4
(a) Depreciation for 30 June 20X1:  × = $500
 5  12
 ( 8000 − 500 )   2
(b) Depreciation for 30 June 20X2:   + ( 3600 × 20% ) ×  = $1,620
 5   12 

Provision for depreciation A/C

20X1 $ 20X1 $
Jun 30 Bal c/d 500 Jun 30 Income statement (a) 500
July 1 Bal b/d 500
20X2 20X2
Jun 30 Bal c/d 2,120 Jun 30 Income statement (b) 1,620
2,120 2,120
Income Statement for the year ended 30 June 20X2 (extract)

$
Less expenses:
Provision for depreciation of fixtures & fittings 1,620
Statement of Financial Position at 30 June 20X2 (extract)

Accumulated
Cost Book Value
depreciation
$ $ $
Non-current asset:
Fixtures & fittings 11,600 2,120 9,480

8.1.3 Reducing-balance method of depreciation

Formula:
( Cost - Accumulated depreciation ) × Rate of depreciation (%)
Effect on Profit for the year:

Depreciation expenses decreases over the asset's useful life
Profit for the year increases as depreciation expenses decreases
Example:
Company X paid a cheque of $80,000 for a car on 1 March 20X1. On 1 May 20X2, the
company purchased a delivery van for $130,000 on credit.
The company depreciates motor vehicle at 10% per annum using the reducing-balance
method. A full year depreciation is charged in the year of purchase.
Prepare the Motor vehicle account and Provision for depreciation of motor vehicle
account for the years ended 30 June 20X1 and 20X2.
Answer:
Motor Vehicles A/C
20X1 $ 20X1 $
Mar 1 Bank 80,000 Jun 30 Bal c/d 80,000
20X2 20X2
May 1 Other payable 130,000 Jun 30 Bal c/d 130,000
210,000 210,000
(a) Depreciation for 30 June 20X1: [80000 × 10% ] = $8,000
(b) Depreciation for 30 June 20X2: ( 80000 − 8000 ) × 10%  + [130000 × 10% ] = $20,200


20X1 $ 20X1 $
Jun 30 Bal c/d 8,000 Jun 30 Income statement (a) 8,000
20X2 20X2
Jun 30 Bal c/d 28,200 Jun 30 Income statement (b) 20,200
28,200 28,200
Income Statement for the year ended 30 June 20X2 (extract)

$
Less expenses:
Provision for depreciation of motor vehicles 20,200
Statement of Financial Position at 30 June 20X2 (extract)

Accumulated
Cost Book Value
depreciation
$ $ $
Non-current asset:
Motor vehicles 210,000 28,200 181,800

8.1.4 Revaluation method of depreciation

Formula:
Value of asset Value of asset
Purchases Disposal
at start of + during the year
- during the year
- at end of
accounting year accounting year
Example:
Machinery was valued on 1 January 20X1 as $25,000. During the year, the company sold
an old piece of machinery costing $5,000 and purchased a new set for $13,000. On 31
December 20X1, machinery was valued at $28,000.
Prepare the Provision for depreciation of machinery account for the year ended 31
December 20X1.
Answer:
Depreciation: 25,000 + 13,000 - 5,000 - 28,000 = $5,000

20X1 $ 20X1 $
Dec 31 Bal c/d 5,000 Dec 31 Income statement 5,000
20X2
Jan 1 Bal b/d 5,000
Income Statement for the year ended 31 December 20X1 (extract)

$
Less expenses:
Provision for depreciation of machinery 5,000

8.2 Sales of non-current assets

Determining Gain or Loss on sales:
Loss on sales of non-current asset
( Cost - Provision for depreciation ) Selling price
Gain on sales of non-current asset

( Cost - Provision for depreciation ) Selling price
Components in the Disposal of non-current asset account:

Disposal of non-current asset A/C
$ $
Cost of non-current asset X Provision for depreciation X
Cash / Bank /
other receivables X
Income statement - Profit X OR Income statement - Loss X
Recording Disposal of non-current asset in Income Statement:

Income Statement (extract)
$
Other Income:
Profit on disposal XX
Expenses:
Loss on disposal XX

Example:
Company Y had the following balances on 1 July 20X2: Machinery $130,000 and
Provision for depreciation of machinery $50,000
On 1 April 20X3, one of the machines bought in May 20X1 was sold on credit for $15,000.
This machine was previously purchased for $60,000.
It is the business policy to charge a full year’s depreciation in the year of purchase and
none in the year of sale. Machinery are depreciated at an annual rate of 20% using the
reducing-balance method.
Record the disposal in the Machinery account, Provision for depreciation of machinery
account and Disposal account.
Answer:
Machinery A/C
20X2 $ 20X3 $
July 1 Bal b/d 130,000 Apr 1 Disposal 60,000
*Common error
recording selling price of
$15,000 instead of cost
Depreciation for machinery sold:

Year ended 30 June 20X1: 60,000 x 20% = $12,000
Year ended 30 June 20X2: (60,000 - 12,000) x 20% = $9,600
Total depreciation = $12,000 + $9,600 = $21,600

20X3 $ 20X2 $
Apr 1 Disposal 21,600 July 1 Bal b/d 50,000
Disposal A/C
20X3 $ 20X3 $
Apr 1 Machinery 60,000 Apr 1 Provision for depreciation 21,600
Other receivables 15,000
Income statement 23,400
60,000 60,000

Chapter 9. Other Payables and Other Receivables

9.1 Recording Accrued and Prepaid Expenses
Expense Accounts
Debit (+) Credit (-)
Balance b/d [Prepaid expense] Balance b/d [Accrued expense]
Cash/Bank/Other payable [Expense paid] Income statement [Expense incurred]
Balance c/d [Accrued expense] Balance c/d [Prepaid expense]
Recording in Statement of Financial Position:

Prepaid expense : Current asset > Other receivables
Accrued expense : Current liability > Other payables
Example:
Company Z has a balance of $3,000 in its prepaid rent account on 1 January 20X1. On 1
July 20X1, $12,000 rent was paid by cheque. The premise was rented at $1,200 per
month. Prepare Rent Expense account for the year ended 31 December 20X1.
Answer:
Rent Expense A/C
20X1 $ 20X1 $
Jan 1 Balance b/d 3,000 Dec 31 Income statement 14,400
(1200 × 12 months )
Jul 1 Bank 12,000 Dec 31 Balance c/d 600
15,000 15,000
20X2
Jan 1 Balance b/d 600

$
Less expenses:
Rent expense 14,400
Statement of financial position at 31 December 20X1 (extract)

$
Current asset
Other receivables 600

9.2 Recording Accrued and Prepaid Income
Income Accounts
Debit (-) Credit (+)
Balance b/d [Accrued income] Balance b/d [Prepaid income]
Cash/Bank/Other receivable
Income statement [Income earned]
[Income received]
Balance c/d [Prepaid expense] Balance c/d [Accrued income]
Recording in Statement of Financial Position:

Prepaid income : Current liability
Accrued income : Current asset
Example:
Company Z was owed $500 interest for the year ended 31 December 20X1. On 30 June
20X2, the company received a cheque of $2,000. At the end of the accounting period,
$800 of interest income remains outstanding. Prepare Interest Income account for the
year ended 31 December 20X2.
Answer:
Interest Income A/C
20X2 $ 20X2 $
Jan 1 Balance b/d 500 Jun 30 Bank 2,000
Dec 31 Income statement 2,300 Dec 31 Balance c/d 800
2,800 2,800
20X3
Jan 1 Balance b/d 800

$
Other income:
Interest income 2,300
Statement of financial position at 31 December 20X2 (extract)

$
Current asset:
Prepaid interest income 800

Chapter 10. Irrecoverable Debts and Provision for doubtful

debts
10.1 Irrecoverable debts
Definition:
Debts that are confirmed not collectible from trade receivables
Expense
Debit account
Double-entry:
Debit Irrecoverable debts
Credit Trade receivables
Example:
On 1 January 20X1, a trade receivable owing $600 has been declared bankrupt. The debt
is to be written off as irrecoverable.
Answer:
Trade receivables A/C
20X1 $ 20X1 $
Jan 1 Bal b/d 600 Jan 1 Irrecoverable debt 600
Irrecoverable debt A/C

20X1 $ 20X1 $
Jan 1 Trade receivables 600 Jan 1 Income statement 600

$
Expenses:
Irrecoverable debts 600

10.2 Recovery of irrecoverable debts

Definition:
Debts that are previously written off as irrecoverable was subsequently recovered
Income
Credit account
Double-entry:
Debit Cash / Bank
Credit Irrecoverable debts recovered
Example:
On 1 January 20X1, a debt of $600 owed by a trade receivables was written off as
irrecoverable. On 1 July 20X1, the trade receivable returned to repay the debt of $600
by cash.
Answer:
Cash A/C
20X1 $ $
July 1 Irrecoverable debt 600
recovered
Irrecoverable debt recovered A/C

20X1 $ 20X1 $
July 1 Income statement 600 July 1 Cash 600

$
Other Income:
Irrecoverable debts recovered 600

10.3 Provision for doubtful debts

Definition:
Provision for debts that are deemed uncollectible based on reasonable estimation
Contra-asset
Credit account
Calculating Provision for doubtful debts:

Trade receivables at end of accounting period × Rate of provision for doubtful debts (%)
Double-entry:
Creating Provision for doubtful debts:
Debit Income statement Expense

Credit Provision for doubtful debts
Adjusting an Increase in Provision for doubtful debts
Debit Income statement Expense

Credit Provision for doubtful debts
Adjusting a Decrease in Provision for doubtful debts
Debit Provision for doubtful debts Income

Credit Income statement
Presentation in Income Statement:

$
Other Income:
Decrease in provision for doubtful debts
Expenses:
Increase in provision for doubtful debt
Presentation in Statement of Financial Position:

Statement of Financial Position (extract)
$
Current assets:
Trade receivables
Less Provision for doubtful debt

Example 1: Creating Provision for doubtful debts

Company X decides to create a provision for doubtful debts at 5% of its trade receivable.
For the year ended 31 December 20X1, trade receivable was $20,000.
Answer:
Provision for doubtful debts for 31 Dec 20X1 = $20,000 X 5% = $1,000
Provision for doubtful debt A/C

20X1 $ 20X1 $
Dec 31 Bal c/d 1,000 Dec 31 Income statement 1,000
20X2
Jan 1 Bal b/d 1,000
Example 2: Increase in Provision for doubtful debts

Continuing from Example 1, Company X's trade receivables amounted to $34,000 for
the year ended 31 December 20X2. Provision for doubtful debts is maintained at 5% on
trade receivables.
Answer:
Provision for doubtful debts for 31 Dec 20X2 = $34,000 X 5% = $1,700

20X2 $ 20X2 $
Dec 31 Bal c/d 1,700 Jan 1 Bal b/d 1,000
Dec 31 Income statement 700
1,700 1,700
20X3
Jan 1 Bal b/d 1,700

Example 3: Decrease in Provision for doubtful debts

Continuing from Example 1, Company X's trade receivables amounted to $16,000 for
the year ended 31 December 20X2. Provision for doubtful debts is maintained at 5% on
trade receivables.
Answer:
Provision for doubtful debts for 31 Dec 20X2 = $16,000 X 5% = $800

20X2 $ 20X2 $
Dec 31 Income statement 200 Jan 1 Bal b/d 1,000
Dec 31 Bal c/d 800
1,000 1,000
20X3
Jan 1 Bal b/d 800
Income Statement for the year ended 31 Dec 20X2 (extract)

$
Other Income:
Decrease in provision for doubtful debts 200
Statement of Financial Position at 31 Dec 20X2 (extract)

$ $
Current asset:
Trade receivable 16,000
Less: Provision for doubtful debts (800)
15,200

Chapter 11.Valuation of Inventory

Inventory is valued at the lower of cost and net realisable value. This is in accordance to
the Prudence concept.
Effect of Incorrect Valuation of Inventory

Inventory is Overvalued
Profit for Owner's Asset

Effect on Gross profit
the year Equity valuation
Current period Overstated Overstated Overstated Overstated
Next period Understated Understated No effect No effect
Inventory is Undervalued
Profit for Owner's Asset

Effect on Gross profit
the year Equity valuation
Current period Understated Understated Understated Understated
Next period Overstated Overstated No effect No effect

Chapter 12.Sole Traders

12.1 Advantages and Disadvantages of Sole Traders
Advantages
Easy and less expensive to set up and maintain
Owner has full control over the management of the business
Disadvantages
Owner may lose more than his/her investment in the business if the business fails
Banks and financial institutions may be less willing to lend
More difficult for ownership to be transferred
12.2 Difference between Trading Business and Service Business

Trading business
Earns its profit through the buying and selling of goods
Assets includes unsold inventory
Service business
Earns its revenue through the provision of services to customers
Do not hold any inventory

12.3 Income Statement

Income statement measures the profitability of a company for a specified time period,
at regular intervals.
12.3.1 Trading business

“Name of company”
Income Statement for the year ended “date”
$ $
Revenue XX
Less Sales Returns ( XX )
XX
Opening inventory XX
Purchases XX
Carriage inwards XX
XX Trading
Purchases Returns (XX) portion
XX
Drawings of goods (XX)
XX
Closing inventory (XX)
Cost of sales ( XX )
Gross profit XXX
Net revenue > Cost of sales = Gross profit

Net revenue < Cost of sales = Gross loss
Other Incomes:
Irrecoverable debt recovered XX
Decrease in provision for doubtful debts XX XXX
Profit & Loss
Expenses: portion
Irrecoverable debts (XX)
Loss on disposal (XX)
Provision for depreciation of non-current asset (XX)
Increase in provision for doubtful debts (XX) (XXX)
Profit for the year XXX
( Gross profit + Other income ) > Expenses = Profit

( Gross profit + Other income ) < Expenses = Loss

12.3.2 Service business

Income Statement for the year ended “date”
$ $
Revenue XXX
Other Incomes:
Irrecoverable debt recovered XX
Decrease in provision for doubtful debts XX XXX
Expenses:
Irrecoverable debts (XX)
Loss on disposal (XX)
Provision for depreciation of non-current asset (XX)
Increase in provision for doubtful debts (XX) (XXX)
Profit for the year XXX
( Revenue + Other income ) > Expenses = Profit

( Revenue + Other income ) < Expenses = Loss

12.4 Statement of Financial Position

Measures the financial position of a company at a given date.
Statement of Financial Position at “date”
$ $ $
Accumulated Book
Cost Depreciation value
Non-current Assets
Fixtures & Fittings XX XX XX
Motor vehicles XX XX XX
Office equipment XX XX XX
Premises / Buildings XX XX XX
Plant & Machinery XX XX XX
XXX XXX XXX
Intangible Assets
Goodwill XX
Copyrights XX XXX
Current Assets
Trade receivables XX
Less: Provision for doubtful debts (XX)
XX
Inventory (Not applicable for service business) XX
Other receivables (prepaid expense/accrued income) XX
Petty cash XX
Cash / Bank XX XXX
Total Assets XXX
Owner's Equity
Capital XX
Add: Profit for the year (OR Less: Loss for the year) XX
Less: Drawings XX
XX
Non-current liabilities
Loans or Mortgages XX
Current liabilities
Trade payables XX
Other payables (accrued expenses / prepaid income) XX
Bank overdrafts XX XX
Total equity and liabilities XXX

12.5 Equity Accounts
12.5.1 Drawings accounts

Assets that the owner withdraws from the business for personal use are recorded in the
drawings account.
Drawings A/C
$ $
Cash / Bank X
Purchases [ drawing of goods ] X Capital A/C XX
XX XX
12.5.2 Capital accounts

Personal assets that the owner brings into the business are recorded in the capital
account.
Capital A/C
$ $
Drawings A/C XX Balance b/d XX
Income statement X Cash / Bank X
Loss for the year Assets / Expenses X
Balance c/d XX Income statement X
XXX Profit for the year XXX

Example:
On 1 January 20X1, John, a sole trader has a balance of $6,000 in his capital account.
During the year, the following transactions took place:

1. Withdrew goods worth $300 for personal use on 1 March 20X1.
2. Took stationery valued $60 for use at home on 1 May 20X1.
3. On 1 April 20X1, paid $2,500 using personal cheque for a computer to be used in
office.
4. Withdraw $200 from the business bank as personal allowances on 1 August 20X1.
5. Deposited $2,000 cash into business bank account on 1 November 20X1.
Profit for the year amounted to $5,000.
Answer:
Drawings A/C
20X1 $ 20X1 $
Mar 1 Purchases 300 Dec 31 Capital 560
May 1 Stationery 60
Aug 1 Bank 200
560 560
Capital A/C
20X1 $ 20X1 $
Dec 31 Drawings 560 Jan 1 Bal b/d 6,000
Bal c/d 14,940 Apr 1 Office equipment 2,500
Nov 1 Bank 2,000
Dec 31 Income statement 5,000
15,500 15,500
20X2
Jan 1 Bal b/d 14,940

Chapter 13.Partnerships
13.1 Advantages and Disadvantages of Partnership
Advantages
Bigger pool of capital
Combined skills and experiences of partners
Sharing of business tasks or duties between partners
Disadvantages
Disagreements due to conflicting views of partners
All partners are held responsible for contractual losses of the business
Partners can be forced to pay partnership debts with their personal assets
13.2 Partnership Agreement

Purpose
To specify matters of concern to the partners so that all partners are clear on how the
partnership operates to avoid future disputes.
Contents of partnership agreement

Contribution of capital
Appropriation of profits / losses
Drawings of assets for personal use
Interest chargeable on drawings
Interest payable on capital
Partners’ salary
Interest chargeable on loans from partners

13.3 Accounting for Partners' Transactions
13.3.1 Interest on Capital

To compensate any partner who has contributed more capital than the other partners
Calculation
Interest on capital = Capital x Rate (% per annum) x Time (year)
Example:
The balances in the partners' Capital accounts on 1 January 20X1 are: $30,000 for
partner A and $45,000 for partner B. On 1 June 20X2, partner B contributed additional
capital of $12,000 into the business bank account. Interest on capital is at 8% per annum.
Answer:
On 31 December 20X1, interest on capital for:
Partner A = 30,000 x 8% = $2,400
Partner B = (45,000 x 8%) + (12,000 x 8% x 7/12 months) = $4,160
Effect on Current account and Profit

Partners' current account: Increases
Profit available for allocation: Decreases
13.3.2 Interest on Drawings

To discourage the withdrawal of cash or goods by the partners so as to keep its assets
for business opportunities
Calculation
Interest on drawings = Drawings x Rate (% per annum) x Time (year)
Example:
On 1 January 20X1, partner A withdraw goods costing $2,000. On 1 July 20X1, partner B
withdrew cash $1,500 from the business. Interest on drawings is at 10% per annum.
Answer:
On 31 December 20X1, interest on drawings for:
Partner A = 2,000 x 10% = $200
Partner B = 1,500 x 10% x 6/12 months = $75

Partners' current account: Decrease
Profit available for allocation: Increases

13.3.3 Partners' Salary / Bonuses / Commissions

Provides compensation to partners who has contributed time and effort to operate the
business
Accounting Treatment
Not a business expense but an entitlement of the partner
If unpaid, credited to partner's current account
If paid, do not need to record in partner's current account
Example:
Partner B is allowed an annual salary of $8,000. The business paid him $3,000 on 1 May
20X1. The balance amount remains outstanding at 31 December 20X1.
Answer:
Debit Appropriation account $8,000
Credit Cash / Bank $3,000
Credit Current a/c - Partner B $5,000

Partners' current account: Increases
Profit available for allocation: Decreases
13.3.4 Loan from Partners

Treated the same way as loan from external parties. Therefore, it is considered a
business liability
Recorded in Statement of Financial Position as a liability
Example:
Partner A provided a loan of $15,000 to the business on 1 September 20X1.
Answer:
Debit Bank $15,000
Credit Loan from Partner A $15,000

Partners' current account: No effect
Profit available for allocation: No effect

13.3.5 Interest on Loan from Partners

To provide a return on the funds loaned to the business by the partner
Calculation
Interest on loan = Loan x Rate (% per annum) x Time (year)
Business expense in the Income Statement
If unpaid, credited to partner's current account
If paid, do not need to record in partner's current account
Example:
Partner A provided a loan of $15,000 to the business on 1 September 20X1. Interest on
loan is charged at 5% per annum. Half the interest is paid to the partner while the
balance amount remains owing at 31 December 20X1.
Answer:
On 31 December 20X1,
interest on loan = 15,000 x 5% x 4/12 months = $250
Debit Interest expense $250

Credit Bank $125
Credit Current a/c - Partner A $125

Partners' current account: Increases (if not paid)
Profit available for allocation: Decreases as Profit for the year decreases

13.4 Appropriation account

Purpose
To determine the final profit or loss for allocation to all partners after taking into
account interest on capital, interest on drawings, partners' salary, bonus or commission.
Calculation of Profit Available for Distribution to Partners
Profit for the year + Interest on drawings

- Interest on capital
- Partners' salary / bonus / commission
Format:
Appropriation Account for the year ended “date”
$ $
Profit for the year X (A)
Interest on drawings
Partner A X1
Partner B X2 XX (B)
XXX (A+B)
Interest on capital
Partner A X1
Partner B X2 XX (C)
Partners' salary
Partner A X1
Partner B X2 XX (D)
XXX (A+B) - C - D
Share of profit
Partner A [(A+B) - C - D] x profit sharing ratio X1
Partner B [(A+B) - C - D] x profit sharing ratio X2 XXX

Example:
A and B are business partners. The balances in the partners' Capital accounts on 1
January 20X1 are: $30,000 for partner A and $45,000 for partner B.
Total drawings made by the partners for the year are: $2,000 for partner A and $3,000
for partner B.
Their partnership agreement states the following:

1. Interest on capital is at 8% per annum
2. Partner B is paid a monthly salary of $600
3. Interest on drawings is at 10% per annum
4. Partner A provided a loan of $15,000 to the business. Interest on loan is charged at 5%
per annum
5. Profits or losses are to be shared between A and B in the ratio of 3:2
Profit for the year ended 31 December 20X1 before interest on loan is $20,000
Answer:
Appropriation Account for the year ended 31 December 20X1
$ $
Profit for the year [20,000 - (15,000 x 5%)] 19,250
Interest on drawings
Partner A (2,000 x 10%) 200
Partner B (3,000 x 10%) 300 500
19,750
Interest on capital
Partner A (30,000 x 8%) 2,400
Partner B (45,000 x 8%) 3,600 6,000
Partners' salary
Partner B (600 x 12 months) 7,200
6,550
Share of profit
Partner A 6,550 x 3/5 3,930
Partner B 6,550 x 2/5 2,620 6,550

13.5 Capital account

Records capital contribution or withdrawal by each partner. It shows the total capital
invested in the business by the partner.
Format:
Capital A/C
$ $
Cash / Bank / etc X Balance b/d X
Cash / Bank X
Capital withdrawn
Additional capital contributed
Example:
A and B are business partners. The balances in the partners' Capital accounts on 1
January 20X1 are: $30,000 for partner A and $45,000 for partner B.
On 1 June 20X1, partner B contributed additional capital of $12,000 which was

deposited into the business bank account; while partner A transferred $15,000 of his
capital into loan for the business. The business closes its books on 31 December.
Answer:
Capital A/C
Date Details A B Date Details A B
20X1 $ $ 20X1 $ $
Jun 1 Loan 15,000 Jan 1 Balance b/d 30,000 45,000
Dec 31 Balance c/d 15,000 57,000 Jun 1 Bank 12,000
30,000 57,000 30,000 57,000
20X2
Jan 1 Balance b/d 15,000 57,000

13.6 Current account

Records the profits or losses allocated to a partner and the amount of profit withdrawn
by the partner. The closing balance of the Current account shows how much profits that
was undrawn or overdrawn by the partner.
Format:
Current A/C
$ $
Drawings X Balance b/d X
Interest on drawings X Interest on capital X
Salary X
Interest on loan X
Share of losses X OR Share of profits X
Example:
Using figures from example on Appropriation account....The balances in the partners'
Current accounts on 1 January 20X1 are: $3,000 for partner A and $4,000 for partner B.
Answer:
Current A/C
Date Details A B Date Details A B
20X1 $ $ 20X1 $ $
Dec 31 Drawings 2,000 3,000 Jan 1 Balance b/d 3,000 4,000
Int. on drawings 200 300 Dec 31 Int. on capital 2,400 3,600
Balance c/d 7,880 14,120 Salary 7,200
Interest on loan 750
Share of profit 3,930 2,620
10,080 17,420 10,080 17,420
20X2
Jan 1 Balance b/d 7,880 14,120

13.7 Presentation of Partners' Equity in Statement of Financial Position

Format:
Statement of financial position at “date”
$ $
Capital Account
Partner A X1
Partner B X2 XX
Current Account
Partner A X1
Partner B X2 XX
Total Partners' Equity XXX
Example:
Using figures from example on Capital and Current accounts....
Answer:
Statement of financial position at 31 December 20X1
$ $
Capital Account
Partner A 15,000
Partner B 57,000 72,000
Current Account
Partner A 7,880
Partner B 14,120 22,000
Total Partners' Equity 94,000

Chapter 14.Limited Company

14.1 Advantages and Disadvantages
Advantages
Large amount of capital can be raised
Business is managed by professionals
Disadvantages
Expensive and complicated to start
Has to comply with more rules and regulations
High administration cost
14.2 Types of Capital
14.2.1 Issued, Called-up, Paid-up Share Capital

Issued share capital
Amount of share capital issued to shareholders
Called-up capital
The amount of issued share capital that the company has requested for payments
from the shareholders
Paid-up capital
The amount of called-up share capital that the company has actually received the
payment from shareholders.
Example:
Z Ltd issued 500,000 shares of $1 per share on 1 January 20X1. Shareholders were asked
to pay 50% of the sum immediately. The balance 50% are due 1 March 20X2. By 1 March
20X1, holders of 400,000 shares paid the amount due.
Answer:
On 31 December 20X1,
Issued share capital = 500,000 x $1 = $500,000
Called-up capital = 500,000 x ($1 x 50%) = $250,000
Paid-up capital = 400,000 x $0.50 = $200,000

14.2.2 Preference Shares Capital

Definition:
Preference shares are shares that a company issued to its shareholders where a fixed
rate of dividend is payable.
Characteristic:
No voting rights at shareholders' meetings
Dividend are paid before ordinary shareholders
Upon company's closure, preference shareholders are paid after outside liabilities
and before ordinary shareholders
Preference share dividend are recorded as expenses in Income Statement
Calculation:
Preference share capital = Total preference shares issued x Unit share price
Example: Issued 300,000 4% preference shares of $1 each
Preference share capital = 300,000 x $1 = $300,000
Preference share dividend = Preference share capital x Rate of dividend

Example: Issued 300,000 4% preference shares of $1 each
Preference share dividend = $300,000 x 4% = $12,000
Redeemable preference shares

Has a maturity date on which the company will repay the capital amount to the
preference shareholders and discontinue the dividend payment thereon.
Non-redeemable preference shares

Do not have a maturity date, and therefore are also known as perpetual preference
share

14.2.3 Ordinary Shares Capital

Definition:
Ordinary shares are equity shares that a company issued to its shareholders where
dividend payable vary according to the profits of the company.
Characteristic:
Voting rights at shareholders' meetings
Dividend are paid after preference shareholders
Upon company's closure, are paid after outside liabilities and preference
shareholders
Ordinary share dividend are deducted from Profit for the year
Calculation:
Ordinary share capital = Total ordinary shares issued x Unit share price
Example: Issued 200,000 ordinary shares at $0.40 each
Ordinary share capital = 200,000 x $0.40 = $80,000
Ordinary share dividend = Ordinary share capital x Rate of dividend

Example: Dividend of 5% was proposed
Ordinary share dividend = $80,000 x 5% = $4,000
OR
Ordinary share dividend = Total ordinary shares issued x Dividend per share
Example: Dividend of $0.02 per share was proposed
Ordinary share dividend = 200,000 x $0.02 = $4,000
14.2.4 General Reserves

Definition:
A portion of profit for the year that was reserved for the future development of the
company.
Calculation:
Beginning balance + Transfer during the year = Ending balance

14.2.5 Retained Earnings

Definition:
Is an accumulation of balances of profit after distribution of dividend and transfer to
general reserves since the beginning of the company's operation.
Calculation:
Beginning Balance + Profit for the year
- Transfer to general reserve
- Ordinary share dividend proposed / paid
Example 1:
On 1 July 20X1, Company X Ltd had 200,000 ordinary shares of $0.40 each; and retained
earnings of $60,000. On 15 June 20X2, dividend was proposed at $0.02 per ordinary
share. Profit for the year ended 30 June 20X2 amounted to $150,000. $6,000 was
transferred to the general reserves.
Answer:
Retained earnings on 30 June 20X2
= $60,000 + $150,000 - $6,000 - ($200,000 x $0.02) = $200,000
14.2.6 Debentures (Loan Capital)

Definition:
Long-term loan that carry a fixed rate of interest which is payable whether or not the
company makes a profit.
Characteristic:
Not members of the company, therefore no voting rights at shareholders' meetings
Interest on debentures are paid before paying shareholders dividend
Upon company's closure, debenture holders are paid before any capital
shareholders
Interest on debentures are recorded as expenses in Income Statement
Debentures are recorded in the Statement of financial position as non-current
liabilities

14.3 Income Statement of Limited Company

Prepare the Income Statement for a limited company as you would for a sole trader
with the following additional expenses:
Income Statement for the year ended “date” (Extract)

$
Expenses:
Interest on debentures X
Preference share dividend X
14.4 Statement of Changes in Equity

Prepared to explain how profit for the year was divided.
"Name of company"
Statement of Changes in Equity for the year ended "date"
Ordinary General Retained
Total
Shares Reserves Earnings
$ $ $ $
Balance at (beginning of year "date") X X X XXX
Profit for the year X X
Transfer to general reserves X (X) -
Interim dividend paid (X) (X)
Final dividend paid (X) (X)
Balance at (end of year "date") XX XX XX XXX
14.5 Statement of Financial Position

Prepare the Statement of financial position for a limited company as you would for a
sole trader except the Equity section.
Statement of financial position at “date” (Extract)

$
Capital & Reserves
Preference shares of $x each XX
Ordinary share of $x each XX
General reserves XX
Retained earnings XX
Shareholders' funds XX

Chapter 15.Clubs and Societies

15.1 Receipts and Payments Accounts
A summary of the Cash Book
Records all money received and paid
No distinction between cash and bank transactions
No distinction between capital / revenue expenditure and capital / revenue
receipts
No adjustments for prepayments and accruals
Exclude non-monetary transactions
Debit account
Debit balance - Current Asset
Credit balance - Current Liability
Example:
On 1 July 20X1, Z Sports Club had $20,000 in the bank and $3,000 cash. For the year
ended 30 June 20X2, the club had the following receipts and payments:
$
Subscriptions received 10,850
Competition entrance fees received 800
Proceed from shop sales 4,000
Competition prizes 200
Purchase of new motor vehicle 30,000
Wages - Sport coaches 2,700
Shop assistants 1,800
General expense 1,000
Rent 3,500
Answer:
Receipts and Payments Account for the year ended 30 June 20X2
Date Receipts Debit Date Payments Credit
20X1 $ 20X2 $
July 1 Bal b/d 23,000 Jun 30 Purchase motor vehicle 30,000
20X2 Wages - Sport coaches 2,700
Jun 30 Subscription 10,850 Wages - Shop assistant 1,800
Competition fees 800 General expense 1,000
Proceed from shop 4,000 Competition prizes 200
Bal c/d 550 Rent 3,500
39,200 39,200
Jul 1 Bal b/d 550

15.2 Income and Expenditure Accounts

Prepared in the same principle as the Income Statement of a sole trader
Income > Expenditure = Surplus for the year
Income < Expenditure = Deficit for the year
Fund-raising activity: income and expenses for that activity are set off against each
other to determine profit or loss on that activity
Example:
Z Sports Club had the following receipts and payments for the year ended 30 June 20X2:
$
Subscriptions received 10,850
Competition entrance fees received 800
Proceed from shop sales 4,000
Competition prizes 200
Purchase of new motor vehicle 30,000
Shop assistants 1,800
General expense 1,000
Rent 3,500
Profit from the club's shop was $500 and motor vehicle is to be depreciated at 10% per
annum.
Answer:
Income and Expenditure Account for the year ended 30 June 20X2
$ $
Income
Subscription 10,850
Profit from shop 500
Competition: entrance fees 800
cost of prizes 200 600
11,950
Expenditure
General expenses 1,000
Rent 3,500
Depreciation of motor vehicle 3,000 10,200
Surplus for the year 1,750

15.3 Statements of Financial Position

Prepared in the same principle as the Statement of Financial Position of a sole trader
Owner's Equity is replaced with Accumulated Fund
No Drawings
Format:
Statement of Financial Position at “date” (Extract)
$
Accumulated Fund
Opening balance XX
Add: Surplus for the year (OR Less: Deficit for the year) X
XX
15.3.1 Accumulated Fund

Definition:
Capital fund accumulated within the organisation from surpluses obtained from running
the club.
Calculation:
Accumulated fund = Assets - Liabilities

Chapter 16.Manufacturing Accounts

16.1 Direct And Indirect Costs
Direct Material
Raw material required to make finished goods
Calculation:
Opening inventory of raw material + Purchases of raw material
+ Carriage Inwards of raw material - Closing inventory of raw material
Direct Labour
Wages of people directly involved in producing the finished goods
Prime Cost
Total direct cost of producing the finished goods
Calculation:
Direct Material + Direct Labour + Direct Expense
Factory Overheads
Indirect factory expenses
Costs involved in operating the factory which cannot be directly linked with the
manufacturing of the finished goods
Examples:
Wages of factory supervisor
Rent of factory
Depreciation of machinery

16.2 Manufacturing Account

Purpose:
To calculate the total cost of manufacturing the finished goods
Production Cost of Completed Goods:

Work in Progress
Goods which are partly completed at the end of the financial year
To be excluded from cost of production
Cost of production is calculated as:

Prime cost + Factory overheads
+ Opening work in progress - Closing work in progress
Format:
Manufacturing Account for the year ended "date"
$ $
Cost of material consumed
Opening inventory of raw material X
Purchases of raw material X
Carriage inwards of raw material X
XX
Less Closing inventory of raw material (X) XX
Direct wages XX
Direct expenses XX
Prime Cost XX
Factory overheads
Indirect wages X
Rent and rates X
Depreciation of machinery X
Etc X XX
XX
Add Opening work in progress X
XX
Less Closing work in progress X
Production cost of finished goods XX

Example:
Company X Manufacturer supplied the following balances and information for the year
ended 31 May 20X2:
1 June 20X1 31 May 20X2
$ $
Inventory of raw materials 40,000 43,000
Inventory of finished goods 80,000 62,000
Work in progress 20,000 18,000
For the year ended 31 May 20X2,

$
Purchases of raw materials 550,000
Purchase of finished goods 16,000
Wages - factory workers 52,000
factory managers 36,000
Depreciation of machinery 8,000
Rent - factory 60,000
Answer:
Manufacturing Account for the year ended 31 May 20X2
$ $
Cost of material consumed
Opening inventory of raw material 40,000
Purchases of raw material 550,000
590,000
Less Closing inventory of raw material 43,000 547,000
Direct wages 52,000
Prime Cost 599,000
Factory overheads
Indirect wages 36,000
Rent 60,000
Depreciation of machinery 8,000 104,000
703,000
Add Opening work in progress 20,000
723,000
Less Closing work in progress 18,000
Production cost of finished goods 705,000

16.3 Income statement

Prepared in the same principle as the Income Statement of a sole trader except the
following in the calculation of Cost of Sales:

$
Opening inventory of finished goods X
Production cost of completed goods X
Purchases of finished goods X
XX
Closing inventory of finished goods (X)
Cost of sales X
16.4 Statements of financial position

Prepared in the same principle as the Statement of Financial Position of a sole trader
Statement of Financial Position (extract)

$ $
Current asset:
Inventories - raw materials X
work in progress X
finished goods X XX

Chapter 17.Incomplete Records

17.1 Changes in Capital Method
Profit or loss for the year is determined by calculating the change in an owner's equity.
Calculation of profit or loss for the year ended “state the date here”
$
Ending capital XX
Add: Drawings X
Less: Additional capital (X)
Less: Beginning capital (X)
Profit or (loss) for the year XX
Example:
John started a trading business on 1 July 20X1 with a delivery van worth $50,000 and
cash of $18,000 deposited in the business bank account.
The following information relates to his first year of trading:

(a) Withdrew $500 per month from 1 January 20X2 from the business bank account
for personal use.
(b) Took goods costing $1,200 for home use.
(c) Paid $8,000 for office rent from his personal bank account.
(d) Sold his personal investment previously bought at $12,000 for $18,000, and
deposited the profit into the business bank account.
(e) Assets and liabilities balances as at 30 June 20X2 were:
$
Office equipment 4,000
Bank Overdraft 7,500
Motor vehicles 50,000
Accrued Commission income 500
Inventory 8,900
Trade receivables 16,400
Trade payables 7,800
Accrued Rent expense 2 000
Additional information to be taken into account:

1. Depreciation is to be provided on motor vehicle at 10% per annum on net book
value.

Answer:
Calculation of profit or loss for the year ended 30 June 20X2
$
Ending capital * 56,500
Add: Drawings [ ( $500 x 6 months ) + $1,200 ] 4,200
Less: Additional capital [ $8,000 + $6,000 ] (14,000)
Less: Beginning capital [ $18,000 + $50,000 ] (68,000)
Loss for the year (21,300)
* Ending capital = Total assets - Total liabilities

Total assets = 4,000 + 50,000 + 8,900 + 16,400 - (50,000 x 10%)
= $74,300
Total liabilities = 7,500 + 500 + 7,800 + 2,000
= $17,800
Ending capital = 74,300 - 17,800
= $56,500

17.2 Statement of Affairs

Is similar to a Statement of Financial Position except that it is prepared without the use
of double entry recording rules.
Format:
Statement of Affairs at “date”
$ $ $
Accumulated Book
Cost Depreciation value
Non-current Assets
List down all non-current assets XX XX XX
: XX XX XX
: XX XX XX
XXX XXX XXX
Current Assets
Trade receivables XX
Less: Provision for doubtful debts (XX) XX
Inventory (Not applicable for service business) XX
Other receivables (prepaid expense/accrued income) XX
Petty cash XX
Cash / Bank XX
XX
Current liabilities
Trade payables XX
Other payables (accrued expenses / prepaid income) XX
Bank overdrafts XX XX
Net current assets (current assets - current liabilities) XX
(non-current assets + net current assets) XXX
Financed by
Capital
Balance XXX
XXX

Format for Statement of Affairs Including Calculation of Profit for the year
Statement of Affairs at “date” (Extract)

$ $ $
Financed by
Capital
Opening balance XX
Add: Additional capital XX
Add: Profit for the year (OR Less: Loss for the year) XX
XX
Less: Drawings (XX)
XXX

17.3 Account Analysis Method

Profit or loss for the year is determined by reconstructing various ledger accounts to
determine the missing information on income and expenses.
17.3.1 Determining Sales
Total Sales = Cash sales + Credit sales
Obtain from Prepare

Cash Book Sales ledger
control account
Net Sales = Total sales - Sales return
17.3.2 Determining Total Purchases
Total Purchases = Cash purchases + Credit purchases
Obtain from Prepare

Cash Book Purchases ledger
control account
Net Purchases = Total purchases - Purchases return
17.3.3 Determining Cost of Sales
Opening Total Other Cost of Purchases Closing

inventory
+ purchases
+ Purchases
- Return
- Drawings - inventory

17.3.4 Determining Depreciation
Beginning New asset Sale of Ending

Net book value
+ purchased
- non-current asset
- Net book value
17.3.5 Determining Operating Expenses
Opening Opening Current Current

Expenses
Paid
+ Prepaid - Accrued - period + period
balance balance Prepaid Accrued
17.3.6 Determining Other Income
Opening Opening Current Current

Income
Received
+ Prepaid - Accrued - period + period
balance balance Prepaid Accrued

Example:
The following information pertains to the year ended 30 June 20X2:
(a) Extract from the Bank Account:

20X2 $ 20X2 $
Jun 30 Trade receivables 5,000 Jun 30 Trade payables 3,250
Sales 1,800 Purchases 1,500
Rent 2,000
General expense 700
Fixtures 4,000
(b) Extract from Balance Sheet:

1 July 20X1 30 June 20X2
$ $
Inventory 4,500 2,800
Fixtures 2,000 5,000
Trade receivables 3,000 4,500
Trade payables 1,200 1,100
Prepaid rent 200 350
Accrued general expense 90 150
(c) During the year,

(i) Credit note received amounted to $400
(ii) Credit note issued amounted to $600
(iii) Debts written off was $200
(iv) Owner withdraw goods amounting to $600 for personal use
For the year ended 30 June 20X2, calculate the followings:

1. Net sales
2. Total inventory purchased
3. Cost of sales
4. Total expenses
5. Profit or loss for the year

Answer:
1. Cash sales = $1,800
Constructing the Sales ledger control account, we have
3,000 + Credit sales - 5,000 - 200 - 600 = 4,500
Therefore, credit sales = $7,300
Total sales = 1,800 + 7,300 = $9,100
Net sales = 9,100 - 600 = $8,500
2. Cash purchase = $1,500

Constructing the Purchases ledger control account, we have
1,200 + Credit purchase - 3,250 - 400 = 1,100
Therefore, credit purchase = $3,550
Total inventory purchased = 1,500 + 3,550 = $5,050
3. Cost of sales = 4,500 + 5,050 - 400 - 600 - 2,800 = $5,750
4. Total expenses
= Rent expense + General expense + Depreciation of fixtures + Irrecoverable debts
= (2,000 + 200 - 350) + (700 - 90 + 150) + (2,000 + 4,000 - 5,000) + 200
= $3,810
5. Loss for the year = Gross profit + Other income - Expenses

= (8,500 - 5,750) - 3,810
= - $1,060

17.4 Ratio Analysis Method

Key financial information necessary to derived at the profit or loss for the year is
determined by calculating a group of financial ratios that relates to one another.
Gross Profit
1. Gross margin = × 100% = x %
Revenue
Gross Profit
2. Mark-up on cost = × 100% = x %
Cost of Sales
Example:
Mark-up of 20% unit cost $1 + markup $0.20 = unit selling price $1.20
Profit for the year

3. Profit margin = × 100% = x %
Revenue
Cost of Sales
4. Rate of Inventory turnover = = x times
Average Inventory
Beginning inventory + Ending inventory

Average inventory =
2

Chapter 18.Analysis and Interpretation

18.1 Liquidity Analysis
Liquidity measures the ability of a business to repay current debts and fund its daily
business operation.
1. Working Capital
refers to the excess of current assets over current liabilities.
Formula:
Working capital = Current Assets - Current Liabilities
Analysis:
Current asset increase , Working capital increase
Current asset decrease , Working capital decrease
Current liability increase , Working capital decrease
Current liability decrease , Working capital increase
Effects of insufficient working capital:

• Unable to repay debts on time
• Unable to enjoy cash discounts
• Unable to purchase goods on credit
• Unable to enjoy bulk discount
• Difficulty in retaining staffs
• Lose the trust of customers
Improving working capital:

• Owner may inject more capital
• Take up a long-term loan
• Sell excess non-current assets

2. Current ratio (or working capital ratio)

measures the ability of a business to pay its short-term debts using its current
assets.
Formula:
Current asset
Current ratio = = x :1
Current liability
Analysis:
Example:
(a) Current ratio = 1:1
means the business has $1 of current assets to pay every $1 of current debt.
Therefore, business is liquid.
(b) Current ratio = 0.8:1

means the business has $0.80 of current assets to pay every $1 of current
debt; Or
means the business can only fulfill 80% of its current debts with its current
assets. Therefore, business is not liquid.
3. Liquid ratio (or acid test ratio)

measures the ability of a business to pay its short-term debts using its quick
(or immediate) assets.
Formula:
Current asset − Inventory
Quick ratio = = x :1
Current liability
Analysis:
Example:
(a) Quick ratio = 1:1
means the business has $1 of quick assets to pay every $1 of current debt.
Therefore, business is liquid.
(b) Quick ratio = 0.8:1

means the business has $0.80 of quick assets to pay every $1 of current debt
Or
means the business can only fulfill 80% of its current debts with is quick assets.
Therefore, business is not liquid.

4. Rate of Inventory Turnover

measures the rate at which a business sell and replenishes its inventory during
the financial year.
Formula:
Cost of Goods Sold
Rate of Inventory Turnover = = x times
Average Inventory
Beginning inventory + Ending inventory

Average inventory =
2
Analysis:
Example:
Inventory turnover rate of 4 times means the business replenishes its inventory 4
times a year or every 3 months.
High inventory turnover rate means business is selling its inventory quickly.
Low inventory turnover rate means business is unable to sell its inventory
quickly and is holding too much stock.
Effect of inventory on liquidity and profitability:
High inventory level Low inventory level
Cash is tied up causing liquid ratio Unable to meet customer demand

to decrease resulting in lost sales which leads
to:
Increase in expenses which
decrease in profit for the year
reduces profit for the year due to:
lesser cash
High storage and handling
cost Increase in cost of sales which
Obsolescence reduces profit for the year due to:
Theft frequent replenishing which
results in high cost of
purchase
Improving inventory management:

Increase sales of inventory by
reducing selling price
giving trade discounts or special promotions
advertising to raise brand awareness

5. Trade receivables turnover

measures the average time (days) a business takes to collect from its credit
customers during the financial year.
It indicates how efficient a business is in managing its trade receivables.
Formula:
Trade receivables
Trade receivables turnover = × 365 =
x days
Credit sales
Analysis:
Example:
Trade receivable turnover of 30 days means the business takes an average of 30
days to collect from its credit customers.
High trade receivables turnover (days)

Not efficient in collecting its debts
Lead to cash flow problem
6. Trade payables turnover

measures the average time (days) a business takes to pay its credit suppliers
during the financial year.
It indicates how well a business manages its cash outflow.
Formula:
Trade payables
Trade payables turnover = × 365 =
x days
Credit purchases
Analysis:
Example:
Trade payable turnover of 30 days means the business takes an average of 30 days
to repay its trade payables.
High trade payable turnover (days)

Advantages:
increase business' working capital
free short-term cash flow
Disadvantages:
suppliers may not want to offer trade credit or extend further credit line
business loses out on cash discount

18.2 Profitability Analysis

Profitability measures the ability of a business to generate enough income to cover its
expenses.
Purpose of profitability analysis:

Identify areas to improve revenue
Identify areas to improve operating efficiency
Allow investors to determine their return on investments
Ratios used to measure profitability:

Gross Profit
1. Gross margin = × 100% = x %
Revenue
Analysis:
Gross margin of 10% means for every $1 of net sales revenue earned, the business
earns $0.10 of gross profit.
A high / increase in gross margin suggest:

• High / increase in selling price
• Low / decrease in cost price
Gross Profit
2. Mark-up = × 100% = x %
Cost of Sales
Analysis:
Mark-up of 10% means for every $1 cost, the business earns $0.10 of gross profit.
A high / increase in mark-up on cost suggest:

• High / Increase in selling price
• Loss of quantity sold if inventory turnover rate decrease

Profit for the year

3. Profit margin = × 100% = x %
Revenue
Analysis:
Profit margin of 10% means the business earns a profit of $0.10 on every $1 of net
sales revenue earned.
A high / increase in profit margin suggest:

• Increase in gross profit
• Decrease in expenses
Net Profit before Interest

4. Return on capital employed (ROCE) = × 100% = x %
Capital Employed
Capital Employed = Issued shares + Reserves + Non-current liabilities
Analysis:
Return on capital employed of 10% means for every $1 of capital invested into the
business, the business generates a profit of $0.10.
A high / increase in return on capital employed suggest:

• Business is profitable
• High return on investment

Analysis:
Scenario Possible reasons / analysis
1. Gross margin • Increase in quantity sold

Inventory turnover rate • Low selling price or
• High cost price
2. Gross margin • Increase in selling price

Mark-up • Decrease in quantity sold
• Lower sales
3. Gross margin • Decrease in gross profit

Profit margin • Higher percentage decrease in expenses
4. Profit margin • Profit earned is low compared to the

Return on capital employed high amount of capital invested
• Business is worth investing if profit
continues on an increasing trend
Improving profitability:
Source for cheaper supplier to reduce cost of purchase of inventory
Hold promotion to increase sales
Increase product variety to attract more customers
Source for other income
Reduce expenses through cost cutting measures


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Accounting Topical Revision Notes

For Cambridge iGCSE and O Level (7707)

I Produced by Art of POA. Published by Art of Maths LLP

Full profile of author can be found at www.artofpoa.com.

II Produced by Art of POA. Published by Art of Maths LLP

Chapter 1. Accounting Principles and Policies ....................................................... 1

Chapter 2. Business Documents and Books of Prime Entry ............................. 7

Chapter 3. Trial Balance ................................................................................................. 14

Chapter 4. Correction of Errors .................................................................................. 16

Chapter 5. Bank Reconciliation ................................................................................... 18

Chapter 6. Trade receivables and Trade payables ............................................. 21

Chapter 7. Capital and Revenue Expenditure and Receipts .......................... 26

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Chapter 8. Accounting for Depreciation ................................................................. 29

Chapter 9. Other Payables and Other Receivables ............................................. 38

Chapter 11. Valuation of Inventory .......................................................................... 45

Chapter 12. Sole Traders............................................................................................... 46

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Chapter 13. Partnerships .............................................................................................. 52

Chapter 14. Limited Company .................................................................................... 61

Chapter 15. Clubs and Societies ................................................................................. 66

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Chapter 16. Manufacturing Accounts ...................................................................... 69

Chapter 17. Incomplete Records ............................................................................... 73

Chapter 18. Analysis and Interpretation ............................................................... 82

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Chapter 1. Accounting Principles and Policies

2. Money Measurement principle states that only transactions measured in monetary

Unable to measure in dollar ($) value

Capital account: Owner contributes assets Business

Drawings account: Owner withdraws assets Business

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Example where concept is applied:

Year 1 Year 2 Year 3 Year ∞

Depreciation Reducing- Reducing- Reducing- Reducing-

Depreciation of Non-current assets are reported at net book value in the

.... must not overstate its non-current asset and understate

Provision for Trade receivables are reported at net trade receivables in

.... must not overstate its trade receivables and understate

Inventory Inventory are valued at lower of cost and net realisable

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Depreciation of Depreciation is recorded as an expense in Income

.... depreciation expense must be matched against income

Provision for Doubtful debts are recorded as an expense in Income

.... loss from debts estimated to be uncollectible must be

.... all business expenses must be matched against all

NOW 5 YEARS LATER

Statement of financial position Statement of financial position

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8. Materiality principle states that a transaction or an item is considered material if it

This concept is asked in conjunction with questions on Capital and Revenue

9. Going Concern principle states that a business is assumed to operate indefinitely.

Examples where concept is applied:

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12 months 12 months 12 months 12 months 12 months

Prepare Prepare Prepare

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1.2 Accounting Policies

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Chapter 2. Business Documents and Books of Prime Entry

Transactions Business documents

Business documents Transactions / Uses

1. Invoices Credit purchases and sales

2. Credit note Returning of goods by credit customers or to credit supplier