Study Guide

David Austen
Estellita Louisy
Seema Deosaran-Pulchan
Theodora Sylvester
OXFOlill
UNfVERSl1' Y PltSSS

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The exam-style questions and answers th ac appear in t his Access your support webslle tor answers and
book and on t he accompanying website have been written add tlonal aetlvil,es here:
by t he am hors. In an examination. che quesdons and the www.oxfordsecondary.com/9780198437314
way the quescions are marked m ay be different.
 Contents
Introduction 4 6. 7 Worked example: adjustments 98
Section 1 Accountlng as a profession
Practice exam Quest,ons 102
1.1 lntroductr-on to acoounting 6 Section 7 Control system
1.2 Ethical pnnciples and accou nling 8 7.1 lnt:oductlon 104
Practice exam ques:ions 9 7.2 More about errors and the trial balance 107
7.3 Correcting profits 109
Section 2 Accounting as a system
7.4 'No~<ed example: correcting error$ 110
2.1 Concep:s, the accounting cycle
and business organisations 10 7.5 Control accounts 113
2.2 Financial statements, technology and accounting 12 7.6 1No6,ed example: control acocunts 116
14 7.7 Bank teconcil ation statements 118
2.3 The statement of financial cos.lion (balance sheet)
7.8 Worked example: preparing a bank
2.4 The class lied statement of financia
position (balance sheet) 16 reconcilation statement 120
2.5 The effect of transact10ns on the statemen:
Practice exam quest ens 122
of financial ooS'tion (balance sheet) 18 Section 8 Accounting for partnerships
Practice exam ques:ions 20 8.1 lntroducilon 124
8.2 The accounts of partners 126
Section 3 Books of original entry
8.3 More about partnerships 128
3.1 lntreduct,on 22
3.2 Preparing source documents; oiscounts 24 8.4 Partnership statements of financial pos1t10n 130
3.3 us,ng S01.Jrce documents to make emries
8.5 INorked examc'e: partnerships 132
Practice exam quest ens 134
in the purchases and sales books 26
3.4 The returns ou~,vards and returns inwa'ds beaks 28 Section 9 Accounting for limited liability companies,
3.5 The three-column cash book 30 co-operatives end non-profit organisations
3.6 The petty cash book 32 9.1 lnt:oduetlon 136
3.7 The general journal 34 9.2 Types of I mtted liabillty company, co-operative
3.8 Balanc•ng casn books and posting books and non-profit organisation 138
of orig nal entry totals 36 9.3 How ca;:,ltal is calsed by I mi'.ed llabilAy
Practice exam questions 38 companies and co-operatives 140
9.4 Journal e'1trles for the issue of sha,es
Section 4 Ledgers and the trial balanee
40 and debentures; dividend calculations i42
4.1 Preparing ledger accounts
9.5 The apc,opriatoon account; the limlted
4.2 Posting transact,ons 43 company's ,noorr,e statement ·44
4.3 Balanc,ng accounts 46
9.6 Company statements of finarcial position
4.4 CIOsing accounts 48
4.5 lnte(J)reting entries and preparing a trial t:alance
{calanoe Sl1eets) 146
50 9.7 V'/orked example: preparing company finane<al
4.6 'Norked example: preparing books of
statements 148
original entry and double-en1,y records 52
Practice exam questions 60 9.8 Final accounts of co-operat1VeS 151
9.9 Worked example: co-operatNes 153
Section 15 Preparation and analysla of sole 9.10 Non-p,oflt organisat ons 157
trader financial statements Practice exam quest,ons 159
5.1 lntr<Xluct,on 62
5.2 More about income statements 64 Section 10 Manufacturing and Inventory control
5.3 Journal entries and tne income statement 66 10.1 Accounts of manufaciurers 161
5.4 The capital account and ser,nce business t0.2 More abOut manufactunng accoums 163
income Slatements 68 t0.3 The income statement and staterr.ent of
5.5 Classified statements of financial posttion financial pos t<On {balance sheet) 165
(ba~nce sheets) ,n vertical slyle 69 10.4 Worked example: mam.naclunng accounts 166
5.6 'Norked example: so!e trader financial statements 70 10.5 Basic costing p:ocedures 170
5.7 Rat,os and pro~tabll ty 74 t0.6 V'/orked example: costing p<0cedu,es 173
5.8 Rat,os and financial posrt.cn 76 10.7 !rventory va'uattor, 176
5.9 Recommendations based on ratio analyS.s 78 Practice exam Questions 177
5.1 O ~Vorked example: reporting on performance 80
Practice exam questions 82 s.ctlon 11 Accounting for the entrepreneur

Section 8 Accounting adjustments 11.1 Payroll accounting 179

6. 1 Accounting concepts and adjustments 84 11.2 More about payroll 181
6.2 Expense and income adjustments 86 t t.3 Calculat ng net pay 183
6.3 Expense and income adjustments ano t1.4 Budgets ands mple business plans 185
financial statements; bad debts 89 1 t.5 Worked examole: preparing budg&1s
6.4 Crea!lng a provision for doubtful debts 91 and cash flow forecasts 187
6.5 More about provis~:ns for doubtful debts 93 Praciice exam Questions 190
6.6 Deprec.ation 96 Index 192
This Study Guide has been developed exclusively with
1he Caribbean Examinations Council (CXCe) to be
used as an additional resource by candidates . both In
and out of school, following the Caribbean Secondary
Education Certificate (CSEci program me.
It has been prepared by a team with expertise in
the CSEC<t syllabus, teaching and examination. The
contents are designed to support learning by providing
tools to l1elp you achieve your best in CSEC<ll Principles
of Accounts and the features included make it easier
for you to master the key concepts and requirements
of the syllabus. Do remember to refer to yovr syllabus
for full guidance on the course reqvirements and
examination format!
Features
As you work through this Study Guide you will come
across the following features:
LEARNING OUTCOMES
1n this unit you will learn about:
• the concept and purposes of accounting
• the users of accounting Information.
The Objectives boxes tell you which objectives from the
specification the content you are about to read relates to.
KEY TERM
Ethical principles of accounting: the moral
principles and standards that govern the
conduct of those working In the profession.
The Key terms boxes provide definitions of the words
or phrases highlighted in bold in the text. Being able
10 use technical vocabulary will help you in your exam,
and the key terms are also collected togelher In a
glossary on 1he support website.
LINK % can use lo test your understanding of each topic. The
Section 10 explains the accounts
of manufacturing organisations
and Section 5 Includes a focus
on seNice businesses.
The Link boxes explain links between content in
different sections of tne Study Guide, helping you build
a rounded picture of the subject.
. . - ,. ' -· . ;
DID YOU KNOW?
Debit notes are not often encountered. As well
as being issued to prompt the receipt c f a credit
note, they are sometimes issued by a business
to correct an undercharge on an invoice issued
to a customer.
The Did you know? boxes provide you with additional
information to set your learning in context.
EXAM TIP
It <s worti1wl1ile
)>Ytl ct<Sii,cg bt1Lt1..,,cii,cg
t!CCOIA.11\.tS Cl.s tl1t.s is
oftell\. "'-llt olo"'e well i..,,
ex.ti""-'~ t io ""5.
Exam tips are designed to help you overcome common
mistakes or misconceptions.
SUMMARY QUESTIONS
1. Why is accounting important?
2. lden11fy two internal and two external users of
aocounting Information.
3. Describe the main difference between the
work of a bookkeeper and the work o' an
accountant.
4. fden1ify one emerging career for:
a. a bookkeeper
b. an accountant.
The Summary questions box contains questions you
answers are provided on the support website.
Command words
The syllabus Is divided into eleven sections, and each
section is based around specific learnir,g objectives -
tnese are a list of what you should know, understand
or be able to do as a result of learning the Principles
of Accoun!s. This study guide guides you through ,he
objec,ives.
Each objective slarts wtth a command word, whioh l ells
you what you need 10 do. Belov,1 is a list of the mo51
common command words, wlrn a brief description of
whal each of them means:
• Define: Set out a clear definrtion of what a specttic
term means.
• Distinguish between : Explain the difference
between one thing and anotner.
• Identify: Indicate what something is.
• State: Express some'.hing clearly.
• List: Provide an appropriate list of particular aspects
or features.
• Outline: Sel out the key aspecls of.
• Describe: Sel out in words.
• Interpret information: Show wha11r.e informalion
you are supplied wtth means.
• Construct/draw up: Prepare, a financial statement.
• Classify: Arrange according to shared
characteristics.
• Explain: Make an idea clear to the reader.
• Discuss: Set out a brief discussion.
• Evaluate: Assess in order to make a judgement
about something, weighing up t11e arguments for and
again51 and arriving at a measured conclusion.
Make sure lhat you understand these command words,
so that wr en you are faced with them in an assessrnen1,
you know what 1he examiner wanls. Questions lhat use
command words like ·evaluate' and 'disouss' will usually
be worth higher marks than questions that simply ask
for lists or ask you to identify something.
Study skills
The key to revising is to start early and to plan your
revision in an organised way. Allocate sufficienl time
to revise all eleven sections of the syllabus so that you
build up S1rength across the syllabus. The reality is that
you probably vvill no'. be able to do as much revision
as you originally plan. However, if you are organised
and break up your revision into lots o' small sessions.
lhen you will look back and surprise yourself by how
much you have coveredl Don't forge1 to work through
some queS1ions and check your answers against mark
schemes so that you can identify the areas you need to
focus on to improve your understanding.
The greal thing about revising Principles cf Accoums is
lhat the principles you are learning aboUt apply to real
world conteXis. Every day you witness businesses and
other organisations in action. To help you revise, relale
whal you see to the principles of accounts you have
been learning, and talk about them to your friends and
people you share your home wtth. Amaze lhem wtth your
grasp of this exciting field. Al the same lime, follow lhe
business news in your national paper. on the Internet and
in television reports. and particularly any reports about
companies' financial results. This will help to consolidate
your learning ot accoun1ir,:J principles and terms.
This Study Guide is supported by a webstte w'nich
includes a glossary o' the key terms and answers to
the questlons in the Study Guide as well as elecironic
aciivities lo assisl you in developing good examinalion
techniques:
• On Your M arks activities provide example
examination-slyle short answer and essay type
queS1ions, 1J1Jith example candidate answers and
feedback from an examiner to show where answers
could be improved. These activities will build your
understanding, skill level and confidence in answering
examination questions.
• Test Yourself activttles are specifically designed to
promote experience of multiple-choice examination
Que$lions.
So to recap:
• Revise regularly In small chunks.
• Study the lists and tables provided in this book to
support your learning.
• Work lhrough queslions and check model answers
to improve your skills and develop confidence.
• Think aboul how command words hold lhe key lo
specific objeciives.
• Learn from tne real world and talk about aocounting
principles lo others.
• Explore the On Your Marks activities to find out how
marks are awarded.
• Practice answering multiple-choice questions wtth
the Test Yourself aciivities.
• Back yourself to do well.
This unique combination of focused syllabus content
and imeraciive examination practice will provide you
with invaluable support to r elp you reach your full
potential in CSEC~ Principles of Accounts.
'4 Access yoor support website for additional
~ content and activities t,ere:
www.oxfordsecondary.com/9780 198437314
 Introduction to accounting

LEARNING OUTCOMES
In this unit you will learn about:
• the concept and purposes of
accounting
• the users of accounting
Information.
The concept and purposes of accounting
It is important for those individuals responsible for the success of
businesses to know:
• whether a profit is being made, because this is the main reason for
having a business - Is the business profitable?
• whether there are sufficient funds to meet all the commitments of
the business on time - Is the business liquid?
• that they are making the best use of the funds that have been
Invested In the business - Is the decision-making sound?
Accounting will provide accurate and comprehensive financial
information to those responsible for running a business, to help them
make decisions that will support its survival and success.

The users of accounting information

The following table lists the main users of accounting Information.

Internal users of accounting information

Owner(s) \.Yill have invested personal savings in a busine5$ and be dependent on the success of the
business (i.e. profrts, :survival, etc.) for his or her livelinood
Manager Will be concerned about the performance of the business and will wish to Identify any
weaknesses and problems so that steps can be taken to rectify these and to ca,pttalise on
business opportunities
Employees Dependent on tl1e success of the business for job seet,rily, Increases in pay and promolion
opportunities
External users of accounting information
Cus1omers Dependent on the success of 111e busine5$ lo ensure that the goods or services they wish to
buy are of good quality and available when they are needed
Suppliers \.Yill be concerned that ,he business can pay for goods or services on l ime, and aboU1 the
po5$ibility of repeat and growing orders
Banks May have lent funds to a business and will therefore wish to ensure that interest payments and
loan repayments can be made when due
Potential \,Viii carefully consider the possible returns on any Investment made and the risks involved
Investors
GovernmenV \,VIII want to know the profit being made by the business so that accurate tax assessments can
Tax atrthorities be made
Competttors \,Viii wish to compare their own resuhs with those of the business
Local \.Yill consider the impact of the busine5$ on the environment, tr e contribution made to the local
community economy and the possibiltty of employment opportvntties
It is important to remember that access to the accounting records of
sole trader and partnership businesses is limited to internal users and
government/tax authorities.

Traditional and emerging careers in accounting

The provision of accounting Information relies on the work of two
different groups of Individuals - bookkeepers and accountants -
whose responsibilities are summarised in the following table:
Main responsibility Examples
Bookkeeping The recording of financial • Preparing accounts by entering and posting transactions
information, particularly (probably using a computer soltware prcgram)
transactions. in a systematic way
• Preparing trial balances
• Checking the records tor accuracy
• Preparing payroll and inventory records
• Assisting the work of the accountant(s)
Accounting The selecting, classifying and • Preparing financial statements
summarising of financial data
• Preparing budgeis
in ways that provide owners of
business and others wtth useful • Supervising the work of bookkeepers
information to help them assess • Analysing fl'lancial statements
per'ormance and make informed
decisions • Making recommendations and providing advice on how
to improve performance
• Preparing tax assessments

The fcilowing table gives examples of both traoitional and emerging

SUMMARY QUESTIONS
careers in bookkeeping and accounting:
1. \Nny is accounting
Traditional careers Emerging careers
Important?
Bookkeeper • Accounts receivable clerk • Bookkeeping
software specialist 2. Identify two internal and two
• Payrcll clerk external users of accounting
• Payroll software Information.
• General ledger clerk
operative
3. Describe the main oifference
Accounting • Accounts manager • Accounting soltware betvveen the v1or1< of a
developer bookkeeper and the work of
• Tax accountant
• Environment an accountant.
• Internal auclhor
accountant 4. Identify one emerging career
• Management accountant for:
• E-commerce
specialist a. a bookkeeper
b. an accountant.

LEARNING OUTCOMES
In this unit yov will learn about:
• ethical Issues in the field 01
accounting
• the results ol inappropriate
application of ethical
principles of accounting.
KEY TERM
Ethical principles of
accounting: the moral
principles and standaros that
govern the conduct of those
working in the profession.
Ethical principles
and accounting
Ethics is about moral principles and standards of behav1our. In
accounting it Is vital that clients can have complete trust in their
accountant, since the accountant has access to so much information
that Is both confidential and sensitive. Accountants are required
to abide by certain ethical principles to demonstrate honesty and
fairness and to ensure public trust ls maintained.
The ethical principles of accounting are summarised as follovvs:
Ethical principle Description
Being slraightfcrward and honest irl all
Integrity
professional and business relationships
Avoiding bias, conflicts of interest or the
Objectivity undue influence of others when making
professional judgements
Keeping knowledge and skills al the
Prof~sional competence
appropriate level in order to deliver the
and due care
services to clients diligently
Avoiding ,he disclosure of information to
others without expressed permission; not
Confidentiality
using a client's Information for personal
advantage
Taking personal responsibility !or
adopting the highest standards of the
profession by complying with legal
Prol~sional behaviour
requirements and regulations and
avoiding any aclion that would discredit
the profession
Maintaining ethical principles requires strength of character and
courage. Where there is a failure to apply ethical principles the
following consequences could arise:
• Law suits • Fines
• Loss of Job • Imprisonment
• Loss of integrity/reputation
SUMMARY QUESTIONS
1. What is meant by the term ethical principles of accounting?
2 . What could be the consequence of:
a. mahgnlng a colleague
b, missing a deaollne for filing tax documents
c . fraudulent activities?
 Practice exam questions

Paper1
1 Which one of '.he following would you expect to A I and II Only B I and Ill only
be Included In tne duties of a bookkeeper? C II and Ill only D I, II and Ill
A preparing b:.idgets
3 Which o' the 'allowing Is not an etnical pnnciple
B preparing a cash book of account Ing?
C a'>alyslng financial S1atemeots A objectivtty B duecare
D make :ax assessments C lntegmy D ace1;racy
2 Which of the fellowing would you expect to be
incli.,ded in the duties of an accounta'lt?
I developing financial sys1ems
II preparing trial balances
Ill working with avdltors

Paper2

1 The users of accounting Information 3 In eacn of the following situations slate tne
elhical principle of accounting 1hat should
Dwight Is the owner of small retail business. He
be applied by Seema, who works In a firm of
runs the business on his ov✓n. He purchases
accountants.
goods on credtt and has recently taken out a
bank loan. The busi~ess made a profit during Situation Ethical principle
the financial year just ended. Seema Is about to make
a Identify four users of accounling information a tax assessment ior a
about this retail business from the information client, out she has Just been
available. Informed that the government
has made changes to tax
b State the Interest In the business of the four
regulations.
users identified in answer to a.
A c'lem has asked ior
2 Complete the following table, Identifying who depreciation cnarges to be
would be responsible for each task. Answer reduced In the current 1noome
either 'bookkeeper' or 'accountant' Statemem so that profits are
Carried out by shown at a higher value.
Task
A friend has asked Seema
Preparng an Income statement
whether h WOUid be a good
Recording cash takings Idea to Invest some savings
Prepar,rg a saes budget In a ouslness that happens
Calculating an emp!oyee's pay to be a client of the firm of
accountams.
Prepanng a cap,ta1 account
Seema has become aware
Analysing a s1aternem oi flnanc,al
that a fellow emp.oyee may
position (balance sheet)
nor be acilng m the best
Prepanng a report on the Interests of one of ihe firm's
performance of a business clients.
Maintain ng records o1 inven tory
Posting ihe cash book entries to
ledger accounts
,

, - -9 I
:

LEARNING OUTCOMES
In 1his unit you will learn about:
• the concepts and
conventions that guioe the
accounting process
• the accounting cycle
• different types of business
organisation.
LINK
SeC1ion 10 explains the aocoJnts
of manufactunng organisations
and Section 5 includes a focus
on service businesses.
Concepts, the accounting
cycle and business
organisations
Concepts and conventions th at guide
the accounting process
There are a number of fundamental rules that must be followed when
preparing financial statements. These rules are often re!erreo to as
accounting 'principles·, 'concepts' or 'conventions'; the following
are examples:
Concept Description
Accrual In order to calculate pro'tt. income for a financial
{matching) period is ma1ched with expenses tha1 rela1e 10 that
accounting period, whether paid or no:.
Pn;dence Wnere 1here is doubt, asset and profit values should
(conseivalism) be understa1ed rather than overstated.
Consis1ency Accounting policies should be carried out In 1he
same way year after year so 1hal compariscns of
performance can be made on a valid basis.
Separa1e Only transactions affeC1ing the financial position of a
en1ity business are recorded in tts books of account. The
owner's private financial affairs are not recorded.
The accounting cycle
In order to prepare accounting records it Is essential that a particular
sequence of events and processes is followed. This sequence is
often referred to as the ·accounting cycle' (see opposite). The term
'cycle' is used because the seouence of activities is continuous.
Types of business organisation
What is a business? Businesses are organisations that provide goods
and/or services in order to make a profit.
There are a number of ways of classifying businesses. Businesses
can be classified by what they do, for example:
%
• Provide raw materials through mining, farming, fishing, etc.
• Manufacture goods, turning raw materials Into finished products
• Sell goods to the general public (retailers) or to other businesses
(wholesalers)
• Provide seivices to r businesses and the general public
 Step 1
Coect
source
doc uments

Step 2
Steps Extrac: ~Y facts
Prepare and-of• from source
year financial docu=ts a'id
statements reoord In books of
original entry

Step4
Prepare a trial
balance to cnecl<
the accuracy of
the double entry
Step3
Pos: lnformatlor
from !looks of
or glna eritry :o
ledger accounts

The acoounting eye~.

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

them, for example:
• Sole trader one individual owns and controls the business.
If successful, the profits maole by the business belong to this
Individual; If unsuccessful, the Individual can lose whatever has
been invested as well as private resources. Much of this book is
concerned with the accounting records of sole traders.
• Partnerships several individuals own the business. Partners jointly
control the business, sharing profits between them. They are also LINK %
jointly responsible for the debts of the business, and can lose their There is more detailed
private resources If the partnership Is unsuccessful.
information about accounting
• limited liability companies (corporations) owned by for partnersr ips l'l Section 8
shareholders vvho: and acoounting for limited liability
companies, co-operatives and
• contribute the funds needed to establish and run the company
non-proftt organisations in
• are rewarded wlth some 01 the profits made by the company if Seciion 9.
successful
• carry a responsibility for the debts of the company that is limited
to the amount they have Invested SUMMARY QUESTIONS
• are not at risk of losing their private funds if things go wrong. 1 . What ls an accounting
unlike sole traders and partners. concept or convention?
• Co-operatives are organisations that are formed and controlled Give one example to
by members. They are run to provide their members with goods illustrate your answer.
and seNices rather than to make a profit. \II/hen successful. 2. Llst the seouence of
co-operatives may rewaro their members ln a number of ways activities that make up the
including some share of any surplus made, but usually surpluses accounting cycle starting
are reinvested In the organisation. with collecting source
• Non-profit organisations include clubs and societies that are documents.
formeo by their members so that they can meet for particular activlties: 3. Describe two different types
perhaps social or sporting activities. These organisations do not aim to of business organisation.
make a prom, but have to be financially viable In order to survive.

LEARNING OUTCOMES
In this unit yov will learn about:
• the main financial statements
prepared by various business
organisations
• the role and Impact
of technology on the
accounting process.
Financial statements,
technology and
accounting
Financial statements
The main financial statements produceo by business organisations
are as follows:
• Income statement This records the profit or loss made by a
sole trader, partnership or limited company. comparing revenue
{income) with costs. In the case of partnerships and limited
liability companies, the Income statement is accompanied by an
appropriation account showing how profits are to be distributed.
• Income and expenditure account This records the surplus or
deficit made by a co-operative society.
• Statement of financial position (balance sheet) This sets out
for all organisations details of resources owneo by the organisation,
its liabilities and its net value. It helps identify the organisation's
ability to meet its commitments on lime, and also whether its
resources are being used efficiently.
• Cash flow statement This provides summarised details of the
inflows of cash and the outflows of cash during a financial period.
The statement gives users Information about some of the Important
decisions made by the owner{s) of a business and how they will
affect the business's cash funds during a financial period.
Technology and accounting
Nowadays accounting records are usually produced using electronic
systems and specialised accounting software packages. A wide
variety of these is available, including Sage, QuickBooks and
Microsoft Dynamics.
Their main features are described below.
Automatic processing
The computer operator extracts Information from source documents
and inputs the relevant data into the software program. The other
accounting processes are automatic: ledger accounts are updated
Instantly and trial balances and other financial statements can be
produced on demand.
Integration of functions
As VI/ell as the main financial records, most software packages will also
produce inventory records, generate documents such as invoices and
credit notes and. In some cases, produce payroll records.
Management information
Managers can often be provided with aoditional information to
help run the business. such as details of amounts due from credit
customers, analysed according to the age of the debt, i.e. the length
of time it has been outstanding.
Advantages and disadvantages of computerisation
The benelits and potential dravvbacks of computerised accounting
processes are summarised below:
Benefits Potential drawbacks
Greater accuracy due to automation of Capital expenditure: There could be a heavy initial outlay on
processes compUier equipment and soflvvare programs; there is also likely 10
be the need to update at frequent Intervals.
Greater speed because updating and Training costs: Staff will need support In using new equipment
calculations are carried out virtually and software programs. and skills will need updating from time
Instantaneously to time.
Easier access to information using Risk of data loss: Systems can 'crash', arid security of data can
compuler software to find particular details be a serious issue.
More information available to help with Maintenance and support costs: Businesses have to invest in
management and decisicn making technical suppcrt to ensure systems provide conllnual service.
Reduction in staffing costs may be Period of transition: It is sensible to ruri old (manual) systems
possible because record keeping Is mainly alongside new computerised systems at least for a time to ensure
aulomatic that everyl),ing works as it should.

Additional functions
Computerised accounting systems can Include some uselul adoitional
functions, such as:
• Inventory control Inventor'/ records can be automatically updated
every time there Is a purchase ol goods, a sale ol goods, returns of
goods. etc.
• Credit control Computerised records of accounts receivable can
show how much is owed by each customer and for how long any
debt has been outstanding. This can help raise awareness of late
payers. Similarly, computeris~d records can be used to provide
details of amounts owed to credit suppliers, making it easier to
ensure that valuable cash discounts are not missed.
• Payroll Computer software programs can produce all the
necessary detailed information about wage and salary calculations,
payslips, payroll registers, etc.
• Management reports Soft1Jo1are programs can automatically
provide trial balances, income statements, statements of financial
position (balance sheets), ratio analysis and audit trails.

SUMMARY QUESTIONS
1. State the Importance of:
a. Income statements and
b. statements of financlal position (balance sheets)
to business organisations.
2. Why would you recommend a business switches to a
computerised accounting system? Descrtbe 1hree reasons
for doing so.
3. Give two reasons why some busine$ses choose not to have
a computerised accounting system.

LEARNING OUTCOMES
In 1his unit you will learn about:
• the components ot the
statement of 'inancial
position (balance sheet)
• exaMples of assets and
llabllltles
• how to construct a statement
of nnanclal position (balance
sheet).
KEYTERMS
Statement of financial
position (balance sheet):
a statement that shows an
organisation's assets, llabllitles
and capital at a particular date.
Cash at bank: the amount
of funds In the bank current
account of a business.
Cash in hand: the amount
of cash - notes, coins, etc. -
kept on the premises of the
business.
Accounts receivable:
amounts owed to a business
by customers.
Accounts payable: amounts
owed by a business to suppliers.
The statement of financial
position (balance sheet)
The components of the statement of financial
position (balance sheet)
A statement of financial position (balance sheet) Is a financial
statement that gives some important information about a business 10
Its owner, manager, or other interested individuals. II can be prepared
at any point in lime, but the statement of financial position is always
prepared for the end of the financial period of a business. It gives
details of:
• assets - the resources owned by the business
• liabilities - the amounts owed by the business to other individuals,
businesses or organisations
• capital - the net value of the business, which also represents the
owner's investment in the business
• how total assets = total capital + total liabllllies.
Typical assets for a small business include:
• cash at bank • land
• cash In hand • premises
• equipment • accounts receivable
• fixtures and fittings • vehicles
• inventory
Typical liabilities for a small business Include:
• bank loans • accounts payable
• bank overdraft
A simple balance sheet (statement of fi nancial
position)
The link between the assets, llabllltles and capllal ot a business Is
referred to as the accounting equation: Assets = Capital + Liabilities
~Vhatever assets are owned by the business must have been
purchased v,tith finance supplied by the owner (capital) and by
external parties Uiabilities).
,-ILLUSTRATION 1 The accounting equation
Isaac opened a business called 'The VIiiage Stores· on 1 May
2019. On this date he invested $40 000 (his capital} and borrowed
$10 000 from the bank (a liability). So, at lhis date the business
will have total assets of $50 000. Here ls the accounting equation
using this Information:
Assets = Capital + Liabllilies
S50 000 = $40 000 + $ 10 000
A statement of financial position (balance sheet) shows a detailed lisl
of lhe assets and liabilities of a business as well as its capital. The
information shown is always for a particular dale.
/ ILLUSTRATION 2 A simple statement of financial position
(balance sheet)

Here is a statement of flnanc ial position (balance sheet) baseo on

lhe detail In Illustration 1 abool Isaac's business.
Note: this statement
The VIiiage Stores of financial position
Statement of financial position {balance sheet) has been
(balance sheet) at 1 M ay 2019 sel out In what is caJled
s the vertical format, where
ASSETS there Is just one details
Furniture and fittings 17 000 column and one column
Vehicle 15000 for entering values. This
Eqvipment 8000 format is now widely
Inventory 7 500 used by businesses.
Cash at bank 2000
Cash in hand 500
50000

CAPITAL 40000

LIABILITIES
Bank loan 10000
50000

Guidance on preparing a simple statement

of financ ial position (balance sheet)
• The title should include the name of the business, or, if this is not
available, the name of the owner.
• The heading should always be 'Statement of financial position at
(a particular date)' (or 'Balance sheet at (date)').
• Abbreviations should be avoided when preparing financial
statements such as a statement of financial posttion (balance sheet).
• Assets are shown first wtth their values clearly set out In a separate SUMMARY QUESTIONS
column; the list starts with the subheading 'ASSETS',
1. What assets would you
• It is Important to set out figures carefully in a vertical list to make It expect to be owned by a
easy to calculate totals. hotel?
• The values for assets are totalled. In accounting a final total should 2. Explain why the value of
be double underlined. the assets of a business is
• Capital and liabilities are shovvn next, in the second part of the always equal to the total of
statement of financial position (balance sheet). Once again there its liabilities and capital.
is a separate column for values. Subheadings 'CAPITAL' and 3. State four rules to be
'LIABILITIES' are used. followed when preparing
• A total of the values for capital and liabilities is shown at the end of a simple statement of
the statement of financial position (balance sheet). financial position (balance
sheet).
• The tolal of the assets must equal capilal + total liabilities.

LEARNING OUTCOMES
In this unit yov will learn about:
• non-current and current
assets
• non-current and current
liabilities
• preparing classified
statements of 'inanclal
position (balance sheets} in
order of permanence and In
order of liouioity.
KEY TERMS
Non-current asset: a resource
owned by a business that will
be of benefit for a long pertod
(more than one year),
Current asset: a resource
owned by a business that •..viii
be of short-term benefit (less
than one year}.
Non-current liability: a liability
that will be settled in the longer
term (more than one year).
Current liability: amounts
owed by a business that will
be settled in the shorter term
(within one year).
Order of permanence: the
sequence used to list items on
a statement of 1inancial position
(balance sheet) beginning wtth
Items likely to be used by the
business for the longest period.
Order of liquidity: the
sequence used lo list Hems on
a statement of financial position
(balance sheet) beginning wtth
cash ano ending with the Items
least likely to be turneo
Into cash.
The classified statement
of financial position
{balance sheet)
Types of asset
Assets can be divided Into two categories:
Non-current assets: those assets tha1 a business intends to
keep and make use of for a long period (more than one year).
Typical examples of non-current assets are: premises, machinery,
equipment, furniture, fixtures, fittings and vehicles.
Current assets: those assets that are freo,uently changing in value;
they are assets that are quickly turneo into cash and are of benefit to
the business for a short period of time (less than one year}. Typical
examples of current assets Include inventories, accounts receivable,
cash at bank and cash in hand.
Types of liability
Liabilities can also be divided Into two categories:
Non-current liabilities: amounts owed that will be settled in the
longer term (more than one year}. A typical example of a long-term
liability is a bank loan (bank loans are normally repayable over a
number of years).
Current liabilities: amounts owed that will be settled in the shorter
term (less than one year). Typical examples of current liabilities
include accounts payable and bank overdrafts.
Preparing a classified statement of fi nancial
position (balance sheet)
The presentation of a simple statement of financial position (balance
sheet} can be improved by setting out the details to show the
different categories of asset and liability.
Assets are normally shown in an order that reflects how long each
asset is expected to benefi1 the business. This is called order of
permanence:
• In the first part of the statement of financial position (balance sheet}
non-current assets are recorded first, starting with premises.
• Current assets are recorded next in the order: inventories,
accounts receivable, cash at bank and cash in hand.
• In the second part of the statement of financial position (balance
sheet} capital precedes non-current liabilities; current liabilities are
placed last.
/
Preparing a classified statement ol DID YOU KNOW?
ILLUSTRATION 1 financial position (balance sheet) in order
oi permanence Alternative format
terns in a classttied statement
Hightown Retail Store of financial position (balance
Statement of financial position (balance sheet) sheet) can be recorded in
at 30 September 2019 order of liquidity, where
assets that are alreaoy In the
s $
form o' money are placed first
NON-CURRENT ASSETS and assets that are the least
Shop premises 50000 likely to become money in the
Fixtures and littings 9000 near future are placed last.
Equipment 7000 66000 For example, current assets
will precede non-current
CURRENT ASSETS assets and should start with
Inventories 6200 cash in hand ano finish wtth
Accounts receivable 700 inventories. In other words the
Cash al bank 3400 complete reverse of the order of
Cash in hand 200 10 500 permanence. In the second part
76500 of the statement of financial
position (balance sheet) current
CAPITAL 62000 liabilities precede non-current
liabilities; capital is placed last.
NON-CURRENT UABILl1Y
Bank loan 10 000

CURRENT LIABILITIES
Accounts payable 4 500
76500
SUMMARY QUESTIONS

Guidance on preparing a classified statement 1. Explain the difference

of fi nancial position (balance sheet) betv,1een:
a . a non-current asset and
• Have two money columns in each part of the statement ol financial
position (balance sheet). a current asset
b. a non-current liability
• Use the terms 'non-current assets', 'current assets', etc. as
subheadings. and a current liability.

• Use the first money column for the detail and the second money 2. What is meant by the terms
column for the subtotals. Rule a subtotal line (a single line) in the ·order of permanence· and
·order of tiouloity' when
lirst money column in these situations, ano rule a double line below
the total In the second money column. preparing a classified
statement of ' inancial
• When using the order of permanence. non-current assets start with position (balance sheet)?
land and/or premises; other non-current assets are placed in the
order of their value. 3. What is the correct order
of current assets when
preparing a statement
of financial position
{balance sheet) in order of
permanence?

LEARNING OUTCOMES
In this unit you will learn about:
• cash and creoit transactions
• how transactions affect the
accounting equation
• how to record transactions
using statements of financial
position (balance sheets).
The effect of
transactions on the
statement of financial
position (balance sheet)
A transaction is a financial activity or event. Each transaction has two
effects and this idea ls the foundation of what is usually calleo the
double-entry accounting system.
Transactions can be divided into t\lvo categories:
Cash transactions: that involve the immediate use of money
affecting either cash in hand or cash at bank.
Credit transactions: where the payment er receipt cf money Is
delayec until a later date affecting the amount owed to suppliers
(accounts payable) or owed by customers {accounts receivable).

ILLUSTRATION 1 Example of the twofold effect of a transaction

Here are some examples of everyday transactions that could affect a small business. In each example,
the tv1ofold effect of 1he transaction is stated.
Transaction One of the effects ls: The other effect Is:
Purchased some equipment and paid by cheque Equipment Increases Cash at bank decreases
Purchased a vehicle en credit Vehicles Increase Accounts payable increases
The owner inveS1ed more casn in the business Cash (in hand or at Capital increases
bank) increases
Sold some unwanted furniiure for cash Cash in hand Increases Furniture decreases
Paid a credit supplier an amount due by cheque Cash at bank decreases Aocounts payable decreases
The owner withdrew a cheque for private use Cash at bank decreases Capital decreases

Every time a transaction occurs it is possible to work out its effect on

KEY TERMS
Cash transaction: a financial
actlvity Involving the use of
money.
Credit transaction: a financial
activity where the payment or
receipt of money Is delayeo.
the statement of financial position (balance sheet) of a business. This
process is the simplest way of recording transactions. It Is Important
to realise:
• each transaction affects tvvo statement of financial position
(balance sheet) items
• after the effect of the transaction has been recorded the
accounting equation should still hold true, i.e. total assets equal
total liabilities and capital.

Guidance on recording transactions using the

LINK
The process of recording
transactions and tr.a rules of
double entry are developed
fur.her In Sections 3 and 4.
statement of financial position (balance sheet)
%
• For each transaction, Identify the two items that will be affected
{note that various combinations of assets, assets and liabilities,
assets and capital are possible).
• For each Item, decide whether its value will increase or decrease
when the transaction occurs.
• Prepare a nev, statement of 11nancial position {balance sheet)
o.e.
and check that the totals still agree the accounting equation
still holds}. If the statement of financial position (balance sheet}
totals do not agree a mistake must have been made, and it will be
necessary to check the changes that you have made.

,, ILLUSTRATIO N 2 The effects of transac1lons on statement of financial position (balance sheet) Items

Faye has Just opened a business. Transaction 1: Faye purchased Transaction 2: Faye repaid
Her first statement of financial some additional equipment and $1 ooo of the bank loan by
position (balance sheet} is as paid by cheque S3 000. The cheque.
follows: changes have been shown In bold.

Statement of financial Statement of financial Statement of financial

position (balance sheet) position (balance sheet) position (balance sheet)
at 1 March 2019 after Transaction 1 after Transaction 2
$ $ $
Equipment 22000 Equipment 25000 Equipment 25000
Vehicle 15 000 Vehicle 15 000 Vehicle 15 000
Cash at bank 5000 Cash at bank 2 000 Cash at bank 1 000
Cash in hand 1 000 Cash in hand 1 000 Cash In hand 1 000
43000 43000 42000
Capital 35000 Capltal 35000 Capital 35000
Bank loan 8000 Bank loan 8000 Bank loan 7 000
43000 43000 42 000

Transaction 3 : Faye lnvestoo

a further $6 000 in her business
Transaction 4 : Faye purchased
some additional equipment
am ·•·• •l••"'iil,ll•"'""~·. ,
1. \/\/hat is the difference
from her private funds. This on credit. The amount due is
between a cash transaction
amount was paid Into the bank $4 000.
and a crecm transaction?
account of the business.
Statement of financial 2 . Give one example of a
Statement of financial position (balance sheet) transaction that affects only
position (balance sheet) after Transaction 4 assets on the statement oi
after Transaction 3 $ financial position {balance
$ sheet) o' a business.
Equipment 29000
Equipment 25000 Vehicle 15 000 3 . Give one example of a
Vehicle 15000 Cash at bank 7000 transaction that affects
Cash at bank 7 000 Cash In hand 1 000 an asset and a liability on
Cash In hand 1 000 52000 the statement of financial
48000 position (balance sheet) of
Capttal 41 000 a business.
Capital 41 000
Bank loan 7000 4. Give one example of a
Bank loan 7000 Account payable 4000 transaction that affects
48000 52000 an asset anci capital on
the statement of financial
position (balance sheet) o'
For each transaction notice how two ttems change and how the
a business.
accounting equation always holds true.
/
 Practice exam questions

Paper2

1 lden:lfying assets, liabillties and capital a Calculate the 1otal value of assets.
Here is a fist of assets and liabilities and b Caloolate the 101al value of liablllties.
references to capital. Read 1nrough the list and c Use the accounting equa1iqn to calculate the
Identify whicn Items are assets. liabilities. capital. capital o' tne busir.ess.
a motor vehicle d Prepare a simple s1atement of financial
b cash in hand position (balance sheet) at 1 June 2019.
c bank loan 4 Preparing a classr.led statement of financial
d owner's inve~men1 In ihe business position (balance sheet)
e acco1.1n1s payable Nisha owns tne 'Take a Break Caf$'.
f machinery On 31 August 20191ne assets and tiabillt1es
of the business were as follows:
g accoun1 receivable
h bank overdraft $
2 Using the accounting equation Bank overdraft 300
Bank loan (repayable 2025) 7 500
The following table shows details aboJt some Cale prem ses 72 000
businesses' total assets, liabilities and capita!.
Cash nhand 200
Use the accoun11ng equation to find the missing
Equipment 8 900
figure In each case.
Fixtures and fittings 6 300
lnvehtory 1 900
Total Total
assets
Capital
liabilities
Accounts oayable 800
Assets = Capital T Uabilities
a Cal01,late the 101a1 value of assets.
$ $ $
Business A 72000 13000 b Calculate the 101a1 value of liabilltles.
Business B 160000 124 000 c Use the accounting equation to calculate tne
BusinessC 160000 36000 capital ot 1;-,e busiress.
d Prepare a classi'ied statemen1 of financial
3 Preparing simple Statements of financial position position (balance sheet) at 31 August 2019
(balance sheets) setting out the informa11on In order
of permanence.
Avlanne opened a business selling beachwear
e Prepare a classl'ied statemen1 of fir.ancial
on 1 June 2019. The assets and liabilities of 1he
business on that date were as follows: position (balance sheet) at 31 August 2019
setting out tne Information In order of llquidtty.
$ 5 Recording :ransactions using the statement of
Bank loan 12 000 financial position (balance sheet)
Cash at bank 4 500
Seema operied a business on 1 January 2019.
Cash In hand 1 300
The first s;atement of financial posnion (balance
Fixtures and flit ngs 11 900 sheet) of her business was as follows:
Inventory 8300
Shop prem ses 65000
Accounts payab'e 4 100
 statement of financial position Statement of financial position
(balance sheet} at 1 January 2019 (balance sheet) at 2 October 2019
$ $
Premises 75 000 Furnitu<e 15000
Cash a1 bank 5 000 Cash at bank 5000
80 000 20000

80 000 Capital 16000

Bank loan "000
The following transactions occurred during the 20000
first few days the business was In operation.
Jan 2 Purchased equ pmem a~d paid by
cheque $3 ooo. Statement of financial position
(balance sheet) at 3 October 2019
3 Purchased turn !lure and fittings on
credit. The amount due was $8 400. $

4 Arranged a bank loan fo< S10 000. Furnltu'e 15000

Funds were transferred Into the bank Cash at bank "000
account of the business. 19000
5 Seema withdrew a cheque for $500
for private use. Capital 16000
6 Paid the credit supp'ler $5 000 by Bank loan 3000
cheque. 19000
Prepare simple statements of financial position
(balance sheets) to record each of these
transactions. Statement of financial position
6 Identifying transactions from a seq.,ence of (balance sheet) at 4 October 2019
statements of 'inancial pos ltion (balance sheels) $

Here Is a succession of Statements of financial Furnllu'e 15000

position (balance sheets) for a smell business Cash at bank 3000
that opened on 1 October 2019. 18000

statement of financial posit ion Capital 15000

(balance sheet) at 1 October 2019 Bank loan 3000
$ 18000
Fumltvre 12 000
Cash a1 bank 8 000 S1artif'9 wrth tne statement of firancial position
20 000 (balance sheet) on 2 October 2019, compare
each statement with the previous one and
Caphal 16 000 identify the transactions that must have
occurred on 2, 3 and 4 October 2019.
Bank loan 4 000
20 000
 Introduction

LEARNING OUTCOMES
In this unit yov will learn about!
• the uses of books of original
entry
• cash and credit transactions
• source documents related to
books of original entry.
The books of original entry
In the double-entry system of bookkeeping an transactions must
first be recorded in books of original entry. There are seven books of
original entry and details about transactions are listed in these books
in date order. The books of original entry are then used as the source
for all details shown In the ledger accounts, which you will learn more
about In Section 4. In some cases, the books of original entry provide
totals, reducing both the time needed to make en tries in the ledger
accounts and the volume of detail shown In them.

Book of original entry Transactions recorded Alternative names

Purchases book Purchases on credtt of goods for resale Purchases day book or purer>ases
journal
Sales book Sales on credit of goods Sales day book or sales journal
Returns outwards book Returns of goods previously purchased on credit Purchases returns day book or
purchases returns journal
Returns Inwards book Relums ol goods previously sold on credtt Sales returns day book or sales
returns journal
Cash book Receipts and payments affectirg cash In hand
and cash at bank
Perty cash book Cash payments of small value
General journal Transactions that cannoi be recorded in the
other books of original entry

Cash and credit transactions

Cash transactions involve the immediate receipt or payment of money.
These transactions could make use of cash (i.e. notes and coins),
cheques. debit cards or credtt cards, and may take place online.
Credit transactions are those where the receipt or the payment is
delayeo. So, a purchase of goods on credtt means that the goods
are received, but the payment takes place at some later date.
Meanwhile, the business has to keep a record of the amount owing
to the supplier: the account payable. Similarly, a sale of goods on
credit means that goods are sent to a customer, bu1 the customer
pays at a later date. Meanwhile, the business will keep a record of
the amount owed by the customer: the account receivable.

Source documents related to books of original entry

Source documents need to be stored caretully as they provioe
evidence that a transaction has occurred. Every entry in the
accounting system should be traceable to them.
When a source document is receiveo or issued, key information is
extracted from the document and recorded in one of the books ol
original entry.
Book of original entry Source document Notes
Purchases book Invoice received from a Usually referred to as a 'purchase invoice'. used to
supplier make entries in the purchases book
Sales bock Invoice issued to a Usually referred to as a 'sales invoice', oopy used to
cwstomer make entries in the sales book
Returns outwards book Credit note received from Used lo make entries In the returns outwards book
a supplier
Returns inwards book Credit note issued to a Copy used to make entries in the re,ums inwards book
cus tomer
Cash book (receipts) Cash regiS1er tapes or till Provide de'.ails of cash sales
rolls
Cash receipts Copies used to make entries for ,he receipt of cash
Paying-in slip counterfoils Provide evidence that cash, cheques, etc., have been
paid into tne bank account of tne business
Bank statements Provide evidence that money has been transferred
directly into the bank account of the business (e.g. a
costomer settling their account by means of a credit
transfer)
Cash book (payments) Cash recelpis or vouchers Provide evidence that cash was paid (e.g. a cash
receipt from a cash register when making a purchase.
The signature of the recipient is usually shown on
vouchers as proof of receipt of the funds.)
Cheque counterfoils For paymenis from the bank account
Bank statements For details about bank charges and payments made
using direct debit and standing order facilities
Petty cash book Pe1ty cash vouch<lr Records details of payments made in petty cash -
should have cash receipts for tr e expenditure attached
General journal Range of documents Notes, letters and emails, which could be internal
including Invoice for 1he documents (e.g. written by 1he owner) or received from
purchase of a non-current olher businesses and organisations
asset, notes, emails

SUMMARY QUESTIONS KEY TERM

1. Identify the books of original entry that record creoit transactions. Source document: a written
record that provides Information
2. List three source documents that could be used for making
'rom \Nhich ac001,.1nts can be
entries for cash and bank payments.
prepared. Source documents
3. Which transaction is shown on a credit note received from a provioe evidence that a particular
supplier? transaction tool< place.

LEARNING OUTCOMES
In this unit yov will learn about:
• preparing source documents
• transaction descriptions
• distinguishing between trade
and cash discounts
• distinguishing between
discounts allowed and
discounts received
• using source documents
to recoro Information In the
books of original entry.
Preparing source
documents; discounts
Preparing source documents
Source documents record a lot of detailed information about
transactions. Here are some examples of the details that need to be
included (some of which may already be printed on the document).
Document Details
• Name and address of supplier {preprinted)
• Name and address of cuS1omer
• Date of transaction
• Invoice number
Sales invoice • Terms of payment (preprinted)
• Details of each product being supplied (quantity,
description, untt price, total price)
• Deduction of any trade discount
• Total amount due
Cheque:
• Date
• Name of payee (individual/organisation being
paid)
• Amoant in words
• Amount in figures
Cheque
and cheque • Signature of person authorised to make
counterfoil payment (payer)
• Cheque number (preprinted)
Cheque counterfoil:
• Date
• Payee
• Amount in figures
• Date
• Number
Petty cash • Description of ttems paid for
voucher • Amount paid
• Signature of petty cashier
• Signature of person being reimbursed
Transaction descriptions
In orCler to make entries In the accounting system it is necessary to
extract the right Information from each source document. For each
entry the following details will be required:
• date of source document
• any number or reference that will identify the document
• the name of the supplier/customer where personal accounts
will be involved KEY TERMS
• the nature of the transaction Trade discount; a reouction in
• the amount of the transaction. 1he price given as a reward for
buying in large quantities.
Trade discount Cash discount: a reduction
in the amount paid by creoit
Many businesses are able to obtain a trade discount. This is a customers as a reward for
reduction in the unit price of items purchased for resale. However, settling the amount due within
the following conditions must be met: an agreed time limit.
• The businesses must be engaged In the same line of activity. Discount allowed: cash
• A large order must be placed. discount given to a credit
customer for settling their
Trade discounts are not normaJly avallable to private individuals. account within an agreed time
limit.
Cash discount
Discount received: cash
A cash discount is an incentive that a seller offers to a buyer for discount given by a credit
settling the invoice Immediately on delivery or for paying a bill owed supplier whose account has
before the scheduled due date. Prompt settlement of amounts due been settled within an agreed
by customers can be critical tor many businesses in ensuring they time limit.
have sufficient cash resources.

Discounts allowed and discounts rece ived

• A discount allowed occurs when a customer takes advantage of
.- .
cash discount terms. Discounts allowed are given to the customers 1. Identify the Information that
of a company so as to Induce those who owe money 10 settle must be extracted from a
within a time specified by the company. Discounts allowed benefit source document In order
a business because cash resources are received earlier than to make entries in a book of
anticipated. Customers pay less than the amount owed, therefore original entry.
discounts allowed are a reduction in revenue for the business and 2 . Explain how a trade
are recorded as an expense in the income statement. discount differs from a cash
• A discount received occurs when a business takes advantage discount.
of cash discount terms offered by a supplier. The buyer of good or 3 . State one benefit and one
services is granted a discount by the seller. Discounts received are disadvantage of a discount
a reduction In the expense associated with the purchase and are allowed.
recorded as income in the income statement of the business.

As seen in Un t 3.1. all 1ransactl0l'ISare
firsl tecorde::l ma boo~ of onglnal ent,y or
journal. This unrt wi I look at two of these
in partocular. the ourchases book and the
sares bcok.
LEARNING OUTCOMES
In this unit you will learn about:
• using source documents
to make entries into the
purchases and sales books.
KEY TERMS
Purchases book: tli e book of
original entry used to make the
first recoro In an accounting
system oi purchases on credit
of gooos for resale.
Sales book: the book of
original entry used to make the
first recoro In an accounting
system oi sales on credit of
goods in which a business
trades.
Using source documents
to make entries in the
purchases and sales books
Preparing a purchases book
A purchases book is a record of credit purchases of goods
that are to be resold by a business. It records the follo\lvlng details
concerning these transactions:
Purchase Invoice Amount
Transaction date Name of supplier number s
The source documents for these entries are the purchase invoices
received from suppliers. The book Is maintained In date order and is
totalled at appropriate Intervals; this could be weekly or monthly, for
example, depenoing on the volume of business.
It is important to note that:
• cash purchases are recorded in the cash book (see Untt 3.5)
• purchases of non-current assets on credit are recorded In the
general Journal (see Unit 3. 7).
Preparing a sales book
A sales book is a record of credit sales of goods in which the business
trades. It recoros the following details concerning these transactions:
Sa/es invoice Amount
Transaction date Name of customer number s
The source documents for these entries are the sales invoices
Issued by the business and sent to Its credit customers. The book is
maintained In da1e order and Is totalled at appropriate Intervals.
It is important to note that:
• cash sales are recorded In the cash book (see Unit 3.5)
• sales of non-current assets on credtt are recorded in the general
journal (see Untt 3. 7).
Trade discounts and the purchases and sales books
Where a trade discount has been given by a supplier or to a
customer, only the net amount due Is recorded In the books of
original entry. In other words, no record is made in an accounting
system of the actual amount ot the trade discount. It Is the amount to
be paid that matters.
" ILLUSTRATION 1 Preparing a purchases book and sales bock

Navin owns 'IJVheels', a wholesale business selling cycles

and cycle accessories. During June 2019, Navin received the
following purchase invoices from his suppflers.
June 7 Speed Cycles Ltd, Invoice number 74536, for goods,
total value $1 480
June 16 JKD Manufacturers Ltd, Invoice number 84962, for
goods at 11st price $3 200 less 25% trade discount
Here is the purchases bock for June showing these details:

PURCHASES BOOK Pages

Invoice Amount
Date Sunntler number Folio due
$
June 7 Soeed Cvcles Ltd 74536 1 480
16 JKD Manufacturers Ltd 84962 2400
Tctal purchases 3880

During June 2019, Navin issued the following invoices to credit

customers.
June 11 Bestbuy Retail Stores, sales invoice number 2771. ior
goods at list price $1 2<10 less 15% trade discount
June 23 Bike Base, sales invoice number 2772, for gocds at list
price $2 280 less 20% trade discount
Here is the sales book for June showing these details: LINK %
The procedures ior double entry
SALES BOOK Pa,e 12
are covered in Section 4.
Invoice Amount
Date Customer number Folio due
$
Ju~e 11 BeSibuy Retail &.ores 2771 1 054 SUMMARY QUESTIONS
23 Bike Base 2772 1 824 1 . Not all purchases are
Total sales 2 878 shown in a purchases
book. Which purchases
Additional note: are shown and which
The expression 'list price' is a reference to the normal selling purchases are not shown?
price of a product as shown, for example, in the catalogue of 2. How Is trade discount
the business. List price ls the price before deducting any trade treated when preparing
discount. accounting records?
3. A business sold goods on
The oetails shown in the purchases book and sales book are used credit with a list price of
to make the double-entry records in the ledger account. It is when S2 700 less a 20% trade
these double-entry records are made that entries are made in the discount. How much should
folio column of the Journal. be recorded in the sales
book for this transaction?

2'1'.

LEARNING OUTCOMES
In this unit yov will learn about:
• using source documents
to make entries into the
purchases and sales returns
books
• the role o' oebit notes.
KEY TERMS
Credit note: document useo
to recor<i the amount to be
deducted when goods are
returned.
Returns outwards book: a
bOok of original entry listing
all gooos returned to credit
suppliers.
Returns inwards book: a
book of original entry listing
all goods returned by credit
customers.
Debit note: document used to
record details of goods being
returnee to a supplier and the
amount to be deducted from
the total due.
DID YOU KNOW?
Debit notes are not often
encountered. As well as
being issued to prompt the
receipt of a credit note, they
are sometimes issued by
a business to correct an
undercharge on an Invoice
issued to a customer.
The returns outwards and
returns inwards books
Introduction
Goods are returned to their supplier for a number of reasons, tor
example:
• goods were found to be damaged on receipt
• the wrong goods •,vere sent out by the supplier
• goods were received too late so that the ·sell by' date had been
exceeded.
Credit notes
The most commonly used source document for returns is a credit
note. Credit notes are used in the following ways:
• Returns outwards book: goods returned to a supplier that were
previously purchased on credit. In this case a business returns
goods to the supplier and then receives a credit note from the
supplier stating how much can be deducted from the amount due
as shown on the purchase Invoice. The credit notes received are
used to prepare the returns outwards bock.
• Returns inwards book: goods returned by a customer that were
previously sold to that customer on credit. In this case the business
selling the goods would send a credit note to the customer stating
how much can be deducted from the amount due as shown on the
sales invoice. Copies of the credit notes sent are used to prepare
the returns Inwards book.
If a trade discount had been applied to the goods tha1 are being
returned. the same rate of trade discount will be deducted when
preparing the credit note.
Credit notes are also issued if an amount charged on an Invoice Is
overstated in error and needs to be reduced. The amount shown on
the credit note corrects the error.
Debit notes
Just occasionally a debit note could be used as evidence of returns.
This occurs when a business has receiveo faulty goods and Issues a
debt! note to the supplier to request a reduction in the amount due.
Normally, however, In this situation no entries are made In the books
of account of the business until a credit note Is received from the
supplier. In other words, the credit note is the key source document.
A business might receive a debit note from a customer who is
returning goods. The business would use the debit note to make
entrtes In its returns Inwards book.
Summary: source documents and returns
Transaction to be recorded In the accounts M ost commonly used
Book of orlglnal entry
of a business source document
The bvslness re1urns goods to a Credit note received from Returns outwards
Returns outwards
supplier the supplier book
A customer returns goods to the Copy of credit note issued to
Returns inwards Returns inwards book
business the customer

Preparing returns books

Returns books are the 1irst record in the accounting system 01 details shown on credit notes.
The process is similar to that 1or the purchases and sales books (see Unit 3.3).
• Returns books list details in date
ILLUSTRATION 1 Preparing returns books
order.
Sophia owns a wholesale business. During March 2019 the • The amount of the return is
follovving transactions occurred: shown net of any trade discount.
March 8 Returned damaged goods to a supplier, BTL
• The entrtes are totalled at regular
Manufacturing, and received a credit note
Intervals.
(number 473) for $780
13 Issued a credit note (number B83) to Rockport • Only returns on goods previously
Retail Ud tor goods returned by this customer, $370 purchased or sold on credit are
recoro'ed.
20 Returned faulty goods to PCP Ud, which had a
11st price of $600 but on which a trade oiscount of • The details are used to make
25% had been deducted, and received a credit note double-entry records In the !eager
(number T1007) for $450 accounts of the business.
27 Issued a credit note (number B84) to Trent Stores • The folio columns are completed
Ltd, for goods 11,at had been sold at a list price of (with a reference to the ledger and
$960 less a Ira de discount of 20% the account number} when the
details are posted to the ledger
Here are the returns outwards book and returns inwards book
accounts.
recording these transactions.
RETURNS OUTWARDS BOOK Page3
Credit
note Amount
Date Supplier number Folio due
$ LINK ('~

March 8 BTL Manufacturing 473 780 In Section 4, Unit 4 .4 you will be

20 PCP Ltd T1007 450 shown how to post in'ormation
from returns books to ledger
Total re1urns outwards 1 230 acCOU'l!S.

RETURNS INWARDS BOOK Page4

Credit SUMMARY QUESTIONS
note Amount
Date Customer number Folio due 1. Give two reasons v,hy a
business may need to issue
s a credit note to a customer.
March 13 Rockport Retail Ltd 883 370
2. Explain the process that
27 Trent Stores Ltd 884 768
leads to the ~ceipt of a
Total returns Inwards 1 138 credit note from a supplier.
 The three-column
cash book

The book of original entry used for recording cash transactions

LEARNING OUTCOMES
In this unit yov will learn about:
• using source documents to
make entries in a cash book
• how 10 prepare a three-
column cash book.
KEY TERM
Contra entry: the record In the
cash book of cash transferred
to the bank, or cash •,vithdrawn
from the bank. Contra entries
are Indicated by a letter 'O' In
the folio column.
is called the cash book. Like all bocks of original entry. it records
informalion taken from source documents and sets transactions out
in date order for posting to the ledger accounts.
A three-column cash book Includes columns to record receipts
and payments affecting both the cash and bank accounts of the
business, as well as additional columns to record cash discounts.
The oiscount columns are not part of the double-entry record of cash
discounts: they are simply a convenient place for the first record of
any discount involved In a transaction by the cashier. \The cashier
is the one member of the accounts team who knows whether a
cash discount has been claimed and given.) Discount columns
are an example of \Vhat Is often referred to as a 'memorandum'
accounting record. 'Memorandum' means a note of something to be
remembereo.
A cash book is both a book of original entry and also a ledger for the
two accounts, cash and bank.

ILLUSTRATION 1 Preparing a three-column cash book

Anita owns a retail business. Her suppliers offer a cash discount for prompt payment, and she offers her
credit customers a cash discount if they settle their accounts promptly. Her accounting system includes
a three-column cash book. On 1 September 2019, page 11 of her cash book showeo opening balances
of $635 cash in hand and $4 838 cash at bank. During the first week of September the following
transactions occurred:
Date Source document Transaction
Sept 1 Cheque counterfoil Payment of supplier, MNH Supplies, $1 140 in full settlement of the
amount due, S1 200
2 Paying-in slip ooumerfol I Cheque received from credit customer, K Anson, 'or $780, in full
settlement of the amount due, $800
3 Cash receipt In respect of Payment for general expe1JSes, $82
sundry purchases
4 Bank statement Bank charges for the month tolalling $73
5 Cash regiSler roll Cash sales of $1 884
6 Paying-in slip oounlerfoi I Cheque received from credit customer, Leo Adams. Leo Adams
owed $1 200 at tnis date. The cheque was in full settlement of this
amount less a 2.5% cash discount.
7 Cheque counterfoil Payment of supplier, Island Traders Ltd. This company was owed
$2 600 on this date. The account was settled In full less a 5% cash
discount
8 Paying-In slip oounterfol I Cash banked, $1 500

(Continued)
,, ILLUSTRATION 1 Preparing a three-column cash book (Continued)

Here is the three-column cash book recording this information.

Dr CASH BOOK Page 11 Cr

Discount Discount
Folio a llowed Cash Bank Folio received Cash Bank
$ $ $ $ $ $
Sept 1 Balances bid 635 4838 Sep1 1 MNH
Supplies 60 1 140
2 K Anson 20 780 3 General
expenses 82
5 Sales 1 884 4 Bank
charges 73
6 Leo 1 170 7 Island
Adams 30 Traders
L1d 130 2 470
7 Cash C 1 500 7 Bank C 1 500
50 190

Notes:
1. The discount allowed column appears on the left-hand side of the cash book as it needs to be
alongside the columns where money received from creolt customers Is recorded.
2. The discount received column appears on the right-hand side of the cash book as it needs to be
alongside the columns wl1ere payments to creoit suppliers are recorded.
3. Discount columns are totalled at regular intervals. These totals are used to update the discount
accounts in the general ledger.
a. The transactions Involving discounts are presented In two different ways: on 1 and 2 September the
amount of the paymenvreceipt and the amount of the discount are given - there are no calculations
involved; on 6 and 7 September, however, the amount of the discount and the amount actually paid/
received have to be calculated.
5. When cash is transferred to the bank (as on 7 September) or cash withorawn from the bank, the
complete double entry for the transaction Is recorded within lhe cash book. To Indicate that this has
happened a C (for contra entry) is entered in the folio column.
6. As usual, the folio column entries are made when Information is posted to ledger accounts; the
exception Is the contra entry on 7 September.

SUMMARY QUESTIONS

1, What is the purpose of the additional columns in a three-

column cash book?
LINK %
Section 4, Unit 4.2 shows how to
2. Some of the entries In a three-column cash book are post in/orma1ion fyom a three-
'memorandum reccrds'. Explain what this term means. column oash book to tne ledger
3. Explain when It Is correc1 to enter a letter •c· In lhe folio accounts, including the discount
columns of a cash book for certain transactions. accoums.
 The petty cash book

In some businesses a separate book of original entry is used to

LEARNING OUTCOMES
record small payments in cash. The Idea is to ensure that the main
In this unit yov will learn about: cash book is not overburdened with the details of what may be
regarded as less Important transactions.
• using source documents to
make entries in a petty cash
Source documents for petty cash transactions
book
• preparing a petty cash book. Responsibility tor keeping the petty cash book is often given to a
more Junior member of staff, and there is usually a strict control on
how petty cash payments are made. Many businesses operate what
is called the im prest system, which works as follows:
KEY TERMS
• The petty cashier is given responsibility for a maximum amount of
Imprest: a system for petty petty cash at any time. This maximum amount Is called the petty
cash payments, where a float is cash float or imprest. The size of the imprest is decided by the
provided to control expenditure owner or manager of the business. The imprest is set at a level
over a given period. sufficient to cover petty cash payments for an agreed period of
Petty cash voucher: the time. often a month.
$ource document for each petty • There is often an agreement that petty cash will be used to cover
cash payment. expenoiture below a particular amount, for example $25. Payments
higher than this amount will be made by the cashier and recorded
ln the three-column cash book rather than by the petty cashier.
• For many transactions the petty cashier will be required to repay an
employee for cash spent on behalf of the business. Whatever the
petty cash transaction. the petty cashier will ensure that a petty
cash voucher is completed and that a receipt or other proof of
payment is attached to the voucher.

ILLUSTRATION 1 A petty cash voucher

Here is an example of a petty cash voucher. tt shows that an employee (Mark Jones) has been repaid for
paying for some postage on behalf of the business.
r,-;;r,r\'7'S",.....,~'7"S'":-ccTr17"'7',.-.r'l"'T'r7':.,....,,...,..,"""".,.._..:-c-i • Lisa Watson Is the petty cashier. She signs 1he
petty cash voucher to confirm tha1 she has
Numbe( 178
paid out $18.23.
PETTY CASH VOUCHER
• Mark Jones signs the petty cash voucher to
Amount confirm that he has received $18.23.
Item $
• Lisa will attach a receipt, supplied by Mark, for
the amount paid tor the postage. The receipt
Is proof that the payment was made for a valid
reason.
Reoelv&cJby • Petty cash vouchers are numbered. In 1he
example the petty cash voucher Is number
178. Petty cash vouchers usually come in a
pad and are numbered consecutively.
Preparing a petty cash book
A petty cash book is made up of two Important features:
• The first few columns operate as a simple cash account. recording
the amount received (the Imprest) and the payments made with a
record of the relevant petty cash voucher number.
• Additional columns are used to analyse petty cash payments. LINK %
The analysis columns are used to arrive at totals for different There Is more on posting
categories of payment. The categories are chosen to reflect the petty cash totals to 1l'e ledger
types of payment made by the business. Payments are mostly for accounts, including adding folio
expenses. but occasionally it may be necessary to settle a small references, in Section 4. Unit 4.2.
amount due to an account payable.

ILLUSTRATION 2 A petty cash book

Here is a page from the petty cash book of a business.

PETTY CASH BOOK Page6

General Purchase
Receipts Date Details Voucher Payments Cleaning Postage expenses ledger Folio
$ $ $ $ $ $
200.00 Aug 1 Cheque
4 Postage 178 18.23 18.23
7 General
expenses 179 26.29 2629
14 Cleaning 180 38.80 38.80
19 Pos!age 181 11.43 11 .43
24 Cleaning 182 37.22 37.22
29 Supplier
(TXQ Ud) 183 33.18 33 18
165.15 76.02 29.66 26.29 33 18

Every time a payment Is made the amount is recorded twice: once in the paymen1 column and a second time
In the relevant analysls oolumn.
SUMMARY QUESTIONS
Notes:
1. The transaction on 29 August is an example of petty cash being 1. Many businesses operate
used to settle an account payable (in this case 1XO Ltd). The the imprest system of petty
analysis column heaoing tor this transaction is 'Purchase ledger', cash. Describe the main
since this Is where the supplier's personal account is recorded. features of the Imprest
system.
2. At regular intervals, the payments column is subtotalied. {In this
case the subtotal is $165.15.) 2. tdenH!y the main items
of Information that can
3. At the same tlme, the analysis columns are totalled. These
be touno on a petty cash
totals will be posteo to the relevant accounts in the ledger of the
voucher.
business.
3. Explain the purpose of the
Folio references are added when the double entry for transactions analysis columns used In a
is completed.
petty cash book?

Sp ecial note: entrie.S In the general
journal require a good 1.mdetStent:1ing of
the rules of double-entry bookkeeping. It is
recommended, therefore, that You study
Section 4. Units 4. 1 to 4.4 before using
this unit.
LEARNING OUTCOMES
In this unit you will learn about:
• why a seven th book of
original entry Is needeo
• source documen1s useo to
prepare a general journal
• how 10 prepare an entry in
the general Journal.
KEY TERM
General journal: a book oi
original entry useo to make the
first record ot transactions that
it would not be appropriate to
record In the other books of
original entry.
LINK C\)
There Is more Information about tne
correction of errors in Section 7.
The general journal
Why a general journal is needed
Most transactions are recorded in the six books of original entry covereo
In Units 3.3-3.6. These six books of original entry are the first record o'
all money transactions and all credit transactions involving the purchase
and sale of goods in which a business trades. A seventh book of
original entry, the general journal, is required to make a first record of
a small group oi transactions that cannot be recorded in the other six
subsidiary books. Here are some examples of these transactions:
• the purchase and/or sale of a non-current asset on credit
• cancelling entries and correcting errors in accounts
• transferring Information from one account to another
• opening a new set of books of account.
Source documents and the general journal
Many different source documents aie used for entries in the general
Journal, for example a purchase invoice for a new non-current asset.
However, less formal source documents may also be used that include
instructions or financial details that need to be recorded in the accounts.
For example, there could be letters and emails received from other
businesses. or emails and notes written by owners and managers.
Preparing a general journal
An entry In a general journal consists of the following elements:
• the date
• the account to be debtted and the amount
• the account to be creoited and the amount
• a brief explanation of the nature of the transaction (often called the
·narrative')
• folio references, which are completed when the journal entry is
posted to the ledger
Each journal entry ls ruled off to separate It from the next entry.
1. Each entry is set out so that debit entries are recordeo first and
credit entries second (with a slight indent in the details column).
2. Usually there is only one account to debit and one account to
credit; just occasionally it is possible to have several accounts
debtted/credited in one journal entry {as in Illustration 1 on
1 February) - this is called a combined entry.
3. The folio column will be completed when the entries are posted to
ledger accounts.
There are further examples of journal entries throughout the book.
ILLUSTRATION 1 Preparing a general Journal

Here are some typical Journal entries.

Opening a new set of books

JOURNAL Page3
Date Details Folio Dr Cr
$ $
Feb 1 Vehicles 18 000
Bank 4000
Cash 500
Bank loan 8000
Capital 14 500
Assets and liabilities on opening new books of account

Recording the purchase on credit of a non-current asset

JOURNAL Page3
Date Details Folio Dr Cr
$ s
Feb 11 Equipment 2 200
KKZ Office Equipmen1 Ltd 2200
Purchase of new printers for office, invoice number 78328

Recording the correction ,of an error

JOURNAL Page4
Date Details Folio Dr Cr
$ $
Feb 18 Motor expenses 110
General expenses 110
Correction - motor expenses had been recorded In the general
expenses accoun1

SUMMARY QUESTIONS

1. What is the purpose of the general Journal?

2. Give two examples of transactions that should be recorded
In the general Journal.
3. Give tv10 examples of source documents used when
preparing journal entries.
4. What are the main elements In a journal entry?
 Balancing cash books
and posting books of
original entry totals
LEARNING OUTCOMES
Balancing cash books
At regular Intervals cash books will be balanced. The process for
In this unit yov will learn about: balancing is the same as outlined tor ledger accounts. which is fully
• balancing cash books explained in Section 4, Unit 4.3.
• interpreting the balances of
the cash books
• indicating treatment of totals
fr-0m books ot original entry.

ILLUSTRATION 1 Balancing cash books

Here are the cash books from Units 3.5 and 3.6 but now showing how they are balanced at the end of
the month.

Dr CASH BOOK Page 11 Cr

Discount Discount
Folio allowed Cash Bank Folio received Cash Bank
$ $ s $ $ s
Sept 1 Balances bid 635 4838 Sept 1 MNH
Supplies 60 1 140
2 KAnson 20 780 3 General
expenses 82
5 Sales 1 884 4 Bank
charges 73
6 Leo 1 170 7 Island
Adams 30 Traders
Ltd 130 2 470
7 Cash C 1 500 7 Bank C 1 500
7 Balance c/d 937 4 605
50 2519 8288 190 2 519 8288
Sept 8 Balance b/d 937 4 605

Notes:
1. The balanced cash book reveals the business has $937 in cash and $4 605 at the bank on
8 September.
2. A credit balance on the bank account would Indicate that the business was overdrawn at the bank.

(Continued)
' ILLUSTRATION 1 Balancing cash books (Continued)

PETTY CASH BOOK Page6

Receipts Date Details Folio/ Payments Cleaning Post age General Purchase Folio
voucher expenses ledger
$ $ s $ $ s
200.00 Aug 1 Cheque
4 Postage 178 18.23 18.23
7 General
expenses 179 26.29 26.29
·4 Cleaning 180 38.80 38.80
19 Postage 181 11.43 11.43
24 Cleaning 182 37.22 37.22
29 Supplier
(TXQ Ltd) 183 33.18 33.18
165.15 76.02 29.66 26.29 33.18
Balan ce c/d 34.85
200.00 200.00
34.85 Sept 1 Balance b/d

Note:
The balanced cash book reveals the business has unspenl petty cash in hand of $34.85 on 1 September.
/

The treatment of totals from books of original entry

At regular intervals the totals shown In the books of original entry will be posted to ledger accounts.
The following table summarises how totals are treated.

Total(s) in book of original ent•ry Treatment

Purchases book
Sales book
Reiurns outwards book
Returns inwards book
Petty cash book analysis
columns
Cash book discount columns
Pos1ed to the debit side of the purchases acoount in the general ledger
Posted to the credit side of the sales account in ihe general ledger
Posted to the credit side of the returns outwards account in the general ledger
Pos1ed to the debit side of the relurns inwards account in the general ledger
• Totals of expe'lSe columns are posted to the relevant expense accounts in
the general ledger.
• Entries in a column /or payments to acoounts payable are posted to the
individual accounts payable aocounts in the purchases ledger. (The total of
this column is for reference only and is not posted.)
• The total of the discounts allowed column is posted to the debit side of the
discounts allowed accoum in the general ledger.
• The total of the discounts received aocount Is posted to the credit side of
tne discounts received accou~.t in the general ledger.

SUMMARY QUESTIONS

1. Explain why the oiscount columns In a cash book are not

balanced.
2. Interpret a credit balance in the bank column of a cash book.
3. Explain how the analysis columns In the petty cash book are
used.
 Practice exam questions

Paper1
1 Which source document should be used wnen 4 1Nhich source documents should be used for
preparing a sales book? making debit entries in a cash book?
A credrt note A petty cash vouchers and cash register rolls
B delivery note B cheqve counterlods ard cash receipts
C lnvoic;;e C paying-in slip counterfoils and cheque
D 1111 roll counterlo1ls
D cash regis1er rolls and paying-In slip
2 Which source document sho,.ld be used wren
counterfoils
preparing a re1urns lriw,irds book?
A cheque coun!erfoll 5 A petty cash book is operated with an Imprest o'
$120. During one month $70 was spent by the
B credit nole
petty cashier. What amourit will be required to
C invoice restore 1he Imprest at Ire end o' Ire month?
D receipt A $50 B $70
3 Navin owrs a grocery store. Which book of C $120 D $190
original en!ry should be used ~or recording the
p... rchase of some shop equipmern on credit?
A cash bock
B general journal
C purchases book
D sales bock

Paper2
1 Preparing purchases, sales and returns books Credit notes received from suppliers
Rishiowns a wholesale business s-elling electrical Jan 10 Premier Electrics (credit note
equipmen t. He has collected the following number 314) for goods, S80.
source d ocuments for January 2019. damaged n trarislt

Invoices receiVed from suppliers 28 Excel Supplies Ltd (credit no1e

Jan 4 Prem'er Electrics ( nvolce number
2729) for goods, $960
23 Excel Supp.ies Ltd (invoice number
3661) for goods, $3 600 less a trade
discount of 25%
Invoices Issued to customers
Jan 11 Haven Retailers (invoice number
$727) for goods, $650
19 Bestprlce Electrics (lnvoce number
$728) for goods, $2 700 ess a
trade discount of 20%
number 882) for goods, $220 less
a trade discount of 25%, not as
ordered
Credit notes issued to customers
Jan 17 Haven Retal ers (credh note number
R1 17) for goods, $35, damaged
Items
29 Bes1prlce Electrics (creel t note
number R118i for goods, $180
less trade discount of 20%, not as
ordered
 Prepare 1he following for the month of January
2019: 21 Cheque Payment of
counterfoil amount due to
• Purchases book supp'ier. DHP
• Sales book Ltd, $1 800
less a 5% cash
• Re1urns outwards book d·soount
• Returns Inwards book 25 Paying-In sl p Cheque received
counterfoil from customer,
"fbe books should be totalled at 1he end of 1he Parkway Ltd,
month. In settlement
of amount
2 Preparing a three-column cash book due, $400 less
Stepren Is a retailer. His accounting sys1em a2.5%cash
inclvdes a tnree-cctumn cash book. On 1 d·soount
Maroh his cash book showed balances of cash
Prepare the three-column cash book for Marcil
in nand $380 and cash at bank $3 270. He is
2019. T-re discount columns should be totalled
able1o provide the following del.ills aboui cash
at lhe end of lhe month. Balance and rule lne
transactions for Maren 2019.
casn book at montn end.
Source
3 Preparing a general journal
Date document Transactions
March 3 Cash rece pt General On 1 October 2019 N<3vin oper,ed a retail
In respect exoenses $80 business. The following list Includes some of the
of sundry transactions that occvrred during October 2019
purchases
Oct 1 Opened the books of account of
5 Cheque Rent $880 the business wllh the following:
counterfoi casn at bank $1 800. motor vehicle
8 Cash regiSter Cash sa'es $22 000, office equipment S2 800.
ro I $1 290 bank loan $5 000. cap~al $21 600.
10 Pay ng-ln s ip Transfer of cash 3 Purchased shop furniture. $8 800,
counterfoi $1 100 to bank on cred,t from Rajah Supplies Ltd.
1Ll Cheque Paymem of 11 A mistake had been made when
counterfoi supplier, Rex ,eoordlng the payment of rent by
Ltd, $1 140 (in cheque S780. The bookkeeper had
settlement of deb led tne wages aooount w,th
amount due $780 Instead of the rent account,
$1 200) This error was correc!ed.
18 Bank Bank charges of 18 SQme of the shop fum~ure
statement $70 purchased on c,edit from Rajah
Supplies Ltd on 3 October was
20 Pay ng-ln s ip Cheque receNed ,eturned as damaged n transit. The
counterfoi !rom customer. value of the furniture returned was
Astral Ltd, $585 $220.
( n settlement
of amount due Record these transaolions in Navin's gene,al
S600) journal.
 •

Preparing ledger accounts

In this unit you will stuo'y how leoger accounts are prepared. This
LEARNING OUTCOMES
Is often thought of as the core of any accounting system, because
In this unit you will learn about: it is !he analysed record of !he financial transactions of a business.
Preparing ledger accounts represents the next step In the accounting
• the different classes of cycle after preparing the books of original entry.
account
• the different types of ledgers Classes of account
• 11,e significance of debits Ledger accounts can be divided into three different classes:
and creoits in each class o'
account Real accounts Nominal accounts Personal accounts
• preparing simple account Assets Expenses Accounts payable
formats neatly and
Liabiltties Income Accounts receivable
accurately.
Capital Gains
Lesses
Usually regarded as Usually regarded as
permanent accounts temporary accounts

Types of ledger
Ledger accounts are grouped together in three different ledgers
General ledger Purchases ledger Sales ledger
Assets' Accounts payable Accounts receivable
Liabilities
Capltal
Expenses
Income
·Except for cash and bank accounts, which are recorded separately
in the cash book

Transactions and the double-entry principle

In Unit 2.3 tt was shovvn that any transaction (cash or credit):
• has two effects on items in the statement of financial position of
a business
• changes the value upwards or downwards of some combination
of assets, liabilities and capital but with the accounting equation
(A = C + L) always holding true.
The rules for making entries for transactions are summarised In the
following tables.
Making entries in real accounts
ASSET ACCOUNTS LIABILITY ACCOUNTS
Debit Credit Debit Credit
Increases In assets Decreases In assets Decreases In liabilities Increases In liabilities
Examples: Examples: Examples: Examples:
Receiving cash Making a cash payment Paying a credtt supplier Purchasing goods
on credit from
Purchasing an asset Selling an assei Repaying a loan
a supplier
Selling goods on credit Credit customer settles
Taking out a loan
to a customer amount due

CAPITAL ACCOUNT
Debit Credit
Decreases in capital Increases in capital
Example: Example:
The owner withdraws capital (drawings) The owner introduces capital

Making entries in nominal accounts

EXPENSE ACCOUNTS INCOME ACCOUNTS
!)eQ!t Credit Debit Credit
Expense payments Receipts of Income
Examples: Examples:
Paying rent, wages, Sales of goods on
repairs, etc. credit or for cash
Purchasing goods for Receipt of rent from a
resale tenant, interest received
on Investments

Preparing simple ledger accounts

LINK %
A ledger account is a record of transactions affecting a particular You may be wondering about
aspect of the affairs ol a business. Ledger accounts make use of a how a business records
two-sided form that corresponds in shape lo a letter T, and ledger unsold goods (Inventory) In the
accounts are sometimes referred to as 'T accounts' . Accounts have accounting system. This topic is
columns to record the date of each entry, details of the transaction covered In U11it 5.2.
being recorded, a folio column for cross-referencing to the source of
the information, ano money columns to record the amount Involved
In the transaction.
In any account:
• the left-hand side is referred to as the debit side, abbreviated
as Dr
• the right-hand side is referred to as the credit side, abbreviated
as Cr.
/ ILLUSTRATION 1 A typical ledger account
Here is the typical ruling for a ledger account. A double rule divides the left-hand, debit columns from the
right-hand. credit columns.

Dr Account title Cr
Date Details Folio $ Date Details Folio s

And here is an example of a ledger account with some entries.

Dr Vehicles (Account No. 22) Cr

Date Details Folio $ Date Details Folio $
2019 2019
Jan 1 Balance bid 21 000 Feb 6 Bank CBS 2400
18 Bank CB3 9000

Notes:
1. Each account should have a number.
2. It Is good practice to state the year on each side of a ledger account before making entries.
3. Every entry should be dated with a month and day. The month does not have to repeated for each
transaction.
4. The folio column is used to record either (I) bid and c/d when recording balances (sometimes a check
mark {.) is useo instead) or (ii) a cross reference to the page In the book of original entry. ,/

KEY TERMS SUMMARY QUESTIONS

Ledger account: a two-sided
form used to record details
of transactions affecting a
particular aspect the financial
activities of a business.
Debit side: the left-hand side
of an account (Dr).
Credit side: the right-hand
sice of an account (Cr).
1. Give an example ot each of the following types of transaction:
a. affects assets only
b. reduces an asset and a liability
c. increases an asset and capital.
2. What is the oouble entry for:
a. paying for an expense
b. receiving Interest on an Investment
c. purchasing goods for resale
d. selling goods on creolt
e. the owner withdrawing cash for his/her own use?
3. What details are required when making an entry in a ledger
account?
 Posting transactions

Posting from the books of original entry LEARNING OUTCOMES

Here is a table that summarises when accounts are debited ano
credited, based on the Information provided in Unit 4.1: rn this unit you will learn about:
• posting from books of
Debit Credit original entry to ledger
Asse!s (10 increase their value) Assets (lo decrease 1hek value) accounts.
Liabilities (when repayments are Liabilities (10 increase their value or
made) 1he amount owed by tr.e business)
Purchases (when goods are
Sales (when goods are sold)
bought)
Expenses (when payments are Otner income types
made} (e.g. rent/in1erest received)
Drawings (for owner's whhdrawals) Capital (to increase Its value)
Every transaction should lead to a matching debi1 and credit entry,
so that the accounting equat,ion A = C + L always holds true.

Entries In ledger accounts are maoe from information recorded In the

seven books of original entry covered In Section 3. As information is KEY TERM
transferred or 'posted' the folio columns in the books of original entry
and In the ledger accounts are completed. Folio references are Folio references : a system
made In the following way: of cross-referencing entries
for each transaction In the
• In the ledger account the initlals of the book of original entry ledger accounts to which the
and the page number are recoroed (e.g. CB12 would mean the information has been posted
transaction was posted from page 12 of the cash book}. and in the book of original
• In the book of original entry, the account number to vvhich the entry from which the entry was
information has been posted is recorded (e.g. SL3 would mean posted.
that the Information was posted to sales ledger account number 3).

" ILLUSTRATION 1 Posting from a book of original entry and completing the folio columns
This illustration shows how a purchases book is posted to the Individual accounts payable in the purchases
ledger ot the business, and, at tne end ot tne month, the purchases book total is posted to the purchases
account in the general ledger.
Here is the purchases book of a business for May 2019.

PURCHASES BOOK Page5

Date ISupplier I Invoice number Folio Amount due
2019 s
May 10 ISupaSupplies Ud I 3 228 PL1 3280
Total purchases GL7 3 280

(Continued)
/ ILLUSTRATION 1 Posting from a book oi original entry and completing the folio columns (Continued)

GENERAL LEDGER
Dr Purchases (Account No. 7) Cr

2019 s
May 31 Purcoases book PBS

PURCHASES LEDGER
Dr Account payable: SupaSupplies Ltd (Account No. 1) Cr

s 112019
$
May 10 Purchases PB5 3280

Folio references Indicate that the entries for a transaction have been
completed. It follows that any gaps in folio columns Indicate that a
transaction has not yet been fully posted and, therefore. the double
entry is not yet complete. This can help when checking the accuracy
of the accounts.

ILLUSTRATION 2 Posting a cash book

Dr CASH BOOK Pege9 Cr

Discount Discount
allowed Cash Bank received Cash Bank
2019 s $ s 2019 $ $ $
July 1 Balances July 14 Downtown
bi d 300 4000 Prodocts PL1 80 1 520
Lorraine
18 Don SL1 20 380 20 Bank C 180
20 Casn C 180
GL2 20 GL3 80

GEN ERAL LEDGER

Dr Discounts allowed (Account No. 2) Cr
2019 $
July 31 Cash book CB9

Dr Discounts received (Account No. 3) Cr

112019 $
jJuly 31 Cash book CB9 80

(Continued)
" ILLUSTRATION 2 Pos1ing a cash book {Continued)

PURCHASES LEDGER
Dr Account payable: Downtown Products (Account No. 1) Cr

2019 $ $
July 14 Bank CB9 1 520
Discount
14 received CB9 80

SALES LEDGER
Dr Account receivable: Lorraine Don (Account No. 1) Cr

$ 2019 s
July 18 Bank CB9 380
Discount
18 allowed CB9 20

In the cash book:

• the C for contra entry is a reminder that the entries for this transaction are already complete
• a follo reference is placeo beside each discount column total.

SUMMARY QUESTIONS

1. An accounts clerk ls posting information from page 2 of a

sales book to an account numbereo 8 In the sales ledger.
What folio reference should appear in:
a. the sales book
b. the sales ledger account?
2. The total of the sta11onery analysis column on page 8 of a
petty cash book Is being posteo to the s1atlonery account
numbered 11 In the general ledger. \t✓hat folio reference
should appear In:
a. the petty cash book
b. the stationery account?
 Balancing accounts

Periodically it is necessary to balance many ledger accounts. This

LEARNING OUTCOMES
In this unit yov will learn about:
• how to balance accounts
• how to use pencil footings.
LINK
Closing accounts is the topic for
u ~it 4 .4.
Unit 4.5 covers trial balances.
For income statements and
balance shee:s see Section 5.
DID YOU KNOW?
• Accounts where the en1rles
are all on one side can still be
balanced using the three-
step process.
• Accounts with only one entry
do not need to be balanced.
process, together wtth closing some accounts, Is required in order to:
• Make a clear statement about the current value shown in the
account (I.e. the balance) or, In the case of some accounts, that
there is no balance (i.e. the account is closeo}
• Break up ledger accounts into more manageable sections.
• Provide Information for the completion of financial statements such
% as trial balances, income statements and statements of financial
position (balance sheets).
The balancing process
At the end of an accounting or financial period, it is necessary to find
the balance on each ledger account In order that a trial balance can
be extracted as part of the accounting cycle. The process is referred
to as 'balancing off accounts' or balancing the ledger.
Assets, liabilities and the capital accounts are usually balanced at the
end of a financial period {though accounts can be balanced more
often if desired). The balancing process follows the basic rule of
double entry - that there must be a matching debit and credit entry-
and involves three steps:
Step 1: Calculating 1he balance at 1he end of 1he period and recording
this on whichever side of the account has the lowest total {,his is referred
to as the balance carried down, er balance c/d).
Step 2: Recording totals on the next available blank line.
Step 3: Making a second record of the balance below the totals on the
opposite side to complete the double entry (tnis is referred to as the
balance brought down, or balance bid).

ILLUSTRATION 1 Balancing an asset account and a liability account

Here are tvvo ledger accounts as they might appear Just before the end of a financial period.

Dr Account recetvable: Louise Fray Cr

2019 $ 2019 $
Aug 10 Sales SB3 3 100 Aug 12 Bank CBS 1 800
12 Discount allowed CBS 200

Dr Bank loan Cr

2019 $ 2019 $
Aug 30 Bank CBS 500 Aug 1 Bank CBS 8000

(Continued)
/ ILLUSTRATION 1 Preparing a three-column cash book (Continued)
The balance on the asset (account receivable) account is $1 100 (i.e. 11ie total of the debit side S3 100 less the
total of the credit side $2 000).
The balance on the liability (bank loan) account is $7 500 (i.e. $8 000 less $500).
Here are the accounts balanced following the three steps outlined above. To help you identify each step
they are clearly identified In the accounts.

Dr Account receivable: Louise Fray Cr

2019 $ 2019 $
Aug 10 Sales SB3 3 100 Aug 12 Bank CBS 1 800
12 Discount allowed CBS 200
31 Balar.ce c/d Step 1 1 100
Step2 3100 Step2 3100
Sept 1 Balance bid Step3 1 100

Dr Bank loan Cr

2019 $ 2019 s
Aug 30 Bank CBS 500 Aug 1 Bank CBS 8000
31 Balancec/d Step 1 7500
Step2 8000 Step2 8000
Sept 1 Balance bid Step3 7500

Note: When the balance of an account is brought down the date used is the first day of the following
month or period.

Using pencil footings

EXAM TIP
Some inoivlduals find it helpful to make a pencil note of the totals
of each side of an account in order 10 work out the balance. These rt is wovtl,iwi,iile
pencil footings are entered before carrying out the formal balancing
process. and can be erased when the balancing process is
l'~Clct.s,"'-0 bcilci"'-ci"'-0
CiC-COL<V\.ts CIS tn.s is
complete.
ofte"'- "-Ot clo""e welt i""
Remember that discount columns are totalled rather than balanced GXCI l'l<.i"'-Cltto"'-S.
(see Unit 3.5) ano folio references are placed beside or below these
totals

SUMMARY QUESTIONS

1. What benefrts arise from balancing accounts?

2. Describe the three stages in the balancing process.
3 . Explain the difference between the terms 'balance b/d' and
'balance c/d'.
 Closing accounts

LEARNING OUTCOMES
In this unit yov will learn about:
• how to close accounts that
do not have a balance
• how lo transfer an account
balance to 1he income
statement and close the
account.
Closing accounts that do not have a balance
Some asset or llablllty accounts will not show a balance at the end
of the account year. This is because the total of entries on each sloe
of the account is the same. A typical example ls the account of an
account receivable to whom goods have been sold on credit, but
who has paid off the amount due.
To close an account without a balance:
Either: record totals on the next available blank line - this process
is used for accounts where there are a number of entries on
either or both sides of the account.
Or: record double total lines - this process is used where there is
just one entry on each side of the account.

I
ILLUSTRATION 1 Closing accounts that do not have a balance
Here is the account of a credit supplier ln the purchases ledger of a business. The amount due 10 this
supplier has been paid, and !here is no balance on the account, so a total has been added.

I PURCHASES LEDGER
I
Dr Account payable: ABC Supplies (Account No. 3) Cr
2019 s 2019 $
Oct 22 Bank CB9 3 420 Oci 1 Balance b/cf 3600
22 Discount received CB9 180
3600 3600

Here is an acoount receivable in the sales ledger of a business. The amount dve has been paid by this credit
customer. As there is just one entry on eitl>er side of the account, only dovble lines have been added- there
is no need 10 record a tolal.

I SALES LEDGER
I
Dr Account receivable: Kris Williams (Account No. 11 ) Cr

2019 s 2019 s
Oct 1 Balance bid 730 Oct 18 Bank CBS 730
,

DID YOU KNOW?

An alternative format for keeping accounts records the balance
on the account after each entry is made. This format Is mainly
used when computerised accounting software is used. This
running-balance format follows the same rules of double entry.
Closing accounts by transferring the
account balance
LINK %
There is more about enlries in
Some accounts are closed at the end of a financial year because the income stalements in Section 5.
total of the entnes is transferred elsewhere. The accounts that are
closed are those relating to:
• expenses • purchases
• Income (such as discounts received} • sales
These accounts are closed at the end of a financial year because the
total amount shown has to be transferred to the income statement.
The procedure is as follows: SUMMARY QUESTIONS
Step 1: Calculate tne balance of the account and reccrd this on
whicriever side - debit or credit - is :he smaller side (it is likely that there 1. Describe the procedure for
closing an account.
will be no existing entries on this side of tr e account at this point). The
narrative to use is 'income statement'. 2. In which book of original
entry should the transfer
Step 2: Record totals on the next available blank line (if there is only one
entry on each side of the account just rule a double line). of an account balance to
the Income statement be
Step 3: Do NOT bring down :he balance on the aooount. The o:her entry recorded?
for the debit or credit in Step 1 will be in the income statement.

ILLUSTRATION 2 Closing accounts at the year end

GENERAL LEDGER

Dr Administration expenses (Account No. 1) Cr

2019 s 2019 $
Dec 31 Total entries for year CB 5600 Dec 31 Income statement J 5600

Dr Discounts received (Account No. 3) Cr

2019 s 2019 $
Dec 31 Income statement J 850 Dec 31 Total emries for year CB 850

Dr Purchases (Account No. 4) Cr

2019 s 2019 $
Dec 31 Purchases book PB 18970 Dec 31 Income statement J 22 720
31 Cash purchases CB 3 750
22 720 22 720

Dr Sales (Account No. 9) Cr

2019 $ 2019 $
Dec 31 Income s1atement J 58000 Dec 31 Sales book SB 38620
31 Cash sales CB 19 380
58000 58000

Note: The closing entries are first recorded in the general journal and then posted to the ledger
accounts.

LEARNING OUTCOMES
In this unit yov will learn about:
• Interpreting entries and
balances
• using balances brought down
to construct a trial balance
• the uses and limitations of
trial balances.
LINK % system, it is also a very useful summary to refer to when preparing
Tl"e Income statement and
statement of financial position are
covered In Semion 5.
See Section 7. Unit 7 .1 for more
details about the limitations of a
trial balance.
Interpreting entries and
preparing a trial balance
Interpreting entries and balances
It is a valuable skill to be able to explain the entrles made In any
ledger account. This means stating the following:
The date of the transaction {year. month and day)
The nature of transaction (explaining what caused the entry)
The amount of the transaction
The purpose of a trial balance
• The trial balance is designed to check the accuracy of the
double-entry records.
• Because the trial balance lists all the accounts in the accounting
financial statements such as the Income statement and statement
of financial position.
However, the trial balance does have limitations. There are several
types of error which are not revealed by a trial balance.
How does a trial balance work?
The trial balance Is based on the principle that for every transaction
there should be a matching debit and creoit entry, so that the total of
all debit entries should equal the total of all credit entries.
To produce a trial balance the following steps are necessary:
Step 1: List all the accounts in tne accounting system.
Step 2: For each account, record its balance in either the debit column
or credtt column of the trial balance. according to the side on 1•/nich the
balance appears in the account.
Step 3 : Total the debit and credit columns of the trial balance -the totals
should agree.
' ILLUSTRATION 1 Preparing a trial balance
In this Illustration, the trial balance of a business is already partly completed. The balances of the accounts
shown are to be added to the 1rial balance for tt to be completed.

GENERAL LEDGER
Or Fixtures and fittings (Account No. 2) Cr
2019 $ 2019 $
Jan 1 Balance bid 17 300 Nov 3 Bank CB 800
May 12 Bank CB 3600

Dr Sales (Account No. 5) Cr

$ 2019 s
Jan-Nov Total entries SB 53600
Dec 31 Sales book SB 4100

Trial balance at 31 December 2019

Or Cr
$ s
Account payable: QX Manufacturer PL4 4 130
Account receivable: E Jones SL3 2 080
Capital GL1 27 940
Cash in hand CB7 390
Cash at bank CB7 2740
Fixt ures and f ittings GL2 20100
General expenses GL3 5800
Purchases GL4 39900
Sales GLS 57 700
Wages GL6 18 760
89 770 89770

Note: The correct heaoing for a trial balance is always 'Trial balance at ... • (I.e. al a particular date).

SUMMARY QUESTIONS

1. What details should be given when interpreting an entry in a

ledger account?
2. What are the benefits of preparing a trial balance?
3. How do you know which column to record the balance of an
account in when preparing a trial balance?
 Worked example: preparing
books of original entry and
double-entry records
Special note: the question used in this v,;orked example has been
designed to Illustrate many of the techniques and procedures
covered in Sections 3 and 4. The question is, therefore, far more
extensive than could be Included In an examination question.
Examination questions could ask you to prepare Just one or a few of
the many elements covered.

The question
To help you follow the answer, each transaction/item of information
has been given a letter of the alphabet, A, a, C and so on. These
letters have been used In the answer to help you Identify where the
entries have been made in the books of original entry
Roslyn starteo business as a wholesaler of sports equipment on
1 May 2019. The accounting system o: the business has been
designed to Include the follov,,ing books of original entry:
• General journal • Return outwards bock
• Purchases book • Returns inwards book
• Sales book • Three-column cash book
There will be three subdivisions of the ledger: purchases ledger, sales
ledger, general ledger.

A May 1 Business opened wtth the following: delivery vehicle $18 000: cash at bank $6 200; casn in nand
$400; bank loan S8 000
B 2 Paid rent for the month $850 by cheque
C 4 Purchased goods for resale on credit from Dennery Sports Ltd with list price $4 400 less 20%
trade discount
D 6 Cash sales to1alled S960
E 9 Returned goods 10 Dennery Sports Ltd purchased on credtt 4 May wtth list price $350 less 20%
trade discount
F 12 Sold goods on credit to Jamal's Spor:s, $1 200, less 15% trade discoun1
G 14 Transferred cash $500 to 1he bank account
H 18 Jamal's Sports returned goods sold 12 May, $140, less 15% trade discount
I 21 Paid wages in cash $630
J 24 Paid Dennery Sports Lid in full se1tlement of the amount due less a 5% cash discount
K 25 Purchased goods for resale and paid by cheque $720
L 27 Purchased office equipment $1 200 on credit from Interstate Supplies Ltd
M 29 Received cneque from Jamal's Sports for S889 in full settlement of 1he amount due
N 30 Roslyn withdrew cheque for $300 for priva1e use
Prepare the books of original entry and post to the ledger accounts.
The cash book should be balanced on 31 May 2019. No other
EXAM TIP
accounts need to be balanced. Prepare a trial balance at 3 1 May 2019.
r"' i;i"' exi;i .,,._iia,i;itio"" tJ o«.
Getting started CO«.ld i;ic4c4 pe....cil "-Otes
It Is always a good idea to look carefully through the Information to ti-le q«.estio"' 0 "" ti-le
before you start to prepare your answer. Decide which of the exi;i.,,._ pi;iper o,a, i;i"-1;1
transactions in the list are stralghtforv1ard and which might need ketJ poiia,ts ti-li;it vi.cignt
more thought. Points to note: 11elp tJDL< wi-leia, t)DL<
• This is a new business so the first transaction Is to set up an prepi;ire 1:1our i;i,a,swer.
accounting system. For ~i;i,""'-ple, tJOL< CO«.td
• There is a purchase on credit that Involves the daouction of a trade
pe~~•l """ •,;11icl1 boo~ of
orig,l'\./;ll e"'tt'J:j ta «.Se.
discount.
• Some of the goods purchased on credit are returned, so this
transaction also involves a trade discount.
• There is also a sale on credit and a subsequent return by the
customer that Involves a trade discount.
• As well as credit purchases and sales. there are also cash
purchases and sales.
• There is the purchase of a non-current asset on credit.
• The settlement of the account payable and account receivable
includes the deduction of cash discounts.
As the first thing to do is to prepare the books of original entry, it
might also be a good idea to have another look at each transaction
and decide in which book it should be entered. Here is the list of
transactions again with an aoditional column showing which book of
original entry should be used.

A May 1 The business opened with the following: delivery vehicle St 8 000; cash at bank General journal
$6 200; cash In hand $400; bank loan $8 000
B 2 Paid rent for the month $850 by cheque Cash book
C 4 Purchased goods for resale on credtt from Dennery Sports Ltd with list price Purchases
$4 400 less 20% trade discounts book
D 6 Cash sales totalled $960 Cash book
E 9 Returned goods to Dennery Sports Lld purchased on credit on 2 May with list Returns
price $350 less 20% trade discount outwards bcok
F 12 Sold goods on credit to Jamal's Sports, $1 200, less 15% trade discount Sales book
G 14 Transferred cash $500 to the bank account Cash book
H 18 Jamal's Sports returned goods sold on 12 May. $140, less 15% trade discount Returns
inwards book
I 21 Paid wages in cash $630 Cash book
J 24 Paid Dennery Sports Ltd in full sel!lement of the amount due less a 5% cash discount Cash book
K 25 Purchased goods for resale and paid by cheque $720 Cash book
L 27 Purcnased office equipment $1 200 on credh from Interstate SJpplies Ltd General journal
M 29 Received a cheque 'rom Jamal's Sports for $889 in full set:lemem of the amount due Cash book
N 30 Roslyn withdrew a cheque for $300 for private use Cash book
 The answer
Preparing the books of original entry
The general journal
The order In which you prepare the books of original entry does
not matter. Here first Is the general Journal. The table shows that
there are tv10 entries to be made corresponding to transactions
A and L.

JOURNAL Page 1
Date Details Folio• Dr Cr
2019 s $
A May 1 Delivery vehicle GL1 18000
Bank CB1 6200
Cash CB1 400
Bank loan GL2 8000
Capital GL3 16 600~
Entries to open books of account
L 27 Office equipment GL4 1 200
Account payabl e: Interstate Supplies Ltd... PL2 1 200
Purcnase o' non-current asset on credii, irlVOice no. ......
Notes:
• Folio references have been included for the sake of comple:eness
In each of the books of original entry.
In practice they would only have been added when the entries were
transferred to the ledger accounts.
.. The 1igure for capital had to be calculated using the accounting
formula A = C L, I.e. assets ($24 600) less !iabilttles (SB 000).
T

... In some accounting systems the acoount of tne credit supplier would
be included irl the general ledger.
This happens when the decision Is made to use the purchases ledger
only for suppliers of goods tor resale.
The purchases book
There Is Just one entry to be made in the purchases book (see
transaction C). The other purchases are either for cash (transaction K)
or relate to a non-current asset (transaction L), and so should be
EXAM TIP recorded elsewhere.

It ~s a com mo"" mi.sta lu PURCHASES BOOK Page 1

;O tvscl1A.cle cash j>IA.rc.i,,ases Date I Supplier Folio Amount due
'"" the -p1A.rch&1ses book. 2019 $
"TIiie -p1A.rch&1ses book i.s
stri.ctt11 for piA.t-ehases ovc C May I 4 IDennery Sports Ltd PL1 3 520"
credit of goods for res&1te. Total purchases GL5 3520
Note:
• This figure was calculated as fellows: list price S4 400 x 80%
(i.e. less the 20% trade discount).
The sales book
There ls just one entry to be made in the sales book (see transaction F).
The other sale is for cash (transaction D).

SALES BOOK Page 1

Date ICustom er Folio Amount due

2019 $
F May I 12 IJamal's Sports SL1 1 020·
Total sales GL6 1 020

Note:
• This figure was calculated as follows: list price $1 200 x 85% EXAM TIP
(i.e. less 15% nade discount).
ft ~s '1 C.Ovi.c""'-0.,, vi.cista~
The returns books t o Lvsct1-<.ole ci:isi,i stltes i.vs
There Is one entry to be made in each of the returns books (see t"1e s&1tes book. The sates
transaction E for returns outwards, and H tor returns inwards). book is stri.ctli:J foy sa~s
ovs cYeoli.t of goools foY
RETURNS OUTWARDS BOOK Page 1
..-esa~.
Date ISupplier Folio Amount due
2019 $
E May I 9 IDennery Sports Ltd PL1 280'
Total returns outit✓ards GL7 280

Note:
• This figure was calculated as follows: list price S350 x 80%
Q.e. less 20% trade discount).

RETURNS INWARDS BOOK Page 1

Date ICustomer Folio Amount due
2019 $
H May I 1a I Jamal's Sports SL1 119•
Total returns inwards GL8 119
• This figure was calc~lated as follows: list price St 40 x 85% (i.e. less
15% trade discount).
The three-column cash book
There are eight transactions th at affect the cash book, including
the opening balances that are to be posted from the journal. The
question also requires that the cash book Is balanced on 3 1 May.
 CASH BOOK Page 1
Disc Disc
Folio Allw Cash Bank Folio Rec Cash Bank
2019 $ $ s 2019 $ $ $
May 1 Balances A J1 400 6200 May 2 Rent B GL9 850
6 Sales D GL6 960 14 Bank G C 500
14 Cash G C 500 21 Wages GL1 0 630
Jamal's Dennery
29 Spcns M SL1 12- 889 24 Sports Ltd J PL1 162' 3078'
25 Pvrchases K GL5 720
30 Drawings N GL11 300
31 Balances cld 230 2 641
GL12 12 1 360 7 589 GL1 3 162 1 360 7 589
June 1 Balances b/d 230 2 641

Noles:
• The cash discount was calculated as 5% of the balance of the supplier's account {purchase $3 520 less
=
returns $280 $3 240).
" The cash discount was calculated as the balance of the customer's account (sales $ 1 020 less returns
=
$119 $901} less the amount recelveo $889.

Preparing the ledger accounts

EXAM TIP
rt is east, to fovget that
the disecu...t eoLu"'->¼
aye Mt baLa""ced . '""stead
t'1elj ave eaek tctaL~d a"'-cl
t~e totals ave po.steel to
clLSeou..,,t aecou"'-tS i"'- the
ge"."e,-al ~clgev - he"'-ce the
f~L~c Yefeve""ces fcv tloiese
cl~sco'-<"'-t acco'-<vcts aye
~'1owv. &1Lo"'9sicle the totals
'"'- tloie cash boo~.
It is now possible to prepare each of the ledger accounts, posting all
ihe information shown In the books of original entry. It Is suggested
that the following steps are taken:
Step 1: Draw up all lhe accounts reqvired with the litles of lhe accounls
shown, using the three subdivisions of the ledger, before making any
entries.
Step 2: Take each book of criginal ernry 111 turn and post the Information
shown to lhe relevant ledger accounts - it is at this point that the
folio references should be added to the book of original entry
and to the entries made in ledger accounts. 11 is importanl lo be
syslema,ic as otherwise some emries might easily be overlooked.
Here are all the ledger accounts wtth postings from the books
of original entry.

GENERAL LEDGER
Dr Delivery vehicle (Account No. 1) Cr

~
2019 s
May 1 Balance J1 18 ~00

!
Dr Bank loan (Account No. 2) Cr

$ 2019 $
May 1 Balance J1 8000

!
Dr Capital (Account No. 3) Cr

$ 2019 $
May 1 Balance J1 16 600

Dr Office equipment (Account No. 4) Cr

2019 $ $
May 27 lnlersta1e Supplies J1 1 200

Dr Purchases (Account No. 5) Cr

2019 $ $
May 25 Bank CB1 720
31 Purchases book PB1 3520

Dr Sales (Account No. 6) Cr

$ 2019 $
May 6 Cash CB1 960
31 Sales book SB1 1 020

!
Dr Returns outwards (Account No. 7) Cr

$ 2019 $
May 31 Re1urns oU1 book ROB1 280

Dr Returns inwards (Account No. 8) Cr

~
2019 $
May 31 Returns in book RIB1 ~19

Dr Rent (Account No. 9) Cr

2019 $
May 2 Bank CB1 !soi
Dr Wages (Account No. 1O) Cr
2019
May 21 Cash CB1 6:0 I $

Dr Drawings (Account No. 11) Cr

2019
May

Dr
30 Bank CB1 3~0 I
Discounts allowed (Account No. 12)
$

Cr
2019
May

Dr
31 Casn book CB1 ~2 I
Discounts received (Account No. 13)
$

Cr
$ 1 2019
$
May 31 Cash book CB1 162

PURCHASES LEDGER
Dr Account payable: Dennery Sports Ltd (Account No. 1) Cr
2019 $ 2019 $
May 9 Re1urns out ROB1 280 May 4 Purchases PB1 3520
24 Bank CB1 3078
24 Disc received 0B1 162

Dr Account payable: Interstate Supplies Ltd (Account No. 2) Cr

$ $
1 2019
May 27 Office equipment J1 1 200

SALES LEDGER
Dr Account receivable: Jamal's Sports (Account No. 1) Cr
2019 $ 2019 $
May 12 Sales S81 1 020 May 18 Returns in RIB1 119
29 Bank CB1 889
29 Disc allowed CB1 12
Preparing the trial balance
The final task Is the preparation of the trial balance. It is not EXAM TIP
necessary to balance the ledger accounts In order to do this, but
you may prefer to carry out this procedure. The accounts which do rt is uis1:1 to foYget to
not have a balance (for example, the account of the account payable post tne totals of t11e
Dennery Sports Ltd) need not be shown.
~DO~ of DYigi"'-tll ev.t"l:J,
Trial balance at 31 May 2019 <.e. tl1e total of tne sales
boo~, puyc,I, ases boo~,
Dr Cr
YetuYv.s boo~ av.ol
$ $ easl, boo~ (olisc-ouvct
Account payable: Interstate eoLu'¾v.s).
Supplies Ud PL2 1 200
Bank loan GL2 8000
Capital GL3 16600
Cash at bank CB1 2 641
Cash in hand CB1 230
Delivery vehicle GL1 18 000
Discounts allowed GL12 12
Discounts received GL13 162
Drawings GL11 300
Office equipment GL" 1 200
EXAM TIP
Purchases GL5 4 240
Rent GL9 850 rt is a co'¾w..av. "'1.ista~e
to ove.-too~ tl-ie casn
Ret11ms Inwards GL8 119
av.ol ba~ balav.ces
Ret11ms outwards GL7 280 wne.,,, }>YtJ>aYiv.g a tYial
Sales GL6 1 980 batav.ee becaKse tl1e¥, aye
Wages GL10 630 YeooYoleol Stj>aYateli:j Y0"'1.
tl-ie teolge... aec,ou"'-ts .
28 222 28 222
 Practice exam questions

Paper1
1 Odette purchased goods from Stephen. How 4 On 1 November 2019 a bvslness had a positive
should ;his transaction be recorded In Stephen's balance In ns bank accourt of S700. During
aocounts? November S2 300 was paid into the bank and
A debit purchases credn Odette $3 100 was wrthdrawn from the bank. Tne
balance of the bar k account at 30 November
B debit Ode:te credrt sales
2019 was:
C debit Odette credit purchases
A debit $100 B debit $1 500
D debit sales credn Odette
C credit $100 D credit $1 500
2 Vvhich one of the following statements ,s correct?
5 Which of 1he following accounts should be
A nominal accounts appear ln the sales ledger entered in the debt column of a trial balance?
B 1he general ledger contains personal accounts A bank overdraft B capital
C 1he sales account appears In lhe sales ledger C drawings D sales
D accounls payable appear in 1he purchases
6 IA/hich of 1he following accounts should be
ledger
entered in the credit column of a trial balance?
3 A bookkeeper had 1otalled lhe returns outwards A cash In hand
book and sales book of a business at tl'e end of
B drawings
a month. These 1otals should be poS'.ed to the
ledger accounts as follows: C returns inwards
A debit returns outwards account and debit D accounts payable
sales accoun1
B debit returns ou:wards accoun1 and etedit
S<1les accoun1
C credrt r(lturns outwards account and debit
sales accoon1
D credn retvms outwards account and credit
sales accoun1

Paper2
1 Preparing ledger accounts using three
separate ledgers 9 Paid shop rem by cheque, S3 000
12 Purohased shop fittirgs and pa·d by
Prepare a cash book and ledger accounts to cheque, $11 000
record the following i~formaiion. The accounts
should be maintained In a ge'leral ledger, 18 Sold goods on credt to M Church,
purchases ledger and sales ledger. $3200
23 Toe owner withdrew a cheque for
2019 S600 for private use
001 1 A business was opened when a 24 Paid Best Supp'ies Ltd $1 600 by
cheque for $45 000 was paid Imo a cheque In pan settlement oi the
business bank accou11t by the owner amoum due
us1119 funds from his private resources
29 Cash sales total'ed $900
3 Purchased goods for resale on cred~
from Best Suppl·es Ltd. $2 400 30 Paid wages in cash. $700
2 Posting subsidiary books
Account receivable:
Complete the following table to show how Dr Cr
Sandford Stores
entries i'l some books of original entry should
be posted to ledger aocovnts. The firs! item has
2019 s 2019 $

been completed as an example. Aug 1 Balance 4200 Aug 12 Bank 1 900

19 Sa'es 1 150 12 Discount
Entry In book Debit allowed 100
of original or Ledger
entry Ledger credit account Returns
24 220
Inwards
a An entry lor a Sales Dr Account
sale on credit receivable
Dr Account payable: W Carlton Cr
In ihe sa'es
book 2019 $ 2019 $

b Toe total of Aug 15 Saes 900 Aug 1 Balance 1 800

the purchases 22 Purchases 2 400
book
C Toe payment Dr Equipment Cr
of wages in
cash In the 2019 $
cash book Aug 15 Balance 11 900
d The total of 22 Bank 4800
the stationery
analysis
column in the Dr Bank loan Cr
petty cash 2019 $
book
Aug 1 Ba'ance 11 200
e An entry lor the
return of goods 29 Bank 5500
by a credit
4 Preparing a trial balance
cuS1omer in the
returns Inwards Prepare a trial balance dated 30 September
book 2019 irom the followlng information.
f Toe receipt
$ $
01a cheque
from a e<edlt Accounts D scounts
5 420 100
cuS1omer in the payable allowed
cash book
Accounts D scounts
12 260 240
g Toe total of receivable received
the returns
Ad'11inistra1fon
outwards book 450 Drawings 11 850
expenses
3 Balancing accounts Bankl08n 6000 Motor veil cles 22 800
Make a copy of tne 'ollowing ledger accoJnts. Capital 22 630 Purchases 44 830
Balance ti1e accoums on 31 August 2019 .
Cash at bank 3 420 Saes 61 690
Cash in hand 270
 Introduction
LEARNING OUTCOMES
In this unit you will learn about:
• the purpose of preparing
financial statements
• the components of 'lnanclal
statements
• the Income statement of sole
traders.
KEY TERMS
Gross profit (or income):
the profit made by buying and
selling gooos.
Profit for the year: the profit
made by a business In a
financial year taking account o'
operational expenses. Profit for
the year Is sometimes referred
to as ·net profit' or 'income'.
The purpose of preparing financial statements
Financial statements are designed to inform a wide range of users of
important aspects of the performance of a business. In the case of a
sole trader, the owner and managers will need to know how profitable
the business is and also whether it is generating enough funds to pay
its way. The tax authorities will also need lo have reliable information
aboU1 profits in order to make an accurate assessment of the tax the
business should pay or tax benefits the company should receive.
The components of financial statements
A sole trader's financial statements, prepared at the end of each
financial year, consist of an Income statement and a statement of
financial position (balance sheet).
The income statement of a trading business Is in two sections:
• A trading account section, comparing the sales of the business for
the period to the cost of the goods sold, to give a figure for g ross
profit (or income)
• A profit and loss section, comparing the gross pro'it made by the
business to all t~,e day-to-day running costs of the business, giving
a figure for net profit (or income) for the year (or net loss for
the year).
In the case of a service business lhe income statement consists of
Just one section, recording sales less running costs, to show a figure
for profi1 (or loss) for the year. (Service businesses do not have a
gross profit.)
Other forms of business ownership (for example, partnerships and
limited companies) will have additional financial statements. covered
In Sections 8 and 9 of this book.
A statement of financial position (balance sheet) Is a formal document
setting out details of the assels, liabilities and capital of a business.
It provides the Information required 10 enable users 10 judge the
success or otherwise of a business in lerms of profitabilily and
solvency (the ability to pay its debls).
Both income s1atemen1s and statements of financial position
(balance sheets) are usually set oul In a vertical style these days. This
format is now in common use because it has greater flexibility and
Is more easily understood by those who are not enlirely familiar with
double-entry systems.
Preparing the income statement of a sole trader
to determine gross profit and net profit or net loss
An Income statement (sometimes called a trading and profit and
loss account) sets oul a detailed calculation of the profit or loss for
the year of the business. The transfer of information (sales, income,
expenses) to the Income statement from general ledger accounts is
first recorded In the general Journal (see Unit 5.3). Account is taken
of the value of unsold goods (inventory) when calculating the profit
{there is more on this in Unit 5. 2).

" ILLUSTRATION 1 The format tor a simple income statement

Here is the format for a simple income statement of a business
selling goods, using the vertical style.

Income statement for the year ended 3 1 December 2018

$ $
Revenue 220000
Less cos1 of sales:
Opening inventory 70000
Purchases 160000
170000
Closing hventory (20000)
Ccst of sales [150 000)
Gross profit/income 70000 LINKS C''b
Add discounts received 5000 Financial sta,ements will be
75000 studied carefully and will be
Less operating expenses: s.ibject to close analysis. In order
Administration expenses 75000 that tne financial S!rengths and
Rent 17 000 weaknesses of ihe business can
Wages 19000 be established, often by using
Total expenses !51 000) accounting ratios (see Unit 5.7).
Profit for the year 24000 Comparisons wi:h previous years
and with the results ol similar
• 'Revenue' Is the term used In an income statement tor the businesses will be made wherever
Income from sales of goods of a business. possible, and reports prepared
setting out recommendations for
• It Is recommended that any figures that are to be deducted in
improvir g the performance of the
an Income statement are shown Jn brackets.
business (see Unit 5.8).

~ .
SUMMARY QUESTIONS
-~~-
1 . Which statements make up the financial statements of a
business?
2. Why Is the vertical format now the most commonly used
presentation for 'lnancial statements?
3. Describe the main components of an Income statement.
 More about income
statements

LEARNING OUTCOMES
In this unit yov will learn about:
• preparing a sole trader's
Income statement 10 record
inven1ory
• how returns are recorded In
an income statement
• how carriage expenses
are recordeo In an income
statement.
Double entry for inventory
The valuation of unsold goods {inventory) Is taken into account at
the end of each financial year. Often the figure Is found by actually
counting the items in the stockroom and working out the value using
the price paid for the items l'1hen they were purchased. Alternatively,
it is now becoming much more common for inventory records to be
kept electronically using software that can produce figures for the
valuation of Inventory.
Once the closing inventory has been valued, general Journal entries
will be prepared such that. when they are posted to the general
ledger, the following results:
• debited to 1he inventory account in the general ledger
• deducted from the value of goods available for sale during the year
ln the income statement (the equivalent of a credit entry).

I
ILLUSTRATION 1 Recoroing the opening and closing valuations of inventories

Here are the entries to record the opening valuation of inventory $8 000, purchases S82 000,
revenue $191 000 and closing Inventory $11 000 of a business.

Dr Inventory (Account No. 14) Cr

2018 $ 2018 $
Jan 1 Balance bid 8 COO Dec 31 Income statement 8000
2019
Jan 1 Income statement 11 000

Income statement for the year ended 31 December 2018

$ $
Revenue 191 000
Less cost of sales:
Opening inventory 8000
Purchases 82 000
90000
Closing inventory (11 000)
Cost of sales (79 000)
Gross profit 112000

The general Journal is used to recoro the opening ana closing inventories, as Illustrated In the
next unit, Unit 5.3.
If a business has a closing inventory, it follows that this will
be the inventory at the beginning of the next financial period
EXAM TIP
(I.e. the next day). When preparing an Income statement, the
entries for an opening Inventory are: It is i""-porta "'-l: to
• creoit the inventory account. to transfer the opening Inventory to ;e""'-l1%ber th1:1t ccin-i.Age
the income statement <"-WCI m,; Cl l'Coi CCI n-i.A c.e
0<-<twArols C11-e both ~
• add the opening inventory to the purchases figure ln the income
statement to give the value of goods available for sale (the expe"'-Ses.
equivalent of a debit entry).
Remember that entries In the general journal always precede entries
in ledger accounts.

Recording returns in the trading section EXAM TIP

of an income statement
It is AolvisAble t o oleoluct
Goods returned are recorded In the trading section of an Income Yetun,,.s OUtwArols fY01%
statement.
P<-<Yc_hAs~ before ciololi""9
• Returns inward s (sales returns) are deducted from revenue to CAYnAge Ol'CWtlYois.
show a net figure for the yea1 under review.
• Returns outwards (purchases returns) are deducted from
purchases to show a net figure for the year under review.
KEY TERMS
Carriage charges and the income statement Carriage inwards: the cost of
Carriage is the term used to describe the expense of having goods transporting goods purchased
delivereo. by a business - It is added
to purchases In the income
• Carriage inwards refers to the charges paid to have purchases statement.
delivered (a cost of purchases). Carnage inwards is recorded in the
trading section of the income statement. Carriage outwards: the
cost of transporting goods
• Carriage outwards refers to the charges paid by a business to to customers - as a selling
have its goods delivered to customers (a selling expense). Carriage expense. it is recoroed in the
outwards Is recorded In the profit and loss section of the income second part of the income
statement. statement.
See Unit 5.6 for an illustration of a trading section recording returns
and carriage inwards.

SUMMARY QUESTIONS
1 . What is the double entry for recording:
a. a closing Inventory
b. an opening Inventory?
2. What is the difference between carriage Inwards and carriage
outwaids?
3. In what order should the items in the cost o; sales section of
an Income statement be set out?
 Journal entries and the
income statement

All transfers to the Income statement should first be recorded in the

LEARNING OUTCOMES
In this unit yov will learn about:
• preparing journal entries
to recoro transfers to the
income statement.
general journal.
Remember to start each journal entry by stating the account to
be debited followed by the account to be credlteo. Each journal
entry should conclude wtth a narrative (I.e. a brief explanation of the
reason for the entry) unless you are instructed that narratives are not
required.

I
/ ILLUSTRATION 1 Journal entries and the income statement

A business Is about to prepare Its Income statement for the year ended 31 August 2018. On this oate the
following information is available:

$ $
Discounts allowed 700 F Purchases 51 400 C
Discounts received 400 E Returns irwvards 3500 G
lnven1ory Returns oulwards 2000 H
At 1 September 201 7 7 200 a Revenue (sales) 97 700 A
At 31 Av;iust 2018 8500 D Wages 14 700 F

Each of the above items has been given a fetter corresponding to the relevant Journal entry below. Here
are the journal entries required to record this Information in the income statement:

JOURNAL Page3
Oetalls Folio Dr Cr
$ $
A Sales GL6 97 700
Income statement (revenue) GL9 97 700
Transfer of sales to income statement
a Income statement GL9 7 200
Inventory GL4 7200
Transfer of opening inventory to income statement
C Income statement GL9 51 aoo
Purchases GL5 51 400
Transfer of purchases to income statement
D Inventory GL4 8500
Income statement GL9 8500
Entries to record closing inventory
E Discounts received GL2 400
Income statemem 400
Transfer of discounts received to income statement
F Income statement GL9 15 400
Discounts allowed GL1 700
Wages GL3 14 700
Entries to transfer expenses to income statement

(Continued)
' ILLUSTRATION 1 Journal entries and the income statement {Conlinued)

JOURNAL Page3
Data/ls Folio Dr Cr
$ $
G Income siatement GL9 3500
Returns inwards GL7 3500
En1ries to transfer returns inwards to income stalement
H Relurns oulwards GL8 2000
lnoome staiemen1 GL9 2000
Enlries to transfer returns outwards to income Slatement
And here Is the Income sta1ement.

Income statement for the year ended

31 August 2018 (Account No. 9)

$ $
A Revenue J3 97 700
G Less relurns Inwards J3 (3 500)
Ne1sales 94200
Less cost of sales:
B Opening invenlory J3 7 200
C Purchases J3 51 400
H Less returns outwards J3 (2 000)
Nel purchases 49400
CoS1 of goods available for sale 56600
O Less closing inv-enlory J3 (8 500)
Cosf of sales (48 100)
Gross proftt 46100
E Add discounts received J3 400
46500
Less opera1ing expenses:
F Disccun1s allowed J3 700
F Wages J3 14 700
Tolal operating expenses (15 400)
Profrt for 1he year J3 31 100

DID YOU KNOW?

• • •
The Income statement is part
1. Which book o~original entry Is used to record transfers of of the general ledger and so rt
general ledger accounts to the income statement? is shown with a general leoger
2. What is the double entry to record the transfer of sales account number.
(revenue) to the Income sta1ement?
3. What is the double entry to record the transfer to the income
LINK %
statement of: Toe profit (or loss) for the year is
transferred 10 1he capital account.
a. discount received This is covered in the next urit,
b. olscounts allowed? Unit 5.4.

LEARNING OUTCOMES
In this unit yov will learn about:
• updating the capital account
at year end
• preparing an income statement
for a service business.
The capital account
and service business
income statements
Updating the capital account
When the Income statement is complete, the profit (or loss) for the
year, which represents an increase (or decrease) in the value of the
business, is transferred to the capttal account. To complete the
capital account, the total of the owner's drawings is transferred from
the drawings account to the capital account. These transfers should
first appear in the general journal.

ILLUSTRATION 1 Updating a capital account

A business Is about to prepare its

income statement for the year ended GENERAL LEDGER
31 December 2018. On this date the Dr Capital (Account No. 1) Cr
following information Is available:
2018 $ 2018 $
Dec 31 Drawings J6 27 000 Jan 1 Balance bid 83600
s 31 Balance c/d 109 000 Dec31
Capital at 1 January 2018 83600
136 100 Profit for year J6 52 200
Drawings 27000
136 100
Profit for 1he year 52500
2019
Here is the completed capttal account Jan 1 Balance bid 109 100
in the general ledger.

The income statements of service businesses

SUMMARY QUESTIONS
1. What is the double entry to:
a. transfer total orawings
to 1he capital account
b. transfer profit for the
year to the capital
account?
2. What entries would be
required to transfer a loss
for the year to the capital
account?
3. Descnbe how an income
statement for a service
business dHfers from the
income statement for a
trading business.
Many businesses provide services rather than sell goods. In the end-
of-year financial statements there is therefore no need for a trading
section in the Income statement. which insteac:i consists of just one
section showing expenses deducted from revenue to arrive at the net
income for providing services.
I
/ ILLUSTRATION 2 The Income statement of a service business
Here is a typical example of the income statement of a service
business. In this case the business provides a cleaning service to
local businesses.
First Class Cleaners
Income statement for the year ended 30 June 2018
$ $
Revenue (receipts from oustomers) 115600
Less operating expenses:
Cleaning materials 3700
Electricily charges 4 100
Motor vehicle running costs 6600
1Nages 39700
Total operating expenses (54 100)
Proffl 'or the year 61 500
 Classified statements of
financial position (balance
sheets) in vertical style
The statement of financial position (balance sheet) is more useful if
LEARNING OUTCOMES
the capital section is expanded to show:
• the balance of capital at the beginning of the year n this unit you will learn about:

• the profit (or loss} for the year • preparing a class~ied

statement of financial
• the drawings position (balance sheet}
• the closing balance of capttal. In vertical style, to show
working capttal and a
It can also show a subtotal for working capital. This is found by detailed capital section
deducting total current liabilities from total current assets. Working
• how a net profit or loss
capital is often referred to as 'net current assets' (or 'net current
affects the capital In a
liabilities· when the result Is a negative figure}.
statemen1 of financial
The figure for working capital is important when looking at the position (balance sheet},
financial performance of a business. It can help users decide vvhether
the business has enough resources to keep the business running
efficiently on a day-to-day basis.
'Nhen preparing a vertical statement of financial position
(balance sheet):
1. The final column (on the right} is used for the main subtotals: non-
current assets. working capital (net current assets/liabilities}. etc.
2. The second column from the rlght is used to show hov-t the main
subtotals In the final column were calculated.
3. The third column from the right is used when there are yet more
detailed workings to show (in this case the detail leading to the
subtotals for current assets and current liabilities).
4. If necessary, more money columns can be used.
6. The capital section sets out all the details from the capital account
In the general ledger of the business. The figure for profit has been
added to the opening capital figure. The figure for a loss would be
shown in brackets and oeducted from the opening capttal figure.
An example of a vertical statement of financial position (balance
sheet} can be found in Unit 5.6.

1. What is worklng capital and why is It important?

2. A business has total current assets of $37 ooo and total
current llablllt ies o• $42 000.
a. What is the working capital of the business?
b. What al1ernatlve label could be used instead of working
capital on the balance sheet of this business?
 Worked example:
sole trader financial
statements
LEARNING OUTCOMES The question
Nisha is the owner of a business which sells musical Instruments.
In this unit yov will learn about: The following trial balance was extracted from the books of the
• updating the capital account business on 30 June 2020. the end of the financial year.
at year end
Trial balance at 30 June 2020
• preparing an Income
statement 'or a service Dr Cr
business. $ $
Accounts payable 14 500
Accounts receivable 5 920
Bank loan (repayable February 2021) 4500
Capital 52 360
Carriage inwards 680
Carriage outwards 940
Cash at bank 3560
Discounts 330 290
Drawings 21 540
Furniture and fittings 17 900
General expenses 3 190
Insurance 2 010
lmereS1 charges 270
lnventcry at 1 July 2019 23800
Office equipment 34 600
Petty cash in hand 50
Purchases 64330
Rent of premises 8890
Repairs and mainlenance 1 040
Returns 820 770
Revenue 189 240
Slaff wages and salaries 67 550
Utilities 4 240
261 660 261 660

At 30 June 2020 inventory was valued at $25 890.

Prepare:
• An income statement for the year ended 30 June 2020
• A statement of financial posilion (balance sheet) at 30 June 2020.

Getting started
Stage 1
When faced with a lot of detail It is worthwhile taking a few minutes
to look through the information to look out for any special features, to
begin to take in some of the information that has been provided. and
to think about how best to start answering the question.
Stage 2
• It is worth noting that the trading section of the Income statement
will be quite complicated as there are returns and carriage charges
mentioned In the list of accounts.
• It is also worth noting that the accounts listed includes 'petty cash
In hand'. It is a common error to think that this is an expense.
However, the item is an asset as it represents unspent cash.
• Some care will be requireo' with the Item 'discounts': it will be
necessary to decide which item is an expense (discounts allowed}
and which item represents income (discounts received}.
• Care will also be required witth the item 'returns': it will be
necessary to decide which amount Is returns inwards and which
Item is returns outwards.
• The bank loan Includes a datte tor repayment. It is important to note
that, since this date falls within the next financial year, the bank
loan should be recorded as a current liability.
• It could be useful to work through the list of Items and decide
which should be recorded In the income statement trading section,
which in the income statement profit and loss section and which
should appear in the statement of financial position (balance sheet}.
You could pencil in 'IT'. 'IP' or 'S' beside each item.
Here is the trial balance again, with the items marked up as suggested:
Dr Cr
$ $
Accounts payable 14 500 s
Accounts receivable 5920 s
Bank loan (repayable February 2021) 4500 s
Capital 52 360 s
Carriage inwards 680 IT
Carriage outwards 940 IP
Cash at bank 3560 s
Discounts 330 290 IP
Drawings 21 540 s
Furniture and fillings 17 900 s
General expenses 3190 IP
Insurance 2 010 JP
lmerest charges 270 IP
Inventory at 1 July 2019 23800 IT
Office equipment 34 600 s
Petty cash in hand 50 s
Purchases 64330 IT
Rent of premises 8890 IP
Repairs ard mainte,,ance 1 040 IP
Returns 820 770 IT
Revenue 189 240 IT
Slaff wages and salaries 67 550 IP
Utilities 4 240 JP
261 660 261 660
 The answer
You are now ready to prepare the first task: the income statement.
Do not forget the Importance of good presentation. Financial
statements are formal documents to be viewed by the owner of the
business and other users. so they should look as if real care has
been taken to show every detail correctly.
Step 1
Here is the income statement using vertical presentation. Three
money columns will be required in order to set out the details
correctly: use the final column for the most significant figure. the
middle money column is used to show how these key figures were
obtained, and the first money column is required when there is yet
more working out to do.

DID YOU KNOW? Nisha

Income statement for the year ended 30 June 2020
It is recommended that, when
preparing the trading section, $ s s
returns outwaros is deducted Revenue 189 240
from purchases before carnage Less re'.urns inwards !820)
Inwards Is added to net Net sales 188 420
purchases. Cost of sales:
Opening Inventory 23800
Purchases 64330
Less relurns outwards (770)
63560
Carriage inwards 680
64 240
88040
Less closing inventory 125 890)
Cost of sales 62 150
EXAM TIP Gross profn 126 270
Add discounts received 290
It LS worthwhile loo~i"'-0 126 560
bi;ic~ to l¾i;f~e 5'-<Yt l::)D'-< Less expenses:
hi;ive _J>Yovi.ded i;i ft.<.ll Carriage outwards 9<10
hei;i do"'-0 foy the l"'-COl¾t Discounts allowed 330
sti;itel¾e~. It LS best
General expenses 3 190
to i;ivoi.d i;ibbrevii;iti.o= Insurance 2 010
St.<.ch i;is 'l::Jle '. rt i.s ei;isl::J Interest charges 270
to foyget to L~bel cost of Rent of premises 8890
s~l es, g YOSS J>Yofi.t /;I 111,c( Repairs and maintenance 1 040
J>Yofi.t for the l::Je~,; so do Staff wages and salaries 67 550
chec~ thi;it these hi;ive Utiltties 4 240
bee.,, i.111,clt.<.ded. Total expenses (88 460)
Profit for the year 38 100
Step 2
The statement of financial position (balance sheet) can now be
prepared. Again. vertical presentation will be used vvith three money
columns.

Nisha
EXAM TIP
Statement of financial position (balance sheet)
at 30 June 2020
It is Q COl¾l¾O"'- l¾ista)u
$ s $ to YeCOYlil 'pett11 CAS"1 '""
Non-current assels l-i t:1 vcd' as A"- e><pe=e ,...._
Office equipment 3Li. 600 t"1~ i.,.,col¾e stcite""'-e"'-t.
Furntture and fittings 17 900 This ite""'- YtpYese...._ts.
Total non-current assets 52500 ~~l'e"'-t petttl ccis"1, so
Lt LS Cl CIA.Y-YeVl,t cisset of
Current assets tvie llusi"'-tSS.
Inventory 25 890
Accounts receivable 5920
Cash at bank 3560
Petty cash in hand 50
Total current assets 35 420

Less Current liabilities

Bank loan 4500 EXAM TIP
Acccunts payable 14 500
It is A goool iolet:1 to l¾Ake
Total current liabilities (19 000)
Working capitaVnet current assets 16 420
/;I fi,"'-t:lt evi~c.k of tJo<.<v
Capital employed 68 920 sta:e:"'e~ of fi."'-A"'-CLAL
posLho"" (bciw=e svieet)
Capttal: to """ake suye tke titLe LS
Opening balance 52 360 give""""" fuLL (Avoicl.""g
Abl:lyeviAtio=) Avcd
Add Profit for year 38 100
90 460 sull"1ea oli"'-gs "1t:1ve bee""
SVlOW>'\. COYYectLtJ,
Less drawings !21 540)
Owf1€r's equity 68 920
 Ratios and profitability

In order to examine the key aspects of the performance of a business

LEARNING OUTCOMES
In this unit yov will learn how to:
• calculate simple pro'itabllity
ratios
• use profitability ratios to
assess business peitormance.
It is usual to calculate ratios using some of the key figures contained
in financial statements. Ratios can be used to compare the results of:
• one year against previous years
• one business against similar businesses.
These comparisons help to reveal where improvements have
occurred, or where performance has weakened.

Income statement ratios

There are four ratios that can be used to analyse an income statement:

Name of ratio Formula

Gross profit
Gross profit pe<centage x 100
Revenue
Gross profit
Mark-up x 100
Cost of sales
Cost of sales
Rate of inventoiy turnover x 100
Average inventory
Proffl for year
Net proli1 percen1age x 100
Revenue

/ ILLUSTRATION 1 Calculating profitability ratios

Four ratios have been calculated using the following income statement:

Income statement for the year ended 31 December 2018

$ $
Revenue 400 000
Less cost of sales:
Opening inventory 27000
Purchases 296000
323 000
Less closing Inventory (23 000)
Cost of sales (300000)
Gross profit 100 000
Less operating expenses:
General expenses 9000
Rent 17 000
Salaries 44 000
Total expenses (70000)
Profrl for the year 30000

(Continued)
' ILLUSTRATION 1 lcaiculatlng profitability ratios (Continued}

Name of ratio Formula Calculation Result

__G_
ro_ss~pr_o_
ftt__ x 100 000
Gross profit percentage 100 X 100 = 25%
Revenue 400 000
Gross proftt 100 000
Mark-up ---~---x100 X 100 = 33.33%
Cost of sales 300 000
Cost of sales 300 000
Rate of inven1ory turnover -------x100 = 12 times
Average inventory 25000

Profit for year _ 30_0

_ _00
_ _ X 100
Net prom percentage --------- X 100 = 7.5%
Revenue 400 000
What the results mean:
• Gross profit percentage: shows how much gross pro'it is made for every $1 of revenue. In this
case every $1 of sales provided 25c of gross profit.
• Mark-up: shows how muc'.h gross profit Is made for every $1 spent on buying goods for resale.
In this case every $1 of cost of sales provided 33.33c of gross profit.
• Rate of inventory turnover: shows how many times during the year the business managed to sell
the typical amount o' inventory It has for sale at any one time. The average inventory of this
business was sold 12 times during the year, I.e. on average once every month.
• Net proftt percentage: shO'NS how much profit Is made for every $1 of revenue. In this case
every S1 o' sales produced a net proiit of 7.5c.

Positive performance and income statement ratios

SUMMARY QUESTIONS
It is possible to comment on the performance of a business based
on income statement ratios. However. it Is important to have 1. Why are ratios important?
equivalent ratios for a previous year (or years) and/or for a similar
2 . A business has revenue
business. Here are some ideas about performance that can be of $400 000 ano a cost of
Identified from Income statement ratios.
sales of $300 000. 1/Vhat Is:
Gross profit percentage and mark-up percentage
a. the gross profit
If these figures are increasing this is usually seen as good news for
a business. because it means more gross prom is being maoe In b. the gross profit
relation to sales or cost of sales. percentage

Rate of inventory turnover c. the mark-up

percentage?
An Increase In the rate of inventory turnover should be welcome
news for the owner of a business because it could result from selling 3. The Income statement of a
goods more quickly, so profit is being made on a greater volume of business ior a year records
sales. However, it could also result from holding a smaller average a cost of sales o' $84 000.
inventory, which could reduce customer choice. The opening inventory was
S11 1oo ano the closing
Net profit percentage
Inventory was $12 900.
An increase in this percentage will mean that a business is Calculate the rate of
making more profit on each Item sold indicating a strength In the inventory turnover.
performance of the business.
 Ratios and financial
position

Here are three ratios that can be used to analyse the financial
LEARNING OUTCOMES
position of a business:
In this unit you will learn about:
Name of
Formula Notes
• the ratios used to analyse ratio
a statement of financial Current assets The result should be
position (balance sheet) and Current ratio
Current liabilities given as xx:1, e.g. 2.5:1
their significance
• how to comment on Liquid assets are
Liquid assets current assets less
statement of ' inancial position Acid test ratio
(balance sheet) ratios. Current liabilitles inventory. The result is
also expressed as xx: 1.
Profit for the year
Return on X 100 It is possible to use the
Capital employed opening, closing or an
investment
(or capital invested) average cap11al figore.

ILLUSTRATION 1 Calculating ratios to determine the financial position of a business

Stat ement of financial position (balance sheet) at 3 1 December 2018

$ s s
Non-current assets 330000
Current assets
Inventory 15 000
Accounts receivable 12 000
Cash at bank 13 000
40000
Less Current liab!ltties
Accounts payable (20000)
Working capttal (Net current Assets) 20000
Capital employed 350000
Capttal
Opening balance 300000
Proftt for the year 70000
370000
Less drawings (20000)
350000

(Continued)
' ILLUSTRATION 1 lcaiculatlng ratios to determine the financial posttion of a business (Continued)

Name of ratio Formula Calculation Result

Curren! assels 40000

Current ralio = 2:1
Currem llabilltles 20000
Liquid assets 25000
Acid test ralio = 1.25:1
Currenl llabillties 20000

Proftt for the year

X 100 70000
Return on investment Capital employed - - - - x 100 = 20%
350000
(or capita! invested)

VI/hat the results mean:

1. The current ratio measures the funds available to meet the debts of the business.
2. The acid test ratio indicates the funds more immediately available to meet the debts of the
business at short notice.
3. The return on investment measures hov,1 much profit is being made compareo to the owner's
investment in the business. ('This ratio could have been based on the closing capital or an
average of opening and closing capital.)

Positive performance and statement of financial LINK %

position (balance sheet) ratios
There is more lnformallon about
Current ratio
negative performance and
If the ratio Is In line wtth the norm for the type of business being making recommendalions for
reviewed, it means that the business is well placed to meet its improvement in Unit 5.9.
commttments and has just the right amount of net current assets/
working capttal.
Acid test ratio
SUMMARY QUESTIONS
If the ratio is in line with the norm for the type of business being
reviewed, it means that the business is well placed to meet its 1. A business has current
commitments in the short term and has just the right amount of llouid assets of S50 000 (Including
assets. inventory $1O000) and
current liabilities of $20 000.
Return on investment
What is:
If the percentage is Increasing this would signal an improving
performance and a more effective use of all the resources of the a. the current ratio
business. b. the aclo test ratio?
2. \11/hy is it good news tor a
business when it achieves
tl1e expected current ratio
and when there is an
increase in the return on
investment?

LEARNING OUTCOMES
In this unit yov will learn how to:
• prepare simple reports
evaluating a bwsiness wsing
ratios
• make recommendations to
Improve the performance of
a business.
Recommendations
based on ratio analysis
Improving income statement ratios
Gross profit percentage and mark-up
If the trend in these ratios is declining In relation to previews years, or
is weaker than those for other similar businesses, corrective action
could take the form of:
• increasing selling prices (though this could make the business less
competttlve, causing customers to go elsewhere, with the result
that fewer goods are solo)
• finding cheaper suppliers (though this might result in lower qualtty
gooos being purchased, which could deter customers).
Rate of inventory turnover
If the rate of inventory turnover is falling or is less than for other
similar businesses, the owner might consider:
• attracting more customers and getting cwstomers to buy more,
perhaps by:
• reducing prices (though less profit will be made on each sale)
• advertising more effectively (though this could cost more and so
reduce profit)
• reviewing the products on sale (adding new lines and dropping
slow-selling lines)
• reducing average inventory, which could help reduce storage
costs, but might reduce the choice available to cwstomers. leading
to reduced sales.
Net profit percentage
If the percentage Is falling or less than tor a similar business. the
owner should consider:
• Improving gross profit In relation to sales - increasing gross prom
is likely to result in a higher profit for the year (see above for how to
Improve gross profit margin)
• reducing expenses - if the business can be run more e'ficlently
by cutting out unnecessary expenditure, profits should increase.
However, cutting costs could affect the quality of seNice provided
to customers.
Improving statement of financial position
(balance sheet) ratios
Current ratio
If the ratio is lower than the norm for the type of business being
reviewed, it could result In the business having difficulty paying its
debts/current liabiltties when they fall due and paying for everyday
operating expenses. There are a number of courses of action that
DID YOU KNOW?
could be taken to strengthen a decreasing ratio, including:
• Introducing more capttal The ratios described In Units
5.7 and 5.8 can be reviewed
• borrowing addHionaJ long-term iunds under the following headings
• reducing drawings when reporting on the
performance of a business.
• making more profit
Profitability: Are the owners
• delaying capital expenditure and managers of a business
• selling off unused non-current assets. successful In Increasing the its
value over time through trading
If lhe ratio Is higher than normal. this could mean a business has too or providing a seNice?
many funds tied up In current assets.
Liquidity: Are lhe resources
Acid test ratio of the business well managed
If this ratio is too tow, the business ls likely to have more immediate so that debts are settleo on
problems in meeting tts debts. The ratio can be improved by: time and so that the owner can
• the measures listed above for improving the v1orking capital ratio receive a reasonable Income?

• reducing the 1unds tied up In Inventories. Efficiency: Are the owners

and managers of the business
Return on capital employed (return on capital invested) controlling key resources so
When the trend is declining, or the percentage is lower than for a that the maximum benefit is
similar type of business, an Improvement could be made by: derived from the funds tied up
in them?
• Improving pro1its
• reducing the level of capital invested.

How to report on performance

The fcilowing steps should be taken when reviewing the performance
01 a business:
Step 1: Look at the trend in sales.
Step 2: Calculate the ratios described In Units 5.7 and 5.8.
Step 3: Compare the ratios calculated with those for previous years
LINK %
and/or other similar businesses. In Unit 5.1 0 there Is a worked
example of a report on 1he
Step 4: Decide how the business is performing overall; where there performance of a business.
are v1eaknesses. make recommendations for improvement.

SUMMARY QUESTIONS
1. A business has not managed Its working capital and liquid
capital well. How coulo these ratios be Improved?
2. The owner of a business has proposed spending more on
advertising ano Increasing selling prices to improve profits.
What risks are associated with these actions?
 Worked example:
reporting on performance

The end-of-year financial statements of a business include the

following information:

For the year ended 31 December 2018 $

Average inventory 48000
Cost of sales 576 000
Gross profit 144 000
Profil for the year 72000
Revenue (cash and credit sales) 720000

At 31 December 2018 $
Capltal employed (cap~al invested) 900000
Current asse1s 90000
Current liabilities 45000
Inventory 46000

Revenue totalled $740 000 in the year ended 3 1 December 2017.

Here is a table showing the ratio calculations for the year ended
3 1 December 2018 alongside the equivalent information for 2017.

Result
Name of ratio Formula Calculation
2018 2017

Gross profil Gross profit x 144000

100 100 20% 23%
percentage Revenue 720 000 X

Liquid assets 44000

Acid test 0.98:1 0.7:1
Curren! liabilities 45000
Gross profit x 144000
Mark-up 100 576 000 100 25% 30%
Cost of sales X

Profit for the year x 72000 1-1%

Ne: profit percentage 100 100 10%
Revenue 720 000 X

Rate of inventory Cost of sales 576000 12 times 11 times

1urnover Average inventory 48000
Profit for the year 72000
Return on investment 100 100 8% 7%
Capita! employed x 900 000 X

Current ratio Current assets 90000 2:1 1.8:1

Curren~ llabili'.ies 45000
The report would oraw attention to the following:
Revenue has fallen since 2017 by $20 ooo.
Profitability
Improvements in performance:
The return on investment has improved by 1%, meaning that more
pro'it is being earned per $1 of capital investeo by the owner, so
resources are being useo more effectively.
Weaknesses In performance:
The gross pro'it percentage and mark-up are lower than in 2017,
meaning that less profit is being made on each S1 of sales or S1 oi
cost of sales.
The net profit percentage has decreased by 4% since 2017 meaning
that less profit is being made per $1 of sales.
Liquidity
Improvements in performance:
The current ratio has Improved since 2017, which means that the
business shoulo be able to pay Its debts more easily.
The acid test ratio has improved since 2017. which means that the
business shoulo be able to pay ,ts immediate debts more easily.
Weaknesses in performance: None.
Efficiency
Improvements in performance:
The rate of Inventory turnover has Increased since 2017, which
possibly could mean that a smaller average inventory is being sold
more quickly In 2017.
Weaknesses In performance:
None.
Summary
overall, there is a mixed picture regarding the performance of the
business: liquidity and efficiency have improved since 2017, but In
some respects profitability has weakened.
Possible recommendations:
• Increase sales by considering changing selling prices, advertising
more effectively and making changes to the product lines that are
currently being sold.
• Improve the gross profit percentage and mark-up by either
Increasing prices and/or finding cheaper suppliers.
• Increase the net pro'it percentage - this might be achieved by
Improving the gross profit margin, but would also result from a
stricter control of expenses.
 Practice exam questions

Paper1
1 Which one o1 the 1ollowlng appears In both the 4 The ow,,er of a business provided tre following
Income statement and lf'e statement of 1inanclal lntormat,on: non-current assets $110 000, current
posttion (balance sheel) of a sole trader? assets $30 000, current llabilttles $20 000, profit
A closing Inventory B drawings for 1he yeai $15 000. What is the percentage
return on invesiment 1or 1he business?
C gross profit D accounts receivable
A 10.71% B 12.50%
2 The followir g Information has been taken
C 13.64% D 15%
from the Income sta!ement for the year erded
31 December 2018 Of a sole trader: revenue 5 Wesl~ provided the following information about
$160 000, coot of sales $100 000, profit for the his business: bank overdraft $7 000, Inventory
year $28 000. Wnat were the expenses for the $10 000, long-1erfT1 loan $20 000, accounts
year ended 31 December 2018? payable $28 000, accoums receivable S45 000.
A $32 000 B $60 000 INhat was liquid capital ratio of the business?
C $72 000 D $132 000 A 0.82:1 B 1.29:1
C 1.57:1 D 1.86:1
3 Jillian had revenue of $800 000. Her expenses
were $200 000 and prcfit for the year was
$120 000. \/\/hat was Jillian's gross profit
percentage?
A 85% B 75%
C 60% D 40%

Paper2
1 Preparing the income statement $ $
of a service business
Administration e)(penses 1 260 Utiltties 1 520
Gler.roy is an electrician. The
following information about his General expenses 740 Vehicle running costs 2 970
business Is avaJlable for the year Loan imerest 890 Wages of assislant 29 240
ended 31 May :Z018.
Revenue (receipts 1rom 88 430
Prepare an Income Slatement for customers)
me year ended 31 May 2018.
2 Preparing an income statement to include
carriage charges; updating the capital
s s
account Capital Other
22 440
Mendoza Electrical Supplies' financial year ended (1 September 2017) 55 000 expenses
on 31 Augvsl 2018. The 'ollowing informa1lon was Carriage Inwards 830 Purchases 75820
taken 'rom the books of account of 1he business
Carriage outwards 410 Revenue 117 300
on tnat da1e.
Drawings 14930
Inventories
1 September 2017 11 920
31 August 2018 14 380
 Prepare:
a Entries In 1ne general journal to:
i transfer Information from i he general ledger to 1he inoome statement
ii complete 1he capttal account on 31 August 201 8.
b An income statement for 1he year ended 31 August 2018.
c The capttal account in the general ledger showing all '.he entries arising from the Information.

3 Calculating ratios
The following informa1ion has been extrac1ed from the financial statemen1s of the business owned by
Dwight Guzman. The Information is fo< the year ended 31 December 2018.
Items from the statement of financial position
Items from the income statement S (balance sheet) s
Revenue (all on credit) 160 000 Total current assets 37 000
Cost of sales 120 000 Inventory 1.i 000
Average inventory 16 000 Total current liabllities 12 400
To1al cosls 22 000 Capital al 1 January 2018 90000
Profit for the year 18000
Calculaie the following ratios. Slate the formula used. Work lo two decimal places.
• gross profit percentage • current ratio
• mark-up • acid test ratio
• rate of invemory 1vrnover • return on investment
• net profit percentage

4 Reporting on performance
For the year ended 31 December 2017. Dwight Guiman (see also Question 3) catculaled 1he following
ratios for his business. The reverue o' the business for the year ended 31 December 2017 was $150 000.
Gross profit percentage 22% Current ratio 3.2:1
Mark-up 28% Acid test ratio 1.7:1
Rate of inventory turnover 9 Return on 18%
times Investment
Net profit percenlage 13.5%

Prepare a report analysing the performance of Dwight Guzman's business. Compare :he ralios for 2018
wtth 1hose for 2017 (use your answers from Quesiion 3). Use tne following headings in yovr report:
a Profilabillty
b Liquidity
c Efficiency.
Make recommendations to overcome any weakresses in the performance of the business.
 •
Accounting concepts
and adjustments
LEARNING OUTCOMES
In this unit you will learn about:
• the accounting concepts
that underpin the need for
adjustments
• why adjustments are made
to 'lnancial statements.
LINKS % concerned have actually been received/paid. Revenue, income and
Expense and Income adjustments
are covered In Units 6.2 and 6.3.
Untts 6.4 and 6.5 explain now to
make, review and alter provisions
for doubtful debts.
Turn to Unit 6.6 for more on
depreciation.
KEY TERMS
Accruals concept: In order
to calculate profit Income for
a financial period is matched
exactly with the expenses that
relate to that perioo, whether
paid or not. The concept is
sometimes called the 'matching
concept'.
Prudence concept: the
principle that requires that,
where there is doubt. asset and
profit values are understated
rather than overstated
(and liabilities ano losses
are overstated rather than
uncterstated).
A number of adjustments have to be made to financial statements
to enhance the quality of the information they contain and make it
more useful. These aojustments are made to satisfy a number of key
accounting concepts, four of which are explained here.
The accruals (matching) concept
The accruals concept (sometimes referred to as the matching
concept) establishes that, when calculating profits and losses for a
certain period (normally a year), only the revenue and other income
for that period should be lncluoed and It should be 'matched· to
the expenses for the same period. whether or not all the amounts
expenses relating to good ano services supplied or received during
other financial periods should not be included.
Therefore, when preparing an income statement, adjustments have
to be made for expenses and income for the period that are not
yet paid (expense accrualstlncome due) and expenses and income
relating to the next period that have been paid in advance (expense
prepayments/ income received in advanceo} In addition, provisions
for ooubtful debts must be taken into account, and, \"lhen calculating
profit. the wear and tear on current assets (oepreciation) must be
considered.
The prudence concept
It is important that users of accounting information are not misled into
thinking a business is performing better than is really the case. The
prudence concept requires asset values and profits, where there
Is doubt, to be understated rather than overstated, that expenses
and liabilities are recognised as soon as possible where there is
uncertainty, while revenues and assets are only recognised when
they are assured of being received. For example, bad debts are
written off promptly and accounts receivable are adjusted to make a
provision for doubtful debts.
The consistency concept
The owners of businesses have choices to make when preparing
financial statements. Having chosen particular policies, it is important
that they are implemented In the same way each year. This Is an
application of the consistency concept. As a result the users of
financial statements can make valid comparisons of performance.
For example, a business shoulo apply the same depreciation method
KEY TERMS
each year and maintain the same percentage provision for doubtful
debts each year, unless there are overwhelming reasons for making Consistency concept: 1he rule
a change in these policies. Where a policy is changed this must be that aocountlng policies should
clearly Indicated in the notes to the financial statements. be carried out In the same way
year on year.
The true and fa ir principle True and fair: the principle
The true and fair principle reflects the idea that it is not acceptable that aocounling records should
to manipulate figures in the financial statements In order to present be factually accurate wherever
the finances of the business in a false light to gain some kind of possible, or otherwise present
ao'vantage. Rather, the records must be accurate or at least present a reasonable estima:e of, or
a reasonable estimate of the position. j..,dgment about, tne ~nancial
position.
For example, tt it is expected that some accounts receivable will not
be paid, provision should be made for this to reduce the income
recorded.

Benefits of accounting concepts

Accounting concepts are Important because:
• They help decide the right course of action to take when an
accounting sttuatlon is not clear cut.
• They help reassure the users of accounting information that the
statements would have been prepared in the same way regardless
of who had been responsible for preparing them.
• Users can be confident that the financial statements are reliable.

SUMMARY QUESTIONS
1. What rule ,s covered by the accruals (matching) concept?
2. Why is the prudence concept important?
3. State two ways in which accounting concepts are imports1nt.

LEARNING OUTCOMES
In this unit you will learn about:
• preparing journal entries and
leoger accounts lo reftect
adjustments
• tlie treatment of adjustments
in the statement of financial
position (balance sheet).
Expense and income
adjustments
Adjustments to expenses
Expense accruals
This is the term used when an expense is not fully paid at the year
end. leaving an amount that is due but unpaio.
• At the year end the amount of an expense accrual is added to find
the correct amount to be charged to the income statement for that
expense.
• An accrual is recorded as a credtt balance (whe-i broughl down) in an
expense account as it is a current liabil~y.
Expense prepayments
When a payment for an expense covers more than the year under
review, i.e. part of the payment made for an expense covers the
business at the beginning of the next financial year, it is called a
prepayment.
• The amount of any prepayment must be deducted to find the
correct value of the expense to be charged to the income
statement.
• A prepayment is recorded as a debit balance on an expense
account as it represents a current asset.
Adjustments to income
Sometimes businesses receive Income not Just from sales (revenue)
but also from some activities, such as rent received when a business
lets out part oi its premises to a tenant, and Interest received on
investments ano savings. Other Income items are added to gross
profit in the second part of the income statement.
Income due
This is the income that has yet to be received at the year end.
• The amount of any Income due at the year end Is added to find the
correct amount of income to be shown In an Income statement.
• Income due is recorded as a debit balance (when brought down) in
an income account as it is a current asset.
Advanced income
• This is the amount of any income received that covers more than
the year under review, I.e. part ot the amount received covers the
beginning of the next financial year. It is necessary to deduct the
amount of any income received in advance at the year end to find
the correct value of income to be shown In an income statement.
• Advanced income is recorded as a credit balance on an income
account as it represents a current liability.
All transfers to the Income statement from expense accounts and
Income accounts wlll first be recorded In the general Journal.
' ILLUSTRATION 1 Recording expense and income adjustments

Expenses
During the year ended 31 December 2018 a business has paid wages of $27 300. At 31 December
2018, S400 remains due for wages for the last part of the year.
The business has also paid insurance of $9 500. However, this Includes $1 500 that is Insurance for
January 2019.
Journal entries to record transfers to the Income statement:
JOURNAL
Date Details Dr Cr
2018 $ $
Dec 31 Income statement 27 700
Wages 27 700
Transfer of wages for the year 10 1he Income sta1ement
31 Income statement 8000
Insurance 8000
Transfer of insurance for the year to the income statement

This is how the expense accounts will appear in the general ledger:
Dr Wages Cr
2018 $ 2018 s
Dec 31 Cash
Dec 31 Income statement 27 700
(total payments for the year) 27 300
31 Balance cld 400
27 700 27 000
2019
Jan 1 Balance bid 400

Dr Insurance Cr
2018 $ 2018 s
Dec 3 1 Cash
Dec 31 Income statement 8000
(total payments for the year) 9500
31 Balancecld 1 500
9500 9500
2019
Jan 1 Balance bid 1 500

Income
A business has received Interest of $1 450 on an investment during the year ended 31 December 2018.
At 31 December interest of S350 is due but not yet received.
The business has also received rent from a tenant of $3 900. However, this includes rent of $300 for the
month of January 2019. /

(Continued)
ILLUSTRATION 1 Recording expense and Income adjustments (Continueo)

Journal entries to record transfers to the income statement:

JOURNAL
Date Details Dr Cr
2018 s s
Dec 31 Interest received 1 800
Income sialement 1 800
Transfer of interest received for the year 10 the income statement
31 Rent reoeived 3600
Income sialement 3600
Transfer of rent reoeived for the year to the Income stalement

In this case the ledger accounts wll I appear as follows:

Dr Interest received Cr
2018 $ 2018 $
Dec 31 Income statement 1 800 Dec 31 Bank (amount reoeived during 1he year) 1 450
31 Balance c/d 350
1 800 1 800
2019
Jan 1 Balance bid 350

Dr Rent received Cr
2018 $ 20i8 s
Dec 31 Income statemem 3600 Deo 31 Bank (amount reoeived during the year) 3900
31 Balancec/d 300
3900 3900
2019
Jan 1 Balance b/d 300
/

SUMMARY QUESTIONS

1. What are the differences between an expense accrual ano an

expense prepayment?
2. Explain why:
a. an expense accrual is a current liability
b. advanced income is a current liability
3. Explain why:
a. an expense prepayment Is a current asset
p. income due is a current asset.
 Expense and income
adjustments and financial
statements; bad debts
Expense and income adjustments are designed to implement the
LEARNING OUTCOMES
accruals concepts when preparing financial statements.
The following is a summary of how they are treated in the statement In this unit you will learn about:
of financlal position {balance sheet): • how to record expense
and Income aojustments in
Adjustment Shown under ...
financial statements
Expense accrual Currem liabilities • bad debts ano how they are
Prepaid expense Current assets• recorded In the books o•
account.
Income due C.irrent assets•
Income received in advance Cvrren! liabilities
• Plaoed immediately after accounts receivab'e when assets are recorded In
order of permanence

ILLUSTRATION 1 Expense and income adjustments and financial statements

Based on the Information in Illustration 1 of the previous unit. the following details v,1111 appear in the income
statement and statement of f inancial position (balance sheet) of business.

Income statement (extract) for the Statement of financial position (balance sheet)
year ended 31 December 2018 (extract) at 31 December 2018
s $ $ $ s
Gress profit XXX CURRENT ASSETS
Add: imeres1 received 1 800 Inventory XXX
rent received 3600 Accounts receivable XXX
5400 Income due (interest) 350
Less: insurance 8000 Prepayments (rent) 1 500
wages 27700 Cash at bank XXX
other expenses XXX XXX
XXX CURRENT LIABILITIES
Profit for the year XXX Accounts payable XXX
Income received In 300
advance (rent)
Accrvals (wages) 400
(xxx)
WORKING CAPITAUNET CURRENT ASSETS XXX
Bad debts and the income statement
When a creoit customer is unable or unwilling to pay a business the
amount due it is necessary to write off this toss as a bad debt.
Writing off a bad oebt is a good example of the prudence concept.
Writing off a bad debt as soon as It is unlikely that any amount will be
received ensures:
• the profit for the year is not shown at an unrealistically high figure
• the figure for accounts receivable on a statement of financial
position {balance sheet) represents more closely the amount that is
likely to be received .
Wri1ing off a bad debt
• Prepare an entry In the general Journal debiting the bad debts
account and crediting the account receivable.
• Debl1 the bad debts account In the general ledger.
• Credit the account receivable in the sales ledger.
• At the year's end transfer the balance of the bad debt accoun t to
the Income statement.

" ILLUSTRATION 2 IWriting off a bad debt

The sales ledger of a business Included the account of Selena

Wright who owed $1 220. It has become necessary to write off
this account as the amount has been outstanding for over ten
months and the customer cannot be traced.
The Journal entry ls as follows:

JOURNAL
Date Details Or Cr
$ $
Bad debts 1 220
Account rec.,ivable: Selena VVright 1 220
Account of customer written off as a
bad debt

SUMMARY QUESTIONS
- ..
1. How are expense adjustments recorded on a statement of
financial position {balance sheet).
2. How are income adjustments recorded on a statement of
financial position (balance sheet).
3. Why is It Important to wrtte bad debts off promptly?
 Creating a provision
for doubtful debts

What is a provision for doubtful debts? LEARNING OUTCOMES

Many businesses experience bad debts during the course of a year. In this unil you will learn about:
As a resutt, it ls likely that the total of accounts receivable to be
shown on the end of year statement of financial position (balance • the treatment of provisions
sheet) could easily overstate the amount that will actually be received for doubtful debts in both
during the next financial period. To ensure that this is avoided, the Income statement and
statements of financial position (balance sheets) record the total tli e statement of financial
of accounts receivable less an estimate tor future bad debts. The position (balance sheet).
estimate is called a provision for doubtful debts. This procedure Is a
good example of applying three of the accounting rules introduced in
Unit 6.1:
• Accruals (matching) concept
• The prudence concept
• The principle that all financial statements should show a true and
fair view of the affairs of the business

Setting up a provision for doubtful debts

The amount of a provision for doubtful debts is usually based on
the past experience of bad debts of the business compared to the
total amount owed by credit customers. This is often expressed as a
percentage of accounts receivable at year end.
When it Is necessary to create a provision for doubtful debts the
following entries are required:
• General journal: recording the amount of the provision and the
entries to be made In the provision for doubtful debts account and
income statement.
• General ledger: a provision tor doubtful debts account is credtted
with the amount of the provision.
• Income statement: the provision is Included in the list of costs/
expenses; this is the equivalent of making a matching debit entry
for the cre<Jit entry in the ledger account.
• Statement of financial position (balance sheet): the provision Is
shown as a deduction from accounts receivable in the current
assets section.
/ ILLUSTRATION 1 Creating a provision for doubtful debts

At 31 December Year 1, a business has total accounts receivable of S44 000. A provision for doubtful
debts of 5% of accounts receivable is to be created.
Here are the journal entries: And here is the entry ln the general ledger:

JOURNAL Dr Provision for doubtful debts Cr

~
Date Details Dr Cr $
Year1 $ $ $ Dec 31 Income sta1ement 2200
Dec 31 Income statement 2 200
Provision for
doublful debts 2 200
Entries to create
a provision for
doubtful debts

This is the entry in the income statement: The entries in the statement of 1inancial position {balance
sheet) look like this:

Income statement (extract) for the Statement of financial position (balance sheet)
year ended 31 December Year 1 (extract) at 31 December Year 1
$ $ $ $ $
Gross profit XXX CURRENT ASSETS
Less: expenses XXX Inventory XXX
provision for Accounts receivable 44000
doubtful debts 2200 Less provision for doubtful deb'.s 2 200
XXX 41 800
Profit for tne year XXX Prepayments XXX
Cash at bank XXX XXX

Notes:
1. No entries should be made in the provision for doubtful debts account during the course of a financial
year. If any bad debts actually arise, It Is usual to debit these to a separate bad debts expense
account (as explained In Unit 6.3).
2. The income statement shows profit for the year being decreased when the provision Is created. Profits
are decreased by the amount of the provision, because the owner of the business believes that this
amount of profit will not be achieved.
3. The entries In the statement of financial position (balance sheet) are deslgneo to show clearly not cnly the
total of accounts receivable accorcting to the sales ledger, but also 111/hat is actually likely to be received. ,

1. Why do many businesses use a provision for doubtful debts?

2. ldenti'y two accounting ccncepts that are applied when
setting up a provision tor doubtful debts.
3. What does the expression 'true and fair' mean in regard to
financial statements?
4. What is the double entry required to create a provision for
doubtful debts?
 More about provisions
for doubtful debts

Reviewing a provision for doubtful debts LEARNING OUTCOMES

Once a business has created a provision for doubtful debts, It is In this unit you will learn about:
necessary to review the figure at the end of each financial year to
bring it in line with the latest figure for accounts receivable. • the reasons for changing a
provision for doubtful debts
Increasing a provision for doubtful debts • the entries reouired to
Increase a provision
If the total of accounts receivable has Increased, it will be necessary • the entries required to
to Increase the provision tor doubtful debts. decrease a provision.

I
" ILLUSTRATION 1 increasing a provision for doubtful debts

At the end of Year 2 the business (see Illustration 1 in the

previous unit) has 1otal accounts receivable of $50 000, so the
owner makes entries to increase the provision to $2 500 (i.e. 5%
of S50 000). This represents an Increase of S300 since Year 1.
Journal entry to record the Increase In the provision for doubtful
debts:

JOURNAL
Date Details Dr Cr
Year 1 $ $
Dec 31 Income statement 300
Provision for doubtful debts 300
Entries to increase lhe provision
for doubtful debts

The following entries are made In the general ledger:

Dr Provision for doubtful debts Cr

Year 2 s Year 1 $
Dec 31 Balancec/d 2500 Dec 31 Income
sta1ement 2 200
Year 2
Dec 31 Income
sta1ement 300
2500 2 500
Year 3
Jan 1 Balanceb/d 2 500
~

(Continued)
 /
Increasing a provision tor doubtful debts
ILLUSTRATION 1
(Continued)
EXAM TIP

A COV><V><.Oi,\, V><.istt1~e is This Is how the Increase In provision is shown in the Income
to Ye_c~n;I t~e wnole of tne statement:
pYov,s,o"" '"" tne i"'-coV><.e
St t1tt..M"'-t i.., ti i:jttlY Income statement (extract) for the year
ended 31 December Year 2
w11,.., tne provisiovs is
$ $
bei~ , , i~,..et1sect o""ce ti Gross profit XXX
7'YoV1.s,o"" l1t1s bee.,, cYet1teof
Less: expenses )()()(
?"'Li:J ti-le &1V><.ou""1: of A""i:J Increase irl provision for
i"'-CYtt1se or o!ecre&1se is
doubtful debts 300
~flow"" i"" subseq "''""t XXX
'""°omt ste1teV><.e""ts. Profit fer the year XXX

These are the entries in the statement of financial position

(balance sheet):

Statement of financial position (balance sheet)

(extract) at 31 December Year 2
$ s
Accounts receivable 50000
Less provision for doubtful debis 2500
47 500

Decreasing a provision for doubtful debts

tf the total of accounts receivable decreases, the provision for
doubtful debts should be reduced.

/ ILLUSTRATION 2 Decreasing a provision for doubtful debts

At the end of Year 3 the business has total accounts receivable

of $40 000, so the owner makes entries to decrease the
provision to $2 ooo (i.e. 5% of $40 000). (See Illustration 1.) This
represents a decrease of $500 since Year 2.
Journal entry to record the decrease In the provision for doubtful
debts:

JOURNAL
Date Details Dr Cr
Year 2 s s
Dec 31 Provision for doubtful debts 500
Income statement 500
Entries to decrease the provision
for doubtful debts
'
(Continued)
/
Decreasing a provision for doubtful debts
ILLUSTRATION 2
(Continued)

The following entries are made In the general ledger:

GENERAL LEDGER
Dr Provision for doubtful debts Cr
$ $
Year2 Year 1
Dec 31 Balancec/d 2500 Cec 31 Income
statement 2 200
Year 2
Dec 31 Income
statement 300
2500 2500
Year3 Year3
Dec 31 Income Jan 1 Balance bid 2500
statement 500
31 Balancec/d 2000
2500 2 500
Year4
Jan 1 Balance bid 2000

Income statement (extract) for the year

ended 31 D ecember Vear 3
$ $
Gross profit XXX
SUMMARY QUESTIONS
Add: decrease In provision for doubtful
deb'is 500 1. When would it be necessary
Olher income 300 to Increase a provision for
Adjusted gross profit XXX doubtful debts?
Less:expenses XXX
2. What Is the double entry for
Profit for the year XXX
Increasing a provision for
doubtful debts?
Statement of financial position (balance sheet) (Extract) 3. \/\/hen would it be necessary
at 31 December Year 3 to decrease a prov,sion for
$ $ doubtful debts?
Accounls receivable 40000 4. What is the double entry for
Less provision for doubtful cfebls 2000 decreasing a provislcn for
38000 doubtful debts?
.

LEARNING OUTCOMES
In 1his unit you will learn about:
• the nature of depreciation
• how to calculate depreciation
charges
• how to record depreciation.
KEY TERMS
Depreciation: the loss in value
of a non-current asset over its
useful life.
Depreciation could also be
caused by:
• Technological change:
some non-current assets
can become out of date very
quickly and so cease to meet
the needs of a business
(high-tech eculpment such
as computers, mobile
phones are good examples).
• Time factor: the life of some
non-current assets Is llmtted
legally; ;,t the end of the
;,sset's life the asset will have
no v;,lue. For example, some
business premises are held
on ., lease, where there is an
agreement to pay rent for,
say 5 years.
• Inadequacy: some non-
current assets lose their
value when they cease
to meet the needs of the
business. For example. an
office photocopier could
become inadequate if the
volume of business grows
unexpectedly.
Depreciation
What is depreciation?
Depreciation Is the term used for the loss in the value of the non-
current assets of a business over their working life, due to wear and tear.
Calculating depreciation
Depreciation is usually calculated using one of the following two
methods:
Straight-line method: where the non-current asset is depreciated
equally over its useful life. The calculation often takes account of the
asset's estimated residual value Q.e. the scrap or disposal value of
the asset at the end of Its life).
ILLUSTRATION Calcula11ng depreciation using the straight-line
1
method
A business has purchased some new machinery costing
$38 000. The owner believes the machinery will have a useful
life of 4 years and have a residual value of $2 000. The annual
depreciation charge is $9 000 calculated as follows:
Cost ($38 000) tess residual value ($2 000)
useful life (4 years)
Note: This method 1s sometimes called the fixed or equal
lnstalmen1method of depreciation.
Sometimes the straight-line method of depreciation Is calculated
by using a fixed percentage rate applied to the cost price of the
non-current asset.
Reducing-balance method: where the non-current asset is
depreciated by an agreed percentage based on the asset's net book
value al the beginning of the year. Net book value means the original
cost less all the depreciation to date (accumulated depreciation).
,...I LLUSTRATION
2 Calculatlng depreciation using the reducing-
balance method
A business has purchased a delivery van coS1ing $24 000. It
has been decided to depreciate this asset by 25% per annum.
The first year's depreciation c11arge will be:
25% x cost S24 ooo = $6 ooo.
The second year's depreciation charge will be 25% of net
book value ($24 000 less depreciation to date S6 000, i.e.
S18 000}, $4 500.
Note: This method Is sometimes re'erred 10 as the diminishing
balance method of deprecialion.
Recording depreciation KEY TERMS
Depreciation is regarded as an expense. In accordance with the
accruals concept It is Important to take account of this expense Straight-line method: where
every year when preparing financial statements. the depreciation charge Is
based Ofl the cost of the asset
ILLUSTRATION 3 Recording depreciation and allocates an equal amount
of the asset's cost to each
Here are the entries required to record the depreciation of the accounting period in the asset's
delivery van (see Illustration 2) In Year 2 of that asset's life. use'ul life.
JOURNAL Reducing-balance method:
Date Details Dr Cr where the annual depreciation
Year2 $ $ charge is based on a fixed rate,
Dec 31 lnccme statemenl 4 500 like the straight-line method,
Provision for depreciation (venicle) 4500 but is calculated not on the cost
Entrles to depreciate delivery vehicle of the asset but rather on its net
book value at the beginning of
each year.
Dr Delivery vehicle

~
Year 1
Jan 1 Bank 24~0

Or Provision for depreciation (vehicles) Cr

Year 2 $ Year 1 $
Dec 31 Balance c/d 1O500 Dec 31 Income
statemem 6 000
Year 2
Dec 31 Income
s1atemem 4 500
10500 10 500
---i Year3
IJan 1 Ba'ance bid 10 500

Note: The cost of the non-current asset is recordeo separately to

the record of depreciation, which accumulates year by year.
SUMMARY QUESTIONS
Income statement (extract) for the year ended
31 December Year 2 1. Give two reasons ,.,,,hy non-
current assets lose value.
s s
Gross prom XXX 2 . Explain the difference in
Less: Other expenses XXX calculating depreciation
Depreciation of delivery vehicle 4 500 using the straight-line and
XXX reducing-balance methods.
Profit for 1he year XXX 3. Why does an income
statement Include an
Statement of financial position (balance sheet) (extract) amount for depreciation?
at 31 December Year 2 4. Why does a statement of
$ $ $ financial position (balance
NON-CURRENT ASSETS Cost Total Net sheet) show the total
depreciation depreciation to date on
Delivery vehicle 24000 10 500 13 500 non-current assets?
Note: The income statemen1 records depreciation expense
for that year only. However, the statement of financial position
(balance sheet) shows detail of the total depreciation to date.
Worked example:
adjustments

The question
Zamran owns a furniture store called Bridgeford Stores. On
30 September 2019 the following trial balance was extracteo:
Dr Cr
$ $
Accounts payable 8 410
Accounts receivable 12 400
Bad debt expense 420
Capital 168 430
Cash a'. bank 4 870
Discounts allowed 510
Discounts received 730
Drawings 31 300
Electricity charges 5980
Furniture and equipment:
Cost 20000
Provision for deprecialion at 1 October 2018 7200
Insurance 2050
Inventory 1 October 2018 11 420
Purchases 131 800
Provision for doubtful debts 1 October 2018 530
Rent received 4300
Revenue 214 900
Shop premises:
Ccst 150 000
Provision fer deprecialion al 1 October 2018 6000
Wages 39 750
410 500 410 500

Additional information at 30 September 2019

Inventory was valued at $13 700
Wages were accrued $720
Insurance was prepaid S390
Rent received was due $250
Depreciation should be provioed as follows:
• Furniture and equipment 20% per annum using the reducing-
balance method
• Shop premises 2% per annum using the straight-line methoo
The provision tor doubtful debts should be maintaineo at 5% of
accounts receivable
Prepare:
• an income statement ior the year ended 30 September 2019
• a statement of financial position (balance sheet) at 30 September
2019.

Getting started
EXAM TIP
Stage 1
The first task is to look through the trial balance, the additional Ma~ i<p 1:1°"'-rtriat
information and the tasks to be completed. At this point you are just batai,\,Ot
beginning to familiarise yourself vvith the information you are going to
be using.
yoK ""-&11::J Likt to ""-&1 y~ IA.)'
t11e t.-iaL b&1L&1v..ee to show
Stage 2 loiow each ite""- wiLL be KSeoi .
Now focus on the trial balance and think about how each item will be 50""-e e&1v..oii&l&1tes Li~e
treated. to write is (foy '""COl¾t
• Which Hems will be required tor the first part of the income state""-t..,,t) a..,,i;1 SOFP (foy
statement? stt1tel¾eV1.t of fi.""a vceiaL
, ,
postho111,/bal&l111,ee shett)
• Which Hems will be selected to appear in the second part of the
besicle itel¾S, foy ex:a""-pLe.
income statement?
• What items remain to be recorded In the statement of financial
position (balance sheet)?
Stage 3
It is Important now to start working out how to deal with the
ao'dltional Information.
Take each item in turn and consider how It will be used In your
answer. For example:
• Note 1 gives details of the cl-0sing inventory - you should be EXAM TIP
making a mental note that you will neeo this Information for the
first part of the Income statement, but also to record this asset In M a ~ 6'I.Otes Oto\. ~t triat
the current assets section of the statement of financial position bAtai,\,Ot
(balance sheet).
• Note 2 gives details of an accrual concerning wages: you should
yo... IM.LIl::J Likt to IM.LIkt
be setting out some workings to shov,, how to deal with this ttem.
so""-e b.-ief v..otes bl::J
You need to remember to add the accrual to the wages figure in YeLevaVl.t itel¾S ivc the tYiaL
the trial balance to find the figure to be included in the income batal'\,(le to snow wnetheY
statement. You also need to remember that the accrual must be t)O"'- vceecl to al¾tv..cl the
shown as a current liability in the statement of financial position fi.~uve a~ liow 1:jOK a.-e
{balance sheet). goia,cg to <'.l lM.evccl it. SOl¾t
Stage 4
eav..cliclates wouLcl WYite
+;r::i.o beside tlie wages
Prepare workings where there are calculations and/or adjustments to
fi.guYe, fo.- C:X:Lll¾ple, to
be made. These are an Important part of your answer. There can be
sliow liow thi-s ite,,,._ wiLL be
many marks tor this part of your answer, because you may well be
eheia,cge&/.
showing you understand some of the more diffieult elements in the
question.
Here are the \0/0rkings based on the additional information. The
letters A, B, C, etc. have been used to show where the resutts are
used In the final answer.
 A Rent received: $4 300 + due $250 = S4 550
EXAM TIP B Insurance: S2 050 - prepayment 8390 = $1 660
lmpottll--« of s llowi."'!3 c Wages: S39 750 + accrual $720 = $40 470
ljOK Y WO ~ D Increase In provision for doubtful debts: provision becomes 5% x
It is importaw; to s"1ow $12 400. i.e. $620, less existing provision of $530 = S90 increase
tlie perso"" YlA.a,,-ki"'-0 1::1ou,,- E Depreciation of furniture and equipment: 20% x net book value
wo~ I-low )::JOU treate&f "'""cl {$20 000 - S7 200, I.e. $12 800) = S2 560
calcul.ite&f the a&fju.stecl F Depreciation of shop premises: 2% x cost S150 ooo = $3 ooo
elt>¾e.,,ts '"" the a~we,:
111 .it wa l:::f, eve"" if )::JOU
The answ er
"'-t'!ke ;-0me >¾istakes, !'.JOU
ca"" StLll ea,-"" SO>¾f of Step 1
th e YlA.aYks. If /:JOU &lo "'-Ot You are now ready to start to prepare the income statement.
s"1ow !:JOUY worki""9s, a.,,,&( Remember that it is important to present your answer well, so
id~" "'-Q ke mistakes id ou remember to include the name of the business and the correct
W<ll ea,-"" .,,,0 marks fo,,- heading for the Income statement. Show properly drawn subtotal
the fi.=l fi.g1.<,,-es ljOu <-<.se. and total lines where appropriate, and make correct use of the
"fhe,-efo,,-e, .ilwaf:JS show columns. Do not forget to label the key subtotals such as cost ot
sales, gross profit for the year. Here is the income statement:
f:JO'-<Y wo,-ki""9s.
Bridgeford Stores
Income statement for the year ended 30 September 2019
$ s
Revenue 214 900
Less: cost of sales
Opening Inventory 11 <120
EXAM TIP
Purchases 131 800
Alte~ l::IOKY ,h1.swer 143 220
It ma id be ""ecess Q Ylj Less closing inventory (13 700)
to alter l::JO"'-Y A"'-Swe,: Cost of sales (129 520)
111is is "'-Ot "'-""'-<S1.<al Gross profit 85380
uvc&fe,,- t"1e pressure of a"" Add: Discounts received 730
e.x:ami""i1tio"'-. M.ike a""!'.! Rent received ($4 300 + $250) 4 550 see A
cl-1.i"'-ges as ""eatllj as
5 280
i:JOW. CQV\,. Avoicl WYiti"'-g
"'-tW fi.g'-<Yes over w,-0""9 90660
fi.gu,,-es, as f:JOur fi."'-Ql Less: Bad debts 420
"'""swe,,- cow.ld be ittegible. Discounts allowed 510
)~teacl cross out '"'-CoYYect Electricity charges 5980
Ltems vceatlf:J, Q vcd w,,-ite Insurance ($2 050 - $390) 1 660 sees
the vcew versio"" above t"1e
Col V\,Celliltiovc. Wages ($39 750 + $720) 40470 seeC
Increase in provision for doubtful c!ebts
(5% X $12 400 = $620 - $530) 90 seeD
Depreciation:
Furnhure and equipmen1 see E
(20% x net book val1.1e =
20% X /$20 000 - $7 200 = $12 800)) 2560
 Shop premises (2% " cost see F
EXAM TIP
$150 000) 3000
(54 690) Whe..., t1°w.r ,11,.swer does
Profrt for the year 35970 ""Dtwomow.t

wni:it olo 110<-< olo if 110<-<Y

Step2 st&1te""'-t"-t of fi,"-t:l "-CLA L
You can now move on to produce the statement of financial position positi.o"' (bala =e sl1eet)
(balance sheet). t~tals olo ""ot agree?
FLYSt of t:lll, _olo "-Ot WOYtJ:1
Bridgeford Stores Statement of financial position Kl'\.l'\,ecesst:iyLl!:J, l'.JOK will
(balance sheet) at 30 September 2019 '.""'t be Alo"'-t! Do"-'t forget
$ $ $ $ Lt _wo<.<lol tA ke o"-Ll:J O"-t
NON-CURRENT Total Net book sl•p-<-<p to CA<-<Se 1'.fOKY tot&lls
ASSETS Cost depreciation value "'°~ to ~gYee, possibll:J
Shop premises 150000 9000 141 000 loSL"'9jKSt O"-t "'-Ark, Ovclt,.
Furntture and Y0<-< "-teol to tvii"-k e1bout
equipment 20000 9 760 10 240 no"'. "'-<-<en ti""'-t t,ou viave
CIVALlAble to go back ovey
170000 18 760 151 240
l:'.JO<-<Y A"-Swe;; but still
CURRENT ASSETS complete alt the A"-Swevs
Inventory 13 700 "-ecessarl:J to complete tvie
Accoun1s receivable 12 400 ~"'- papey f.<.LL1:1 , if time is
Less provision for LV\, s~oyt S<-<ppt1:1, CO"-StoieY
doubtful debts (620) leav,""0 tvie A"-Swer c.ti-u:il
11 780 towa~ol,; t~e ,.,,,:,1 of tlie
Income due: rent 250 exa"'-•"-Aho"" peYlool A"'"'
the"' goi"-9 bAck to see lf
Prepayments:
Insurance 390 l:J~<-< CA"' spot A"'tJ obviow.s
"'-LStAkes.
Cash at bank 4870
30990
Less CURRENT
LIABILITIES
Acccun1s payable 8410
Accrual: wages 720
(9 130)
WORKING CAPITAU
NET CURRENT
ASSETS 21 860
Capttal employed 173100
CAPITAL
Balance, 1 Oc1ober
2018 168 430
Add profi1 for the
year 35970
Less drawings (31 300)
173100
 Practice exam questions
Paper1
1 Al the end of a financial year a business owes
$220 'or water cnarges. How w,11 che adjustment
for '.his aftec: the financial statements of the
b.isiness?
A ®crease exper,ses and Increase current
assets
B ®crease experses and Increase current
llabiltties
C Increase expenses and inc,-ease current
assets
D increase expenses and ine<ease current
liabillties
2 A1 :he end of a ~nancial period. a business
is owed rem 'rom one of its 1enants. How
will 1he adjustment for this af'ect ,he financial
statements 1Me buslr,ess?
A decrease income and Increase cvrrent asse:s
B decrease income and Increase =rent llabiltties
C increase tncome and increase c 1,,rrent assets
D Increase income and increase current liabilities
3 A busin,ss has decided to introduce a provision
for doubtful debts. The e'fect of introducing a
provision for doubtful debts will be
Paper2
1 Recording depreciation
Bryan's Taxis opened for b->Siness on 1 January
2018 with 1he following ncn-curre'1t assets:
• Motor vehicles at cost $120 000
• Office equipment at cost S16 000
The owner decided that motor vehicles should
be depreciated by 25% per annum using the
reducing-balance method, and 1hat office
eq:.,iprnent should be depreciated by 15% per
annum using the siraight-fine method.
Prepare:
a calculations of the depreciation charge for
2018 and 2019 for:
i Motor vehicles
ii Office equipment
A decrease profits, decrease accoun1s
recewable
B decrease prcfits, increase accounts receivable
C Increase prcfits, decrease accounts receivable
D Increase profits, Increase accounts receivable
4 A business maintai"S a provision for doubtful
debts at 5% of accourts receivable. At
31 December 2018 accounts receivable totalled
$10 000; a1 31 Decerr1ber 2019 aoccunts
receivable totalled $12 000. The entry In the
Income statement for 1he year ended
31 December 2019 will nave tne following e'fect:
A decrease pro'rts S100
B decrease prcfrts S600
C Increase profi1s $1 00
o Increase profits $600
5 A business owns eqviprnent that was purchased
at the beginning of Year 1 'or $32 000. The
equipment is expected to nave a residual value
of $2 000. Eq~lpment is deprecla1ed by 25% per
an<'um using the straight-line methOd. What is the
total prevision fO< depreciation at the end of Year 2?
A $7 500 B S8000
C $15000 D S16000
b ,he fellowing ledger accoums recording the
information avallable fer 2018 and 2019:
• Motor vehicles at cost
• Motor vehicles provision for deprecia,lon
• Office equipment at cost
• Office equipment provision for depreciation
c an extract from the statemen1 of financial
pcsition (bala~ce sheet) of the business at
31 December 2019 showing lhe non-current
assets.
2 Reviewing a provision for doubtful debts
Tne owner of Cassimi 1/1/holesalers reviews the provision for doubtful debts at 1he end of each financial year.
On 31 August 2017 the provision for doubtful debls was $2 780. On 31 August 2018 accounts receivable
totalled $62 300; on 31 August 2019 accounts receivable totalled $52 800. The owner has decided to
maintain tne provisiori for doubtful debts at 5% of accounts receivable on each of these dates.
Prepare:
a tne provision for doub1ful debts account In 1he general ledger starcing wltn the original provision a1
31 August 2017 and showing entries 10 revise the provision on 31 August 2018 and 31 August 2019
b extracts from 1he income sta1ernents for each of tne years ended 31 August 2018 and 31 August 2019
showing how 1he changes In the provision for doubtful debts should be recorded
c extracts from the statements of financial posttion (balance sheets) at 31 August 2018 and 31 August
2019 showing now accounts receivable should be recorded.
3 Preparing end of year financial statements
Thefollowlng trial bsilance 'Nas extracted from the books of Malabar s:ores on 31 December 20H~.
Dr Cr
$ $ Addhioral Information:
Accounts payable 11 250
Inventory a; 31 December 2018 was val~ed
Acoo,mls receivable 14 400 at $28 450
Bad debts written off 86 0
Insurance $420 was prepaid at
Capita! 456 100 31 December 2018
Cash at bank 2890
Wages and salaries due but unpaic;I flt
Drawings 329&0 31 December 2018, $830
Electricity charges 11 270
Rent received paid in advance at
Insurance 6310 31 December 2018, $370
Inventory 1 January 2018 32470
Premises should be deprecia1ed by 2.5%
Office expe~ses 18430 per <3'1nurn using the straight-line metncd
Premises
Shep furntture and fittings should be
cost 4&0000 depreciated by 20% per annum using the
provision for dE)preciation reducing-balance method
1 January 2018 22000
Prevision for doubtful deb1s. The provision 'or doubtful debts should be
maintained at 5% of accounts receivable at
1 January 2018 630
31 December 2018.
Purchases 173 220
Rent received 7350 Prepare:
Returns 1 840 920 a an i0 come s!atement for the year ended
31 Deoernber 2018
Revenue 298 440
b a st1;1tement of financial position
Shop furniture and flt1ings (balance sheet) a1 31 December 2018.
at oost 32000
provision for depreciation
1 January 2018 11 520
Wages and salaries 41 600
808 210 808 210
 Introduction

LEARNING OUTCOMES
In this unit you will learn about:
• the uses of control systems
• the three most commonly
used control systems
• the difference between errors
that affect and errors that do
not affect the trial balance.
Why have control systems?
Accounting records are used by many indMduals and groups to make:
• judgements about the pertormance of a business
• decisions about the future of the organisation.
It is Important, therefore, that accounting records are accurate,
otherv, ise those who use the accounting records will lose confidence
In the Information they are using, and, even worse, might be led to
make inappropriate decisions, which could further harm the business.
Control systems are concerned with:
• confirming compliance with accounting policies and procedures,
• securing the organisation's assets
• producing reliable and timely financial reports.
The control systems covered in this section will help ensure that
accounting records are accurate, and so provide users with reliable
Information.

M ain control systems

The following table shows the control systems that \"lill be covered here.
Control system Purpose
Trial balance To check the arithmetical accuracy of the double-entry records
To record any difference in the totals of a trial balance and part of the double
Suspense account
entry recording corrections of the errors that caused the totals to disagree
Control acoounts To check the artthmetical accuracy of the sales and purchases ledger accounts
Bank reconciliation statement To ensure the bank oolumns in the cash book are up 10 date and agree whh tre
bank's record of the current account of the business

These techniques have the additional benefrt that they can help
reduce the risk of fraud. This Is because they ensure that accounting
records are continually being monitored for errors.
However, the techniques are not pertect. They help reduce errors
and fraud, but they do not eliminate the risk of errors and fraud
altogether.

Errors not revea led by a trial balance

The trial balance was Introduced in Section 4, Unit 4.5. Trial balances
are very useful because they provide:
• a concise list of all the account balances In the accounting system
which can then be used when preparing financial statements
EXAM TIP
• a check on the arithmetical accuracy of the double-entry system,
because the total of debit entries is compared to the total of credit '.'-1""''!:J SttA.tltV1.tS p.~
entries to ensure that these totals agree. it 11elpftA.L to rel¾tV>t.ber
Trial balance totals will not a gree whenever a transaction has been tl1e s•x t1::1pes of ewor
wrongly recorded such that the debit and credit entries do not match. "'-Ot revealed bi::I II t.-•al
baw ""ce b1::1 ""'"k.i.""0 tA.J>
However, the trial balance Is not unquestionable proof of the a p11rase biised 0 .,., t11e
accuracy of the ledger accoun·ts. It is proof only of the artthmetlcal
LVI.Ltliit Letters of tl1ese
correctness of the postings. The total of debits may be equal to the
total of credits yet still there may be errors in the trial balance. t1::1pes of er.-o,; Le. c o
P O C c . For exii""'pte,
The trial balance totals will agree when any of the following types of
Cc!ro~ o.-de.-ed f'"""'"PPLe
error are made: Ov., c>rLsp1::I c>ereiits.
Commission: where the double entry has been made for the correct
amount: the mistake is that either the debit or credit entry 1,as been
made in the wrong account within a particular ledger.
Omission: where an entire tra.nsaction has been overlooked, i.e. a
transaction goes completely unrecorded in both aspects, perhaps
because a source document has gone missing, or a transaction,
after being recorded in the books of original entry, Is not then posted
in the ledger.
Principle: where the double entry has been made for the correct
amount, but either the debit or credit entry ls in the wrong type
of account. For example, a purchase of furniture is debited to the
purchase account instead of the furniture account.
Original entry: where the double entry has been made in the correct
accounts, but the wrong amount has been recorded throughou1 the
accounting system, often because the amount shown on a source
document has been misread. For example, If an Invoice for $3 289 Is
entered In the sales book as $3 829, the trial balance will come out
correctly, since the debit and credit have been recorded as $3 829.
The arithmetical accuracy is th ere, but in fact there is an error.
Complete reversal: where the double entry has been made In the
correct accounts and for the correct amount, but the debit and credit
entries have been swttched round. For example, a cash payment of
$678 to Mr Jude was entered on the receipt side of the cash book in
error and credited to Mr Jude's account.
Compensating: where two (or more) unconnected errors happen to
cancel each other out.
In each of these situations, although there has been an error
of some kind, there have always been matching amounts of
differences between the debit and credit entries in each case.
For example, one account In the ledger Is debited with $200 less
and another account In the ledger Is credited $200 less - these
errors cancel themselves. That Is, one error Is neutralized by a
similar error on the opposite side.
/ ILLUSTRATION 1 Examples of errors not revealed by a trial balance

Here are some examples of errors that are not revealed by a trial balance.
Error Type

1 A credit customer, L Pulchan, settled her account with a cheque for $380. Commission
However, R Pulchan's accoum was credited with this amount
2 An invoice from a supplier, BT S!ores, for $1 200 was overlooked Omission
3 The purcl1ase of some new equipment for $800 was debtted to the purchases Principle
account
4 A cheque counterfoil for S356 for electricity charges was entered In the accounts as Original entry
$365
5 Cash drawings of $50 was deb tted In the cash account and credited to the Complete reversal
drawings account
6 A payment for general expenses of $35 was entered correctly in the cash book bUl Compensating
no entry was made in the general expenses account; meanwhile, the total of the
rerJmS outwards book was understated by $35

SUMMARY QUESTIONS

1. Explain one reason tor making use of control systems.

2 . Describe how control systems help rec;Juce the risk ot fr,11,.1 c;1 .
3. Identify the six types of error that are not revealed by a trial
balance.
4 . Explain \"lhy these six types of error are not revealed by a Irial
balance.

108
 More about errors and
the trial balance

Correcting errors not revealed by a trial balance LEARNING OUTCOMES

Errors not revealed by a trial balance should be corrected by means
of entries In the general journal. In this unit you will learn about:
• preparing journal entries to
/ Correcting errors not revealed by a correct errors
ILLUSTRATION 1
trial balance • the need for a suspense
Using the information in Illustration 1 In 7.1, the entries to correct account
each of the errors 1-6 are as follows. (It has been assumed the • how to construct a suspense
errors were corrected on 31 October 2019.) account.

GENERAL JOURNAL KEY TERMS

Error Date Details Or Cr Suspense account: a
2079 $ s temporary account useo
1 Oct 31 Account receivable: R Pulchan 380 to make the totals of a trial
Account receivable: L Pulchan 380 balance agree.
Error of commission now oorrecied
Errors that are revealed by a
2 31 Purchases 1200 trial balance should also be
Account payable: BT Stores 1200 corrected by means of entries
Errcr of omission now corrected In the general journal. Each
3 31 Equipment 800 correction will require:
Purchases 600
Errcr of orl nciole now correcied • an entry in whichever
account Is affected by the
4 31 Bank 9
error - the entry will be made
Eleciriclty charges 9 on the debit or credit side as
Error of oriolnal entrv now corrected appropriate
5 31 Drawings 100
• a matching corresponding
Cash 100
entry 1n the suspense
Error of comple,e reversal now
account to complete the
corrected
double entry.
6 31 General expenses 35
Returns outwards 35
Com□e'lSaJlnn error now corrected
EXAM TIP

COYYtcti"'-g CIV\. eYYoy of

Correcting errors that are revealed by a trial balance •·eve.-sci~ Y~KiYes especi&1t
A suspense account is opened whenever the totals of a trial ccire. This is becci=e tl,e
balance do not agree. e"'-tYie,; l¾K5t be foy cioubLt
t lie Al¾ou""t of tlie orlgi=L
• An extra entry is made In the trial balance on whichever side, debit
or credit, that will enable the totals to agree. eYYOY Cl$ it is ~=Cl '1:1 to
both, cC!""cet tlie orlgi=t
• The suspense account ln the general ledger records the difference ev.,tyie,; Cl ...,i;1 tl-1e"" recorci the
between the trial balance totals. COYYect e"'-tY~.
• The entry In the ledger account Is made on the same side as the
extra entry In the trial balance.
 • When all errors are corrected the total of the o'ebit side and creoit
EXAM TIP
if l::JO<-< t'1L.,,~ a.,,
/
error affects. 0.,._,tl::J
Ovce CICCO<-<"'-t tntv. ti-le
olot.tbte ev.tY):! to coyyect
ti-le tYYor ""-t.tst ,vcvotve
ti-le 5t.<Sj>t"'-Se accot.tv.t.
H-oweve,:; if a"" error Ls.
0 "'-' of ti-le s.ix vca ""-tol
tl::Jp~ "'-Ot reveateol bl::)
a trie1t balciv.oe, ti-le
~t.<Sj>t"'-St CI CCO<-<"'-t is. V.Ot
•v.clt.toleol '"" tne ev.tries.
to correct t i1e erro,~
side of the suspense account will agree and the account can be
closed.
Correcting errors that have caused the trial
ILLUSTRATION 2
balance totals to oisagree
On 31 December 2018, the totals of the trial balance of a
business failed to agree and a suspense account was opened
to record the difference. The trial balance totals were debit
$108 400, credit $107920.
The following errors \Vere discovered:
• The payment of insurance $700 had been correctly entered
in the cash boo!<, bu1 the entry had not been posted to the
insurance account.
• The total of the purchases book had been miscalculated.
The correct total was $11 200, but the total posted to the
purchases account was $12 100.
• The total of the discounts received column in the cash book.
$280, had not been posted to the general ledger.

GENERAL JOURNAL
Date Details Dr Cr
$ s
Dec 31 Insurance 700
Suspense 700
31 Payment of insurance not posted from
cash book now correCled
31 Suspense 900
Purchases 900
Mis-posting of total purchases now
corrected
31 Suspense 280
Discounts received 280
Discounts received total not posted
· SUMMARY QUESTIONS from cash book now corrected
1. Explain how correcting an
error of reversal Is different
from correcting other types I
/ ILLUSTRATION 3 Constructing a suspense account
of error.
Here Is the suspense account based on the entries In
2. Describe the circumstances Illustration 2.
under which a trial balance
will reveal that there are Dr Suspense Cr
errors in the accounting $ $
records. Dec 31 Purchases 900 Dec 31 Difference In 480
3. State which side of a trial balance
suspense account should Discounts 280 31 Insurance 700
record the difference in the received
totals of a trial balance. 1 180 1180
;
 Correcting profits

If there is a delay in tracing errors In the accounting records. it

LEARNING OUTCOMES
is possible that the end of year financial statements will contain
inaccuracies. As a result, the draft profit (or loss) for the year may In this unit you will learn about:
need correction.
• constructing a statement of
revised profit following the
ILLUSTRATION 1 Correcting a draft profit figure
correction of errors.
The draft Income statement of a business for the year ended
31 December 2019 shows a profit of $56 700. However, the
following errors have been discovered:
• the total of the sates book for December 2019, $1300, had
not been posted to the sa.les account
• Insurance prepaid of $300 was overlooked
• drawings were mistotalled at $18 900 instead oi $19 800
• oiscounts allowed of $600 were treated as discounts received
in the income statement.

Here is a statement detailing a correction of the draft profit.

Correction of draft profit for the year ended

3 1 December 2019
s
Draft profit for 1he year 56 700
Add sales n01 posted from sales book 1 300
Add insurance prepaid overaooked 300
Less discoums allowed (1 200)
Corrected profit for the year 57 100

Notes:
1. The answer ls best set out in the form of a statement.
2. Only errors affecting the income statement are relevant, so the
error in the drawings account has been Ignored. SUMMARY QUESTIONS
3. Correcting the error concerning discounts requires double the 1. Give one example of
amount (as Is usual where an entry Is made on the wrong side an error that. when a
of an account). correction Is made, would
cause a draft profit to be:
A statement of financial posttion may also need to be corrected. a Increased
For example, based on Illustration 1 above It would be necessary to
make the following changes: b decreaseo.
• Draft profit of $56 700 becomes a corrected profit of $57 100 2. Give three examples of
• Drawings will need to be increaseo by $900 from S18 900 to an error that would cause
$19 800 changes to a statement of
financial position.
• Prepaid insurance of $300 'NIii need to be included In the current
assets
 Worked example:
correcting errors

The question

The following trial balance was extrac1ed from the books of St Michael's Stores on 31 August 2019.

Dr Cr The following errors have been discovered.

$ $ 1. The purchase of goods on credtt, $7 40, frcm
Ambers Ltd has been overtooked.
Accoun1s payable 4390
Accoun1s receivable 5680 2. Owner's drawings by cheque of $450 had been
correctly entered in the casl, book but debited to tlie
Capttal 41 000 drawings account as S540.
Cash at bank 3 210 3. General expenses of $230 had been creoited to the
Drawings 18 970 cash book, but had not been posted to the general
ledger.
General expenses 4 780
4. The sale of goods on credit, $440, to A Black was
Inventory 8200
correctly entered in the sales book, but posted to the
Non-current assets accounts of both A Black and A Bat ford.
Cost 44 800 5. The purchase of a non-current asset by cheque,
Provision for 11 200 S500, had been entered in the books as $550.
depreciation Prepare:
Purchases 69950 • Journal entries necessary to correct each of these
Sales 98700 errors (narratives are not requirec)
Suspense 300 • the suspense account recording the opening entry
155 590 155 590 and relevant entries !rem the journal (the account
shoulo be closed)
• a corrected trial balance.

Getting started
In this question there are two types of error listed:
• those that are revealed by a trial balance and so affect the
suspense account
• those that are not revealed by a trial balance so do not affect the
suspense account.
So, the 1irst step Is to consider each error carefully and decide which
of these two types of error applies:
Error Category Reason
1 Not affecting suspense acoount Error of omission, so correction affects two 'routine' accounts
2 Affects suspense account 'One-sided ' error, I.e. only one 'routine' account affec1ed, drawings
3 Affects suspe'lse aoccunt 'One-sided' error, i.e. only one 'routirie' account alteeted, general expenses
4 Affects suspe'lse aoccunt 'Or.e-sided' error, i.e. only one 'routine' account affected, A Batford
5 Not affecting suspense acoount Error of original entry, so correction affects two 'routine' acoounts

The answer
Preparing t he journal entries
It Is now possible to start preparing the Journal entries.

GENERAL JOURNAL
Dat e Details Dr Cr
2019 $ s
Aug 31 Purchases 740
Account payable: Ambers Ltd 740
37 Suspense 90
Drawings 90
37 General expenses 230
Suspense 230
3 1 Suspense 440
Account receivable: A Batford 440
3 1 Bank 50
Non-current asset 50

Note: the ques1ion asks that narratives are not shown.

Preparing the suspense account
The suspense account is shown below. Remember that the opening
balance matches the location of the figure In the trial balance. So, in this
case the suspense account Is shown In the credit column In the trial
balance, and so is shown as a credit entry in the suspense account.
Dr Sus ense account Cr
2019 s 2019 $
Aug 31 Drawings 90 Aug 31 Difference in trial
balance 300
31 A Balford 440 31 General expenses 230
530 530

Preparing a revised trial balance

Before preparing the new trial balance, it may be helpful to make
notes on the original trial balance of each of the changes you vvish
to make. For example, the correction of the first error means that
the purchases figure increased by $740 (so neatly pencil in +740 by
 purchases) and accounts payable also increases (so neatly pencil
in +740 by accounts payable). Apply this process to each of the
remaining error corrections. Your notes will make it easier to work out
the new figures to record in the revised trial balance.
Here is the original trial balance again showing these notes.
Dr Cr Notes
s $
Accounts payable 4 390 Increased by $740 - error 1
Accounts receivable 5680 Decreased by $440- error 4
Capttal ,q 000
Cash at bank 3 210 Increased by $50 - error 5
Drawings 18970 Decreased by $90 - em;r 2
General expenses 4 780 Increased by $230- error 3
Inventory 8 200
Non-current assets
Cost 44800 Decreased by $50 - em;r 5
Provision for depreciation 11 200
Purchases 69950 Increased by $740 - error 1
Sales 98 700
Suspense 300 Eliminated - errors corrected
155 590 155 590

And here ls the revised trial balance based on these notes.

Trial balance at 31 August 2019 (corrected)
Dr Cr
$ s
Accounts payable 5 130
Accounts receivable 5 240
Capital 41 000
Cash at bank 3260
Drawings 18 880
General expenses 5 010
Inventory 8200
Non-current assets
Cost 44 750
Provision for depreciation 11 200
Purchases 70690
Sales 98 700
156 030 156 030

,112 .
 Control accounts

It is possible to check the arlth metical accuracy of the sales ledger

LEARNING OUTCOMES
and purchases ledger by using control accounts. Control accounts
summarise the entries in the sales and purchases ledgers. The totals In this unit you will learn about:
of the sales and purchases general ledger accounts should equal
the totals of the balances of the lnoividual accounts in the sales and • the purposes of control
accounts
purchases ledgers.
• now they are prepared
Control accounts are also used as an easily accessible source of
details about total accounts receivable and total accounts payable • the sources of in•orma11on tor
when preparing trial balances, statements of financial position, etc. control accounts
They can help reduce the risk of fraud since the work of purchases • the construction o• accounts
ledger and sales ledger clerks is checked by a more senior employee receivable and accounts
at regular intervals. payable control accounts
Control accounts are prepared from totals taken from the relevant • the significance of balances
on control counts.
books of original entry. Control accounts ere not (normally} part of
the double-entry system. They resemble a credit supplier's account
(accounts payable control account) or a credtt customer's account
(accounts receivable control account) in terms of how entries are KEY TERMS
debited and credited within the accounts Control account: a process
However, rather like trial balances, control accounts cannot reveal all for checking entries In the
the errors that could be made In these two ledgers. If a balance of a purchases ledger (accounts
control account agreed with the total of balances In its corresponding payable control account)
ledger, there could still be errors of commission, omission and and sales ledger (accounts
original entry. receivable control account).
Note:
• accounts payable control ac~ounts are sometimes called
purchases ledger control accounts
• accounts receivable control accounts are sometimes called sales
ledger control accounts,
The fcilowing table shows the source of Information for many of the
entries shown In these two control accounts.

Accounts receivable control account Accounts payable control account

Source of Source of
Transaction Information Transaction Information
Total credit sales Sales book Total credit purchases Purchases book
Total receipts from accounts Total payments to accounts
Cash book Cash book
receivable payable
Total discounts allowed Cash book Total discounts receNed Cash book
Returns inwards
Total returns inwards Total returns outwards Returns outwards book
book
Total of bad debts written off General journal
 The opening balances of the control accounts are brought down
from the previous period.
Some less common transactions are as follows:

KEY TERMS Source of

Transaction Information
Dishonoured cheque: a
Dishonoured cheques received from a credit Cash book
cheque that 1he payee's bank
will not accept for payment customer
because the payer (person Interest charged on credit cus!omers' overdue General
writing the cheque) does not balances journal
have sufficient funds to cover Interest charged by cred~ suppliers on overdue General
the amount being paid. (This balances Jo.imal
Is sometimes referred to as a
·returned cheque' .) Contra entries (set off) between a sales ledger General
account and a purctiases ledger account (or vice journal
Contra entry (set off): {relating versa). Contra entries occur when an individual or
to control accounts) a transfer business Is both a customer and a supplier, and the
between an Individual account balance of the two accounts are set off against each
payable and an account other.
receivable arising from the
tact that the supplier Is also a
Sometimes the account of a credit customer (an account receivable)
customer. to establish a net
will have a credit balance. This can arise tt the customer has
amount to be paid or to be
overpaid. Similarly, the account of a credit supplier (an account
received.
payable) will have a debit balance if the supplier has been overpaid.
These balances must be reflected when preparing the relevant
control accounts.

/ ILLUSTRATION 1 Format for the two control accounts

Dr Accounts payable control account Cr

2019 $ 2019 $
May 31 Ba'ance bid 450 May 31 Ba'ance bid 18 400
31 Bani< 17 270 31 Cred t purchases 19 550
31 Discounts received 540 31 Interest charges 130
31 Returns outwards 1 210 31 Ba'ance Cid 270
31 Cont<a with sales ledger 380
31 Ba'ance Cid 18500
38350 38 350
June 1 Ba'ance bid 270 June 1 Ba'ance bid 18 500

This control account shows that, at 1 June, credit suppliers are ovved $18 500 and there is a credit
supplier's account that has been overpaid by S270. These figures should agree with those shown by
totalling the balances ot accounts in the purchases ledger.

(Continued}

.114 .
,. ILLUSTRATION 1 Format for the tv;o control accounts {Continued)

Dr Accounts receivable control account Cr

2019 $ 2019 s
May 31 Balance bid 14 320 May 31 Balance bid 140
31 Cred1 sa•es 17 240 31 Bank 14820
31 Interest charges 90 31 Discounts a lowed 770
31 Dishonoured cheque 410 31 Returns inwards 6 10
31 Balance c/d 280 31 Contras with pu•chases
ledger 380
31 Bad debts written oil 560
31 Ba~nce c/d 15060
32 340 32340
June 1 Balance bi d 15 060 June 1 Ba'ance bid 280

This control account shows that at 1 June credit customers owe $15 060 and that there is a credit
customer's account that has been overpaid by $280. These figures should agree with those shown by
totalling 1he balances of accounts in 1he sates ledger.

SUMMARY QUESTIONS
EXAM TIP
1. Describe three benefits oi preparing control accounts.
2. List three items that should be recorded in an accounts Rt!M.l1M.ber ti1&1t if t11ere
payable control accoun1 and state the source o' Information ii re COll\.trt:1 e""tries,
tor each ot these entries. tl1e1::1 &1ppe&1r i"" botl1 tl1e
3. List three items that should be recorded in an accounts t1 cco...,""ts 'f>&l 1::1 Cl bLe co111.troL
receivable control account and state the source o f ti cco.... ""t &I ""a tl1e &lcco...,111.ts
information for each of these entries. receivtibte co...troL &1cco"'-"'-t.
4. Explain the term 'contra entry' when used in connection wtth
control accounts.
 Worked example: control
accounts

The question
On 31 December 2019 Alvin must prepare control accounts to
check the accuracy of his sales and purchases ledgers. He has the
following information. (Note that for the purposes of this worked
example, every item of information has been given a reference letter
to help you identify how the item has been used in the answer.}

$
Control account balances, 1 December 201 9
Sales ledger control acoount debit balance 6520 A
Sales ledger comrol acoount credtt balance 290 B
Purchases ledger control account credit balance 8480 C
EXAM TIP Purcnases ledger control account debit balance 310 D
Cash book totals
~tnet¼,ht~ Receipts from credit customers 5990 E
ii C.0""'-""'-0 "" ""'-istiilu is Payments to credit suppliers 8630 F
~o t'1::1 to LV\.e,L<,<."e ALL H1e Discounts allowed 240 G
'""fol'1M.tl1:io"" give,,.,, ivc
Discounts receNed 450 H
~ne c-oi'\trol (;lccou""ts. rt is
'""'-)>Ort&r"'-l: to setect ol-\Ll::J Dishonoured cheques (from credit customers} 180 I
tne ,te""'-S tkat relcrt:e to Cash purchases 3920 J
tne t:1c-cou,,.,,ts receivi:ibt.e Cash sales 15 870 K
~l'\.d &ICCOIA.V\.ts }'Cll::JC!ll(.e, Totals from books of original entry
,.e. tnose c-o=er,,.,,£"'-0 the Sales book 7 440 L
""'-&lk.i"'-0 i:tl'\.d settle""'-tvct Purchases bock 9300 M
of oredit tr&rl'\.6i:tctiovcs.
Returns inwards bock 510 N
Ht"'-Ce, cash sates i:tl'\.d
M&h p1.<rcnases t:1re Returns outwards book 450 0
ig=vui '"" &rl'\.6wel'i"'0 General journal totals
tl-,is qKtstLOV\.. Bad debts written off 270 p
Contra entry betv.reen sales ledger and purchases
ledger accounts 880 Q
Balances Shown in the sales ledger at 31 December 2019
Total of debit balances 6350
Total of credit balances 390 R
Balances shown in the purchases ledger at 31 December 2019
Total of debit balances 520 s
Total of credit balances 7 270

• Prepare the sales ledger control account and purchases ledger

control account tor December 2019.
• Explain what the balances of the control accounts at 3 1 December
2019 tell Alvin about his sales and purchases ledger records.
Getting started
EXAM TIP
Read through the details carefully. You need to begin to think about
where you will record this information. \/I/hat Items will need to be
"8414!~ the 00>\tn>L
selected to be shown In the accounts receivable control account?
What items will need to be selected to be shown in the accounts olo.,,'t forget
llOOOw....ts:
payable control account? to baui=e ijO"<Y co....tr-oL
acco"'""t.s a.,,o1 b,.-£""9 the
bALa ...ce olow.... yo"'" ow"'
The answer
bA4l"'ces O"'- tke co""tr-oL
Preparing the control accounts acco"'""ts ca.,, tne"" be
When you have selected the Items to be shown in each control check,eol agail'l<St t'1e
account, the next step is to think carefully about on which side of the total M ur-es prod"'ced
control account to record each item. btJ tke sales Leolger a.,,ol
J'"<Yc'1Ases Leolger cle,-!,es
Explaining the balances to see if t'1etJ agr-ee.
The sales ledger account debit balance of $6 350 agrees with the
total balances shown In the sales ledger, so it appears that the total
of the sales ledger balances Is arithmetically correct. The control
account confirms the business Is owed $6 350.
However, the credit balance of the purchases ledger control
account, $7 580, does not agree with the total of the balances in the
purchases ledger, so there are errors in the accounting system. This
discrepancy must be resolved in order for the business to have valid
information about how much is owed to credit suppliers.
Dr Accounts receivable control account for December 2019 Cr
$ s
Dec 1 Balance bid A 6 520 Dec 1 Balance old B 290
31 Credit sales L 7 440 31 Returns Inwards N 510
31 D shonoured cheque 180 31 Bank (rece.p1s) E 5990
31 Balance Cid R 390 31 Disoounts allowed G 240
31 Bad debts written off p 270
31 Contra entry wth purchases
ledger Q 880
31 Balance c/d 6350
14530 14530
Jan 1 Balance bid 6350 Jan 1 Balance bid R 390

Dr Accounts payable control account for December 2019 Cr

$ $
Dec 1 Balance bid D 310 Dec 1 Balance bid C 8480
31 Returns outwards 0 450 31 Credit purchases M 9300
3 1 Bank (payments) F 8 630 31 Balance cld $ 520
31 D scounts rece.ved H 450
31 CoPtra emry with
sales ledger Q 880
3 1 Balance Cid 7 580
18300 18300
Jan 1 Balance bid $ 520 Jan 1 Balance bid 7 580

. 117

LEARNING OUTCOMES
In this unit yov will learn about:
• Items that cause Cfifferences
between cash book ano
bank statement balances
• how to update the cash
book
• how 10 construct a bank
reconciliation statement.
EXAM TIP
Do""' t foyget to bala.,,,ce
t vie casl-l book: a "'-Of 1,y("'-0
t vie bcita"'-Ce clowV\, wne""
Kpciat,""0 a casl-l boo~.
KEY TERMS
Direct debit: where authority is
given to a bank by a customer
to make payments on the
customer's behalf to another
organisation. The amount
paid is that reouested by that
organisation up to a specifieo
limit.
Standing order: where
a bank's customer gives
Instructions for the automatic
payment to another
organisation of a fixed amount
at regular intervals.
Credit transfer: the aU1omatic
transfer of funds into the bank
account of a business by one of
its customers.
Bank reconciliation
statements
The balance of cash at bank as shown by the cash book of a
business on a particular date rarely coincides •..vlth the balance shown
on the bank statement for the same date. The usual reasons for this
are shown below, but it is Important for a check to be made to ensure
that there are no errors In the cash book or in the bank statement. To
do this a bank reconciliation statement must be drawn up.
Usually the difference in the two balances is accounteo for by:
• Timing differences: it takes time for transactions involving a bank
account to progress through the banking system. For example, a
business coulo:
• make a payment by cheque and record this transaction in the
cash book, but it may take days or even weeks for the cheque
to be paid in to a bank account by the payee/recipient and then
be processed by the bank (often re'erreo to as an ·unpresented
cheque', 'outstanding cheque· or a 'late lodgment')
• pay cash, cheques, etc. into the bank and record the transaction
in the cash book, but the transaction could take a few days to
appear on the bank statement of the business (referred to as
outstanding deposits, or deposits in transit).
• Omission of transactions: many transactions are now carried
out au1omatlcally by banks and so may be overlooked when
preparing the cash book. Examples Include:
• the payment of various expenses by direct debit or standing
order
• the deduction of bank charges
• the cancellation of a cheque paid Into the account because the
payer had no funds (a returned or dishonoured cheque)
• the receipt of money from a customer using a credit transfer
facility or similar process.
• Errors: occasionally an error may have been made in preparing the
cash book, and sometimes errors come to light in the bank's own
records. The bank reconciliation process helps detect these errors.
The bank reconciliation process is usually carried ou1 at least once a
month and involves:
Step 1: Checking every entry In the cash book against the entries In
the relevant bank statement. It Is usual to tick entries that appear In
both documents. Any entry that is not ticked must, therefore, help
account for the differences in the two balances.
Step 2: Updating the cash book with any entries that have been
omitted, such as bank charges , or direct debit payments that were
overlooked.
' ILLUSTRATION 1 Updating a cash book

On 3 1 January 2019, the cash book of a business sho\,ved a balance of cash at bank of $2 740.
However, the bank statement at this date showed a balance of only S820. After comparing the two
documents. the following items were found to have been omitted from the cash book: direct debit
payment for water charges of $430; bank charges of $80; credit transfer of S11O - one of the customers
of the business, PQ Ltd, had transferred S110 directly into its bank account.
Here is an extract from the cash book of the business updating the balance of $2 740. For convenience,
only the bank columns are shown.

Dr Cash Book (bank columns) Cr

2019 $ 2019 $
Jan 31 Balance bid 2 740 Jan 31 Water charges 430
31 PO Ltd 110 31 Bank charges 80
31 Balance c/d 2340
2850 2850
Feb 1 Ba'ance bid 2 340 I
Step 3: Preparing a bank reconciliation statem ent that takes
KEY TERMS
account of those transactions 1hat have not yet been processed by
the bank. This final stage should result in agreement between the Bank reconciliation
updated cash book balance and the bank statement balance. If this statement: a document
agreement (or reconciliation) Is not achieved, then errors must have prepared by businesses at
occurred reciuii'ing further checks. regular intervals to check that
their bank records agree with
/'
those provided by the bank.
ILLUSTRATION 2 Preparing a bank reconciliation statement

The following liming differences were discovered: a cheoue for $670

In payment of a supplier had not yet been presented for payment
cash takings o' $2 190 were paid into the bank on 30 January, but
this transaction had not yet been recorded by the bank.
Here Is the bank reconciliation statement using information from
Illustration 1 and the details above. SUMMARY QUESTIONS

Bank reconciliation statement at 31 January 2019 1. Describe the reasons why

s a cash book and bank
Balance as per bank statement 820 statement for the same
period will not always
Add: amount not yet credited 2190
record exactly the same
3 010
Information.
Less: unpresented cheques 670
Balance as per cash book 2340 2. Define the term
'unpresented cheque'.
Notes: 3. Describe how amounts not
1. When the timing dlfferenc,es are taken into account, the I\IVO yet credited will be recorded
balances do agree. It can be assumed, there'ore, that the In a bank reconciliation
cash book and the bank statement are free of error. statement it the statement
2. In the format shown, the thinking process is: 'What would the begins with the upoated
bank statement balance have been had the bank reccroeo cash book balance.
the missing transactions?·
Worked example:
preparing a bank
reconciliation statement
The question
Michael Lee owns a retail business. The cash book of his business
showed a balance at bank of $850 on 31 July 2019. However, on
this date his bank statement showed an overdrawn balance of $190.
Michael has compared his cash book and bank statements and has
noted the following differences:
1. A cheque paid tor the purchase of some computer equipment,
$1 759, had not yet been entered on the bank statement.
2. Bank charges not yet entered In the cash book amounted to
$105.
3. A cheque paid to a supplier, Tangle Ltd, for $1 983 had been
entered in the cash book as $1 389.
4. A cheque received from P Joseph tor $850 had been recore1eo in
the cash book. This cheque has been dishonoured.
5 . A standing order payment for rent, $710, had been omitted from
the cash book.
6. Bank deposits not yet credited by the bank totalled $540

Prepare:
• an updateo cash book at 31 July 2019
• a bank reconciliation statement at 31 July 2019.

Getting started
It is, of course, important to read through the question details
carefully. On the first read-through you should notice that the bank
statement is overdrawn (rather than positive), and that the list of
items to be processed is in no particular order and includes a
mixture of items affecting the cash book and items affecting the bank
statement. Some of the Items are more unusual (for example, the
error mentioned In Item 3).
The first task is to sort the Items into the two categories before
producing the updated cash book:
• those affecting the cash book
• those affecting the bank statement.
Here is a table showing how to do this.

Item Affects ..• Treatment

,.computer Bank This is an unpresented cheque. II will make tne current bank statement
equipment statement overdraft figure even higher Vlihen ii is presented for payment.
2. Bank charges Cash book This will reduoe the currem cash book balance when added to the cash book.
3. Error recording Cash book This will reduoe the current cash book balance, since the correct figure for
cheque this payment was higher than the one actually recorded .
.G.. Dishonoured Cash book This will reduce the ct..rrent cash book balance, since it is necessary to cancel
cheque the receipt as the cheque was dishonoured.
5. Standing order Cash book This will reduce the cvrrent cash book balance as this payment has not ye1
for rent been recorded.
6. Bank depostts Bank This item will red.;ce the current bank overdraft balance as this is a receipt
statement missing from the bank statement.

The answer
Preparing an updated cash book
Selecting the relevant items, it is now possible to update the cash
book.
EXAM TIP
Dr Cash Book (bank columns only) Cr
$ $ t>owt forget to bata..,,ce
H1e cctsl1 book. a...,cf bti....g
July 31 Ba'ance bid 850 July 31 Bank charges 105
tl-ie bctL&!"-C-e clow"'" wl-Je"'"
31 Ba11;1,nce c/t;I 1 409 31 T.ing1e I.to 594
UJ>clttt•....g Cl Cctsl1 book. .
31 PJoseph 850
31 Rem 710
2 259 2 259
Aug 1 Balance btd 1 409
It is Important to note that the cash book now has an overdrawn
balance at bank.

Preparing t he bank reconc iliation statement EXAM TIP

Using the other items, It is no,v possible to prepare the bank
reconciliation statement.
It is ,.,,,_portC! i,,,t to tC! ke
e.i:tt-&! CC!Yt wl-Je"'" 1vork.i....g
Bank reconciliation statement at 31 July 2019 w,tl-J Cl"'" overclr-C!ft
s fi.gure. i t is eC1si::, to
Balance as per bank statement (190) get c,o"'-fuseix witl1 tl-ie
Add: amount not yet crediteo 540 &! tit11.,,,_etic becci '-<St Cl '"'-1:1
overclr-C!f\:
,
-{1.c.ur-es Clre
(350) '"'-egC1t,ve.
~

Less: unpresented cheque 1 759

Balance as per cash book (overdrawn) (1 409)
Note: the negative {overdrawn} figures are shown in brackets.
 Practice exam questions

Paper1
1 A bookkeeper posted a credrt sale to the debit 4 A retailer's cash book shewed a balance of $400
of \"lalter Owen's account Instead o1 to 1he (credit). \"lhen ;he bank statemem was received,
debrt of Wayne Owen's account Tnis mistake is additional entries were made In tne cash book
known as: for: standing order omrtted $100, interest
A an error of commission received $200. The updated cash book balance
will be:
B an error of orlginal entry
A $100 credit B S300 etedlt
C an error of pnnciple
C $500 credit D S700 credit
D an error of complete reversal
5 Which one o' the following shoJld be entered in
2 The trial balance totals of a business were
a sales ledger control account?
Dr$47 200 and Cr $47 400. Wnici'lof 1he
following errors could have caused t/iis A cash sales B discounts received
d1sagreerrie:,t? C purchases D returns inwards
A a reh.irns inwards o' $200 had rot been 6 IA/hich one of toe following shovld be entered In
posted to '.he customer's aoco unt a p1,1rchases ledger control account?
B a sale o1 gocds. $200, rad been omitted A cash purchases
from the books of account
B discounts received
C 1he total of discounts received, $200, had
C imereSl charged on overdue acco-.1nts
not been posted 'rom the cash book
receivable
D 1he total of1he stationery colunnn, $200, had
D re1urns Inwards
no1 been posted from the petty cash book
3 An Income stater1ent showed a draft profrt for
the year of $36 800. However. .,i.n error was
made when a sale of goods, $500, was treated
as a purchase of goods. When this miS!al<e Is
corrected the profit for the year wil I be:
A $35 800 B $36 300
C $37 300 D S37 800

Paper2
1 Correcting errors that are revealed by a
trial balance
Gloria's trial balance totals did no1 agree. The
totals of the columns were: debit $186 300:
credit $1 85 110. Gloria has discovered the
following errors in her books of account.
• The total of the petty cash analysis column for
travel expenses. $80, had not been posted to
2 Preparing a bank reconciliation statement
the general ledger.
• An aoco<.1n1payable, Hostens Flowers, had been
paid $1 180 by c,ieque. The transaction had been
entered correctly in ,he cash book, but had been
posted to Hos1ens Flowers' aocount as $1 810.
• The dlscoun1s received column iotalled $320.
This amount tiad been posted In error 10 the
debit of the d1scoun1s received account.
Prepare: a lhe entries in the general journal
required to correct these errors: b 1he s.,spense
acoovnt showing en1ries arising from ;his
Information.
Keith's cash book showed a deb rt balance ol
$8 750 on 30 Sep1ember 2019. This did no1
agree with me balance o1 $8 294 shown on ,he
bank S1atement of his business at this date.
 A comparison o' 1l7e cash book and bank
S1atemen1has revealed tne following differences:
• A standing order payment of S980 for rent nad
been overlooked when preparln9 l he casn book.
• Cash and cheques totalling $643 paid Into
the bank had no1 yet appeared on lhe bank
statemenl .
• Bank charges of $112 tiad not yet been entered
in the cash book.
• Tnere were two vnpresePted cheques: Seeriath
Seafoods Ltd $382; Radiant Tours Ltd $515.
• Tne bank sta1ement included a credtt 1ranster of
S382 from a credit cuS1omer, L Nelson, which
had no1 yet been included In 1he cash book.
Update Keith's cash book on 30 September
2019 ar d prepare a bank reoonciliation
S1atemen1a1 l his date.
3 Preparing control accounts
On 30 Sep1ember 2019, Michelle totalled the
balances of her sales and purchases ledger
accounts. The tolals were as follows: sales
ledger$16 395: purchases ledger $10 292.
Michelle prepares comrol accounts m check 1he
accuracy of these figures.
Tile following lnformal ion is available for the
month of September 2019:
$
Control account balances at
1 Sep1ember 2019
Sales ledger 16 493
Purchases ledger 12 204
Totals from book of original entry:
Cash book
Discoun1s allowed 8L17
Discoums received
668
Payments to accoun1s payable 34 224
Receipts from accounts 45 183
receivable
General journal - bad debts
written off 224
Purchases book 33808
Returns inwards book 1 626
727
Relurns outwards book
Sales book 47 782
Prepare the accounts receivable and accounts
payable oon!rol accounts for Sep,ember 2019.
State wha11ne closirig balances of the con1rol
accounts reveal.
4 Identifying errors not revealed by a trial
balance
The following errors have been found in the
accounting records of the grocery store owned
by Jagmonan. In each case identify 1he type of
error that nas occurred .
a Goods were returned to a credit supplier,
Gee1a Traders, value $370. However, a debit
en1ry was made in 1he account of Gee1a
Suppliers ra1her lhan Geeta Traders.
b Some new office eqviprnent w,;s pvrcha~eo
by cheque $2 200, The entries made were: Dr
Purchases Cr Bank $2 200.
c An lnvoice was received from TrinBay Ud for
$2 320. The entry in the purchases book was
for $2 230.
d Jagmonan vvtthdrew cash for private use
$240. The entries made were: Dr Cash Cr
Drawings $240.
e The total of 1he discounts allowed column
$450 was l ransferred to the debit of the
discounts allowed account as $540; 1he
pi;1ymen1 of general expenses $90 by cheque
was not posted from tne cash book,
f A paying-in slip counterfoil for cash and
cheques relating ;o casn sales totalling $650
had been overlooked and had not been
en1ered In the books of account.
5 Correcting errors not revealed by a trial
balance
Prepare entries In Jagmohan's general journal
10 correct each of the errors listed in QueS11on 4
above.
 ••
Introduction
LEARNING OUTCOMES
In this unit you will learn about:
• how a partnership business
is defined
• the features of a partnership
• the reasons for establishing
partnerships
• 11,e essential components of
a partnership agreement
• sharing pro'its and tosses.
KEY TERMS
Partnership: a fom, of
business ownership where
two or more lndiviouals work
together with the intention of
making a profit.
Limited partnerships: one or
more partners has limited liability
for the debts o' the business,
meaning they can onty lose the
amount they invested in the
business shoulo it fall. Limited
partners cannot 1ake part In the
oay-to-day decision making of
the partnership.
Unlimited liability: where
the owne~s} of a business are
responsible for all the debts o'
the business and miiy lose all
their investment In the business.
and private possessions as
well, in order to pay off the
debts of the business.
Voluntary association:
a group of individuals who
Join together on the basis of
common objectives.
Features of a partnership
• A partnership is a form of business ownership where two or more
Individuals work together with the intention of a making a profit.
• Unless it is a limited partnership, each partner will have
unlimited liability for the debts of the business. This is exactly the
same disadvantage that is experienced by a sole trader.
• A partnership is a voluntary association, I.e. a business Vlt here
a group of Individuals join together on the basis of common
objectives.
• All the partners are jointly responsible for the oebts of the
partnership, even if an individual partner played no direct part in
incurring the debt.
• This is one example of mutual agency, whereby each partner has
the power to make contracts on behalf of the partnership and is
bound by the other partners' actions in the normal running of the
partnership.
Why partnerships are formed
Partnerships enjoy some important advantages that do not apply to
the sole trader form oi ownership, such as:
• raising more capital because several owners can contribute
• sharing ideas and expertise
• sharing the workload involved In running a business.
There are, however, some drawbacks that are faced by partnerships,
in addition to unlimited liability for the debts of the business:
• Decision making can be more difficult because every partner must
agree to important proposals about how to run the business.
• Each partner must follow any agreements made by the partners.
• Each partner is jointly responsible tor the debts of the partnership.
• Partnership businesses can be short-lived, because they may have
to close on the retirement or oeath of a partner.
• There is always the risk that partners will disagree and that
relationships may break down, possibly bringing the partnership to
an end.
Partnership agreements KEY TERMS
The deed of partnership
Mutual agency: each partner
Partners usually make a formal agreement when the partnership is has the power to mal<e
established. The agreement may be merely spoken or may be written contracts on behalf of the
down In the form of a deed of partnership. partnership ano Is bound by
Agreements often Include: the other partners' actions
In the normal running of the
• how much capital is to be contributed by each partner partnership.
• the responsibilities of each partner in running the business
• a llmtt on each partner's drav,ings
• how profits and losses are to be shared. EXAM TIP
Note: where partners do not have a formal agreement about sharing
pro'its and losses, the law requires proms and losses to be shared ALwa tfS. b~ a wave of
equaJly. t he J'YOVLSLO"'-S """ t he
Sharing profits and losses ]>llrt"'-tYsh•J> agr-eeV>1.el'\.t.
The agreement about sharing proms and tosses can be very simple:
partners could agree to share all pro'its and losses equally. for
example. However, more elaborate arrangements can be made:
• Each partner may receive a share o' profits based on his/her
capital contribution. This is referred to as Interest on capital. A rate
of Interest per annum will be agreed.
• One or some oi the partners may receive a ·partnership salary', a LINK %
share of profits awarded for taking special responsibility for some
There Is more on interest on
aspect of managing the business. This benefits partners who are
drawings In Unit 8.3.
more active than others in running the business.
• Proms (or losses) remaining after these awards have been allocated
may be shared equally, or in some other ratio.
• Some agreements may also provide for 'interest on drawings', a
penaJly based on the amount of a partner's drawings.

SUMMARY QUESTIONS
1. Give two reasons why a sole trader might choose to form a
part nershlp.
2. Give tv,o reasons why a sole trader might prefer to stay as a
sole trader rather than !orm a partnership.
3. What oetalls might be included in a deed of partnership?

There ls an example of how profile are shared in Unit 8.5.


LEARNING OUTCOMES
In this unit yov will learn about:
• preparing partners' capital
accounts
• how lo prepare an
appropriation account
• how to prepare partners'
current accounts
• the significance of the
brought down balances of
partners' current accounts.
JOURNAL ENTRIES
General Journal Cash Book
DEBIT assets a/cs DEBIT Casn ale or
brought into the Bank ale for monies
business brought in
CREDIT the partner's capita! account for the value
oomribuled.
TOTAL DRS muSl equal TOTAL CRS
DID YOU KNOW?
Fluctuating capitals: this form
of capital account combines
all the Information about a
partner's investment In one
account, I.e. In the partnership's
first year it will lncluoe the Initial
capital contnbution, shares of
the year's profit, orawlngs and
a closing balance.
The balance on a partner's
current account can be:
• a debit: where the partner's
drawings have exceeded lhe
share of profits, I.e. the partner
is In debt to the partnership
• a credit: where !he partner's
share of pro'its has exceeded
drawings, I.e. the partnership
is in debt to lhe partner.
The accounts of
partners
Partners' capital accounts
In many cases, partners agree to contribute a fixed amount of
capital that cannot be changed except by agreement of all the
partners. Where this is the case. separate accounts called current
accounts are maintained to record day-to-day changes in lhe
partners' investment In the partnership. Alternatively, in some
partnerships all these records are kept In what are called fluctuating
capital accounts.
Entries to record the capital introduced by partners
When a partnership is established the follo\ving entries will be
required to record the capital introouced by each partner:
LEDGER ACCOUNTS POSTINGS
General Ledger
DEBIT the accounts of asse:s other than cash/bank
contributed by eacn partner.
CREDIT ihe capital aocoum of eaon partner 1,.i1h the total
of their capital contribution.
Capital accounts are often set out in columnar format
because this is less time consuming.
" ILLUSTRATION 1 Columnar format for capital accounts
Ryan and Sonya agreed lo form a partnership on 1 January
2018. Ryan contributed capital of $50 000 in cash and Sonya
contributed S60 ooo ln cash. Here are the partners' capital
accounts in columnar formal.
GENERAL LEDGER
Dr Capital accounts Cr
Ryan Sonya Ryan Sonya
$ $ 2018 s s
Jan 1 Bank 50000 60000
,I
The partnership appropriation account
A partnership's financial statemen!s will include an appropriation
account to show how profits (or losses) have been shared In
accordance with the partnership agreement.
"ILLUSTRATION 2 Preparing an appropriation account

Notes:
Ryan and Sonya 1. Ryan and Sonya share profits
Appropriation account for the year ended 31 December 2018 and losses equally after
$ $ allowing 10% per annum
Profit for the year 48000 interest on capitals and a
Less interest on capitals salary of $ 11 000 per annum
Ryan 5000 for Ryan.
Sonya 6000
(11 000)
2. Entries would be made in the
general journal to transfer the
37 000
profit lo the income statement
Less sa'ary (Ryan) p1 000) and to transfer information to
26000
the partners' current accounts.
Shares of residual profits
Rya'l 13 000
Sonya 13000
26000

Partners' current accounts ..

'Nhen partners' maintain fixed capital accounts, other transactions
affecting the partners are recording In current accounts, for example: 1. What in'ormation would
you expect to see recorded
• drawings (transferred from separate drawings accoun ts on the debit side of a
maintained for each partner during a financial year) partner's current account?
• shares ot profit (Including interest on capital, salaries, residual 2. What does a debit
pro'it shares) balance on a partner's
• shares of losses. current account mean?

/
ILLUSTRATION 3 Preparing partners' current accounts

IDr
GENERAL LEDGER
Current accounts Cr
I
Ryan Sonya ' Ryan Sonya
2018 $ $ 2018 $ $
Dec 31 Drawings 27000 28000 Jan 1 Balances bi d 3 700 6200
31 Balance c/d 5 700 Dec 31 Interest on capltal 5000 6000
31 Salary 11 000
Share of residual
31 profit 13000 13 000
31 Balance c/d 2800
32 700 28000 I 32 700 28000
Jan 1 Balance b/d 2 800 ' Jan 1 Balance b/d 5 700
 More about partnerships

LEARNING OUTCOMES
In this unit you will learn more
about sharing profits and
losses, in particular:
• interest on drawings and
how this Is recorded
• what action to take If
partners cannot agree, on
how to share profits and
losses.
Interest on drawings
Some proilt-sharing agreements Include a penalty, In the form of an
interest charge, for each partner, based on the amount of orawings
taken out during a year. Interest on drawings helps deter a partner
from making excessive drawings, which would adversely affect the
liquidity of the business.
The entries for interest on drawings are:
Debit the current account of each partner (this reduces the amount
ovved to the partner by the partnership).
Credit the appropriation account (i.e. increase the amount of profit
that can be distributed to the partners).
To calculate Interest on orawings, it is necessary to take account of:
• the Interest rate, vvhich is usually expresseo as x% per annum
• the period of time for which the partnership has been deprived of
the funds.

,.,ILLUSTRATION 1 Calculating and recording Interest on drawings

Louis and Monique are in partnership, sharing Recording Interest on drawings

profits and losses equally. Their partnership
agreement provides for interest to be charged Appropriation account for the year ended
on drawings at 10% per annum. During the 31 December 2018
year ended 31 December 2018. Louis withdrew $ $
$15 000 on 1 May and Monique wit hdrew Profit for the year 60000
$18 000 on 1 September. In the same year, Add imerest on dra,,v.ngs
the partnership made a profit of $60 000. Louis 1 000
Calculation of interest on drawings Moniq~e 600
1 600
10% X $15 000 X 8/12 61 600
Louis (i.e. for the 8 months = S 1 000 Snares of residual profits
1 May to 31 December) Louis 30800
10% X $18 000 X 4/12 Monique 30800
(i.e. for the 4 months 61 600
Monique = $600
1 September to
31 December)

(Continued)
" ILLUSTRATION 1 Calculating and recording Interest on drawings (Continued)

GENERAL LEDGER
Dr Current accounts Cr
Louise Monique Louise Monique
s $ $ $
Dec 31 Drawings 15 000 18 000 Dec 31 s·nares of residual 30800 30800
profits
31 lnteres! on
drawings 1 000 600
31 Balances c/d 14 800 12 200
30800 30800 30800 30800
Jan 1 Balances b/d 14 800 12 200

Notes:
1. Without the penalty oi interest on drawings, these partners would have shared the prom equally:
$30 ooo each.
2. With the interest on drawings the net effect for the partners Is that Louis receives 829 800 and
Monique $30 200, i.e. the total profit of $60 000 is allocated slightly to Monique's aovantage because
her drawings deprived the business of resources for a much shorter time than Louis's drawings.

Sharing profits and losses where there is

no agreement EXAMTIP
Where there is no written agreement and partners are in dispute
about how to share profits, tt Is necessary to apply the terms of the rti.s " co""'-"'M>"'- l¾ist&i ke
Partnership Act of 1890 as follows: to Yeco,a iw:eyest 0 "" "
part"'-tY·s Lo&i"" i,.,, Hie
• profits and tosses rue to be shared equally between partners "'f''f'YO-pn.atlo"" ciceouw:
• there will be no provision for a partnership salary. interest on their (it sl-iouloi appe&1 y as "'""
capitals or interest on drawings. expe.,,s;e i."" ti-le i.,,c0 " " '
The Act also provides that a partner viho has made a loan to a stcite1M.e.,,t). A""ot'1ev
partnership should receive interest of 5% per annum where there is COl¾l¾0111, l¾LSt&I Ju

no agreement to the contrary. is to foy9et to credit

Cl p&lrtl'\.ty's CUYYew:
Interest on a partner's loan should be charged as an expense to the
income statement and credited to the partner's current account. ~ccou""t wltn "'""l:1
Ll'\.tevest o"' ci lo&1.,,

SUMMARY QUESTIONS

1. What is the double entry for lnlerest on drawings?

2. Calculate the Interest on drawings that should be charged at
31 December in a year ,..,hen a partner withdrew $20 000 on
1 May. Assume the Interest rate Is 12% per annum.
3. What are the key provisio ns of the Partnership Act tha1apply
when partners cannot agree about sharing profits or losses?
 Partnership statements
of financial position

LEARNING OUTCOMES
In this unit yov will learn about:
• how to prepare a partnership
statement of ' lnanclal
position showing the details
of the partners' current
accounts
• how to prepare a partnership
statement of 'inancial
position vvhere summarised
lntormation is given about the
partners' current accounts.
Preparing a partnership statement
of f inancial position
tn many 'Nays a partnership's statement of financial position will
closely resemble that of a sole trader. However, the capital section
will be different, because it will need to reflect the fact that there
is more than one owner, and that, in many cases, the owners'
investment is divided into two different aspects: fixed capital
accounts and current account balances.
There are two ways of setting out the capital section:
• Detailed capital section: showing the capital account balances
at the year end and all the detailed Information recorded In each
partner's current account
• Summarised capital section: showing only the final balances on
each partner's capital and current accounts.

ILLUSTRATION 1 Preparing a partnership statement of financial position

This Illustration shows the two First, here Is the statement of financial posttion \ivith a detailed capital
ways of preparing a partnership section:
slatemenl of financial position.
For convenience, only subtotals
Tamara and Urban
are shown for non-current
Statement of financial position at 31 December 2018
assets, current assets and
current liabilities. $ $ $
NON-CURRENT ASSETS 420000
CURRENT ASSETS 32600
Less CURRENT LIABILITIES (14 600)
Working capital/Net current assets 18 000
Capital employed 438 000
Less NON-CURRENT LIABILITY
Loan from Urban (10 000)
428 000
CAPITAL ACCOUNTS Tamara Urban
220 000 190 000 410 000
CURRENT ACCOUNTS Tamara Urban
Opening balances 3400 4 000
Interest on capital 22 000 19000
Share of residual profits 14 000 14 000
39 400 37000
Less: interest on drawings (800) (1 000)
drawings (17 400) (39 200)
21 200 {3 200) 18000
428000

(Continued)
" ILLUSTRATION 1 Preparing a partnership statement of financial position (Continueo)

Here is an extract from the s~atement of financial position With a summa,ised capital section:
N otes:
Tamara and Urban 1. The more detaJled capital section
Statement of financial position at 31 December 2018 provides more information for
(extract: capital section only) anyone using this financial
CAPITAL ACOOUNTS Tamara Utban statement.
$ $ $
220 000 190 000 41 0 000 2. The summarised version o• the
capltal section takes less time
CURRENT ACCOUNTS Tamara Urban to prepare, but It Is necessary to
21 200 (3 200) 18000 have access to the detailed current
428 000 accounts In o,der to quote the final
balances.

The following ratio should be used to calculate the return on capital

employed: EXAM TIP
Profit for the year
--------------''-------- X 100 rt L-S i""'-pol't.i ""t to
Total of partners' capital and current account balances keep tlie fi.gunis fo y
The partners' capital and current account balances could be those at tlie e.ipit.il .iecou~s
the beginning or end of the year, or an average of these figures. """°' C<.<YYe"'-t Clecou~s
quite sep.iy.ite Cl
0 .,._,
'ILLUSTRATION 2 Calculating the return on capital employed pci >t""eYS '1 ip st.iteV1<.e~
~f fi.""~=•cil pos,tio...., cis
In the case of the partnership of Tamara and Urban, their return """ tlie •Lt=tYcitio"-.
on capital employed for the year ended 31 December 2018 Is
calculated below. The information In the statement of tinanclal
position shown in Illustration 1 has been used.
The profit for the year was $67 200 (found by adding together
Interest on capital, shares of residual profits and deducting the
Interest on drawings).
In this example the opening balances of the capital and current
accounts have been used.
These are: capital $41o ooo (capital accounts) + $7 400 (current SUMMARY QUESTIONS
accounts), I.e. $417 400
1. How does a partnership's
The calculation is: statement of financial
Profit for the year position differ from that of a
= X 100
Total of partners' capital and current account balances sole trader?
$67 200 2. How should the return
= -----xlOO on capital employed be
$417 400
calculated In 1he case of a
= 16.09% partnership?

131·
Worked example:
partnerships

The question
Stephen and Tricia are in partnership sharing profits and losses
equally. On 31 December 2018 the follo\lvlng trial balance was
extracted from the books of accounts of the business after the
income statement for the year ended on that date had been
prepared.

Dr Cr
$ $
Bank overdraft 1 290
Capital
Stephen 200000
Tricia 150000
Current accounts at 1 January 2018
Stephen 820
Tricia 2300
Drawings
Stephen 36000
Tricia 30000
Insurance prepaid '140
Inventory at 31 December 2018 30610
Loan from Tricia (repayable 2027) 20000
Non-current assets
Cost 648 000
Provision for depreciation al 297 000
31 December 2018
Profi1 for the year 64 440
Trade payables 19 800
Trade receivables 9590
Wages accrued 630
755 '160 755 460

Additional Information at 31 December 2018:

1. The partners have realised that no entries have been made for
interest on Tricia's loan. Tricia is entitled to receive a full year's
Interest on her loan at 10% per annum.
2. The partners have agreed to the following arrangements for
sharing profits and losses:
• Interest is to be allowed on capital at 10% per annum.
• Interest is to be charged on drawings at 12% per annum.
Stephen's drawings were all taken on 1 April 2018; Tricia's
drawings were all taken on 1 June 2018.
• Residual profits v<1ill be shared equally.
Prepare:
• an appropriation account for the year ended 31 December 2018
• the partners' current accourits for the year ended 31 December
2018 .

The answer
Appropriation account
Before preparing the appropriation account it is necessary to alter the
draft profit for the year oi $64 '140 because Tricia's loan Interest was
overlooked. Tricia should receive interest of $2 000 (10% of the loan
$20 000). This reduces the profit for the year to $62 440. A partner's
loan Interest is credited to that partner's current account.

Stephen and Tricia

Appropriation account for the year ended 31 December 2018
$ s
Profi1 for the year (amended see note above) 62 1140
Add Interest o n drawings
Stephen (12% x S36 000 x 9/12 months) 3 240
Tricia (12% x $30 000 x 7/1 2 months) 2 100
5340
67 780
Less interest on capital
Stephen (10% x $200 000) 20000
Tricia (10% x $150 000) 15 000
(35 000)
32 780
Shares of residual profit
Stephen 16 390
Tricia 16 390
32 780

Partners' current accounts

Dr Current accounts Cr
Stephen Tricia Stephen Tricia
s $ s $
Jan 1 Balance bid 820 Jan 1 Balance bid 2300
Dec 31 Drawings 36000 30000 Dec 31 Interest on capital 20000 15000
31 Interest on drawings 3240 2 100 31 Snare of residual profits 16390 16390
31 Balancec/d 3590 31 Loan interest 2000
31 Balancec/d 3670
40060 35690 110060 35 690
Jan 1 Balance bid 3 670 Jan 1 Balance bid 3590
 Practice exam questions

Paper1
1 Which Of the following sn0vld not be entered In 5 Ravi and Suzette are l'l partnership and :his year
,m appropriation account? made a profit of Sa5 000. They soare profi'.s
A drawings and losses equally aiter charging Interest on
drawings. Tnis year interest on drawings was
B interest on capital
Ravi $1 000 and Suzette $2 000. Ravi's net
C Interest on drawings share of profits Is:
D partners' salaries A $20 000 B S22 000
2 Nerissa ,md Ortando are in partnership sharing C $24000 D $25000
profits and losses In tne ratio 2:1. This year rne
6 Wesley's cvrrent accoun: includes tne follovvlng
pannership made a loss o' $60 000. Which entry
entries: opening debit balance $1 000, drawings
should be made in Nerissa's current account?
$12 000, interest on drawings $3 000, residual
A credn $20 000 B credr: $.40 000 profit S15000. Theclosirg balance on his
C debit $20 000 D debit $40 000 current account is:
3 Bill arn:I Csirmen are In partnership soaring profits Acredit $7 000 B credit S1 000
and losses equally. Bill is entitled to a partnership C debit $1 000 D debit $7 000
salary of S20 000. This year tt,e partr ership
made a profit of $70 000. Bill's total share of
profits is:
A $25000 B $35000
C $45000 D $55000
4 Listra and Micah are in partnership wltn capitals
of $200 000 end $100 000 respec:tlvely. The
par'.ners share profits and losses equally and
are receMng Interest on capital of 10% per
annum, This year 1he partnership made a prof'rt
of $80 000, Listra's total share of the profit is:
A $35 COO B $40 000
C $45000 D SSOOOO

Paper2
1 Preparing the accounts of partners
$
Natasha and Oliver are In partners,.,ip wnh fixed Current accounts at 1 January 2018
capital of $160 000 (Natasha) and $120 000
(Olive~. The following informal!on is available for Natasha 4 400
tile year ended 31 December 2018: 0 ,lver 900
Drawings
Natasha 25 700
0 Iver 19 600
Profit tor the year 72 300
 The partnership agreement includes the Current accounls at
following terms: 1 January 2018
• Partners are to share profits in the ratio Na1asha
3/~. Oliver ~IG.
s 400
T 2500
• ln1erest is to be allowed on caprtals at 10% per Drawngs
annum. s 14300
T 17 100
• Oliver is to ,eceive a partnership salary of Gross Income 12& 600
$14 000. Inventory,
a Prepare: 31 December 2018 14500
• an appropria1ion accoum for the year ended Non-current assets
31 December 2018 Cost 360000
Prov sion for
• the capital accounts of the partners depreciation at
• 1he curren1 accounts of the partners. 1 January 2018 144 000
Operating expenses 32900
b Describe two advantages of forming a Trade payab'es 7 4 00
partnership rather than operating as a sole Trade receivables 11100
trader. 458500 458500
c Explain the meaning of a credit balance on a
partner's curren1 account. Additional in'orma11on:
2 Sharing profits and losses where partners • Operating expenses $700 were prepaid at
are in dispute 31 December 2018.
E and F are in partnership but 1hey have no • Non-curren1 assets should be deprecia'.ed
agreement about the sharing of profits and losses by 20% per annum using the straighl-line
F ten: toe partnership S24 000 on 1 January 2018. melhod.

During the year ended 31 December 2018 the
partnership made a profit before charging any
interes1on F's loan of $142 000. The partners
cannot agree on interest to be charged on F's
loan or how to share tne profit for the year.
a Calculate 1'1e profit to be given 10 E 'or 1ne
year ended 31 December 2018.
b Give a brief explana1ion as regards your
proflt-sharir,g ratio for E.
3 Preparing end of year financial statements
from a trial balance
The following trial balance was ex1rac1ed from
the accoun1s of Sand Tat 31 December 2018.
Dr Cr
s $
Capital
s 100000
T 80000
Cash at bank 8200
• The partners have agreed the following:
• inlerest to be allowed on capital at 10% per
annum
• T to receive a partnership salary of $8 000
per annum
• inlerest on drawings to be charged as
follows: S $600, T $900
• pR:>fits and losses 10 be shared equally.
Prepare:
a an lncome statemenl for the year ended
31 December 2018 staning wtth the gross
Income
b 1he appropriation account for tre year
ended 31 December 2018
c lhe partners' currem accounts, balanced at
31 December 2018
d 1he statemem of 'inancial position at
31 December 2018 (showing summarised
Information aboU11he partners' capttal and
current accounts).
 •
Introduction
LEARNING OUTCOMES
In this unit you will learn about:
• the essential features of
llmiteo liability companies
• the advantages and
disadvantages of limited
liability companies
• the essential features of
co-operatives
• the essential features of
ncn-proftt organisations.
KEY TERMS
Shareholders: the owners of
the stlare capital of a limited
company, sometimes called
'members'.
Essential features of limited liability companies
A limited company is a form of business organisation whose capi1al is
divided into units calleo shares. Those \/\/hOinvest in a company own
shares and are referred to as shareholders.
The most Important feature of ownership in a limited company is that
each shareholder's responsibility for the debts of the organisation
is limited to the amount they have invested in the company. This
means that, should the organisation run into serious difficulties and
face closure, shareholders cannot be asked to make any further
contributions so that the company can pay its debts. This is in
contrast to a sole trader or a partner who would have to use private
funds if their businesses were to face this sttuation.
The correct term for this special privilege enjoyed by shareholders is
'limited liability', hence the term limited liability company. Individuals
are tar more likely to be inclined to Invest il'I a compMy as a result
of limited liability, because there is a clear limit to the risk they are
taking. As a result, companies can be very large organisations wtth
many shareholders. almost all of whom do not play any part in the
day-to-day running of the organisation. The shareholders elect
directors to manage the running of the company.
Limited liability companies are also known as corporations.
Advantages and disadvantages of limited
liability companies
As well as the advantage of limited liability, companies can:
• raise large amounts of finance because there is the potential to
have many shareholders
• call upon the expertise of a wider group of Individuals to help
manage and develop the company
• continue to operate, despite changes In the indivlduals who own
shares.
Since shares in a company are freely transferable, subject to certain
conditions, no shareholder is permanently or necessarily wedded
to a company. Therefore, the shareholders of a company may keep
on changing from time to time, but that does not affect life of the
company. Neither does the Insolvency or death of a member affect
the existence of the company itsett.
However, companies are:
DID YOU KNOW?
• subject to many legal reouirements (for example, they are required
to follow strict procedures when they are set up, and they must The main features of
follow detailed and ccmplex rules when preparing their annual co-operaHve societies are
accounts tor publication) as follows :

• subject to changes in control, if, for example, an lnoividual or • they are formed for the
a particular group of shareholders acquires sufficient shares to benefit of their members and
control more than 50% of the voting rights. local communities
• they provide goods and
Principles of co-operative societies services
• making a profit is not their
Co-operative societies are based on some important principles: main priority
Open membership: membership is open to anyone regaroless of • they are owneo by their
their social, political, religious or racial background. members who each buy a
Democratic control : each member has an equal say in the running share in the business
of a co-operative society, because each member has Just one vote, • members are both the
irrespective of the number of shares held. owners ano the customers
Limited return on share capital: the key objective Is always • they are subject to various
to provide a service for members, so dividends as a reward for regulations and laws
membership are likely to be small (ano in some years non-existent). • their financial statements
comply with accounting
Patronage refund: all surpluses {profits) made by a co-operative principles and concepts.
belong to the members. but it is a legal requirement that 20%
of any surpluses are set aside in a statutory reserve fund.
Remaining surpluses can be used for the further development of the
co-operative, and can be distributed to members. The distribution
to members Is based on the amount of custom they have provided
(I.e. the extent to which they have patronised the co-operative) rather
than the number of shares owned.
Continuous education: co-operative societies have a duty to
provide continuous education tor their members to ensure that
they are in a position to participate effectively In the control and
management of their society. Co-operative societies are required to SUMMARY QUESTIONS
transfer a percentage of their surplus to an education fund for the
financing of educational provision. 1. Explain what is meant by
Co -operation among co- operatives: co-operative societies are the term 'limited flablllty'.
expected to work together locally, nationally and Internationally, to 2. Descrlbe two benefits of
share ideas and experience for the mutual benefit of all. forming a limited !!ability
company,
Non-profit organisations 3. Explain how one Individual
• Non-profit organisations exist for the benefit of their members or could control a llmlteo
for society in general. !!ability company.

• Unlike businesses. they are not formed vvith the aim of making a 4. Identify three important
pro'it. principles on wh1ch co-
operatives are based.
• They are often funded through membership subscriptions,
charitable donations and grants, and they may also trade. 5. Identify three ways in which
a sports club could be
• They are usually run by some of the members. who form a financed.
committee that includes a Chair, Treasurer and Secretary.

LEARNING OUTCOMES
In this unit yov will learn about:
• the types of limited company,
co-operative and non-profit
organisation.
Although shareholders are the
owners of a limited company,
most of them will no1 lake part
in the day-to-day running of the
company. Instead, shareholoers
appoint directors to manage the
company. Tl1e directors report
to the shareholders at the
annual general meeting (AGM).
The shareholders also use the
AGM 10 appoint olrectors if they
so desire.
In some countries, for example
the USA. the abbreviation
'Inc' is used Instead of pie. nc
means Incorporated.
Types of limited liability
company, co-operative and
non-profit organisation
Private limited companies
• A private limited company is one where the ownership of shares
is restricted to members of a family, their friends and possibly
employees.
• They are generally small organisations with few shareholders.
• Members of the general public cannot invest in a private limited
company.
• Shares in a private limited company are bought and sold priva1ely
and only with the consent of all the existing shareholders.
• A private limited company could have Just one shareholder.
• The abbreviation 'Ltd' appears In the title of a private limited
company.
Public limited companies
• A public limited company is one in which the general public can
Invest.
• Shares In a public limited company are traded on stock exchanges.
• They are large organisations with hundreds or even thousands of
shareholders.
• The abbreviation 'pie' appears In the title of a public limited
company.
Co-operatives
I
ILLUSTRATION 1 Types of co-operative
Here are some examples of co-operative societies:
The Openport Fishing Co-operative was formed in 2007
by a group of fishermen who share the use of equipment
purchased by the co-operative. The funds raised by the purchase
of shares by the members have been used to buy some
specialist equipment that is hired out to individual members. The
equipment would have been beyond the means of Individual
members.
The Wide Horizon Retail Co-operative is a co-operative
society formed by a group of villagers to buy groceries in
bulk from suppliers and sell products at favourable prices to
members. ,
(Continued)
,, ILLUSTRATION 1 Types of co-operative (Continued)

The Outoftown Transport Co-operative was formed by a

group of individuals who live in the more remote areas on one of
the Caribbean islands, but who all work in the largest town on
the island. The co-operative has purchased two minibuses that
are used to take members to and from work each day.
The North Island Credit Union provides members with
opportunities to save regularly and to borrow at low interest
rates. The co-operative provides members wtth guidance and
support In making personal financial decisions as part of its
continuous education programme.
Note: co-operative societies also exist in other spheres
such as manufacturing, the provision of housing, marl<etlng,
entertainment, etc.

Non-profit organisations
The main aim of many non-profit organisations is to provide facilities
for their members to use and enjoy. In the case of clubs and societies
these facilities are acquired to provide social, sporting, recreational or
leisure activities. Examples Include gott, yachting, football and netball
clubs. In other cases, the organisation will have been established to
provide some form of charity tor those in need, or to benefit society
In general, for example the Rotary and Lions clubs.
DID YOU KNOW?

SUMMARY QUESTIONS Larger co-operatives are likely

to need to call upon a wider
1. What are the main differences between private limiteo range of expertise and skills,
companies and public llmtted companies? and so 1hey tend to employ
professional staff to manage the
2. Identify five different types of co-operative based on the type
organisations. The wages and
of activity, traoe or service they cover.
salaries of all employees are
3. In what areas/activities 'NOuld you expect to find non-profit treated as an expense in the
organisations? financial statements.

LEARNING OUTCOMES
In this unit you will learn about:
• the various methods of
raising capital available to
limlteo liability companies
and co-operatives
• the various types o' share
and the rights of the owners
of each type of share
• debentures.
KEY TERMS
Authorised share capital:
:he maximum amount of share
capital thal a llmltecl company
may Issue.
Issued share capital : the
amount of share capital that
has actually been issueo by a
limited company.
Dividend; the reward paid to
shareholders out of the pro'its
of a limited company.
Directors: inoividuals who are
appo1nteo by shareholders to
manage the company on their
behal'.
AGM (annual general
meeting): a yearly meeting of
shareholders where directors
report on the performance of
the company.
How capital is raised by
limited liability companies
and co-operatives
The capital of a limited company
When a limited company is formed a decision has to be made as
to the maximum amount of capital that can be raised. This amount
is known as the authorised share capital. It is not necessary to
actually raise this amount immeoialely because inilially the company
will nol require resources of lhat value. A company can. at any lime,
issue new shares up to the full amount oi authorised share capital.
The tolal of a company's shares that are halo by shareholders Is
called Issued share capital. The capital of a company is divided
into shares. Shares can be of two types.
Ordinary shares
All companies have ordinary shares, which are also called equity
shares.
• Ordinary shares have a face value or nominal value. Many ordinary
shares have a nominal value of S1 , but it is possible for shares to
have a face value of say 50c, $2, etc.
• The ovvner of an ordinary share would expect to be rewarded for
Investing in the company by receiving an annual payment called a
dividend. The amount of !he annual dividend will depend partly on
how much profit the company makes and partly on how much the
directors feel the company can afford to pay.
• Ordinary shares have voting rights, which can be used at the
AGM (annual general meeting). tor example in the appointment
of directors.
Preferenc-e shares
Some companies also issue preference shares.
• Preference shares also have a nominal value (for example $ 1) and
preference shareholders also expect to receive a dividend.
• However, the amount of dividend that can be paid to a preference
shareholder is a fixed percentage of the amount Invested.
Preference shareholders are entitled to receive their fixed divideno
as long as the company has made a profit.
• Preference shareholders are allocated their oivldend before the
allocation of a dividend to ordinary shareholders. and woulo have
their investment returned before ordinary shareholders should the
company be wound up - hence the term 'preference· share.
• However, pre'erence shareholders do not normally have any
voting rights.
The capital of a co-operative
EXAM TIP
When a co-operative is formed the capital is provided by members
who purchase shares in the organisation.
A COl¾l¾O"'- ""'-t..StQ)u is
Co-operatives may also have access to other sources of finance to tl-li.v.k?. ti'lt1t olebe.,,tuyes
such as government grants. t!Ye pa•t of tl-ie ct1pitaL
vof tv.e co""'-pt!v.l::J
Debentures t1lo"'-g witl'l t i'l e s i'lt1Yes.
t>ebev.tuYes t!Ye "'-Dt
A debenture is one of the most common forms of long-term loan
that a company can take. It is a loan that should be repaid on a pt!':' of ti'le COl¾j)tl"'-1::J'S
specttic date. The oebenture certificate issued by a company is an ct1p•tt1l; tl-iel::J aye
acknowledgment that the company has borrowed an amount of Ytgt1Yoieol as t1 "'-D"'--
money which it promises to repay at a future date. Debenture holders c1<.n·e""t Lit1 bititl::J.
are, therefore, creditors of the company. Debentures have a fixed rate
of interest, and this amount of interest Is payable yearly or half-yearly.
Debenture Interest is charged to the income statement.

.., - . - ~- - .' .-
· SUMMARY
- . QUESTIONS
- - EXAM TIP
1. What Is meant by the term authorised capital?
It i.s "'-Ot "'-"'-COl¾l¾O"'-
2, Identify two differences between preference shares and for tYYOYS to OCCl,f,y
oroinary shares. ~ne"': wYitiv.g fi.guyes
3 . A company has Issued 400 000 6% preference shares of S1 •v. l¾•LLio.,,s. A wnole
each and 1,6 million ordinary shares of soc each. How much . of, l¾ilti.0.,,s
"""'-""'-ber
cash shoulo this share issue raise? requ~res six v.ou.ciliits
4. Explain two ways In v,h,ch debentures differ from ordinary foY ei<t11¾pLe, s ""'-ZLtiov.
shares. •s 5 ooo ooo. It follows
tl1t1t, St!l::J, 3 .G l¾illiov.
wo1<.Lol t1ppea1• t1s
3 GOO 000, etc.

LEARNING OUTCOMES
In this unit you will learn about:
• recording the issue of shares
and debentures In the
general Journal
• the calculation o' share
olvldends.
KEY TERM
Share premium: the difference
between the nominal value of
shares ano the price at which
they are issued.
Journal entries for the
issue of shares and
debentures; dividend
calculations
Recording the issue of shares
~Vhen a company Issues shares. the amount of money received will
depend upon the following factors:
• the number of shares issued
• the face value of the shares (sometimes called the 'nominal' or
·par' value}
• whether the company is able to issue the shares at a value above
the face value.
If the company issues the shares for a price above the face value,
the additional amount received is called the share premium. In the
accounting records, It is essential to keep a separate record of the
face value of shares and the share premium.
,,ILLUSTRATION 1 Journal entries for the issue of shares
On 1 January 2019 a company issued 500 000 ordinary shares
with a face value of $ 1 each and 100 000 6% preference shares
of $1 each, The ordinary shares were Issued at a market price of
$1.50 per share.
The amounts that will be received from this share Issue are as
follows:
Ordinary shares: a total of $750 ooo made up of $500 000
(face value, i.e. 500 000 x $1} and $250 000 (share premium,
Le. 500 ooo x S0.50)
Preference shares: S100 000.
The Journal entries to record the Issue are:
GENERAL JOURNAL
Date Details Dr Cr
2019 $ $
Jan 1 Bank 850000
Ordinary share capital
(500 QQQ X $1) 500 000
Preference share capital
(100 000 x S1) 100 000
Share premium
{500 000 x SO.SO) 250 000
Issue of ordinary shares at a
premium and preference shares
at face value
,
 ILLUSTRATIO N 2 Issuing oebentures

A company Issued $140 000 of 7% debentures {2028) on

1 March 2019.
The journal entry required to record 1he Issue is as follows:

GENERAL JOURNAL
Date Deta/1s Dr Cr
2019 s $
March 1 Bank 140000
7% Debentures (2028) 140 000
Issue of 7% detentures

Note: {2028) in the title of this non-current liability is a reference

to the year In which the debentures must be repaid.

Calculating dividends SUMMARY QUESTIONS

Where there are distributable profits, directors must pay preference 1. A company issued 400 000
shareholders their fixed dividend; they then have to decide the ordinary shares of $1 each
amount of dividend to be paid to ordinary shareholders. Their at S1.50 per share. The
decision will be Influenced by: share issue was successful
• the desire to reward the owners of the company and all the icimo1.1nts 01.1e
were received. State the
• the amount of profit available for dividend double entry required to
• the amount of liquid funds the company will have available •,vhen record the share issue.
the time comes to pay the dividend 2. A company issued $300 000
• alternative priorities for expendtture, 1or example replacing or of 7% debentures (2025).
improving non-current assets. a. State the double entry
required to record the
.,..ILLUSTRATIO N 31Calculating dividends debenture issue.
Company A has 200 000 8% preference sliares 01 $1 each. b. State what Is meant by
2025 In lhe title of the
The preference share dividend will amount to 8% of debentures.
(20QQQQ X $1), i.e. 8% X $2QQ0Q0 : $160QQ
3 . The directors of a company
Company B has 400 000 ordinary shares of $1 each and the have proposed the
directors have announced a 25% dividend. payment of a preference
The ordinary share dividend •Nill amount to 25% of share oividend and a 20%
(400 ooo x $1), Le. 25% x $400 ooo = s 100 ooo ordinary share dividend.
The company has 400 000
Company C has 1 000 000 ordinary shares of 50c each and the 8% S1 pre:erence shares
directors 1,ave announced a 15% divldeno. and 900 000 $1 ordinary
The ordinary share dividend •NIii amount to 15% of shares. What is the total of
(1 ooo ooo x soc), i.e. 15% x S500 ooo = $75 000 the proposed dividends?

LEARNING OUTCOMES
In this unit you will learn about:
• the appropriation of profit
between dividends and
reserves
• the financial accounts of
llmlteo liability companies.
KEY TERMS
Proposed dividends: the
amount of oivideno suggested
to shareholders by the board
of directors (BOD} 'or approval
at the annual general meeting
(AGM).
General reserve: the retained
earnings or a company that are
set aside out of the company's
profits to meet rut ure (known or
unknown} obligations. General
reserves are unlikely to be used
to finance divioends.
The appropriation account;
the limited company's
income statement
The appropriation account
The financial statements of a limtted company Include an
appropriation account that shows the decisions made by the
directors about the profits of the company. The account includes:
• the profit (or loss) for the year, transferred from the income
statement
• any profits mace in the past that were not distributed (sometimes
called the opening balance or 'retained profits brought forward')
• proposed dividends
• the transfer of some of the profits to a g eneral reserve or any
other reserve
• the closing balance of profits that have not been distributed
{sometimes called 'retained profits carried forward').
,, ILLUSTRATION 1 Preparing an appropriation account
Here Is a company's appropriation account.
Appropriation account for the year ended
30 September 2019
$ $
Profit for the year 205 000
Less: transfer to general reserve 44 000
Proposed dividends:
Preference shares (7% x $100 000) 7000
Ordinary shares (15% x $800 000) 120 000
{171 000)
Relained proftt for the year 34 000
Add: retained profrts brought 'orward 57 000
Retained profits to carry forward 91 000
,
The income statement
A limited company's Income statement will include all the usual
information. but may also record the following items:
Directors' remuneration: this is the expression used to cover
payments made to directors, such as salaries and fees; the item is an
expense to the company.
Debenture interest: this is an expense, and the appropriate amount
should be shown in the income statement in accordance with the
accruals concept - in other words any debenture interest due should
be included and should also be shown as a current liability in the
KEY TERM
statement of financial position (balance sheet}.
Auditors' rem uneration: all but the smallest limited companies are Auditors: tliose responsible
required to have their accounts audited; the amounts paid to the for auditing the accounts 01
auditors are an expense to the company. a business. Auoiting is an
Independent check o' the
Preparing a limited company's Income accounting information used to
ILLUSTRATION 2 prepare a financial statement.
statement
Auditors are appointed by the
Here is an example of a limited company's Income statement shareholders o1 the company.
that includes the three categ cries of expense described on the
previous page.
Note: limited company 1inanciaJ statements often show 1igures ln
thousands or even millions of dollars; where this is the case the EXAM TIP
money columns should be clearly headed $000 or Sm.
~ COl¾l¾O"'- Yl<-~tt:lk,e
cs to si1ow olebe""1:uve
Income statement for the year ended 30 June 2019
i"'-terest '"" ti1e
sooo $000
appropriati.o"" ciccot.tV\.t.
Revenue 1 972 t>ebe"'-t«ve i""tevest ~
Less cost of sales: ve0avole~ ~s a"" ex-peV\.Se
Opening inventory 72 a""ol so ct l-S s i1owv. t.V\.
Purchases 996 ti1e •=ol¾e statel¾eY\.t.
1068
Closing inven1ory (88)
Cost of sales (980)
Gross proftt 992
Auditors' remuneration 38
Administration expenses 69
Debenture interest 50
Depreciation o1 non-current assets 115
Directors' remuneration 162
Distribution costs 39
Wages and salaries 256
(729)
Profit for 1he year 263

SUMMARY QUESTIONS
1. What Is the purpose of an appropriation account tor a limited
liability company?
2. identify two ways in which the income statement of a limited
liability company could difi'er trom that of a sole tracer or
partnership.
3. ~Vhat Is meant by the term 'auditors· remuneration'?
4. Why is debenture Interest included in the income statement
rather than the appropriation account?

LEARNING OUTCOMES
In this unit you will learn how to:
• prepare a limited company's
statement of financial
position (balance, shoot)
• analyse performance and
position using ratios for a
limited company.
Company statements
of financial position
(balance sheets}
The statement of 1inancial position (balance sheet) of a limited
company is different to that of a sole trader or partnership because
its capital S1ructure is different. consisting 01 issued capital and
reserves. So the second part of the statement of financial position
(balance sheet) Is set out to show the following:
• main heading: EQUITY
• authorised capital: set ou1 as a note on the statement of financial
position {balance sheet) because the figures for au1horised capital
do not affeC1 the statement of financial position (balance shoot)
totals

I
' ILLUSTRATION 1 The statement of financial position (balance sheet) 01 a limited llablllty company
Here is a statement of financial
posttion (balance sheet) of a llmtted Statement of financial position (balance sheet) at 31 October 2019
liability company: $ $ $
Total
Notes: NON-CURRENT ASSETS Cost depreciation Net
1. A company's statement of Land and buildings 960000 48 000 912 000
financial position {balance sheet) Motor vehlc'es 58000 29000 29000
will often include the tollowlng 1018000 77000 941 000
current liabilities: debenture CURRENT ASSETS
interest due but unpaid; proposed lnvemory 84000
dividends. Accounts receivab e 22 000
Cash at bank 17 000
2. Proposed dividends are a current 123000
liability because they represent Less CURRENT LIABILITIES
amounts due to be paid to the Accounts payable 17 000
shareholders. Debenture Interest due 5000
Proposed dividends 82 000
3. Dividends are proposed by
(104 000)
the directors and voted on by
NET CURRENT ASSETS 19000
shareholders at the AGM. Capltal employed 960000
4. Debentures are a non-current NON-CURRENT LIABILITIES
liability of the company until the 10% Debemures (2024) (200 000)
year In which they are due to be 760000
repaid, when they become a EQUITY
current liability. Authorised share capital
800 000 ordinary snares ol $1 each 800000
5. It is usual to set out detailed 200 000 6% preierern;e shares of S1 each 200000
inlormation about the authorised Issued share cap.taJ
and issued share capital: number 500 000 ordinary snares o! $1 each 500000
of shares, their face value. e1c. 100 000 6% preference snares of $1 each 100000
Share premium 50000
6. The authorised capital can General reseNe 45000
alternatively be set out as a note Reta·ned profits 65000
to follow the statement of financial 760000
position {balance sheet).
• issued capital: giving details of the ordinary shares and
DID YOU KNOW?
preference shares currently issued by the company - ordinary
shares should precede preference shares A number of different versions
• reserves: starting with the share premium, If any, followed by of the ratio tor return on capital
the general reserve. It any, and finally the retained profit (i.e. the employed can be useo when
balance of the appropriation account}. analysing the statement of
financial position (balance
slieetJ of a limited company.
Analysing the performance of a limited company You are recommended to use
All the ratios covered In Section 5, Units 5.7 and 5.8. can be applied the ratio described above
to the financial statements of a limited company In order to analyse during your studies.
performance. However, it is important to note that the return on
capital employed can be found by:
_______P_ro_ffl _ fo_r_t_
he____,_
ye_a_r_ _ _ _ _ _ x
100
Capital invested (total of issued shares and reserves}

/ ILLUSTRATION 2 Calculating a company's return on

capital employed
Referring to the statement of financial position (balance sheet) In
Illustration 1 above, and assuming the company made a profit tor
the year of $121 000. the company's return on capttal employee
is as follows:

$121 000 ,
---- X 100, l,e.1 5.92%
$760000
In other words, the company made 15.92 cents of profit for every
$1 invested by the shareholders in the company.

SUMMARY QUESTIONS
1. ~Vhy is the authorised capital of a company shown as a note
on the statement of financial position (balance sheet}?
2. Explain v1hy proposed dividends should be shown as a
current liability.
3. What is the correct order to record reserves on a company's
statement of financial position (balance sheet)?
4. a. A company has lssueo capital of S800 000, share
premium S70 000 ano retained profits o• S11 O000.
What Is the ccmpany's total capital?
b. This company made a profit for the year of $-'9 000.
What is this company's return on capital employed?
 Worked example:
•
preparing company
financial statements
The question
The following balances were taken from the books of Soufriere
Packaging Ltd on 30 November 2019 after the company's gross
pro!it had been calculated:

$
10% Debentures 80000
Accounts payable 17 000
· DID YOU KNOW? ·
Accounts receivable 32000
The following Important points Administration expenses 14 000
should be noted: Auditcrs' fees 9000
• The gross profit has already Cash at bank 19 000
been calculated, so the Debenture interest 8000
Income statement will consist
of the second part only. Directors' remuneration 82000
Gross pro'tt 331 000
• The preference shares have
a face value of $5 each, not Inventory at 30 November 2019 62000
the more usual $ 1 each. lss1;ed share capltal
• Tl1e list of balances includes 400 000 ordinary shares 400000
a number of items that are 40 000 8% pre'.erence snares 200000
particularly Important In
Non-current assets
limited company financial
statements, for example: Cost 900000
10% debentures, auditors' Provision for depreciaticn 1 December 2018 90000
fees, debenture Interest, Retained profit 1 December 2018 75000
olrectors' remuneration, Share premium 50000
oetails of Issued share
capital, retained profi1 at the Selling expenses 8000
beginning of the year and Utility charges 12 000
share premium.
• There are very few The company's authorised capital consists of:
adjustments to make: utllitY
charges will be lncreaseo by • 500 000 ordinary shares of $1 each
the accrual, and non-current • 40 000 8% preference shares of $5 each
assets are 10 be depreciatea.
Additional information:
• It will be necessary to
calcu1a1e the dividends • At 30 November 2019, utility charges due but unpaid totalled $2 000.
that have been paid and • Non-current assets are to be depreciated by $90 000.
proposed.
• During tne year the directors had proposed and paid the preference
• The tasks Include the
share dividend and a divideno of 20% on ordinary shares.
expected items, but note that
only part o' the statement Prepare:
of financial position (balance a. an Income statement tor the year endeo 30 November 2019
sheet) Is required Oust the
starting with the figure for gross profit
capital and reserves section).
b. an appropriation account for the year ended 30 November 2019
c. an extract from the statement of financial position (balance sheet}
at 30 November 2019 to show only the capital and reserves of
the company.

Getting started
As always it is Important to read through the question carefully and
to begin to think about how you will approach producing an answer
before rushing into the first tas~.
Selecting the right informaNon at the right moment
This question will really test your understanding of how to treat
each item in preparing a range of financial statements. You may,
therefore, find It helpful to spend a few moments marking off each
Item as to where in the answer it will be used: perhaps writing I for
income statement, A for appropriation account and S for statement
of financial position (balance sheet) extract where appropriate. Don't
forget to mark off the additional information as well.
Calculations and workings
There are relatively few calculations required in this question, but it
might be sensible to do these b eiore preparing the formal answer.
Utility charges: paid $ 12 000 l)ut ado accrual $2 000, so $14 000
should be shown In the Income statement.
Dividends
EXAM TIP
• p reference shares: the preference shareholders receive a fixed
cl!videno ot 8%, anc;t this rate of c;iiVic;teno shOl,,!lc;t be based on the C411.ou~ ?)L\ltd~
issued capital figure of $200 000, to give a dividend of $16 000
• ordinary shares: the ordinary share dividend is 20% and this . COl¾l¾O""
A , l¾iStAJu
is to l¾LSc&1lcut11te
should be based on the Issued capttal figure o' $400 000, to give a
clivicle.,,c/s, foy
dividend of S80 000.
O:&ll¾ple btJ biisi"'0
These workings should form part of your answer, so that you ti1e ctilcuLAti.0.,, 0 .,.,
demonstrate your understanding of the techniques Involved. ti1e A«ti1oYisecl c11pit&1t.
Y/lti1eY ti1&1.,, ti1e iss«ec:I
The answer ,
cC1pit&1L. R.tl¾e ...... beYti111t
The income statement clivicle.,,,cls A,e II YtWl! yc/
to si111Yenolcle,s o"" the
SOUFRIER E PACKAGING LTD
Income statement for th e year ended 30 November 2019
fAot vcit.«e of wi1&1t the):j
~11ve &1ct«ALl1::J """vested
$ s :"" th e c-o"""P"""tJ, i .e. tne
Gross profit 331 000 'Ui,w,I C-llj)LtAl.
Less: administration expenses 14000
Auditors' fees 9000
Debenture interest 8000
Directors' remuneration 82000
Depreciation 90000
Selling expenses 8000 Notes:
Utility charges 14 000 1. The formal answer should start
(225 000) with the name of the company.
Profit for the year 106 000 2. Abbreviations of any kind have
been avoided in the 11eading.
 SOUFRIERE PACKAGING LTD
Appropriation account for the year ended 30 November 2019
s $
Profit for the year 106 000
EXAM TIP Less dividends paid:
Preference shares 16000
Heaal~ Ordinary shares 80000
Whe"" 'f>YtpaYL"'-g 96000
-fiv,,civcc[aL stt1te~111,ts Relained profit for the year 10000
foy Cl ""ti bv.sLv.ess, lt Ls Add relained profits broughl foP1✓ard 75000
atwci tJS coi,,.,sideYu:I good Relained proflls to carry forward 85000
'f>Y&!cttce t o stciyt wltl.1 t"1e
v.ame of the bt.<Siv.ess
a s sviowv. heYe. ' The appropriation account
Note: the dividend calculations (here shown on the previous page
under the heading 'calculations and workings') should be Included
with the appropriation account; they are a valuable part of your
answer in an examination.
T he statement of financial position (balance sheet) extract

SOUFRIERE PACKAGING LTD

Statement of financial positton (balance sheet) (extract} at
30 November 2019
$
EQUITY
Authorised share capital
500 000 ordinary shares c f S1 eacn 500000
.10 000 8% preference shares of $5 each 200000
Issued share capital
400 000 ordinary shares cf $1 each 400000
.10 000 8% preference shares of $5 each 200000
Share premium 50000
Retained earnings 85000
735 000

N ote: It is good practice to lncluoe the word 'extract' In the litle of

an incomplete stalement such as this statement of financial position
(balance sheet).
 Final accounts
of co-operatives

The accounting records of all co-operatives follow the same

LEARNING OUTCOME
principles, concepts and procedures as any other form of business
organisation. Smaller societies are likely to have more basic In this unit you will learn about:
records kept by one of the members who has some knowledge of
bookkeeping and accounting. Larger societies will maintain a full • how to prepare the final
accounting system. accounts of a co-operative.

Income and expenditure account

This account Is similar to an income statement and is designed to
show the surplus (profit) or de'icit (loss} for the year. The Income and
expenditure may be supported by separate accounts designed to
shovv the gross profit or loss made on specific activities.

f ILLUSTRATION 1 A co-operatlve's Income and expenditure account

INideHorlzons Retail Co-operative Society was formed several years ago to provide members with good
quality fruit and vegetables a t favourable prices.
Notes:
WIDEHORIZONS RETAIL CO-OPERATIVE SOCIETY
Inc ome and expenditu re account for the year ended 1. This retail co-operative's main
31 December 2018 source of Income is from t1ading
s $
in fruit and vegetables. The
INCOME gross profit on this activity Is
Gross profit on 1rading activities shown separately in the income
{see Note 1) 81 700 statement (see Note 1}.
ln!erest received on investments 7 500 2. The co-operative also receives
Members' annual fees 18300 income in the form of Interest on
107 500 investments. Many co-operatives
EXPENDITURE use any surplus cash funds to
Administration expenses 8400 purchase Investments (an asset)
Depreciation of non-current assets 22000 on \l'thich Interest Is received
Transport costs 4 700 annually.
V~ages and salaries 19900 3. The other source of income is
(55000} from membership fees. Members
Surpl.;s fer year 52500 are required to pay an annual fee
Note 1:
to entitle them lo use the benefits
Income statement for t he year ended 31 December 2018 provlded by the co-operative.
s s
Revef'ue 186 000 4. The co-operative's expenses
Less cost of sales: are typical of any business
Opening Inventory 6200 organisation.
Purchases 105 400
11 1600
Closing inventory (7 300)
Cost of sales {104 300}
Gross profit on trading operations 81 700
 Appropriation account
This account is designed to show how the surplus for the year Is
to be oistrlbuted. It will Include entries for any honorarium paid to a
member and transfers to statutory reserves. including an education
reserve.

ILLUSTRATION 2 A co-operatlve 's appropriation account

Here is the WideHorizons

Co-operative Society's appropriation WIDEHORIZONS RETAIL CO-OPERATIVE SOCIETY
account. It includes the figure for the Appropriation account
surplus shown In Illustration 1. for the year ended 31 December 2018

N otes: $ $

1. The Co-operative is required to Surplus for the year 52500

transfer 20% of its surplus to the Less: transfer to staMory reserve 10500
statutory reserve; II must also Honoraria 4 600
transfer a specttied percentage Transfer to education reserve 5 250
{depending on which state's
Proposed dividend 9300
regulations should be applied -
here 10%) to the education fund. (29 650)
2. The honorarla are the token Undistributed surplus for the year 22850
payments made to particular Add: ur dis'.ributed surplus brought fcrvvard 48650
members who have made a
Undistributed surplus to carry forward 71 500
significant contribution to the
successful working of the
Co-operative.
3. The proposed dividend could be based on the value of shares owned by members Oust as diVldends
are calculated in the case of a limited liability company) but they could also be based on 1he amount
of business (patronage) provided by each member {i.e. the sales of fruit and vegetables). Here the
dividend has been based on 5% of sales (revenue), which was S186 ooo. As the dividend is
proposed and not yet paid, ii will be shown as a current liability on the statement offinanclal position
(balance sheet).
4. The undistributed surplus for the year Is added to any undistributed surplus from previous years. This
ttem will be shown as one of the reserves on the statement of financial position (balance sheet}.

SUMMARY QUESTIONS Statement of f inancial position

1. Explain the purpose of a co-operative
society's
a. Income and expenditure account
b. appropriation account.
2, List four items that are likely to be recorded
In a co-operative society's appropriation
account.
3. Which items make up the capita! and reserves
section of a co-operative society's statement of
financial position (balance sheet}?
(balance sheet)
A co-operative society's statement of financial
position (balance sheet} recoros assets and
liabilities In the same way as an other business
organisations. The assets could include
Investments owneo by the co-operative.
Investments should be shown unoer the heading
non-current assets (or under the heading current
assets if they are likely to be cashed in during the
next linancial period). The capital and reserves
section will show share capital, the statutory
reserve, other reserves (such as the education
reserve) and any undistributed surplus Income.
 Worked example:
co-operatives

The question
The St Martin's Village Co-operative Society runs a village store
serving the everyday needs of its members, who live in St Martin and
nearby communities.
On 31 December 2018 the foll owing trial balance was extracted from
the Society's books of account:

Dr Cr
$ $
Accoun1s payable 1 940
Administraticn costs 4530
Cash in hand and at bank 3650
Dividends paid 4000
Education fund at 1 January 2018 6200
General expenses 8 210
l~teresl received on Investments 670
Inventory at 1 January 2018 6 590
Investments in otner retail co-operatives 8 200
Membership fees 4 280
Non-wrrent assets:
Cosl 95000
Provision for depredation at 1 January 2018 19000
Purchases 33940
Revenue 80000
Secretary's honorarium 650
Share capital 40000
StatVtory reserve a1 1 January 2018 8400
Undistributed surplus at 1 January 2018 4 280
164 770 164 770

Additional Information at 31 December 2018:

• Inventory of unsold goods was valued at $4 280.
• General expenses S280 were due.
• Interest due on investments 1otalled $490.
• Some members had paid fees of $570 ln advance for 2019.
• Non-current assets should be depreciated by 20% per annum
using the straight-line method.
• 20% of the surplus for the year should be transferred to the
statutory reserve.
• 10% of the surplus for the year should be transferred to the
education fund.
• All the investments are long term.
 Prepare:
a. an income and expenditure account for the year ended
31 December 2018
b. an appropriation account tor the year ended 31 December 2018
c . a statement of financial position {balance sheet) at
31 December 2018.
Note: The list of tasks required in this question is probably more
extensive than is likely to be required In an examination situation.
These tasks are included here to provide a comprehensive
example of hovv to prepare an answer to a question on the financial
statements of co-operative societies.

Getting started
This question requires three different financial statements to be
prepared. so it is very Important to ensure that the right information
is selected for use in each statement. It is, therefore, worth spending
a short time reading through the list of items in the trial balance ano
deciding where each ttem will be used, perhaps pencilling in I Qncome
and expenditure account), A (appropriation account) and S (statement
of financial position (balance sheet)) to help you as you prepare the
formal answer. It Is also important to spend a few moments working
out the effect of the additional information on the items in the trial
balance and deciding which statement will be affected.
Here is the trial balance again, but with some notes adoed based on
this aovice.

Dr Cr
$ $ Notes based on additional information
Aooounts payable 1 940 s
Administration costs 4 530 I
Cash In hand and at bank 3650 s
Dividends paid 4 000 A
Education fund at 1 January 2018 6200 S Add10% of surplus (A and S)
General expenses 8 210 Add $280 due (I and SJ
Interest received on investments 670 I Add $490 due (I and S)
Inventory at 1 January 2018 6590 I Closing inventory $4 280 ~ and SJ
Investments in other relall co-operatives 8200 s Record as a non-current asset
Membership fees 4 280 less $570 (I and SJ
Non-current assets:
Cost 95000 s
Provision for depreciation at 1 January 2018 19 000 S Add $19 000 /I and S)
Purchases 33940
Revenue 80000 I
Secre,ary's honorarium 650 A
Share capna1 40000 S
Statutory reserJe at 1 January 2018 8400 S Add 20% of surplus /A and$)
Undistributed surplus at 1 January 2018 4 280 A
164 770 164 770
The answer
EXAM TIP
Preparing t he income and expenditure account
As this is a retail co-operative society, the first step is to calculate the It L.s &t COl¾l¾O"" l¾[St&t ~e
gross profit made on trading by preparing an Income statement. to ;econ:;( &11>1.1:j i,, 0 ""DYGIYi«""'
Once the gross profit has been calculated, it will be possible to prepare J>il•cl to" l¾tl¾btY 'ls"""
the Society's income and expenditure account, which will show: expe1>1.se i,.,_ ti1e i"'-COJ¾t
• sources of Income, Including the gross profit calculated in the sti1tel¾e~. 1t i.s; i.mportt:l~
income statement to Ytl¾tl¾btY tl1i1t
fiO"'-OYGIYi.CI G!Yt Ytgt:ly,:;le,:;l C!S
• expenses of running the society
""" ."J>J>YOJ>Yir;itio"" of the
• surplus {or deficit) for the year. soc.etl:J's s«YJ>L«s fo ,• tl1e
1:Jtilt,: so &iye Ytcoyclecl ;,.,_ tne
ST MARTIN'S VILLAGE CO-OPERATIVE SOCIETY &lj>j>YOJ>Yi&tti.o.,_ G!CCOt<l'\.t.
Income statement for the year ended 31 December 2018
$ $
Revenue 80000
Less cost of sales:
Opening Inventory 6590
Purchases 33940
40530
Closing Inventory (4 280)
Cost of sales (36 250)
Gross profit 43750

ST MARTIN'S VILLAGE CO-OPERATIVE SOCIETY

Income and expenditure account
for the year ended 31 December 201 B
$ $
Gross profit 43 750
Add: Interest on investments 1 160
Membership fees 3 710
4 870
48620
Less: Administration cosis 4 530
General expenses 8490
Depreciation of non-current assets 19 000
(32 020)
Surplus for year 16 600

Preparing t he appropriation account

The appropriation account must provide members with information
about the society's surpluses and how these are being used. It shows:
• the surplus for the year
• transfers to reserves
• dividends paid to members
• undistributed surpluses.

Notes:
1. The transler to the statutory
reserve was calculated as 20%
of the current surplus,
I.e. 20% X $16 600 = $3 320
2. The transfer to the education
reserve was calculated as 10%
of the current surplus,
i.e. 10% X $16 600 = $1 660
ST MARTIN'S VILLAGE CO-OPERATIVE SOCIETY
Statement of financial posltiom (balance sheet) at
31 December 2018
Cost
NON-CURRENT ASSETS 95000
Investments in other retail
co-operatives
CURRENT ASSETS
Inventory
lnves!men1 imerest due
Cash in hand and at bank
Less CURRENT LIABILITIES
Accounts payable
General expenses due
Membership fees received
in advance
NET CURRENT ASSETS
Capital employed
CAPITAL AND RESERVES
Share capital
Statutory reserve
Education fund
Undistributed surplus
ST MARTIN'S VILLAGE CO-OPERATIVE SOCIETY
Appropriation account for the year ended
31 Dec,e mber 2018
$ $
Surplus for year 16 600
Less: Trans'er to staM ory reserve 3320
Transfer to education fund 1 660
Secretary's honorarium 650
Dividends paid lo members 4000
(9 630)
Undistributed surplus for the year 6970
Add: undistributed surplus brought forward 4280
Undistributed surplus to carry forward 11 250
Preparing the statement
of financial position
(balance sheet)
The co-operative society's statement of
$ $ $ financial position (balance sheet) will show
Total the business assets, liabilities and capital. It
Depre- Net is set out in a style similar to that of a limited
ciation company's statement of financial position
(balance sheet) (see Unit 9.6). Some special
38000 57 000
points to note are:
8 200 • Non-current assets should
include investments in other
65 200
co-operative societies as they
are said to be long-term investments.
4 280
• Current assets should lncluoe
'1190 the investment interest due as it
3 65-0 Is income yet to be received.
8420 • Current liabiltties should include the
general expenses due and also the
1 940 membership fees received in aovance.
280 • The capital and reserves
section shows the capital
570 (shares) and the three reserves
(2 790)
in the trial balance: statutory
reserve, education fund and
5 630 the undistributed profits at the year end.
70830
40000
11 720
7 860
11 250
70830
 Non-profit organisations

Revenue and capital expenditure LEARNING OUTCOMES

All organisations have to make a careful distinction between capital
and revenue expenditure when preparing financial statements. This n this unit you will learn about:
is important because otherwise the financial statements will provide • the difference betvveen
misleading information, which could result in poor decision making revenue and capital
by owners, managers and others. expenditure
Capital expenditure • how to prepare a receipts
Capital expenditure Is money spent on non-current assets. It is and payments account for a
expenditure that is of long-term (i.e. more than one year) benefit. non-profit organisation.
Capital expenditure covers not Just the basic cost of non-current
assets (for example, a new clubhouse or sports equipment) but also
the following:
KEY TERM
• Money spent on improving non-current assets. For example, If a
club installed air-conditioning in Its clubhouse, the money spent Capital expenditure: amounts
would be regarded as capital expenoiture and added to the value spent on non-current assets
of the clubhouse, because the benefit from the expenditure is that are shown on a statement
Intended to last for several years. of financial position (balance
• Some Items that seem to be•routine expenses, but that in fact will sheet).
benefit the organisation for a longer period. For example, wages
paid to install some new sports fittings should be treated as capital
expenditure and added to the cost of the sports fittings. The
'capitalisation' of the wages Is correct, because the view is taken DID YOU KNOW?
that the benefit from the payment for wages will last as long as the The rules about capital and
club is using the sports fittings. revenue expenditure should
Revenue expenditure be applied to the financial
statements of businesses as
Revenue expendit ure is money spent on everyday running costs.
It is expencliture that Is of short-term (I.e. less than a year) benefit •Nell as non-profit organisations.
to the organisation. A feature of most revenue expenditure is that
It is recurring, i.e. has to be paid for again and again. So expense
payments such as rent, electricity costs, water charges, wages,
salaries, and repairs, maintenance and servicing costs qualify as KEY TERM
revenue expenditure. Revenue expenditure:
amounts spent on everyday
Receipts and payments account running costs that are taken
Into account when calculating
Clubs may receive money from a variety of sources. Here are some an organisation's annual profit
typical examples: (or loss).
• members: in the form of an annual subscription
• money-raising activities
• loans
• donations.

•

EXAM TIP
~e.,,,ue GKJ>e""olituYe
is Yecoroleol ;,.,,, the
•
iV\.OOIM.e Sti:lte""'-eV\.t of
11 busi""ess, wheYe&1s
c&1pi.ti:1 L GKJ>e""ol itu ve i.s
i:lccou""teol foy '"" the
stA:e~e""t of fi-"'-&1 "'-Cit:1 L
pos,tio.,,, (bt:1LA.,,,ce sheet) .
The club treasurer will be responsible for making the following
payments:
• running costs
• expenses of money-raising activities
• purchase of non-current assets
• repayment of loans.
All these transactions will be recorded in a cash book, which is
summarised at the end of each financial year In the form of a
receipts and payments account.

/ ILLUSTRATION 1 A receipts and payments account

Here is a typical receipts and payments account, which will be shol'm to members and which will help
them understand why the club's cash funds have decreased during the year by $455.
THE RIVERFORD COMMUNITY CLU B
Receipts and p ayments account
for t he year ended 3 1 December 2018
RECEIPTS $ PAYMENTS
Opening balance of cash in
hand and cash at bank 1 420 Hire of ccmmunity hall
Members' subscriptions 2 750 Refreshment cosis
Sales of refreshments 445 Guest speakers' fees
Donation from local Interest on loan from
business 200 member
Loan from member 400 Purchase of equipment
Club secretary·s expenses
Closing balances of cash
in hand and cash at bank
5 215
Notes:
1. The account is set out
using a very simple
format so that members
$ can easily understand
the contents.
880
2. Some treasurers may
332 prefer to use a vertical
660 style of presentation.
3. The opening and closing
36 balances shown In a
2 200 receipts and payments
142 account are the
combined balances of
965 cash in hand and at
bank as recorded In the
5 215 treasurer's cash book tor
the period.

KEY TERM
Receipts and payments , SUMMARY QUESTIONS
account: a summary of a
club's cash book. It Is designed 1. What is the difference between capital expenditure and
to help members understand revenue expenditure?
how and why the club's cash
2. What is the purpose of a receipts and payments account?
resources have changed ourlng
a financial period. 3. identify three typical receipts for a social club.
 Practice exam questions

Paper1

1 Which of the following should be shown In the 5 \1\/hich o' tne 'ollowlng shovld be Included In
income statement of a limited liability company? lhe income aPd expenditure account of a
A debemure Interest B dividends cc-operative .society?
C general reserve D share premium A annual general meeting costs
B dividends paid
2 \1\/hiC'l of the fellowing should be shown in the
appropriation account of a Ilmlted company? C secretary's honorarium
A auditors' remunerallcn D 1ransfer to an education fund
B debenture interest 6 \/Vhich o' the following Items should be treated
C diree10rs' remunera1ion as oaprtal expendih,re in the accounts of a
spcnsclob?
D proposed dividends
A coach nire for away matches
3 A limited company r as an authorised capital of
B purchase of sports equipment
500 000 ordlnc1ry snares of 50c each, of wnich
400 000 have been issued. The directors are C re" t of clubhouse
proposing 1o pay a 20% dMdend. The 1o1al D secretary's admlnis:ratlon expenses
proposed dividend is:
A $40 000 B $50 000
C $80000 D $100000
4 Tne excess of income over expenditure in 1ne
accounts o' a cc-operative is called:
A a deficit B a less
C a proftt D a surplus

Paper2

1 Preparing an income stat ement and an

appropriation account Revenue 1 717
Se I ng a~d distribution expenses 44
On 31 December 2019 the following Information
was extracted from the books o'. Glenroy Ud: Transfer to be made 10 general reseNe 100

$000 Prepare:
Administration expenses 32 a an income statement for the year ended
31 December 2019
Aud tors' remuneration 21
b an appropriation accqunt for tne year ended
Cost o' sales 979
31 December 2019.
Debenture interest 25
112 2 Preparing financial st atements
Depreciahon of non-current assets
for a co-operative
Directors' fees and salaries 84
Proposed dividends ior 2019: The Verve\ Retail Co-operative Society's financial
year ended on 31 August 2019. On that date the
Ordinary shares 215
following trial balance was extracted from the
Preference st>ares 60 society's books.
Retained profits at 1 January 2019 258
 • Members' annual fees received in advance
Dr Cr
totalled $320.
$ $
Accounts payable 4 320 • Deprecia1icn should be provided on tne delivery
Accounts rece vab!e 830 vehicle at 20% per annum using the reducing-
balance melr od, and 10% per a,,num on shop
Cash at bank 9 480
furniture and fittings using the slralght-li0e
Delivery vell,cle: me1hod,
CoSl 19 500
• 20% of the surplus ior the year should be
Provis on for depreciation 1ransferred to the ste1utory reserve.
1 September 2018 3 900
• 10% of the surplus for the year should be
Education <eserve 8 450 1ransferred to the education reserve.
General expenses 3 470
• It has been agreed to pay members a dividend
Honoraria paid 5000 of 5% of 1he amount invested in sl"ares. The
Insurance 1 190 dividend will be paid in December 2018.
Inventory at 1 September
2018 6 280 Prepare:
Investment nterest 1 600 a an income and expenditure account for the
year ended 31 August 2019
Investments (long-term) 45000
Members' annual fees 6 730 b an appropriation account for 1he year ended
31 August 2019
Purchases 31 240
e a statement of financlal position (balance
Revenue 89 580 snee1) at 31 August 2019.
Share capr.al 25000
3 Preparing a non-profit organisation's
Shop nrnnure and equipment:
receipts and payments account
Cost 14 500
The treasurer o' the CapeView Sports Club has
Provision for depreciation
1 September 2018 2 900 provided the following details about the club's
receipts and payments for the year ended
Shop rent 8800
30 September 2019.
Statutory reserve 16 900
The club had a balance of cash at bark of
Undlstnbuted surplus at
1 Seoternber 2018 5 440 $3 120 on 1 October 2018. During the year
ended 30 September 2019 subscriptions
U1ilities 2 230
received from members totalled $22 450,
Wages 17 300 cornpetttion recelpls totalled $4 190 and a
164 820 164 820 donation of $5 000 was received from a local
business. The treasurer paid administra11on
expenses of $6 400, rent of the club's sports
Addttional information at 31 Aug1,st 2019: ground $8 300, purchase of new sports
• The inventory of unsold goods was valued at equipment $14 500 and wages of grounds staff
$8 350. $6 650.
• Wages due but unpaid totalled $450. Prepare the receipts and payments acoount for
1he year ended 30 Sep:ember 2019 to show the
closing balatJce a1 bank.
 •

Accounts of manufacturers

Introduction LEARNING OUTCOMES

Manufacturers proouce goods for resale rather than purchasing
them. It is important, therefore, to calculate how much is spent on n this unit you wlll learn about:
the manufacturing process. In order to do this an additional financial • direct and lnoirect cos1s
statement called a manufacturing account is prepared. • preparing a manufacturing
The following costs are relevant when calculating production costs: account
• Raw materials
• Labour costs, i.e. payments to those who are engaged in making KEY TERMS
the product, perhaps using tools, machinery or other Items of
Direct costs: manutactunng
equipment to do so
costs that are attributable to
• Factory cost/manufacturing overhead, i.e. the cost of operating a single product, particularly
a workshop. proouctlon area or perhaps a factory building, that olrect materials and direct
would include: labour.
• electricity (to provide light and power for the machinery and Prime cost: the total of direct
equipment) costs.
• insurance (e.g. for the machinery) Cost of raw materials
consumed: the direct cost of
• depreciation of the machinery and equipment
raw materials used curing a
• rent of the production area {assuming it is not owned by the financial year.
business).
Indirect costs: manutacturing
All these costs added together make it possible to calculate total costs that cannot be attributed
production costs or total manufacturing costs. to one product. lnoirect
manufacturing costs are also
Direct and indirect cos\ts referred to as manufacturing
overheact, factory overhead,
A manufacturing account Is used to show the total cost of producing factory burden or burden.
goods during a financial year. The account lists the costs that can be
associated with the production area, which could be anything from a
small workshop to a large factory. In a simple manufacturing account
the costs are organiseo Into two groups:
• Direct costs: These are the costs incurred In manufacturing that
can be associated with an individual product: raw materials and
wages paid. These two Cirect costs are the first to be shown In
the manufacturing account and are subtotalled to show a figure
called the prime cost. The term 'direct' Is used because it ls
known exactly how much should be spent on making one unit of
production. The direct cost of materials is based on purchases
of raw materials, with adjustments made for opening and closing
inventories of raw materials, to give a figure called the cost of raw
materials consumed.
 • Indirect costs: These are the other costs linked to the
EXAM TIP manufacturing process. i.e. the costs of operating the production
area, which may be a workshop or factory. Indirect costs include
1"'-oli.,-ect costs snoulol all the costs arising from having machinery and equipment, as
0 "'-L/::1 i.""cluole costs well as electricity, insurance, rent, etc. regardless of the quantity
that Cl Ye to olo witl-1 of goods produced. Also included In this category would be
'."'Cl "'-"'-f&1ctuYi"'9. It i.s
wages or salaries (indirect labour) paid to staff who are not directly
involved in production, e.g. supeNisors and factory managers. The
'""''P0 rta""t tl1t1t ti-le costs term 'indirect' Is used because It would not be possible to know
of Cloimi~tyati,0 .,,
exactly how much of any of these costs could be identified with
di.s~Yibuti"'-0 goool~, the production of one unit. Indirect costs are shown as the second
seU,"'0 goools Cl V\-ol section in a manufacturing account, and the costs are subtotalled
&1""1::J fi-"';ii=iaL cnayges to give a figure for total indirect costs.
&!Ye "'-Ot ' ""Cludeol '"'-
tnis c iiteg 0 ,-1::1 · No""- I
/ ILLUSTRATION 1 Preparing a manU:acturing account
v,,ca.,,ufiictuyi.,_g costs Decibels Lto manufacture steel drums. Here is the company's
snoulol co.,,ti""ue to manufacturing account for the year ended 30 September 2019.
appea Y i."" tne •=o""-t
stiite""-t""t. DECIBELS LTD
Manufacturing account for the year ended
30 September 2019
$ $
Raw materials:
EXAM TIP Opening inventory 36400
Add purchases 342 000
MA~otk~ 378 400
A()O()l,(...,t, .stet:io"-& Less closing inventory !31 200)
Cost of raw materials consumed 347 200
It is iv,,cporta~ to
Direct wages 202 000
cLeii YLt, snow'"" tne
Prime cost 549 200
"'-Cl """'-fCl cturi"'-0
Factcry overheads:
CICCO<A.""t:
Depreciation of machinery 30000
• cost of YClW miite,-iaLs Electricity 17 800
COV1,S<A.V><.e&( Insurance 6400
Indirect wages and salaries 47 800
• pYime cost
Rent 25000
· facto,-1::1 ove,-1,,eaols Repairs to machinery 1 800
128 800
• cost of pYooluctio""·
Cost of production 678 000

SUMMARY QUESTIONS

1. What is the purpose of a manufacturing account?

2. Explain the difference between a oirecl cost and an Indirect
cost. Give two examples 01 each type of cost relevant to the
manufacturer of sportswear.
3. A manufacturer's costs for a year include raw materials
$70 000, direct labour $90 000 and indirect manufacturing
costs of $50 000. Calculate the prime cost for the year ano
the total cost of production.
 More about manufacturing
accounts

Work in progress LEARNING OUTCOMES

It is very unlikely that all products will be finished at the moment when
the end of year financial statements are prepared. On the production In this unit you wlll leam about:
line there will be some items at different stages of production, some • worK in progress and
nearly finished. others In the early stages of production. The cost 01 how it is recorded In a
unfinished goods is called work in progress. manufacturing account
An opening inventory of wor1< I!, progress should be added to the • how to make adjustments,
cost of production, as these items will have been completed ouring Including the sharing o' costs
the year under review. between different sections o'
a manufacturing business
The closing inventory of work In progress is deducted from the
cost of production for the year; ensuring that the cost of production • how to calculate the cost of
represents only amounts spentt on goods actually finished during that producing one unit.
year.

Adju stments and the end of year financial EXAM TIP

statements
It will be necessary to make adjustments for prepayments, accruals.
1f l::fO« Qre trl::Ji"-0 to
etc., when preparing a manufacturer's end of year financial ;el¾elMbev now to tYecit
slatements. II will also be necessary to share certain costs between u,..,ve11.torif!; &f work """
the different sections of the business. For example, a manufacturer progyess, betlr iv. ...,i""d
could pay rent for all the premises (factory and offices) occupied t ncit t het:J ci re tvecited ;,.,,, t he
by the business. It would then be necessary to charge part of the ~Q"1,\,e WCI!::' CIS Ci""l::J otlotey
total rent to the factory and part to the offices of the business. As •v..ve""tones. '"" otviev woyds
a result an appropriate amount of rent would be charged to the ~he ope.,,,£"'-0 '"'-Vevstor1::1
manufacturing account and the remainder to the Income statement. •s cidded to the costs Qi,cd
the ctosi"'-0 iv..ve.,,,tor1:1 is
Calculating the cost of a unit of production deducted fro1M the costs.
In order to calculate the cost of producing one unit, it is necessary
to divide the total cost of production by the number of units
manufactured during the financial year, I.e.
Cost of production
Number of units manufactured
This information Is 01 great importance In assessing the pertormance
of the business and in helping with decision-making. For example,
the cost of making one unit will Influence the selling price of the
product.
" ILLUSTRATION 1 Recording work in progress, making adjustments. and calculating unit cost
Whitewater Ltd manufactures surf coards of one type.
On 30 June 2019, the following information was available:

$
Cost of raw materials consumed 156000 Additional Information at 30 June 2019:
Depreciation of machinery 20000 • Direct wages due but unpaid totalled S9 000.
Direct wages 110000
Indirect wages and salaries 32500 • Rent is to be shared: three-fifths to the factory,
Insurance of factory 8500 two-fifths to administration.
Rent 12 000 • Insurance $1 700 was prepaid.
Work in progress:
The company made 600 surfboards during the year.
1 July 2018 5100
30June 2019 7600

Here is the manufacturing account based on this information:

WHITEWATER LTD
M anufacturing account f or the year
ended 30 June 2019
$ $
Cost of raw materials consumed 156000
Direct wages ($100 000 + S9 000 due) 119000
Primeco:.t 275 000
Factory overneads:
Deprecia11on of machinety 20000 The cost of making one surfboard was:
Indirect wages and salaries 32500 Cost of production
Insurance ($8 500 - $1 700 prepaid) 6800
Rent (~ x $12 000) 7200 Number of surfboards manufactured
66500 $339 300
341 500 I.e. = $565 per surfboard
600
Add opening work in progress 5 100
346600 Note: Rent of S4 800 (~ of $12 000)
Less closing work in progress (7 600) should be charged to the company's
Cost of production 339 000 Income statement.

SUMMARY QUESTIONS

1. A business has total manufacturing costs of $750 000, an opening Inventory ot work in progress of
$1o ooo and a closing inventory of work in progress of $25 000. What ls its cost of production?
2. A business has paid $24 000 for Insurance tor the year 2018. Two-thirds of the insurance relates to
the factory and one-thlro' relates to administration. How much insurance should be charged to the
manuiacturlng account and how much should be charged to the Income statement?
3. A manufacturer of a favourite b rand of confectionery made 30 000 bars of a particular proCiuct
during one year. The cost of producing this product was $22 500, How much did it cost to produce
one bar?
 The income statement
and statement of financial
position (balance sheet}
Income statement of a manufacturing company LEARNING OUTCOMES
Just like any other business, a manufacturer's income statement
Is designed to show the gross profit on selling goods (i.e. finished rn this unit you will learn about:
goods) and the profit or loss for the year. • preparing 'inal accounts for
a manufacturing concern:
ILLUSTRATION 1 Preparing a manufacturer's income statement Income statement and
Here Is an Income statement for Whitewater Ltd statement o1 ' inancial
(see also Illustration 1 In Unit 10.2): position.

WHIT'EWATER LTD
Income statement for the year ended 30 June 2019
$ $ 1. State the key difference In
Revenue 625000 the way a manufacturer's
Less cost ol sales of finished goods: gross profit is calculated
Opening inventory of finished goods 17 200 compared to that 01 a retail
Add cost of production 339 000 organisation.
356 200
2. How does a manu'acturer's
Less closing lnvertory of finished goods (14 400)
current assets differ from
Cost of sales of finished goods (341 800) that of a retail organisation?
Gross profit 283 200
Less expenses:
Depreciation o' office equipment 5 500
Flnance charges 3 200
Office wages 32900
Insurance (1/s of $12 000) 4800
Selling expenses 11 400
(57 800)
Profit for the year 225 400

Notes:
1. The first part of the income statement will include the cost of
production and this will replace the item ·purchases'. All the
Information In this section of the income statement will be
about finished gooo·s.
2. The second part of a manufacturer's income statement will
show the deduction of non-factory costs from the gross profit,
I.e. aominlstratlon, distribution, finance and selling costs.

Statement of financ ial position (balance sheet)

of a manufacturing company
The statement of financial position {balance sheet} of a manufacturer
closely resembles those for other types of business. There Is Just
one major point of difference: a manufacturer's statement of financial
position (balance sheet} is likely to show three figures for inventories:
raw materials, work ln progress and finished goods.
 Worked example:
manufacturing accounts

The question
Island Desks Ltd is a small manufaC1uring company that makes one
type of office desk. At the end of the accounting year, 31 March
2019, the following information was available:
$ Additional information:
Administrative experises 11 200 • Machinery should be depreciated by 20% per
Carriage on raw materials 4 100 annum on cost.
Direct factory wages 85 400 • Direct factory wages in arrears $3 100 at
Factory machinery at cos1 250000 31 lvlarch 2019.
Factory malnlenance costs 6800 • Rent is oivlded in the ratio 2:1 between the factory
Fac1ory power 14 300 and the office.
Indirect factory wages and salaries 63500 • Insurance is divided in the ratio 3: 1 between the
lnsurar1oe 17 100 factory and the office. Insurance was prepaid by
Inventories, 1 April 2018: $300 at 31 March 2019.
Finished goods 13 300 • During the year 1 481 office desks were
Raw materials 6900 completeo.
Work In progress 1 700 Prepare:
Inventories, 31 March 2019: • A manufaC1uring account for the year ended
Finished goods 11 200 31 lvlarch 2019, showing clearly the following:
Raw materials 7 400 (i) the cost of raw materials consumed, (ii) prime
cost, (ill) total factory overheads, (iv) cost of
Work in progress 1 300 production.
Purchases of raw ma1eriats 186 000
• An income statement for the year ended
Rent 30000 31 March 2019.
Relurns outwards 1 400
• A calculation of the cost of producing one office
Revenue 724 000 desk.
Selling expenses 4 900

Getting started
One of the main tests in questions on manufacturing businesses
Is being able to select the right information for each element of
the financial statements required . So it is wise to start by working
through the information supplied and Identifying how each Item will
be used - perhaps pencilling in 'M' for manufacturing, 'I' for income
statement. You might wish to go even further and, for the items
marked lv1. indicate whether the item will appear in the direct costs
section {MD), or the indirect costs section {Ml). (In this case work In
progress can just be left marked up as M).
Of course, the value of the machinery will be shown in the statement
of financlal position {balance sheet), the figure is given in the question EXAM TIP
to enable you to calculate the depreciation charge for the year.
For Income statement Items, it could be useful to mark up those '."""""M.'fcl~ AOCOl,t~
appearing in the first section {leading to the gross profit) as IF (where ~tt-
F stands for first) and those appearing in the second section (leading
lt i.s iv,,:porti:r >'Ct
to the profit or loss for year) as IS (where S stands for second
section). to Yt"'-tmbeY ti1At
i.te1M.S sl-iow,,._, i,,._, tne
These indications are shown below - of course, you can use any
""-A "'-Uf .r Ct«. n"'-0 ACC OU >'Ct
abbreviations you like. In this question there is more Information than
m1<.st be to do witi,, t'1e
usual aboul raw materials. Did you notice that there was carriage on
raw materials and returns outwards as well as the inventories ano l¾AV1,uf.rct1,<n"'0 J'YOC!SS,
purchases? so tne1:1 .rye ci Lwi:r us
fcictoyi:'.J costs. A"'-1:1 item
$ Identifying which t~At is "'-Ot Afi:rctori:, cost
financial statement WLLL cippe.ry i.,, tn e otney
fi. v,,i:r "'-Ci Cl L s ti:rte V\,\,el'l.ts .
Simple More detailed
version version
Administrative expenses 11 200 I IS
Carriage on raw materials 4 100 M MD
Direct factory wages 85 '1.00 M MD
Factory machinery at cost 250000 EXAM TIP
Factory maintenance costs 6800 M Ml
1111.00t'Kl ~~ £tt-
Factory power 14 300 M Ml
:,ne fi,Yst pci rt of tl-ie
Indirect factory wages and 63500 M Ml LV\.COV\,\,e StAte"1,tV\,t is
salaries cov,,ceY,,,,ed wit'1 fi.v,,di..,,g
Insurance 17 100 MIi Ml and IS tl-ie g YOSS J>Yofi.t OV\, seLLi"'-0
Inventories. 1 April 2018: goods . It is LV\,\,porti:r.,,t to
; emeV\,\,bey tl-ii:rt 1::JO"- ""eed to
Finished goods 13 300 I IF Lv.clude Q ""1:1 i"'-fDYv>A.CltioV\,
Raw materials 6900 M MD i:r bo1<.t fi.,,._,isl-ied goods
Work in progress 1 700 M M 1-ieYe (i..e. '""ve"'-tones,
cost of J>Yod'<ctio"" Clv,,d
Inventories, 31 March 2019:
Yevev.1<.e) . The secov,,d pcirt
Finished goods 11 200 I IF ?f t'1e ,.,,come sti:rtev,,cev,,t
Raw materials 7 .6.00 M MD LS CO"'-CeY"'-!d wi.tn
decl«.cti"'-0 i:r""!j otney
\l\lork in progress 1 300 M M
""D"'--fA;-toYtJ expevsses of
Purchases of raw materials 186000 M MD
t'1e b:,<5.'"'-'SS: ti:,pice1LL!j
Rent 30000 MIi Ml and IS Q d l¾L>'\.LStYAtLOV\./offi.ce

Returns outwards 1 400 M MD

costs, fi.,v,,.r"'-ce cl-ii:r yges,
""'-&IY~th "'-0 i:r .,,_c4 seLLi"'-0
Revenue 724 000 I IF costs.
Selling expenses 4900 I IS

It is also necessary to calculate the effect of the adjustments shovvn

as additional information in the question. Here are the workings:
• Machinery depreciation (a factory indirect cost) is 20% >< machinery
costs $250 000 = S50 000.

EXAM TIP
II\.VeMO~
[.,(.~e,, J>Yessure i.t i.s
tCiSl:J to l¾tX IA.j> DJ>t"-i"'-g
~ "'-i;;( closi.a,cg -fi,gures foy
OY1,\/tV\.tori.es, so &1LWC11:JS
cneck tn&1t 1:Jou ni:ive
selectei;;! the coyyect i.te""" &It
ti,,e COYYect l¾Ol¾tl'\.t
• Direct factory wages (a factory direct cost) are given as $85 400,
but it is necessary to add the accrual of S3 100 "' $88 500.
• Rent of $30 000 Is to be shared between the factory and the office
In the ratio 2: 1 - so rent $20 ooo should be charged to the factory
(manufacturing indirect cost) and $1O 000 to the office (income
statement).
• Insurance of $17 1oo Is also to be shared betv1een the factory
and the offiee In the ratio 3: 1, bu1 first It Is necessary to deduct
the prepayment of $300. Insurance $16 800 {$17 100 - $300)
is therefore to be shared $12 600 to the factory (manufacturing
lnCirect cost) and $4 200 to the office (Income statement).

The answer
Preparing the manufacturing account
Having worked 01.11 which items are required and the adjustments to
certain items, it is possible to proouce the manufacturing account.
It Is Important to remember that labels for various subtotals are
EXAM TIP required and should always be shown In a manufacturing account as
part of producing a well-presented answer.
Rletot'}j O\ler+leads
ISLAND DESKS LTD
A co""'-..,,.,o"'- ..,,.,i.sta ke M anufacturing account for the year ended 31 March 2019
is to dei;;luct fi:ictor-1:J
?VtYne&1ds fr-o""" pri...,,.,e cost
$ s $
Opening invemory of raw materials 6900
""" tl-ie V\,\,&1V1.1<fiicturL"'-tl
i:iccou.,,.,t. I:>o ""Dt for-get Add: purchases 186 000
tncit, ;,.,,_, ge"'-tY&1L, ti,,e Carriage on raw materials 4 100
f
'.""&I "-'." Cl Ct L< Yi "'-g Cl CCOIA. l'\.t 190 100
•s " lLSt of fcictor-1:J costs Returns outwards (1 "00) 188 700
&1Ll of wni.cn "'-ttd to be 195 600
&1di:;led togetneY.
Less closing inventory of raw
materials (7 400)
Cost of raw materials consumed 188 200
Direct wages 88500
Prime cost 276 700
Factory overheads:
Maintenance costs 6800
Power 14 300
Indirect wages and salaries 63500
Insurance 12 600
Rent 20000
Depreciai ion of machinery 50000 167 200
443900
Adjustment for work in progress:
Add opening Inventory 1 700
Less closing inventory (1 300) 400
Cost of production 444 300
Preparing the income statement

ISLAND DESKS LTD

Income statement for the year ended 31 March 2019
$ s
Revenue 724 000
Le&> cost of sales:
Opening Inventory of finished goods 13300
Cost of production 444 300
457 600
Closing inventory of finished goods (11 200)
Cost of sales (446400)
Gross profit 277 600
Less: administrative expenses 11 200
Insurance 4 200
Rent 10000
Selling expenses 4 900
(30300)
Profi1 for the year 247 300

Cost of production of one office desk

The total cost of production Is $444 300 and 1 481 office desks were
produced. So the cost of one oftice desk Is:
$444 300 = $300
1 481

LEARNING OUTCOMES
In this unit you will learn about:
• the basic costing principles
o: cost-plus (mark-up) pricing
and absorption costing.
Basic costing procedures
Cost-plus pri cing
Deciding on the right selling price for a product is Important to the
success of any business. The selling price must:
• ensure that costs are covered
• provide the business with a good return on investment
• ensure that the business remains competitive.
The selling price can be based on the cost of making one product
(see Unit 10 .2) plus a percentage of the cost. This is referred to as
cost-plus pricing or mark-up pricing.
r ILLUSTRATION 1 Calculating the selling prlce of a single product
Miguel manufacturers a computer keyboard. The cost of making
one unit Is as follows:
$
Direct materials 24
Direct l1;1bour 33
Indirect costs/factory overhead 11
Total cost 68
Miguel uses cost-plus pricing and adds 50% of the cost to
calculate a selling price. The selling price will be:
$
Cost of one unit 68
Profit (50% of cost
= 50% X $68) 34
Selling price 102
Absorption costing
Some manufacturers use a technique called absorption costing to
calculate the lnoirect cost of maklng a product. The technique is
useful where the manufacturing process Is quite complicated, with
several different processes required, carried out in a number oi
departments (sometimes callee cost centres}.
The technique requires a number of steps. In the following example.
assume the costs given are for a year.
 Example
Step 1 Set up a table with a oolumn for each department Machining Finishing
department department
$ $
Step2 Allocate costs
Record any indirect costs that can be easily attributed to a particular
department (e.g. the depariment manager's salary). 38000 32000
Step3 Apportion oosts
Divide any indirect costs that apply to the business as a whole on
some rational basis between the departments.
Examples:
Rent $33 000 divided on the basis of ffoor area in the ratio 2: 1 22000 11 000
Depreciation of machinery $32 000 divided on the basis of the cost
of machines in each department in the ratio 3:1 24 000 8000
Step 4 Total all the indirect oosts 84 000 51 000

Step s Calculate the absorption rate

Divide the total indirect costs by the number of labour hours or
machine hours available in the department. The choice depends on
which is the more dominant factor in tne department.
Example:
The machining d epartment is machine Intensive and has 21 000 $4 per
machine hours available each year, machine
hour
The finisning department is labour inlensive and has 17 000 labour $3 per
hours available each year. labour hour

/
Calculating a selling price using absorption
ILLUSTRATION 2
costing KEY TERMS
The following iniormation is available for the product of a business: Cost centre: part of a
business to wnich costs can be
Materials 4 kg at $3 per kg allocated and apportiored.
Direct labour:
Allocated: where an entire
Machining departmem 3 hrs at $9 per hour cost is charged to a cost
Finishing department 4 hrs at $9 per hour centre.
Machine hours:
Machining departmem 5 hours Apportioned: where indirect
Finishing department 1 hour oos,s are divided between cost
cen1res in a ratjcnal manner.
The business uses cost-plus pricing. The selling price of a product
Is based on cost + 25% mark-up.
Using the absorption rates arrived at In Step 5 of the previous
example, the calculation of the selling price is as follows:
(Continued)
 Calculating a selling price using absorption
ILLUSTRATION 2
costing (Continued)

s
Materials 4 kg at S3 per kg 12.00
Direct labour:
Machining department 3 hrs at S9 per hour 27.00
Finishing department 4 nrs at $9 per nour 36.00
Indirect costs:
Machining department 5 hours >< S4 per machine
hour 2000
Finishing department 4 hours >< S3 per labour
hour 12.00
Total COS! 107.00
Add profit (25% x cost =25% x $107) 2675
Selling price 133.75

Note:
The calculation of indirect costs needs special care. In the
Illustration the machining department hours are used because
this department absorbs costs using an absorption rate per
machine hour: the finishing department labour hours are used
because this department absorbs costs using an absorption rate
per labour hour. .,

SUMMARY QUESTIONS

1. What method is used to establish the selling price if a

business uses cost-plus pricing?
2. What Is the difference between allocating an inoirect cost and
apportioning an indirect cost?
3. How is an Indirect cost absorption rate calculateo?
 Worked example:
costing procedures

The question
Sherry owns a business which makes cakes for celebrations.
She uses absorption costing. The business has two cost centres:
preparation department and baking department. Some indirect costs
have been allocated to each department as follows:

Monthly indirect cost Preparation Baking

department department
s $
Depreciation o' eqvloment 800 3000
Supervisor's salary 2 200 2500

Some other indirect costs apply to the business as a whole and are
to be apportioned:
M onthlv indirect cost $ Annortionment basis
Insurance of equipment 450 Cost of equipment (S)
Rent of premises 2 700 Floor soace (sn ml
Electricity charges 700 Power (kilowatt hours)

The following data has been provided abou1the business:

Preparation Baking
denartment deoartment
Equipment cost $10000 $140000
Rent of premises 800sa m 400 sn m
Power (kilowatt hours) 500 3000
(a) Prepare a table to show total inoirec t costs allocated and
apportioned to each of the departments.
(b) The following data Is available abou1 labour hours and machine
hours:

Labour hours M achine hours

per month per month
Prenaration deoanment 600 300
Bakina department 400 1 500

Calculate absorption rates tor each department.

(c) n July 2020 Sherry received an order from a local chain of shops
for celebration cakes. The following details are available about
this order:
 Direct materials Ingredients for cakes $950
12 nO\Jrs in preparation department
Direct labour Labour is paid $16 per hour
5 hours in baking department
3 hours in preparation department
Machine hours
11 hours in baking department
Sherry's policy is to apply a mark-up of 50% to all orders
Calculate the charge tor the Job.

Getting started
There is a lot of detail here to understand, so, as always, do take
your time to read through all the information. Fortunately, the ouestion
as a whole is made a little easier as it is broken up into stages. Do
highlight any points you think are particularly important. There Is a lot
ot calculating to do, so do double-check each calculation as you go
along to ensure you are using accurate information In the final stages
of the question.

The answer
Step 1
Answering task (a) requires a table to be set up to show each of the
indirect costs and details of the apportionment of Insurance. rent and
electricity charges.
Here is a suitable table before the figures have been Included:

Apportionment method Preparation department Baking department

$ $
Allocated costs:
Depreciation of equipment
Supervisor's salary
Apportioned costs:
Insurance of equipment Equipment cosl
Rent of premises Floor area
Elec!ricity charges Kilowatt nours
Total Indirect costs

And here is the completed table:

Apportionment method Preparation department Baking department

$ $
Allocated costs:
Depreciation of equipment 800 3000
Supervisor's salary 2 200 2500
Apportioned costs:
Insurance of equipment Equipment cost 30 420
Rent of premises Floor area 1 800 900
Electricity charges Kilowatt hours 100 600
Total Indirect costs 4930 7 420
Calculation details (ior the apportionment of costs):
Ratio to be used
Preparation department Baking department
Equipment Total ccst of equipment 10 000/150 000 140 000/150 000
Insurance $450 $10 000 + $140 000 = $150 000 i.e. 1/ 15 x $450 = S30 i.e. 14/15 X $450 = $420
Rent of premises Total floor space 800/1 200 400/ 1 200
$2 700 800 + 400 = 1 200sq m i.e. 2/3 X $2 700 = $1 800 i.e 1/3 x S2 700 = S900
Electricity Total kilowatt hours 500/3 500 3 000/3 500
charges S700 500 + 3000 = 3 500 i.e. 1/7 X $700 = $100 i.e. 6n x s100 = $600

Step 2
DID YOU KNOW?
Answering task (b) requires the calculation of absorption rates.
The process involves deciding the most Important factor in each It Is always advisable to show
department: labour hours or machine hours. It is important to detailed calculations so that
correctly label each absorption rate and it is usual to work to two at least some marks can be
decimal places (unless you are told to do otherwise). scoreo for the process even if
the final result is Incorrect.
Preparation department: labour hours Is the most important factor.
Absorption rate is: total Indirect costs/labour hours, i.e. $4 930/600 =
$8.22 per labour hour.
Baking department: machine hours is the most Important factor.
Absorption rate is: total Indirect costs/machine hours, i.e.
$7 420/ 1 500 = S4 .95 per machine hour.
Step 3
It Is now possible to move on to the final task (c}. This is the most
Interesting part of the question because it requires you to use all your
calculations and work out how much to charge a customer. All the
hard work will mean that the business will be able to ensure that the
customer pays tor the materials and labour involved in the order, plus
pay a fair share of all the Indirect costs of running the business. plus
make a profit for Sherry.
The calculation should be set out in detail as follows:
$ DID YOU KNOW?
Direct materials: ingredients for cakes 950.00
tt Is best to set out a 'ormal
Direct labour: 17 nours x S16 per hour 272.00
statement to show the price to
Overheads/indirect costs: be charged for an order. Marks
Preparation department: 12 hours x absorption rate will be available for each step In
S8.22 per labour hour 9664 the calculation, so avoid cutting
Baking department: 11 hours x absorption rate $4.95 corners.
per machine hour 54.45
Total cost of order 1 375.09
Mark-up: 50% of cost (50% x $1 375.09) 687.55
Total charge to customer 2 062.64
 Inventory valuation

LEARNING OUTCOMES
n this unit you will learn about:
• methods of inventory
valuation
• how to calculate the value of
closing inventory using either
FIFO, uFO or AVCO.
There can be a problem valuing inventories when the unit price of
Items has changed during the financial period under review due to
inflation or deflation. To resolve this problem assumptions are made
about the Items In stock as in Illustration 1.
Note: Because one period's closing inventory becomes the next
period's opening inventory, the effect on profit of these different
valuations Is evened out over several financial periods.

I
ILLUSTRATION 1 Using the three methods of inventory valuation
The FIFO (first in fir st out) and LI FO (last in first out) methods

Date Inventory IN Inventory OUT FIFO Unsold Inventory LIFO Unsold Inventory
May 5 10@$15 10@$15 10@$15
11 7@$24 3@$15 3@$15
17 10@$17 3@$15 3@$15
10@ $17 10@$17
24 7 @$24 6@$17 3@$15
3@$17
= $102 = $96
• FIFO valuation is based on the most recent prices and gives a l1igher valuation of Inventory (when
prices are Increasing).
• LIFO valuation tenCis to value inventory on older prlces and this gives a lower valuation {when prices
are increasing).
The AVCO (weighted average cost) method
Date Inventory IN Inventory OUT Unsold Inventory Calculation of Value of inventory
average cost
May 5 10@$15 10@$15 $15 $150
11 7@$24 3@$15 $15 $45
17 10@$17 3@$15 3@$15 = $45
10@ $17 = $170
10@$17
So average cost ls
$215 + 13 = $16.54 $215
24 7@$24 6@$16.54 $99.24

• The AVCO method is more complicated to use because II is necessary to recalculate the average
cost after each movement of Inventory. {Calculations have been made to two decimal places.)

SUMMARY QUESTIONS

1. How does the FIFO method of inventory valuation differ from the LIFO method of inventory valuation?
2. A business had 50 unsold units, which cost S1 o each, and it has Just purchased 30 units at $11
each. What Is 1he (weighted) average cost of one unit {wor1<1ng to two decimal places)?

.
·,.178 I
. .
 Practice exam questions

Paper1

1 Which of the following Is required v.,t,en 4 A rnanufactvring account lnoli,cJes direct costs
calculati'lg prime cost? of $70 000 and factory ovel'l'eads of $20 000.
A depreciation of factory macninery During 1he year work in prqgress Increased
In valve by S10 000. The number of Items
B factory rent
completed during the year was 1O000. The
C raw materials purchased cos, of producing or,e Item was:
D work ln progress A $4 B $6
2 Which of the fOllowing 'actory costs would not C $8 D $10
be affected by tne number of products made?
5 The owner of a business values inventory using
A carriage lrwards on raw materials the FIFO method. At 1he beginrir,g of a period,
B manager's salary the lnve11tory consisted of five lter1s valued at
C power to rvn machinery $9 each. During 1he period nine items were
D wages of machine operators purchased for S10 each and seven rtems were
sold for $18 each. What was the value of the
3 A manufacturer's costs lnck,de the following: inventory at the er d cf ,he period usii,g tne FIFO
direct wages $50 000. machinery repairs me1hod of valua!ion?
$30 000, o,ice satanes $20 000, factory rent A $27 B $30
S"-0 000. Faciory overheads total:
C $63 D $70
A $140000 B $110000
C $90 000 D $70 000

Paper2

1 Preparing financial statements

Raw rnaterla's 12800
Island Productions ltd manufactvres sets of Work in progress 2400
o..rtdoor rurni:ure. The following information is
Purchases of raw materia s 145000
available for the yP..ar ended 31 December 2018:
Rent 22000
s Returns Inwards 2200
Carriage Inwards on raw ma1erlals 1 100
Revenue 425000
Deprec·at;on of faetory machinery 30000
for 2018 Se I ng expenses 7900
Deprec;at on of office equipment tor 6000 Utilit es 14800
2018 Wages and salaries:
Facto,y Insurance 3 400 Direct factory wages 57300
Factory maintenance 800 Factory supervisor's salary 26500
Inventories 1 January 2018: Office wages and sa'aries 29400
Finished goods 14 900 Additional lnforma11on:
Raw materials 11 200
• Factory Insurance $300 Is prepaid at
VVork ,n progress 1 700
31 December 2018.
Inventories 31 December 2018:
• Rent should be shared: factory 75%, office
Finished goods 11 300 25%.
 • Utilities is In arrears $200 at 31 December
Overhead Annual t otal Apportionment
2018. Utilities Should be shared factory 80%,
S rat io
office 20%.
CUtllng department
• D.iring the year ended 31 December
2018, 580 sels of outdoor furn~ure were
Power
charges 48 ooo j.finish ng
manufac!I.Jred. department ¼
Prepare: CUtling depattmem
a a marufac1urlng account for 1he year ended Depreciation } finish ng
of machinery 33 000
31 December 2018 department &
b an income s1atement for the year ended
31 Decembef 2018 Addttlonal Information:
c a calculation of the cost of production of one Department Labour M achine
set of outdoor furnrture. hours hours
2 Calculating the value of inventory available available
per year per year
From the Information below, calculate 1he value Cuttlng department 20000 40000
of inventory at 30 September 2019 using ihe
Finishing departmem 30000 10000
following methods o' valJalion (working to two
decimal places rt necessary): a Calculate the tolal Indirect costs ft>r e.ich
a FIFO department.
b LIFO b Calwlate the overhead absorption rate for
c AVCO. each department.
0'> 1 September there were five items in the An order from a customer will cos1 S1 800
stockroom tnat had cost $20 each. In direct materials, $3 100 in direct labour.
It will take 400 machine ho.irs in the cutting
Date Inventory In Inventory Out departmen, and 200 labour hours in the finisning
Sept a 10@$22 departm~•. The company's policy Is to caloulate
14 12 selling price by adding 50% to tne cost of an
order.
21 10@$24
c Calculate the price to be charged to the
3 Calculating price using absorption costing customer for this order.
QX Ltd man:tactures a variety of products. Tre
company uses absorption costing. The following
information has been provided about annual
indirect costs:

Cutting Finishing
department department
$ $
Depa~ment
35 000 29000
marager's sala<Y
There are tv,10 other indirect costs ihat snovld be
apportioned using the ratio provided.
 Payroll accounting

Methods of payment LEARNING OUTCOMES

The following methods can be used to pay employees and suppliers
of goods and services: n this unit you will learn about:

• Cheques • methods of payment

• voluntary and statutory
• Standing orders oeductlons
• Cash • the source oocuments for
• Electronic fund transfers. payroll
• spreadsheets to arrive at net
In addition, suppliers can often be paid via oirect debit or electronic pay amounts and deouctions
funds transfer at point of sale (EFTPOS).
• the main accounting
software used for payroll
Payroll: introduction
• calculating employees'
Payroll is the term used for the document that summarises details earnings using fixed rates.
of each employee's pay on a weekly or monthly basis. The payroll will
show the following details for an individual:
• Gross pay: pay before any deductions KEY TERMS
• Statutory deductions: amoun ts that are legally required to be Payroll: the O'ocument that
subtracted from gross pay, tor example, income tax and national summarises details of each
Insurance (social security) contributions employee's pay on a vveekly or
• Voluntary deductions: amounts that the indMdual has requested the monthly basis.
employer to deduct from gross pay, for example, contributions to a Contract: legal document
trade union or contributions to credtt unions or savings schemes. setting out terms of an
employment.
Source documents for payroll Clock card : a document that
• For fixed amount salaries/wages the employee's contract will gives oetails of the number of
provide details of pay rates and voluntary deductions to which the hours an employee has worked,
employee has agreed. obtaineo by using a special
clocking in/out machine or time
• For time rates (see details below) records of when an employee recorder.
signs in and out for work are used. sometimes In the form of a
clock card . Time sheet: a document that
records the hours worked by an
• Where an employee works away from the business premises a employee who works off site.
time sheet \/o/111 provide details of the work done and the time
taken. Piecework ticket: a document
that recoros the number of
• A piecework ticket is used to provide details of the number of prooucts an employee has
products an employee has made. This document is used where maoe.
pay is based on the amount of work done.

Employee Hourly Normal Overtime
rate hours hours
X
y
LINK % maintaining payroll records; these lnclude Gusto. OnPay, Xero,
There is more on the different
payment methods in Section 3.
Unit 3.5 (the cash book) and
Section 7, Unit 7.7 (bank
reconciliation).
1. loentify three ways a
business may use 10 pay
an employee.
2. Explain the difference
between a statutory
deduction and a voluntary
oeduction.
3, Identify tvvo sources of
Information for calculating
an emp!oyee·s pay.
4. Stale:
a. three benefits of using
a software program for
payroll
b. one disao'vantage.
5. An employee's contract
states that their annual
gross pay is $45 000. What
is this employee's monthly
salary?
Spreadsheets and software used for payroll
A payroll summarises for each employee all the key facts for the
calculation of net pay. This can be kept manually but is otten
maintained using a spreao'sheet. Here is a typical layou1 for a payroll
spreadsheet.
Normal Overtime Gross Income National Health Net
pay pay pay tax Insurance scheme pay
Alternatively, there are soft\,vare programs that can be used for
Sage intact, etc. These are often found to be worth the initial outlay
because they provide some very desirable advantages, such as:
• speed and accuracy
• automatic generation of payslips
• calculations of bonuses, holiday pay, etc.
• application of current tax regulations
• forecast of future staffing costs .
On the other hand, like any IT system, payroll software programs can
have certain weak points, with potential for problems around such
issues as data security, loss or theft.
Payroll calculations: fixed rates
Salaries, and some wages, are often an agreed amount for a year
with the possibility of a pay rise. Details of an Individual's salary will be
found in their personnel records, which are based on the individual's
employment contract.
I
/ ILLUSTRATION 1 Calculating gross pay using a fixed rate
Carissa is the manager of a branch oi an insurance company.
Her salary for the year ended 31 December 2018 was $44 400.
For the year ended 31 December 2019 she received a pay rise
of5%.
Carissa ·s gross monthly pay for the year ended 31 December
2018 was $44 400 .;. 12 = $3 700.
Her salary for the year ended 31 December 2019 was:
S44 400 + (5% x $44 400) =$44 400 + S2 220 =$46 620.
Her gross monthly pay was: $46 620.;. 12 = S3 885.
 More about payroll

Time rate LEARNING OUTCOMES

Time rate is the expression used when 1/\tages are based on the
hours worked and according to an hourly rate agreed with the In this unit you will learn about:
employer. • calcula11ng employees'
• Usually an agreed number ot hours is 1/\tOrked per week. earnings using time rates
and piece rates
• 'Nhen employees work more than the agreed hours, the extra • calcula11ng nel pay.
hours worked are referred to as overtime.
• Overtime hours are paid at a higher rate than normal working
hours. The higher rate paid varies. If an employee is paid 1.5 times
the normal rate this is usually expressed as 'time and a half': if the
rate is 1.25 times the normal rate, this is expressed as 'time and
a quarter', If the rate is twice the normal rate, this is expressed as
'double time·, and so on.

/ ILLUSTRATION 1 Calculating gross pay based on time rates

Zachary works In the assembly department of a business that manufactures children's toys. Zachary Is
expected to work an eight-hour day and Is paid $24 per hour. Overtime is paid at time and a hatt.
During the week ended 6 July 2019, Zachary's time card was as follows:
MORNING AFTERNOON EVENING HOURS WORKED
IN OUT IN OUT IN OUT Normal Overtime
Monday 830 13.00 1330 4.30 8
Tuesday 830 13.00 1330 4.34 6.30 9.30 8 3
Wednesday 8.30 13.00 13.30 4.32 8
Thursday 8.30 13.00 13.30 5.30 8 1
Friday 8.30 13.00 13.30 4.30 8
Note:
it is usual for an employee's lunch time to be considered part of the normal working hours.
Zachary's wages for the week are calculated as follol/\1s:
• Total hours normal working: 5 x 8 = 40 hours
• Total overtime hours: 3 + 1 = 4 hours
• Pay based on normal working: 40 hours x $24 per hour = $960
• = =
Overtime pay 4 hours x {$24 x 1.5) per hour 4 x $36 $144 =
Total gross pay: $1 104
Piece rate
Piece rate is the term used where pay is based on the amount of
work done. i.e. the number of products made or operations carried
out. The rate of pay will be per product/operation. The employee who
works faster will, therefore. be paio more than the slower worker.
Sometimes employees vvho are paid in this way are subject to:
• minimum wage agreements: where a minimum weekly gross pay is
agreed for full-time employees and Is applied where the amount of
work done is less than normally expected
• quality checks: to discourage careless work, piece rates are only
applied to work that passes a quality check.

I
,..ILLUSTRATION 2 Calculating gross pay using piece rates

Lydia works full-time In a factory. She is paid $1.20 for

each product that is accepted. She has a minimum wage
agreement, so that her gross pay must be at least $840
per week. Lydia's piecework ticket for the week ended
23 November 2019 was as follows:
Number Number Number
produced rejected accepted
Monday 130 6 124
Tuesday 144 9 135
Wednesday 158 4 154
Thursday 145 3 142
Friday 133 5 128
Totals 710 27 683

Lydia's gross pay wmbe based on the number of accepted

items. i.e. 683 x $1.20 per item = $819.60.
However, this figure Is below the minimum agreed level of
gross pay, so Lydia will be paid S840 for the week ended
23 November 2019.

SUMMARY QUESTIONS

1. Kia is paid $32 per hour for a 40-hour week. Overtime Is paid
at time and a quarter. Calculate Kla's gross pay for a week In
which she worked for 46 hours.
2. Issa is paid a piece rate of $5 per Item. During a recent week
he produced 175 Items: 11owever, 14 of these Items were not
accepted. Calculate lssa's gross pay for the week.
 Calculating net pay

Statutory deductions LEARNING OUTCOMES

Note: Each Caribbean state has its own regulations regarding
statutory deductions and these are subject to change from year to In this unit you will learn about:
year, so the information given in the examples that follow should be • calcula11ng employees'
treated as a guide only. net pay.
Income tax
Most indlviouals pay income tax on their earnings. Income tax is
an example of a statutory o'eduction, which means that it is a legal
requirement. There are often complex rules about how income tax
should be calculated, but the following are key features of most
Income tax systems:
• Personal allowance: each individual is entitled to receive at least
some pay that Is free of tax. For example, the first $8 000 of
earnings could be tax tree.
• Tax deductible items: these are also deducted from gross pay
before applying the income tax rate. Examples Include national
Insurance, pension contributions and professional subscriptions
and expenses. The employer may be required to deduct these
from gross pay using rates set by the tax authority in order to arrive
at taxable pay. Alternatively, the employee will claim back the tax
on some of these Items later via their own tax return.
DID YOU KNOW?
• Taxable pay: gross pay less the personal allowance and other
allowable items gives what is called taxable pay. Income tax will Many individuals also have
be baseo on an individual's taxable pay; it will be calculated at a to pay:
particular rate, for example 20% of taxable pay.
• National Insurance (social
security) contributions: this
deduction is made to provide
' ILLUSTRATION 1 A simple income tax calculation the funds to pay state
Nerissa's gross pay is $45 000 per annum. Nerissa Is entitled to a retirement pensions, disablllty
personal allowance of $9 000. benefits, unemployment
benefits, etc. This deduction
Income tax Is charged at a rate of 20% on taxable pay. coulo be a percentage of
Step 1: Calculate taxable pay gross pay.
• Pension plan contributions:
Taxable pay is gross pay $45 ooo less personal allowance
some employees v,111 be
$9 000, I.e. $36 ooo. required to contribute to a
Step 2: Calculate Income tax scheme that will provide a
pension from their employer
Income tax is 20% of taxable pay, i.e. 20% x $36 ooo = $7 200.
upon retirement. This
So, Nerissa will pay a iotat of $7 200 In Income tax during one deduction could also be a
year; this will amount to $600 per month. percentage of gross pay.
DID YOU KNOW?
Voluntary deductions could
include:
• membership o• the
organisation's sports club
• membership of the
organisation's social club
• donations to charities
• membership of a trade union
• con1ribution 10 a private
health scheme
• life insurance contributions
• conltlbutions 10 credit unions
or savings schemes
• loan repayment instalments
to banks or credit unions.
SUMMARY QUESTIONS
1. Michelle's annual salary is
S82 ooo. She is entitled to
a personal allowance of
s 12 000. She is charged
income tax at 20% on
taxable pay. How much
Income tax should Michelle
pay in one year?
2. Harry's weekly gross pay Is
S900. He pays 20% income
tax on all weekly earnings
above $200. He asked his
employer to make voluntary
deductions of $80 per
week from his pay. 1/Vhat is
Harry's weekly take home
pay?
Voluntary deductions
In some organisations, an Individual can request that deductions
are made from their pay to meet their particular needs and
circumstances. Where the deduction is optional ano· requested by an
employee it is referred to as a voluntary deduction.
.,..ILLUSTRATION 2 Calculating an individual's annual net pay
taking account of statutory deductions
Sepaul's annual gross pay is $52 000. He Is entitled to a personal
allowance of S8 000. Income 1ax is charged at 22% of taxable pay.
In addition, Sepaul is required 10 make national Insurance (social
security) contributions of 5% of gross pay and a pension plan
contribution of 4% of gross pay. Calculate Sepaul's annual net pay.
(Assume national insurance and pension plan contributions are
allowable deductions when calculating taxable pay.)
Sepaul
Calculation of Inc ome tax:
s $
Gross pay 52000
Less:
Personal allowance 8 000
National insurance
(5% x Gross P<IY $52 000) 2 600
Pension plan
(4% x Gross pay $52 000) 2 080
Total allowable deductions (12 680)
Taxable pay
(Gross pay less Total
allowable deductions) 39 320
Calculation of net pay:
$ s
Gross pay 52 000.00
Less:
lncome1ax 8 650.40
National insurance 2 600.00
Pension plan 2 080.00
(13 330.40)
Annual net pay 38 66960
Income tax =22% x Taxable pay $39 320 =$8 650.40 .I
 Budgets and simple
business plans

Cash flow projections LEARNING OUTCOMES

An Important part of managing a business is forward planning to
ensure that resources are used efficiently. One aspect of forward In this unit you will learn about:
planning is forecasting cash flows, which helps owners and • preparing cash flow
managers to be prepared for times when there could be a shortage projecttons within a
of cash funds, requiring an overdraft to be arranged. or when there is six-month period
a surplus oi cash, which could be used more effectively. • preparing sates and
A cash flow projection requires forecasts to be made oi: production budgets for a
three-month period
Cash Inflows Cash outflows
• using accounting knowledge
Cash sales Cash P'Jrchases and skills to prepare a simple
business plan.
Receipts from credit customers Payments to suppliers
Capital introduced by the owner Expense payments
Grants Owner's drawings

Format

Month 1 Month 2 Month 3 Month 4 Month 5 Month 6

$ $ $ s $ $
Cash inflows
Cash sales 2000 2 400 2600 2800 2 500 2600
Grant 4 000
Total inflows 2000 2 400 2600 2800 6 500 2600
Cash outflows
Purchases 1 100 1 600 1 800 2 100 2300 1 700
Expenses 800 900 1100 1 400 1 200 800
Total outflows 1 900 2 500 2900 3500 3 500 2 500
Net Inflow/outflow 100 (100) (300) (700) 3000 100
Cash balances
Opening 800 900 800 500 (200) 2800
Closing 900 800 500 (200) 2 800 2900

Notes:
• There are various ways of setting out cash flow projections. The format shown is just one example.
• Negative figures are shown in brackets. (The closing balance is negative in Month 4 and this leads to a
negative opening balance in Month 5 .)

Sales and production budgets

A sales budget is used to forecast the number of units that will be
sold each month and the value of those sales.
 " ILLUSTRATION 1 IAsales budget
Sales budget for each of the three months ending
31 August 2020
June July AJ.Jqust
Sales u,iits 1 200 1 300 1 400
Sales value S7200 $7 800 $8400

A production budget is used to forecast the number of units that

will need to be made each month in order to meet o·emand. A
production budget takes account of levels oi inventory of finished
goods. It is Important to note that the budget shows details In units
rather than $.

/ ILLUSTRATION 2 A production budget

Production budget for each of the three months ending

31 M ay 2020
March Aonl Mav
untts untts untts
Sales 900 1 000 1 200
Less opening Inventory (100) (200) (300)
Add closing inventory 200 300 200
Production 1 000 1 100 1 100
/

1. Owen has prepared a cash Simple business plans

flow projection that shows
cash Inflows for June will be
SB 400 and cash outfl0\11/S
S9 100; in July cash inffows
will be S9 300 and cash
outflows $9 500. The
balance of cash funds on
1 June ls preoicted to be
S200. Calculate the closing
balance of cash funds for
the end of:
a. June
b. July.
2. What Information should be
recorded In:
a. a sales budget
b. a production budget.
3. Identify three key sections
of a simple business plan.
When planning to set up In business. it Is Important that ideas about
the venture are carefully thought through. A business plan should
make it clear what the business will do and how It will be successful.
The key elements in a business plan are:
• Executive summary: a concise statement about the key features
of the venture. i.e. what the business will do. how It will make
money, how it will attract customers and the amount of finance
required
• Company background: who are the owners and other key
personnel. their skills, experience and qualifications
• M arketing plan: answering questions about who will be the
customers for the goods or services being offered and whether this
target group wlll lncrease ln the future
• M arketing analysis: identifying the likely competitors and how
the venture will ensure that customers are attracted away from the
competttion
• Financial plan: Including detailed statements about the capital
required to set up and run the business, a forecast of profits based
on details about revenues. expenses, etc., cash flo\111 projections
and other budgets.
 Worked example:
preparing budgets and
cash flow forecasts
The question
Bill is planning to open his own business in October 2020. He is
going to make a high-quality garden chair of his own design. He has
been preparing a business plan and he has been told that he should
include a sales budget, production budget and a cash flow forecast.
He has provided the following details:
The chair will sell at S240 each. All sales are for cash. He believes he
can sell the following chairs in the first months of trading:
October 100
November 120
December 160

He will produce sufficient chairs each month to meet sales demand.

He also plans to hold an Inventory sufficient to provide 20% of the
following month·s sales. Sales for January 2021 are forecast to be
1tlO chairs.
The following Information is available about cash inflows and cash
outflows:
A In October 2020 Bill will in~roduce $22 000 as capital tor his
business.
B He will purchase machinery and equipment for $18 000. Half
of this amount will be paid In October 2020 and the balance in
December 2020.
c Each month he will purchase materials to make the chairs
shown in the production budget. Materials will cost S100 per
chair. All purchases of materials will be paid for in the month of
production.
D Wages will be S80 per chair and will be paid in the month of
production.
E Bill Is entitled to a grant of $5 000 for setting up his business.
This amount will be received In November 2020.
F Bill Intends to wtthdraw S2 000 per month from the business as
drawings.
G General expenses of $8 000 will be paid each month.
Prepare to r each of the months October, November and
December 2020:
• a sales budget In untts and value
• a production budget
• a cash flow forecast.
 Getting started
Stage 1
It is important to read the details of the story of Bill's business
carefully so that you give yourself the opportunity to understand what
Is happening.

The answer
Step 1
Focus on producing the sales budget. Notice that you must provide
details both In units ano· sales values. As always take care with the
presentation of your answer because budgets are produced tor
owners and managers of businesses and they would expect details
to be recorded carefully.

Bill
Sales budget for each of the
three months ending December 2020
October November December
Sales untts 100 120 160
Sales value ($240 per unit) $24 000 $28 800 $38 400

Step 2
Focus on producing the production budget. It is important to
remember that production budgets are in units not $. The information
shown •..viii be important for calculating the value of monthly
purchases and monthly wages in the cash ilow forecast.

BIii
Production budget for each of the
three months ending December 2020
October November December

Sales 100 120 160

Less opening inventory• (24) (32)
Add closing Inventory'" 24 32 28
Production 124 128 156

EXAM TIP • There was no opening inventory for October because that was the
month the business started.
A co""'-""'-O"'- l¾ista koe is
·• Closing Inventory is to be 20% of the following month's sales. So
to iittempt to J'YOol1<.ce ii
the calculations of closing inventory are:
)'YOol uctio,,,, b1<.ciget i,,,, -1
YAtf!ey tflA,,,_ i,,,_ t.<i,,,[ts.
October 20% x 120 = 24 untts
November 20% x 160 = 32 untts
December 20% x 140 = 28 untts
Step 3
Finally, the cash flow forecast can be prepared. There are some
calculations to be made (purchases figures and wages figures) and
these shoulo form part of your answer. The cash sales figures are
transferred from the sales budget. Remember to show negative
figures In brackets. (There are alternative presentations of a cash flow
forecast which you could use.)

BIii i:.DID YOU KNOW?

Cash flow forecast for each of the
It Is worth noting the correct
three months ending December 2020 title for the cash ilow forecast
October November December and the use of 1he word
$ $ s 'enaing' (because tt is about
Receipts: the future) rather than 'ended'
(which woulo relate to the past).
Capital (A) 22 000
Grant (£) 5 000
Sales (from safes budget) 24 000 28 800 38 400
To1aI receip,s
-46
-000
---- - - - -38-400
33 800
--
Payments:
-------------
Machinery (BJ 9000 9000
Purchases of materials' 12 400 12 800 15 600
1Nages· 9920 10 240 12 480
Drawings (F) 2000 2000 2000
General expenses (G) 8000 8000 8000
Total payments 41 320 33040 47080
EXAM TIP
Opening balance (closing 4 680 5440
balance of previous month) rt [s wortl,i cneck.i""g t htit
Net inflow/outflow 4 680 760 (8 680) "'""!:1 "'-'lgtitive fi,g"'res ntive
Closing balance 4 680 5 440 (3 240) bee"" si1ow"" """ brtlck?.ets .

• Calculations:

Purchases of materials Wages

(Production x S100) (C} (Production x $80) (OJ
$ $
October 124 X 100 ; 12 400 124 X 80 ; 9920
November 128x 100 ; 12800 128 X 80 ; 10 240
December 156 X 100 ; 15 600 156x 80 ; 12480
 Practice exam questions

Paper1
1 An employee is paid $20 per hour 1or a 40-hour 4 1Nhich of the following ls not a volun1ary
week. Overtime is paid at time anci a half. What deduction from pay?
is the employee's gross pay In a week when 44 A Donations to charities
no.irs are worked?
B Membership ~ee for social cll.,b
A $800 B $880
C Trade union membersnlp
C $900 D $920
D Social security contribl.lllons
2 An employee is paid $5 for eaci, completed
S Which of t1'e following should not be included In
product that passes a quality check. Tre
a cash flow projl)C:ion?
employee is entttled to a minimum weekly wage
of $1 000. During one week the err,ployee A Owner's drawings
oompleted 21 Oitems, of wnicr 20 failed to pass B Payments to suppliers
the quality check. The employee's pay for the C Credit sales
week Is: D Gran;s
A $950 B $1000
C $1050 D $1150
3 Zachary's anrual salary Is $45 000. He nas a
personal allowance of $5 000. Income tax Is
charged at 20% of taxable pay. Zachary's net
pay Is:
A $45000 8 $40000
C $37000 D $32000

Paper2
1 Calculating gross monthly pay In normal working hours. For the week ended
18 October 2019, Giselle's l ime card was
Maseo ls the manager o' a retail store. His gross
as follows:
annual salary for 2018 was $42 000. In 2019 his
gross annual salary was Increased by 5% on 1he MORNING AFTERNOON EVENING
figure for 2018. Calculate Maseo's gross monthly our our
.
salary for
IN IN OUT IN
Monday 8.00 '2.30 "3.30 4.00 6.00 7.30
a 2018
Tuesday 8.00 12.30 '3.30 4.03
b 2019
Wednesday 8.00 12.30 '3.30 4.04 6.00 8.30
2 Calculating gross pay based on time rates Thu,sday 8.00 12.30 13.30 4.01
Giselle works on the production line in a local Fndav 6.00 12.30 ' 3.30 4.00
factory. Glselle is expeoled 10 work an e1ght-tiour
day and Is paid $28 per hour. Overtime ls paid Calculate Giselle's gross pay for 1he week ended
at time and a quarter. The lunch hour is Included 12 October 2019.
3 Calculating gross pay based on piece rates Calcula;e:
Vernon wori<s full-1ime In a fac1ory. He Is paid a Celiria 's taxable pay
$1 .40 for each product that is accepted. lre b income tax charged on Celina·s annual salary
business operates a minimum wage agreement.
For Vernon this means he must be paid at least c Celina's annual net pay
$800 per week. During tne ,,,eek ended d Celina's monthly net pay.
18 Oc1ober 2019 V61'non's p iecework ticket
showed that he had 662 products ljCCepted. 5 Forward planning
During tne week ended 25 October 2019 his Yasmin Is planning to open a bl>Siness In
piecework ticket was as follows: January 2020. She will be selling a produCi 1hat
Number Number Number will have a selling price of $20 per unit. All sales
produced rejected accepted will be on a cash basis.
Monday 128 6 She nas prepared a forecast of likely sales for
Tuesday 122 tne first three months of trading:
8
Wednesday 121 3 2020 Units

Thursday 119 5 January 500

Friday 121 7 February 600
Totals 710 27 March 650

C.ilcul.ite: She has also prepared forecasts of cash

receipts and payments for each of the three
a Vernon's pay for the week ended
months ending 31 March 2020.
18 October 2019
January February March
b the 1otal number of nems accepted during the
week ended 25 Oc1ober 2019 s $ s
c Vetnon's pay for the week ended Capital 43000
25 October 2019. Introduced
Grant 2000
4 Calculating net pay after statutory
deductions Purchases of 37 000 8000
non-current
Celina's annual gross pay Is $66 000. She Is assets
entiiled to a personal allowance of S9 000.
Payments to 7 000 9000 9000
Income tax is charged at 18% of t(l)(able pay. credit suppliers
In addition, Celina Is required to pay national Expenses 1 200 1300 1 100
insurance (social security} ccntributicns of
5% of gross pay and io make a pension platJ Drawings 900 1000 1 200
oor,tribu1ion of 4% of gross pay (assume these a Prepare a sales budge; for each of the three
are allowable deductions before calculating months ending 31 March 2020.
income 1(1)().
b Prepare a cash flow projection for each o: tne
three months ending 31 March 2020.
c Describe ,he main details you would expecl
to find In tne marketing analysis S6Cllon of
Yasmin's bushess plan.
absorption cowng 17C-1 directors 1<0, 144 partnerships 11, t 24-5, t 32-3
accosntlng 5-8 discounts 25. 26-7 merest on c,awlngs 128-9
accounting concepts 84-5 cllscoJnt>a'lowed ard 1e,celve-d 25 oartnersh,p accocrts 126-7
accountlngcycie 10 dlv,dends 1•0, 143 partnersh p agreemems 125, 129
acco1,.nts payable and accounts receiv,3ble 1.a proposed d"icer,ds 1'4 statement of financial oos,t;on 130- t
acc,ua :s concept 84 cocble-entry pr1nc,ple •0-1, 52-9, 64-5 payroll 13, 179-80
acd 1esrratio 77, 79 plecerate 182
adjustmems 84, 98-101 efficiency 79 statutory deductions t 83
adjJstmer,ts to expenses 86,89 errors 104-8, 110-12, 118 time rate 181
correcting pro~ts 109 volunta1ydeduc1 ons :a,.
aoJ-stmems to Income 86-8. 89 etMcal prlncl~ es of a"ountlng 6
manJfa::tu ng accounts 163 penc I footings 47
AGr./,s (anncal general meetlr9s) i40 ex~enses e6. 89 performance. repo1tlng on 75. 77. 79-81. 147
allocat,on of costs , 71 linar,clal statements 12. 62 pe:ty cash 32-3
apportionment of costs 171 company nnancla 1statements 148-50 oetty cash •,oJcrers 32
appropr,atlon accoum 126-7 1¥ . 152 manufactJrlng acco.r.ts 163 p,e.;e rates t 82
assets, l}lpes of 16 so!e traders 62-3, 70-3 p:ecewo11<t,ckets 179
auolro,s 145 fluctuatlr-g capitals 126 prime cost 161
autho<lsed share caprtal 140, 1"6 folio refe,er,::.es 43 profit for the year 62
prolitaol llty 74-5. 79
balance sheet 12, 14-19,69. 77, 78-9, 146-7, general Jocrnal 34•5 prudence concept 84
152 165 Income statement 66-7 pJrchases boo, 26-7
balancing accounts <6-7 Issue of shares 142
Interpreting entries and oalances 50 genefal reserve 1.44 ratos 74-7
bank reconcl'latlon statements I I 8-2 1 gross and net prolit {or Income) 62, 63 linarr.lal position 76-7
books of o!lglnal entry 22-3, 37, 43-5. 52-9 gross prolit percentage 75. 78 receipts an-d P•Y'nentsaccount 157-8
bJogets 185-9 re::l ...clng~balarx:e method 96. 97
bJslness organlsatons 10-11 mores, 32 reserves lt.4, 147
bJslness olans 186 nco,ne 86-8, 89 reti..m on l:westmen.t 77
,ncorne and expenditure a::.coJrt )2. 151 ren.ms nv11afdS and Ol.twards 65
1

capl•al 140--1 ncomestatement 12 returrs Inwards and ourNards tooks 26.

capital accoJrt 68, 126 bao debts 90 29
capital expenoltue 157 carrege cr.arges 65 revenue expendl:ore 157
can age Inwards ar.d ouv,•ards 65 do Joieentr; for ln·,emor; 6<-5
cash and cred,t transactions 18, 22 joJrnal entries 65-7 sales and prodJCt•on buoge1s 185-{i
casr, at bark and cash n i'and 1• lmhed llab llty companies 144--5 sales book 26-7
cash books 30-3 manufactJrlng accoJnts 165 serlice business~ 68
balanci~g cash oook1 36-7 ratios 74-5. 78 sh.1reholoers 135
cash discounts 25 service businesses 68 shares 140, 142
cash flow projections 185, 187-9 so'e traders 63 share premlt,.im 1£2
cash flow statemert 12 trad ng section 65 sole traders 11, 62-3. 70-3
cheques, dishonoured I I< upoa:ing the capital account 66 sosrce documents 22-3,26-7. 32. 34
clock cards 179 ncome tax 183 orepallng source doccmems 24-5
closing accoJnts ~-9 nd rect costs 161-2 source docJmems for payroll 179
co-operatives 11, 138-9. 153.5 nventory 13, 64-5 standing orders 118
accourm 151-2 Inventory vah.•ai:lon , 75 statement of linanc,al position (balance
capital 1< I rate of Inventory tJrno,er 75. 78 sheet) 12, 14-15
prlr,cloles of co-operat,ve societies 137 ss.ed si'arecap,tal 140, 1<7 classlfieo staternen1 16-17, 69
statement o• financial oosltlon 152 co•operatlv~ 152
consistency con.;ept 84-5 edger ac<.01,nts 4C-2 gsldanceon preparing 15
contra entry 30. 31 . 11 4 debit and credit side 41, 42 lrr,l:ed 'lablltycompanes 1<6- 7
contracts 179 labliltles. l}lpes of 16, t 24 manJfacturlng acco"nts t 65
control accoJnts 113-17 lmlted 'labl!I~; companies 11. 136. 136, partnersh,ps 130-1
control systems 104 148-50 ratios 76-7, 78-9
errors 104-<i advantages and dlsaovar,tages 136-7 trarsact•ons 18-19
corporations 11 anal,slng performance 147 stralgnt-llne r-netrod 96. 97
COSl•plJS pr clrg 170 appropr!a~IO" account J.tt sJspense accocrt 107
costing procedures 17C-5 caoltal 140
costs 161-2. 171 lncone statenem 1.£4-5 technology and accounting t2-t3
calcJlatlng the cost of a un,t of production pubhc and prl•,ate 138 three-colJmn cash book 30-1
163-4 Statement of linar.clal position 146-7 time rates 181
cost cenrres 170. 171 lmlted oartnersh ps 124 time sheets 179
cost of raw matetlals conswmed 161 IQcldll}I 79 trade disco.nts 25. 26-7
-cred;t control 13 transactions IS-'9. 22. 32
manJfacturlng accounts 161, 163-<, 166-9 posting fron tr,e booksof orlgloal en11y
cred t not~ 28 directand ndrectcosts 161-2 <3-5
-credit transfers 118 Income statement 165
currer,c acco1.Jnts 126, 127 transact,on descrlotons 25
statementoflinanclal position 165 mu•,sact,ons and the oouo!e•entry
current rat,o 77, 78-9 mark-up ~ercentage 75. 78 prlnclp'e <0-1
debentcres 141, 1<4-5 matchlr.g concept 84 trial balance 50-1, 104-8
deb ,1 not~ 28-9 mutcal agenc, 12<, 125 true and fair pr·nc pie 85
debts. bad 90 net prolit percentage 75. 78
debts.doubtfJI 91-5 unamlteo 'laol lty t 2<
non•prolit organisat ons i t. 137, 139, 157-8
dep,ec atlon 96-7 voluntary associations 124
direct costs 161 -2 order of IIQuloll}I 15, t 7
dlfect deb~s 118 order of pem>anence 16
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