Accounting Revision Notes

Index
Index ....................................................................................................................................................1
1 Accounting Concepts ..................................................................................................................... 2
2 Accounting in general .................................................................................................................... 4
3 Accounting Cycle: (Documents  Journal  Ledger  Trial Balance) ..................................... 5
4 Accounting Cycle: (Special Accounts & Income Statements) ..................................................... 8
5 Accounting Cycle (Statements of affairs)................................................................................... 16
6 Adjustments ................................................................................................................................. 20
7 Division of Books.......................................................................................................................... 26
8 Errors ............................................................................................................................................ 29
9 Control Accounts ......................................................................................................................... 33
10 Analysis ..................................................................................................................................... 34
11 Accounting terms & Comparisons .......................................................................................... 36
12 Notes & FAQ ............................................................................................................................. 40

Legend:

* is a term that is explained in Section 11: Accounting Terms and Comparisons

 is part of a non-numbered list isn t listed according to a certain criterion)

1) is part of a numbered list (listed according to a certain criterion)

Therefore

Since

^ It is not needed to study the item in detail. It is only required to know little about it.

Note:

If you ever happen to misunderstand a part, please refer to sections

1. Section 1: Accounting Concepts

2. Section 11: Accounting Terms and Comparisons
3. Section 12: Notes & FAQ

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1 Accounting Concepts
Below, are all the accounting concepts and their applications for the syllabus (0452) for the year
2015/2016

Concept Explanation

Business Entity Business and owner have two separate identities

Accounting Period Life of a business is divided into accounting periods (usually years)

Duality
Every transaction has two effects
(Double entry)

Businesses are assumed to stay in existence for the foreseeable future,

Going Concern
otherwise all assets will be valued at *net realisable value

All fixed assets should be recorded at their original cost, since it can be
Historic Cost
verified

Expected loss should be provided for and expected profits are ignored until
Prudence
realised

Expenses of a certain period are matched against incomes of the same

Matching
period to assess net profit or loss

Consistency Treatment of an item shouldn t be changed from one period to the next

Materiality Immaterial items, of low value, are not worth recording as separate items

Profit is only realised when ownership of goods is transferred to the buyer,

Realisation
either via money or the goods itself

Money
Only items of monetary value are recorded in business books
Measurement

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Concept Application



Business Only business transactions are recorded in business books.
Entity Owner s capital is a liability on the business to the owner.



Accounting Comparisons are made b/w different years for same or different business.
Period New financial statements are prepared for each accounting period.

Duality  Transactions are recorded twice under the *double entry system, once on
(Double entry) the credit & debit sides.



Fixed assets are recorded at their original cost.
Going Concern
Stock is valued at the lower of cost or *NRV (due to prudence concept).


Cost of fixed assets is reduced by depreciation to make it realistic
Historic Cost )t s a limitation of final accounts, since comparisons over different times


are hard due to inflation of prices


Provision for depreciation is to provide for loss in value of fixed assets


Prudence Provision for bad debts is to provide for expected bad debts


Stock is valued at the lower of cost or *NRV
*Depreciation is recorded in the period of using the asset, to spread the


cost of it over its useful life
*Provision of bad debts is maintained in the year debts are due to credit


sales in.
Matching Incomes and expenses transferred to the income statement should be
related to their accounting period, thus prepayments are excluded as
they are related to another period, even though they are paid. Same
applies to accruals as they are related to the period when they were


unpaid
Depreciating method for fixed assets should be consistently applied from
one period to the next, as the change in method will make comparison
Consistency
between financial periods impossible. If a change is necessary, a note


should be made to the final account to explain its reasons and effects
A business may consider items of very low value: a pen, calculator, etc an


expense instead of an asset bought for usage
A business may enter all small expenses in one account; sundries or
Materiality

general expenses instead of keeping individual records for each
Office supplies are considered stationery expenses and the unused stock


at year end is transferred to future periods like prepayments
Credit sales are recorded even though unpaid for yet, because goods


were transferred
Realisation
Nothing is recorded when order is placed by customer, as goods weren t
transferred
Money  )tems of importance can t be mentioned in final accounts; efficiency of
Measurement labour

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2 Accounting in general
Accounting is a system businesses apply in order to understand their financial positions and take
decisions on its basis. Accounting relies on a number of concepts & rules which are to be taken
for granted. (See section 1: Accounting concepts before continuing)

First thing to learn about accounting is that, according to the business entity concept, businesses
are considered have standalone entities. Hence, all the transactions we study are viewed from
the business s point of view, who we consider to be a separate person (NOT the owner)

There are two rules that the whole accounting process is based on: (They must always equate)

Basic Accounting Equation:

Assets = Liabilities + Capital See section 12: Notes & FAQ

for reasons behind these
Extended Accounting Equation: categories lying in the
debit/credit sides

Uses of finance Sources of finance

(Debi
Expenses + Assets = Liabilities + Capital + Incomes

Where the Uses of finance are called debit (the business owns them)
Sources of finance are called Credit (the business owes them)

Below, are some examples of each of the categories mentioned in the rules above:

Expenses Assets Liabilities Capital Incomes

Purchases Debtors Creditors Rent
Commission
Wages Land Mortgage Owner s received
Taxes Bank Bank overdraft investment in the Interest received
business
Salaries Equipment Sales
Rent Cash

Sad enough, it isn t that simple. The breakdown of these categories continues as shown in the
table below. Each of these terms are explained in detail on (Section 11: Accounting Terms & comparisons)

Expenses Assets Liabilities Capital Incomes

Capital Expenditure Current assets Short term Capital employed Capital receipts
Revenue Expenditure Fixed assets Long term Working capital Revenue receipts
Running Expenses Capital owned
One-time expenses

Properties of accounting policies:

 Relevance: Financial information are relevant to the business decisions.

 Reliability: Financial information must be: free from error, bias and able to represent events.
 Comparability: Financial reports/statements can be compared with others.
 Comprehensibility: Final reports must be simple to be understood by all users.

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3 Accounting Cycle: (Documents  Journal  Ledger  Trial Balance)
Order of the accounting cycle (first prepared to last):

1) Documents
2) Journal
3) Ledger
4) Trial Balance
5) Income Statement
6) Statement of Affairs (Balance sheet)

Step 1: Documents
Document Usage
^Receipt Used to record cash transactions
^Voucher Used to record petty cash transactions
^Cheque Used to record bank transactions
Issued by buyer to ask seller for allowance to return goods purchased
^Debit Note
on credit (Not used in recording)
Invoice Used to record sales on credit
Credit Note Issued by seller to buyer to accept return of goods. They are recorded.
Statement of A copy of debtor s account at the creditor. )t is sent by the creditor to
account the debtor at each period end.

Examples:
Invoice:
o Offers a cash discount for prompt
payment
o Shows date of document issue
o Shows amount due before and after
trade discount

Credit Note
o Shows date of document issue
o Shows amount due before and after
applying the discount offered on its
purchase

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Step 2: Journal
A book of prime entry in which transactions are recorded for the first time under the double
entry system. Items in the journal are listed according to date (on a daily basis).

Layout of a journal (for profit organisations):

If we are recording the purchase of an asset and the money was transferred by cheque

Date Details Dr Cr
1/1/01 Dr Car 5000
Cr Bank 5000
Car bought by cheque

The journal provides us with a number of useful pieces of information:

 Date of the transaction

 Accounts debited and credited
 Amounts debited and credited
 Narrative explaining the transaction briefly

However, for non-for-profit organisations, the cash book is replaced by the Receipts and
Payments. It is basically a bank account, with the Dr side for money in and Cr side for money out.

Receipts and Payments

Dr (Receipts/Money in) Cr (Payments/Money out)
Date Details $ Date Details $
1/1/01 Balance b/d 4600 16/2/01 Purchase of equipment 4000
2/3/01 Subscriptions 200 15/3/01 Wages 500
Donations 2000 Interest on loan 6000
Gate collections 1245 Bar purchases 1000
Loan 5444 Party band 500
Rent received 788 Rent 500
Proceeds of FA Sale 444 Electricity 540
Bar takings 687 Loan repayment 450
Party tickets 9450
31/12/01 Balance c/d 7228
Total 20718 Total 20718
1/1/02 Balance b/d 7228

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Step 3: Ledger
)t s the book of second entry, In this book, every page contains an account of every item that is
recorded in the journal. Items are transferred from the journal to its respective accounts in the
ledger, following the double entry system. It lists items according to its category

T-account Format

Debit-Nature Account: Bank

Dr Cr
Date Details $ Date Details $
1/1/01 Balance b/d 4600 16/2/01 Rent paid 4000
2/3/01 Commission 200 15/3/01 Wages 500
31/12/01 Balance c/d 300
Total 4800 Total 4800
1/1/02 Balance b/d 300

Note: )ncomes/Expenses accounts are items that can t be brought down, thus instead of the
balance c/d, we write Income statement, and that is the value that goes directly to the Income
statement. There are, however, running expenses and incomes (exception)

Step 4: Trial Balance

The trial balance is a list of all debit and credit balances at a specific date.

Account Dr Cr
Asset account 5000
Liability account 1100
Income account 300
Opening stock 100
Expense account 200
Capital 3900
TOTAL 5300 5300

Notes:

 Trial Balance debit and credit sides must be equal. Otherwise, a *suspense account is opened
at the side with the lower value. The suspense is of the value equal to that missing to equate
both sides. (See Section 8: Errors for details)
 Only the opening stock appears in the trial balance. The closing stock doesn t appear because
it s leftover balance out of goods which were purchased during an accounting period but are
unsold till now. Total purchases are already included in the trial balance. Hence, closing stock
should not be included in the trial balance again. If it is included, the effect will be doubled.
 Bank balance may appear on the credit side in the case of Bank overdraft, but cash can never
appear with a credit balance

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4 Accounting Cycle: (Special Accounts & Income Statements)
In the syllabus 0452, we study 6 cases of ownership, thus 6 cases of income statements and
statements of affairs;
1. Sole trader 2. Incomplete 3. Manufacturing 4. Partnership 5. Non-for-profit 6. Limited
records organisations companies

Step 5: Income Statement:

Case 1 (Sole trader):

The income statement is made to show the business profits and losses for a certain accounting
period. It is divided into two sections: Trading account & Profit and Loss account, in the following
layout:

Note: The sole trader s financial statements are the basic financial statements. Other business
forms financial statements only differ a little from the sole trader s, so make sure to memorise it!

Details $ (balance) $ (Total)

+ Sales 500
Don t forget to calculate
- Sales Returns 100
subtotals!
Net sales $400
- Cost of Sales
+ Opening Stock 10 Expenses written under
+ Purchases 105 Cost of sales are directly
- Purchase returns (20) related to purchases.
- Purchases withdrawn (2) For example; the trader
+ Carriage inwards 60 has to pay for his goods to
+ Packing expenses 50 reach his warehouse. But it
is possible that he charges
+ Warehouse expenses 30
customers for delivery to
- Closing Stock (35) (202) their destination.
Gross Profit/Loss $198
+ Other income Numbers between
+ Commission received 10 brackets are to be
+ Rent received 50 lessened.
+ Bad debts recovered 5
+ Provision for bad debts 2 67 Normally, a sole trader s
(if less than last acc period) main source of income is
- Other Expenses sales. Other incomes are
+ Rent paid 10 less than that value.
+ Salaries & Wages 20
+ Carriage outwards 15 Normally, a sole trader s
+ Provision for depreciation (new) 30 other expenses are more
+ bad debts 25 than his other incomes.
+ provision for bad debts 0 Make sure to give a look to
(if more than last acc period) your totals to check
+ Accrued expenses 50 whether they show that or
- Prepaid expenses (30) (120) not.
Net Profit $145

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Case 2 Incomplete records

Some businesses don t keep an adequate set of accounting records due to inexperience.
Layout of an income statement prepared from incomplete records:

Details $ (balance) $ (Total)

+ Sales 500 Sales = Cash Sales + Credit Sales
- Cost of Sales
Where you will be required to
+ Opening Stock 50 acquire any of these values from the
+ Purchases 105 *Sales Ledger Control Account

- Closing Stock (35) (120)

Purchases = Cash purchases + Credit
Gross Profit/Loss $380 purchases
+ Other income 50 Where you will be required to
- Other Expenses (100) acquire any of these values from the
*Purchases Ledger Control Account
Net Profit $330

Case 3: Manufacturing business:

Manufacturing businesses need an extra step before preparing their income statements. Why so?
As any process has its incomes and expenses, the process of producing finished goods has many
expenses, which would crowd the income statement. Hence, a separate account entitled
Manufacturing is opened and all related expenses are added to that account. Then, the total
Cost of production of finished goods is transferred to the income statement.

The manufacturing account shows the breakdown of the cost of production into:
(Listed in the order of placement in the manufacturing account)
1. Direct Raw Materials
2. Direct Labour
3. Direct Expenses
4. Overhead (Indirect) Expenses
5. Work in progress

Showing the *Prime Cost and the *Cost of production of finished goods in the process.

In a manufacturing company, there are two departments whose expenses we are studying:

1. Factory section
2. Administrational section

Important: That means that the factory and the administrational section share some expenses,
like insurance, rent, electricity, etc. In some cases, you will be required to divide these expenses
on the 2 sections in a certain ratio. Note that the part of the expense related to the factory,
normally, should be significantly higher than the administrational section.

Hence, only factory expenses are written in the manufacturing account. Administrational
expenses go under the title other expenses in the )ncome Statement

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Layout of the manufacturing account:

Details $ $ (Totals)
+Direct Raw Material:
Don t forget: Calculate
+Opening stock RM 5000 subtotals to make it
+Purchases of RM 4000 easier at the end.
+Carriage inwards of RM 300
Don t forget: Writing
- Closing stock of RM (3200) 6100 lessened values b/w
+Direct Labour: brackets is crucial to avoid
+Direct wages 2000 errors when calculating
+Accrued Wages 210 2210 totals

+Direct Expenses:
+Royalties 50
Prime Cost $8360
+Indirect (Overhead) expenses:
+Factory indirect wages 1500 Factory indirect wages
+Factory Insurance 500 include wages for janitors,
+Factory Rent 900 cleaners, security guards,
etc. NOT office wages,
+Depreciation of factory machinery 220
administrators salaries,
+General expenses 310 3430 etc
Cost of Production $11790
+ Opening stock of Work in Progress 900
- Closing stock of Work in Progress (500) 400
Cost of Production of Finished Goods $12190

Layout of the manufacturing business’s income statement:

Details $ $(Totals)
+ Sales 51600 Normally, manufacturing
- Cost of Sales: businesses don t
purchase finished goods.
+Opening Stock of finished goods 20000
(owever, it s possible
+Cost of production of finished goods 12190 that businesses fail to
+Purchases of finished goods 3000 provide enough finished
-Closing Stock of finished goods (1000) (34190) goods. Hence, they
Gross Profit/Loss $17410 purchase finished goods
from other businesses.
+ Other Income:
+Commission received 500
- Other expenses:
+ Office rent 800 As seen in the example,
+ Administrational salaries & wages 1200 expenses and parts of
+ Office Insurance 600 expenses related to the
administrational section is
+ Carriage outwards 600
put under other expenses
+ Bad debts 450
+ Advertising 900
- Prepaid office rent (300) (4250)
Net Profit/Loss $13660

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Case 4: Partnership

A partnership is defined by the Partnership Act 1890 as a relationship as the ownership of a

business which exists between two or more persons (2  20 for normal businesses, 1  10 for banks) who carry the
business with the intent of gaining profit.

Between partners, there has to be a partner agreement that defines general terms. However, in
the case of absence of a partner agreement, certain rules laid down by the Partnership Act 1890
are presumed to apply:

 Profits are to be shared between partners equally

 There are no salaries for any of the partners
 There is no interest on capital
 There is no interest on drawings
 Partners get only 5% interest of loans per annum

Partnership also means that there are special accounts that are made in order to prepare an
income statement and a statement of affairs and these are:

1. Appropriation account
2. Drawings account for each partner
3. *Capital account for each partner (We study only the fixed capital account case)
4. *Current account (because capital account is fixed)

Before starting, we can say that a partner s net share from profits can be calculated using this
rule:
Share of Profits = Interest on capital + Salary + Remaining share of Profit – Interest on drawings

Layout of an appropriation account:

Details $ $(Totals)
Net profit 14000
+ Interest on Drawings
Hummels 5000
Sanches 10000 15000
- Interest on Capital
Hummels 5000
Sanches 3000 (8000)
- Interest on Loans
Hummels 1000
Sanches 2000 (3000)
- Salary
Hummels 1000
Sanches 0
Remaining profit 17000
- Profit Share
Hummels 12000
Sanches 5000 (17000)

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After appropriation, the current accounts and capital accounts are prepared for the partners.

Layout of the capital account:

Hummels Capital account

Dr Cr
Date Details $ Date Details $
31/12/01 Balance c/d 32000 1/1/01 Balance b/d 20000
15/3/01 Bank 12000
Total 32000 Total 32000
1/1/02 Balance b/d 32000

The capital account only includes the case of additional capital. (NO DRAWINGS) Thus, a current
account is opened for each partner, in order to view the changes occurring to each partner s
capital due to the appropriation of profits.

Layout of the current account:

Partners Current account

Dr Cr
Date Details $(S) $(H) Date Details $(S) $(H)
1/5/01 Drawings 40000 10000 1/1/01 Balance b/d 50000 30000
31/12/01 Interest on Drawings 10000 5000 15/3/01 Bank 0 12000
Rent received 0 300 31/12/01 Rent 5000 0
Balance c/d 10000 40000 31/12/01 Salary 0 1000
31/12/01 Profit Shares 5000 12000
Total 60000 55000 Total 55000 55000
1/1/02 Balance b/d 10000 40000

As noticed, there won t be any difference between a sole trader and a partnership-led company.
However, there may be one or more items that are related to partnership that can be present in a
partnership-led company s income statement. (ere s a sample:

Details $ $(Totals)

+ Sales 20000

- Cost of Sales 11000

Gross Profit 9000

+ other incomes: It is possible that a partner

can rent a warehouse/shop
+ rent received from Hummels 300 from the business.

- other expenses:
It is also possible that the
+ rent paid to Sanches 5000 business rents a
warehouse/shop from a
+ Interest on loan 3000 (8000) partner.

Net profit 1300

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Case 5: Non-for-profit organisations

Non-for-profit organisations differ from other organisations as they don t seek profit. They
provide services with the intention of social contribution.
(See difference between profit and non-for-profit organisations in Section 11: Terms and comparisons section)

They don t have a trading account. (ence, their other incomes have to increase to match their
expenses and maybe have a bit of surplus to allow for development. The means we study for this
purpose are the subscriptions and the bar.

Note: )t s disallowed to write more than one entry for the same item in the )ncome Expenditure
statement. For instance, you are not allowed to write the ticket sales of a party in the incomes
and expenses of the party in the expenses section. Therefore, all workouts to calculate nets are
made OUTSIDE of the income expenditure statement.

Layout for subscriptions account:

Subscriptions (Credit natured)

Dr Cr
Date Details $ Date Details $
1/1/01 Balance b/d arrears 460 16/2/01 Balance b/d in advance 5000
31/12/01 Income Expenditure 6260 31/12/01 Bank 200
Cash 4000
Balance c/d in advance 3000 Balance c/d in arrears 520
Total 9720 Total 9720
1/1/02 Balance b/d arrears 520 Balance b/d in advance 3000

The value of the Income Expenditure is the value that will go under Incomes in the Income
Expenditure statement.

Another account we study is the bar s income statement:

Details $ $(totals)
+ Bar Sales 5000
- Bar Cost of Sales
+ Bar opening stock 500
+ Bar purchases 1700
- Bar closing stock (200) (2000)
Bar Gross Profit 3000
+ Other incomes
+ Discount Received 50
- Other expenses
+ Bar wages 100
+ Bar rent 300 (400)
Bar Net Profit/Loss 3650

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The Income Expenditure account layout:

Details $ $(Totals)
+Incomes:
 Subscriptions Please note that you re not allowed
 Bar Net Profit (or loss) to include more than one entry for

 Event Net Profit (or loss)

the same item. Hence, all the entries

 Gain on Disposal (or loss)

must be NET.

 Gate collections
 Rent received (incomes)
-Expenses:
 Depreciation – Asset
 Bar Net loss (or profit)
 Event Net loss (or profit)
 Loss on disposal (or profit)
 Interest on loan
 Electricity
Take care of the differences in the

 Rent
names between the for-profit and
the non-for-profit organisations. For
 Accruals reference, refer to Section 11: Terms
and comparisons
- Prepayments (expenses)
Surplus/Deficit

Case 6: Limited Companies

Limited companies differ from other types of companies in many ways:

 Capital: (Actual capital/Issued capital) = Number of shares x Nominal Value of the share
 Profits: Not all the profit is distributed, as:
1. Some of the profit is kept as general reserves
2. *Interim dividends are distributed according to the directors agreement
3. The rest is kept as *Retained Profit
See section 11: Terms and comparisons for the
difference between ordinary and preference shares
How to calculate dividends?

There are three ways to calculate dividends depending on the given information;

 �ℎ × � � ℎ ×%
 �ℎ � ×%

See section 12: Notes & FAQ for types of preference
shares
�ℎ × � � ℎ
Where the Share capital = �ℎ × � � ℎ

Till here, we ve acquired all the info we need to prepare an income statement. After the
preparation of the income statement, the company will be required to prepare an Appropriation
account or a Statement of Changes in Equity

Note: interim = paid

Proposed = not yet paid We don t record ordinary shares proposed dividends in financial statements

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Layout of an income statement of a limited company:

Details $ $(totals)
+ Sales 100000
- Cost of Sales (60000)
= Gross Profit 40000
+ other incomes: 10000 Items in the finance
- other expenses cost section include
the full balance related
Directors *Remuneration 2000 to the year ended. That
means that they
*Finance costs:
include (paid + accrued
1.Interest on Debentures 4000 expenses)

2.Interest on Bank overdraft 5000

3.Interest on Loans 7500
4. Redeemable preference share dividends 3500 (20000)
= Net Profit 30000

The next 2 special accounts are to be prepared after the income statement. They are very similar
and act as a means to calculate retained profits/change in capital.

Appropriation account

Details $ $(totals)
Profit of the year less finance costs 30000
- General reserve 5000
- Ordinary Dividends PAID (interim) 3500 (8500)
- Retained Profit/Loss (15000)
+ Retained Profit/Loss b/d 10000
= Retained Profit/Loss c/d 16500

Layout of the Statement of Changes in Equity:

Share capital General Reserve Retained Profit Total

Balance b/d 50000 3000 10000 63000
New Ordinary shares issued 2000 2000
Profit for the year 30000 30000
Ordinary dividend paid (3500) (3500)
Transfer to general reserve 5000 (5000) -
Balance c/d 52000 8000 31500 91500

As noticed:

 New shares issued only affect share capital

 Profit for the year affects only the retained profit
 Interim dividends paid only affects the retained profit
 Transfers to the general reserve affect the general reserve & retained profits

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5 Accounting Cycle (Statements of affairs)
In this section, we continue what we ve started in the previous section and finally end the
accounting cycle. We are going to prepare the statements of affairs/balance sheets for the 6
different cases of businesses in the 0452 syllabus

Balance sheets rely on the basic accounting equations, that Assets = Capital + Liabilities
Note: Numbers mentioned in this section do not relate to those in the previous section

All balance sheets are the same in layout, except for the businesses with incomplete records.
They only differ in the Financed by section.

Case 1: Sole trader

Balance sheet at 31/12/01 $ $(totals)

Non-Current (Fixed) Assets:
+ Land/Buildings 50000
+ Machinery 35000 Non-current assets have not to
be ordered. (owever, it s better
+ Motor Vehicle 20000 to order them from largest value
+ Equipment 15000 to the lowest
+ Good will 4680
+ Patent Right 3000
+ Trademark 2750 130430
Current Assets
+ Stock 6000
+ Debtors 5000 Current Assets are ordered
according to liquidity. They are to
+ Prepaid expense 1200 be ordered from the least liquid;
+ Accrued income 0 Stock, to the most; cash
+ Bank 6500
+ Cash 4000 22700
= Net Assets 153130
Financed By:
Capital:
+ Opening Capital 100000 Goods withdrawn can be merged
with Drawings. If not, they can
+ Net Profit/Loss 20000 be separately presented as
- *Drawings (10000) shown as lessening the capital
section
- Goods withdrawn (870) 109130
Short Term (Current) Liabilities: Current Liabilities are liabilities
+ Bank overdraft - that are due in the year following
the year ended. Beware in the
+ Creditors 5000
case of loans as they are
+ Loans due in less than 1 year 9000 14000 normally due in longer periods
Long Term (Non-Current) Liabilities:
+ Loan 20000
+ Mortgage 10000 30000
=Total Financed by 153130

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Case 2: Incomplete Records

Businesses with incomplete records have different statements of affairs. They prepare an
opening and closing statement of affairs where they are used to calculate the capital at the start
and at the end of the year.

Added to that, the aim from their statement of affairs is to calculate the capital, unlike other
businesses whose statements of affairs are used to present the values of items and prove the
basic accounting equation

Layout of a statement of affairs prepared from incomplete records:

Statement of affairs at 31/1/01 $ $(totals)

+ Fixed assets:
+ Land/Buildings 50000 Businesses with incomplete
records are usually small
+ Machinery 4200 24200
businesses, so the values for
+ Current Assets their items are relatively
+ Stock 3000 smaller than other businesses.
+ Debtors 5000 Just beware of that in case you
miscalculated a number to a
+ Bank 2000
larger value ;)
+ Cash 15000 25000
- Current Liabilities
+ Creditors (5000)
- Non Current Liabilities
+ Loan (12000)
+ Mortgage (6000)
= Capital 26200

It is possible that you are given values from a capital account and are required to find the capital
using a capital account or via direct calculations

Direct Calculation: � � � +� � � � + � � − � = � �

Capital Account:

Capital Account
Dr Cr (Capital is of a credit nature)
Date Details $ Date Details $
1/5/01 Drawings 1/1/01 Balance b/d
31/12/01 Net Loss 23/9/01 Additional Capital
Balance c/d 31/12/01 Net Profit

To calculate any value in the table, just make sure to make use of the concept that Dr = Cr, but
beware of the terms (at the start = b/d & at the end = c/d)

Marouane Mokhles 17 | P a g e
Case3: Manufacturing companies

Manufacturing companies balance sheet doesn t differ at all from the sole trader. The only
difference is that the inventory item will be broken down into: (Arranged according to liquidity)

1. Stock of raw materials

2. Stock of Work in progress
3. Stock of finished goods

Example:

Balance sheet at 31/12/01 $ $(totals)

+ Fixed assets: 250000
+ Current Assets
+ Stock of Raw Materials 60000
+ Stock of Work in Progress 20000
+ Stock of Finished goods 8000
+ Debtors 90000
+ Bank 60000
+ Cash 30000 268000
Net assets 518000
Financed by:
Capital 400000
Current Liabilities 50000
Non Current Liabilities 68000
Total Financed by 518000

Case 4: Partnership

Like other businesses, their balance sheet only differs a bit from the sole trader s according to
their special accounts.

Layout of a balance sheet of a partnership company:

Balance sheet at 31/12/01 $ $(totals)

+ Fixed assets: 50000
+ Current Assets 30000
Net assets 80000
Financed by:
Capital - Hummels 30000
Current - Hummels (5000)
Capital – Sanches 20000
Current – Sanches 5000 50000
Current Liabilities 15000
Non Current Liabilities 15000
Total Financed by 80000

Marouane Mokhles 18 | P a g e
Case 5: Non-for-profit organisations

Nothing different. In the case of non-for-profit organisations, however, we must remind you that
there should not be 2 entries in the financial statement for the same item, unless necessary.

Layout of non-for-profit organisations’ balance sheet:

Balance sheet at 31/12/01 $ $(totals)

+ Fixed assets:
+ Club house 60000
+ Land 80000
+ Equipment 15000 155000
+ Current Assets
+ Bar inventory 3000
+ Bar debtors 1200
+ Accrued income 600
+ Prepaid expense 480 5280
Net assets 160280
Financed by:
+ Accumulated fund (opening) 100000
+ Surplus/Deficit 3000 103000
Current Liabilities 50000
Non-Current Liabilities
+ Accrued expense 1000
+ Bank overdraft 5500
+ Prepaid income 780 7280
Total Financed by 160280

Case 6: Limited Companies

Balance sheet at 31/12/01 $ $(totals)

+ Fixed assets:
+ Land 90000
+ Machinery 65000
+ Investments 150000 305000
+ Current Assets 260000
Net assets 565000
Financed by/Capital & Reserves
+ Ordinary Share Capital 480000
+ Preference Share Capital 20000
+ General Reserve (total) 20000
+ Retained Earnings (c/d) 30000 550000
Current Liabilities
+ Debentures 3000
+ Loans 2000 5000
Non-Current Liabilities
+ Accrued interest on debentures 2000
+ Proposed preference dividend 8000 10000
Total Financed by 565000

Marouane Mokhles 19 | P a g e
6 Adjustments
)n this section, we ll be studying the adjustments that occur at the end of the accounting year.
These adjustments are:

1. Provision for 2. Provision for bad 3. Prepayments & 4. Withdrawal of

depreciation debts Accruals goods

Added to these adjustments, we re going to study the cases of Disposal & Stock Valuation as part
of these processes includes adjustments of accounts at the end of the accounting year.
Refer to section 12: Notes and FAQ for the
Note: All provision accounts are credit natured! reasons behind the end of year adjustments

1: Provision for *Depreciation

Depreciation is the amount of the asset used up from a fixed asset. According to the prudence
concept (mentioned in section 1: Accounting terms), we provide for the expected loss from the value of the fixed
asset.

There are many ways to calculate depreciation. However, in the syllabus 0425, there are only 3
ways to calculate depreciation:

 Straight Line
 Reducing Balance Method / Diminishing Balance
 Revaluation

1.1: Straight Line Method

ℎ −�
Depreciation per year = �
or Total Depreciation = Cost – Scrap Value

Or Depreciation per year = × � � %

In this method, the depreciation per year is constant regardless the basis on which the asset is
used.

1.2: Reducing Balance Method

Depreciation per year = � × � � %

Where the Netbook Value = Original cost of the asset – Total depreciation of the previous years

In this method, the depreciation per year is variable and depends on the Net Book value.

1.3: Revaluation Method

Total Depreciation = � � � − � ℎ ℎ �

This method depends entirely on the valuation of the asset at the end of the accounting period.

(You can find a comparison between the different methods of depreciation in Section 11: Accounting Terms and Comparisons)

Marouane Mokhles 20 | P a g e
Step 2: How to record depreciation?

To record depreciation, an account is opened under the name of *Provision for Depreciation. This
account is called a contra account and it is opened to lessen the account of a fixed asset account

Journal entry: Dr Income Statement

Cr Fixed Asset

Provision for depreciation of Fixed asset

Dr Cr (Credit Natured) Remember that the
Date Details $ Date Details $ adjustment happens at
1/1/01 Balance b/d 4000 the end of the year. The
31/1/01 Balance c/d 5000 31/1/01 Income Statement 1000 dates of Income
statement is at the end
Total Total
of the year
1/1/02 Balance b/d 5000

As noticeable from the account above:

 Provision for depreciation is credit natured, as it is used to lessen a fixed asset (debit-
natured).
 The value that is transferred to the income statement is only that of the year ended.

In the Income Statement, it goes under Other Expenses:

- other expenses:
+ Provision for 1000
depreciation of Machinery

In the balance sheet, it goes under the fixed asset, directly lessening it.

Fixed Assets
+ Machinery at cost 10000
- Total provision for (5000) 5000
depreciation

2: Provision for bad debts

Bad debts are losses that occur when a debtor fails to pay his debts. As you ve thought, it s not
always possible to predict the occurrence of this incident. Thus, there are three cases related to
bad debts that we study. Each of these has their own account:

1) Bad debts written off (at any time of the year)

2) Provision for Bad debts (happens at the end of the year)
3) Bad debts recovered (at any time of the year)

Bad debts are written off if the debtor fails to pay his debts within the pre-set period (Case 1).
However, companies tend to calculate percentage of bad debts from the total balance of their
debtors (Case 2). Sometimes, debtors are able to pay their debts or part of them after they were
written off. (Case 3)

Marouane Mokhles 21 | P a g e
Case 1: Bad Debts written off

First of all, writing off a bad debt is the lessening the value of the bad debt from the debtor, and
increasing the value of the bad debts.

Initial transaction (Sales) Writing off the bad debt

Dr Debtor X 2000 Dr Bad debts 2000
Cr Sales 2000 Cr Debtor X 2000

As noticeable:

 There has to be a credit sales transaction for a debtor to exist in the books
 Writing off the bad debt includes the whole value of the initial transaction, unless the debtor
has paid part of it
 The Bad debts account is Debit-natured

Remember: Written off bad debts are not an adjustment that happens at the end of year!

Bad debts account:

Bad debts written off (expense) As bad debts are an

Dr (Debit Natured) Cr expense, this account
Date Details $ Date Details $ is closed by
transferring the
15/2/01 Debtor X 2000 15/2/01 Income Statement 2000
balance due to the
Total 2000 Total 2000 income statement
directly
Case 2: Provision for bad debts

This is the adjustment we perform at the end of the year, to try and predict how much of our
debtors balance will be bad debts. (ence, there are many ways to calculate this, but we only
focus on 2 in the 0452 syllabus:

 Provision of bad debts as a percentage of debtors, based on past experience

 Investigating debtors to predict whose debt will be bad

Provision for bad debts (expense case)

Dr Cr (Credit Natured)
Date Details $ Date Details $
1/1/01 Balance b/d 1500
31/1/01 Balance c/d 2500 31/1/01 Income Statement 1000
(If expense)
Total Total
1/1/02 Balance b/d 2500
Provision for bad debts (Income)
Dr Cr (Credit Natured)
Date Details $ Date Details $
31/1/01 Income Statement 1000 1/1/01 Balance b/d 1500
(If expense)
31/1/01 Balance c/d 500
Total 1500 Total 1500

Marouane Mokhles 22 | P a g e
As noticeable from the two accounts above:

 Income statement value is used to lessen/increase the provision for bad debts
 If Income statement is on Cr side, then the value is an expense as it increases the provision.
 If Income statement is on Dr side, then the value is an income as it decreases the provision.

In the income statement, it goes under Other expenses if it has increased (compared to last year)

- other expenses:
+ Provision for bad debts 1000

Or in the other incomes if decreased (compared to last year)

+ other incomes:
+ Provision for bad debts 1000

In the Balance sheet, it goes under Debtors, directly lessening the total balance of debtors

Current Assets
+ Debtors 10000
- Provision for bad debts (1000) 9000
(new)
= Net Debtors

Case 3: Bad debts recovered

In this case, there are two options for an accountant to take:

1) Adding the debt once again to the debtor s account, then recording the payment of that
debt (2 transactions)
2) Leaving the debtor s account closed, the accountant could just record payment of cash as
a recovery for a bad debt, without mentioning the debtor paying (1 transaction)

Case 1 Journal Entry Case 2 Journal entry

Dr Debtor X Dr Bank/Cash
Cr Back debts recovered Cr Bad debts recovered
Dr Cash/Bank
Cr Debtor X

Layout of the bad debts recovered account:

Bad debts recovered

Dr Cr (Credit Natured)
Date Details $ Date Details $
31/12/01 Income Statement 2000 15/2/01 Bank/Cash 2000
Total 2000 Total 2000

Marouane Mokhles 23 | P a g e
3: Prepayments & Accruals
There are 4 cases to be studied in this section:

1) Prepaid Expense (becomes an asset)

2) Accrued expense (Liability)
3) Prepaid Income (becomes a liability)
4) Accrued Income (Asset)

The following two tables illustrate the hardest situation you could encounter

Expense account
Dr (Debit-Natured) Cr
Date Details $ Date Details $
1/1/01 Balance b/d (prepaid) 1000 1/1/01 Balance b/d (accrued) 2000
31/12/01 Income Statement 2000 Bank 1000
Balance c/d (accrued) 500 Balance c/d (prepaid) 500
Total 3500 Total 3500

Income account
Dr Cr (Credit Natured)
Date Details $ Date Details $
1/1/01 Balance b/d (accrued) 2000 1/1/01 Balance b/d (prepaid) 2000
Bank 1000 31/12/01 Income Statement 500
Balance c/d (prepaid) 500 Balance c/d (accrued) 1000
Total 3500 Total 3500

4: Withdrawal of goods:
An owner may withdraw goods at will. These withdrawals are added to the *drawings account

Journal entries:

Dr Drawings
Cr Purchases

It is negated from purchases in the income statement and added to the drawings in the balance
sheet or shown on its own as negating the capital.

+ Purchases 60000
- Purchases withdrawn 1000

+ Opening Capital 50000

- Drawings (10000)
- Purchases withdrawn (1000) 39000

Marouane Mokhles 24 | P a g e
Stock Valuation
Briefly, to valuate stock, we tend to choose the lowest of:

 Cost of the stock

 Net Realisable value

Where the cost of the stock = Cost of purchase + direct costs of purchase

Net realisable value = Selling Price – Selling Expenses

You are normally given a table like the following:

Item # of units Cost per unit Net realizable Value per unit Total
A 100 10 7 700 (NRV)
B 200 20 25 4000 (Cost)

You will be then asked for the total. Here, we deal with each item individually. Hence, the answer
for item A s total should be 7 , not and that of B is , not , as they are the lower
values

Disposal
The *disposal account is only opened when a fixed asset is to be disposed of. When disposing of a
fixed asset, we must cancel all its records and record the revenue that resulted from its disposal,
if present

Steps of disposal:

1) Cancelling the cost of the disposed fixed asset

2) Cancelling the provision for depreciation of the disposed asset up to that date
3) Recording the debited account in value for the disposed-of asset
4) Recording the gain/loss made at the disposal of the asset

Journal Entries:

Cancelling Provision Recording debited

Cancelling cost Recording gain/loss
for depreciation account
Dr Provision for Dr Income Statement (if loss)
Dr Disposal Dr Cash/bank/debtor
depreciation Cr Disposal (if loss)
Dr Disposal (if gain)
Cr Asset Cr Disposal Cr Disposal
Cr Income Statement (if gain)

Where each of these transactions has its own effect on the financial statements.
As noticeable:

 Disposal account is included in the 4 transactions

 Only one value goes to the income statement under the name of Disposal
 3 accounts only are concerned; Fixed asset account, Provision for depreciation account,
Disposal of the asset account
 Only the gain/loss is transferred to the income statement

Marouane Mokhles 25 | P a g e
7 Division of Books
As a business expands, the load on the accountants due to the increase of transactions increases.
These businesses, then, decided to divide their books according to the transactions each book
holds. It was then agreed that the journals are to be divided into 6 primal entry books, while the
ledger will be divided into 3 secondary entry books.

Types of journals and ledgers:

Journals: Ledgers:

 General Journal  General (Nominal) Ledger

 Sales Journal  Sales Ledger
 Sales returns Journal  Purchases Ledger
 Purchases Journal
 Purchases returns Journal
 Cash books

Journals and the transactions they contain:

Journal Transactions it holds Documents used
 Correction of errors
 Provision for depreciation/bad debts
 Bad debt expenses
General Journal
 Purchase of Fixed assets on credit
Sales Journal Sales on credit Invoices issued
Sales returns Journal Sales returns on credit Credit notes issued
Purchases Journal Purchases on credit Invoice received
Purchases returns
Purchases returns on credit Credit notes received
Journal
Cash Books Any transaction including cash/bank Receipts & cheques

Sales Journals, Purchases Journals and the returns Journals have the following format:

Sales/Purchases/Sales returns/Purchases returns Journal

Date Document # Details $
5/1/01 Debtor/Creditor
6/1/01 Debtor/Creditor
31/1/01 Total

As noticeable:

 Document # is included in the journal

 A total is required at the end of the journal
 No narrative is required

Marouane Mokhles 26 | P a g e
Cash Books:

As bank/cash transactions are the most occurring, the cash book was divided into:

 Two column cash book

 Three column cash book
 Petty Cash book

It is not required for every business to keep the three, but each of them has its use.

2 column Cash book:

It is called the 2 column cash book as it calculates the balances for the bank and cash transactions

2 Column Cash book

Date Details Cash Bank Date Details Cash Bank

31/1/01 Balance c/d

Total Total
1/2/01 Balance b/d

3 Column Cash book

It is called the 3 column cash book as it includes cash, bank and discounts balances

2 Column Cash book

Dr Cr
Disc Disc
Date Details Cash Bank Date Details Cash Bank
allowed received

31/1/01 Balance c/d

Total Total
1/2/01 Balance b/d

As noticeable from the laid above layouts:

 The only difference between the 2 column and the 3 column cash books is that discounts are
included in the 3 column cash book
 Both books contain the balances for cash and bank

Important Note: Discounts are incomes/expenses. Hence, they do NOT get carried/brought
down to the next period. Their totals are transferred to their account in the general ledger.

3: Petty Cash book

It is kept under the *imprest system. It is used to record small payments or receipts. The
document used to record in the Petty cash book are vouchers.

It has extra columns in the expenses section. These columns are called analysis columns. They are
used to provide totals of each expense to be posted to their respective expense account. It also
provides better control over spending

Marouane Mokhles 27 | P a g e
Layout of the petty cash book:

Petty Cash Book

Dr Cr
Date Details $ Date Details $ Clean Office Travel Postage
1/2/01 Balance b/d
Cash
Balance c/d
Total 30/2/01 Total
1/3/01 Balance b/d
Cash

As noticeable:

 Imprest value is restored at the end of each month with the transaction:
Dr Petty Cash
Cr Cash
 At the end of each month, there is supposed to be some remainder of the imprest amount
 All expenses totals are calculated aside from Dr and Cr totals

Ledgers and what they contain

General Ledger )t s a book that contains all non-personal accounts (Any accounts without
names)
Sales Ledger Sales ledger contains debtors accounts
Purchases ledger Purchases ledgers contain creditors accounts

Important notes:

 Sales and Purchases ledgers only contain accounts of debtors and creditors
 Purchases, Sales, Purchases returns, sales returns accounts are posted in the general
ledger

Marouane Mokhles 28 | P a g e
8 Errors
Throughout the accounting cycle, errors can occur. )n this section, we ll study most types of
errors and how to tackle them.

Errors can be classified into two

types:

1. Errors that affect the trial

balance
2. Errors that don t affect the
trial balance

Errors affecting Trial Balance Errors not affecting Trial Balance

 Overstatement/Understatement of an  Error of Omission

account s balance 

Error of Principle
Error of addition in the Trial Balance 

Error of Commission
Single Entry 

Error of Original Entry
Wrong Side of an account s balance  Error of Compensation
 Error of Complete Reversal

First of all, we’ll study the Errors that affect the trial balance:

For an error to affect the trial balance, it has to form some sort of deficit in the equation that
says:

Debit side = Credit Side

Thus making a side less than the other. However, as the equation is impossible not to equate, we
open an account entitled *Suspense so as to equate the sides until the errors are discovered. The
suspense account has no nature. It is opened on the side with the deficit and is
decreased/increased through journal entries that fix the errors.

For instance; Kimmich s trial balance failed to agree. The credit side was less than the debit side
by $5000, whereas the following were discovered.

 Salaries were underestimated by 5000

 Purchases journal was overcasted by 3000
 Commission received of 5000 was debited, but wasn t credited to Neuer
 The total balance of commission paid of 1000 was posted on the credit side in the Trial
balance

Answer: First of all, the suspense account is opened.

Suspense account
Dr Cr
Date Details $ Date Details $
Difference on Trial Balance 5000
Total Total

Marouane Mokhles 29 | P a g e
Then, we prepare the journal entries to correct our errors:
First error:

First Error Second Error Third Error Fourth error

Dr Salaries 5000 Dr Suspense 3000 Dr Suspense 5000 Dr Suspense 2000
Cr Suspense 5000 Cr Purchase Journal 3000 Cr Neuer 5000 Cr Commission paid 2000

Explanation:

1 - For the first error, we needed to increase salaries. Salaries being an expense of a debit nature,
it increased on the debit side, thus increasing also the suspense. (Effect = Suspense increased by
4000)

2 - For the second error, we needed to decrease purchases journal total. The purchases journal
total being an expense of a debit nature, it was decreased on the Credit side, thus decreasing
suspense (Effect = Suspense decreased by 2000)

3 – For the third error, we needed to credit Neuer for his payment of commission. Thus, since an
increase on the credit side happened, an equivalent decrease in the Suspense account had to be
made. (Effect = Suspense decreased by 5000)

4- For the final error, the commission paid was debited, despite the fact that it s an income. Thus,
to correct that error, we had to cancel the debited balance, then credit the balance once again.
Since both steps have the same effect and same procedure, we credited commission paid by
2000. (Effect = Suspense decreased by 2000)

After all the errors have been corrected, the suspense account is adjusted:

Income account
Dr Cr (Credit Natured)
Date Details $ Date Details $
31/12/01 Purchases Journal 3000 31/12/01 Difference on Trial Balance 5000
Neuer 5000 Salaries 5000
Commission paid 2000
Total 10000 Total 10000

However, it is possible that a balance remains on the Suspense account if not all the errors were
corrected. In this case, it will be shown on the balance sheet on the current assets if it was on the
debit side, or on the current liabilities if it was on the credit side.

Marouane Mokhles 30 | P a g e
Errors not affecting Trial Balance:

Errors that don t affect the equation of the trial balance, logically, affect both sides of the trial
balance. To do so, the error must increase/decrease both sides with the same amounts. The
following are the errors and their explanation.

Omission Completely overlooking a transaction/document

Principle Posting a transaction to the wrong account of the same nature
Posting the transaction to the correct type of account, but incorrect
Commission
name
Original Entry Posting a transaction with a wrong amount
Compensation Two errors of the same value cancelling each other s effect
Complete reversal Posting a transaction to the wrong side of account

Example: A trader s trial balance for the year ended / / was made and then, the following
errors were discovered, as they were not revealed by the trial balance:

 Goods bought of credit from Lewandowski for 9000 was overlooked

 Machinery for 8000 bought from Boateng Ltd debited to the purchases account
 Sales on credit were made to Lahm, but the amount of 5000 was debited to Lewandowski
 Purchase of goods from Ulreich for 5000 recorded as 3000
 Purchase ledger was under-casted by 1000, commission paid was overcasted by 500 and the
commission received was undercast by 500
 Purchase of motor vehicle by credit from Costa for 70000 debited to Costa and credited to
Motor Vehicle

Correction of errors Effect on Net Profit

1) Dr Purchases 9000 1) Decreases NP by 9000
Cr Lewandowski 9000 (increase in purchases  decrease in gross profit)

2) Dr Machinery 8000 2) Decreases NP by 8000

Cr Purchases 8000 (increase in purchases  decrease in gross profit)

3) Dr Lahm 5000
3) No effect
Cr Lewandowski 5000

4) Decreases NP by 2000
(increase in purchases  decrease in gross profit)
4) Dr Ulreich 2000
Cr Sales 2000

5) Dr Purchases 1000 5) Increase NP by 500

Cr Commission paid 500 (Increase in Purchases by 1000  increase in other incomes by 500)
Cr Commission received 500
6) No effect
6) Dr Motor Vehicle 140000 (Debtor  Creditor = Asset  Liability)
Cr Costa 140000

Marouane Mokhles 31 | P a g e
Bank Reconciliation
Businesses keep track of their bank accounts through their Bank account in their ledgers.
However, banks send statements of accounts to businesses periodically.

(owever, it happens that the balance in the business s books is not equal to that of the bank
statement, thus both accounts have to be matched against each other, to update the cash book
with remaining entries, and discover dishonoured cheques.

Items in the cash book, but may not be shown in the bank statement:

 Deposit on transit: Cheques received by business, but not yet banked

 Unpresented cheques: Cheques sent by the business, but not yet presented to the bank for
payment

Items in the bank statement that may not be shown in the cash book:

 Credit Transfers: Collections from debtors

 Direct Debit: Payment to creditors
 Standing orders: payments on regular basis
 Bank Charges for their services
 Bank interest: interest on bank deposit
 Dishonoured cheques

Steps to find the correct balance:

1: Adjust the Cash book balance

Updating cash book

Dr (Money in) Cr (Money out)
Date Details $ Date Details $
1/1/01 Balance b/d 31/1/01 Bank charges
(balance of cash book)
31/1/01 Bank interest Direct Debit
Credit Transfers Dishonoured Cheques
Standing orders
Balance c/d
(Updated CB Bank Balance)

2: Readjust the bank statement balance with the updated Cash book bank balance

Bank Reconciliation Statement

Balance in the bank statement
+ Deposit in Transit
+ Debtor 1
+ Debtor 2
- Unpresented Cheques
+ Creditor 1
+ Creditor 2
= Updated Cash book Bank Balance

Marouane Mokhles 32 | P a g e
9 Control Accounts
As per their naming, control accounts are made to provide more control over debtors and
creditors using their ledgers, the sales and the purchase ledgers respectively.

First: Sales Ledger Control Account

The account is basically debit natured. It is started with the summation of the debit balances
from the Sales ledger at the start of the accounting period. Then, items that increase debtors
balances in the business s books are kept on the debit side, while items that decrease debtors
balances are kept on the credit side. The balance c/d should be equal to sum of debit balances in
the Sales ledger at the end of the month

For example: The total debit balances on the Sales ledger control account at the start of the
month was 1894 and 3368 at the end of the month

Sales Ledger Control Account

Dr + to debtor’s balance Cr (- to debtor’s balance
Date Details $ Date Details $
1/1/01 Balance b/d 1894 31/1/01 Bad debts 200
(Sum of Sales Ledger debit balances)
31/1/01 Sales 2500 Bank/Cash 1968
Interest on credit sales 500 Sales returns 500
Cash refund to debtor 342 Discount allowed 300
Dishonoured cheque 1500 *Contra Purchase Ledger 400
Balance c/d
(Should be = Sum of Sales Ledger debit 3368
balances at the end of the month)
6736 Total 6736
1/2/01 Balance b/d 3368

If there are no errors in the ledger, the value of Balance b/d should be equal to that of the
balance c/d

Second: Purchase Ledger Control Account (Same as Sales Control, but with credit purchases)

Purchases Ledger Control Account

Dr (- to creditor Balance) Cr (+ to creditor Balance)
Date Details $ Date Details $
Cash/Bank Balance b/d
(Sum of Purchase Ledger credit balances)
Purchase returns Purchases
Discount Received Cash refunds to us
*Contra Sales ledger Interest on credit purchases
Balance c/d
(Should be = Sum of Purchases Ledger
credit balances at the end of the month)
Total
1/2/01 Balance b/d

Marouane Mokhles 33 | P a g e
10 Analysis
Analysis is one of the main aspects of accounting. )t s the part where the whole accounting cycle
is demonstrated in figures that help owners take decisions and help other users of financial
statements with their uses.

The means of analysis we ll focus our eyesight on are the ratios. There are 3 types of ratios we
study:

1. Profitability Ratios 2. Liquidity Ratios 3. Efficiency Ratios

Profitability Ratios:
 Gross Profit Margin See Section 12: Notes & FAQ for all the information


and questions about ratios and analysis
Net Profit Margin
 Markup %
 Return on Capital Employed

Gross Profit Margin:

� �
The Gross profit margin = �
× = ⋯%

The gross profit calculates the gross profit as a percentage of Sales. Hence, the higher the
percentage, the more profitable the business

Net Profit Margin:

�
The Net profit margin = �
× = ⋯%

The net profit margin calculates the net profit as a percentage of sales. Hence, the higher the
percentage, the more profitable the business (is usually less than the gross profit margin)

Mark up %:
� �
The Mark up percentage = �
× = ⋯%

The Mark up percentage calculates the gross profit as a percentage of cost of sales. Hence, the
higher the percentage, the more profitable the business.

Return on Capital Employed:

�
Return on capital employed = � �
× = ⋯%

The return on capital employed calculates the net profit as a percentage of the capital employed.
The higher the percentage, the more profitable the business.

Marouane Mokhles 34 | P a g e
Liquidity Ratios
 Current Ratio
 Quick Ratio

Current Ratio:
�
Current Ratio = �� �� �
= ⋯:

It measures the availability of current assets to cover current liabilities. The higher the ratio, the
better, till a certain limit.

To clarify: Of course, it s best to stay covered and have more current assets than current
liabilities. However, too much current assets is also a disadvantage, as these assets are costly to
keep and can be used to acquire more fixed assets or take development decisions.

Quick Ratio:
� −�
Quick Ratio = �� �� �
= ⋯:

It measures the availability of current assets to cover current liabilities without selling stock. The
higher the ratio, the better, till a certain limit, as explained in the Current ratio.

Efficiency Ratios
 Debtors collection period
 Creditors collection period
 Stock Turnover ratio

Debtors’ collection period:

Debtors collection period = � �

×3 =⋯ �

The debtors collection period calculates the number of days the money owed by debtors could
be collected. The less the days, the more efficient and the more liquidity the business has.

Creditors’ collection period:

�
Creditors collection period = � ℎ
×3 =⋯ �

The debtors collection period calculates the number of days the money owed by the business to
its creditors can be paid. The more the days, the more efficient and the more liquidity and
efficiency the business has. (if long term credit periods are agreed upon) The less the days, the more liquidity
and efficiency the business has, if discounts are received, etc.

Stock Turnover Ratio:

� � �
Stock turnover ratio = ×3 =⋯ � �
=⋯ �
� � + �
Where the average stock =
2

It calculates how often the stock is replaced. The shorter the days, the longer the times, the
better the efficiency and liquidity of the business. Having long period turnover stops liquidity

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11 Accounting terms & Comparisons
Below are some of the most misunderstood terms in the syllabus and their correct explanation.

It is ordered according to the order of their section s position in this document. (ence, for
instance, terms related to section 1 are found first, and terms related to the last section are found
last.

Term Explanation

Everything the business owns, be it physical or not.

Assets
Examples: land, building, trademark, cash, bank balance
Everything the business spends
Expenses
Examples: purchases, electricity, interest on loans

Capital The capital is the owner s investment in the business.

All amounts the business is obliged to pay for as settlements to

Liability
their debts

Income All amounts the business gains from its trade

Amounts the business spends to acquire new fixed assets or to add

Capital Expenditure
value to an existing one (recorded in balance sheet)

Revenue Expenditure Amounts the business spends to meet day to day expenses. (recorded
in income statement)

Expenses that are required to paid on a time basis. Thus, it is

Running expenses
One-time expenses
Current Assets
Fixed assets
Capital employed
Working Capital
Capital owned
Short term liabilities
possible that there may be prepayments & accruals, thus balances
that carry down to the next accounting periods
Examples: Electricity, Subscriptions, rent
Expenses that are only paid once and settled once. It is not possible
to have balances carried/brought down in this case.
Examples: cash purchases, repairs
Assets whose values are not stable. Their values are vulnerable to
increase/decrease due to day-to-day transactions
Examples: cash, bank, debtors, stock
Assets whose value is fixed as transactions related to them are
limited
)t s the capital the business employs to meet future liabilities and
expenses.
To calculate employed capital = total assets – current liabilities
)t s the capital the business uses to meet current liabilities and
expenses.
To calculate working capital = current assets – current liabilities
The capital owned is the current capital of the business
To calculate owned capital = Opening Capital + Net Profit/Loss +
Additional Capital - Drawings
Liabilities the business is required to meet during 1 year

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Continued – Accounting Terms

Long term liabilities Liabilities the business is required to meet during more than 1 year

Capital receipts Amounts received at the disposal of a fixed asset (recorded in balance
sheet)

Revenue receipts Amounts received from day to day incomes of the businesses
(recorded in income statement)

A system of transaction-recording, where transactions are recorded

Double entry system
twice; once on the debit and once on the credit side.

Net Realisable Value (NRV) The net sellable value of the asset. (Sellable Value – Selling expenses)
A contra account opened to adjust the value of assets in order to
Provision account
give a fair view of that account
Discount issued by seller to buyer. It is NOT recorded in business
Trade Discount
books.

Cash Discount Discount issued by seller to buyer and is recorded in business books
A temporary account that is opened when the trial balance fails to
agree. Its balance is equal to the deficit between the credit and
Suspense account
debit side in order to equate the sides. It has no nature, but it
stands on the side with less mathematical value
Prime Cost Total direct Cost of production = Direct Raw Material + Direct
(Manufacturing) Labour + Direct expenses
Cost of Production of Total Cost of production of goods = Prime Cost + Overhead
finished goods expenses + net work in progress.
(Manufacturing)
It carries the record of initial capital and any additional capital
Capital account contributed by the partner. It is fixed and is not affected by any
(Partnership)
entry other than contribution of capital.
Current account This account records the share of profits and losses and drawing of
(Partnership) a partner
Authorised Capital Maximum capital the company is allowed to raise
(Limited companies)
Issued Capital
Actual capital issued by the company to shareholders
(Limited Companies)
Called-up Capital
Amount issued of share capital and required by the company
(Limited Companies)
Paid-up Capital Amount PAID of the called-up capital
(Limited Companies)
Dividend
Amount of money given to shareholders as their part of the profit
(Limited Companies)
Interim Dividend Amount of money paid to the shareholders as part of the profit
(Limited Companies) DURING the year
Proposed Dividend Amount of money proposed by the directors to be paid to the
(Limited Companies) shareholders as their part of the profit

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Continued – Accounting Terms
Debentures Long term liabilities where the company loans money and issues
(Limited Companies) interest on its terms
The cost of getting money. For instance; to acquire a loan, you will
Finance Cost
be required to pay interest. Interest, in this case is the finance cost.

Remuneration Money paid for work or service = Salary

Bad debts Actual loss when a debtor can t pay his debts
Debts that were previously written off that are later recovered
Recovered bad debts
(In a later period. NOT SAME PERIOD)
The Satisfaction of a debt or installment payment before its official
due date. A prepayment can be for the entire balance or for any
Prepayment
upcoming payment that is paid in advance of the date for which the
borrower is contractually obligated to pay it
Accruals Amounts due from a period, but unpaid at its end
A contra-capital account opened to adjust the capital account as the
Drawings owner withdraws money from the business for his own personal
use
A temporal account opened at the disposal of fixed assets, due to
Disposal account
sale, theft, fire, etc
A system where the cashier is given a fixed amount of money. It is
Imprest System to be spent on small expenses. At the end of the period, the
amount of money with the cashier is restored to its imprest value
If a debtor is at the same time a creditor, for instance a business
Contra entry who sells and buys equipment, accounts can be set off to cancel the
lower balance, so only one cheque could be sent
Goods sent by the business to outlets so that they may be sold
Goods sent on sale or
there. If they are not sold, they are returned to the business. They
return
are, till sold, part of the business s stock.

Comparisons
Differences between for-profit and non-for-profit organisations:

For-profit organisations Non-for-profit organisations

Cash book Receipts and payments
Income Statement Income & Expenditure
Profit Surplus
Loss Deficit
Capital Accumulated fund

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Differences between the account of actual bad debts & provision for bad debts:

Actual Bad debts written off Provision for bad debts

Debit Natured Credit Natured
Can be expense if increasing or an income if
Expense by nature
decreasing
Made to adjust a debtor s account Made to adjust the total

Differences between Sole/Partner/Limited companies:

Sole Trader Partnership Limited

One owner
Unlimited liability
No separate legal entity
Trader has to run business
himself
Capital raised by the trader
Two or more partners
Unlimited liability
No separate legal entity
Running business shared
among partners
Capital raised by partners
Unlimited number of owners
Liability limited to amount
invested in shares
Has separate legal entity
Company ran by directors
Capital is raised on the issue
of sales

Differences between Ordinary Shares and Preference Shares (Limited Companies):

Ordinary Shares Preference Shares

Receipt of dividends depend on availability of
profit and its amount
They are entitled to vote in inter-firm
elections/polls
They are 2nd to receive:
 Dividends on distribution of dividends
 Their share in the case of the liquidation
They receive fixed interest/dividend
regardless the profit
They have no right to vote in inter-firm
elections/polls
They are 1st to receive:
 Dividends on distribution of dividends
 Their share in the case of liquidation of

 
of assets assets
Their share capital in the case of the Their share capital in the case of the
company being winded up company being winded up

Differences between Straight Line, Reducing Balance & Revaluation depreciation method:

Straight Line Method Reducing Balance Method Revaluation Method

Depreciation is based on the
original cost of the asset
Fixed depreciation per year
Easy to determine
depreciation rate
Scrap value is considered
Depreciation is based on both
Depreciation is based on the
the starting and ending
net book value
valuations of the asset
Depreciation decreases every
Depreciation is variable
period
Hard to determine
Depreciation rate is variable
depreciation rate
Scrap value is ignored Scrap value considered
(as an ending valuation)

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12 Notes & FAQ

Syntax: Section - Note

 Financial Documents: When dealing with questions related to Credit notes and invoices. On
deciding whether a discount is deserved or not, refer to the date the document was issued
on, not the date of the transaction.

 Ledger: When balancing an account at the end of an accounting period, the journal entry for
balance c/d and balance b/d is e.g:

31/12/01 Cr Bank 300

1/1/02 Dr Bank 300


� �
Ratios: Gross profit margin = ×
�

� �
Markup % = × Gross profit = Sales – Cost of sales

 Gross profit margin% =

� − � −
and markup% =

� �
Gross Profit % × � =� − �
 Mark-up % × =� − �
 Sales = Cost of sales + % of margin × Sales
 Sales = Cost of Sales + % of markup × Cost of Sales

 Limited Companies : When preparing financial statements for a limited company, please note
that the PROPOSED ORDINARY shares dividend don t appear in any of the statements. Only
the interim values are included. The only PROPOSED dividends mentioned in financial
statements are those of the PREFERENCE shares. They appear in the income statement in the


finance cost section and in the current liabilities section in the balance sheet
Capital Employed: The capital employed can be calculated in 3 ways:
o Capital Employed = ��� � +� −� � �� �
o Capital Employed = ��� � +� � �� �
o Capital Employed = � � + � � � �� � � �
 Non-for-profit organisations: the value transferred to the Income Expenditure account
related to Subscriptions could be easily calculated if given the # of members and the annual
fee. Formula = # ×
 Non-for-profit organisations: Most of the time, you use the balance b/d from the receipts and
payments account to know the accumulated fund, while you use the balance c/d in the


balance sheet as the current asset: bank


Partnership: Any entry must include the name of the partner involved, if present
Bank reconciliation: Beware of the entry at which the value at the bank statement equates
that of the cash book, as any entries written before that are already entered in both!

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The debit side includes categories the business uses its sources of finance in acquiring. Assets,
being the business s properties, it is of debit nature. Expenses are transactions the business uses
its sources of finance to meet, thus are of debit nature

The credit side includes categories that are the business s sources of finance. Capital, being the
owner s investment, is thus credit natured. Liabilities are made to purchase items for the
business, thus is of credit nature. Incomes are sources of gaining money, thus are of credit
nature.

 Owner; to calculate his net profit/loss

 Bank; to accept/reject loans and to set credit periods
 Manager; to take development decisions/actions
 Government; to calculate taxes
 Creditors; to accept/reject credit purchases
 Investors; To Assess business profitability and efficiency

 All Fixed assets are recorded at their original cost which doesn t match current values due to
historic cost concept
 Only items of monetary value are recorded in business books leaving out important
nonfinancial item; like labour skills, management efficiency
 important transactions between date of preparation of F/s and their presentation will not
appear in Financial statements
 Financial statements are condensed and brief leaving out important details

 Detecting Errors
 Proving mathematical equality between Debit and Credit sides under the double entry system
 Its usefulness in preparing financial statements

A debit note is a document issued by a buyer to the seller asking for allowance to return goods
that were purchased on credit, for being damaged, faulty, wrongly sent, or to reduce an
overcharged invoice. They are not used in recording

 To remind his debtors of the amounts due and their due date
 To offer a cash discount in case of prompt payment

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Advantages Disadvantages

 Work is shared  Profits are divided

 More skill and knowledge  Disagreements may occur
 More capital can be raised  Partners can t act individually
 Risk is shared  Partners share other partners
mistakes

 Easier to see the profit retained by each partner

 Easier to calculate interest on capital

Limited companies are organisations owned by shareholders, where the liabilities of the business
are limited to the amount of money invested in shares of the business

Advantages: Disadvantages

  Formation costs are high


The liability of the shareholders are
Running costs are very high

limited, thus in the case of bankruptcy,
individual assets of owners won t be Profit distribution applies to many
used to pay the company s debts restrictions, thus not all profit goes to
 the shareholders

There is formal separation between
owners and managers, and that helps in Company accounts must always stay
identifying people responsible for the accessible to the public
business
 Shares in the business can be transferred
easily
 No number limit for shareholders
 Funds are easily raised via; shares,
debentures & loans

 ^Capital reserves: Capitalised revenues

 Revenue reserves: Appropriated out of the net profit as general reserves, and these are:
o General reserve: to meet any future unknown liability the company may face
o Specific reserve: specifically reserved money to meet certain liabilities

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 Cumulative: Profits may be accumulated in arrears if there is insufficient net profit
 Non-Cumulative : Profits are not accumulated. If there is not sufficient net profit, then no
profit is acquired.
 Redeemable: The company has the right to redeem at a pre-set date & pre-set price
 Participative: is both a preference and ordinary share. Hence, its holder receives preference
dividend first, then the ordinary dividend if present.

Debentures are long-term loans whose holders are not members of the company. Debentures
holders receive a fixed rate of interest and are repaid before shareholders in a winding-up.

 Debentures
 Long term loans
 Mortgage

However, they are at the disadvantage of payment of fixed annual interest for the durations due.

 As an application of prudence, since depreciation is an expected loss in the value of a fixed

asset, it should be provided for in order to avoid overstatement of fixed assets and the net
profit in the financial statements
 As an application of matching, as we provide for depreciation in the period of its usage, in
order to spread the cost of the fixed assets over its useful life.

 Usage of Fixed assets

 Depletion
 Passage of time
 Release of new technology

As an application of consistency, as treatment of the asset should stay the same over its useful
life in order to avoid misleading the users of the financial statements

As an application of prudence, expected profits should be ignored and expected losses should be
provided for. Hence, we valuate the stock at the lowest price of cost or net realizable value, to
ignore unrealized profits in the stock

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 To allow specialization of labour
 Division makes it easier to prepare accounts in the ledgers
 It makes it easier to refer to transactions

The cash book is a book of prime entry where transactions are recorded for the first time and a
book of second entry as it takes the ledger s T account format. So, it acts as both

Providing totals of discounts allowed and received to be posted to their accounts, which reduces
the entries in the nominal ledger

 Training junior accountants

 Avoiding over crowdedness of the cash books
 It provides more control over spending
 It helps to reduce entries in the cash book and nominal ledger

 Provides totals of each expense to be posted to its expense accounts, reducing entries in the
nominal ledger
 Provides better control over spending

 To allow the division of work

 It makes control over debtors and creditors easier
 Reduces possibility of errors and fraud
 Easier reference by classifying similar accounts

1) Re sum Dr and Cr columns

2) Check side of each a/c balance
3) Check no balance is omitted
4) Check value of each balance
5) Re total balances in ledger
6) Check posting from journal
7) Open a suspense account

 To detect errors by checking the bank statement against the business s books
 To inform the business of the account balance and the dishonoured cheques

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 Insufficient funds
 Unable to verify signature
 Amount in numbers is different than the amount in letters
 Cheque has expired

 Detect Errors
 Detect fraud
 Useful in the preparation of financial statements

Sales Ledger Control: Purchase Ledger Control:

 Sales Journal  Purchases Journal
 Sales Returns Journal  Purchases returns Journal
 General Journal  General Journal
 Cash book  Cash book

 Overpayment of an account
 Return of goods after payment
 Payment in advance of goods

As control accounts check on the Purchases ledger and the Sales ledger, the prime entry books
are used to avoid the mistakes that may have occurred in the purchases ledger or sales ledger

 Trend analysis: To compare the ratios with those of previous periods to assess improvement
 Interfirm comparisons: To compare between similar businesses and assess performance

 By increasing selling price

 By controlling the costs of sales by:
o Finding cheaper suppliers
o Buying in bulk to get trade discounts
o Control expenses such as carriage inwards

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 By improving GP margin (ways mentioned above)
 By finding other sources of income
 By controlling other expenses

 By improving net profit (ways mentioned above)

 Obtain long term loans

 Sell excess fixed assets
 Introduce additional capital
 Reduce cash drawings

As keeping too much current assets can be a disadvantage, since keeping stock is risky and
costly. Keeping Debtors increases the risk of bad debts, while keeping money in the bank means
that the business isn t developing/involved in investments. Keeping cash makes a business
subject to theft, as well as the loss of profit they may have gained if the cash was invested.

 Sell more stock through advertising and market research

 Offer cash discounts

 Charge interests on late debts
 Send regular statements of accounts to debtors
 Fix a credit limit for each customer

 Obtain long credit periods from suppliers

 Increasing sales through selling more stock

 Advertising
 Market research

The difference between both is that the quick ratio ignores stock, as it can be quite difficult to
convert to cash in the short term. Even if it can be sold within a reasonably short period of time, it
will be a trade receivable (if sold on credit), and so there is an additional wait until the buyer pays
the receivable. Consequently, the more reliable measure of short-term liquidity is the quick ratio.

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 Size of business; measured by the capital of the business
 Type of goods; depending on durability of the goods
 Structure of expenses; labour and capital intensive
 Accounting policies as depreciation methods
 Experience and goodwill of the business
 Market conditions
 Type of ownership
 Seasonal sale variations

As they will not be able to:

 Short term debts

 Running day to day expenses
 Benefit from discounts offered
 Buy stock when needed

 )t s the equivalent to the capital in the non-for-profit organisations

 Assets – Liabilities = Accumulated funds
 Formed by the accumulation of surpluses over the years

 Less risk of errors

 Less risk of fraud
 Financial position can be ascertained
 Easier to prepare financial statements
 Easier to calculate ratios

End of text. Good Luck ;)

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