Chapt

erOne
I
ntr
oduct
iont
oAccounti
ngandBusi
ness
1.1. I ntroduct i
on
Account ing i st he pr ocess of i dent ifying,measur ing,r ecor di ng,cl assifying,summar izi ng,
i
nter pret ing and communi cat ing an or gani zation’ s economi c act ivities to user sf ordeci sion
maki ng.Account inghasr i
ght lybeent ermedast hel anguageoft hebusi ness.Thebasi cf unct i
onof
al anguagei st oser veasameansofcommuni cat i
on.Account i
ngal soser vest hisf unct ion.The
mai npur poseofaccount ingi st oascer tainpr of itorl ossdur i
ngaspeci fi
edper iodandr epor ts
oper atingr esul tsf orspeci f i
edper iodoft ime,andal sot oshowf inanci alcondi ti
onorposi ti
onof
thebusi nessonapar ticul ar dat eandt ohav econt rolov ert hef i
r m' spr operty.Suchaccount ing
recor ds ar erequi red t o be mai ntained t o measur e t he i ncome of t he busi ness and
communi cat ethei nf ormat i
onsot hati tmaybeusedbymanager s, owner s,gov ernment alagenci es
andot heri nterest edpar ties.Account ingi sadi sciplinewhi chr ecor ds,cl assi f
ies,summar izes
andi nter pretsf inanci ali nf ormat ionaboutt heact iviti
esofaconcer nsot hati ntelli
gent deci sions
canbemadeaboutt heconcer n.
1.2. Nat ur eofAccount ing
(i
)Account ing as a ser vice act iv i
ty:- Itsf unct ion ist o pr ov i
de quant it
at i
v ei nfor mat ion f or
economi cdeci sion.
(i
i)Account i
ng as a pr of essi on:- A pr of essi on i s a car eert hat inv olves the acqui ring ofa
speci alizedf ormal educat ionbef orer ender ingany ser v ice.
(i
ii
)Account ingasal anguage:- Account ingi sr i
ght lyrefer redt oast he" languageofbusi ness" .Iti s
onemeansofr epor tingandcommuni cat ingi nf ormat ionaboutabusi ness.
(i
v)Account i
ngassci enceorar t:-Sci encei sasy stemat izedbodyofknowl edge.I tisal sobased
on some f undament alpr inci ples,e. g.t he doubl e ent ry sy stem.Ar tr equi r
es a per fect
knowl edge,i nter estandexper iencet odoawor kef fici ent ly.Ar tal sot eachesushow t odoa
wor ki nt hebestpossi bl ewaybymaki ngt hebestuseoft heav ailabl er esour ces.
(v)Account i
ngasani nf or mat ionsy stem:Account ingdi sci plinewi llbet hemostusef ulonei nt he
acqui sitionofal lthebusi nessknowl edgei nt henearf ut ur e.
1.3.Obj ect i
v esofAccount ing
Thef ollowi ngar et hemai nobj ect i
v esofaccount ing:
1.Tokeepsy st emat icr ecor ds:Account i
ngi sdonet okeepasy st emat icr ecor doff i
nanci al
transact i
ons.
2.Topr ot ectbusi nesspr oper ties:pr ov i
despr ot ect iont obusi nesspr oper ti
esf rom unj ust ifiedand
unwar rant eduse.
3.Toascer taint heoper ationalpr ofitorl oss:hel psi nascer tainingt henetpr ofitear nedorl oss
suf f
er edonaccountofcar ryingt hebusi ness.
4.Toascer taint hef i
nanci alposi t i
onoft hebusi ness:ThePr of itandLossAccountgi vest he
amountofpr of i
torl ossmadebyt hebusi nessdur ingapar ticularper i
od.
5.Tof aci li
tater ationaldeci si onmaki ng:Account i
ngt akescol lect i
on,anal ysisandr epor ti
ngof
i
nf ormat ionatt her equi redpoi nt soft imet of aci li
tater at i
onal deci si on- making.
6.I nf ormat ion Sy st em:Account i
ng f unct ions as an i nf or mat ion sy stem f orcol l
ect ing and
communi catingeconomi ci nf ormat i
onaboutt hebusi nessent erpr ise.
Ther ear esi xmaj orst epsi naccount i
ngpr ocess:
1.Anal yzi ng-i sl ooki ngatev ent s,ort ransact i
onst hat hav eexpr essedi nmonet ar yter ms
hav et akenpl aceandt hinkingabouthowt heyaf fectt hebusi ness.
2.Recor ding-i sent eringf i
nanci al inf ormat ionaboutev entsi nt ot heaccount i
ngsy stem.
3.Cl assi fy i
ng-i ssor tingandgr oupi ngsi mi l
ari t emsand/ orev entsr athert hanmer ely
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 keepingnumer ousitemsand/ orev entsallt
oget her
.
4.Summar i
zing-isbringingt hev ar
ioussimi l
aritemsofi nformati
ontogethertodetermine
ar esult
.
5.Interpreti
ng -i
sdeci ding t hemeani ng and impor t
anceoft heinfor
mat i
oni nv ar
ious
reports.
6.Repor ti
ng-i scommuni catingtheresultstodeci si
onmaker s.
1.4. User sofAccount ingInformat ion
Thebasi cobj ecti
veofaccount i
ngi st oprovi
dei nfor
mat ionwhi chisusef
ulforpersonsinsidethe
organi
zat i
onandf orpersonsorgr oupsout sidetheor ganizati
on.Therearetwot ypesofuser sof
accountinginformat i
on’
s.Thesear e:
1.InternalUser s:arethoseper sonsorgr oupswhi char ewor ki
ngwi t
hintheorganizat
ion.These
i
ncludemanagementandempl oyees.

2.Exter
nalUsers:
Exter
nalusersarethosegr
oupsorper
sonswhoar eoutsidetheorganizat
ion
forwhom account
ingfunct
ioni
sperfor
med.Thosear
eInvest
ors,
Credi
tors,suppl
i
ers,bankers,
Consumers,gover
nmentalagenci
es,andetc.

1.5. Ty pesofBusi nessOr gani zat i

ons
Anor gani zati
oni sagr oupofi ndiv i
dual swhocomet oget hertopur sueacommonsetofgoal sand
objecti
ves.Ther ear et ypicallyt wot y pesof organi zations:busi nessandnon- busi ness.Abusi ness
organizationsel lsproduct sorser v i
cesf orprofit.Anon- busi nessor gani zati
on, suchasachar i
tyor
hospital,existst omeetv ar i
oussoci etalneedsanddoesnot havepr ofi
tasagoal .Allorganizat i
ons
record,repor t
, and, most i
mpor tant l
y, useaccount ingi nformat ionformaki ngdeci sions.Threet ypes
ofbusi nessesoper atedf orpr ofiti ncludeser v i
cer ender i
ng,mer chandi sing,andmanuf act uri
ng
businesses.
1.Ser vicer ender ingbusi nesses: -provi
deser vicesr athert hanpr oduct stocust omer s.
2.Mer chandi sing busi nesses:-t heypur chase goods f orr esale ata pr ofi
tf rom ot her
busi nessest ocust omer s.
3.Manuf act ur i
ngbusi nesses:- changebasi ci nput sintopr oductst hatar esol dt ocust omer s.
1.6. For msofBusi nessOr gani zat ion
a)Sol epr opr ietorship
Asol epr opr i
etorshi pi sabusi nessownedbyoneper son.Fr om account ingpoi ntofv i
ewt he
affai r
sofsol epr opr i
et orshi pi ssepar ablef rom t heaf fairoftheowner .Butf r
om l egalpoi nt
ofv i
ew,i tisnotasepar atelegalent it
y,whi chmeanst hatthebusi nessandt heownerar e
consi der edt obet hesame.
b)Par tnershi p
Par tner shipi sabusi nessownedbyt woormor eindiv i
duals.From account ingpoi ntofv iew
theaf f
ai rsofsol epr opr ietorshi pissepar ablef rom t heaf fai
rsoft heowner s/par tnersli
ke
thatofsol epr oprietor shi p.Butf r
om legal pointofv i
ew, iti
snotasepar atelegalent i
ty.
c)Cor por ation
Cor por ationi sanar t
ificialper soncr eatedbyt hel aw,andi tisasepar at elegalent ity.Bot h
from account i
ngandl egalpoi ntofv i
ewt heaf fairsoft hecor por ationissepar ablef rom the
affai r
soft heowner s.
A cor por ation i sabusi nessowned byoneormor eowner s.
Theowner sar eknown as
shar ehol der s.Shar ehol dersownshar esoft hecor poration.Shar esar euni tsofowner shipi n
acor por ation.
1.7. Account ingPr inciplesandPr actices

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Thegoalofaccount i
ngi st oensur ei nf or mat ionpr ov i
dedt odeci si
onmaker si susef ul.Tobe
useful, i
nfor mat ionmustber elevantandf ai t
hf ullyr epr esentabusi ness’seconomi cact i
v i
ties.Thi s
requireset hics,bel iefst hathel pusdi ffer ent i
at er ightf rom wr ong,i ntheappl icationofunder lying
account ingconcept sorpr inci ples.Ther ear eunder lyingaccount ingconcept sorpr i
nci ples, orr ules
ofaccount ingt hatar ei ncl udedwi t hi nGener allyAccept edAccount ingPr inciples( GAAP) .Ther e
areanumberofaccount ingpr incipl esorr ulest hatgui dethedev elopmentofGAAP.Thesear e:
1.Busi nessEnt ityconcept :Requi rest hateacheconomi cent i
t ymai ntainssepar at er ecor ds.
Exampl e:Abusi nessownerkeepssepar ateaccount i
ngr ecor dsf orbusi nesst r
ansact ionsofan
entityandf orper sonal transact i
ons.
2.Goi ngConcer nconcept :Assumest hatt hebusi nessor gani zati
onswi l
lbei noper ationf or
indef ini teperiodoft i
me.
3.Monet ar yUni t :
Requi r
est hatf inanci al infor mat ionbecommuni catedi nst ableuni tsof money .
4.Ti me- per i
odorper i
odi cityconcept :impl i
est hatt heeconomi cact i
vitiesofanent erpr i
secan
bedi v idedi ntoar tifi
ci alt i
meper iods. Thel i
feofabusi nessent it
yshoul dbebr okeni nto
equal segment sofper iodsf orr epor tpur pose.
5.Hi stor icalCostpr inci ple:Requi rest hateacheconomi ct r
ansact ionbebasedonor iginal
cost .Itr equi rescompani est oaccountandr epor tbasedonacqui siti
oncost sr at hert hanat
currentf airmar ketv aluef ormostasset sandl iabi l
ities.
6.Rev enuer eal i
zat i
on/ Recogni ti
onpr inci ple: requi r
escompani est orecor dwhen:
 Rev enuei sr eal i
zedorr eal izabl eandear ned, notwhencashi sr ecei v
ed.
 Requi rest hatr evenuesber ecor dedwhenear nedandnotnecessar ilywhencashi s
receiv ed.
 Thi swayofaccount ingi scal ledaccr ualbasi sofaccount i
ng.
7.Mat chi ngpr inciple:Expenseshav et obemat chedwi thr ev enuesasl ongasi ti
sr easonabl e
todoso.I trequi rest hatexpensesber epor tedi nt heper iodi nwhi cht heyar ei ncur red,not
whencashi spai d.
8.Obj ect ivity:thecompanyf i
nanci alst atement spr ov idedbyt heaccount ant sshoul dbebased
onobj ect i
v e(f actual)ev idence.
9.Mat erial it
yconcept :Al lowsaccount ingpr i
nci plet obev iolatedi ftheef fectont hef inanci al
statement si ssoi mmat eri
alt hatuser swi llnotbemi sl
ed.Exampl e,basket /binpur chased
canber epor tedasanexpenser at hert hanasanassetsi ncei ti si mmat er i
al.Buti fi tem
makesadi f
fer encei ndeci sionmaki ng, ithast obei ncludedi nthef i
nanci alr epor tsbecause
iti
smat erial.
10.Consi stencyconcept :I tmeans t hatt he companyshoul d use t he same account ing
princi plesandmet hodsf rom y eart oy earorf oral ongper i
odoft ime.I tr equi rest hata
busi nessuset hesameaccount ingpol iciesandpr ocedur esf r
om per i
odt oper iod.
11.Conser vatism:St at es t hatasset s,andneti ncome shoul d nei therbe ov er stat ed nor
under st atedi nt her epor tsdur ingt hepr ev alenceofi nflationanddef lat i
onr espect i
v ely.When
choosi ngbet weent wosol utionsorpr i
nci ples,t heonet hatwi l
llikelynei t
herov erst atenor
under st ateasset sandneti ncomebesel ect ed.
12.Ful lDi sclosur e:I fcer taini nf ormat ioni si mpor tantt oani nvestororl ender ,ort oot her
par ti
esusi ngt hef inanci alst atement s,thati nf or mat ionshoul dbedi sclosed. Itr equi rest hat
account ing i nf ormat i
on communi cat e suf ficienti nf ormat ion t o al l
ow user st o make
knowl edgeabl edeci sions.
1.8. TheAccount ingEquat i
onandEl ement soft heEquat ion
Theaccount i
ngequat i
oni scomposedofasset sandequi ti
es.Asset scanbecat egor izedi nt o
currentasset sandl ongt erm asset sasdi scussedher eunder .
Ther esour cesownedbyabusi ness
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areitsasset
s.Exampl esofasset sincl
udecash,l and,
buildi
ngs,andequipment.Ther ightsor
clai
mst otheassetsar edivi
dedintotwot ypes:
(1)ther i
ghtsofcredi
tor
sand( 2)t herightsof
owners.Theri
ghtsofcredit
orsarethedebt
soft hebusinessandar ecal
l
edli
abil
it
ies.Therightsof
theownersarecall
edowner ’
sequity.Thefollowi
ngAccount i
ngequati
onshowst her el
ationshi
p
amongassets,l
iabi
l
iti
es,andowner’
sequity:

Asset
s=Li
abi
li
ti
es+Owner
’sEqui
ty
Assets
Whati sanAsset ?
 Asset sar eeconomi cresourcesthatprovi
def ut
urebenef i
t stothebusiness.
 Asset sar et hepr operti
esownedbyabusi nessenterpri
se.
 Exampl esofasset si ncludecash,account sreceivable,pr epaidexpenses,equipment,and
tr
ucks, andet c.
Li
abilit
ies
Whati saLi abi l
it
y ?
 Al i
abil
ityi sanobl i
gationt opayanasseti nthefuture.Itisalsoknownasdebt .
 Liabi l
i
tiesar edebt sandobl i
gat
ionsowedbyt hebusinessor ganizat
ions.
 Exampl eofl iabili
ti
esi ncludeAccountpay abl
e,Not epay abl
e,unear nedrevenue,Taxpayabl
e
etc.
Owner '
sequi ty/Shar eholders’Equit
y
Whati sshar ehol ders’equity?
o Shar ehol ders’ equityrepresent
st henetassetsownedbyt heowners( thesharehol
der
s).
o Netasset sar easset smi nusli
abili
ti
es.
o Itisdiffer encebet weenwhati sowned( assets)andwhati sowed( l
iabili
ty)
.
o I tisalsocal l
edcapi t
al,networth,netassetandpr opri
et orship.

Revenues
Whatisr evenue?
Revenuesar eincreasesincapit
alduet oinfl
owofr esourcesastheresul
tofbusinessoperati
ons
suchas, provi
sionofser vi
cesorsalesofgoods.Exampl e:Salesr
evenue,
serv
icerevenue,
inter
est
i
ncomeet c.
Expenses
Whatisexpense?
Expenses are decr eases i
n capi
taldue t o out
flow ofr esour
ces as t
he resul
tofbusi ness
operat
ions.Exampl e:Salar
yexpense, wagesexpense,suppli
esexpenseet
c.
1.9. Busi nessTr ansacti
onsandFi nanci
alStat
ement s
1.9.1.Businesst r
ansact
ions
Busi nesstransacti
onsareeconomicevent
sorcondit
ionsaboutbusi
nessent
erpr
iset
hatmustbe
recor ded.Transacti
onsmaybei dent
if
iedasexternalorint
ernal
.Exter
naltr
ansact
ionsi
nvol
ve
economi cev entsbetweent hecompanyandsomeout sideenterpri
seorpart
y.Forexampl e:for
JimmaUni versi
ty,pur
chaseofdi ff
erentequipmentf r
om asuppl i
er,t
hepaymentofmont hlyrentto
the house owner ,and col l
ecti
on off ee from st udents are exter
nalt
ransact
ions.I nter
nal
transacti
onsar eeconomi cev entsthatoccurent i
rel
ywi thi
nonecompany .Theuseofof f
ice
suppliesill
ustrat
est hi
st ypeoft r
ansacti
onf ort heJi mmaUniversi
ty.
Theequali
tyoft hebasi c
accountingequationmustbepr eserved.Therefore,eacht r
ansacti
onmusthav eadualef fecton
theequat i
on.Forexampl e,ifanindivi
dualassetisincreased,t
heremustbeacor r
esponding:
1.Decr easei nanotherasset,or
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 2.I ncreasei
naspeci fi
cli
abili
ty,or
3.I ncreasei
nowner ’
sequi t
y.
Itf
ollowst hattwoormor eit
emscoul dbeaf fectedwhenanassetisincreased.Forexample,as
oneasseti sincreasedBr.30,000,anotherassetcoul
ddecreaseBr.18,
000, andaspecif
icl
iabil
i
ty
couldincreasesBr .
12,000.Not ealsothatanychangeinani ndi
vi
duall
iabil
i
t yorowner
shipclai
m
i
ssubj ecttosimilaranal
ysi
s.

TransactionAnal y
si sandAccount ingEquation
Assumet hatMr .Chalaest abli
shesacomput erpr ogrammi ngtobeknownasSof t
wareGall
ery(SG)
.
Transact ion-1
Mr .Chal a decidet oopenacomput erProgrammi ngt obeknownasSof twaregal
ley(
SG).Assume
thatMr .Chaladeci destoopenacomput erprogr ammi ngser vi
ce.OnSeptember1,2015heinvests
$15, 000cashi nthebusi ness,whichhenamesSof t
war eGall
ery(SG).
Assets = Li abil
it
ies + Owner ’
sEqui t
y
Cash Chala,Capital
(1)+15, 000 +15, 000
$15,000 = $15, 000
Ther ei sani ncreaseint heassetCash,$15, 000,andanequali ncr
easeintheowner’sequi
ty,Mr.
Chal a,Capi t
al,$15,000.
Transact ion-2
SGpur chasescomput erequipmentf or$7,
000cash.
Asset s =Liabili
ties+Owner ’
sEqui ty
Cash +Equi pment= +Chal a,Capital
Old
$15, 000 = $15,000
(2)-7,000+ 7, 000 -
New
$8, 000 +$7, 000 = $15,000
Cashi sdecr easedby$7, 000andt heassetEqui pmenti sincr
easedby$7, 000.
Tr
ansaction-3
SGpurchasedsuppli
esexpectedt
olastforsev er
almont hsfor$1,
600f r
om ABCSuppl
yCompany
.
 ABCagr eest
oall
owSGt opaythisbi
llnextmont h,i
nOct ober
.
 Thistransact
ioni
srefer
redtoasapur chaseonaccountoracr edi
tpurchase.
Asset
s = Liabili
ties + Owner ’
sEquit
y
Cash +Suppl i
es+Equip. = Acct s.Pay.
+Chala,Capit
al
Ol
d $8, 000 +$7,
000 = $15,000
(3)__+$1,600 ______
_ +$1,600 ____
_ ___
New $8,000+$1, 600 +$7,000 = +$1, 600 + $15,000

$16,600 $16,600
TheassetSuppl i
esisincreasedby$1,
600andt heliabi
lit
yAccountsPayablei
sincreasedbyt
he
sameamount .
Transacti
on-4
SGr ecei
ves$1,200cashf r
om cust
omersf
orprogrammi ngser vi
cesi
thasprovi
ded.
 Thi str
ansacti
onrepresentst
heSG’spr
inci
palrev
enue- produci
ngact
ivi
ty.

Asset
s = Li
abi
l
iti
es + Owner
’sEqui
ty
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 Cash +Suppli
es+Equi
p. = Accts.Pay.
+Chal
a,Capi
tal
Ol
d $8,
000+$1,600+$7,000 = $1, 600 + $15,
000
(
4) +1,
200 _ ____ _____ _ _
_____
__ _
____
_+ 1,200

New $9,
200+$1,
600+$7,
000 = $1,
600 $16,
200

$17,
800 $17,
800
 Cashi sincreasedby$1,200andChal
aCapi
tal
isi
ncr
easedby$1,200.
Transaction-5
SGr eceivesabi l
lfor$250fr
om theDai
l
yNewsforadver
ti
singbutpost
ponespay
mentoft
he
bi
lluntil
al aterdat
e.

Asset
s = Li
abi
l
iti
es + Owner
’sEqui
ty

 Cash +Suppl
i
es+Equi
p.= Acct
s.Pay
.+Chal
a,Capi
tal

Ol
d$9,
200+$1,
600 +$7,
000 = $1,
600 + $16,
200

(
5)_
__Adv
ert
isi
ngExpense_
_ +250_ -250

New $9,
200+$1,
600 +$7,
000 = $1,
850 + $15,
950

$17,
800 $17,
800
Account
sPay
abl
eisi
ncr
easedby$250andChal
a,Capi
tal
isdecr
easedby$250.
Tr
ansacti
on-
6
SGprovi
des$3,500ofprogrammingser
vicesforcustomer
s.
 Cashof$1,500isrecei
vedfr
om cust
omer s,andthebal
anceof$2,
000i
sbi
l
ledonaccount
.

Asset
s = Li
abi
l
iti
es + Owner
’sEqui
ty
Cash +Acct
s.Rec.+Suppl
i
es+Equi
p. = Accts.Pay
. + Chal a,
Capi
tal

Ol
d$9,
200 + $1,
600+$7,
000 = $1,
850 + $15,
950

(
6)+1,500 +2,
000 + 3,
500
New $10,
700+$2,000 + $1,
600 +$7,
000 = $1,850 + $19,
450

$21,
300 $21,
300
 Cashi si
ncreasedby$1,500;AccountsReceivableisi
ncreasedby$2, 000,
andChala,Capi
tali
s
i
ncr easedby$3, 500.
Transact i
on-7
Expensespai di ncashforSeptemberar estorer ent
,$600;empl oyees’ sal
ari
es,$900;and
uti
li
t i
es,$200.
Asset s = Liabi
li
ti
es+ Owner ’sEquity
Cash +Acct s.Rec.+Supplies+Equip.
= Acct s.Pay . + Chal a,Capital
Old$10,700+$2, 000 +$1, 600+$7, 000 = $1, 850 + $19,450
(7)-1,700RentExpense -600
SalariesExpense -900
Ut i
l
iti
esExpense -200
New
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Arsi
FBE/DeptACFN/Pr
inci
plesofaccount
ing 2013-
2020/
21 Page6
$9,
000 +$2,
000 +$1,
600+$7,
000 = $1,
850 + $17,
750

$19,
600 $19,
600
 Cashisdecr
easedby$1,700andChala,Capit
ali
sdecr
easedbythesameamount
.
Tr
ansact
ion-
8
SGpaysi
ts$250DailyNewsadvert
isi
ngbil
lincash.
Asset
s = Li
abi
li
ti
es + Owner ’
sEquit
y

Cash +Acct
s.Rec.+Suppl
i
es+Equi
p. = Acct
s.Pay
.+ Chal
a,Capi
tal

Ol
d$9,
000+$2,
000 +$1,
600 +$7,
000 = $1,
850 + $17,
750

(
8) -
250 -250 .

New

$8,
750+ $2,
000 +$1,
600 +$7,
000 = $1,
600 + $17,
750

$19,
350 $19,
350

 Bot hCashandAccount sPayablearedecr

easedby$250.Si ncetheexpensewaspr evi
ously
recorded,i
tisnotrecor
dednow.
Transaction9
Thesum of$600i ncashisrecei
vedfr
om customerswhohaveprevi
ouslybeenbi l
ledf
orser
vices
(i
nTr ansacti
on6).
Assets = Liabil
i
ties +Owner’
sEquit
y
Cash +Acct s.Rec.+Suppli
es+Equip. = Accts.Pay
. + Chal a,Capi
tal
Old$8,750 + $2,000 + $1, 600 +$7,000 = $1,
600 + $17,750
(9)+600 -600 .
New$9, 350 +$1, 400 + $1, 600 +$7,000 = $1, 600 + $17,750

$19,
350 $19,350
 Cashisi
ncreasedby$600andAccount
sRecei
vabl
eisdecreasedbythesameamount
.Chal
a,
Capi
tali
snotincr
easedbecauset
herev
enuewasal
readyrecorded.

Tr
ansacti
on10
Mr.Chal
awit
hdraws$1,
300i
ncashf
rom t
hebusinessf
orhi
sper
sonaluse.
Asset
s = Li
abi
l
iti
es + Owner’
sEqui
ty

Cash +Acct
s.Rec.+Suppl
i
es+Equi
p = Acct
s.Pay
.+ Chal
a,Capi
tal

Ol
d$9,
350+$1,
400 + $1,
600+$7,
000= $1,
600 + $17,
750

(
10)
-1,
300 Dr
awi
ng-
1,300

New$8,
050+$1,
400 + $1,
600+$7,
000 = $1,
600 + $16,
450

$18,
050 $18,
050
 Cashi
sdecr
easedby$1,
300and Chal
a,Capi
tali
sal
sodecr
easedbyt
hesameamount
.Thi
s

AU/
Arsi
FBE/DeptACFN/Pr
inci
plesofaccount
ing 2013-
2020/
21 Page7
 i
snotanexpense,
butr
atherawi
thdr
awal
ofowner
’sequi
ty.

SummaryofTr ansact
ions
Thetr
ansact
ionsofSof t
war
eGaller
y(SG)aresummar
izedi
nthef
oll
owi
ngt
abl
etoshow t
hei
r
cumul
ati
veeffectonthebasi
caccounti
ngequat
ion.
Asset
s Li
abi
li
ti
es Owner
’sequi
ty
Trans Cash+ Account Suppl
i
es+ Equi
pment Account Mr.Chal
a’s
acti
on Recei
vabl
e = payabl
e + Capi
tal
+
1 Br
.15,
000 +Br
.15,
000 I
nvest
men
+ t
2 -
_7,
000 +Br.7,000 _
__ _
____
8,
000 7,000 15,
000
=
3 _
___
___
__8 +Br
.1,
600 _______ +Br.
1,600 _
__ _
____
,
000 + 1,
600+ 7,000 1,
600 15,
000
= +
4 +1,
200 _
_ _
___
__ ___
_ _____ _______
_ +1,
200 Servi
ce
9,
200 + 1,
600+ 7,000 1,
600 16,
200 rev
enue
= +
5 _
__ _
___ ____
___ ______ __ +250 -
250 Advert
isi
9,
200 + 1,
600+ 7,000 1,
850 15,950 ng
= + expense

6 +1,
500 +2,
000 __
___
__ _
____
___
_ ___
_ _
___
_ +3,
500 Servi
ce
2,
000 1,
600+ 7,
000 1,
850 rev
enue
10,
700 + = + 19,450
7 -1,
700 -600 RentExp.
_
__ _
___ _
____
___ -900 Salari
es
_
___
___
_ 2,000 __
___
__ __
___
___ 1,
850 - 200 exp
+ 1,
600+ 7,
000= + 17,750 Uti
lit
y
9,
000 exp.
8 -
250 ____
___ _
__ _
___ __
___
___ -250 ___
___
8,
750 2,
000+ 1,600+ 7,
000= 1,600+ 17,
750

9 +600 -600 _
__ _
___
_ _
__ _
___ __
___
_ ___
___
9,
350 1,
400+ 1,600+ 7,000 1,
600 17,
750
10 -
1,300 = + -
1,300 Dr
awi
ngs

AU/
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FBE/DeptACFN/Pr
inci
plesofaccount
ing 2013-
2020/
21 Page8
 Br.
8,050 Br
.1,
400+ Br
.1,
600+ Br
.7,
000= Br
.1,
600+ Br
.16,
450
Br
.18,050 Br
.18,
050

1.9.2.FINANCI ALSTATEMENTS
Aftertheef fectofbusi nesst ransact ionshasbeeni dent i
fied,analysed,r ecorded,classi f
ied,and
summar ized, theessent i
alinformat ioni scommuni catedt ouser s( i
nternal&ext ernal).So,financi al
statement sar eaccount i
ngst at ement sthatcommuni cateaccount ingi nformat i
ont ouser s.The
fourprincipalf inancialstatement sarei ncomest atement ,owner '
sequi tyst atement ,balancesheet
andcashf l
owsst atement swhi char epr epar edf r
om t hesummar izedaccount i
ngdat a:
 I ncomeSt atement :asummar yofr evenuesandexpensesofabusi nessent ityfor a
speci ficper i
odoft i
mesuchasamont h,oray ear.
 Owner ’sEqui tySt atement :asummar yoft hechangesi nowner ’
sequi tyofabusi ness
ent it
yf oraspeci fi
cper iodoft i
mesuchasamont h,oray ear .
 Bal anceSheet :showsasset s,liabil
iti
es,andowner ’
sequi tyataspeci ficdat e,
orasof
speci ficdat e.
 St atementofCashFl ows:i ndicat escashi nf l
ows( receipts)andout fl
ows( pay ment s)fora
speci ficperiodoft ime.Thepr imar ypur poseofast atementofcashf lowsi stopr ovide
financi alinfor mat i
onaboutt hecashr eceiptsandcashpay ment sofanent erpr i
sef or
speci ficper iodoft ime.Toachi evet hispur poseandt oaidi nvest ors,creditors,andot hers
int hei ranal ysi
sofcash,t hest atementofcashf l
owsr epor ts( 1)t hecashef f
ect sofa
company ’
soper ationsdur i
ngaper i
od,( 2)itsi nvestingt r
ansact ionssuchaspur chaseand
sal esoff i
xedasset s,(3)i t
sf i
nanci ngt r
ansact ionssuchascashi nv estment sbyt heowner ,
andbor rowingsandcashwi thdr awal sbyt heowner ,oroftheowner .

Softwar
eGaller
y
I
ncomestatement
Fort
heMonthEndedSeptember30,
2015
Revenues:
Servi
cer evenue.
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
Br4,
700
Expenses:
Salari
esexpense. .
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
Br900
Rentex pense . .
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..600
Adv ert
isi
ngexpense. .
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..250
Util
iti
esexpense. .
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
. 200
Totalexpenses...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
.. 1,
950
Netincome. .
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
Br2,750

Netincomeofbr2,750shownont heincomest
atementi
saddedt
othebegi
nni
ngbal
anceof
owner’
scapi
tal
int
heowner’sequi
tyst
atement
.
Soft
wareGall
ery
St
atementofOwner’
sequi
ty
Fort
heMonthEndedSeptember30,2015

Chal
a,capi
tal,
September1,2015...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
.. Br-
0-
Add:I
nvestments.
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
Br15,
000
Netincome..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
. 2,75017,
750

AU/
Arsi
FBE/DeptACFN/Pr
inci
plesofaccount
ing 2013-
2020/
21 Page9
 17,
750
Less:Drawings.
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
.. (1,
300)
Chala,
capit
al,
September30,2015...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
.. Br16,
450

Neti ncome ofBr2, 750 carr

ied f
orwardf r
om the income statementtot he owner
’sequity
statement.Theowner’
scapital
ofBr16,450attheendoft her
epor t
ingperi
odisshownast hef
inal
totaloftheowner
’sequit
ycolumnoft hesummaryoftransact
ions(Ill
ust
rat
ion1-10)
.
Endingcapital
=Begi
nningcapit
al+Neti ncome+Investment–Wi t
hdrawals
Wher e,Neti
ncome=Rev enue–expenses

SoftwareGal l
ery
BalanceSheet
September30, 2015
Asset s
Cash..
...
..
..
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
...
..
..
..
...
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..Br8,050
Accountsreceivable..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
...
..
..
..
..
...
..
..
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
.. 1, 400
Suppli
es...
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
...
..
..
..
..
...
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
.. 1, 600
Equipment...
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
...
..
..
..
..
..
..
...
..
..
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
. 7, 000
Totalassets..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
...
..
...
..
..
..
..
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..Br18,050
Liabil
it
iesandOwner ’sequity
Liabil
it
ies
Accountspay able..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
...
..
..
..
..
..
..
...
..
..
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..Br1,
600
Owner ’
sequi t
y
Chala,capit
al.
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
...
..
..
..
..
..
...
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
...
..
..
..
..
..16,
450
Totall
iabil
it
iesandOwner ’
sequity.
..
..
..
..
..
...
..
...
..
..
..
..
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
...
..
..
..
..
..
Br18,
050

SoftwareGallery
StatementofCashFl ows
Fort heMont hEndedSept ember30, 2015
Cashfl
owsf r
om operat
ingactivi
ti
es:
Cashrecei
ptfr
om revenues..
...
..
..
..
..
..
..
..
...
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
Br3,300
Cashpaymentsforexpenses...
..
..
...
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..(
1,950)
Netcashprovi
dedbyoper ati
ngact i
vit
ies...
..
..
..
..
..
..
..
..
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
. 1,350
Cashfl
owsf r
om i
nvesti
ngact i
vit
ies
Purchaseofequi
pment .
..
...
..
..
..
..
..
...
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
.(7,000)

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inci
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ing 2013-
2020/
21 Page10
Cashfl
owsf r
om financingactivi
ti
es
Cashinvestmentbyowner ..
..
..
..
..
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..Br15,000
Cashpaymentf orwithdrawal..
..
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
.. ( 1,
300)
Netcashprovidedbyf i
nancingact i
vi
ties..
..
..
..
..
..
..
..
..
..
..
..
..
..
. 13,
700
Neti
ncreaseincash...
..
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
. 8,
050
Cashatthebeginningoftheper i
od...
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
.. -
0-
Cashattheendoft heperiod...
..
..
..
..
..
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
...
Br8,050

CashofBr8,050ont
hebalancesheetandst at
ementofthecashflowsi
sshownast
hef
inalt
otal
ofthecashcol
umnoftheSummar yofTransacti
ons(
Il
lust
rat
ion1-
10).

Uni
tTwo
Account
ingCy
clef
oraSer
vice-
Giv
ingBusi
ness

2.
1.Char
act
eri
sti
csofAccount
s
Account
ing Cycl
e:-i s a sequence ofprocedures used t
or ecord,cl
assif
yand summari
ze
account
inginfor
mat i
oninfi
nanci
alrepor
tsonar egul
arbasi
s.
Account
s:
 Arethebasicstorageuni t
sf oraccount
ingdataandar eusedt oaccumulateamount
sfr
om
si
mil
artr
ansacti
ons
 Ar
erecor
dst
hatkeptf
ort
hei
ndi
vi
dualasset
,li
abi
l
ity
,capi
tal
,rev
enue,expense,anddi
vi
dend
components
 Anaccounti
ngf ormthatisusedt
orecordthechangescausedbybusi nesstr
ansacti
ons
 Accountisanindivi
dualrecor
dorfor
m usedt orecordort osummarizeinf
ormati
onr el
atedt
o
eachasset,
eachl i
abi
li
tyandeachaspectofowner ’
sequity
,eachexpenseandrevenue.
 Usedtorecordthechangescausedbybusinesstransact
ions
 Accounti
sast oragebin.

Theaccount i
ngcycleusuallystar
tsfrom occurrenceofbusi nesstransactions:
 When occur renceorev entst hatar eexpressed int ermsmoneyappear sin busi
ness
tr
ansact i
ons,sourcedocument sshoul dbepr epared.
 Af terbusinessdocument swer epr epared,i t
shouldber ecordedi naj ournal
.Recordi
ng
tr
ansact i
onsintheJour nalisknownasJour nali
zing.
 Thenweposti ttotheledgeraccount s.Posti
ngt otheledgerisforclassi
ficat
ion
 I nor dertocheckourr ecordinaj ournalandpost i
ngi nledger s,weneedt ouset r
ial
balance.Thi
sistosummar i
zedat a.
 Af tert he t
ri
albal ance isprepar ed,we need t o prepare wor ksheet
.Thi sisy earend

AU/
Arsi
FBE/DeptACFN/Pr
inci
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ing 2013-
2020/
21 Page11
 pr
ocedur
e.
 Thenfinanci
al statementisprepared.Thi sstepinv
olvesprepar
ati
onoffinanci
alr
epor
ts.
 Closi
ngt empor aryaccountfol
lows.Itisyearendprocedureand
 Fi
nall
ypost -
closingtri
albalanceispr epared.Iti
salsoyearendprocedur
e.

2.
2.Cl
assi
fi
cat
ionofAccount
s
Ther
ear e5t ypesofAccount s
1)Asset s
2)Li abi
li
ties
3)Owner s' Equit
y( St
ockholders'Equityforacor por
ation)
4) Rev enues
5) Expenses
1.Asset s:
isanyphy sicalt
hing(tangible)orright(intangi
ble)thathasav alueisanasset .
a.Cur rentasset :assetthatmayr easonabl ybeexpect edtober eali
zedi ncashorsol dorused
upusuallywi thinoney earorlesst hr
ought henor maloperati
onoft hebusiness.
Exampl e: cash,accountreceivable,suppl i
es,invent
or y,
shortterm notesreceivabl
e.
b.Pl antasset s( fi
xed assets):Iti st angible assetused i nt he business thatare ofa
permanentorr elati
vel
yf i
xednat ure.Fixedasset si
nclude:equipment ,machinery,
buil
dings,
andland.

2.Li
abi
li
ti
es:
debt
sowedt
oout
sider
s(cr
edi
tor
s).
a.Currentli
abil
it
ies:li
abil
it
iesduewit
hinashor
ttime(usuall
yoneyearorl
ess)andt
hatareto
bepaidoutofcur rentassets.
Exampl e:accountpay able,shor
tnote payabl
e,salar
ies pay
able,i
nter
estpayabl
e,tax
payable,unear
nedr evenue.
b.Long- t
erml iabil
ity:li
abili
tythatwi l
lnotbeduef oracompar at iv
elylongt i
me( usuallymor e
thanoney ear)orcompany ’
sobl i
gati
onsnotexpect edt obepai dwi t
hinoney ear(ora
longeroper ati
ngcy cl
e).Exampl e:long-ter
m not espay able,bondspay able,leaseliabil
it
ies.
3.Owner ’
sequity:residual cl
aim againstthebusi nessassetaf t ert
het ot
alli
abili
tiesar ededuct ed.
4.Revenues:gr ossi ncreasei nowner ’sequi t
yasar esul toft heoper ationsuchassal eof
mer chandize,per f
ormanceofser vicet ocust omer ,r
ent alofpr oper t
y,lendingofmoney ,and
otherbusinessandpr ofessionalactiv
iti
es.
5.Expenses: decreasei nowner ’sequityasar esul
toft heoper ation.Andcost st hathav ebeen
consumedi nthepr ocessofpr oducingr evenuear eexpi redcost sorexpenses.
Drawi ngs:drawingsr epr esentaccountt hatisusedt or ecordt heamountofwi thdrawal smade
byt heownerofsol epr opietor
ship,andpar tnershipf orm ofbusi nessor ganizations.And
di
v i
dendi susedt or ecor dpay mentmadet oshar eholder sbyacor porati
on.

Standar
df orm ofaccounthasthr
eemaj orpart
s:
1.Theaccountt i
tl
eandnumber
2.Thel eftsi
de,whichiscall
edthedebitside
3.Ther ightsi
de,whichiscall
edthecreditsi
de.
Ther
earetwof or
msofaccounts:twoamountcolumnsaccountandf
ouramountcol
umnaccount
.
Twoamountcol
umnaccount
:
AccountTi
tl
e: _
___
___
___
___
___
___
___
___
___
__AccountNo.
:_
___
___
___
__

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 Dat
e I
tem PostRef
. Debi
t Dat
e I
tem PostRef
. Cr
edi
t

Four
-amountcol
umnaccount
:
AccountTi
tl
e:_
___
___
___
___
___
___
___
___
___
___ AccountNo.
:_
___
___
___
__
Bal
ance
Dat
e I
tem Post
.Ref
. Debi
t Cr
edi
t Debi
t Cr
edi
t

Thef
oll
owi
ngadv
ant
agesoft
hef
our
-col
umnaccountascompar
edwi
tht
het
wo-
col
umnar
e:Thef
our
-
col
umnaccount
:
1)provi
desaneasymeansofanal yzingandexami ni
ngtheaccount s,
2)present
stransact
ionsint
heirchronol
ogicalorderofoccurrenceast hejournaldoes,f
aci
l
itat
ing
easylocat
ion,
3)usesonlyonedatecolumn,savi
ngspaceandt i
mer equir
edf oranalysis,and
4)Makesbal anceofanaccountal waysav ai
labl
eaf tereacht ransact i
onist ransf
err
edtot he
account.
Accountsareoftengr oupedt ogetherinabookf or
m;suchagr oupingofaccount
si scall
eda
l
edger.Thus,account sar ef r
equentlyreferredtoasl edgeraccount s.Askel
etonv er
sionofa
st
andardform ofaccount ,usedforeaseanal ysi
sofaccountbal anceiscal
l
edT-account.
TheT-accounthast hreepar ts:
1.Theaccountt it
le
2.Spaceforrecor dingi ncr
easesi ntheamountoft heitem, and
3.Spaceforrecor dingdecr easesint heamountoft heitem
Titl
eofaccount
LeftSide Rightside
(Debitsi de) (Creditside)

 Thel
eftsi
deofanyaccounti
sthedebi
tsi
deandt
her
ightsi
dei
scal
l
edt
hecr
edi
tsi
de.

2.
3.Char
tofAccount
s
 Agroupofaccount sforabusi nessent i
tyiscall
edal edger.
 Thus,Chartofaccount sisthel istofaccount swi t
htheirnamesandaccountnumber si
nt he
l
edger.
 Theaccount sar enor mal l
ylistedi ntheor derinwhicht heyappearinthef i
nancialstat
ement s.
 Forexampl e:
 Thebal ancesheetaccount sar eli
stedf i
rst,i
ntheor derofassets,li
abil
i
ties,andowner ’
s
equity.
 Thei ncomest atementaccount sar ethenl i
stedi
nt heorderofrev enuesandexpenses
 Outl
inetheor derofaccount sint heledger
 Di r
ectoryofaccount savailableinthel edger
 Eachaccountnumberhast wodi gi
ts
st
 The1 di gitindicatest hemaj ordivisi
onoft heledgerinw/ ctheaccountispl aced.
 Account sbegi nningwi thnumber :
 1- represent sasset s;
 2- li
abili
ty;

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  3- Owner’sequit
y(Owner’
sequit
ycapit
alanddrawings);
 4- Revenueand
 5- Expenses.
nd
 The2 di gitindi
catestheposi
ti
onofaccountwit
hini
tsdivi
sion.
 Theadv antageofsuchnumber i
ngsy st
em i
sthelateri
nserti
onofnewaccount
sin
t
hei
rpr opersequencewi t
houtdi
stur
bingot
heraccountnumber .

Char
tofAccount
Classi
fi
cation
BalanceSheet I
ncomeSt atement
Account AccountTi tl
e Account AccountTi
tl
e
No No
1.AssetAccount :4.RevenueAccount :
11.Cash 41.Sales
12.Accountr eceivable 42.Feesear ned
13.Supplies 43.Int
erestincome
14.PrepaidRent 44.Rentincome
15.Furnit
ure
16.Offi
ceequi pment 5.ExpensesAccount :
17.Accumul ateddepr eci
ati
on 51.Suppl i
esexpense
2.Liabil
ityAccount : 52.Salar
iesexpense
21.Accountpayable 53.Rentexpense
22.Notespay able 54.Depr eciat
ionexpense
23.Salari
espay able 55.Uti
li
tiesexpense
3.Owner ’
sequityAccount : 56.Miscel l
aneousexpense
31.Biftu,Capital
32.Biftu,Drawing
33.IncomeSummar y
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2.
4.Rul
esofDebi
tandCr
edi
t
 Whenanamounti senteredont heleftsi deofanaccount ,iti
sadebit
, andtheaccountis
saidtobedebi ted.
 Whenanamounti sent er
edont her ightsi de,itisacr edit,andtheaccountissaidt obe
credi
ted.
 Theabbr evi
ationsfordebitandcreditar eDr .andCr .,respect i
vel
y.
 Whetherani ncreaseinagi veni
tem isdebi tedorcr editeddependsont hecategoryofthe
i
tem.
 Byconv enti
on,assetandexpensei ncr easesar er ecor dedasdebi t
s,wher easliabil
i
ty,
capit
al,andincomei ncr
easesar erecor dedascr edi
ts.
 Assetandexpensesdecr easesar er ecordedascr edits,whereasliabil
it
y,capit
al,and
i
ncomedecr easesarerecordedasdebi ts.Thef oll
owi ngt ablessummar izet
herule.
DebitandCr editrulesofaccount s:
Account I
ncr
ease Decr
ease Nor
malBal
ance
si
de si
de
AnyAsset Debi
t Cr
edi
t Debi
t
AnyLiabil
it
y Cr
edi
t Debi
t Cr
edi
t
Owner’sequit
y Cr
edi
t Debi
t Cr
edi
t
(
Capit
al)
AnyRevenue Cr
edi
t Debi
t Cr
edi
t
AnyExpense Debi
t Cr
edi
t Debi
t
Owner ’
sdrawing Debi
t Cr
edi
t Debi
t

2.
5.Nor
mal
Bal
anceofanaccount
:
Accountbalancei sthediffer
encebetweenthei ncreaseanddecreaserecordedinanaccount.The
normalbalanceofal laccountsareposi
tiv
er at
hert hannegati
vebecauset hesum oftheincr
eases
recor
dedi nanaccounti susuall
yequaltoorgr eaterthanthesum oft
hedecr easesr
ecordedinthe
account.
Double-
Ent r
ySy stem
 Equal debitsandcr edi
tsmadeaccount sforeacht r
ansact
ion
 Tot aldebitsal
way sequalthetot
alcredi
t s
 Account ingequationalwaysstaysi
nbal ance
i
.e.Asset s=Liabil
iti
es+Equit
y
Debi
tandCr edi
tEffect
sonAssets,
Liabil
it
ies,
Owner sEquit
y,Rev
enue,
andExpenses
Debits Credit
s
I
ncreaseassets Decreaseassets
Decreaseli
abil
it
ies I
ncreaseli
abil
it
ies
Decreaseowner sequi
ty I
ncreaseOwner sequit
y
I
ncreasedrawing Decreasedrawing
Decreaserevenue I
ncreaserevenue
I
ncreaseexpense Decreaseexpense

EXPANDEDBASI
CEQUATI
ONANDDEBI
T/CREDI
TRULESANDEFFECTS

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2.
6.Anal
yzi
ngandRecor
dingTr
ansact
ions
Journal
Thejournali
sthebookofor igi
nalentryforaccounti
ngdata.Aft
erward,t
hedataistr
ansfer
redor
postedtothel edger,thebookofsubsequentorsecondar yentry
.Thev ar
ioustr
ansact
ionsare
evi
dencedbysal est ickets,purchaseinvoices,checkstubs,andsoon.Ont hebasisoft hi
s
evi
dence,thetransactionsar eenteredinchronologi
calor
derinthejour
nal.
Thus,
 I sthebooki nwhi chther ecordsofbusinessarewrit
ten.
 I ti
sachr onologicalrecordofev ent
s.
Gener
aljournal
:
 Ist heori
ginal bookofent r
y
 Informationr ecordedont hisbookisusual
lyextract
edf r
om thesourcedocumentssuchas
i
nvoices,receipts,cont
ractsagreementsandmanyot herrel
evantdocuments.
 Itwoul dusual l
yshowt heaccountt obedebitedandcr edi
tedandshortdescri
pti
ononthe
tr
ansacti
on.
 Informationont hi
sbookwi l
lbepostedtotheledger.
 Gener alj
our nalisusedtor ecordal
lkindsofentri
es

Typically, agener al journalhas; spacesf ordates, accountt it

lesandexpl anati
ons,ref
erences,and
twoamountcol umns.
Thej our nal makessev eralsi gnifi
cantcont r
ibuti
onst otherecordingpr ocess:
1.I tdiscl osesi nonepl acet hecompl et
eef fectofat ransact i
on.
2.I tpr ovidesachr onol ogical recordoftransact i
ons.
3.I thel pst opr eventorl ocateer ror
sbecauset hedebi tandcr editamount sforeachent r
ycan
ber eadi lycompar ed.
Speci alJour nals:
 Aj our nal i
nwhi chonl yoneki ndofbusi nesst ransactionisrecor dedisaspeci al
journalused
tor ecor donl yonet ypeofent r
ies.
 Speci aljournalsdi f
ferf rom t hegeneraljournal orthecombi nati
onj ournali
nthattheyare
meantonl yf orspeci fiedty pesoft r
ansactions- onl
yonet ype.
Jour nal i
zing
 Thepr ocessofr ecordi ngat r
ansactioninthej ournaliscalledj ournali
zing.Theentryinthe
jour nal i
scal ledaj our nalent ry.

Thef l
owofaccounti
ngdat af rom thet meat
i ransactionoccur r
edt oit
sr ecor
dingint heledger
maybeshowni nthef ol
lowingdi agram.Per i
odicall
yt hejournalentr
iesar etr
ansferredtot he
accountsi
nthel edger.Thispr ocessoft r
ansferri
ngt hedebi tsandcr edit
sf r
om t hejournal
entr
iestot
heaccount siscalledpost ing.Theflowofat ransacti
onfrom itsauthor
izationtoits
posti
ngint
heaccount sisshowni nt hediagram below

Post
ing
 Thepr ocessoft
ransferr
ingthedebitsandcredi
tsfr
om t
hejour
nalentr
iest
ot heaccountsi
n
thel
edgeriscal
l
edpost i
ng
 Thepr ocessoft r
ansferri
nginfor
mat i
onf r
om thejour
naltotheledgerforthepurposeof
summar i
zi
ngiscaledpost
l i
ngandi sordi
nari
lycar
ri
edouti
nthefol
lowingsteps:
1.Recor dt
heamountanddat e.Thedateandtheamountsofthedebi
tsandcreditsar
e
enter
edi
nt heappropri
ateaccounts.
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 2.Recordt
hepost
ingref
erencei
ntheaccount
.Thenumberoft
hej
our
nal
pagei
s
enter
edi
ntheaccount
.

Il
lustrati
onofAnal yzingandRecor di
ngTr ansactions
Toi l
lustr
aterecordingat ransactioninanal l
-purposej ournalandpost inginamanualaccount i
ng
system, wewi l
luset hef oll
owi ngsteps:
Step-1:Thedat eoft het ransactionisenteredint heDat ecolumn.
Step- 2:Thet it
leoft heaccountt obedebi tedisr ecordedatt heleft-
handmar ginundert he
Descri
ptioncol umn, andtheamountt obedebi t
edisent er
edint heDebitcolumn.
Step-3:Thet it
leoft heaccountt obecr editedi slistedbelow andt other ightoft hedebit
ed
accounttit
le,andt heamountt obecr edi t
edisent eredintheCr edi
tcolumn.
Step-4:Abriefdescr i
ptionmaybeent eredbelowt hecr edit
edaccount .
Step-5:ThePR( Post i
ngRef erence)columni sleftblankwhent hejournalentr
yi sini
ti
all
yrecorded.
Wewilluset hiscol umnl ateri
nt hi
schapt erwhenwet ransferthejournalentryamountst o
t
heaccountsi nt hel edger.

Exampl e:
Nafyad, anAccountant
,openedanof
fi
ceonJanuary1,
2012.Dur
ingt
hemont
h,hecompl
etedt
he
fol
lowingt r
ansact
ionrel
atedwit
hhi
sprof
essi
onalpr
act
ice:
Januar
y1.Transfer
redcashf r
om apersonalbankaccounttoanaccountt
obeusedf
ort
he
business,$30,
000,
equipment$2,
400andsuppl
ies$400.
Anal
ysi
s:Thet
hreeasset
saccount
s,cash,equi
pment
,andsuppl
i
esi
ncr
easeanddebi
tedf
or
$30,
000,$2,400and$400respect
ivel
y.Theowner
’sequit
yintheseasset
sisequalt
o
thesum ofasset
s,i
.e.
$32,
800.Thenassetsdebitedfort
het ot
alamountandNaf yad,Capi
talcr
edi
tedforthesame
Step2 amount.
Jour
nal Step5 Page1
St
ep1 Date Descri
pti
on PR Debit Credit
2012 1 Cash $30,000 00
Jan
Equi
pment $2,400 00
St
ep3
Suppli
es $400 00
Nafyad,Capi
tal $32,800 00
St
ep4 (I
nvestmentofCash,
Equi
pmentandSuppl
ies)
January4.Purchasedusedaut omobilefor$18,
300,pay
ing$16,
000cashandagr eedtopaythe
remaini
ngattheendoft hismont h.
Analysi
s:Theassetaut omobileincreasedanddebitedfor$18,300.Ont heotherhandcash
decr
easedandcr edi
tedf or$16,000andaccountpayableincr
easedandcr edi
tedf
or
$2,
300.
Journal Page1
Date Descri
ption PR Debi t Credi
t
2012 4 Aut omobi l
e $18,30 0
Jan 0 0
Cash $16,
000 00

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 Accountpay
abl
e $2,
300 0
0
(
Pur
chaseofAut
omobi
l
e)
Januar y5.Paidoffi
cerentf
ormont hJanuarycash$400
Analysis:Rentexpenseincr
easedanddebitedfor$400:t
heassetcashdecr
easedandcredi
tedf
or
$400
Jour nal Page1
Date Descri
pti
on PR Debit Credit
2012 5 RentExpense $400 0
Jan 0
Cash $400 00
(Pai
drentforJanuary
)

January7.Pai
dcashf orsuppl
ies$300
Analysi
s:Theassetsuppli
esincreasedanddebit
edf or$300andcashdecr
easedandcredi
tedf
or
t
hesameamount .
Journal Page1
Date Descripti
on PR. Debi
t Credit
2012 7 Supplies $300 0
Jan 0
Cash $300 00
(Purchasedsuppl
i
esoncash)

January8.Purchasedoff
iceequipmentonaccount$4,
200
Analysi
s:Assetequi pmenti ncr
eased and debi
ted f
or$4,
200:t
he l
i
abi
l
ity accountpay
abl
e
i
ncr
easedandcr edi
tedfor$4,
200.

Journal Page2
Date Descr
ipti
on PR Debit Credit
2012 8 Equi
pment $4,
200 0
Jan 0
Accountpay
abl
e $4,200 00
(
PurchasedEqui
pmentonaccount
)

January12.Pai
dcashforinsurancepoliciesfort
hefol
l
owing6mont hsonaut
omobile$810
Analysi
s:Theassetprepaidinsuranceincreasedanddebi
tedfor$810:t
heassetcashdecreased
andcr
editedf
or$810.
Jour
nal Page2
Date Descri
ption PR Debit Cr
edit
2012Jan 1 Pr epai
d $810 0
2 insurance 0

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 cash $810 00
(
Pai
dpremi
um f
or6-
mont
hspol
i
cy)
January14.Receivedcashf rom acl i
entforserv
icedeli
ver
ed,$5,
700
Analysi
s:Assetcashi ncreasedanddebi tedfor$5,700:t
herevenuef
eesearnedincreasedand
cr
edi
tedfor$5,700.
Jour
nal Page2
Date Descript
ion PR. Debi
t Credit
2012Jan 1 Cash $5,
700 0
4 0
Feesearned $5,700 00
(Receivedfeesfrom cust
omers)
January17.Paidcashtocr
editor
sonaccount$2, 100
Analysi
s:Thepaymentdecr easet hel i
abil
i
tyaccountpay
ableand debit
ed for$2,100:cash
decr
easedandcredit
edfor$2,100
Journal Page2
Date Descripti
on PR Debi
t Credit
2012Jan 1 Accountpay able $2,
100 0
7 0
Cash $2,100 00
(Paidcredi
torsonaccount
)

January25.Paidcashf ormiscel
laneousexpense$120
Analysi
s:Expensesaffectowner’sequity:t
heownerequitydecreasesbytheamountofexpense
pai
d.Theexpense$120i ncreasedanddebi
ted:cashcredit
edfor$120.
Journal Page2
Date Descri
ption PR. Debit Credit
2012Jan 2 Mi scel
laneous $120 0
5 expense 0
Cash $120 00
(
Paidexpenses)
January27.Recordedfeeearnedonaccountforser
vicedel
iver
ed,pay
menttoberecei
vedi
nFeb,
$4,500
Analysi
s:Accountrecei
vabl
eincreasedanddebi
tedf
or$4,500:f
eesearnedi
ncr
easedandcr
edi
ted
for$4,
500

Journal Page3
Date Descri
pti
on PR.Debit Credit
2012Jan 2 Accountreceivabl
e $4,
500 0
7 0
Feesearned $4,500 00
(
Recordedf eesearnedonaccount
)

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January28.Paidsalaryofassistant$1,500
Analysi
s:Simil
artotransact
ionofJan.25
Journal Page3
Date Descripti
on PR Debi t Credit
2012Jan 2 Sal aryexpenses $1,500 0
8 0
Cash $1,500 00
(Paidsalaryexpensef orJanuar y)
January30.Pai
daccountpay able$2,300f orautomobi lepurchasedonJanuary2
Analysi
s:accountpayabledecreased&debi tedfor$2,300:cashdecreased&creditedf
or$2,
300.
Journal Page3
Date Descripti
on PR Debit Credit
2012Jan 3 Accountpay able $2,300 0
0 0
Cash $2,300 00
(Paidcreditorsonaccount )
January31.Paidgas,oil
,andrepair
sonaut omobi
lef
orApr
il$170
Analysi
s:Si
mil
artotr
ansactionofJan.25
Journal Page3
Date Descri
pti
on PR Debit Credit
2012Jan 3 Ut i
li
tyexpense $2,300 0
1 0
cash $2,300 00
(
Paidexpenseforgas,
oil
&repair
s)

January31.NafyadwithdrawBi r
r1,
200f orpersonaluse.
Analy
sis:withdrawi
ng af f
ects Owner’
s equi ty
:Naf yad drawing incr
eased and debi
ted:cash
decreasedandcr edit
ed.
Journal Page3
Date Descri
ption Post Debit Credit
Ref.
2012Jan 3 Naf yad,drawing $2,
300 0
1 0
Cash $2,300 00
(Naf
yadwi thdrewcashf orpersonaluse)

Preparat
ionofLedger
Whenpost ingisdonemanual l
ythedebit
sandcr edit
sinthej ournalpost
edintheorderthatthey
occurorifmanyi temsar etobepostedatonet imeallthedebi tsmaybepost edfir
stfoll
owed
byt hecredit
s.Thepost ingofdebitsandcr editsf r
om j ournaltoledgeri
sper f
ormedi nt he
fol
lowingmanner :
1.Recor dthedateandt heamountoftheentryint heaccount .
2.I nser
tthenumberoft hejour
nalpageinthepost ingreference(PR)columnoftheaccount
3.I nser
ttheledgeraccountnumberinthepostingr ef
erence(PR) col
umnofthejournal
.

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Account
:Cash AccountNo.11
Pos Bal
ance
Dat
e I
tem t Debi
t Cr
edi
t Debi
t Cr
edit
Ref
.
Jan 1 1 $30,
000 0 $30,
000 00
0
4 1 00 $14,
000 00
$16,
000
5 1 $400 00 $13,
600 00
7 1 $300 00 $13,
300 00
12 1 $810 00 $12,
490 00
14 1 $5,
700 0 18,
190 00
0
17 2 $2,
100 00 16,090 00
25 2 $120 00 $15,
970 00
28 2 $1,
500 00 $14,
470 00
30 2 $2,
300 00 $12,
170 00
31 2 $170 00 $12,
000 00
31 2 $1,
200 00 $10,80 00
0

Account
:AccountRecei
vabl
e AccountNo.12
Pos Bal
ance
Dat
e I
tem t Debit Cr
edi
t Debi
t Cr
edi
t
Ref
.
2 2 $4,
500 00 $4,
500 00
7
Account
:Pr
epai
dInsur
ance AccountNo.13
Pos Bal
ance
Dat
e I
tem t Debi
t Cr
edi
t Debi
t Cr
edi
t
Ref
.
1 1 $810 00 $810 0
2 0

Account
:Suppl
i
es AccountNo.14
Pos Bal
ance
Dat
e I
tem t Debi
t Cr
edi
t Debit Cr
edi
t
Ref
.
1 $400 00 $400 00

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 7 1 $300 0 $700 00
0
Account
:Equi
pment AccountNo.15
Pos Bal
ance
Dat
e I
tem t Debit Cr
edi
t Debit Credi
t
Ref
.
1 $2,
400 0 $2,
400 00
0
8 1 $4,
200 0 $6,
600 00
0
Account
:Aut
omobi
l
e AccountNo.16
Pos Bal
ance
Dat
e I
tem t Debi
t Cr
edi
t Debi
t Credi
t
Ref
.
4 1 $18,
300 0 $18,
30 00
0 0

Account
:AccountPay
abl
e AccountNo.21
Pos Bal
ance
Dat
e I
tem t Debi
t Cr
edi
t Debi
t Cr
edit
Ref
.
4 1 $2,
300 00 $2,
300 0
0
8 1 $4,
200 00 $6,
500 0
0
1 2 $2,
100 00 $4,
400 0
7 0
3 2 $2,
300 00 $2,
100 0
0 0

Account
:Naf
yad,
Capi
tal AccountNo.31
Pos Bal
ance
Dat
e I
tem t Debi
t Cr
edi
t Debi
t Cr
edi
t
Ref
.
1 $32,
800 00 $32,
800 0
0

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 Account
:Naf
yad,
Drawi
ng AccountNo.32
Pos Bal
ance
Dat
e I
tem t Debi
t Cr
edi
t Debi
t Cr
edi
t
Ref
.
3 1 120 00 1200 00
1 0
Account
:Feesear
ned AccountNo.41
Pos Bal
ance
Dat
e I
tem t Debi
t Cr
edi
t Debi
t Cr
edi
t
Ref
.
1 2 $5,
700 00 $5,
700 0
4 0
2 2 $4,
500 00 $10,
200 0
7 0

Account
:Rentexpense AccountNo.51
Pos Bal
ance
Dat
e I
tem t Debi
t Cr
edi
t Debit Cr
edi
t
Ref
.
5 1 400 0 400 0
0 0

Account
:Sal
aryexpense AccountNo.52
Pos Bal
ance
Dat
e I
tem t Debi
t Cr
edi
t Debi
t Cr
edi
t
Ref
.
2 2 $1,
500 0 $1,
500 0
8 0 0

Account
:Ut
il
it
yexpense AccountNo.53
Pos Bal
ance
Dat
e I
tem t Debi
t Cr
edi
t Debi
t Cr
edi
t
Ref
.
3 2 $170 0 $170 0
1 0 0

Account
:Mi
scel
l
aneousexpense AccountNo.54
Pos Bal
ance
Dat
e I
tem t Debit Cr
edi
t Debi
t Cr
edi
t
Ref
.
2 2 $120 0 $120 0
5 0 0

2.
7.Prepar
ingaTri
alBal
ance
Theequali
tyofdebi
tsandcredi
tsi
nthel
edgermustbepr
ovedatt
heendofeachaccount
ing
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inci
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per
iod.Thi
sismadebypr epari
ngatri
albal
ance.Tr
ialbal
ancei
sasummar
yli
sti
ngoft
het
it
les
andbal
ancesoft
heaccountsinthel
edger
.
Tr
ial
Bal
anceofNaf yadTr adingi sshownbel ow
NafyadTrading
Tri
alBalance
January31, 2012
AccountTi tle Debit Cr
edi
t
Cash $10, 800 00
Accountr eceiv able 4,500 00
Prepaidinsur ance 810 00
Supplies 700 00
Equipment 6,600 00
Automobi le 18,300 00
Accountpay abl e 2,
100 00
Nafyad, Capital 32,
800 00
Nafyad, Drawi ng $1,200
Feesear ned 10,
200 00
Rentexpense 400 00
Salaryexpense 1500 00
Uti
lit
yexpense 170 00
Miscellaneousexpense 120 00
Tot
al 45,100 00 45,
100 00

2.
8.TheAdj
ust
ingPr
ocess–Accr
ual
vscashbasi
sofaccount
ing
MeaningofAdj ustingEntri
es
 Adjust
ingentr
iesareent
ri
esmadeattheendoftheaccount
ingper
iodtobr
ingthebal
ancesof
accountsthatdonotshow theirt
ruebalancetothet r
uebalancetober epor
tedont he
fi
nancialr
epor
ts.
 Ad j
u sti
ngent r
iesarerequi
redeveryti
mef inanci
a lst
ateme nt
sa r
ep repar
e d.

TheNe edofAdj usti

ngEn tri
es
 Toreportallrevenuesearnedd ur
ingtheaccount
ingperi
od,orfi
scalper
iod.
 Tor epor
ta llexpensesi ncur
redt op r
oducetherevenuese ar
nedin t hesame
accounti
ngp eri
od ,
orfiscalperi
od.
 Toa ccur
a t
elyreporttheassetsont hebal
ancesheetdat
e.Somea ssetsma yhave
beenu sedupd uri
ngt heaccountingperi
od.
 Toa ccur
a t
elyreporttheli
abil
it
iesont hebal
ancesheetdat
e.(Expensesma yhave
beenincurred,butnotyetpaid.
)

TypesofAdj usti
ngEn tr
ies
Then umb erofa dj
ustme nt
sn ee dedatthee ndofe achaccount
ingp er
iod/
fi
scal
per
iod(atthee ndoft hemon th,quar
ter
,s emi-
annualora ttheendoft hey ear
)
dependse nti
rel
yu pont hen at
ureofthec omp any’
sbusinessact
ivi
ti
es.Howe ver,
mos tadj
usti
nge ntr
iesfal
lintoon eoft
hefou rgener
alcat
egori
es:
1.Con ver
tingassetstoe x
p enses
2.Con ver
tingli
abil
it
iestorevenue
3.Ac cr
uingu npai
de xpenses,and
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 4.Ac cr
uingu ncoll
ectedreven ue
2.8.
1De ferral
s:
 De f
erral
sa rep revi
ou sl
yre cordeda sse t
s,li
abil
iti
es,revenues,orexpensesthat
ne edtob ea djust
e da tthee nd oft hep eri
od tor efl
ectrevenuesearned or
exp ensesincurr
edi nthecu r
renta ccountingperi
od .
 Someoft hed efer
redi t
emsf orwh icha djust
inge ntr
ywou l
db ema deincl
ude:
p r
epaidi nsurance,p r
ep ai
dr e nt
,of fi
ces uppl
ies,d epr
eciati
on,andu nearned
revenue.
De f
erraladj
ustme ntsareoftwot ypes:
1.Prepaide xpense(Ass et
s/exp ense)ad j
ustme nt
s
Tran sf
era mou nt
sf r
om a sseta ccountstoe xpenseaccounts
2.Un ear
n edrevenue(d ef
erredRe venue)imp li
esL i
abil
it
y/r
e v
e nuea dj
ust
me nt
s
Tran sf
erri
nga mou ntsfrom li
ab i
li
tytorevenuea ccounts.
1.Conver
ti
n gassetstoEx penses/ PrepaidExpenseAdjustme nt
s:
Pr
e pai
dexpensesa reexpe nsesp ai
dinc asha ndrecor
deda sa sset
sb ef
oretheyare
usedorconsume d.Prepai
de xpensese x
p i
rewiththepassageoft i
meort hroughuse
andconsump t
ion.
 Ana sset
-expenseac countrel
ationshi
pe xi
stswit
hp repai
de xpenses.
 Pri
ortoa dj
ustment,as set
sa r
eov erst
atedan dexpensesareunderstat
ed.
 Thea dj
usti
nge ntr
yr esul
tsinad ebi
ttoane xpenseaccou ntandac redi
ttoan
assetaccount/prepaidexpen ses.

Example1:As sumethatonJ anuar

y1 ,NafyadTradingpai
dBr8 10forthecomingsix
monthsi
ncludi
ngJ anuaryfori
nsurancec overage.Thisresul
tsinBr1 35insurance
pr
emu i
me x
p i
rat
ionasofJ anuar
y3 1(thee ndofthemon th).
Ther
efore,t
hefol
l
owi ng
ent
rywou l
db enecessar
y:
Ther
efore,
onJ anuar
y1,thefol
lowingjour
n alent
ryisma de:

Da t
e Jour
nalent
ry Debi
t Cr
edi
t
2012
Jan.1. Pr
epai
dinsurance 810
Cash 810

OnJ anuar
y1 ,theamou ntpa i
drepresent
sfutur
eb enef
it
s(insur
ancecover
age)to
Nafy
a dtr
ading.Theadjust
inge nt
rya sofJanuar
y3 1istodebitI
nsur
anceExpense
andcredi
tPrepai
dInsur
anc e.OnJanua r
y31,t
hefoll
owingadj
usti
ngentr
yispr
epared:
Da t
e Ad j
ustingent
ry Debi
t Cr edi
t
2012
Jan. Insur
anceEx pense 135
31 PrepaidInsurance 135

Example2:As sumethatNafyadTradi
ngp ur
chasedBr7 00ofs uppl
iesona ccount
anddeb i
tsSuppl
iesas ofJanuar
y1,2012.AttheendofJ anuar
y312 012,Br425of
suppl
ieswasonh and.Theadj
usti
ngentr
ywou l
d,ther
efor
e,be:

Dat
e Adj
ust
ingent
ry Debi
t Cr
edi
t

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 2012
Jan.31 Suppl
iesexpense 275
Suppli
es 275

2. Con vert
ing li
a bil
it
ies(unearned r eve nue)t o Re ven ue/ Unea r
ned Re venue
Adjustme nt
s:
The searecashr eceivedb ef
orep rovidi
n gp roductsors ervices.Thec ashreceivedis
debitedtocasha ndc redit
edt othel i
abil
it
y (unearnedr e v
e nue)account.Reven uesare
recordedwh enthewor kors erviceisp r
ov i
d ed.So, weowet hework- it
’saliabil
i
ty.At
thee ndofthepe r
iod,wer educ etheliabil
itytoreflectt hep ort
ionofthewor kt hathas
beend one(thi
sinc r
ea sesar evenuea ccou nt).
 Un ear
nedrev enuesa rerevenu esrece i
vedi na dva ncea ndrecordeda sli
abili
ti
es
b ef
oretheya r
ee arned.
 Un ear
nedrev enuesa r
es ubs equentlyea r
n edb yr enderi
n gservi
cetoac u st
ome r.
 Al i
abi
li
ty-
reven ueaccou ntrel
a t
ionsh i
pe xist
swi t hune arnedrevenues.
 Priort
oa dj
us tme nt
,li
abil
iti
esa reov erstat
eda n dr evenuesa r
eu nderstat
ed.
 Th eadjust
inge n t
ryre sul
tsinad ebittoal i
a bili
tya ccountan dac r
edittoa
revenueaccou nt.
Exampl e:Assumet hatonDe cemb er1 ,
thed e ntaloffi
c eac ceptedaBr2 ,400p ayment
fr
om l ocalbusi
nes sestop rovided entalca r
et ot heire mp l
oye esoverthen extthree
mon ths.Theini
ti
al entr
yonDe cemb er1wou l
db ea sf oll
ows :

Dat
e Jour
nalent
ry Debi
t Cr
edi
t
2012
Dec.1 Cash 2,
400.
0
0
UnearnedDe ntal 2,
400.0
Fee s 0
Thea mou ntofc ashrecei
vedonDe ce mber1r epr
esentswh atthed ent
aloffi
ceowe s
toc l
ient
si nt hefuture.Thisi sal i
a bi
li
tys i
ncee i
therthec ashr ecei
vedmu stb e
retur
nedort heservicesmu stbed el
ivered.
From Decemb er1t oDe cemb er31,onemon t
hofd entalser
vicehasb eenprovi
ded;Br
800x1mon th=Br8 00dental f
eer evenue.Therema i
nderofBr1 ,600(Br2,400–Br
800)r epr
esentsf ut
u r
ed entals er
viceowe dt ocustome r(aliabi
li
ty)
.De cember3 1
adjust
ingen t
rywou ldbe:

Dat
e Adj
ust
ingent
ry Debi
t Cr
edit
2012 800.
0
Dec. Unear
nedDe ntalFees 0
31 DentalFeesEarned 800.
00

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2.
8.2ACCRUALADJ USTMENTS
 Accruals arerev en uest hath aveb ee ne ar
n eda nde xpensest hath aveb een
i
n cur
redb ythee n doft hec urrentacc ount
ingp eri
od,butthatwillbec oll
ectedor
paidinaf ut
urea cc ounti
ngp eri
od .
 Accrualsoc curwh enn oc ashh asb eenreceivedorp aid,butthec omp an yhas
under¬takenac t
iviti
est hatresul
tine arni
ngrev enuesorincur
ri
n gexpens es.
 Unli
ked efer
rals,noor igi
na lent
ryh asb eenrecorded.
Examp l
es:-
a.Int
erestearnedb u tnoty etcol
lectedonal oan: AccruedInt
erestReceiv
a bl
e( Asset
)
(orsimplyInt
eres tRe cei
va bl
e)¬–a ccr
uedr evenue.
b.Wa gese arnedb ye mp l
oyeesb u tn oty etp ai
d:Ac crued Wa gesa nd Sa l
ari
es
Payab l
e(Liabi
li
ty)( orsimp l
yWa ge san dSalar
iesPa yabl
e)–a na ccr
uede xpense.
Accrualadj
ustme ntsa reoftwot ypes:
a ccr
ue dr evenuea nd
a ccr
ue de x penses
1.Accrui
n gu ncollectedRe venue( Accrue dRe venue):
 Ac cruedr evenue sa r
er evenuese arned,butn otyetreceivedinc ash.
 Ac cruedr e v
e nuesma ya ccumu l
atewi tht hep assingoft i
mea si nthec aseof
i
nteresta ndrent,ort hr
ou ghser v
icesp erf
or me d,butnotbil
ledorc oll
ect
ed.
 Ac cruedre venuerequ i
resa na sset/r
e venuea dj
ustme nt
 Ana sset-
reve nueaccou ntrelat
ionshipe xi
s t
swi t
ha ccruedrevenues.
 Pr iortoa djustme nt
,botha sse t
sa ndr evenuesa r
eu nde r
stated.
 Th ea djusti
nge n t
ryresultsinad ebittoa na sseta ccounta ndac r
edittoa
r
e ve nueac count
Toi l
lust
rate ,conside ra1 2%n otep ayab l
e( Br.15 00)dueonMa rch3 1,2009wa s
recei
vedb yy ourb usiness.Th en otewa sr eceivedonOc tober1 ,2008.Thei nt
erest
revenuee arn edont hisn oteu nti
lDe c.3 1,2 008i sc al
cu l
atedu si
n gthefoll
owing
formula:
Inter
es t=Pr i
ncipalxRa texTi me=
I=PRT
Therefore,theinterestinth i
ss pecif
icca sewou l
db e,
Inter
est=1 ,500*1 2 %p erye ar
.=1 ,
500x1 2%x 3/12year
=Br .45
Thea djusti
n ge nt
rytor ecordthein ter
este xpen seincurr
edinOc t
oberis:
Da te Adjusti
nge ntry De bit Credit
20 08
De c.31 I
n t
erestRec eiv
a bl
e 4 5
Int
erestIncome 45
2.
Accr
uingu npai
dEx penses(Ac cruedEx pense):
 Accr
ue dexpensesa r
ee xpense sincurred,butnotyetpai
dorr ecorded.
 Accr
ue de xpensesre sul
tf r
om t hes amec ausesa sac cruedrevenuesa nd
i
ncl
u deint
erest,r
ent,t
axes ,
a nds al
aries.
 Al i
abi
li
ty-
ex penseaccou ntrel
ationshipexist
swi t
ha ccr
u edexpenses.
 Priort
oa djust
me nt,bothli
a bi
li
ti
e sande xpensesareund erst
ated.
 Th eadjust
ingen t
ryresult
si nad e bi
ttoa nexpensea ccountandac r
ed i
tto

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 al iabi
lit
ya ccou n t.
Example:Accruedsalari
es: Somet ypesofexpenses, suchasempl oyeesalari
esandcommi ssi
ons,
arepai
df oraftertheserviceshav ebeenper f
ormed.Assumet hatatWi sdom Ser
viceCompany ,
sal
ari
eswer elastpaidonOct ober26( Fri
day);thenextpaymentofsal ari
eswil
lnotoccuruntil
November9( Fri
day).Threewor kingdaysremai ninOctober(Oct29-31).
AtOctober31,t hesalar
iesf ort hesedaysr epresentanaccruedexpenseandr el
atedl
iabil
it
yto
Wisdom Company .Theempl oyeesreceiv
et otalsalar
iesofBr.2,
000f oraf i
ve-
dayworkweek,or
Br.
400perday .

Thus,
accruedsal
ariesatOctober31areBr
.1,
200(Br
.400x3),
andt
headj
ust
ingent
ryi
s:
Date Adjusti
ngentry Debi
t Cr edit
Oct.31 Salariesexpense 1,
200
Salari
espayable 1,
200
(Torecordaccruedsal
ari
es
)

Depreci
at ion:
 Apor tionofcostpl antassets,orfixedassetsissi mplyallocat edtoeachaccount i
ngper i
od.
 Th i
spr ocessi scalleddepr eciati
on.
 Depr eci at
ioni sanexampl eofadef er
redexpense.I nthiscaset hecosti sdef erredov era
numberofy ears,r at
hert hananumberofmont hs.Pr inciplesofaccount ingI Iwi l
lcov er
depreci ationmet hodsi ngreatdetail.Howev er,onesi mpleappr oachi scalledt hestr ai
ght-l
ine
met hod.
 Undert hismet hod,anequalamountofassetcosti sassi gnedt oeachy earofser v
icel i
fe.In
otherwor ds,thecostoft heasseti sdiv
idedbyt hey earsofusef ulli
fe,resul ti
ngi nannual
depreci ationexpense.
Example:OnJanuar y1, 2012thecompanybuy sTr uckf orBr12, 000.I texpect stheTr uckt olast5
year
s.Itdeci dest ouset hest raightlinemet hod,wi thasal vagev alue(SV)ofBr2, 000.The
depr
eciabl ev alueisBr10, 000( Br12,000cost-Br2, 000SV) .Theannualdepr eciationexpensei s
Br2,
000( Br10,000/5y ears).

Attheendof5year
s,t
hecompanyhasexpensedBr
10,
000oft
het
otalcost
.TheBr
2,000sal
vage
val
ueremai
nsonthebooks.

Gener
alJour
nal
Dat
e Jour
nalent
ry Debi
t Cr
edi
t
Jan.1,
2012 Del
i
ver
yTr
ucks Br
12,
000
Cash Br
12,
000
Tor
ecor
dpur
chaseofdel
i
ver
ytr
uck

Dec-
31 Depr
eci
ati
onExpense Br
2,000
Accumul
atedDepr
eci
ati
on Br
2,000
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 Torecorddepr
eci
ati
onexpensef
or
theyear
BookVal
ue&Sal
vageVal
ue
Book v alue i
st he diff
erence bet
ween t he costofan asset ,and the related accumul at
ed
depreciati
onforthatasset
BookVal ue=Cost-Accumul atedDepr eciati
on
BookVal ue=( Br12,000-Br10,000)=Br 2,000
Thecompanywi llstopdepr eci
ati
ngt het ruckaf tertheendoft hefif
t hyear.Thet ruckcost
Br12,000,butonl yBr10,000i ndepreciati
onex pensewast aken.Ther emainingbookv al
ueis
equivalenttothesalvagev alueest
ablishedwhent hevehicl
ewaspur chased.Bookv aluewi l
lbe
usedt ocalcul
ateanygai norlosswhent hetrucki ssold,ortr
aded.

Summar yofAdjust
mentandThei rEf f
ectsont heFi
nancialSt atement
s
Typesof Bef or
eAdjust
ment
Adj ustment BalanceSheet IncomeSt atement Adj
ust
ingEnt
ri
es
Prepai d  Assetov er st
ated  Expense Expense…Dr
Expense Asset.…Cr
 Owner ’sEquity Underst ated
(
Def erred overstat
ed  NetI ncome
Expense) Ov er
stat ed
Unear ned  Li abil
it
yov erst
ated  Rev enue Liabi
li
ty……Dr
Rev enue Revenue….
…Cr
 Owner ’sEquity Underst ated
(Deferred Under st
ated  NetI ncome
Rev enue) Underst ated
Accr ued  Li abil
it
yUnder stated  Expense Expense-
--
-Dr
Expense Li
abil
it
y--
--
-Cr
 Owner ’sEquity Underst ated
overstat
ed  NetI ncome
Ov er
stat ed
Accr ued  AssetUnder stated  Rev enue Asset--
--Dr
Rev enue Rev
enue-
--
-Cr
 Owner ’sEquity Underst ated
Under st
ated  NetI ncome
Underst ated
FixedAsset s  Assetov er st
ated  Expense Expense--
--Dr
ContraAsset-
--
-Cr
 Owner ’sEquity Underst ated
overstat
ed  NetI ncome
Ov er
stat ed

Meani
ngandI
mpor
tanceofRever
singEnt
ri
es
 Areversi
ngentryissi
mp l
ya nentr
ythatr
eversest
hed ebi
tsandt
hecredi
tsofthe
pr
eviousadj
usti
n gent
ry.
 Reversi
ngentr
iesareopt
ional.
 Theya r
eu sedinordertoma ketheaccount
ingprocessmoreconsi
stentorto
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 makelat
err ecordi
ngofrel
atedtr
ansacti
onsimpler
.
I
fthecompan yha stheaccount
ingpol
icyofpr
ep ar
ingrever
singent
ri
es,
theadj
ust
ing
ent
ri
esforallacc r
ualsandforthedeferr
alst
hata r
ef i
rstrecor
dedasexpenseand
r
evenue(i
ncomes tat
ement)account
sarerever
sed.

2.10.PREPARI NGAWORKSHEET
Awor ksheetisamul tiplecol umnf ormt hatmaybeusedi ntheadj ustmentpr ocess&i npr eparing
fi
nancialst
atement s.Asi tsnamesuggest s,t
hewor ksheetisawor ki
ngt ool.Awor ksheetisnota
permanentaccount ingr ecord.Itisadev i
ceusedt omakei teasiert oprepar eadjusti
ngent ri
es&
thefinanci
alstatement s.Insmal lbusinesseswithrelativ
elyfew account s&adj ustment s,awor k
sheetmaynotbeneededwhi l
eitisindispensabl
eforl ar
gecompani eswithnumber saccount s.
Therearefivestepst opr eparewor ksheet
1.Prepareat ri
al bal anceont hewor ksheet
2.Entertheadj ust ment sintheadj ustment
scol umns
3.Enteradjustedbal ancesi ntheadj ust
edtr
ialbalancecolumns.
4.Extendadjust mentt rial
balanceamount stoappr opri
atefinancialstatementcolumns
5.Totalthestat ementcol umns, comput et
heNetI ncome/ loss, andcompl etethewor ksheet

Toprepareawor ksheetf orNaf yadtradi

ng, thefoll
owingadj
ustmentsar
egi
ven.
Adj
ustmentdat a:
a.Prepai dinsuranceis$675att heendofJanuar y
.
b.Att heendofJanuar ysuppliesi nv
entoryshows$425.
c.Depr eciati
onexpenseofequi pmentf orthemonthis$250.
d.Depr eciati
onexpenseofaut omobi l
ef orthemonthi
s$450.
Theadj ust
ingent ri
esofNaf yadTradingarej ournali
zedher
eunder.
2012,Jan. Adj usti
ngEnt ri
es
31
Insuranceexpense……. .
…………………. .135
PrepaidInsurance………………………. .
………135

Suppli
esexpense…………………….
.…….275
Suppl
i
es…………………………………………….275

Depreci
ati
onexpense-Equi
pment………..
.250
Accumulat
eddepreci
ati
on-Equi
p…………….
….. 250

Depr
eciat
ionexpense-Automobil
e…….
… 450
Accumulat
eddepr eci
ati
on-Aut
omobi
le………….450

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 Naf
yadTr
ading
WorkSheet

Tr
ialbal
ance Adj
ust
ment Adj
ust
edTr
ialBal
ance I
ncomest
atement Bal
ancesheet
Debit Cr
edi
t Debi
t Cr
edi
t Debi
t Cr
edi
t Debi
t Cr
edi
t Debit Cr
edi
t
Cash 10,
80 00 10,
80 00 10,
80 00
0 0 0
Accountrecei
vabl
e 4,
500 00 4,
500 00 4,
500 00
Prepai
dinsurance 810 00 135( 00 675 00 675 00
a)
Suppl
i
es 700 00 275( 00 425 00 425 00
b)
Equipment 6,
600 00 6,
600 00 6,
600 00
Accum dep.
- 250( 00 250 00 250 00
Equipment c)
Automobil
e 18,
30 00 18,
30 00 18,
30 00
0 0 0
Accum dep.
- 450( 00 450 00 450 00
Automobil
e d)
Accountpayabl
e 2,
100 00 2,
100 00 2,
100 00
Nafyad,Capit
al 32,
80 00 32,
80 00 32,
80 00
0 0 0
Nafyad,
Dr awi
ng 1,
200 00 1,
200 00 1,
200 00
Feesearned 10,
20 00 10,
20 10,
20 00
0 0 0
Rentexpense 400 00 400 00 400 00
Salaryexpense 1500 00 1500 00 1500 00
Uti
lit
yexpense 170 00 170 00 170 00
Miscell
aneousexpense 120 00 120 00 120 00
Total 45,
10 00 45,
10 00
0 0
I
nsur
anceexpense 135( 00 135 00 135 00
a)
Suppl
i
esexpense 275( 00 275 00 275 00
b)
Dep.expenseEqui
p. 250( 00 250 00 250 00
c)
Dep.expenseAut
o. 450( 00 450 00 450 00

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 d) For
1110 00 1110 00 4580 00 4580 00 3,
300 10,
20 00 the
0 0 0
Neti
ncome 6,
900 00 6,
900 00
Tot
al 10,
200 00 10,
20 00 42,
50 00 42,
50 00
0 0 0
Mont
hEndedJanuar
y31,
2012

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2.
11.PREPARI NGFI NANCIALSTATEMENTSFROM AWORKSHEET
Af
terawor ksheethasbeencompl et
ed,al
lthedat
athatar
erequi
redf
ort
he
pr
eparat
ionoffinancial
stat
ement
sareathand.
NafyadTradi
ng
IncomeSt atement
Fort
heMonthEndedJanuary31,
2012
Feesear
ned 10,
20 0
0 0
Rentexpense 400 0
0
Sal
aryexpense 1500 0
0
Ut
il
it
yexpense 170 0
0
Mi
scel
l
aneousexpense 120 0
0
I
nsur
anceexpense 135 0
0
Suppl
i
esexpense 275 0
0
Depr
eci
ati
onexpense-Equi
pment 250 0
0
Depr
eci
ati
onexpense-Aut
omobi
l
e 450 0
0
Tot
alexpenses (
3,300 0
) 0
NetI
ncome 6,
900 0
0

NafyadTr
adi
ng
St
atementofOwners’Equi
ty
Fort
heMont hEndedJanuary31,2012
Naf
yad,
Capi
tal
,Januar
y1,
2012 32,
80 0
0 0
Add:
netI
ncomef
ort
hemont
h 6,
90 0
0 0
Less:
wit
hdr
awal
s 1,
20 0
0 0
I
ncr
easei
nowner
’sequi
ty 5,
700 0
0
Naf
yad,
Capi
tal
,Januar
y31,
2012 38,
50 0
0 0

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 Naf
yadTr
adi
ng
BalanceSheet
January31,2012
Asset
s
Cur
rentAsset
s
Cash 10,
80 0
0 0
Accountr
ecei
vabl
e 4,
500 0
0
Pr
epai
dinsur
ance 675 0
0
Suppl
i
es 425 0
0
Tot
alcur
rentAsset
s 16,
400 0
0
Pl
antAsset
s
Equi
pment 6,
600 0
0
Less:Accumul
ateddep.
- 250 0 6350 0
Equipment 0 0
Automobile 18,
30 0
0 0
Less:Accumul
ateddep.
- 450 0 17,
850 0
Automobile 0 0
Tot
alpl
antasset
s: 24,
200 0
0
Tot
alAsset
s 40,
600 0

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 0
Liabil
it
ies
Currentli
abi
l
iti
es:
Accountpay
abl
e 2,
100 0
0
Owner
’sEqui
ty
Naf
yad,
Capi
tal
,Januar
y31,
2012 38,
500 0
0
Tot
alLi
abi
li
ti
esandCapi
tal 40,
600 0
0

2.12ADJUSTI NGANDCLOSI NGENTRI ES

Adjusti
ngent ri
es:att heendofaccount ingperiodorfiscalperi
odinourcaseat
theendoft hemont hadj ust
ingent riesappear i
nginthewor ksheetarerecor
ded
i
nt hejournalandpost edt ot heledgerandi ti
sdatedasoft helastdayoft he
period,
event hought heyar eusual l
yr ecordedatalaterdate.
Theadjusti
ngent ri
esofNaf yadTradingar ej
ournal
i
zedher eunder .
Pos
Date Descr i
ption t Debi t Credi
t
r
ef.
Jan. 3 Adj ustingEnt ries
1
3 I nsuranceexpense……. .
……………. . 135 0
1 Prepai dInsur ance………………… 0 135 0
0
3 Suppl iesexpense……………………… 275 0
1 Suppl ies……………………………. 0 275 0
0
3 Depr eciat i
onexpense-Equi pment 250 0
1 ……. 0 250 0
Accumul ateddepr eciation- 0
Equip…
3 Depr eciat i
onexpense-Aut omobile 450 0
1 …… 0 450 0
Accumul at
eddepr eci at
ion- 0
Automobi le

Cl
osi
ngEnt
ri
es
Anaccountt it
leincomesummar yi susedf orsummar izi
ngt hedat aint he
revenueandexpenseaccount s-i
tisusedonlyatt heendofaccount ingperiod
andbot hopenedandcl oseddur
ingtheclosingpr ocess.Otheraccountt i
tles
usedf orthesummar i
zi
ngaccountar eexpenseandr evenuesummar y,pr
of i
t
and loss summar y
,and i ncome and expense summar y.Fourent r
ies are
requir
edinordert
ocl osethetemporaryaccountsofNaf yadTrading.Theseare:

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1.Eachr evenueaccounti sdebi tedf ort heamountofitsbalance&i ncome
summar yiscredi
t edf orthet otalr
ev enue.
2.Eachexpenseaccounti screditedf ortheamountofitsbalance&i ncome
summar yisdebitedf orthet otalexpense
3.Incomesummar yi sdebi t
edf ortheamountofi t
sbalance(netincome)&the
capit
al accountiscr editedfort hesameamount .
4.Thedr awingaccounti screditedfort heamountofitsbal
ance&t hecapi
tal
accounti sdebit
edf orthesameamount .

Cl
osi
ngent
ri
esf
orNaf
yadTr
adi
ngi
sasf
oll
ows
Feesearned 10,
20 00
1. Income summar
y 0 10,
200 0
0
2. I
ncome s umma ry 3,
300 00
Rentexpense 400 0
Sal aryexpense 1500 0
Utilit
yexpense 170 0
Mi scel l
aneousexpense 120 0
Insur anceexpense 135 0
Suppl i
esexpense 275 0
Depr eci
ati
onexpense-Equi
pment 250 0
Depr eci
ati
onexpense- 450 0
Aut omobi le 0
0
0
0
0
0
0
0
3. I
ncomesummar y 6,
900 00
Nafy ad,Capital 6,
900 0
0
4. Naf
yad, Capi t
al 1,
200 00
Nafy ad,Drawing 1,
200 0
0

2.13.POST- CLOSINGTRI ALBALANCE

Thel astprocedureoftheaccount i
ngcycleisthepr epar
ati
onofat ri
albalance
afterallofthetemporaryaccount shavebeencl osed.Iti
stomakesur ethatthe
l
edger sar ein balanceatt hebegi nni
ng oft henew account i
ng peri
od for
permanentaccount ,orbal ancesheetaccounts.Balancesheetaccount
scannot
becl osedattheendoff iscal per
iod.

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 Naf y
adTrading
Post-
closi
ngTrialBal
ance
January31, 2012
Asset
s Debi
t Cr
edi
t
Cur
rentAsset
s
Cash 10,
80 0
0 0
Accountr
ecei
vabl
e 4,
500 0
0
Pr
epai
dinsur
ance 675 0
0
Suppl
i
es 425 0
0
Equi
pment 6,
600 0
0
Accumul
ateddep.
-Equi
pment 250 0
0
Aut
omobi
l
e 18,
30 0
0 0
Accumul
ateddep.
-Aut
omobi
l
e 450 0
0
Accountpay
abl
e 2,
100 0
0
Naf
yad,
Capi
tal 38,
500 0
0
Tot
al 41,
30 0 41,
30 0
0 0 0 0

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 Chapt erThree
AccountingforCashandRecei vable
CASH: -
isamedi um ofexchanget hatthebankaccept sf ordepositatface
value.Itist hel i
quidasset,whi chr eadyforimmedi ateuse.I tincludes
papermoney ,coins,certai
nundeposi t
ednegot i
ableinstrument,(suchas
check,bankdr aftandmoneyor der),amountsi nchecki ngandsav i
ng
accountsanddemandcer t
if
icatesofdeposi t
.
Check-isawr i
tt
eni nstr
umentsi gnedbyt hedepositororderingthebankt o
payacer tainsum ofmoneyt otheor derofdesignatedper son.Checki sa
writt
enor dersignedbyt hedeposi tororauthori
zedper soncalled(drawer),
orderi
ngt hebank( drawee)t opayspeci fi
csum ofmoneyt otheper son
designated(pay ee).

3.1.
Contr
olov ercash
Cashistheassetmostl
ikel
ytobemi sused,diver
tedandmisappr
opriat
ed
byemployees.Hence,t
hecompanyshoul dcont r
olcashbyusingBank
account
.
Bankaccountisameansofcont r
olovercash.Therearevari
oustypesof
bankaccount
s.Thetwocommononesar e:

i
.sav
ingaccountand

i
i
.Checki
ngaccountbot
har
edemanddeposi
t

Savi
ngaccount
/deposit
/i
saccount
st hatpayint
erestt
hatdonothav
e
speci
fi
cmatur
it
y,andthatusual
l
ywi
thdrawnupondemand.

Bankstatement-Bankstat
ementshowst hebeginningbalance,checks,
andotherdebi
ts(
deduct
ionbythebank)andothercredi
ts(addit
ionbythe
bank)
,andthebal
anceattheendoftheperi
od.

Bankstatement -i
saf orm pr
eparedbythebankandsenttothedeposi
tor
toshowt ransacti
onsintheaccount.Thebankstat
ementshows/ r
epor
ts/
thebeginning balance,deposi
tmade,checkscl ear
ed,chargest othe
account ( e.
g.bankser vicefees)
,credi
ttot heaccount(e.g.i
nter
est

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ear
nedont
heaccountbal
ance)andendi
ngbal
ance.

3.2.
Bankr econci l
iati
on
Somet i
mes t he bank bal ance(bank st atement ) and the deposi t
or’s
balance(deposi t
or’srecor d)arenotl i
kelyt obeequalonanyspeci fi
cdat e
becauseoft hef ollowingr eason:
i.Delaybyei therpar tyinr ecordingt ransactions.Ordinar
il
y,thereisatime
lagofonedayormor ebetweent hedat eacheckwr i
ttenandt hedat e
thatt hecheckpr esent edtot hebank.Thebankmayal sodebitor
creditthedeposi tor’saccountf ortransact i
onsaboutw/ cthedepositor
willnotbei nformedunt ill
ater.
i
i.Errorbyei t
herpar tyi nrecordingt ransaction
BankReconci liati
oni s,therefore,thear rangement /processofbr ingi
ngthe
balance perbank st atementand t he bal ance percompanybooks
/deposi t
or/int oagr eement .

Thef oll
owi ngi temswi llbei nat i
mel agbet weent het wopar ti
es.
1.Deposi tsout standi ng-t hesear ecashr ecei ptssendf ordeposi ttot he
bankbutnotr ecei vedbyt hebank.Duet ot hisi temsbankbal ancei sless
thandeposi tor ’sbal ance.
2.Checkout st andi ng-t hesear echecki ssuedf orpay mentbydeposi tor s
butnoty etpai dbyt hebank.Duet ot hisbal ance,t hebankbal ancei s
l
argert hant hebal anceperdeposi tor ’sl
edger .
3.Bankcr edi tmemos-t hebankmi ghtcr editt hedeposi tor ’
sbal anceby
collectingr ecei v ablesorbyadv anci ngsomeamountofl oanort helike.
Thedeposi torwi l
lnothav et heinf ormat ionconcer ningt hesei temsand
deposi tor’sbal ancei sl esst hanbankst at ementbal ance.
4.Bankser v i
cechar ge-amount st hebankdeduct edf rom t hedeposi t
or ’
s
balancef ort heser v
icesi thasr ender eddur ingt hemont h.Becauseof
thesebal ance,t hebal anceperdeposi tor’sl edgeri sgr eat ert hant he
balanceperbankst atement .Bankser vicechar gei ssuppor t
edbybank
debi tmemor andum.
5.Acheckr etur nedf ornotsuf fi
cientf und( NSF) -acheckr eceivedf r
om a
credi tcust omeri sal way sdebi t
edt ot hedeposi tor ’sledgerandsentt ot he
bankf ordeposi t.Howev er,ifthecr editcust omerwhohasi ssuedt he
checkhasnosuf fici
entbal ancei ndeposi t,thechecki sr eturnedt ot he
deposi tormar kedNSFbei ngdeduct edf rom t hedeposi tor ’
sbal ance.Li ke
bankser vicechar ge,i ti ssuppor tedbyadebi tmemoandduet othi s
balance,t hebal anceperbankst atementi sl esst hant hebal anceper
deposi tor’sl edger .
6.Concer ni nger ror-ei thert hebankort hedeposi tormi ghthav emade
errorst hathav er esultedi nov er
st atementorunder statementofei ther
balance.

I
ll
ust
rat
ion:
1
The bank st
atementf
or ABC company
’si
ndi
cat
es a bal
ance of

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$5,039.67asofJul y31.Thebal anceincashinABCCompany ’
sledgeras
oft hesamedat eis$3, 352.985.Useoft heproceduresoutl
i
nedabov e
reveal
sthefoll
owingr econcil
iati
oni t
ems.
Deposit of July 31 not recorded on bank
statement.
..
..
..
..
..
..
..
..
...
..
..
..
..
.$1,
224. 3
o
Checkout
standi
ng:
N 813,
$1,
591,
o
N 865,
$653.
085,
o
N 950,$72.9..
...
..
..
..
..
..
..
..
..
...
..
..
..
..
...
..
..
..
..
..
...
..
..
.$2,316.985
Noteplusinterestof$12col lectedbybank( creditmemor andum)
not recorded in cash r
eceipt
s
j
ournal.
..
..
...
..
..
..
..
..
...
..
..
..
..
..
..
..
..
...
..
...
..
..
..
..
..
.$612
Bankservicechar ge(debitmemor andum)notr ecordedincashpay ment -
Journal
..
..
...
..
..
..
..
..
...
..
..
..
..
..
..
..
..
......
..
..
..
..
..
...
..
..
..
..
...
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
$4.5
o
CheckN 650f or$1, 098.39toBonaCompanyonaccount
,recor
ded
i
n cash payment j
our
nal as $1,
084.
89
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
...
..
..
..
..
.$13.
5
Requir
ed:prepareBankr econcil
iati
on

ABCCompany
Bankreconci
li
ati
on
Jul
y31, 2015
Balanceperbank
statement .
..
..
..
..
..
..
..
..
..
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
.$5,
039.67
Add: depositofJuly31notr ecordedby
bank. .
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
.$1,224.
3
Subt otal $6,
263.97
o
Deduct
:out
standi
ngcheckofN 813.
..
..
..
..
..
..
..
$1,
591,
o
N 865.
..
..
..
..
..
..
..$653.
085,
o
N 950, .
...
..
..
..
..
..$72.9..
..
..
..
..
..
..
..
..
..
..2,
316. 985
Adjustedbal ance-...
..
..
..
..
..
..
..
..
..
..
..
...
..
..
..
..
...
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
.$3,
946.985
Balanceperdeposi t
or’
s
record..
..
..
..
..
...
...
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
...
..
..
.$3,352.985
Add: note&i nterestcoll
ectedbybank- ..
...
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
.$612
Deduct :bankser vicecharges 4.
5
Errorinrecor di
ngcheck 13.5..
..
..
..
....
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
$18
Adjustedbal ance. ..
..
..
..
..
..
..
..
..
..
..
..
..
..
...
..
..
..
...
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
$3,
946.985

Entriesbasedonbankr econci
li
ation
Afterbankr econci
l
iat
ionhasbeenpr epared,t
hedeposi tortobri
ngit
s
cashi nbankaccounttoacor rectbalanceshallrecordjournalent
ry.
Theent riesforABCCompanybasedont hebankr econcili
ati
onabov ear
e
asf oll
ows:
July 31cashinbank..
..
..
..
..
..
..
..
..
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
.612

AU/
Arsi
FBE/DeptACFN/
Pri
nci
plesofAccount
ing/2013- 21Pa
2020/ ge40
 Not
esreceiv
able..
..
..
..
..
..
..
..
..
..
..
..
..
...
..
..
..
..
..
..
..
..
..
..
...
..
..
..
.600
Int
eresti
ncome..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
...
..
..
..
..
..
..
..
.12
(Torecordnotecollectedbybank)
Jul
y31 Miscell
aneousexpense/ser vicechargeexp...
..
.4.
5
Accountpayable.
..
..
..
..
..
..
..
..
..
..
..
..
..
..
...
..
..
..
..
..
..
..
13.5
Cashinbank..
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
...
..
..
18
o
(Bankser
vicechar
geander
rori
nrecor
dingcheckN 650)

Il
lustration2
Ther ecor dspr eparedbyXYZ CompanyShowsabal anceofcashon
deposi tatJune30of$6, 273.855.Thebankbal anceasofJune30shows
$7, 500.Thepur poseofbankr econcili
ati
oni stoidentif
yt heitemst hat
makeupt hedi f
fer
enceof$1, 226.145andt odet er
mi nethecor r
ectcash
balance.Assumet hatt hespeci fi
cst epstobet akeninpr eparingbank
reconciliat
ionhav ebeencar ri
edoutandt hatthef oll
owingr econci
ling
i
temshav ebeendiscov er ed:
a)Adeposi tof$466. 605mai l
edt othebankonJune30doesnotappear s
ont hebankst at
ement
b)Acr editmemor andum i ssuedbyt hebankonJune29i ntheamountof
$750 was r et
urned wi t
ht he June bank st atement.Thi s cr
edit
represent sthepr oceedsofanot erecei
vable.XYZCompanyhasnot
yetr ecordedthecol lectionoft henote.

c)Fourchecksi
ssuedi
nJunemont
hhav
enoty
etbeenpai
dbyt
hebank:
o
CheckN :Dat
eJune Amount
601 14 150
777 23 15.375
790 25 603. 75
795 29 307.
5
d)Debitmemorandum i
ssuedbyt hebankonJune30f
ora$18ser
vice
char
gewasenclosedwit
ht heJunebankstat
ement

o
e)CheckN 850wasi ssued June22i ntheamountof$127. 5butitwas
err
oneousl
yli
stedonthechecksubandi nthecashpaymentjour
nalas
$87.Checkinpay mentoft elephoneservi
ce,waspaidbyt hebank,
ret
urnedwi
ththeJunebankst atementasof$87chargetotheaccount
.
Thecashaccounti
sov er
stat
edb/ coferrorin$40.
5.(
127.5-
87)

f)Noent r
yhasy etbeenmadei nXYZCompany ’
saccountt
orefl
ectthe
bank’s action on June 29 ofchargi
ng agai
nstt
he NSF check f
or
$75.375
Requir
ed:pr epareBankreconci
li
ati
on
XYZcompany
Bankreconcil
i
ati
on
June30,2014

AU/
Arsi
FBE/DeptACFN/
Pri
nci
plesofAccount
ing/2013- 21Pa
2020/ ge41
Balance per deposit
or’s June
30,
2014...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
$6,273.855
Add: noter eceivabl
e col l
ected by t he bank...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
$750.00
Deduct: bank ser vi
ce char ge..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
$18.00
:
NSF...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
$75.375
o
:Err
or in check sub N 850. ..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
.
$40.500
Adjusted cash bal
ance
..
..
...
..
..
...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
$6,
889.98

Balance per bank st

atement.
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
.
$7,
500.00
Add:deposi
tofJune 30 notrecorded by bank...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
.
$466.605
o
Deduct: out
standi
ng check N -601,777,790, 795...
..
..
..
..
..
..
..
..
..
..
..
..
..
..
.
$1,
076.625
Adj
usted cash bal
ance.
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
.
$6,
889.98

Il
lust
rationIII
The following data are accumul ated f
oruse i nreconci
li
ng t
he bank
accountofSi fancompany .
a)Bal anceperbankst atementatFeb28, $7,
929.50
b)Bal anceperdeposi t
or’srecordsatFeb28, $6,
017.05
c)A check f or$230 i n pay mentofa v oucherwas erroneousl
y
recordedinthecheckr egisteras$320
d)Checksout standing,$2,510.40
e)Bankdebi tmemor andum f orservi
cechargesas,
$16.70
f) Depositintransit
, notrecordedbybank, $671.
25

Required:pr
eparebankreconci
liati
on
Sif
ancompany
Bankr econcili
ati
on
Feb28, 2015
Balanceperbankst atement $7929.50 Bal
anceperdeposi
tor
$6017.05
Add: Depositi
ntransi
t $671.25Add: Err
or $90.
00
Sub-total 8, 600.75 Sub-
total
$6,107.05

AU/
Arsi
FBE/DeptACFN/
Pri
nci
plesofAccount
ing/2013- 21Pa
2020/ ge42
Deduct:
Checkoutstanding($2,
510.
40)Deduct
:Bankser
vicechar
ge(
16.
70)
Adj
ustedbalance$6,090.35Adj
ust
edbal
ance $6,090.
35

Cont r
oll
ingcashreceipts
Int
ernal control
ofcashr eceipts
Retailbusinessreceivescashf r
om twomai nsour ces:
1.ov ert
hecount erf r
om cashcust omerand
2.Bymai lfrom charge/ credit
/customersmaki ngpay mentonaccount.
Att heendoft hebusi nessday ,eachsalesclerkscountsthecash i nthe
assignedcash dr awerand r ecord theamount ont hememor andum
for
m.An empl oyeef rom cashi er’
sdepar t
mentcount st hecash and
compar es t he t otalwi th memor andum and t het
ape,noting any
dif
ferences.

3.3. Pet t
ycashandchangef und
Pettycashi sasmal lamountofcashsetasi def ormaki ngmi norcash
pay mentf orwhi chwr iti
ngofchecki snotpr act i
cable.Inmostbusi ness,
thereisaf requentneedf ort hepay mentofr elativelysmal lpay ment ,such
aspost age,f ort ranspor tationchar ge,f orpur chaseofur gent lyneeded
suppliesatnear byr et ai
lst ores.Pay mentbychecki nsuchcasewoul d
resulti ndel ay,annoy ance,andexcessi veexpenseofmai ntai
ningt he
records.Yetbecauseoft hesesmal lpay mentmayoccurf requent l
yand
therefore,amountt oaconsi derablet otalsum,i tisdesi rablet or etai
n
closecont rolov ersuchpay ment .Thismaybebymai ntai
ningspeci alcash
fundcal ledpet tycash.
Establishi ngapet tycashf und
Toest abl ishapet tycashf und:
 Est imat et he amountof cash needed f ordi sbur sement s of
relativ elysmal lamountdur ingt hemont horweek.
 Pr epar eav oucherf ort heamountest ablishedandsoon.
Il
lustr
at i
on
Assumet hatapet t
ycashf undof$100i sest ablishedonAugustone.At
theendofAugust ,thepet tycashr eceiptsindi cateexpendi turef orthe
foll
owi ngi tems.
Of fi
cesuppl ies $26.00
Post age( offi
cesuppl ies) 24. 00
Stor esuppl i
es 33. 00
Newspaper 5.70
Tor ecor dt heest abl i
shmentandr eplenishmentoft hepet t
ycashf und, t
he
entri
eswoul dbeasf ollows.
August1 pet tycash. ..
...
..
...
..
..
....
..
..
...
..
..
..
....
..
...
..
..
...
.$100
Accountpay able...
..
...
..
..
..
....
...
..
...
..
..
..
...
..
...
...
.$100

August1 Accountpayabl
e..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
$100
Cashinbank.
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
.$100

AU/
Arsi
FBE/DeptACFN/
Pri
nci
plesofAccount
ing/2013- 21Pa
2020/ ge43
Repl enishment :
August31Of f
icesuppl ies. ..
...
....
...
...
...
...
....
......
...
..
..
....
.50
St oresuppl ies. ..
....
..
..
...
...
..
......
....
...
..
..
....
...
..33
Mi scellaneousexp( N/paper ).....
..
..
...
...
..
.....5.7
Accountpay able...
..
....
..
....
...
...
...
..
...
.88. 7
August31 Accountpay abl e....
..
...
...
..
....
.....
...
...
..
...
...
....
...
.88. 7
Cashi nbank. ..
...
....
...
...
....
..
..
...
...
..88. 7
Cashchangef unds
Whenacompanyorr etail st or es makesmostofi ts sal es on acash
basis andsome amountofcash i s mai ntained f ormaki ng changes.
Suchf undi scal l
edchangef unds.Thati s, abusi nesst hatr ecei vesdi r
ect l
y
from cust omer smustmai ntainf undofcur rencyandcoi ni nor dert omake
change.Thej ournalent ryt or ecor dt heest ablishmentoft hechangef und
debi tscashonhandandcr edit scashi nbankf ort heamountwi thdrawn
from bankandar epl acedf orthecust odyoft her esponsi bl ecashi er.Sifan
companyEst abl i
shedchangef undofbi rr800onJanuar y2014andpl aced
i
ti nt hehandoft heonl ycashi er.Int henextday ,cashont hehandoft he
cashi erwas deposi tticketwaspr epar edf ort heappr opriat eamount .The
ent r
iest or ecordt heabov et ransact i
onwi ll be:
Januar y1, 2014 Cashonhand. .
..
...
...
..
.....
.....
...
..
..
....
.800
Cashi nbank. ..
...
....
..
...
...
..
....
..
...
....
800
(Tor ecor dt hechangef undest abl i
shed)
Cashi nbank. ..
..
....
..
...
...
......
..
...
birr1, 110. 50
Sales....
....
..
...
..
..
....
...
...
....
..
...
...
.1,110. 50
(Tor ecor ddai lycashsal es)
CashShor tandOv er
Theamountofcashact ual l
yr ecei veddur ingadayof tendoesnotagr ee
wi t
ht her ecor dofcashr ecei pt s.Forexampl e,ift heact ualcashr eceived
from cashsal ei sl esst hant heamounti ndicatedbyr egi ster ,theent r
y
woul ddebi ttocashshor tandov er.Somet imes,t hecashcol lectedf rom
dailycashsal esmaynotbeequalt ot her eadi ngoft hecashr egi stertape.
Suchmi nordi fferencesar ebel i
ev edt oar isef rom maki ngchangesandar e
account edf ori nt hecashshor torov erl edgeraccount .Ifcashcol l
ection
i
sgr eatert hansal es,cashshor tandov eri scr edited, andi fcashcol l
ection
i
sl esst hansal es, cashshor tandov erisdebi ted.
Cashi nbank. ....
..
....
...
..
...
..
....
..
....
...
...
...
..
...
..4,000
Cashshor tandov er..
..
...
..
....
...
...
....
..
...
...
..
.....
.50
Sale...
....
..
....
...
...
...
..
...
....
.....
..
....
..
....
..
...
....
..4,050
But ,whencashact uall
ycol l
ect edi sgr eat ert hansal e:
Cashi nbank. .
....
...
...
...
..
...
....
.....
..
....
..
....
..
...
....
660
Sal e...
...
..
...
..
...
....
..
....
..
..
...
...
....
..
....
...
..
...
...
..
.....
...600
Cashshor tandov er.
...
....
.....
...
...
..
....
..
....
...
...
....
.60

AU/
Arsi
FBE/DeptACFN/
Pri
nci
plesofAccount
ing/2013- 21Pa
2020/ ge44
 3.4. CLASSI FI
CATI ONOFRECEI VABLE
Receivables ar e al lmoney cl aims agai nstpeopl e orot herent i
ties
(debtors).Manycompani essel loncr edi t/onaccount sinor dert osel l
mor eserv i
cesorgoods.
i.Account sr eceivabl es-arenor mal l
yinformalcl aimsexpect edt o
be col lected wi thinar elat i
velyshor tper iod,wher easnot es
receivabl esar eformal ,writteni nstrument sofcr edit
.
ii
.Not eRecei vable-isawr it
tenpr omi setopayasum ofmoneyon
demandoratdef i
ni teperi
od.
Ifanot eandaccountr eceivablesar eor iginatefrom sal estransact ions,
theyar ecal ledt r ader eceiv able.Non- t
rader eceivablesar ethoseot her
thant r
ader eceivabl esandi ncludei nterestr eceivables,rentrecei vables,
l
oansbyt hecompanyt oot herent i
tiesandsoon. Accountsr eceiv able
ari
sef rom cr editsal est ocust omer sbybot hr etail
ersandwhol esaler s.
The amountofcr editsal eshasi ncr eased i nr ecenty ear
s,r efl
ect ing
severalf act orsi ncluding anef fi
cient banki ng sy stem and a sound
economy .Mer chandi singbusi nessescansel ltheirmer chandisesei ther
oncashoroncr edi tbasis.

Accountsr
eceivablearecurrentassetsbecausebydef
ini
ti
on,t
heywi
l
lbe
conver
tedtocashwi thint
henormal operati
ngcycl
e.
Whensalesaremadeonaccount ,theentryis:
Account srecei
vable………….XX
Sal
esrev enue…………………. XX

3.4.1.Internalcontrolofrecei vable
The empl oy ee who handl es t he account i
ng fornot es and account s
recei
v abl
eshoul dnotbei nvolvedwi t
hcr editapproval
sand col l
ecti
onof
recei
v abl
e.Separ ationofthesef uncti
onsr educesthepossi bil
i
t yoferrors
andembezzl ementandal sot hewor kofoneempl oy
eecanser v
e asa
checkont hewor kofanot herempl oy eei nt heseparationoff uncti
on.
Adequat econt roloveraccountr eceivablebegi nswiththeappr ov al
soft he
salesbyar esponsiblecompanyof fi
cial.Ef f
ecti
vecollectionpr ocedures
should al so be est abli
shed t o i nsure t i
mely col lecti
on of
Account r
ecei vableandtomi ni
mi zelossesf r
om uncoll
ectibleaccount s.

3.4.2.Account i
ngforuncol l
ecti
bleaccount s
Whenmer chandiseorser vi
cesar esol dwit
houtt heimmedi
ater ecei
ptof
cash,a par toft he claims agai nstcustomer s usual
lyproves to be
uncol l
ectible.Thatis,adebt orfail
stopayanaccountaccor dingt oasal e
cont r
actordi shonorsanot eont heduedat edonotnecessaril
ymeant hat
theaccountwi l
lbeuncollecti
ble.
Indicati
ons ar e as f ollows: bankr upt
cy, closing of t
he busi ness,
disappear anceoft hedebt or,&Fai lureofr epeatedatt
emptst ocollect
receivable.

AU/
Arsi
FBE/DeptACFN/
Pri
nci
plesofAccount
ing/2013- 21Pa
2020/ ge45
Ther ear etwomet hodsofaccount ingf oruncol l
ectibl
er eceiv ablet hati s
believedt obeuncol l
ect ible:
1)Al lowancemet hodwhi chi ssomet i
mescal ledr eservemet hodwhi ch
prov i
desi nadv ancef oruncol lectiblerecei vable.
2)Di rectwr it
e- offmet hod.I tr ecogni zest heexpenseonl ywhencer tai
n
account sar ej udgedwor t
hless.
1)Al l
owancemet hodofaccount i
ngf oruncol lectible
Theamountoft r
ader ecei vableest imat edt obecomeuncol lectibleint he
future.
Il
lustrati
on:Assumet hatt heaccount srecei v
abl eaccounthasabal ance
of$202, 000att heendoft heper iod.Basedonacar ef ulst udy ,iti s
estimat edt hatat ot alof$4000wi l
lev entuallypr ov etobeuncol l
ect i
ble.
Theamountexpect ed t o ber ealized f r
om t heaccount si s,t herefore,
$198, 000netr eal i
zabl ev alue,andt he$4000r educt i
oni nv aluei st he
uncol l
ectibleaccount sexpensef ort heper iod.Theadj usting ent r
yt o
recordt heexpenseandt her educt i
oni nt heasseti sasf oll
ows:
Dec31uncol l
ect ibleaccountexpense. .
..
..
...
...
.$4000
Allowancef ordoubtf ullaccount .
..
..
..
..
...
...
...
$4000
Whenanaccounti sbel ievedt obeuncol l
ectible,itiswr itt
enof fagai nst
all
owanceaccountasi nt hef ollowingent ry
:
All
owancef ordoubtf ullaccount. .
...
..
...
..
..
$210
Accountr ecei vabl e.
....
...
...
..
...
...
..
..
....
..
..
...
..
..
$210
Anaccountr ecei vabl et hathasbeenwr i
ttenof fagainstt heal lowance
accountmayl aterbecol lected.I nsuchacase,t heaccountshoul dbe
reinstatedbyanent r
yt hati st heexactr ev erseoft hewr ite-offent ry.
Assumet hatt heaccountof$210wr itt
enof fint hepr ecedingj our nalent ry
i
sl atercol l
ected.Theent rytor einstatet heaccountwoul dbeasf ollows.
Accountr ecei vabl e.
....
...
...
..
...
...
..
..
....
..
.$210
All
owancef ordoubtf ullaccount ...
...
..
...
..
..
...
...
.$210

2.Di r
ectwr it
e-offmet hodofaccount i
ngf oruncol lectibl
e
The use of Al l
owance met hod,as pr eviouslyi llustrated,r esultin
theuncoll
ectibleaccountexpensebei ngr eportedi nt heper i
odi nwhi ch
salesar emade.Thi smat chingof expensewi thr elatedr evenuei sthe
prefer
red met hod ofaccount i
ng f oruncollectibl
er ecei v
able.Howev er,
therearesi t
uat ionsi nwhi chitisi mpossibletoest imat e,withr easonable
accuracy,theuncol l
ectibleatt heendoft heper i
od.I ti ssat isfactoryto
delay recognition ofuncol l
ectibi
lit
y untilthe per iod i n whi ch cer tai
n
amount sar ebel ievedt obewor thlessandar eact ual l
ywr i
ttenof fas
anexpense.Accor dingl
y ,all
owanceaccountoranadj ustingent ryi snot
neededatt heendoft heper iod.
May10.Uncol lecti
bleaccountexpense…………. .100
Accountr eceivabl e-
xy………………………100
(Towr it
e-offuncol l
ectibl
eaccount )
Ifanaccountt hathasbeenwr itt
en-offcoll
ected,t heaccountshoul dbe
rei
nstated.

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plesofAccount
ing/2013- 21Pa
2020/ ge46
 3.4.3.Est imat inguncol l
ectibl eaccountexpenses( BadDebt sExpense)
Met hodsof est i
mat ingbaddebt sexpense
Ther ear et wocommonmet hodsofest imat i
nguncol l
ectibleaccountor
bad debtexpense:t heamountofsal esmet hod,and t heageoft he
recei vableaccount satt heendoft hef i
scal period.
1.Est imat ebasedonsal es
Accountr ecei v
ablei sacqui red asar esultofsal eson account .The
amountofsuchsal esdur ingt hey earmayt hereforebeusedt odet er
mi ne
the pr obabl e amountoft he account st hatwi l
lbe uncol lecti
ble.The
amountoft hi sestimat ei saddedt owhat everbalanceexi stsi nal l
owance
fordoubt fulaccount s.Toi llustrateassumet hatt heal lowanceaccount
hasacr edi tbal anceof$700bef oreadj ustment .Ifiti sknown` from past
exper iencet hatabout1% ofchar gesal eswi llbeuncol l
ectibleandt he
char gesal esf oracer tainy earamountt o$300, 000, theadj ust ingentryfor
uncol lect i
bleaccount satt heendoft hey earwoul dbeasf ollows:
Dec31 uncollectibleaccountexpense. .
...
..
..
...
..
.3000
Allowancef ordoubt ful account .
....
..
...
..
.3000
Aftert headj ustingent r
yi spost ed, t
hebal ancei ntheal lowanceaccounti s
$3,700.I fther ehadbeenadebi tbal anceof$200i nt heallowanceaccount
bef oret hey earendadj ust ment ,theamountofadj ustmentwoul dsti
llhave
been$3, 000.Thebal ancei nt heal l
owanceaccount ,af t
eradj ust i
ngent r
yis
post ed, woul dbe$2, 800( $3, 000- $200) .

Theper centofsalesmethodusesst at
ementr el
ati
onst oest
imat
ebad
debtexpenses.Iti
sbasedontheideathatagivenpercentofacompany’
s
credi
tfort heperi
odareuncol
lect
ibl
e.Theincomest at
ementwouldthen
repor
tthatpercentast
heamountofbaddebt sexpense.

Toill
ustr
ate,assumeABCcompanyhascr editsalesofBi r
r500,000i n
2016.Basedonpastexper ienceandtheexperienceofsimil
arcompanies,
ABCestimates0.6%ofcr editsal
esareuncol
lectibl
e.Usi
ngthispredi
cti
on,
ABCexpectBirr3,000ofbaddebt sexpensefrom 2016’ssal
es(computed
as Bi
rr500,000x0.006=Bir
r3, 000)
.The adjusting ent
rytor ecordthis
est
imatedexpensei s:

Dec. 31Uncoll
ecti
bleaccountexpense. ..
..
..
...
..
..
.3000
Allowancef ordoubtf
ulaccount ..
..
..
..
..
..
...
..
.3000
Thisent r
ydoesn’tmeant heDecember 31,2016bal anceinAl lowancef or
Doubt f
ulAccountswi l
lbeBirr3000.ABi rr3000bal anceoccur sonl yifthe
accounthad azer o balancepr iort o posting theadj ust
ing ent r
y .For
severalr easons,the unadjusted bal ance ofAl l
owance f orDoubt ful
Account scannotbezer o.Unl essacompanyi si ni t
sfirstper iod of
operati
ons, t
heallowanceaccountwi l
lhav eazer obalanceonl yifthepr i
or
amount swr it
ten-
offasuncollectibl
eexact lyequalt ot hepriorest i
mat ed
baddebt s.

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Arsi
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Pri
nci
plesofAccount
ing/2013- 21Pa
2020/ ge47
 2.AccountsRecei vablemet hod
Theaccount srecei vablemethodsusebal ancesheetr elati
ont oesti
mat e
baddebt s,primar il
y,ther el
ationbet weenaccount sr eceiv
ableandt he
all
owanceamount .Itisbasedont heideat hatsomepor ti
onoft heend-of
periodaccountr eceivablebalancei snotcol l
ecti
ble.Theobj ectiv
eforthis
baddebt sadjustingent ryistomaket heAl l
owancef orDoubt fulAccount
balanceequalt ot hepor ti
onofout standingaccountr ecei vableesti
mat ed
asuncol l
ecti
ble.Toobt ainthisrequiredbal ancef ort heAl l
owancef or
Doubt fulAccount s,wecompar ei t
sbal ancebef oret headj ustmentwi th
ourest imatedbal ance.Accounti sdonei noneoft woway s:(1)simple
estimat esofper centuncol l
ect i
blef r
om t het otalout standingaccount
receivableand( 2)agi ngaccountr eceivable.

a.Per centAccount sRecei v ablemet hod

Theper centofaccount sr eceiv abl
eappr oachassumesagi venper centof
a company ’s outstanding r eceivable are uncol lectibl
e.Thi s est imated
per centi sbasedonexper ienceandt heexper i
enceofsi mi l
arcompani es.
Cur rentcondi tionssuchasr ecenteconomi ctrendsanddi f
fi
cul ti
esf aced
bycust omer sdoal sohav ei mpact soni t.Thet otaldollaramountofal l
out standingr eceivableismul ti
pli
edbyanest imat edper centt ogett he
estimat eddol laramountofuncol l
ecti
bleaccount .Thi samounti srepor t
ed
i
nt hebal ancesheetast hebal anceforal l
owancef orDoubt fulAccount s.
Wepr epar eanadj usti
ngent rydebi t
ingBadDebt sExpenseandcr editi
ng
Allowance f orDoubt f
ulAccount s.The amountofadj ust
menti st he
amountnecessar yto gi ve us t he requir ed balance in Al l
owance f or
Doubt fulAccount s.
AssumeABCcompanyhadBi rr50,000ofout st
andi ngaccount srecei vable
on December31,2015 pastexper ience suggest s 5% ofout standing
recei vablear euncol l
ecti
ble.Thi smeanst hataf t
ert headj ustingent ryi s
post ed, wewantt heAllowancef orDoubt f
ulAccount stoshowaBi rr2,500
credi tbal ance comput ed as 5% of Bi rr 50,000=2500) .Bef oret he
adjust ment ,t
heaccountappear sas:
Priort ot heDecember31,2015adj ustment ,theal l
owancef ordoubt ful
accounthasacr edi
tbal anceofBr200.TheAdj ustingent r
yt ogi vethe
all
owancet her equir
edBi rr2,500bal ancei s:
Dec.31BadDebt sExpense………………….2, 300
Allowancef orDoubt fulAccount ……2, 300

b.Agi ngofAccount sreceivablemet hod

Bot htheper centofsales(incomest atement)met hodandt heper centof
account sr eceivabl
e( bal
ance sheet ) met hod use i nf
ormat i
on f r
om
exper i
ence to est i
matet he amountofbad debt s expense.Anot her
balancesheetmet hodusingr eceivablesi
nf ormationpr oducesamor e
preciseestimat eandusesexper ienceandcur rentinformation.Theagi ng
ofaccount sr ecei
vabl
e met hod exami neseach accountr ecei
vablet o

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plesofAccount
ing/2013- 21Pa
2020/ ge48
esti
matet heamountuncol l
ectibl
e.Receiv ablesareclassifi
edbyhowl ong
theyarepastt heirduedat es.Then, esti
mat esofuncol l
ecti
bleamountar e
madeassumi ngthel ongeranamounti spastduet hemor elikel
yitistobe
uncoll
ecti
ble.
In agi
ng account sr eceivableout standing att heend ofaper i
od,we
examineeachaccountandcl assi
fyitbyhowmucht i
mehaspassedsi nce
i
twas due.Cl assif
icati
on depends on t he judgmentofa company ’
s
management .Howev er,classesar eof t
en based on 30- days( orone-
mont hperiod).Af t
ert heout standingamount sar eclassi
fied(oraged) ,
experi
ence is used t o est i
matet he per centofeach cl ass thatis
uncoll
ecti
ble.Theseper centsar eappl i
edt ot heamounti neachcl assto
gettherequiredbalanceoft heAllowancef orDoubt f
ulAccount .

Agi
ngofAccount
sRecei
vabl
e
Esti
mated
AgeI
nter
val Bal
anc uncoll
ect
ibl
eAmou
e nt

Notpastdue 75,
000 2% = 1500
1-30dayspastdue 4000 5% = 200
31-60 days past 3100 10%= 310
due
61-90 days past 1900 20%= 380
due
91-180 days past 1200 30%= 360
due
181-365dayspast 800 50%= 400
due
> 365 day s past 300 80%= 240
due

Tot
al 86,
300 Br3,
390
Thelongeranaccount sreceivableremai nsoutstanding,t helessl
ikely
thati
twillbecol l
ected.I
nt heagingofr ecei
vables,anagi ngscheduleis
prepar
edbycl assifyi
ngeachr eceivablebyi tsduedat e.Basedont he
above exhi bi
t,the desir
ed balance f orthe allowance f ordoubtful
accountsisest i
mat edasBr3,390.Assumet hatt heunadjust edbal
ance
oftheall
owanceaccounti scr
editbalanceofBr510.Theamountt obe
addedtot hisbalanceistheref
oreBr2, 880(3,390-510) .
Thentheadjust i
ngentrywillbe:
Uncollecti
bleaccountsexpense………2880
Al l
owancef ordoubtf
ul account………2880

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FBE/DeptACFN/
Pri
nci
plesofAccount
ing/2013- 21Pa
2020/ ge49
Estimation of uncol lect
ible account s expense based on aging of
receiv
abl esemphasi zesont hecurr entnetreal
izablevalueofr
ecei
vables
andhencet heamountofuncol l
ectiblerecei
vablesestimatedbyagingis
theadj ust edbalanceofr ecei
vables.Requir
edadj ust
mentf orAccounts
Receivabl eisBr
.3,390.

3.5. NOTESRECEI VABLE

Promi ssor
ynot esar eusedi nmanyt ransact
ions,i ncl
udingpay i
ngfor
productsandser vi
ces,inthelendi
ngandbor r
owi ngofmoney ,andtopay
foraccountsr ecei
vable.Inthissect
ion,wewi lldiscusscomput ati
onsof
mat uri
tydateandmat uri
tyvalueofanote, howt orecordreceiptofanote,
how t oaccountf ordiscounti
ngofanot ebef orei tmat ures. Wealso
discusscasesofdi shonorednote.

Int erestbear ingnot e

Thet y picalnot esr ecei v abl er equi rest hepay mentofaspeci f
iedf ace
amount ,al socal ledpr inci pal,ataspeci f
iedmat ur i
tydat eordat es.I n
addition,i nt er esti spai d atast at ed per cent ageoft hef aceamount .
I
nter esti st hecostofbor rowi ngmoneyf ort hebor rowerort hepr ofitfor
l
endi ngmoneyf ort hel ender .Unl essot herwi sest ated, t
her ateofi nterest
onanot eist her at echar gedf ortheuseoft hepr incipal f
oroney ear.
Int erestonnot esi scal cul atedas: I=( P)(R)( T)
Wher e,I =Int er est ,P=Pr incipal,R=AnnualI nter estRat e,and T=Ti me
(Per iod)
Forexampl e-OnJanuar y1,2017,Chi l
alo Tr adi ng sol df erti
li
zer st o
cooper at i
v esagr eei ngt oaccept ,Br700, 000, 12- mont h, 12%not es.The
not ei spay abl eonDecember31, 2017.
Theent ryi s:
Jan- 1, 2007 Not esr ecei v able..
....
....
..
.700,000
Salesr ev enue. .
..
....
.....
...
...
..
.700, 000
(Tor ecor dt hesal eoff er ti
l
izers)
Dec, 31, 2017.Cash. ....
....
...
...
..
..
.....
...
..
...
784, 000
Not esr ecei vable.....
...
..
...
..
...
..
....
...
....
..700, 000
I
nt eresti ncome( 700, 000x12%x1y r)...84,000
(Tor ecor dt hecol lect i
onofcashatmat urity)
Mat urit
yDat eandPer iod
Themat uritydat eofanot ei st hedayonwhi cht henot e( pri
ncipaland
i
nterest )mustber epai d.Theper i
odofanot ei st het imef rom t hedat eof
thenot et oi tsmat ur i
tydat e.Manynot esmat ur ei nl esst hanaf ullyear,
andt heper iodcov er edbyt hem i sof tenexpr essedi nday s.Whent het ime
ofanot eisexpr essedi nday s,themat uritydat eist hespeci fi
ednumber
ofday saf tert hedat eoft henot e.Asanexampl e,af i
ve-daynot edat ed
June15mat ur esandi sdueonJune20.A90- daynot edat edJul y10
mat ur esonOct ober8.ThusOct ober8,duedat e,i scomput edasshown
below:

AU/
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plesofAccount
ing/2013- 21Pa
2020/ ge50
 Mat
urit
yDat eComput at
ion:
DayinJuly……………. 31
Minus:the date oft he 10
note
Daysremai ni
ngi
nJul y 21
Add:daysinAugust 31
Add:daysinSeptember 30
Dayst o equal90 day s,orMat
urit
y
Date,October 8
Matur
it
y
Dat
e

Per
iod of t
he not
ein 90
day
s

Theper iodofanot ei ssomet imesexpressedi nmont hsory ears.When

mont hsar eused,t henot emat uresandi spay ableint hemont hofi t
s
mat uri
tyont hesamedayoft hemont hasitsor i
ginaldate.At hr
ee-month
note,dat edJul y10,f orinstance,i spayabl
eonOct ober10. Thesame
analysisappl ieswheny earsar eused.
ReceiptofaNot e
Notesr ecei v
abl ei susual lyrecordedinasi ngl
enot esrecei
vableaccount
to simpl ifyr ecor d keepi ng. Weneed onl yoneaccountbecauset he
ori
ginalnot esar ekeptonf i
le.Thi smeans,thatwecanunder standthe
maker ,r ateofi nterest,duedat e,andotherinformat i
onbyexami ni
ngthe
actual not e.
Toillustrat ether ecor dingf ortherecei
ptofanot e,assumeABCr eceivesa
noteoft heBi rr1,000.90- day ,12%.

Thi
str
ansact
ioni
srecor
dedas:
Jul
y10Not
esreceivabl
e………………1,000
Sales…………………………..1,
000
(Sol
dmer chandi
sei
nexchangefora90-
day
,
12%not e)

Companiesal sosomet i
mesacceptanot efrom anoverduecust omerasa
wayofgr anti
ngat imeextensiononapast -dueaccountr eceivable.When
thi
soccur s,acompanymaycol l
ectpartoft hepast
-duebal ancei ncash.
Thispart
ialpaymentf or
cesaconcessi onf rom t
hecust omer, reducesthe
customer’sdebtandpr oducesanot ef orasmal l
eramount . ABC,f or
i
nstance,agreedt oacceptBi rr400incashandaBi rr600,60- day,15%
notetoset tl
eitsBi r
r1000past -dueaccount . ABCmadet hef ol
lowi
ng
entr
ytorecordr ecei
ptofthiscashandnot e:

AU/
Arsi
FBE/DeptACFN/
Pri
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plesofAccount
ing/2013- 21Pa
2020/ ge51
 Oct
.5 Cash…………………….
.….
.400
Not
eRecei
vabl
e……….
……600
Di
scount
in
Agn t
e
ccou r
ec
nt
s e
Ri
ev
ca
eb
i
vl
e
abl
e………1,
000
Recei
vedcashandnot
etoset
tl
eaccount

Discountingnot esRecei v abl

e
Althoughi ti snotacommont ransact ion,acompanyi nneedofcash
mayt r
ansf eritsnot esr eceivabl etoabank. Thedi scountor( i
nter
est )
chargedbyt hebanki scomput edont hemat urit
yv alueofthenot efor
theper i
odoft i
met hebankmusthol dt henot e,namel ythet i
met hat
wi l
lpassbet weent hedat eoft het r
ansf erandt heduedat eoft henot e.
Theamountoft hepr oceedspai dtot heendor serist heexcessoft he
mat uri
tyval ueov erthedi scount.
Toi ll
ustr
at e,assumet hata90- day,12% not er eceivabl
ef or$1,800,
datedNov ember8, isdiscount edatt hepay ee’sbankonDecember3at
the rate of14%.The dat a used i n det er
mi ning the eff
ectoft he
transacti
onar easf oll
ows:

Facev alueoft henot edat edNov .8...

..
..
..
..
..
..
..
...
..
..
..
..
..
..
.$1,800
Interestonnot e-90day sat12%. .
..
...
..
..
..
..
..
...
..
..
..
...
..
..
..
..
..
. 54
Mat urityv al
ueofnot edueFeb.6. .
...
..
..
..
..
..
...
..
...
..
..
..
..
..
..
..$1,854
Discountper iod-Dec3t oFeb.6..
..
....
..
..
..
..
..
..
..
...
..
..
..
..
..
..
..
.65day s
Discountonmat urit
yv al
ue-65day sat14%. .
..
...
..
..
..
..
..
..
...
46.87
Proceeds. ..
..
..
..
..
...
..
..
..
..
...
..
...
..
..
..
..
..
...
...
..
..
..
..
..
..
..
...
..
..
..
..
..
..
$1,807.13
Theexcessoft hepr oceedsr eceivedbyt heendor serfrom discounting
thenote,$1,807. 13ov eri t
sf acev alue,$1800,i sr ecordedasi nter
est
i
ncome.Theent r
yf ort het r
ansact i
on,ingener aljournalform,i sas
fol
lows:
Dec3. Cash. ....
..
..
..
..
..
....
..
..
..
...
..
..
..
.$1,
807. 13
Not ereceivable..
..
..
...
..
..
..
..
...
..
..
..
..
..
...
1,800
I
nterestincome. ..
..
...
..
..
..
..
...
..
..
..
..
..
...
..
.7.13

Honor i
nganddi
shonori
ngaNot e
Thepri
nci
palandint
erestofanotearedueoni tsmat uri
tydate. The
makerofthe not
e usual
lyhonorsthe not
e and paysitinf ul
l. But
somet
imesamakerdishonorst
henot
eanddoesnotpayi tatmaturi
ty.

Recor
dinganHonoredNote
WeusetheABCnotetr
ansact
ionabov
et oi
ll
ustratet
hehonoringofanot
e.
WhenABCcoll
ect
sanot eoni
tsduedate,I
trecordsi
tsr
eceiptas:
Cash……………………….
.615
Not
esr
ecei
vabl
e…….
.….
600
I
nter
esti
ncome….
..
..
……15
(Col
l
ect
ednot
ewi
thi
nter
estof
AU/
Arsi
FBE/DeptAC
BF
iN
r
r/P0
6r
inci
0xpl
1e5
s%x
ofAc
6c
0o
/u
3nt
i
6n
0g
)/
.2013- 21Pa
2020/ ge52
Inter estEar ned,alsocal l
edI nt
erestRev enue,isreport edont hecur rent
per i
od’ sincomest atement .
RecordingaDi shonoredNot e
Whenamakerofanot eisunableorr ef
usest opayatmat ur i
ty,
t henot eis
saidt obedi shonored.Theactofdi shonori
nganot edoesnotr el
ievet he
makeroft heobl i
gat iontopay .Thepay eeshoul duseev er
yl egit
imat e
meanst ocol lect
.
Thebal anceoft heNot esReceivableaccountnor mallyincludesonl ythose
not est hathav enotbeenmat ured. Whenanot ei sdi shonor ed,we,
ther efore,remov et heamountoft hi
snot ef r
om t henot esrecei vables
accountandchar gei tbackt oanaccountr eceiv
ablef r
om i tsmaker .For
i
nst ance, Hawani holdsaBi r
r800, 12%,60-daynoteofBont u.
Atmat uri
ty,Bont udi shonoredthenot e.Hawanir ecordst hisdishonor ing
ofit snot esr ecei
vabl easf ol
lows:
Account
srecei
v able-
Bontu…816
I
nterestincome………………. 16
Notesr ecei
vable………………800
TochargeaccountofBont uf oradi
shonorednot
eandi
nter
est
ofBir
r800x12%x60/ 360
Char gingdi shonor ednot ebackt otheaccountofi tsmakerser vestwo
pur poses. Fi rst,i tremov est heamountoft henotef rom thenot es
receivableaccount ,leavi
ngi ntheaccount sthathavenotbeenmat ured.It
alsor ecordst hedi shonor ednot einthemaker ’saccount.
Second,andmor eimpor tant,ifthemakeroft hedishonorednoteapplies
forcr editint hef uture;hisorheraccountwi l
lshow al lpastdeali
ngs,
i
ncl udingt hedi shonor ednot e.Rest oringtheaccountal soremindst he
companyt o cont i
nuecol lecti
on efforts. Notet hatBont u owesbot h
principalandi nterest.Theabov eent ryrecordsthefullamountowedi n
Bont u’s accountand cr editsthe interestearned. Thi s ensur
es that
i
nt erestisincludedi nef fortstocollectfrom Bontu.

When a di scount
ed not erecei
vabl
ei s di
shonor ed,the holderusual l
y
noti
fi
est heendorserofsuchf actsandasksf orpay ment
.Ift herequest
forpaymentandnot if
icati
onofdishonoraretimely,theendorserislegall
y
obli
gatedtopayt heamountdueont henote.Theent i
reamountpai dto
theholderbyt heendorser,
incl
udi
ngt hei
nterest,shouldbedebi t
edt othe
accountreceivabl
eofthemaker .

End-
of-
Per i
odI nt
erestAdjustment
Whennot esrecei
vableareoutstandi
ngatt heendofanaccountingperi
od,
accr
uedi nter
estiscomput edandr ecorded. Thi
srecognizesbotht he
i
nter
estrevenuewheni ti
sear nedandt headdedasset(
int
erestrecei
vable)

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ownedbyt heholderoft henot e. Forinstance,onDecember16,ABC
acceptedaBi r
r3,000,60-days,12%not efrom acustomeri ngrant
ingan
extensiononapast -
dueaccount .WhenABC’account i
ngper i
odendson
December31, Bir
r15ofi nt
eresthasaccruedont hisnot
e( Bi
rr3,
000x12%
x15/ 360).Thefol
lowingadjusti
ngentryrecordsthi
srevenue:
Dec.31 I
nterestr eceivabl
e…………………. 15
Interestincome……………………………15
Torecor daccr uedint
erestadj
ustment
.

Thisadj usti
ngent rymeansi nterestr eceiv
ableappear sont hebalance
sheetasacur rentasset.
Pr
esent ati
onofr eceivabl esinthebal ancesheet
Account srecei
v abl esarecurrentasset sbecauset heywi l
lbeconv er
tedin
tocashwi thint hecur rentaccount ingper i
od.Hence,i ti sreport
edas
curr
entasseti nt hebalancesheetsect i
on.Howev er,notesreceivabl
es
maybe cl assifi
ed as cur r
entornon- curr
entassetdependi ng on the
expectedpay mentdat es.Receiv ablesar ereportedi nthebal ancesheetat
netreali
zableval ue.Al l
owancef ordoubt fulaccounti sacont raaccountto
accountsr eceivabl e.Inthecur r
entassetsect ionoft hebalancesheet ,
accountsreceivabl ewoul dber eport ednetoft heal lowanceasf oll
ows
Account srecei vabl
e…...
..
..
...
...
..
....
..
..
...
..
..
..
..
..
..450,000
Less:all
owancef ordoubt fulaccount .
...
..
..
…..
.50,000
Balance…………………………………. ..
…..400,000

ChapterFour
AccountingforInvent
ori
es
4.
1.Meaningandi
mportanceofi nventor
ies
I
nventori
esareassetitemshel df orsaleint heor
dinar
ycourseof
busi
nessorgoodsthatwillbeusedorconsumedi ntheproduct
ionof
goodstobesold.

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 Theyar emai nlydi v i
dedi ntot womaj orcat egor i
es:
 I nvent or i
esofmer chandi singbusi nesses; and
 I nvent or i
esofmanuf act uringbusi nesses
. I
i nvent oriesofmer chandi si ng busi nesses:ar e mer chandi se
pur chasedf orr esal ei nt henor malcour seofbusi ness.These
typesofi nv ent ori
esar ecal ledmer chandi sei nvent or i
es.
i. I
i nvent ories of manuf act ur ing busi ness: manuf act ur ing
busi nesses ar e busi nesses t hatpr oduce phy si calout put.
Theynor mal lyhav et hr eet y pesofi nv entor ies.Thesear e:
o Rawmat erial inv ent or y
o Wor kinpr ocessi nv ent or y
o Fi nishedgoodsi nv ent or y
1.Rawmat er i
ali nvent or y–i st hecostassi gnedt ogoodsandmat erials
onhandbutnotpl acedi nt opr oduct i
on. Raw mat er i
alsi ncludet he
woodt omakeachai rorot herof fi
cef ur nitur e’s,thest eelt omakeacar
etc.
2.Wor kinpr ocessi nvent or y-i st hecostofr aw mat erialonwhi ch
productionhasbeenst ar
t edbutnotcompl eted,andt hedi rectl abor
costappl iedspeci fical l
yt ot hismat erialandal locat edmanuf act ur ing
overheadcost s.I nsi mplet er ms,wor ki npr ocessi nv ent or yr ef erst o
thecostoft hosei temst hatst artedi npr oduct i
onbutnoty etcompl eted.
3.Fini
shedgoodsi nvent ory–i st hecosti dent i
fiedwi tht hecompl et ed
butunsol duni tsonhandatt heendofeachper i
od.
Inthischapt er ,onl yt hedet ermi nat ionoft hei nv ent or yofmer chandi se
purchasedf orr esalecommonl ycal ledmer chandi sei nvent orywi llbe
discussed.
Impor tanceofI nv ent or i
es
Mer chandisepur chasedandsol di st hemostact iveel ement si na
mer chandisi ngbusi ness, i
.e.i nwhol esal eandr etai ltypeofbusi nesses.
Thisisduet ot hef ollowi ngr easons:
1.Thesal eofmer chandi sei st hepr i
ncipalsour ceofr evenue
fort hem.
2.Thecostofmer chandi sesol di st hel argestdeduct ionsf rom
sal es.
3.I nv ent ories( endingi nv ent or ies)ar et hel argestoft hecur rent
asset sf ort hosef i
rms.
4.2Det ermi ni ngact ual quant iti
esi ncl udedi nI nv ent or y
Regar dl
essoft hesy stem used,t hemeasur ementofi nv ent or yandt he
costofgoodssol dst artswi thdet er mi ningt hephy si calquant i
tiesof
goods.Det er mi ningt hephy si calquant i
tyt hatshoul dbei ncl udedi n
i
nv entoryi s a si mpl e mat terbecause i tconsi sts ofi tems i nt he
possessi onoft hecompany .Thephy si calcountofi nv ent or yi sneeded
underbot hi nv ent or ysy stems.Underper iodi ci nv ent or ysy st em,i ti s
neededt odet ermi net hecostofi nvent or yandgoodssol d.
Thei nventor yaccountunderper pet uali nv ent orysy stemsi sal way sup
todat e.Yetev ent scanoccurwher et hei nv entor yaccountbal ancei s

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 dif
f er entf rom i nvent oryon hand. Such ev ent sincludet heft,loss,
damage,ander rors.Thephy sicalcount( somet imescal l
ed“ takingan
i
nv ent ory”)i
susedt oadj ustthei nventoryaccountbal ancet otheact ual
i
nv ent oryonhand.
Wedet ermineabi rramountf orphy sicalcountofi nventoryonhandat
theendofaper i
odby :
 Count ingt heuni tsofeachpr oductonhand;
 Mul t
iplyingt hecountf oreachpr oductbyi tscostperuni t
;
and
 Addi ngt hecostf orallproducts.
Att het i
meoft aki ngani nv
ent ory,allthemer chandiseownedbyt he
busi nessont hei nv entorydat e,andonl ysuchmer chandise,shoul dbe
i
ncl udedi nt heinvent ory.Goods- i
n-tr
ansit,consignmentsal esandsal es
retur nsar ei mpor tantar east hatshoul dbeconsi deredwhi l
et akingthe
phy sical inventory.
Thel egalt i
tletot hemer chandi sei nt r
ansitont heinventorydat ei s
knownbyexami ningpur chaseandsal esinvoicesoft helastf ewday s
oft hecur rentaccount ingper iodandt hefirstfewday soft hef oll
owing
account i
ng per iod. Thi sl egalt it
le depends on shi pping t erms
(agr eement s).

1.Goods- i
n-transi t:Att heendoft her epor t
ingperiod,i
tisimpor tantto
ensur e a pr operi nvent orycut -off.Thi s means determi ning the
owner shipofgoodst hatar ein-transitbetweent hesellerandbuy er
.
The t ypes ofshi ppi ng t er ms det ermi ne the legaltit
le and t he
owner shipoft hei tems, whi char ein-transit
.
Therear etwomai nt ypesofshi ppingt erms.FOBshi ppingpoi ntand
FOBdest i
nat ion.FOBst andsf or‘FreeOnBoar d’.
a.FOBshi ppi ngpoi nt–t heowner shipt it
lepassest othebuy erwhen
thegoodsar eshi pped( whent hegoodsar eloadedont hemeansof
transpor t
at ion, i .e. at t he sel l
er’
s poi nt). The pur chaser i s
responsi blef orf reight( transpor tation)char ges.
b.FOBdest inat i
on– t het i
tlepassest ot hebuy erwhent hegoods
arri
v eatt hei rdest inat i
on, i.e.atthebuy er’
spoint.
Therefore, i
ngener al,goodsi nt ransitpur chasedonFOBshi ppi ngpoint
ter
msar eincl udedi nt hei nv entoriesoft hebuy erandexcl udedf rom
theinv entori
esoft hesel l
er .Mor eov er,goodsi ntransitpurchasedon
FOBdest inationt er msar ei ncludedi nthei nventor
iesoft hesel l
erand
excludedf rom t hei nv ent oriesoft hebuy er .

2.GoodsonConsi gnmentsal e:
Undert hi
sar r
angement ,t
hegoodsar ephy si
call
ytransf
erredt othe
othercompanycal ledt heconsignee.I
tisaspecialsalestransact
ion
whereowner( consigner)transf
erstheproductstoanagent ,cal
led
consignee.
Therear ealsoproblemswi thgoodsonconsi gnmentatt hetimeof

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 taki
ngi nventory.Theowner shi
pofconsi gneditemsst i
l
lbelongst othe
ownernott heagent . A consigneeagr eestosel lthegoodsf orthe
owner (
consigner )usual
lyon commi ssion basis and the consigned
i
temsar eincludedintheconsigner’
sinventor
iesandexcl udedfrom the
consignee’sinventor
ies.

4.3:TheEf fectsofI nventori

esonFi nancial
Statements
Whatmakesi nv entoriesspecialthananyofot heraccount i
ngi t
emsi s
theirmultidi
mensi onaleffect.Theireffectisnotlimit
edi nonef i
nanci
al
statementorev enwi thinasingl
eper i
od.Wheny oucompl etethi
ssecti
on,
youwi llprobablybeamazedbyt hefactt hati
nventoryinaffect
ingmany
account i
ngcalcul ati
ons, f
inanci
alstat
ement sofdif
ferentperi
ods.

Ef fectofEndingI nventor
yonCurrentPeriod’
sFi
nancialStatement s
Endi nginventor
yi st hecostofmer chandiseonhandatt heendoft he
account i
ngper iod. Letusseei t
sef fectoncur r
entperiod’sf i
nancial
statement s.
Theef fectofendi nginvent
oryi
sreflect
edinbothincomest atement sand
balancesheet s.Fi r
st,l
etusseei
tsef f
ectonthei
ncomest atement :
IncomeSt at
ement
a).Endinginventoryisusedincal
culati
ngcostofgoodssoldi nt heincome
statement .Costofgoods( mer
chandise)sold=Begi nni
ngi nventory+
Netpur
chase–Endi
ngi
nvent
ory.
As y ou see,ending inventoryi s a deduct ion in calculat
ing costof
mer chandisesol
d.So,i thasani ndir
ect( negati
ve)relat
ionshiptocostof
mer chandisesold,i.
e.i fending i nvent
or yisunder stated,thecostof
mer chandisesol
dwi l
lbeov erstated,andi fendinginventoryisoverstat
ed,
thecostofmer chandisesoldwi ll
beunder stat
ed.
b).
Thecostoft hemer chandisessol dwillthensubsequent l
ybeusedi n
calculat
ingthegrossprofitoftheent erpr
ise.
Gr
ossPr
ofi
t=Netsal
es–Costofmer
chandi
sesol
d
Her e, thecostofmer chandi sesol dhadi ndi r
ectr elat
ionshiptogr osspr ofi
t.
So,t heef fectofendi ngi nvent or yongr osspr ofitistheopposi t
esoft he
effecton costofmer chandi se sol d. Thati s,ifendi ng invent or
yi s
under stat ed, t
hegr osspr ofi
twi llbeunder stat edandi fendinginv entoryto
over stat ed, thegr osspr of i
twi l
lbeov erstated.
c) Oper atingincome=Gr ossPr of i
t-Expenses
Grosspr ofitandoper atingi ncomehav edi rectr elati
onships. Thus,t he
effectofendi nginv ent oryonneti ncomei sthesameasi tseffectongr oss
profit.
BalanceSheet
Now l etusseet heef fectofendi ngi nv entor yont hebal ancesheet .A
balancesheeti saf inanci alst atementt hatl istsal lassets,li
abilit
iesand
capi talsofanor ganizat iononaspeci fi
cdat e.Theendi nginventor yofan
organi zationaf f
ect sthet womaj orcomponent sofabal ancesheet :
1. Cur r
entAsset s-Endi ngi nv entoryi spar tofcur r
entasset s,ev enthe

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 l
argest . Ther efore,i thasadi rect( positi
v e)r elationshi pt ocur rent
assets. Ifendi ngi nv entorybalancei sunder stated( ov erstated),the
tot
alcur rentasset swi llbeunder stated( ov erstated) . Si ncecur rent
assetsar epar toft otalasset s,endi nginvent oryhasdi rectr elati
onship
totot
al asset s.
2. Liabi l
it
ies:Noef fectonl iabi
li
ties.I nvent orymi sstatementhasno
eff
ectonl i
abili
ties.
3. Owner s’equi ty-Theneti ncomewi l
lbet ransfer r
edt ot heowner s’
equit
yatt heend ofaccount i
ng per iod. Cl osing i ncomesummar y
accountdoest his.Ther efore,neti ncomehasdi rectr elationshipwi th
owner s’equityatt heendofaccount i
ngper i
od.Theef fectofendi ng
i
nventor yonowner s’equi tyisthesameasi tsef f
ectonneti ncome, i.e.
i
fendi ngi nventor yisunder stat
ed( Ov erst
at ed) ,t
heowner s’equi t
ywi l
l
beunder stated( Ov erstated).

Il
lustr
ation:
Theef fectofi nventoryont heCur rentPeriod’sStat ement s
Aner rorint hedet erminationoft hei nventoryamountatt heendoft he
periodwi l
l causeanequal mi sstatementofgr osspr ofi
tandneti ncome,
andt heamountr eportedf orbot hasset sandowner ’sequi tyi nthe
balancesheetwi llbei ncorrectbyt hesameamount .Theef fectsof
understatement sandov erstatement sofmer chandi seinventoryatt he
end oft heper i
od ar edemonst rated int hef ollowing threeset sof
condensedi ncomest atement sandbal ancesheet s.
Thef ir
stsetofst atement si sbasedonacor rectendi nginv entoryof
$30,000;t hesecondset ,onani ncor r
ectendi ngi nventoryof$22, 000;
andt het hirdset ,onani ncor rectendi ngi nventor yof$37, 000.I nal l
threecases,netsal esar e$200, 000,mer chandiseav ai
lableforsal eis
$140,000, andexpensesar e$55, 000.

IncomeSt atementfortheYear BalanceSheetatEndofYear

1.Inventoryatendofper i
odcor rect
lystatedat$30, 000
Netsales… $200,000 Merchandi sei nv
entory $30,
000
Costofgoodssol d.
..
..
..
.11
11
00
,0
,
000
00 Otherasset s……… 80,
000
Grossprofi
t… $90,000 Total asset $110,
000
Expenses…… 55,
000 Liabi l
it
ies………… $30,
000
Netincome...
..
. $35,
000 Owner ’sequi t
y…… 80,
000
Tot al l iabil
ity and $110,
000
capi tal
2.Invent
oryatendofper i
odi ncorrectl
ystatedat$22, 000; (understatedby$8,
000).
Netsales $200,000 Mer chandi seinventory $22,000
Costofmdsesol d 118,
000 Otherasset s……… 80,000
Grossprofi
t $82,
000 Tot alasset s $102,000
Expenses…… 55,
000 Liabi l
it
ies……… $30,000
Netincome $27,
000 Owner ’sequi t
y… 72,000
Tot al liab.
&Owner ’
s $102,000

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 equ.

3.Invent
oryatendofperiodincorrect
lyst
atedat$37, 000;(over
statedby$7,
000) .
Netsales $200,000 Mer chandiseinventory $37,
000
Cost of mdse 103,000 Otherasset s… 80,
000
sol
d
Grossprofit $97,000 Total $117,000
assets...
..
..
..
..
..
..
..
..
Expenses… 55,000 Liabil
it
ies…… $30,
000
Netincome $42,000 Owner ’
sequi ty…… 87,
000
Total $117,000
l
iab.
&Owner ’
equity
Notethati
nt hei
ll
ustrati
ont hetot
alcostofmer chandiseav ai
l
ablefor
sal
ewasconst ant$140, 000. Itwast hewayi nwhi cht hecostwas
al
locatedt
hatvar
ied.

Effect of Endi ng Inventory on t he Foll

owing Peri
od’s Financial
Statement
Theendi nginventor
yoft hecur rentperiodwillbecomet hebegi nni
ng
i
nventor yforthef ol
lowingper iod. So,itwillhavethesameef fectas
beginninginventor
yofthecur rentperi
od.Letussummar i
zeit.
IncomeSt at
ementoft heFol lowingPeriod
a)Endingi nv
entoryisusedi ncalculat
ingcostofgoodssoldintheincome
statement.Costofgoods( mer chandise)sold=Beginninginventory+
Netpur
chase–Endi
ngi
nvent
ory.
Asy ousee,endinginventoryoft heprevi
ousperiodwi l
lbecomebegi nni
ng
i
nventoryofthef ol
lowingperiod.Ther ef
ore,whenendi nginv
entoryoft he
curr
entperiodincreases( er
reneously),i
tmeanst hatbegi
nninginventory
ofthenextper i
odi ncreasest oo.Duet othi
scostofgoodssol doft he
nextperi
odincreases.
b)Thecostoft hemer chandi sessoldoft hef oll
owingperiodwi l
lt
hen
subsequent
lybeusedi ncalculat
ingthegrosspr of
itoft
hatperiod.
Gr
ossPr
ofi
t=Netsal
es–Costofmer
chandi
sesol
d
Inthiscase, youhav etonot ethat,endingi nventor
yofthepr ev
iousperiod
hasi ncreasedcostofgoodssol doft hef oll
owingper i
od. Ther efore,
grosspr ofi
toft hefoll
owingper i
odwi lldecreaseascostoft hegoodssol d
i
ncr ease.
c) Oper atingincome=Gr ossProfit–Oper ati
ngExpenses
The effectofendi ng invent
oryon t he f
oll
owing period’soper ati
ng
i
ncomei sthesamewi ththatofgrosspr ofi
t.
Balancesheetoft hef oll
owingper iod
Theendi ngi nventoryoft hecurrentper iodwi l
lnothaveanef fectont he
fol
lowi ngperiod’sbalancesheetitems.Thi sisbecauset hebal ancesheet
oft hefoll
owingper i
odr eportsonlyendi nginventoryofthatper i
odinstead

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ofendi
ngi
nvent
oryoft
hepr
evi
ousper
iod.

4.4:I nventorySyst
ems: Per
iodicVsPerpetual
.
You hav e seen the meani ng and effectof invent
ory on fi
nancial
statement s. Thenextquest i
onthaty ouwoul dprobabl
yaski swhat
techni queswecanappl yt ocalcul
atethatbalanceofinventor
y.Int hi
s
section,y ouaregoingtoseet hesystemsappliedtodeterminecostand
physical quanti
tyofi
nventor
y.

4.4.
1.Per i
odi cI nventor ySy stem
Ther e ar e t wo pr inci pal sy st
ems of i nv entory account ing:
periodicinvent oryandper petual inventorysy stem.
Undert heper iodi cinvent orysy stem,ther ei snocont i
nuousr ecor dof
mer chandi sei nv entoryaccount .Thei nventor ybal ancer emainsthesame
throughoutt heaccount ingper iod,i .
e.thebegi nningi nventor
ybal ance.
Thisi sbecausewhen goodsar epur chased,t heyar edebi ted tot he
purchasesaccountr athert han mer chandi se inv ent ory account . The
revenuef rom sal esi sr ecor dedeacht i
measal eismade. Noent r
yi s
madet or ecor df ort hecostofgoodssol d.So,aphy sicalinventorymust
bet akenper i
odi callytodet erminet hecostofi nv entoryonhandand
goodssol d.
Theper i
odi cinv entorysy st em i slesscost lyt omai ntaint hantheper petual
i
nv entorysy stem,buti tgi vesmanagementl essi nf ormationaboutt he
statusofmer chandi se.Thi ssy stem i softenusedbyr etailenter
prisest hat
sellmany ki nds ofl ow uni tcostmer chandi se such as gr ocer i
es,
drugstor es,har dwar eet c.
Thej ournal ent ri
est obepr epar edare:
1.Att
het
imeofpur
chaseofmer
chandi
se:
Purchases XX
Accountspay
abl
eorcash XX
2.Att
het
imeofsal
eofmer
chandi
se:
Account
sr ecei
vabl
e,orcash XX
Sales XX
3.Tor
ecor
dpur
chaser
etur
nsandal
l
owance:
Account
spay abl
e,cash XX
Purchaseretur
nsandal
l
owance XX
4.Tocl
osebegi
nni
ngi
nvent
ory:
I
ncomeSummar y XX
Merchandi
sei
nvent
ory(
begi
nni
ng) XX
5.Tor
ecor
dendi
ngi
nvent
ory:
Merchandisei
nvent
ory(ending) XX
Incomesummar y XX
4.
4.2.Perpet
ualI
nventor
ySy stem
Undert hi
s syst
em the account i
ng record conti
nuousl
y di
scl
ose t
he
amountofinvent
ory.So,t
hei nvent
orybalancewill
notremaint
hesamein

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theaccounti
ngper iod.Al li
ncreasesaredebit
edt omer chandiseinvent ory
accountandal ldecreasesar ecredi
tedtot
hesameaccount .
Therearenopur chaser eturnsandal l
owancesaccount sint hissy stem.
Atthet i
meofsal e,thecostofgoodssol disr ecordedinaddi tiont o
Journalentr
yf orthesal e.So,wecandet er
minet hecostofi nventoryas
wellasgoodssol df r
om t heaccountingrecord. Noneedofphy sical
counti
ngt odet er
mi nethei rcosts.Companiesthatsellitemsofhi ghuni t
val
ue,such asappl i
ancesoraut omobil
es,tend t o use the perpet ual
i
nventorysystem.

Givent henumberanddi versi

tyofi temscont ai
nedint hemer chandi
se
i
nventor yofmostbusi ness,t heper petuali
nventor
ysy stem i
susual l
y
mor e effect
iveforkeeping t rack ofquanti
ti
es and ensuring opti
mal
customerser vi
ce.Managementmustchooset hesystem orcombinati
on
ofsystemst hatisbestf
orachi evingthecompany’sgoal.
Journal ent
ri
estobepr eparedar e:
1.
Att
het
imeofpur
chaseofmer
chandi
se:
Merchandi
seinventor
y XX
Account
spayable/cash XX
2.
Att
het
imeofsal
eofmer
chandi
se
Account
srecei
vabl
eorcash XX
Sal
e XX

Costofgoodssold XX
Merchandisei
nvent
ory XX
Tor
ecor
dthecostofmer
chandi
sesol
d

3.
Tor
ecor
dpur
chaser
etur
nsandal
l
owances
Accountspayable,
orcash XX
Merchandi
seinvent
ory XX
Noadjusti
ngentryorclosi
ngentryf
ormerchandiseinventoryi
sneededat
t
heendofeachaccount ingperi
odunderper
petualinventorysyst
em.

Consi
der the fol
lowi
ng t
ransact
ions r
ecor
ded under per
iodi
c and
per
petualsyst
em
SupposeonJanuar y1,2016;Chi
lalo-
mer chandisi
ngcompany had120
units ofmer chandises t
hatcostBr .8 perUni t. The foll
owing
transact
ionswerecompl et
eddur ing2016.
February5:Purchasedoncredit150uni tsofatBr.10perunit
February9:Returned20det ecti
veuni t
sf rom February5purchasest o
thesupplier
.
June15: Purchasedforcash230uni tsofmer chandiseatBr
.9peruni t.
September6:Sol d220uni tseachatapr i
ceofBr .15perunit.These
goodsar e120uni t
sf r
om thebegi nningi nv
entoryand100uni t
sf or
Februarypurchases.
December31:260uni t
sar eleftonhand,30uni tsf r
om February5

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 pur
chases.

Requi
red:Pr
epar
egener
alj
our
nalent
ri
esf
orChi
l
aloTr
adi
ngt
orecor
d
t
heabovet r
ansact
ionsandadj
usti
ngorclosi
ngentr
yformer
chandi
se
i
nvent
oryonDecember31.
a.Underperi
odici
nvent
orysyst
em,and
b.Underperpet
uali
nvent
orysyst
em

Soluti
on
a)Per i
odicinventorysy st
em
February5;Purchases( 150xBr .10) Br 1,
500
Accountpay able Br1,500
Febr
uar y9:Accountpay able(20xBr .10)200
Purchasereturnsandal l
owance. .
..
..
. 200
June15; Purchases( 230xBr .9) .
..
..
..
..
..
....
.2,
070
Cash ..
..
..
..
..
..
..
..
..
..
..
..
. 2,
070

September6:
Cash( 220xBr .15) 3,
300
Sales 3,300
December31:Torecordorcloset hemer chandi
seinvent
oryaccount
Incomesummar y(120xBr .
8) 960
Merchandiseinv
ent ory(begi
nning)..
..
960

Mer
chandi
sei
nvent
ory(
endi
ng) ..
..
..
..
..
2,370
I
ncomesummary[(
30xBr
.10)+(
230xBr .9).
..
.2,
370

b)Perpet
uali
nvent
orysystem
Febr
uar
y5Merchandi
seinventor
y Br
1,500
Accountspayabl
e Br
1,500

Febr
uar
y9:Account
spayabl
e 200
Mer
chandi
sei
nvent
ory 200

June15: Mer
chandi
seinvent
ory 2070
Cash 2,
070

Sept
ember6:i
) Tor ecordt hesales
Cash 3,300
Sales 3,
300
i
i) Tor ecor dcostofmer chandi
sesol
d
=(
120xBr .
8)+( 100xBr .
10)
=Br.960+Br .1,
000=Br .1,960
Costofmer chandi sesold 1, 960
Mer chandiseinventor y 1960
December31: Noent ryisneededt or ecordorcl
osemer
chandi
se
i
nventoryaccount .

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 4.5. DETERMI NI NGTHECOSTOFI NVENTORY
Inthis sect ion,we wi l
ldi scuss t he det ermi nation oft he costof
i
nvent ory.Usual ly,t heamountandsi zeofi nv entor i
est ober ecor ded
andr epor t
edar el argei nnumber .Duet ot his,assi gni ngamonet ary
val
uef ort hesebul kymer chandi sei nvent or iescoul d beacompl ex
acti
vity.Consi deringt hisfactwewi llappl yv ar iousi nv ent orycostf low
assumpt i
ons.Thi s sect i
on di scusses aboutt he i nv ent ory cost i
ng
methodsandassumpt i
ons.
CostofMer chandi seI nv ent ories
Regardlessofwhet hertheper petualorper iodi csy st em i sused,i ti s
necessar ytoassi gndol l
aramount st ot hephy sicalquant it
iesofgoods
soldandgoodsr emai ni
ngi nendi ngi nv ent or y.Unl esseachi tem of
i
nvent oryi s speci fi
callyident ifi
ed and t raced t hrough t he sy stem,
assi
gni ngdol larsi saccompani edbymaki nganassumpt i
onr egar ding
howgoodsandt heirassoci atedcost sf l
owt hrought hesy stem.
Costsi ncluded i n mer chandi se i nv entor y ar et hose expendi tur es
necessar y,direct l
yori ndirectly,tobr ingani tem t oasal ablecondi t i
on
andl ocation. I not herwor ds,costofani nv ent oryi tem i ncludesi ts
i
nvoicepr i
cemi nusanydi scount ,pl usanyaddedori ncident alcost s
necessar yt o puti tin a pl ace and condi tion f orsal e. Added or
i
ncident alcost scani ncludei mpor tdut ies,t ranspor tat ion- i
n,st orage,
i
nsuranceagai nstlosseswhi l
et hegoodsar ei nt ransi t, andsoon.
Minorcost st hatar ediffi
culttoal locat et ospeci fi
ci nv ent oryitemsmay
beexcl udedf rom i nventorycostandt reatedasoper at ingexpensesof
theper i
od.Thi sisbasedonmat erial itypr inci pleort hecost -
to-benef i
t
constraint.

4.5.1.Inv entoryCost ingMet hodsunderPer iodicInventorySy stem

Oneoft hemosti mpor t
antdeci sionsi naccount i
ngf orinvent oryis
determi ningt heperuni tcostsassi gnedt oi nventoryitems.Whenal l
unitsar epur chasedatt hesameuni tcost ,thispr ocessi ssimplesi nce
thesameuni tcosti sappl iedtodet ermi net hecostofgoodssol dand
endingi nv entory.
Howev er,when i denticali temsar epur chased atdi f
ferentcost s,a
quest i
on ar i
ses as t o whatamount s ar ei ncluded int he costof
mer chandi sesol dandwhatamount sr emai ni ninventory.It hinky ou
recallthataper i
odi cinv entorysystem det ermi nescostofmer chandi se
soldandi nventoryatt heendoft heper i
od.Wemustr ecordcostof
mer chandi sesol dandr eductionsi ninv ent or yassal esoccurusi nga
perpetuali nvent
or ysy stem.How weassi gnt hesecost stoi nventory
andcostofmer chandi sesol daf fectst her epor t
edamount sf orbot h
systems.
Ther ear ef ourmet hodscommonl yusedi nassi gningcost stoinventory

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 andcostofmer chandisesold.Theseare:
 Specif i
cidentifi
cat
ion
 First-
in-f
ir
st-
out( FI
FO)
 Last-i
n-fir
st-
out( LI
FO)
 Wei ghtedav erage
Inv
entor
ycostingmet hodsunderperi
odici
nvent
orysy
stem
I
ll
ust
rat
ion:
Hawani Companyhast hef ol
lowingmer chandi
ses:
Jan-1 Begi nni
ngi nventory …………… 80uni ts@ Br.60=Br .4,
800
Feb.16Pur chase 400uni t
s@ 56=
22,
400
Sep.2Pur chase 160uni t
s@ 50= 8, 000
Nov .26Purchase 320uni t
s@ 46=
14,
720
Dec.4 Pur chase 240uni t
s@ 40= 9, 600
Total 1200Uni t
s Br
.59,520
Theendi nginventoryconsi st
sof400uni t
s.
1.Specifi
cIdenti
fi
cat i
onMet hod
Wheneachi t
em ini nventorycanbedi rect
lyidentif
iedwi thaspeci fi
c
purchaseandi t
sinvoice,wecanusespeci f
icidenti
fication(al
socal led
specifi
ci nvoi
cepr i
cing)t oassigncost s.Thi smet hodi sappropriate
whent hev ari
etyofmer chandisecar r
iedinst ocki ssmal landt he
vol
umeofsal esi srelati
v el
ysmal l
. Wecanspeci fi
callyi
dentif
yt he
i
temssol dandt heit
emsonhand.
Exampl
e
From theabov eill
ustrati
on,theendinginv ent
oryconsistsof400units,
100uni t
sf r
om eachoft helastpurchases.So,theitemsonhandar e
specif
ical
lyknownf rom whi chpurchasestheyare:
Costofendi nginv entori
esunderspeci f
icidenti
fi
cat
ionmet hod.
Br .40x100 = Br.4,
000
Br .46x100 = 4,
600
Br .50x100 = 5,
000
Br .56x100 = 5,600
400uni ts Br .
19,200
CostofEndi ngi nventorycost=Br .19,
200
Thecostofmer chandisesol d =Costofgoodsav ai l
abl
ef orsal
e–
Endinginventory
=Br.59,520–Br .19200=Br .40,
320

2.First
-in,
First-out(FI
FO)
Thismethodofassigningcostt oi nventoryandthegoodssoldassumes
i
nventor
yi t
emsaresoldint heorderacqui r
ed.Thismeansthecostflowis
i
nt heorderinwhichtheexpendi tureswer emade.So,t odeter
minet he
costofendinginv
entory,wehav et ost ar
tfrom t
hemostrecentpurchase
andcontinuetothenextr ecent.Becauset hefi
rstpur
chasedit
ems( old

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purchases)ar et he f i
rstt o be sol dt heyar e used ( i
ncluded)i nt he
comput ationofcostofgoodssol d.
Forexampl e, easilyspoi ledgoodssuchasf ruits, vegetabl esetc.
,mustbe
sol
dneart het imeoft hei racqui sition.So,t hei nventoryonhandwi l
lbe
fr
om t he r ecentpur chases. As an exampl e,consi dert he previ
ous
i
ll
ustrati
on.
Thecostofendi ngi nv ent or yunderFI FOmet hod
=Br .40x240 = 9,600
=Br .46x160 = 7, 360
400uni t s Br .
16, 960
CostofEndi ngi nv ent ory:Br.16, 960
Costofmer chandi sesol d=Br .
59, 520- Br .16,960
=Br.42, 560
3.Last -in,first-out( LIFO)
Thismet hodofassi gni ngcostassumest hatt hemostr ecentpurchases
aresoldf i
rst. Thei rcost sar echar gedt ocostofgoodssol d,andt he
costsoft heear l
iestpur chasesar eassi gnedt oi nv entory.Thecostf l
owi s
i
nt herever seor deri nwhi chexpendi tureswer emade.
Incalculat i
ng t hecostofgoodssol d,wewi llst artf r
om t heear l
iest
purchases.
Asanexampl e,taket hepr eviousi ll
ust rat
ion
Thecostofendi ngi nv ent or yunderLI FOmet hod
=Br .60x80=Br .4,
800
=Br .56x320= 17, 920
400uni ts
Endingi nv entor ycost=Br .
22,720
Costofmer chandi sesol d=Br .59, 520–Br .22, 720
=Br.37,000
4.Wei ght edAv erageMet hod
Thismet hodofassi gni ngcostr equi r
escomput i
ngt heav eragecostper
unitofmer chandi seav ailablef orsal e.Thatmeanst hecostf l
owi san
averageoft heexpendi tur es.
Tocal cul atet hecostofendi ngi nv entory ,
wewi l
lcalculatefir
stthecost
peruni tofgoodsav ailabl eforsal e.

Thent hewei
ghtedaverageunitcostismulti
pli
edbyunitsonhandat
theendoftheperi
odtocalcul
atethecostofendinginv
entor
y.Also,
the
sameav er
ageunitcostisappl
iedinthecomput at
ionofcostofgoods
sold.
Wei
ght
edaver
ageuni
tcost
=Br59,520=Br49.
60
1,
200
Endi
nginv
entorycost=Br
.49.
60x400=Br .
19,840
Costofmerchandi
sesol
d=Br.59,
520-
Br.
19,840 =Br
.39,
680

4.
5.2Compar
isonofI
nvent
oryCost
ingMet
hods

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 I
ft hecostofuni tsandpr icesatwhi cht heyar esol
dr emai
nsst able,al
l
thef ourmethodsy i
eldt hesamer esul ts.Howev er,
ifpri
ceschange, the
threemet hodsusual lyy ielddifferentamount sfor:
 Endi nginv ent ory
 Costofmer chandi sesol d
 Gr osspr ofitorneti ncome
Inper iodsofr ising( i
ncr easing)pr ices: ( orifthereisinf
lationary
trend):
a.FI FOyiel
ds–Hi gherendi ngi nvent ory
-Lowercostofmer chandi sesol d
-
Highergr osspr of i
t( netincome)
b.LI FOyields–Lowerendi ngi nvent ory
-Highercostofmer chandisesol d
-Lowergr osspr ofit(netincome)
c.Weightedav eragey ieldsther esul t
sbet weenthetwo.
I
nperi
odsofdecl
ini
ng(decr
easi
ng/def
lat
ionar
y)pr
ices
a.FI
FOyi
elds–Lowerendi
nginv
entor
y
-Hi ghercostofmer chandi sesol d
-Lowergr osspr ofitorneti ncome
b.LIFOyields–Hi gherendinginv entory
-Lowercostofmer chandisesol d
-
Hi ghergrosspr ofitorneti ncome
c.Wei ght
edav erage–y iel
dsr esultst hatf al
lbet weenthev aluesof
FIFOandLI FO
4.
5.3.I
nventoryCost i
ngMet hodsunderPer pet ualInventorySystem
Underperpetualinv entorysystem,wewi llappl yt heinventorycosting
methodseacht i
mesal eofmer chandisei smade. Wecal culatethe
costofgoods( mer chandises)sol dandi nv entoryonhandatt het i
meof
each sale. Thi s means t he mer chandi se i nventor
y account i s
conti
nual
lyupdat edt orefl
ectpur chaseandsal es.

I
ll
ust
rat
ion:
Thebegi
nni
nginventor
y,pur
chasesandsal
esof
Chi
l
aloCompanyf
or
themont
hofJanuarywereasfol
l
ows:
Uni
t Uni
t
s Cost
Jan. I
nvent
ory 15 Br
.10.
00

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 1
6 Sal
e 5
10 Pur
chase 10 Br
.12.
0
0
20 Sal
e 8
25 Pur
chase 8 Br
.12.
5
0
27 Sal
e 10
30 Pur
chase 15 Br
.14.
0
0

1.First
-i
n,Fir
st-outMethod( FIFO)
Assignmentofcost st ogoodssol dandi nventory-
usingFIFO isthe
samef orbotht heperpetualandper i
odicinventorysystems.Because
eachwi t
hdrawalofgoodsi sf r
om theoldestst ock/i
nventoryonhand.
Theol destist hesamewhet herweuseper iodicinventorysyst
em or
perpetualinventorysystem.Letuscal cul
atet hecostofgoodssol d
andendi nginventoryunderper pet
ualinventorysy st
em f r
om theabove
i
ll
ustration.
Perpetual–FI FO

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 Dat
e Pur
chase Costof
mer chandi
sesol
d I
nvent
orybalance
Qt
y Uni
tCost Tot
alcost Qty Unit Total Qty Unit Total
cost cost cost cost
Jan.
1 15 10.00 150.00
6 5 Br
.10.
00 Br
.50.
00 10 10.00 100.00
10 10 Br
.12.
00 Br
.120.
00 10 10.00 100.00
10 12.00 120.00
20 8 10.
00 80.
00 2 10.00 20.00
10 12.00 120.00
25 8 12.
50 100.
00 2 10.00 20.00
10 12.00 120.00
8 12.50 100.00
27 2 10.
00 20.
00 2 12.00 24.00
8 12.
00 96.
00 8 12.50 100.00
30 15 14.
00 210.
00 2 12.00 24.00
8 12.50 100.00
15 14.00 210.00
23 Br
.246.
00 25 Br
.334.
00

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 So,thecostofmer chandisesol dandendi nginvent
oryunderperpet
ual–
FIFOmethodar eBr .246andBr .334r especti
vel
y.
Letusseet hem underper iodic–FI FOmet hod:
Unit
sonhand=uni t
sav ai
lableforsale–uni t
ssold
=(15+10+8+15)–( 5+8+10)
=48–23=25
Costofendinginv entor
y=Br .14x15=Br .
210
Br.12.50x8=100
Br.12x2= 24
=Br.334
Cost of goods av ail
able f or sal e =Br 15x10 + Br .
120+Br.
100+Br .
210=Br .
580
Costofgoodssol d=Br .
580–Br .334
=Br .
246
So,thesamer esultsofcostofgoodssol dandendinginventoryunder
bothper
iodicinventorysystems.

2. Last-in,First-
outMet hod( LI
FO)
Unlike FIFO met hod,di ff
erentr esult
s may occurunderper i
odic and
perpetualinv entorysystem.Themostr ecentpur
chasechangewhennew
purchaseoccur s.
Letuscal culatefirstt
hecostofgoodssol dandendinginvent
oryforthe
abov eil
lustrati
onunderper petualinventor
ysyst
em.Then,wewi l
lseethe
result
sunderper i
odicinventor
ysy stem.

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 Perpet
ual–LIFO
Pur
chase Costofmer
chandisesold I
nvent
orybal
ance
Date Unit Total
Qty Totalcost Qt
y Unitcost Qt
y Uni
tcost Tot
alcost
Cost cost
Jan.1 15 10.
00 150.
00
6 5 Br.
10.00 Br.
50.00 10 10.
00 100.
00
10 10 Br.
12.00 Br.
120.00 10 10.
00 100.
00
10 12.
00 120.
00
20 8 Br
.12.
00 96.
00 10 10.
00 100.
00
2 12.
00 24.
00
25 8 12.
50 100.
00 10 10.
00 100.
00
2 12.
00 24.
00
8 12.
50 100.
00
27 8 12.
50 100.
00 10 10.
00 100.
00
2 12.
00 24.
00
30 15 14.
00 210.
00 10 10.
00 100.
00
15 24.
00 210.
00
23 Br
.270.
00 25 Br.
310.
00

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 So,t he costofmer chandise sold and ending inv
entory underLI
FO
perpetuali
nventorysystem areBr .
270andBr .310respect
ivel
y.
Ther esul
tsunderperi
odi cinventorysyst
em are:
Costofendingi nv
entor y=Br.10x15=Br .150
=Br10x12=Br120
Br.270
Costofmer chandisesol d=Br .580–270
=Br .310
Asy ousee,t heresul
tsar ediff
erentunderperiodi
c&per petualinv
ent
ory
systems.

3.WeightedAverageCostMet hod
Undert hi
s met hod,the aver age uni
tcosti s calculated each t ime
purchasedismadet obeappliedont hesalesmadeaf t
ert hepur chases.
The resul
ts may be diff
erentunderper i
odic and perpet ualinventory
system.
Letuscalculat
ethecostofmer chandi
sesoldandendingi nvent or
ycomes
outfrom t
hepreviousil
l
ustr
ationunderperpetuali
nventorysy stem.

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Weightedaver
ageCostMet hod(
Mov i
ngAv er
age)
Pur
chase Costofmer chandi
sesold I
nvent
orybal
ance
Date Total
Qty UnitCost Qt
y Unitcost Tot alcost Qt
y Uni
tcost Tot
alcost
cost
Jan.1 15 10.
00 150.
00
6 5 Br.
10.00 Br
.50.00 10 10.
00 100.
00
10 10 Br.
12.00 Br.
120.00 20 11.
00 220.
00
=100+120
10+10
20 8 Br
.11.
00 88.
00 12 11.
00 132.
00
25 8 12.
00 100.
00 20 11.
60 232.
00
132+100
12+8

27 10 11.
60 116.
00 10 11.
60 116.
00
30 15 14.
00 210.
00 15 13.
04 326.
00
116+210
10+15
23 Br
.254.
00 25 Br.
13.04 Br
.326.
00

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 So,t
hecostofgoodssol dandendi nginvent
oryunderper
pet
uali
nvent
orysy
stem ar
eBr
.
254.
00andBr .326.
00,respecti
vely
.
Theresul
tsunderperi
odicinventor
ysystem ar
e:
Wei
ght
edav
erageuni
tcost=

Endi
nginventorycost=Br .12.
08x25
=Br .302
Costofmerchandisesold=Br .
580-
Br.
302
=Br .278
So,t
heresultisdi
ffer
entunderperi
odi
candper
pet
ual
inv
ent
orysy
stems.

4.
6.Addit
ionalval
uat
ionproblemsforinv
entori
es
4.6.
1:Invent
oryValuat
ion:LowerofCostorMarket(
LCM)Met
hod
I
nvent
oryvaluati
onis:
It
wasexplainedhowcost
sar
eassi
gnedt
oendi
ngi
nvent
oryandcostofgoodssol
dusi
ng
oneofthefourcostingmet hods(FI
FO, LI
FO,weightedaver
age, orspecif
icident
ifi
cat
ion)
.
Yet,t
hecostofi nventoryi snotnecessar i
l
yt heamountal waysr eport
edonabal ance
sheet. Account
ing principlesrequi
ret hatinventor
yber eport
ed atcost . Howev er
,
sometimes itmightbe necessar ytov al
ue invent
ori
es ata v alue otherthan cost
.
Especi
all
y,whent hereexi stsasignif
icantdif
ferenceinhi
st or
icalpurchasingpri
ceand
curr
entmarketcostofinv entori
es.

Oneal ternativet echni queofi nventoryv aluati

oni sbasedonacompar i
sonoft hemar ket
valueofi nv entoriesagai nstt heircostandt akingwhi chev erislower . Mer chandise
i
nv entoryist hensai dt ober eportedont hebal ancesheetatt helowerofcostormar ket
(LCM) .
Inappl yi
ngLCM,costi st heacqui siti
onpr i
ceofi nv entor ycomput edusi ngoneoft he
histori
calcostmet hods– speci fi
ci dent i
fi
cat ion,FI FO,LI FO,andWei ght edav erage.
Wher eas, mar keti sdef inedast hecurrentmar ketv alue( cost )ofreplaci
ngi nventory.Itis
thecur rentcostofpur chasi ngt hesamei nv ent oryi temsi ntheusualmanner .I tis
i
mpor t
antt oknowt hatmar keti snotdef inedast hesal espr ices.
A decl i
nei nmar ketcostr eflectsal ossofv aluei ni nv entory. Thisisbecauset he
recordedcostofi nvent or yishi ghert hant hecur rentmar ketcost .Whent hisoccurs,a
l
ossi srecogni zed. Thi si sdonebyr ecognizi ngt hedecl ineinmer chandisei nventory
from recor dedcostt omar ketcostatt heendoft heper iod.
LCM i sappl i
edi noneoft hreeway s:
(
1) Separ atelyt oi ndividualitems
(
2) Tomaj orcat egor i
esofi t
ems
(
3) Tot hewhol eofi nv entori
es
Thel esssi mi l
art hei t
emst hatmakeupi nventor yar e,themor eli
kelyitisthatcompani es
applyLCM t oi ndi vi
duali tems.Adv ancesi ntechnol ogyf ur t
herencour aget hei ndiv
idual
i
tem appl ication.

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 I
ll
ust
rat
ion
Thef
oll
owingar
ethei
nvent
oryofABCmot
orspor
ts,
ret
ail
er.
I
nvent
ory uni
ts Cost
I
tems onhand peruni
t mar
ket
Cy
cles:
Roadst er 30 Br
.25,
000 Br
.23,
333
Sprint 20 9,
000 9,
500
Of
fRoad:
Trax-4 10 10,
000 11,
000
Bl
az’ m 6 16,
000 14,
500

LetusseeLCM comput
ati
onunderthet
hreeway
s:
(1)Separ
atel
ytoeachi
ndivi
duali
tem
I
nvent
oryi
tem Tot
alcost Tot
almar
ket LCM
Roadster Br
.750,
000 Br
.700,
000 Br.
700,
000
Sprint 180,
000 190,
000 180,
000
Categori
es
subtotal Br.
930,
000 Br
.890,000
Tr
ax-4 100,
000 112,000 100,
000

Blaz’
m 96,
000 87,
000 87,
000
Categori
es
subtotal Br
.196,
000 Br199,
000
Total
s Br
.1,
126,
000 Br
.1,
089,
000 Br
.1,
067,
000

(
2)Maj
orcat
egor
iesofi
tems
I
nvent
ory
Cat
egories Cat
egor
ies
t
otalcost t
otalmar
ket LCM
Cycles Br.930,000 Br.890,000 Br.890,000
Off.Road 196,000 199,000 196,000
Totals Br.
1,126,000 Br.1,
089,000 Br.1,
089,000
 WhenLCM i sappl i
edt ot hewholeinventory,
themarketcosti sBr 1,
089,
000.Since
thismarketcosti sBr .37, 000lowert hanBr .1,
126,000r ecordedcost,iti
st he
amountrepor t
edf orinventoryonthebal ancesheet
.
 WhenLCM i sappl iedt oi ndi
vidualitemsofi nventory,themar ketcosti
sBr .
1,067,
000.Si ncemar ketisagai nlesst hanBr.1,
126, 000cost ,iti
stheamount
report
edforinventory.
 WhenLCM i sappl i
edt ot hemaj orcategori
esofi nventori
es,t hemarketi
sBr .
1,089,
000whi chisalsol owerthancost .

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 4.
6.2.
Est
imat
ingI
nvent
oryCost
Techni
quesofest
imat
ingi
nvent
ori
es.
I
npract
ice,aninv
entoryamounti
sest
imatedforsomepurposes.Wheni
tisi
mpossi
ble
t
otakeaphy si
cali
nventor
yort
omaint
ainperpet
uali
nvent
oryrecor
ds.
Exampl
e
1) I nt
erim fi
nancialstat
ement sareneeded. I tmaybet oocostlytot akephy si
cal
i
nventory.Thisisespecial
l
yt hecasewhenperiodi
cinventorysystem isused.
2) Whenacat astrophesuchasaf i
re,f
loodetchasdest r
oy edthei nvent
ory.Insuch
case,to ask cl ai
ms fr
om i nsur
ance companies,therei s a need ofest i
mati
ng
i
nventory.
Therear etwocommont echniquesofinventor
ycostestimat i
on;retai
lmet hodandthe
grosspr ofi
tmethod.Letusf i
rstseetheret
ailmethodofinventor
ycostest i
mat i
on:

4.
6.2.1.RetailMethodofI nventor
yCost i
ng
Ast henamei mplies,t
hismet hodi smostl
yusedbyr etai
lbusinesses.Theesti
mateis
madebasedont herel
ationshipbetweenthecostandt heretailpri
ceofmerchandi
ses
avail
ableforsale.
Thest epst obefoll
owedt oappl yt
hismethodare:
1.Cal culatethecosttoret ai
lrati
obyusingthefol
lowingfor
mul a
=

2.Cal
cul
atet
heendi
ngi
nvent
oryatr
etai
lpr
ice
Endi
ngi
nvent
oryatr
etai
lpr
ice=Ret
ail
pri
ceofmer
chandi
seav
ail
abl
eforsal
elessSal
es

3.Cal
culat
et heesti
matedcostofendingi
nvent
ory
Est
imatedcostofendinginvent
ory=Costtoretai
lrat
io(
cal
cul
atedi
nst 1)XEndi
ep- ng
i
nvent
oryatretai
l(cal
cul
atedinstep-
2)
Exampl
e
Cost Retail
Sept.1,begi
nninginv
entory Br.35,
000 Br.50,
000
PurchasesinSeptember(net) 125,000 150,000
Sal
esi nSeptember(net
) 140,
000

(
1)Costr
etai
lrat
io= =0.
80

Thisi
mpl i
esthatforever yoneBi rrretai
lpr i
ce0.80birror80cent
sist
hecostoft
hat
i
nventor
yandt heremaining20cent sisgr ossprof
it.
(2)Endinginv
entoryatretail=( Br
.50,000+Br .
150,
000)-140,
000
=Br.60,
000
(3)Esti
matedendinginvent oryatcost=0. 80XBr.60,000
=Br.48,000

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4.
6.2.
2.Gr
ossPr
ofi
tMet
hod
Canyouguesspr
obabl
yhow canweuset
heconceptofgr
osspr
ofi
ttoest
imat
e
i
nvent
orycost
?
Grosspr ofi
tmet hodal soknownast hegrossmar ginmet hodr efer
stotheamountof
i
ncomet hatanor ganizati
onearnsfrom sel
lingofitemsaf terdeductingt
heircost.Thi
s
met hodusesanest imateoft hegrossprofitreal
i
zeddur i
ngt heperiodtoesti
mat et
he
costofi nventory. Thegr osspr of
itrat
emaybeest i
mat edbasedont heav er
ageof
previousperi
od’sgr ossprofi
trates.Thegr ossprofitratewilltel
lyouthepercent
ageor
rati
oofgr ossprofi
tf r
om everyonebirrsal
es.
Usual l
ythegrossprof i
trat
eiscalcul
atedwiththefollowingformula:

Thest epstobef oll

owedi napply
ingthegr osspr ofi
tmet hodare:
(1)Thegr osspr of
itrateisestimatedandt henest imatedgrossprofi
tiscal
cul
atedi
nbi
rr
val
ue.
Estimatedgrosspr ofit(
inBir
r)=Gr osspr of
itrateXsales
(2)Costofmer chandisesoldisestimat ed
Esti
mat edcostofmer chandisesold=sal es–Est imatedgrossprofi
t
(3)Cal cul
atetheestimat edcostofendi nginventory
Esti
mat edcostofendi ngi nv
entoryisequal to:
Costofmer
chandi
seav
ail
abl
eforsal
e–Est
imat
edcostofmer
chandi
sesol
d.
Pl
easerecallthatcostofmer chandi
sesav ai
l
abl
eforsal
eist
hesum ofcostof
begi
nningi
nventoryandnetcostofpur
chases.
Exampl
e
Beginni
ngi nv ent
orycost :……………Br .46,000
Netpurchasesdur i
ngt heper i
od………. 210,000
Netsalesdur i
ngtheper iod……………240, 000
Est
imat edgr ossprof i
trate…………….40%
Theendi nginventoryisest i
mat edasf ollows:
(1) Estimat edgr ossprof i
t=0. 4X240,000
=Br .96,000
(2) Estimat edcostofmer chandisesol
d
=Br .
240,000–Br .96,000
=Br .
144, 000
(3) Estimat edcostendi ngi nventory
=(Br.46,000+210, 000)–Br .144, 000
=Br .
256, 000–Br .
144, 000
=Br.112,000

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 Chapt
erFi
ve
Account
ingf
orPlantAsset
s
Introduct ion
Pl antasset sar emaj orexpendi t
ur esf ormanycompani es.Theymakeupal argepar tof
asset sont hebal ancesheet .Plantasset sar ef uturebenef i
tsforanyor gani zations.I ti s
helpf ult ot hink ofa pl antassetas an amountofusef ulness cont ri
but i
ng t ot he
oper at i
onsofacompanyt hr oughoutt heasset ’
sl i
fe.Whi l
et hepl antasset sar eusedi n
theoper at i
onoft hebusi ness,t hei rv aluegr adual l
ydecl i
ne.Anaccount ingmet hodt o
accountf orsuchdecl inei nser vi
cecapaci tyofpl antasset siscal l
eddepr eciation,and
thiswi l
lbedi scussedi nt hischapt er.Youwi llalsost udyhowdepr eciati
oni scomput ed
andr ecor ded.
Addi tionalexpendi turesar ei ncur redt omaket hepl antasset sr enderbet terser vice.
Hence,y ouwi l
lbei ntroducedwi tht her evenueexpendi tur
esandcapi talexpendi tures.
Theaccount i
ngt reat mentatt meofdi
i sposi ngpl antasset swi llalsobeexpl ained.The
basi cpl antasset sdi sposalmet hodssuchassel l
ing,exchangi ngf orot herasset ,and
discar dingar ei ncludedi nt hedi scussi on.
Nat ure,CostAndDepr eciationofPl antAsset s
Int hischapt er ,youwi lllear naboutchar act eri
st i
csofpl antasset sthatdi fferent i
atet hem
from ot herasset s.Theny ouwi l
lbeabl et odet er minet heacqui siti
oncostofpl antasset s
andr ecor dt heirinit i
al costi naj our nal .
5.1:Char acter i
sticsofPl antAsset s:
Asset st hatcanbeusedbyabusi nessent erprisef orar elati
velyl ongper i
odusual lymor e
thanay earar ecal ledl ong- term asset s.Long- term asset sar edi videdi nt ot angi bleand
i
nt angi bleasset s.
Long- ter m asset sar ecl assi fi
edaspl antasset s, i
ntangi bleasset s,andnat ural r
esour ces.
Tangi bl e asset s( also cal led pl antasset s orf ixed asset )ar e asset s wi th phy sical
subst ancet hatcanbechar gedi nt heoper at i
onsofabusi nessf orar elativelyl onger
per i
od.Exampl esar el and, bui l
dings, equipment ,machi ner ies,truck, etc.
Plantasset s,orf ixed asset s,ar e acqui red bybusi ness ent erpr i
se foruse i nt heir
oper at i
onov ery ear sf orani ndef i
nit eorl imitedeconomi clife.Thecar ry i
ngv aluesof
thesel ong- term asset sar enor mal lybasedonhi storicalcost s.Measur ementpr oblems

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 associ at edwi thpl antasset si ncludei dent ify
ingt het ypesandamount sofexpendi t
ures
thatmakeupt heor iginal r ecor dedcostoft hepar ti
cul arasset .
Plantasset shav et hef ol l
owi ngchar act er i
st i
cs:
(a)Theyar eacqui r edf orusei noper ati
ons, notf orsal e.
(b)Theyar et angi bl ei.e.theyhav ephy sical exist ence.
(c)Thei reconomi cbenef i
tdimi ni shest hr ought i
meoruse, exceptl and.
Theabov e- ment i
onedchar act eri
sti
csofpl antasset shel pust odi st ingui shpl antasset s
from ot hert y pesofasset s.Forexampl e,pl antasset sdi ff
erf rom i nt angi bleasset swith
respectt ophy sicalexi stences.Thi si sbecausei nt angi bleasset sar easset swi t
houta
phy sicalf eat ur et hatcanbechar gedi nt heoper at i
onsofbusi nessf orl ongper i
od.They
gener allyconsi stofr ight soradv anceshel d such asgoodwi l
l,pat ent s,copy r
ights,
franchi se, trademar ks, or gani zat i
onscost set c.
Plantasset sbasi cal lydi f
f erf rom inv entor iesandl ong- termi nv estment sbecauseoft he
factt hati nv ent or iesar eacqui redforsal e,notf oruse,andi nv est ment sar enotcur rentl
y
i
nusef oroper at ion.Acompanyt hatpur chasesacomput erf orpur poseofr eselli
ngi t
repor tst hecomput eront hebal ancesheetasmer chandi sei nv ent or y,notasapl ant
asset .Howev er ,i ft he same company pur chased t he same comput erf oruse i n
oper ations, i
ti sapl antasset ,notamer chandi sei nv entor y .
Whenal andi shel dasaf act orysitet hatwi l
lbeusedi noper at ions,t hel andi spar tofa
plantasset .Butwhent hel andi sheldf orf utureexpansi on, itisani nv estment ;notapl ant
asset .
5.2:Acqui si tionCostofPl antAsset s
Plantasset sar ei nitiallyr ecor dedatt hei rcostcal ledor iginalcost s.Thi scostbecomes
historicalast i
mepasses.Thi sisbecauseusual lyt her ecor dofpl antasset sdoesnot
refl
ectsubsequentchangesi nt hemar ketv al uesofpl antasset s.Thei nitialcostofa
plantasseti sequalt ot hecashand/ ort hecashequi val ent,whi chi sgi venupi nor derto
acqui ret heassetandt opr epar eitforuse.I not herwor ds, initi
alcosti ncludest heasset ’
s
(1)impl iedcashpr iceand( 2)costofpr epar ationf oruse.
Of t
enanasset ’
shi st oricalcosti ssimpl yt heamountofcashpai dort hatshoul dbepai d
whent heasseti sacqui redandr eadyf oruse.Consi der ,f orexampl e,t hef ol
lowing
expendi tur esf oracer tainpi eceofequi pment :
Pur chasepr icef act or s:
Gr ossi nv oicepr ice Br10, 000
Sal est ax 400 10, 400
Rel at edexpendi tur es:
Fr eightchar ges Br .200
Inst al l
at ioncost s 500
Test ingofi nst al ledmachi ne 300 1, 000
Costofequi pment 11, 400
Thet otali nitialequi pmentcosti sBr .11, 400,consi st i
ngofacashpur chasepr i
ceofBr .
10,000andpr epar ationcost sofBr .1,000.Thesal est axi sanecessar ycomponentof
thepur chasepr iceandshoul dnotbei ncl udedi nt het axexpenseaccount .Si milarly
,the
cost soff reight ,inst allat i
on, andt estingar eexpendi turesnecessar yt ogett heasseti na
condi ti
onandposi tionr eadyf oruse.Thej our nal ent rywoul dbe:

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 Equipment 11,400
Cash( A/P) 11,400
Ifanasset ’spur chasepr iceisnoti mmedi atelypaidincash, asanaccount anty oushould
deter minet hecashequi valentpur chasepr i
ceatt heacqui sit
iondateandr ecordthat
amounti nt heassetaccount .
Apur chaseofl andof tenr ai
sessomei nterestingquest i
onsaboutr el
atedexpendi tures.
Supposeaf irmr etai
nsal ocalr ealestatebrokerataf eeofBr .2,
000t olocateappr opri
ate
sit
ef oritsnewof fi
cebui l
ding.Thepr opertyev entuall
ychosenhasanol dresidenceoni t,
whi chwi llber azed.Thet ermsoft hesalei ncludeapay mentofBr40, 000t ot hesell
er,
witht hebuy erpay i
ngof fanexi stingmor tgageofBr10, 000andBr300ofaccr ued
i
nter est.I naddi t
ion,thebuy eragreest opayaccr uedr ealestatetaxesofBr800.Ot her
rel
at edexpendi t
uresincludel egalfeesofBr400andat it
leinsurancepremi um ofBr500.
Al ocalsal v agecompanywi l
lrazet heoldr esidence;levelthelot ,
keepsal lthemat eri
als,
andpay st hef i
rm Br200.
Ifweappl yt hegener alplantassetmeasur ementr ul
e,wecomput etheiniti
alcostoft he
l
andasf ollows:
Paymenttothesel l
er Br40,000
Commi ssi
onforf indingproperty 2,
000
Paymentofmor t
gageandi nter
estdueatt
imeofsal
e 10, 300
Paymentofpr oper t
yt axesowedbysell
er 800
Legalf
ees 400
Tit
lei
nsurancepr emi um 500
Br54,
000
Less: Netrecover yfrom razi
ngcostofl
and (200)
CostofLand………………………………………. . Br53,
800
Jour
nal
ent
ry: Land………. . 53, 800
Cash( A/P.)……. 53, 800
ACTI VITY1:Det ermi ningt hecostofpl antassets
Dearst udent,thi
sact ivit
yhel psy ouhowt odeterminethecostofspeci ficplantassetand
makeaccount sr ecor d.
1.SupposeABCCompanysi gnsaBi rr300,000notepay abl
etopur chaseal andfora
new St oresi te. ABC al sopay sBirr10,000inbackpr opertyt ax,Birr8,000in
transfertaxes, Bir
r5, 000f orr emov alofanoldbuildi
ngbutr eceivedBi r
r1500f r
om
salvagepr oceedsoft heol dbui l
ding,Birr1,
000ofsur veyf ee,andBi rr26,000to
pav ethepar kingl ott hathasl imit
edeconomi cli
fe,all
incash.
Requi r
ed:a)Whati st hecostoft hisland?Showt hecomput ati
on
b)Recor dtheent ryfort hepur chaseofl and.
2.Whatamounti sr ecor dedast hecostofnew machi negiv ent hef ol
lowingdata
relatedtoi tspur chase?
Grosspur chasepr i
ce, Birr700, 000;
Salestax ,Bir
r49,000;
Purchasedi scountt aken, Birr21,000;
Freighttomov emachi net of actor yareaterms: FOBshippingpoint,
Birr3,500;
Assembl ycost s,Bir r3, 000;
Costoff oundat i
onf ormachi ne, Birr
2,500;

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 Costofspar epar tsusedi nmai ntainingthemachi ne,Bir
r4,200.
Now,i fy ouhav eat tempt edt heabov ewor k,checky ouranswerwi
tht
hef
oll
owi
ng
feedback.
1. Costoft hel andwoul dbe:
a).
Purchasepr i
ceofl and……………………………………. ….300,000
Add:r elatedcost s:
Backpr oper t
ytax…………………………………….10, 000
Transfertax……………………………………. ….. 8,000
Remov alofbuilding(5000- 1500)…………. 3, 500
Surveyf ee…………………………………………. 1,
000
Totalincidentalcosts…………………………………22, 500
Totalcostofl and……………………………………. ….Bi
rr322,500
b).ABC’ sent rytorecor dpurchaseofl andis:
Land…………………………………….322, 500
Notespay able…………………………………. .300,000
Cash…………………………………………….22, 500

2. Thecostoft hemachi necanbedet erminedasf ollows.

Pur chasepr i
ce Birr700, 000
Add: Sal estax 49, 000
Assembl ycost s 3,000
Costoff oundat i
on 2,500
Less:Pur chasedi scount (21,000)
Tot alcostoft hemachi ne Birr733, 500
5.3.Account ingf orDepr eciation
Int hispar t,y ouwi l
llear naboutaccount ingf ordepr eci ationandr elatedi ssues. I n
deter mi ningper i
odicdepr eciation,youhav et oidentifycausesofdepr eciationandappl ya
givent y peofdepr eciati
onmet hod.I fplantasset sar eacqui redot herthant hebegi nning
ofthey ear , itisrequi redt odet erminepar ti
alyeardepr eci ation.Whennewi nf or mationi s
obtai ned, itmaybenecessar yt orevisedepr eciation.
Aspl antasset sar eusedi nt heoper ati
onofabusi ness,t hei rvaluetopr ov ideser vice
decr easest hroughusageandt hepassageoft i
me.
Depr eciat ioni sadecl i
nei nt hev al
ueoft hepl antasset s.I tist heallocati
onoft hecostof
apl antassetov eri t
susef uleconomi cl if
e.Aspl antasset sar eusedov ert imei nthe
oper ationoft hebusi ness, theircapaci tytoy iel
dser v i
cedecl ines.Thepar toft heor iginal
costoft heassett hatisassi gnedt ot hebundl eofser vicebenef itsthathav ebeenused
upi ncal l
eddepr eci ati
on.Depr eci
ationi snotapr ocessofv aluationbecausebusi nesses
donotr ecor ddepr eciati
onbasedonappr aisalsoft hepl antasset s.Depr eciat iondoes
notmeant hatt hebusi nessset sasi decasht or epl aceasset sast heybecomef ul l
y
depr eciat ed.Depr eciati
onaf fectsnei thercashi nflownorcashout flowdi r
ect ly.
Witht heexcept ionofl and,t heuseofpl antasset si noper ati
ont ogener ater evenue
consumest hei reconomi cpot enti
alusual l
ybef oretheyar et otall
ywor thless.Ev entually,
theseasset sar edi sposedofandpossi blyreplacedwi t
hsi mi l
arasset s.

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 5.3.1.CausesofDepr eci ati
on
Wi t
ht heexcepti
onofl and,t heuseofpl antassetst ogener ater evenueconsumest heir
economi cpotential. Sev eralf actorsar enaturall
yr elatedtot heper iodical l
ocati
onof
depr eciati
on.Depr eciationcanbecausedbyphy sicalf act
orswhi chi ncludewearand
tearf rom use,nat uraldet eriorati
ont hroughi nteractionwi t
hnat ur
alel ement sandt he
passage oft me,and f
i unct ionalf actors which i nclude inadequacy and t echnical
obsol escence.Apl antassetbecomesi nadequatei fitscapacityisnotsuf fici
enttomeet
thedemandsofi ncr easedpr oduction.Obsol escencei samor eimportantconsi derati
on
thanphy si
caldeteri
or ationpar t
icularl
yindev el
opedeconomi es.Apl antasseti sobsolete
i
ft hecommodi t
yi tpr oducesi snol ongerindemandori fanewerpl antassetsuchas
machi necanproduceacommodi t
yofbet terqualit
yoratagr eatreduct i
onofcost .
Phy sicalfact
orsthataf fectt heasset ’susefulli
fear ethenor malwearandt earthatresult
from usageandt hepassageoft i
me. Economi cf actorsincludeobsol escenceand
i
nadequacy .

Forsomepl antasset s,phy sicalwearandt earf rom oper ati

onsandf r
om t heel ement s
maybet hepr i
mar ycauseofdepr eciat i
on.Forexampl e,phy sicaldet eri
orationt akesi ts
tollont heusef ulnessoft r
uckst hatmov egoodsf rom onepl acet oanot her .Thest ore
fixturesusedt odi splaymer chandi sear eal sosubj ectt ophy sicalwearandt ear .
Asset s such as comput ers and ai rplanes maybe obsol et e bef oret heyphy sicall
y
det eriorat e. Anasseti sobsol et ewhenanot herassetcandot hej obbet terormor e
ef f
icient ly.Thus;anasset ’
susef ullifemaybemuchshor t
ert hani t
sphy sicall i
fe.I n
shor t,thet erm obsol escencemeanst hepr ocessofbecomi ngoutofdat eorobsol ete.
Inadequacyofapl antassetmaynecessi tat er eplacementwi thal ar geuni tev ent hough
theasseti si ngoodphy sicalcondi ti
on.Obsol escenceandi nadequacyar eof tencl osely
associ ated.Bot hr elatet ot heoppor tuni tyf oreconomi calandef ficientuseofanasset
rathert hant oitsphy si
cal condi t
ion.
Fourf act or saffectt hecomput ationofdepr eciation.Theyar e:
 Costoft hepl antasset
 Resi dual /salvagev alueoft hepl antasset
 Depr eci ablecost ,and
 Est imat edeconomi c( useful)l i
feoft hepl antasset .
Cost -i st henetpur chasepr icepl usal lreasonabl eandnecessar yexpendi turest ogett he
asseti npl aceandr eadyf oruse.
Resi dualv alue-alsoknownassal vagev alueordi sposalv alueorscr apev aluer epr esents
theest imat edmar ketv alueoft heassetatt het imeofi tsretir
ement .
Depr eci abl ecost -Repr esent sthedi f
fer encebet weent heassetcostandi tsest imat ed
residual v alue.
Est imat ed economi c( usef ul)l i
fe-i tr epr esent st he totalnumberofser vi
ce uni ts
expect edf r
om t heasset .Theseser viceuni tsmaybemeasur edi nt ermsofy ear st he
asseti sexpect ed t o beused,uni t
sexpect ed t o bepr oduced,mi l
esorki lomet ers
expect edt obedr i
v enorsi milarmeasur es.

To r
ecor
dthe per
iodi
c depr
eci
ati
on ofpl
antasset
s,an expense accountcal
l
ed

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 Depreciat
ion expense and a contr
a assetaccountcal l
ed Accumul
ated depr
eci
ati
on
accountar eused.Hence,t hej
ournalentr
yt orecorddepr
eci
ati
onofplantasset
swould
be:
Depreci
ati
onexpenseDr.XXX
Accumul at
eddepreci
ati
on–speci
fi
cplantassetCr.XXX

5.3.2Depr eci at i
onMet hods
Wehav eseent hatwi t
ht heuseofapl antasseti noper at
ion,depr eci ationshoul dbe
recor dedt oaccountf ort hedecl inei nt heser v i
cecapaci tyoft heplantasset .Howev er,
theact ualamountoft hecostappl icabl et ot heut il
izedpr oduct i
vecapaci tycanhar dlybe
known.Thusdepr eci ati
oni sanest i
mat edamount .
Theopt imum est imat eofeconomi cl if
ei sr equi r
ed. Theest imat eofeconomi cl i
fe
affect si ncomemeasur ementoft heor gani zation.Ther efore,taxaut hor i
tiesandr evenue
agenci eswi llpr oducegui del ines, whi chshoul dbef oll
owed.Forexampl e, i
nEt hiopia, the
economi cl i
f eofpl antasset slookl iket hef ol l
owi ng:
 Bui lding 20y ears
 Machi ner y 8y ears
 Vehi cles 5y ears
 Fur ni shings 10y ears
Thisdoesn’ tmeant hatawel l
-bui l
tbui ldingwi llbewor t
hlessaf ter20y ear s.Ont heot her
hand, af terbei ngonusef or5y ears, amachi nemaybeoutofor derduet oobsol escence.
Depr eci at ionmet hodspr imar il
ydi fferi ntheamountofcostal l
ocatedt oeachper i
od.
Themostcommonmet hodsofcomput i
ngdepr eciati
onf orplantasset sar e:
1-Thest raightl i
nemet hod
2-Thesum-of -t he-y ears-di gitsmet hod
3-Thedoubl e-decl ini ngbal ancemet hod
4-Theuni tsofpr oduct i
onmet hod
Asani llust rat i
on, assumet hatanequi pmentcost sBr1, 000andhasanest imatedusef ul
l
ifeof5y ear s.Theest i
mat edsal vagev alueatt heendoft hef i
ve-yearper i
odi sBr 100.
Differentdepr eciat ionmet hodsar eusedt oal locat etheamountdepr eci atedt hroughout
thel i
feoft hepl antasset .
1.St raightLi neMet hod
Straight -linedepr eci ati
onmet hodi st hesi mpl estmet hodt ocomput edepr eci
at i
on.The
straight -linemet hodassumest hatt heownerr eceivesequalbenef i
tsf rom anasseteach
dayoft heasset ’
sl ife.Accor dingt ot hest raight -
li
nemet hodofest i
mat ingdepr eciation,
anequalpar toft hecostoft heasseti sal locat edt oeachdayofanasset ’
sl i
fe.I neach
account i
ngper iod,equalamountofdepr eciationi sr ecorded.Basedont heabov edat a
andusi ngst r aight -li
nedepr eciationmet hod, annual depreciationiscal culat edasf oll
ows:
Original Cost–Sal vageVal ue
Annual Depr eciat i
on= Est i
mat edusef ulLife
Fort heabov eexampl e,
= Br1, 000–Br100= Br .180pery ear
5y ear s
Theent ryt or ecor deachy ear ’sdepr eci ationexpensei s:

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 Depreciati
onExpense 180
Accumul at
edDepr eciation--
-Equipment 180
(Torecorddepr eciati
onexpensef orthey ear.)
Depr eciati
onExpensei saddedt ot heexpensesoft hef i
rmi ndeterminingneti ncome,
andi scl osedaty ear-
endt otheIncomeSummar yaccount .Theof f
sett
ingcr edi
tisposted
tot hecont r
aaccount ,Accumul atedDepr eci
ati
on,whi chi sdeduct edf rom ther el
ated
plantassetaccountont hebalancesheett ocomput et heasset ’
sbookv alue,orcarryi
ng
value.I nthi
smanner ,theor i
ginalcostofanasseti smai ntai
nedi ntheassetaccount ,
andt hecumul ati
vebal anceofdepr eciationtakeniscar ri
edi nthecont raaccountasl ong
ast heasseti sinser vi
ce.
The annualdepr eciati
on expense,accumul at
ed depr eciati
on and t he effect of
depr eciati
onadjust mentont hebookv alueoft heassetisindicatedbelow:

Perio Bal
ance of Peri
odic End-of Peri
od ( Year
)
d Asset Depreci
ati
o Balance
(Year) Account nExpense Accumul ate Book
d Val
ue
Depreciati
o
nAccount
1 Br Br180 Br180 Br820
1,00
0
2 1,00 180 360 640
0
3 1,00 180 540 460
0
4 1,00 180 720 280
0
5 1,00 180 900 100
0
Totaldepr eciation Br900
Basedont heabov edat a, youcanobser vethat:
 Thepl antassetaccountal way sshowst heor i
ginalcostoftheasset,
 Eachper i
odr eflectsBr180ofdepr eci
ati
onexpense,
 Theaccumul at eddepr eci
at i
onaccountbal ancei scumul ati
veandshowst he
port
ionoft heor i
ginalcosttakenasdepr eci
ati
ont odate,
 Theasset ’
sbookv al
ueist heor i
ginalcostlesstotalaccumul at
eddepr eci
ati
on
todate, and
 Theasset ’
sbookv al
ueatt heendoff i
v eyearsequalst heestimat edsalv
age
val
ue.
Str
aight-
li
neallocat i
oni sbestsui t
edt oanassetwi thar elat
ivel
yuni f
orm peri
odicusage
andal owobsol escencef actor.Theset ypesofasset scanpr ovi
deappr oximatelyequal

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 uti
li
tydur i
ngallper iodsoft heirusef ullives.
2.Sum oft heYear s’ DigitsMet hod
Thebasi cideabehi ndt hesum oft hey ears’di gitsmet hodisthatmor eser vi
cebenefits
arer eceivedi nt heear lyy ear sofanasset ’slif
ewheni ti
snew,andf ewerbenef it
sar e
receivedeachy ear sast heassetgr owsol der .Manyasset sareef fi
cientwhenf i
rst
purchasedbutbecomel essef ficientast imepasses.Thesum- of-
the-
year s’
-
digit
s(SYD)
met hodi samet hodofaccel erateddepr eciati
onbecausei tassignsmor edepr eci
ati
ont o
theear l
yy earsoft heplantasset ’slifeandl esst olaterones.
Depr eci
at i
onaccor di
ngt osum- oft he-y ears-digitmet hodi scalcul
atedbasedont he
economi clif
eoft heplantasset .
Annual Depr eciation=( Or iginal Cost–Sal vageVal ue)xRemai ningusefulLife
Sum ofthey ear
sdigit
Sum oft heyear sdi gi
t=t hesum oft hey earsoft heeconomi cli
feoftheplantasset
=1+2+3+....+n
Or =n( n+1)wher eni st hel if
eoft hepl antasset.
2
Aspert heabov ei ll
ustrationdat a, thesum oft hey earsdigi
t=1+2+3+4+5=15
Or = 5( 5+1) /2=15

Accor
dingl
y,cal
cul
ati
onofdepr
eci
ati
onbasedont
heSYD met
hodf
oreachy
eari
sas
fol
l
ows.
Year Year
s Depr
eci
abl Depr
eciat
io
of remaini
n eCost nExpense
Usefu g÷
lLi
fe Sum of
theyear
s
1 5/
15 x Br900 = Br300
2 4/
15 x 900 = 240
3 3/
15 x 900 = 180
4 2/
15 x 900 = 120
5 1/
15 x 900 = 60
Tot aldepr eciat
ion 900
Asanaccel erateddepr eciationmet hod,t heSYDappr oachi smostappr opriatewhent he
assetrender sgr eat erut il
itydur i
ngi t
sear l
ylif
eandl essi nitslaterl if
e.Accel erated
depreci
ationi ssuitabl eforasset swi thei t
herahi ght echnologicalobsolescencef actorin
theearl
ylifephaseorahi ghmai nt
enancef actorint heirl
aterlif
ephase.
3.Doubl eDecl iningBal anceMet hod
Doubledecl i
ningbal ancemet hodi sanaccel erateddepr eci
ati
onmet hodev enmor e
duri
ngt heear lyyear st hant hesum- of-t
he-years’digitsmet hod.Thismet hodi sbasedon
thesamei deaast hesum- of-t
he- years’ di
gitsmet hodandi susedf orasset st hatprovide
evenmor econsumabl eser vicebenef i
tsint heear l
yy earsandt herefor er equir
emor e
depreci
ation int hose y ears.Doubl e declini
ng bal ance met hod,anot heraccel erated
depreci
ationmet hod,appl iesaconst antper centageorr at
eeachy eart ot hebookv alue
atthebegi nningoft hey ear .Forexampl e,thedecl i
ning-bal
ancer ateforanassetwi than
esti
matedl ifeof5y ear swoul dbedoubl ethestraight-l
inerateof20%; or40%.Thi srateis

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 thenappl
i
edtothecostoftheassetf
orthefi
rstyearofit
suse andt
her
eaf
tert
othe
decl
ini
ngbookv
alue(
costmi
nusaccumulat
eddepreci
ati
on)
.Thus,

100%x2 =100%x2=40%
Doubledecli
ningbal
anceRat e= Year sofusef ulli
fe 5
Then,t
heannualdepr eciat
ionwoul dbe:
=RateXt hebookv al
ueoft hepl antassetatthebeginningofthaty
ear
Usi
ngthesameexampl e,t
heannual depreciat
ioniscalcul
atedasf ol
lows.
Yea Ori
ginal Beginning Beginni Double Amount
rof Cost Accumul at ngBook decl
inin of
use ed Value g Depreci
ati
ful Depreciatio depreci on
Life n ati
on Expense
rat
e
1 Br Br0 Br1,000 40% Br400
1000
2 1,
00 400 600 40% 240
0
3 1,
00 640 360 40% 144
0
4 1,
00 784 216 40% 86
0
5 1,
00 870 130 30*
0
Totalamountdepreciated 900
*5thyeardepr
eciati
on=900–870=30.Pl easenotethati
tisnot130x40%.
Observethatinthef i
ft
hy eardepreci
ati
onexpensei sonl
yBr30,t heamountneededto
reducetheasset’sbookv aluet
ot heesti
mat edsalv
agev al
ueofBr100.Assetsarenot
depreci
atedbelowtheirsalv
agev al
ues.

4.Uni t
sofPr oduct i
onMet hod
Theuni t
s-of-
productionmet hodallocatesdepr eciationi npr opor ti
ont otheasset ’
susei n
operati
ons.Theamountofdepr eciati
ondependsont henumberofuni t
st heasset
producesi nthatper iod.First
,thedepr eci
ationperuni tofpr oduct ioniscomput edby
di
v i
ding the depreciable costbyt he asset’s pr ojected uni ts-of-
product
ion capaci t
y.
Therefore,
Depreci
ati
onperUni t = Or i
ginalCost–Sal vageVal ue
Est
imatedTot al UnitsofPr oduct ion
Theuni tsofout putdepr eciati
onmet hodr equi ressomewayofmeasur i
ngt heasset ’s
outputdur i
ngapar ticul
arper i
odoft i
me.Uni ts-of-product ioncapaci tymayr epresent
milesdr i
ven,tonshaul ed,hour sused,ornumberofcut ti
ngs,dr il
l
ing,orstampi ngsof
parts.Supposetheabov eexampl eisdril
li
ngequi pmentt hatwi l
ldr il
lanesti
mat ed45,000
partsduringit
susef ulli
fe.Thedepreciati
onperuni tofpr oduct i
oni s:
Br1,000–Br100=Br0. 02perpar t

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 45, 000par ts
Tof indper iodi cdepr eciat ionexpense,t henumberofuni tspr oduceddur i
ngt heper i
od
mul tipliest hedepr eci ationperuni tofpr oduct ion.I f8, 000uni t
sar edrill
eddur i
ngt hefirst
year ,then8, 000xBr0. 02=Br160i st hef i
rsty ear’sdepr eci ati
onexpense.I f12, 000par ts
aredr il
ledt henexty ear ,thaty ear ’
sdepr eciationexpensei s12, 000xBr0. 02=Br240.
Theuni ts-of -product ionappr oachi spar t
icular lyappr opr iatewhenphy sicalwearandt ear
i
st hemaj orcauseofdepr eciat ionandt heamountofusev ariesf rom per iodt oper iod.Of
cour se, ifusei suni f orml yspr eadov ert heasset ’
sl i
fe, thesameal locationofdepr eciati
on
woul dr esul tfrom ei t hert hest raight -l
ineoruni ts-of-pr oduct ionmet hod.
Par tialy earDepr eciat ion
Plantasset sar epur chasedanddi sposedofatdi ffer entt imesdur i
ngt hey ear.Inal lthe
abov edi scussi ons,wehav eassumedal lpl antasset swer ebought[ pur chased]att he
begi nni ngoft hef i
scaly earandt hust hedepr eci ationi neachmet hodwascomput edfor
af ull year .Buti tispossi bl et hatanassetcanbeboughtanyt i
mewi thinay ear .
Whenapl antasseti spur chasedordi sposedofatat i
meot hert hant hebegi nningorend
ofanaccount ingper iod,depr eci ationi sr ecor dedf orpar tofay ear.Thusi tisnecessar y
tor ecogni zeandr ecor dt hedepr eciationexpensef ort heper i
od.
Toi llust rat e,assumet haty ourof f
iceboughtamachi neonMar ch1,y ear1.Thecostof
themachi nei sBr50, 000.Theest imat edsal vagev aluei sBr10, 000.Theusef ull i
fei s
estimat edasf oury ear sst artingf rom Mar ch1,y ear1.I ftheaccount ingper iodendson
June30, fory ear1andt heconsecut ivey ear s, thent hedepr eciati
onexpenseundereach
met hodofdepr eciat ionwi l
l beasf ollows.
(1) St raight -l
inedepr eci ationmet hod.
Year1= 4/ 12X( 50, 000–10, 000) /4=3, 333
Year2= ( 50,000–10, 000) /4=10, 000
(2) Sum oft hey ear sdi gitmet hod
Sum- of -
the- year s’digi ts=4( 4+1)÷2=10
Year1=4/ 12x4/ 10x( 50, 000–10, 000)=5, 333
Year2=8/ 12x4/ 10x( 50,000–10, 000)
+4/ 12x3/ 10x( 50, 000–10, 000)=14, 667
(3) Doubl edecl iningbal ancemet hod
Rat e=¼x2x100%=50%
Year1=4/ 12x50%x50, 000=8, 333
Year2=50%x( 50,000–8, 333)=20, 834
Pleasenot et hatuni tofpr oduct ionmet hodwoul dnotgi vey ouadi fferentr esultf orthe
factdepr eci ationdependsont heusageoft hepl antasset ,nott heper i
odoft imeunder
consi der at ion.
Cal cul at i
ngdepr eci at ionexpense
Thisact ivityhel psy out oappl ydi fferentdepr eciationmet hodst ocal culatet heexpi red
costofpl antasset s.
Assumet hatacompanypur chasesat ruckonApr il1f orBi rr500, 000.I tsest imat edl if
ei s
20y ear s,andi tsest imat edr esi dualv aluei sBi rr80, 000.Thecompany ’sfiscaly earends
onDecember31.
Requi red:Fort hef i
r stt woy ear s,comput et hedepr eci ationamountoft het ruckunder

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 eachofthefol
lowi
ngdepreciat
ionmethods.
A.Str
aightLi
neMethod,
B.Sum oftheYear
sDigitMethod,
and
C.DoubleDecl
ineBal
anceMet hod

Activi
ty: Appl y i
ngdepr eciationmet hods
I
thelpsy out oappl ydifferentdepreciati
onmet hods.
Thef oll
owi ngdat aarer el
atedt oBonaCompanyf oracquir
ingtruck:
DataI t
em Amount
Costoft ruck……………………………… Br41, 000
Esti
mat edr esidual value…………………. 1, 000
Depreciablecost………………………….40, 000
Estimatedusef ulli
fe:
Years………………….5y ear s
Unitofpr oduct ion……100, 000mi l
es
Required:
1.Assumi ngt hatt heasseti sacquiredatt hebegi nni
ngoft hey ear
,calcul
ateannual
depr eciationf orthefirstyearundert hefollowingdepreci
ationmethods:
a)
.Straight-li
nemet hod
b) .Unitsofpr oduct i
onmet hod,assumi ngthatactualnumberofmi l
esdriv
en
are 20, 000,30, 000,25, 000,15, 000 and 10,000 fory ears one tofive
respect iv
ely.
c).Doubl edecl i
ningbal ancemet hod
d)
.Sum ofy earsdi gitsmet hod
2.Comput eannualdepr eciati
onundereachmet hodstarti
ngf r
om y earonethr
ough
year5

Rev i
sionofDepr eciation
Depr eciati
on al l
ocat i
on i s based on est imat e of usef ull ife and salvage v alue.
Cir
cumst anceschangeandor i
ginalestimatesmaybet oohi gher ,ortoolow.Oncei tis
deter minedt hator i
ginalest imat esar ewrong,t hecomput ati
onofper i
odicdepr eciati
on
expensef ortheasset ’sremai ningusef ull
ifemustber evised.Your evi
seadepr eciati
on
estimat ebyal l
ocatingt her emai ningdepreciablecostoft heassetov erit
sr emai ni
ng
usef ull
ife.
Rev i
singanest imateoft heusef ullif
eorsalvagev alueofapl antasseti scalledChange
i
naccount i
ngest imat e.
Achangei naccount i
ngest imat eresul t
sf rom newinformat i
onor
new dev el
opment sori mpr ovedj udgment. A changei naccount i
ngest i
mat ewi llnot
aff
ectpr i
orper i
odr ecordsbutonl yfutur
efinancialrepor t
s.
Consi derapl antassetwi thor iginalcostofBr1000,sal vagev alueofBr100andf ive
yearsl i
fe.Nowsupposet hatj ustbef orerecordingt hef ourthy ear’sdepreci
at i
on,itwas
l
ear ntthattheasset ’
slif
ewi llbesi xyearsi
nst eadoff iv
eandt hatitssalvagev al
uewi llbe
Br40. Ther eviseddepr eciati
onexpenset obet akendur i
ngt her emaini
ngusef ullife
usingast r
aight-l
inedepr eciat i
onmet hodiscomput edasf oll
ows:
Or i
ginalassetcost Br1,000

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 Depr
eciationalreadyrecorded(3years@ Br180) 540
Bookvalueatst artoffourt
hyear 460
Revi
sedsal vagev al
ue 40
Revi
sedr emainingdepr eci
abl
ecost 420
Revi
sedr emainingusef ull
i
fe 3y ears
Rev
isedperi
odi cdepreciati
onexpenseforfour
th,f
if
th,andsi
xthyears
Br420/ 3=Br140pery ear

Revisionofdepr eci
at i
on
Thisact i
v i
tyenabl esy out omakear evi
sionofper iodicdepr eci
ati
onbasedoncur rent
i
nfor mat ion.Assumeamachi newaspur chasedonMesker em 1,1990.Thei niti
alcost
oft hemachi newasBi rr10,000.Theest imatedsal v
agev al
ueoft heassetwaszer o.The
estimat edusef ulli
fewasest imatedasf iv
ey ears.St r
aight-
li
nemet hodofdepr eciati
oni s
chosen.
OnMesker em 1, 1993,itisestimatedthatthismachi necanbeusedf orthenext4y ears
withest i
mat edsal vagev al
ueofzer o.Not ethatont hi
sdat et hemachinehasbeeni nuse
fort hreey ears[ f
rom Mesker em 1,1990t oPagume5, 1992].Thus,itwasdepreciatedf or
three y ears. The accumul ated depreci
at i
on on Mesker em 1,1993 i s Bi
rr6, 000 =
[Bi
rr 2,
000X3y ears].Therefore,t
hebookv alueofthemachi neisBirr
4,000=[Birr10,000
–Bi r r
6,000] .
Requi red:Det erminetheneworr eviseddepreciat
ionexpensepery ear.

5.4.Rev enuesandcapi talexpendi t

ures
Addi ti
onalexpendi turesar eincur r
edt omaket hepl antasset sr enderbet t
erser vice.
Hence, y ouwi l
lbeintroducedwi thther evenueandcapi t
alexpenditures.
5.4.1.Rev enueExpendi tur
eandCapi t
al Expenditur
e
Dur i
ngt hel if
eofanasset ,expendi turemaybei ncurredt okeept heassetoper at i
ng
economi call
y.Theseexpendi turesfallintotwocat egoriesnamel yr evenueexpenditures
(ordinaryrepairsandr egularmai ntenance) ,andcapitalexpenditures( i
mprovement sand
extraordinaryrepairs).Suchexpendi tureswi llberecognizedasanexpenseorcostoft he
plantasset .
Ami sclassifi
cati
onofexpendi turesresul t
si nincorr
ectf i
nancialstatement sforsev eral
periods.Forexampl e,capitali
zingr evenueexpendi tureov erst
atest hecur r
entperiod’ s
i
ncome and under states the income i n subsequentper iods. Si mi l
arl
y,ifa capi tal
expendi tureisimmedi at el
yexpensed,t hent hecurrentperiod’
si ncomei sunder stated
andi ncomei soverstateddur ingt hesubsequentper i
ods.

1.Rev enueExpenditur
es
Expendituresi
ncurredfor,orassoci
atedwith,asset
st hatwi
llpr
ov i
deeconomi cbenef
its
only during t
he cur r
entaccount i
ng per
iod ar e call
ed r
evenue expendi
tures.Such
expendituresareincurredinordert omaintainthenor maloperati
ngeffi
ciencyofthe
assets. Suchexpendi tur
esar eexpensedwhent heyar ei
ncurred. Thefollowi
nglist

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 i
dent
if
iesthr eecommont ypesofrev enueexpendi t
ures:
 Expendi t
ures foror di
nary mai ntenance and r epairs ofexi sti
ng pl antasset s.
Peri
odi cupkeep–suchasl ubricati
on,cleaning,andr eplacementofmi norparts–
i
snecessar ytomaintainanasset ’sexpect edlevelandl engthofusef ulness.These
peri
odi cupkeepcost sarechar gedtoexpenseast heyar eincurred.
 Expendi t
urestoacqui relow-costi t
emst hatbenef itthef i
rmf orsev eralperiods.
Mostbusi nessespur chaseitemswi threlati
velysmal lcostthatpr ovideser vi
cef or
moret hanoney earsuchaspaper weights,puncher ,stapler,papercut t
er,and
wast ebaskets.Becauseoft hesmal lBi rramount si nvolved,est abli
shi ngthese
i
temsasasset sanddepr eciatingt hem ov ert heirexpect edusef ull i
vesreally
servesnousef ulpurpose.
 Expendi t
ures considered i
mmat erialori nsignifi
cantar er ecorded as r evenue
expendi t
ure.

I
dent i
f yingt hecl assificat i
onofexpendi tur
e
Dearst udentt hi
sact ivityhel psy out oi dent ifythet ypeofexpendi t
ure.
Assumet hatABCCompanyboughtabui l
di ngf orBi rr120, 000onMesker em 1, 1988.The
buildi nghasest imat edusef ullifeof20y ear s.Thesal vagev alueatt heendofi tsl i
fei s
Birr20, 000.Af ter5y ear sofuse,ABCCompanymadeanaddi t
ionalexpendi tureofBi rr
12,000t opai ntt hebui l
ding.Thecol oroft hepai ntwasdi fferentf rom t heor i
gi nal.What
typeofexpendi turei sitandhowi si tgoi ngt obeaccount edf or?
2.Capi talExpendi ture
Cost si ncur redf or,orassoci atedwi th,asset sthatwi l
lpr ovideeconomi cbenef i
tsov er
sev er alaccount ing per iods ar e cal l
ed capi t
alexpendi tures.Al lcapi talexpendi t
ur es
associ at edwi t
hapar ticularassetar eaddedt othecostoft hatasset .Someexpendi ture
i
ncur redaf tertheasseti sacqui redandpl acedi nser vicear econsi der edascapi tal
expendi turesi ft heyi ncreaset hel ifeoft heassetbymor et hanoney earbey ondt he
original estimat eori mpr ov et hequal it
yorquant i
tyoft heasset ’sout put.
Capi t
al expendi turesar esupposedt ogi veaser vicef ormor eper iodsandar er ecor dedas
assetpar ti
cularlyfixedasset s.Capi talexpendi turesi ncreaset hebookv alueofl ong- term
asset s.Capi talexpendi turesar ecost sincur redinr elati
ont oaddi t
ions,bet t er
ment s,and
extr aor dinar yrepai rsofpl antasset s.Thosecost s,whi chmayi mpr ov etheef f i
ciencyor
thel ifeoft hepl antasset ,aret reat edast hecostoft hepl antasset .
a.Addi ti
ons
Ther emaybeaneedt oaddpar t
sorext endt heexi st i
ngpl antassett hatmaycost
signi ficantamount .Addi nganewwi ngt oabui l
di ngorexpandi ngt hesi zeofanasphal t
par kingl otar eexampl esofaddi tions.Thesecapi talexpendi tur es,sincet heyi mpr ov et he
serv iceoft hepl antasset ,shoul dbedebi tedt oanassetaccount .Somet i
mes,separ ate
account(depr eciat i
onschedul e)shoul dbeusedf oranaddi ti
onwheni tsest imat ed
usef ul l
ifedi ff
ersf ort her emai ningusef ul l
ifeoft heexi stingpl antasset .

b.Bett
erments
Bet
terment
si mpr
ovethequal
i
tyofser
vicesr
ender
ed bya pl
antassetbutdo not

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 necessar il
yex t
endi tsusef ulli
fe.Exampl esi ncludeaddi ngapowerwi ncht oahi ghway
servicetruckorai rconditi
oni ngtoanaut omobi le.Ineachi nst ance,t
hev ehicl
e’
sSer vices
areenhanced, butitsuseful l
ifeisnotchanged.Expendi turesf orbetter
ment saredebi ted
tot heappr opriateassetaccount ,andt hesubsequentper iodicdepreciati
onexpensei s
i
ncr easedt oallocatetheaddi ti
onal costov ertheasset ’
sr emai ningusefulli
fe.
Toi ll
ustrate,l
etusassumeSi fanSer vi
ceSt ationpurchasedanew ser v i
cetruckf orBr.
6,500onJanuar y2,20X1.I t
sest i
mat edusef ulli
feissixy earswi thasal v
agev al
ueofBr
500. Usi ngt hest rai
ght-l
inemet hod,Br1, 000ofdepr eciat i
onexpensei srecordedon
December31,20X1[ (
Br6, 500–Br500) /6=Br1, 000].OnJanuar y2,20X2,apower
winchcost i
ngBr700i saddedt ot hetruck.Thet ruck’susef ullif
edoesnotchange,but
i
tsest i
mat edsal vagev al
uei ncreaset oBr600.
(A)TheJanuar y2,20X2, entrytor ecordt henewwi nchis:
Truck 700
Cash 700
Tor ecordcostofpowerwi nchaddedt ot r
uck.
(B)Annualdepr eciat
ion expense ofBr1, 120 fort he y earsf rom 20X2 t o 20X6 i s
comput edasf oll
ows:

Ori
ginaltr
uckcost Br6,
500
Powerwi nchcost 700
Totalcost Br7,
200
Depreciat
ion recorded i
n 1,
000
20X1
Book v alue af t
er 20X2 Br6,
200
bett
erment
Revisedsalvagev al
ue 600
Remai ni
ng Depr eci
abl
e Br5,
600
cost
Remai ni
ngusef ulli
fe 5Year
s

Revi
sedper i
odi
cdepr eci at
ionexpensef or20X2t o20X6=Br5, 600/5=Br1,120peryear
(C)TheDecember31, 20X2ent r
yt orecor ddepreciati
onexpenseis
Depreciati
onExpense- ---Truck 1,120
Accumul atedDepr eciation-
--
-Tr uck 1,120
Tor ecord20X2depr eciati
onont ruck
c.Ext r
aordinaryRepai rs
Extr
aordinaryrepairsar eexpendit
ur est hatext
endanasset ’
sexpectedusefull
if
ebey ond
theori
ginalestimat e.Thesecapi talexpendi t
uresar edebit
edtotheasset’sAccumulated
Depreci
ationaccount( whi chincr
easest heasset’sbookv al
ue).

AssumeBr12,800worthofequi
pmentispurchased.Ithasanest imatedusefulli
feof
ei
ghtyear
sandasalvageval
ueofBr800.Annualstrai
ght-
li
nedepreciati
onexpenseisBr
1,
500[(Br12,
800--
-Br800)/
8].Atthebegi
nningoft heseventhyear ,t
heequipmentis
ext
ensi
velyover
haul
edatacostofBr2, 200. Theov er
haulext
endst heequipment
’s

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 usefulli
feforanest imat edt woyear sbeyondtheor iginalest
imatewi t
hnochangeint
he
expectedsalvagev alue.
(1)Thecosti sdebi t
edt oAccumul ateddepreci
ationaccountt houghitiscapi
tal
expenditur
e.
Accumul at eddepr eci
ation--
-Equipment2, 200
Cash 2,
200
(Tor ecordcostofequipmentov er
haul
)
(2) Annualdepr eciationexpenseofBr1, 300fort hecomi ngper i
odsi scomput
edas
fol
lows:
Origi
nal cost Br12,80
0
Less: Accumulated Br(9,000)
depreciation
Add:Ext raor dinaryrepairs Br2, 200
(6,
800)
Bookv alueatst artofsev enth Br6,000
year
Salvagev alue 800
Remai ningdepr eciablecost Br5,200
Rev i
sedr emai ningusef ulli
fe 4y ears
Rev i
sed per iodi c depredati
on expense f ory ears7t o 10 = Br
5,200/4=Br 1,
300pery ear

Inpracti
ce,thedisti
ncti
onsamongaddi t
ions,better
ments,andextraor
dinar
yrepai
rsto
plantassetsoftenbecomebl urred. Someexpendi tur
e,forexample,mayi mprovean
asset’
squalit
yofser vi
cesandext endit
susef ulli
fe.Accountant
smustuser easonabl
e
j
udgmentt oidenti
fy(andaccountfor)t
hepr i
mar yeff
ectofthetr
ansacti
on.

Account
ingt
reat
mentf
oraddi
ti
onalexpendi
tur
es
Assumet hatABCCompanypur chasedabui l
dingonJanuar y1,2000f orBirr
210,000.
Theusef ull i
feoft hebui ldingwasest imatedas20y ears. Thesal v
agev aluewas
esti
matedasBi rr10,000.ABCusesast raight-
linemet hodofdepr eciati
on.Af t
erusing
thebuil
dingf or5y ears,[
onJanuar y1,2005]ABCaddedawi ngtot hatbuildi
ngatacost
ofBirr
150,000.Thewi ngi sest i
mat edtohav eausef ullifeof15y earsandnosal vage
val
ue.ABCusesast r
aight-
linemet hodofdepr eciation.
a) Istheaddi ti
onalexpendi turebeclassi
fiedasr evenueorcapi talexpendi t
ure?
b) Recor dthenecessar yjour nalent
ryfortheaddi t
ional expendi
ture.
c) Determi netheannual depr ecati
onofthebui ldingaf tertheadditi
onal expendit
ure.

Theanswerf oracti
vit
yi sgivenbelowforyourchecking.
a) Thi sexpenditureincreasest hecapaci
tyoft heor i
ginalbuil
ding. Theref
ore,i
tis
classi
fi
edascapi t
alexpenditure.I
tmustber ecordedont hebuil
dingaccount.
b) Thej our
nalentrywil
lbe:
Bui
lding 150, 000

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 Cash 150,
000
c) Theor i
ginaldepr eciationwasBi r
r10,000perannum [ (
210, 000–10, 000)/20years]
.
Theaccumul at eddepr eci
at i
ononJanuar y1,2005i sBirr50,000[ Bir
r10,000X5year s]
.
Thebookval ueoft hebui ldingi
s,therefor
e,Birr160, 000[Birr210,000–Bi r
r50,
000].The
addi
ti
onalexpendi t
urewi l
lbeaddedt othebui l
dingtogetnewbookval ue.Thenewbook
val
ueisBirr310, 000[Birr160,000+Bi rr150,000].Thenewbookval uewillbedepreci
ated
fort
her emai ninglif
eoft hebui l
ding.Theor i
ginalbuildinghas15year s[20years–5
year
s]remai ning,whi chi st hesamewi tht henew wi ngaddedt oit. Ther
efore,the
remai
ninglifeoft hebui l
dingwillbe15year s.
Thedepreciationexpenseperyear= Newbookval ue–Sal vageval ue
Remai ningusef ulli
fe
= Birr310,000–Bi rr10,000
15year s
= Birr20,000
5.5: Di sposal ofPl antAsset s
Ther ei sacommonsay i
ngt hathumanbei ngsar ebor n,growandf inall
ydi e.Thesamei s
forpl antasset sf rom t heent erpr isepoi ntofv iew.Act ual lyt heyar enotbor n,but
pur chased,t heydon’ tgr ow i nst eadputi noper ationandabsor bcapi talandr evenue
expendi tur es.Howdot heydi e?Thi ssubuni ttri
est oexpl ai
nabouti t.Plantasset scannot
beusedf or ev erandmaywearoutort hebusi nessmayr epl acet hem wi thnewermodel .
A pl antassetr arelyl ast s exact l
y as l ong as i ts estimat ed l ife.The pur pose of
depr eci ationi st ospr eadt hedepr eci ablecostoft heassetov ert heeconomi cl ifeoft he
asset .Iftheasseti sst i
llusedi nt hebusi nessbey ondt heendofi tsest i
mat edl ife,it
scost
andaccumul at eddepr eci ationr emai ni nthel edgeraccount s.Ift her esidualv aluei szer o,
thebookv alueofaf ullydepr eciat edasseti szer o.I fsuchanasseti sdi scar dednogai n
nol ossr esul ts.
Apl antassetmaybedi sposedby :
1- Discar dingi taswor thless
2- Sel li
ngi t; or
3- Tr adi ngi twi thanewasset .
1.Di sposalofPl antAsset st hroughAbandonment/ Discar ding/
Acompanymaysi mpl yst opusi nganassett hatnol ongerhasser vicepot ent ial.Ifsuch
anassethasbeenf ullydepr eciat ed,nogai norl ossar ises.I ft heassethasanon- zero
bookv alue, howev er,thecompanymustr ecogni zeal ossequal tot hebookv alue.
Forexampl e, assumet hatatt heendof2017, RT-Cor por ati
ondi scar dedequi pmentwi t
ha
histor icalcostofBi rr8,000,onwhi chaccumul ateddepr eci ationofBi r r7, 000hasbeen
recor ded.
Thedi sposal entrycanber ecor dedasf oll
ows:
Accumul ateddepr eci ati
on………………………….7000
Lossondi sposal ofequi pment………………………1000
Officeequi pment……………………. .
………………8000
2.Di sposalofPl antAsset st hroughSal e
Theent ryt or ecordt hesal eofanassetf orcashi ssi mi l
art ot heonei l
lust ratedabov e
exceptt hatt her eceiptofcashshoul dal sober ecorded.

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 Taketheaboveoffi
ceequipmentandconsi
derthefol
l
owi ngthr
eecases.
Case-1:Sol
dtheoffi
ceequipmentequaltothebookvalue,Br1,
000.I
nt hi
scasenogai
n
nolossresul
ts.
Cash………………………………………….1, 000
Accumulateddepreci
ati
on…………………. .
.7,000
Of
fi
ceequipment …………………….8,000

Case-
2:Sol
danequi pmentatBr2, 500,gainofBr1,
500
Cash……………………………………………. .
2,500
Accumul
ateddepreciat
ion………………………. 7,000
Offi
ceequipment
…………………………………. 8,000
Gainonsaleofpl
antasset ………………………. .
1,500

Case-3:Sol
danequipmentatBr500,
lossofBr500
Cash……………………………………………. 5,
00
Accumul at
edepreci
ati
on………………………..7,
000
Lossonsaleofplantasset
………………………500
Off
iceequipment
………………………………. .
8,000

3.Di sposalofPl antAsset st hroughExchange

Businessesof tenexchange( tradei n)t heirol dpl antasset sf orsi milarordi ssi
mi l
ar
assets.Tor ecordt heexchange,t hebusi nessmustr emov et hebal ancesf ort heasset
beingexchangedandi tsr elatedaccumul ateddepr eciat ionaccountf r
om t hebookand
recordt heot herconsi der at i
ongi venorr eceived.I fy ouexchangeonepl antassetf or
anothersi mi l
arasset ,y oushoul dr ecogni zet hel oss. Howev er,thecomput edgai n
shouldnotber ecogni zedunl esst herei sacasht hatisr eceivedbecauseoft heexchange
transaction.Ev enwheny our eceiv ecash,y our ecogni zeonl yt hepr opor t
ionat eamount
ofgai n. Buti fonepl antasseti sexchangedf oranot herdi ssi milarplantasset ,any
comput edgai norl ossshoul dber ecogni zedi nt heaccount ingr ecor dbecauset he
earningpr ocessi sconsi der edcompl ete.
Whyar elosses,butnotgai ns,r ecogni zedi nexchangeofsi mi larasset sexchange? The
Account ingPr i
nci plesBoar dhasr easonedt hatacompanyshoul dnotr ecor dagai n
mer elybecausei thassubst itutedonepl antassetf oranot hersi mi larplantasset .Losses
arer ecorded,howev er ,becauseconser v ati
sm f av orst her ecogni t
ionofl ossesr ather
thangai ns.
Let’sassumet hatHawaniacqui resanew si mi l
arcomput eri nexchangef ort heol d
comput ert hatoriginal l
ycostBi rr12, 500andhasaccumul at
eddepr eciati
onofBi rr8,
500
andpay i
ngcashofBr18, 000.Thecur rentf airvalueoft henewcomput eri sBr19, 000.
Thecostoft henewcomput ercannotbeBr22, 000( Br4, 000bookv alue+Br18, 000cash)
becausei thasf airmar ketv alueofBr19, 000expl icitlyst ated. Thecostoft henew
comput er ,
then, mustbeBr19, 000.
Thegai norl osscal cul ati
onshedssomel i
ghtonwhatr eal lyhappened:
Fairmar ketv alueofnewcomput er Birr19, 000
Less:Bookv alueofassetgi ven:

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 Bookv alueofol dcomput er(Br12,500–Br8, 500)…(4,000)
Bookv alueofcashgi ven (18,000)22,000
Lossi ndicat ed( andr ecor ded) (3,
000)
Hawani wi l
lber equiredt or ecor dalossont hist r
ansact i
onbecauset hebookv alueofthe
twoasset sgi v enup( t
heol dcomput er,Br4, 000,pluscash,Br18, 000)isBr3, 000mor e
thanthev alueoft heassetacqui r
ed,Br19,000.Theent r
ytor ecordtheexchangei s:
Off iceEqui pment( newcomput er) 19, 000
Accumul ateddepr eciati
on( oldcomput er) 8,500
Lossonexchangeofasset s 3,000
Of ficeEqui pment( oldcomput er) 12, 500
Cash 18, 000
Tor ecordt radeofol dcomput erfornewone
Act ivity: Di sposal ofpl antassets
Dearst udent ,thisact ivi
tyhelpsy out oidentif
yt hegai norl osstober eali
zed
whenapl antasseti sexchangedf oranot hersimi larasset.
Assumet hatt heol ddel iverycarofChi lal
oCompanycostBi rr9,000andhasaccumul ated
depreciationt otali
ngBi r
r8000.I tisexchangedf orasi milarnewdel iverycarwithacash
pri
ce( f
ai rmar ketv alue)ofBi rr11,000. Youar er equiredt or ecordt heappropri
ate
entr
yift hecardeal erof fers:
a)Bi rr1, 000t radei nal lowanceandChi lal
ocompanypay scashbi rr10,
000f orthe
remai ni ng.
b)Bi rr600t radei nal l
owanceandChi lal ocompanypay scashbi r
r10,400f orthe
remai ni ng
c)Bi rr1, 300t radei nal lowanceandChi lalocompanypay st hebalanceofbirr9,700in
cash.

Chapt
erSi
x
Pay
rol
landot
hercur
rentl
iabi
li
ti
es
Intr
oduction
Thischapt erwillintr
oducey ouwi t
ht heonecommonandv eryf amil
iaror
ganizati
onal
practi
ce;call
ed pay rollaccounti
ng.I nt hi
s chapt er
,y ou wi
llbe st udyi
ng the basic
proceduresandt echniquestobeappl iedi naccountingtopr operlyrecor
d,calculate,
summar izeandrepor tpersonali
ncomer el
atedtransacti
ons.
Thechapt eriscomposedoft hr
eesy stemat i
csections.Thefir
stsect i
ondealswi t
ht he
needf orandt er
msusedi npayrol
laccount ing.Thesecondsect ionpresentsaboutt he

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ing/2013- 21Pa
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 maj oraccount ingpr ocedur esi nv olvedi ndet ermi ningt heempl oy menti ncome.Thet hird
sectiondeal swi thnot espay abl es,inter estexpenseandcont ingentl iabi
lit
ies.
Eachoft heseconcept swi l
lbei l
lust ratedanddi scussedbyt aki ngi nt oaccountt he
currentEt hiopi ant ax-laws.Asmuchaspossi blet hisuni tattempt st ogi vey ouadequat e
knowl edgeaboutpay rollsy stemsi nEt hiopi a.
Thischapt eri sv eryessent ialasi tt ri
est of ami li
arizey ouwi tht heempl oy menti ncome
taxsy stem inEt hiopia.Her eaf tery ouknowhowt ocal cul atet hei ncomet axandy oucan
ri
ghtnow cal culateandknow how mucht axl iabili
t yy ouar epay ingf rom y ourmont hly
salaryi ncome.To bet t
erunder st and t heconcepty ouwi l
lf i
nd act ivi
tiesand i n-text
quest i
onsandsel f-
testexer ci ses.
6.1:Impor tanceofpay r
ollaccount ing
Dearst udent !Hav ey ouev erhearaboutpay r oll?Thi swor dist hei ssueofal lempl oy eesi n
thegl obe.Thi ssect i
oni nt roducesy ouwi tht heneedf orappr opr iatepay rollaccount i
ng
andot heri mpor tantt ermsi npay roll.
Account i
ngsy stem f orpay rollandpay rollt axesar econcer nedwi thther ecordsand
repor t
sassoci atedwi tht heempl oy er-empl oy eer elationshi p.I ti si mpor t
antt hatt he
account i
ngsy stem pr ov i
deasaf eguar dt oensur et hatpay ment sar einaccor dancet o
management 'sgener alplansandi tsspeci fi
caut horizat i
ons.
Empl oy eesofanor gani zat ionar eent i
tledt or eceiver emuner ationatr egul arint ervals
foll
owi ngt hecl oseofeachpay rollper iod.
Pay rol
l account i
ngi si mpor tantf ort hef ollowi ngr easons:
 Pay rollof t
enr epr esent st hel argestexpenset hatacompanyi ncur s.
 Bot hf eder al andst at egov ernment sr equi ret hatdet ailedpay r
ollrecor dsbekept
 Empl oyeesar esensi ti
vet opay rol lerror sori rregul ariti
es.
 Adequat epay rollsy stem saf eguar dst hef i
nanci alresour cesoft heor gani zati
on
from mi suseandt hef t.

6.1.1Def init
ionofpay roll
r el
atedt er
ms
Pay r
ollaccount i
nginvolvessomanygener all
yacceptedandst andar di
zedt erms.Thi s
helpst oat t
ainuni f
ormityi nt hesy stem bothwi t
hintheor ganizati
onandwi t
hot her
rel
atedpar ti
es.Thef ol
l
owi ngar ethemostcommont ermsusedi npay rollaccounting:
1.Sal ar yandWages:Sal aryandWagesar eusuall
yusedi nter changeabl y
.Howev er,the
term wagesi smor ecor r
ectlyusedt orefertopayment st ounski l
l
ed- manuall abor.It
isusual lypaidbasedont henumberofhour sworkedort henumberofuni tsproduced.
Ther efore,wagesar eusual l
ypai dwhenapar ti
cularpi eceofwor ki scompl eted
weekl y.
Ont heot herhand, salari
esr efer
st opayment stoempl oyeeswhor endermanager ial
,
admi nistrat
iveorsi milarser vi
ces,andt heyar eusual l
ypai dt oski ll
edl aborona
mont hlyory earl
ybasis.
Bothwagesandsal ari
esar er el
atedtoan‘empl oyee,’thati s,individualwhowor ks
pri
mar i
lytooneor ganizationandwhoseact i
vi
ti
esareundert hedi rectsupervisionof
theempl oyer.
2.ThePayPer i
od:-Apayper i
odr ef
erstot helengthoft imecov eredbyeachpay rol
l
pay ment .

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 3. ThePayDay :i
ti st hedayonwhi chwagesorsal ar iesar epai dt oempl oyees.Thi si s
usuallyont hel astdayoft hepayper iod.Usual lyt hel astdayoft hemont hinEt hiopi a.
4. Apay rol lRegi ster( sheet ):ist hel istofempl oy eesofabusi nessal ongwi theach
empl oy ee’sgr ossear ning;deduct i
ons,andnetpay( takehomepay )f orapar ticul ar
payper i
od.Theni nputf orpay rollr egisteri st heempl oyeeswor khourdur ation
summar izedf r
om anyoft hef ol
lowi ngsour ces:
Attendancesheet s: i
swher eempl oy eessignatt het imeofar ri
val i
nt hewor kingar ea.
Itisusual lyplacedi nof ficesandadmi ni
strativear eas.
Punched( clock)car ds;i sanel ectronicallyr ecordedcar d,wher eeachempl oyeewi l
lhav e
his/herowncar df orr egi ster
ingbot hatt het imeent eri
ngandl eavingt hewor king
place.Thi smechani sm i scommonl yplacedatt hegat eofmanuf actur i
ngpl ant s.
Timecar ds:i smor eorl esssi milartopunchedcar dexceptt hatt het i
mei smanual ly
writt
eni nhandwr i
ttenf ormatbyt heempl oy ee.
5.Grossear nings: Total incomeear nedbyanempl oy eedur i
ngpayper iod.
6. Empl oy menti ncomet ax:ar etaxescol l
ectedf rom t heear ningsofempl oy eesbyt he
empl oy eror gani zationaspert her egul ati
onsoft hegov ernment .Thesehav et obe
submi tted( pai
d)t ot hegov ernment (
Taxaut hor i
t y)becauseempl oyeror gani zationi s
onlyact ingasanagentoft hegov ernmenti ncol lect ingt heset axesf rom empl oy ees.
7. PayrollDeduct ions:ar ededuct ionsf rom thegr ossear ningsofanempl oyeesuchas
empl oy menti ncome t axes ( withhol ding t axes) ,l aboruni on dues,f ines,cr edi t
associ ationpay set c.
8. NetPay :Netpayi st heear ningofanempl oyeesaf teral ldeduct i
onshav ebeenmade.
Thisist akehomepayamountcol lectedbyanempl oy eeont hepayday .

NetPay=Gr
ossEar
ning–Tot
alDeduct
ions

9. PayCheck:abusinesscanpaypay r
ollbywit
tingacheckfort
heamountofthenet
pay.Achecki spreparedinthenameofeachempl oyeeandhandedtoemployee.
Alt
ernat
ivel
yacheckf orthetot
alnetpayofallempl
oyeescanbeprepar
edsothatit
wil
lbepaidincashattheorgani
zati
onforeachemployee.

6.
1.2BasicComponentsofapay r
ollRegi
ster
1.Employ
eeNumber
Numberassigned to employeesf ori
denti
fi
cati
on purposewhen arelat
ivel
yl ar
ge
numberofemployeesareinvolvedi
napay r
ollr
egist
er.I
tisal
wayshel
pfultoassignan
o
i
dentif
icat
ion number(ID N )toindivi
dual
l
yident
if
yemploy
ees.Thisis because;
sometimes there coul
d be ident
icalname f
ort wo ormore empl
oyees in an
organi
zati
on.

2.Nameofempl oyees
Eventhoughitisadv
isabletoassignanemployeei
denti
fi
cati
onnumber
,itdoesnot
avoidtheneedf ori
ncludi
ngt hei
rnames.A complet
er ecor
dofemployeeshould
i
ncludebotht
henameandI dNo.oftheempl
oyee.

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3.Earnings
Moneyear nedbyanempl oy eef rom v arioussour ces.Thi smayi nclude:
a.Basi cSal ar y–Af l
atmont hlysal ar yofanempl oyeef orcar ryingoutt henor malwor k
ofanempl oy mentandsubj ectt ochangewi ththeposi t
ionoft heempl oyee.
b. Al l
owances-Moneypai dmont hlyt oanempl oyeef orspeci alreasons, li
ke:
- Posi t
ional lowance-amont hlypai damountt oanempl oy eef orassumi ngapar ti
cular
of fi
cer esponsi bili
ty.
- Housi ngAl lowance– a mont hl yal l
owancegi vent ocov erhousi ngcost soft he
indi vi
dualempl oy eewhent heempl oymentcont ractr equirest heempl oy ert opr ovi
de
housi ngbutt heempl oyerf ailstodoso.
- Har dshi pal l
owance-asum ofmoneygi vent oanempl oyeet ocompensat ef oran
inconv enientci rcumst ance caused by t he empl oyer.Fori nst
ance,unexpect ed
transf ert oadi f
ficultanddi stantwor kar ea.
- Deser tal l
owance-amont hlyal l
owancegi vent oanempl oyeebecauseofassi gnment
toar elativ elyhotr egi on.
- Tr anspor tat i
on( fuel)al lowance-amont hlyal l
owancet oanempl oy eet ocov ercost
oft ranspor tati
onupt ot hewor kpl acei ft heempl oyerhascommi tt
edi t
sel ftopr ovi
de
transpor tat i
onser vice.
c. Ov er ti
meEar ning:Ov ertimewor ki st hewor kper formedbyanempl oyeebey ondt he
regul arwor king hour s.Ov er ti
me ear ningsar et herefor et he amountpai dt o an
empl oy eef orov ertimewor kper f
or med.
Ar t
icle33ofpr oclamat ionNo:64/ 1975di scussedt hef ollowingabouthow ov ert
ime
wor kshoul dbepai d.
Awor kershal l beent itl
edt obepai datar ate:
i.
.oneandone- quarter(11/4,,1. 25)t i
meshi sor dinar yhour lyr atef orov er t
imewor k
per formedbef ore10: 00P. Mi ntheev eningt i
meor4o’ clocki nt heev ening(night)i n
Et hiopiat i
me.
ii
.oneandonehal f(11/2,or1. 5)t imeshi sor dinaryhour lyr atef orov er t
imewor k
per formedbet ween10: 00P. M andsi x6: 00A. Mi nt hemor ninginwest ernt imeor
from 4o’ clockt o12o’ clocki nthemor ningi nEt hiopiat i
me.
ii
i.Twot i
mest heor dinar yhour lyratef orov erti
mewor kper formedonweekl yr estday s.
iv. Twoandonehal f(21/2,or2. 5)t i
mest heor dinaryhour lyr atef orov ert
imewor k
perfor medonapubl i
chol iday.

Gr
ossEar
ning=Basi
cSal
ary+al
lowances+Ov
ert
imeEar
ning

4.Deductions:aresubt racti
onsmadef rom theear ningsofempl oyeesr equir
edbyt he
governmentorper mi tt
ed byt he empl oyee himsel f.The f ol
l
owi ng aret he most
commondeduct ionsf r
om empl oyee’
sear ni
ng:
a.Empl oymentI ncomeTax:Ev eryciti
zeni sr equiredt opayempl oyeet axtot he
governmentinal mostal lcountri
es.InEthiopiaal so,incomet axi schargedont he
grossearnings( i
.e,taxableincome)oft heempl oyeeatt her ateindicatedunder
scheduleAoft hecur rentPr
oclamation–I ncomet axpr oclamation.
b.Pensi oncont r
ibution:Allpermanentempl oyeeswor ki
ngi ngov er
nment,andnon-

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 gover
nmentor
gani
zat
ionsar
erequi
redt
opaypensi
oncont
ri
but
ion(cur
rent
ly7%of
basi
csal
ary
).

Thetaxr
atesunderschedul
eAar
ePresentedbel
ow
Tabl
e1.1:
Empl oy
mentIncomeTaxSchedule
EmploymentIncome Dif
ference I
ncome
(PerMonth) Taxr
ate
OverBi
rr ToBirr
0 600 600 Exempt (
free
fr
om Tax)
601 1650 1,
050 10%
1651 3200 1550 15%
3201 5250 2050 20%
5251 7800 2550 25%
7801 10900 3100 30%
0ver - - 35%
10900

*I
ncomput
ingandwi
thhol
dingt
ax,
thei
ncomet
axpr
ocl
amat
ioni
ndi
ctat
est
hat
i
ncomeat
tri
but
abl
etot
hemont
hofNehassi
eandPagumeshal
lbeaggr
egat
ed
(
added)andt
reat
edast
hei
ncomeofonemont
h.

Taxabl
ei ncome incl
udes anypaymentorgains i
n cash orin ki
nd r
eceived f
rom
employmentbyani ndi
vi
dual,i
ncl
udi
ngincomef
rom f
ormeremploymentorotherwi
seor
fr
om prospect
iveemployment.

Practicall
yalli ncome of i ndividualmay be t axabl e.Pr ocl
amation No.286/ 2002
designatesthef oll
owingcat egor yofi ncomeasnon-taxable:
1. Income f r
om empl oymentr eceived bycasualempl oyeeswho ar e notregularl
y
empl oyedpr ovidedt hatt heydonot wor kformor et hanonemont hforthesame
empl oyerinanyt welvemont hsper iod
2. Pensi oncont ri
bution,prov i
dentf undandallfor
msofr et
irementbenefit
scontri
buted
byempl oyersi n an amountt hatdoesn’ texceed 15% oft hemont hl
ysalaryoft he
empl oyee.
3. Pay mentsmadet o(anempl oy ee)asacompensat ionorgr at
itudeinrel
ati
onto:
 Per sonalinjuri
essuf feredbyt hatper
son
 Thedeat hofanot herper son

I
ll
ustr
ati
ononpayr
ollregi
ster
s
Enj
oycompanyhasf ouremploy
eeswhosesal
ari
esar
epai
daccor
dingt
otheEt
hiopi
an

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 Cal
endarmont
h.Thefol
l
owi
ngdat
arelat
estot
hemont
hofMesker
em,
2010.
Nameof Positi
on Over Durati
o
employ
e Basi all
owanc ti
me nofOT
e c e Worke work
sal
ar d(hr
)
y
Oly
ad 7530 - 4 6-10
pm
Beri
hun 6020 - 8 Sunday
Anas 5300 300 - -
Oda 3470 - - -

Addi
ti
onal
Informati
on
 Theempl oyeesusual
l
yareexpectedt
oworkfor40hoursperweek
 Allemployeesareper
manentexceptOda
 Berihunagreedt
ocontri
but
eBr300t ocr
edi
tassoci
ati
on

Requi red:
1-calculat ethegrossearnings,
deduct i
onsandnetpay
2-prepar et hepayrol
lregi
sterofEnjoyforthemonthofMesker em
3-Recor dt hepay mentofNetpay ,employmentincomet ax(wit
hhol
dingt
ax)
,pensi
on
contribut i
on.
Solution
Gr ossearnings=Basi csal ar
y+Al l
owance+Ov ert
imeear ni
ngs
A)-Ov ert i
meear ningsandGr ossear ni
ngs
Ov ertimeear ni
ngs=OThr swor kedXhour l
yrat
eXOTr ate
Hour lyrat e= Basi
csal ar
y
Total monthlyworki
nghours
1-Olyad.
OTear nings=4hour sX( 7530/160)X1. 25=Br235.3125

Tot
alGr
ossearni
ngsofOlyad=basi
csal
ary+OTear
nings
=7530+235.3125=7765.
3125

2-Beri
hun.
OTearni
ngs=8hour sX(6020/160)X2=602
Totalgr
ossear
ningsofBeri
hun=6020+602=6622
3-
Anas.,hasnotworkedov er
ti
mewor k.Hi
sgrossearni
ngsisbasi
csal
arypl
ushisposi
ti
on
all
owance=5300+300=5600
4-Odahasnotwor kedov er
ti
mework.Gr ossear
ningsar
ehisbasi
csal
aryonl
y.Thati
sBr
3470

B)
-Deduct
ionsandnetpay

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 1-Ol y
ad: taxablei ncome=7765. 3125
I
)I ncomet ax:
Ear nings taxr ate Incomet ax
0-600 0 =Br0
601- 1650on105010% =105
1651- 3200on155015% =232.5
3201- 5250on2050 20% =410
5251-7765. 3125on2515. 3125 25% =628.
83
Tot alincomet ax……………………………. ……. .Br1376. 33
I
I)Pensi oncont ri
but i
on
Basicsal ar yX7%=Br7530X0. 07=527. 1
Tot aldeduct ions( Br1376. 33+527. 1)=Br1903.43
II
I)Netpay=Gr ossear ni
ngs–deduct ions
7765. 3125–1903. 43=5861. 8825
2-Ber ihun:Taxabl eIncome:6622
I
)I ncomet ax
Ear nings taxr ate I
ncomet ax
0-600 - Br0
601- 1650on1050 10% 105
1651-3200on155015% 232.
5
3201-5250on2050 20%410
5251- 6622on1371 25% 342.
75
Tot al i
ncomet ax…………………… Br1090. 25
I
I)Pensi oncont ri
but i
on
Basi csal aryX7%=6020X0. 07=421.4
I
II)Pay mentt ocr edi tassoci ati
on=Br300
Tot aldeduct ions=1090. 25+421. 40+300=1811. 65
I
V)Netpay=Gr ossear nings–deduct ions
6622–1811. 65=4810. 35

3-Anas:Taxabl
eincome=5600
I
)Incometax
Earni
ngs Taxrat
e I
ncometax
0-600- Br0
601-1650on1050 10% 105
1651-3200on1550 15% 232.50
3201-5250on2050 20% 410
5251-5600on350 25% 87.
5
Totali
ncometax…………………. ……Br835

I
I) Pensi
oncontri
bution:
Basi csal
aryX7%=5300X0.07=371
Totaldeducti
ons=835+371=1206
I
II
)Netpay=Gr ossear ni
ngs--deduct
ions

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2020/ ge100
 =5600-1206=4394
4-
Oda:gr
ossearni
ngs=3470

I)I
ncomet ax-
Earni
ngs taxrat
e Incometax
0-600 - Br0
601-1650on1050 10% 105
1651-3200on155015% 232.
50
3201-3470on270 20% 54
Totali
ncometax………………………. .
..
Br391.5
I
I)Netpay=Basi csalar
y-I
ncometax
= 3470-391.50=3078. 5

Pay
rol
lRegi
sterofEnj
oy
Enj
oycompany
Payrol
lRegi
stersheet
Fort
hemont hofmeskerem

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Name of Basic Al
lowan Overt
ime Gross I ncome Pensi
on Other Total Netpay Si
g
empl
oyee sal
ary ce Earni
ngs Tax deduct
ion deducti
on
Ol
yad 7530 - 235.
31 7765.31 1376.
33 527.
1 - 1903.43 5861.
8825
25
Ber
ih 6020 - 602 6622 1090.
2 421.
4 300 1811.
65 4810.
35
un 5
Anas 5300 300 - 5600 835 371 - 1206 4394
Oda 3470 - 3470 391.
50 - - 391.
50 3078.5
Tot
al 22,
320 300 837.
31 23457.3 3693.
08 1319.
50 300 5312.
58 18144.
7325
125

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Pr
ov i
ngt hepay roll
Theaccur acyoft hepayr
ollcalculati
oncanbecheckedusi
ngt
heappr
opr
iat
ejour
nalent
ryas
fol
lows
Totalearnings:
Basicsalary…………………………. .
…22, 320
All
owances……………………………. .
.300
Overti
me………………………. …………. 837.3125
Grandt ot
al………………………………23, 457. 3125
Deduct i
ons:
Employ mentincomet ax……………. .3,693.08
Pensioncont ribut i
on…………………. 1,319. 50
Otherdeduct ions………………………300. 00
Totaldeduct ions……………………5, 312.58
Netpayt otal………………………. ...
18,144. 7325
Totaldeductionspl usnetpay……………23, 457.
3125

 Journalentrytorecor dPayroll
Salar
yexpense……………. 23,457.3125
salar
ypayable…………………………18, 144.7325
Pensionpayable…………………. …….1,319.50
Taxpayable…………………………. .
….3,693.
08
Credi
tass.payable………………………300
 Journalentrytorecor dPayrollexpensepayment
:
salar
ypayable…………. 18,144.7325
Pensi
onpayabl e…………1, 319.50
Credi
tass.payable……….300
Taxpayable………………. .
3,693.08
cash…………………………………23, 457.3125
6.2:Curr
entl i
abil
it
iesandcont i
ngentliabi
li
ti
es
Thissectionintroducesy ouwi thcurrentandcont i
ngentli
abi
l
iti
es.Li
abil
i
tiest
hataret
obe
paidoutofcur r
entassetsandar eduewi thi
nashor tti
meusuallywit
hinoneyearar
ecall
ed
currentl
i
abi l
i
ties.
6.2.1Natureofcur rentl
iabil
it
ies
Mostcur r
entliabil
it
iesari
sef r
om twobasi ctransact
ions:
 Receiv i
nggoodsorser vi
cespr i
ortomaki ngpayment
 Receiv i
ngpay mentpr i
ortodeliver
inggoodsorser vi
ces.

Anexampl eoft hefi

rsttypeoft ransactioni saccount
spayabl
e.Accountspay ablearises
fr
om purchaseofmer chandiseforonaccount .Anexampleofthesecondtypeofl i
abil
ityis
unearnedrentari
si
ngfrom thereceiptofrentinadvance.
Someaddi ti
onalexamplesofcur rentliabil
i
tiesarewagespayable,sal
arypayable,int
erest
payableandtaxespayabl
e.

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Thecur rentl iabi l
itysect i
onoft hebal ancesheetcancont ai
ni temst hatar eusedt of i
nance
busi nessoper ations, suchasshor t
-term not espay ableandt hepor ti
onofl ong-ter m debtt hat
i
sduewi thi nt hecur r
entper iod.
Not esPay abl e:Not esmaybei ssuedwhent hemer chandi seorot herasset sar epur chased.
Theymaybeal soi ssuedt ocr edi torst ot empor arilysat isfyanaccountpay ablecr eatedear li
er.
Forexampl e, assumet hatabusi nessi ssuesa- 90- day ,12%not eforBr1000, datedAugust ,1,
2016t oBr ot her scompanyf ora1000ov erdueaccount .Theent r ytor ecordt hei ssuanceof
thenot ei s:
Account spay able. ..
..
...
..
1000
Not espay abl e. .
....
..
...
...
....
.1000
(Issueda90- day ,12%not eonaccount )
Whent henot emat ures,t heent ryt or ecor dt hepay mentofBr1000pr i
ncipalandBr30
i
nt erest( 1000X12%X90/ 360)i sasf ol l
ows:
Not espay abl e..
...
..
.....
..
...
...
1000
Interestexpense. ..
.....
..
..
...
...30
Cash- ----
--
----
-----
---
---
---
--1030
(
Pai dpr i
nci pal andi nterestdueonnot e)
6.2.2:Cur rentpor ti
onofl ong- terml iability
Long- ter ml i
abi liti
esar eof tenpai dbacki nper i
odi cpay ment s, cal
ledi nstallment s.Long- t
erm
l
iabi li
tyinst allment st hatar eduewi thint hecomi ngy earmustbecl assifiedascur rentliabil
it
y.
Thet ot alamountoft hei nst all
mentdueaf t
ert hecomi ngy eari scl assifi
edasl ongt erm
l
iabi li
ty.
Exampl e:ADAMA t ext i
leon Januar y1 pur chased Cot ton f r
om Humer acompanyf orBr
6,000, 000, pay mentt obemadei nt hreeequalannualpay ment sfr om Januar y2016.Assume
adebtofBr .2,000, 000wi llduei nthey ear2016.So,t hedebtofBr2, 000, 000t hatwi llduei n
thecur r enty earwi l
lber epor t
edascur r
entl iabi l
it
yandt her emai ningBr4, 000,000wi l
l
cont inueasl ong- t
erml iabil
ityint hebal ancesheet .
6.2.3:Cont i
ngentl i
abi li
ties
Somepastt ransact i
onswi llresul tinl iabili
t i
esi fcer tainev entsoccuri nt hef ut ur
e.These
pot ential obl igat ionsar ecal ledCont ingentl iabili
ties.
Ifacont i
ngentl iabilit
yi spr obabl eandt heamountoft hel i
abil
itycanber easonabl yestimated,
i
tshoul dber ecor dedi nt heaccount s.
Ifiti shar dt or easonabl yest imat et heamountoft hecont ingentl i
abilit
y,suchcont i
ngent s
shoul dbedi scl osedi nnot est ot hef inanci alstatement s.Thati ssuchcont i
ngent scannotbe
repor tedi nt hebodyoft hef inanci alst atement sascur rentorl ong- terml i
abili
ti
es.

AU/
Wol
i
soFBE/DeptACFN/
Pri
nci
plesofAccount
ing/2010- 18Pa
2017/ ge104
AU/
Wol
i
soFBE/DeptACFN/
Pri
nci
plesofAccount
ing/2010- 18Pa
2017/ ge105