zTopic 1

What do large companies and small businesses have in common that characterise them as
businesses? A business is an organisation that processes basic resources (inputs) to provide goods
or services to customers (output) in exchange for cash. The general objective of this vehicle will be
to maximise profits (def: difference between the amount received from customers for goods
provided and the amount paid for the input used to provide the goods). However, non-business
organisations (or non-profit organisations) do exist and they play an important role in our society.

Types of businesses
Three types of business that operates for profit: manufacturing, trading and service businesses.
Manufacturing: Process raw materials using labour and machinery into products that are sold to
customers.
Trading: What differentiates trading from manufacturing is that trading businesses purchase the
final products from other businesses. They are sometimes required to help bring goods and
customers together.
Service: They provide services rather than products to customers.

Forms of businesses

Stakeholders
Although businesses are independent entities, they are still accountable to other parties. These
parties who have an interest in the performance of the business are known as stakeholders. They
can either be internal stakeholders or external. Owners, managers, employees, customers, creditors
and the government are primary stakeholders for most companies. Maybe you could give an
example of why certain parties are interested in the performance of the business: E.g. govt for tax
purposes.

Role of Accounting
The role of accounting is to provide financial information for stakeholders in their decision-making
processes. Therefore, many will regard accounting as the language of business. To help with the
day-to-day operations of a company, accountants produce more detailed and timely financial
information for internal stakeholders. To communicate with external stakeholders (ie, parties who
are not involved in the operation of the company), accountants produce more summarised financial
information.

Stakeholders make use of various techniques, including ratio analysis (will be covered in later
lessons) to evaluate a company’s past performance and to predict future success of business
organisations. By investigating the financial condition of a business, investors can understand if the
company has the financial backup to support it through difficult times and if it is has a competitive
advantage over other firms in the industry. In short, it helps the stakeholders to understand the
strength and weaknesses of businesses.

How do we then communicate this information to stakeholders?

When business transactions occur, source documents are produced. These source documents are
used to substantiate a transaction entered in the books of original entry.

For example, a company's source document for the recording of merchandise purchased is the
supplier's invoice supported by the company's purchase order and receiving ticket.
Books of original entry are accounting journals on which business transactions are initially recorded.
An accountant will record the journals daily. At the end each financial period, this information is
summarised and posted to the general ledger. The final account balance of the general ledger will
be extracted, together with the account name, at the end of the financial year to be included in the
trial balance. Balance day adjustments are then performed to correct any mistakes. Finally, the
statements of accounts are produced.

The difference between accounting and bookkeeping

Accounting is the entire process of recording, summarising, reporting, analysing and interpretation
of financial information of an organisation. The recording process is commonly known as
bookkeeping. Therefore, it is only a part of the accounting process.

The importance of Accounting Principles

If businesses recorded and reported financial data as they saw fit, comparing financial statements
from different companies and even over the years of a particular company will be a difficult task.
There will also be leeway for the distortion of numbers without accounting principles. Therefore,
accounting will follow principles developed over the years to guide them in recording and reporting
financial information.

Accounting Principles

Accounting Entity
The business has economic assets and resources that must be accounted separately from the
personal dealings of its owners.

Linda Lee is the owner of POP Delivery Service. Linda paid her tuition fees of $3,500 for a business
degree course she is doing. Should Linda POP Delivery Service record the payment? Explain.

NB: If the owner provides resources for the business or withdraws resources for his personal use,
these are transactions that affect the resources of a company. Therefore, they are recorded
accordingly.

Accounting Period
An accounting period is the span of time covered by a set of financial statements. They should be
prepared at regular intervals.

Consistency
Once an accounting principle is adopted, the business has to follow it consistently in the future
accounting periods.

Going Concern
The business is assumed to continue to operate indefinitely. It implies that the business has the
intention to keep running it activities at least for the coming year. The company also does not face
threat of liquidation for the foreeseeable future.

Historical Cost
The value of the asset on the balance sheet is based on the original cost when acquired by the
company.
On 01 Dec 20x1, Linda Lee made an offer of $95,000 to buy an equipment that has been priced for
sale at $100,000. On 15 Dec 20x1, Linda Lee accepted the seller’s counteroffer of $97,500. Describe
how Linda should record the equipment.

POP Delivery Service bought a land for $350,000. Seven years later, this plot of land has risen in
value to $450,000. The business receives an offer of $400,000 for it. Should the value of the land in
the buiness records now be increased?

Matching
Expenses incurred must be matched against revenue earned in the same period, regardless of when
the transfer of cash takes place. This is what differentiates accrual accounting from cash basis
accounting.
Accrual Cash Basis
Timing of (when) revenue Accounts for revenue only Accounts for revenue when
and expenses are when it is earned and money is received and for
recognised expenses good when they expenses when the money
are incurred. The revenue is paid out.
is recorded even if cash has
not been received (ie,
credit sales) or if expenses
have been incurred but no
cash has been paid
(accrued expenses).
Materiality
The item is only significant if it can influence the economic decision of users using the financial
statements.

Monetary
Only transactions, which can be measured in monetary terms, are recorded.

Objectivity
Accounting information and financial reporting should be independent and supported by verifiable
evidence. If estimates are involved (for example, in establishing the market value of the inventory),
two independent accountants agreeing on a particular estimate wil ensure that the value is more
objective.

Prudence
Only recognise revenues and assets when they are assured of being received.

Realisation
Revenue can only be recognised once the underlying goods or services associated with the revenue
have been delivered or rendered (the act of being earned).

End
Topic 2

What happens when a business transaction takes place?

The accounting cycle starts with the business transactions taking place. We shall examine what is a
business transaction to understand when we need to perform accounting. A business transaction is
an activity carried out by a party to provide goods and services in exchange for money. Examples of
such transactions are like sales of goods to customers, bought inventory from suppliers and pay
wages to employees. It affects the business’s financial condition. Therefore, it will directly impact
the company’s assets, liabilities or owner’s equity.

How do you measure this impact then?

All business transactions can be shown in terms of changes in the elements of the accounting
equation-A=L+OE. The resources owned by a business are its assets. Examples of assets include
cash, machinery and inventory. The rights to these assets are divided among (1) the rights of
creditors and (2) the rights of owners. The rights of creditors represent debts, known as liabilities.
The rights of the owners are known as owner’s equity. In effect, what a business owns is what a
business owes.

NB: The accounting equation also demonstrates the accounting entity concept as it treats the owner
of the business as a separate entity, just like the creditors.

When a transaction occurs, at least two items in the accounting equation will change. The equation
will always be maintained after each transaction.

In-Class Discussion Question (Pg 25; Exercise 1-6)

Describe how the following business transactions affect the three elements of the acounting
equation.
a) Invested cash in business
b) Received cash for services performed.
c) Purchased supplies by cash.
d) Paid for electricity bills used in the business.
e) Purchased supplies on credit.
NB: Both items may involve the same type of accounts.

Now, let us break the accounting equation up.

On the left side of the equation, we have assets. They represent resources owned by the business.

Fixed assets are resources that will used in the production of revenue over more than one
accounting year. They cannot be bought for the sole purpose of resale as if so, they will be inventory
and classified under current assets.

Current assets are liquid assets, assets which can be easily converted into cash.

Long-term liabilities are obligations of the company that become due in more than one accounting
year. Generally, they are obtained to finance a specific area in the operation of the company.

Current liabilities are obligation due within one accounting year.

The more complicated area of the accounting equation lies in the owners’ equity. As mentioned
above, the owners are treated as separate entity. Therefore, if they have withdrawn assets from the
business for personal use, from the business’s perspective, the company has repaid the owners and
therefore, the company now owes less to the owners.

Vice versa, if the owners inject more capital into the company in the form of any assets, the owner’s
equity will increase (Recall Lesson 1).

Creditors lend money to the business to seek interest income. Similarly, business owners invest for
returns from the company. This return comes in the form of net profits that increase the owner’s
equity. Owners will also bear the risk of the investment during years when the company makes net
loss. This will decrease the owner’s equity.

Equity can be shown in two formulas, depending on the form of which the business takes.

If the business is established as a simple sole proprietorship (Recall, sole proprietorship means that
it is owned and run by only one person), the equation will be equity = Capital+Profit-Drawings
If the business is run as a company, then equity = Share Capital + Profit – Dividends (you can’t draw
as and when you want from a company as they are other shareholders!).

Before we start practicising some equations, let us first further expand the profit equation. Profit is
equals to income (including revenue, other income and gains) minus expenses (COGS, salaries,
rental,etc).

In-Class Discussion Question (Pg 25, 1-8)

Indicate whether each of the following types of transaction will increase or decrease owner’s equity.
Owner investments
Revenues
Expenses
Owner’s withdrawals

Now, let us go through a few examples to illustrate the effects of business transactions on the
accounting equation.

In-Class Discussion Question

Transaction I
Leonard Lee has decided to set up a business called ABC Electronics. He deposited $25,000 into
ABC’s bank account. The effect of this is business transaction is to increase the asset cash by
$25,000. To balance the equity, the owner’s equity is increased by the same amount. One can
inteprete this as the business now owes the owner, Leonard Lee, $25,000. This equity is referred to
as “Capital”. The effect of this transaction on ABC is shown as:

Assets= Owner’s Equity

Cash= Capital (Leonard Lee)
25,000 25,000

NB: Note that under business entity concept, Leonard Lee’s personal assets (eg: his cash in his
personal cash account, his house,etc) are excluded from the equation

Transaction II
To run his business, Leonard Lee purchased a land for $20,000 in cash. The purchase of the land
does not change the total assets. Instead, it changes the different categories of assets.
Assets= Owner’s Equity
Cash+Land= Capital (Leonard Lee)
Balance: 5,000+20,000= 25,000

Transaction III

Chances are, you have probably borrowed money when you did not have enough for lunch. You
exchange cash with a promise to pay your friend in the future. Essentially, you received an asset and
incurred a liability to pay an amount in future.

ABC Electronics is running low in cash after buying the land. Therefore, it buys supplies for $1,400
for agreeing to pay the supplier in the near future. This creates a liability called an account payable.
The supplier is also ABC’s creditor. The supplies will be used in the business in the future. Hence, it
fits into the definition of assets.

Assets= Liabilities + Owner’s Equity

Cash + Supplies + Land Accounts Payabe + Capital (Leonard Lee)
Balance: 5,000 + 14,000 + 20,000 1400 + 25,000

Transaction IV
During the ABC’s first week of operation, ABS has provided services to customers. This sums up to a
total of $7,500 in cash. The receipt of cash increases ABC’s assets and also increases Leonard’s
equity in the business.

Assets Liabilities + Owner’s Equity

Cash + Supplies + Land = Account Payable + Capital (Leonard Lee)
Balance: 2,500 + 1,400 + 20,000 1,400 + 32,500

Over the course of your study, you will come across many terms to describe revenue. Eg: sales (for
goods), fees earned (providing services), rent revenue (from rent) and interest revenue (from
money).

Transaction V

ABC electronics have spent cash or used up assets in earning its revenue. ABC Electronics have paid
all these expenses during the week: salaries $1,125, rent $800, utilities $450 and miscellaneous
$275. The effect of expenses is the opposite of the effect of revenues. Expenses reduce owner’s
equity. These transactions reduce cash and owner’s equity.

Assets= Liabilities + Owner’s Equity

Cash + Supplies + Land Accounts Payable + Capital (Leonard Lee)
8,850 + 1,400 + 20,000 1,400 + 28,850

Transaction VI

When ABC Electronics repays $900 of its account payable, we need to decrease ABC’s cash and the
amount ABC owed to its suppliers
Assets= Liabilities + Owner’s Equity
Cash + Supplies + Land Account Payable + Capital (Leonard Lee)
Balance: 7,900 + 1,400 + 20,000 450 + 28,850

Paying up liability is different from paying for an expense. The payment for an expense reduces
owner’s equity, Paying up liability reduces the amount owed.

Transaction VII

At the end of the week, the supplies on hand (not yet usued) is $550. The remained of the supplies
($1,400 - $550) was used in the operation of the business. This amount is treated as an expense.

Assets = Liabilities + Owner’s Equity

Cash + Supplies + Land Accounts Payable + Capital (Leonard Lee)
7,900+ 550 + 20,000 450 + 28,000

Note that the supplies that are not utilised at the end of the week is capitalised (remains as assets).
Only when it is utilised in generating revenue, it is then expensed off. The difference between
expenses and assets is that assets are costs that produce a benefit that will last substantially longer
than the end of the fiancial year.

Transaction VIII

At the end of the month, Leonard Lee withdraws $2,000 in cash from the business for person use.
This transaction is the exact opposite of an investment in the business by the owner. Cash and
owner’s equity are decreased. The cash payment is not a business expense. It is a withdrawal of
owner’s equity. This is can be viewed as the owner takes out from the amount that the business
owes to him.

Assets = Liabilities + Owner’s Equity

Cash + Supplies + Land Accounts Payable + Capital (Leonard Lee)
5,900 + 550 +20,000 450 + 26,000

Note that withdrawals do not represent assets or services used by the busienss to earn revenues.
That is why it is not an expense.

Summary for this lesson

 The effect of every transaction is an increase/decrease in one or more of the accounting

equation elements.
 The two sides of the accounting equation are always equal.
 The owner’s equity is increased by amounts invested by the owner and is decreased by
withdrawal by the owner. In addition, the owner’s equity is increased by revenue and is
decreased by expenses.
NB: Consider talking about Worldcom.
Topic 3

Previously, we have discussed how transactions were summarised in the accounting equation
format. This format is too simplified to ensure that the information is useful for analysing effects of
the transactions on the business and for making decisions. We need to further breakdown the
accounts but nevertheless following the principles given from the equation.

For instance, there is a cash account on the balance sheet. A separate account record is kept for the
changes in this account. This applies to all other accounts like suppliers, land, expenses, etc.

Characteristic of an Account (T-account)

1. Title, name of the account
2. The amount entered on the left side of the T-account is called a debit while amount entered
on the right side of the T-account is called a credit
3. For example, cash receipts are listed on the debit side while cash payments are listed on the
credit side. At the end of a period, the cash on hand is calculated and the amount will
represent the balance of the account.

Title
Left Side represents Debit Right Side represents Credit

There is an alternative way of presenting a ledger. Normally, we use the columnar format (in
practice, this is more common as businesses are using computers to do their accounts).

What is special (or confusing) is that different accounts have different natures. While an increase in
cash, like all assets and expenses, results in an increase in debit balance, an increase in other
accounts like revenue, liabilities and capital result in credit balance. To remember the rules of the
various accounts, you can remember the phrase After Eating Dinner (to increase them, debit them),
Let’s Read Comics (to increase them credit).

Increase (Normal Balance) Decrease

Balance Sheet Accounts
Asset Debit Credit
Liability Credit Debit
Owner’s Equity:
Capital Credit Debit
Drawing Debit Credit
Profit and Loss Statement
Accounts
Revenue Credit Debit
Expenses Debit Credit

Let us look at why this is done. We have the accounting equation assets= owners’ equity + liabilties.
An increase in the value of assets is a debit to the account. Every business transaction affects at
least two accounts. It can either be due to reasons like injection of capital (credit) or increase in
debt (credit). Therefore, your net debits will always equals to your net credits.

Let us go through a few examples to understand how double entry works.

For each example, we need to identify the accounts, the effects and ascertain if the accounts are to
be debited or credited.

In-Class Discussion Questions

Transactions for Capital and Drawings

a) On 1 Jan 20x1, Ken bought in a $50,000 motor van for business use.
The two accounts affected would be Cash account (business’s cash increases) and Capital account
(since Ken now has a right to the company’s assets).
Step 1 Step 2 Step 3
Accounts Involved Effects Account to be debited Account to be credited
Motor vehicles (Asset) Increas Cash
e
Capital (OE) Increas Capital
e

Motor Vehicles
$ $
1 Jan 20x1 Capital 50,000

Capital
$ $
1 Jan 20x1 Motor Vehicles 50,000
NB: Take note that corresponding acount name is shown in each account.

b) On 2 Jan 20x1, Ken withdrew $500 cash for personal use.

Step 1 Step 2 Step 3
Accounts Involved Effects Account to be debited Account to be credited
Cash (Asset) Decrease Cash
Drawings (Contra- Increase Drawings
OE)

Drawings
$ $
2 Jan 20x1 Capital 50,000

Capital
$ $
2 Jan 20x1 Motor Vehicles 50,000

c) On 3 Jan 20x1, Ken took $1,000 of inventory for private use.

Step 1 Step 2 Step 3
Accounts Involved Effects Account to be debited Account to be credited
Purchases (Expenses) Decrease Purchases
Drawings (Contra- Increase Drawings
OE)

Drawings
$ $
 3 Jan 20x1 Purchases 1,000

Purchases
$ $
3 Jan 20x1 Drawings 1,000

NB: When goods are bought, they are first recorded as debit in the purchase account. Therefore, for
drawings of these goods, pruchases account is credited.

Transactions for Purchases and Purchases Returns Transactions

The stock account is further broken down to record the buying (purchase account), returns of
purchases (purchases return account), selling (sales account), and returning of goods (sales return
accounts). The stock account on its own is used to record unsold goods (inventory) at the start and
end of the accounting period.

Sales Account Purchases Account Sales Returns Purchase Returns

Account Account
Revenue account. Expense account. Negative Negative expense
This account does Similar to sales, revenue account.
not apply for selling buying of goods account. AKA Returns
of fixed assets excludes buying of AKA returns outwards account.
(Recall that fixed assets. inwards account.
stocks/inventory are For drawings of
short term assets, goods for personal
different from fixed use, purchases
assets). account is credited
to show reduction in
goods purchases.

a) On 1 Jan 20x1, Ken’s company purchased $500 worth of goods by cheque.

Step 1 Step 2 Step 3
Accounts Involved Effects Account to be debited Account to be credited
Purchases (Expenses) Increase Purchases
Bank (Asset) Decreas Capital
e

Purchases
$ $
1 Jan 20x1 Bank 50,000

Bank
$ $
1 Jan 20x1 Purchases 50,000

b) On 10 Jan 20x1, Ken’s company purchased goods worth $400 on credit from XYZ Co.
Step 1 Step 2 Step 3
Accounts Involved Effects Account to be debited Account to be credited
Purchases Increase Purchases
(Expenses)
XYZ Co (Liabilities) Increase XYZ Co. (Creditors)

Purchases
$ $
10 Jan 20x1 Creditor 400

XYZ Co.
$ $
1 Jan 20x1 Purchases 400

c) On 15 Jan 20x1, Ken’s Company returned $200 damaged goods to XYZ Co.

It is important to note in this question, the company has not paid for the goods. Therefore, after
returning the goods, the creditors account decreases.

Step 1 Step 2 Step 3

Accounts Effects Account to be debited Account to be credited
Involved
Purchase Return Increase Purchase Returns
(Contra-Expense)
XYZ Co (Liabilities) Decrease XYZ Co.(Creditors)

XYZ Co.
$ $
15 Jan 20x1 Purchase 200
Returns

Purchase Returns
$ $
15 Jan 20x1 Creditors 200

d) On 20 Jan 20x1, Ken’s Company returned $100 of goods bought in 1 Jan 20x1.

In this case, the company will receive a cash refund, instead of a decrease on creditors.

Step 1 Step 2 Step 3

Accounts Involved Effects Account to be debited Account to be credited
Purchase Return Increase Purchase Returns
(Contra-Assets)
Cash (Assets) Increase Cash

Cash
$ $
15 Jan 20x1 Purchase 100
Returns

Purchase Returns
$ $
 15 Jan 20x1 Cash 100

Transactions for Sales and Sales Returns Transactions

a) On 5 Jan 20x1, Ken managed to sell some of its inventory to Jimmy at $500. Ken gave a
trade discount of $100 to encourage Jimmy to buy in bulk.
Step 1 Step 2 Step 3
Accounts Involved Effects Account to be debited Account to be credited
Sales (OE) Increase Sales
Cash (Assets) Increase Cash

Cash
$ $
5 Jan 20x1 Sales 500

Sales
$ $
5 Jan 20x1 Cash 500
NB: Trade discount is an incentive given to encourage buying in bulk. It is not recorded in the books.

b) On 10 Jan 20x1, Ken sold goods on credit to ABC Co. for $400.
Step 1 Step 2 Step 3
Accounts Involved Effects Account to be debited Account to be credited
ABC Co. (Assets) Increase ABC Co. (Debtors)
Sales (O) Increase Sales

ABC Co.
$ $
10 Jan 20x1 Sales 400

Sales
$ $
10 Jan 20x1 ABC Co. 400

c) ABC.Co returned some goods worth $150 on 15 Jan 20x1. The goods have not been paid for.
Step 1 Step 2 Step 3
Accounts Involved Effects Account to be debited Account to be credited
Sales Returns (OE) Increase Sales Returns
ABC Co. (Assets) Decrease ABC Co.

Sales Returns
$ $
15 Jan 20x1 ABC Co. 150

ABC Co.
$ $
10 Jan 20x1 . Sales Returns 150

d) If ABC Co. had paid up before 15 Jan 20x1, Ken’s company would have given cash refund of
$150.
 Step 1 Step 2 Step 3
Accounts Involved Effects Account to be debited Account to be credited
Sales Returns Increase Sales Returns
Cash Decrease Cash

Sales Returns
$ $
15 Jan 20x1 Cash 150

Cash.
$ $
10 Jan 20x1 Sales Returns 150

Transactions for other major transactions

a) At the end of the January, Ken paid $1500 to John, the company’s clerk.
Accounts Involved Effects Account to be debited Account to be credited
Salaries (OE) Increase Salaries
Bank (Asset) Decrease Bank

Salaries
$ $
31 Jan 20x1 Cash 1500

Bank
$ $
31 Jan 20x1 Cash 1500

b) Ken received a bank loan of $20,000 for the company on 31 Jan 20x1.
Accounts Involved Effects Account to be debited Account to be credited
Bank (Asset) Increase Bank
Bank Loan (Liabilities) Increase Bank Loan

Bank
$ $
31 Jan 20x1 Bank Loan 20,000

Bank Loan
$ $
31 Jan 20x1 Bank 20,000

c) Ken’s company received $4000 from renting out its office for the month Jan.
Accounts Involved Effects Account to be debited Account to be credited
Bank (Asset) Increase Bank
Rent Revenue (OE) Increase Rent Revenue

Bank
$ $
31 Jan 20x1 Rent Revenue 4000
 Rent Revenue
$ $
31 Jan 20x1 Bank 4000
Topic 4
The Role of Source Documents

Recall the whole accounting process. Transactions will result in source documents, which are then
used to support the accounting record. This relates to the objectivity principle. We also need the
details found in the documents to make the correct entries in the accounting journal. Lastly, it
allows for the checking of accounts by a third party.

Activities Document Function

Purchasing Invoice A document sent by the supplier to inform the
business of the amount payable for the goods
supplied.
Credit Note A document sent by the supplier to inform the
business of the reduction in AP due to either
overcharging or returning of goods.
Debit Note A document sent by a seller to the buyer to correct
undercharging in the previous invoice.
Payment A document that records the payment of money to
Voucher parties like suppliers, employee and other expenses.
Cheque The leftover portion in a cheque books that records
Counterfoil the details of a payment.
Sales Receipt A document issued by the business to acknowledge
payment received from customers.
All activities Bank A monthly document sent by the bank to the
involving cash. Statement business that shows the company’s transactions and
balances.
Incurring Petty Cash Record petty (small amount) cash expenses.
expenses Voucher
Drawings/ Office Memo Record the company’s internal transactions.
Contributions

These documents will serve to support the record in books of orginal entry (AKA: day books and
prime entry). There are three categories under the books of original entry.

1. Special Journals: All credit transactions relating to debtors and creditors. They are namely
the sales journal, sales returns journal, purchases journal and purchases returns journal.
2. For transactions that do not involve credit, the accountant will then record it in the cash
book (AKA petty cash book).
3. Lastly, there are credit transactions that do not concern sales or purchases. These are
recorded in the general journal.

The need to create special journals just for credit transactions

1. These transactions make up a large proportion of all transcations. There are similar in
nature and therefore special journals can help to reduce work of multiple entries. Eg: all
credit sales are recorded in a sales journal.
2. It reduces unncessary details in the ledger as only the aggregated amounts are posted to
the ledger.

Illustrations of the mechanism of special journals

Debit Entry Credit Entry
Sales Journal Dr Debtors’ personal account Cr Sales account
(individual entries posted) (total amount posted)
Sales Return Dr Sales Returns account Cr Debtor’s personal account
Journal (total amount posted) (individual entries posted)
Purchases Journal Dr Purchases account (total Cr Creditor’s personal accounts
amount posted) (individual entries posted)
Purchases Return Dr Creditor’s personal Cr Purchases Return account
Journal accounts (individual entries (total amount posted)
posted)

Uses of General Journal

The purpose of general journal is to record
 Opening entries (brought down from last accounting year)
 Closing entries (not required for GCE O level)
 Purchases and sale of fixed assets on credit (since they are not part of sales and purchases)
 Depreciation, bad debt, accurals and prepayments (we will learn all these adjustments later
on)
 Correction of errors
 Other credit transactions not part of special journals (drawings of goods are not cash
transactions and not part of sales)

Go through one question to show how the double entries are posted from general journal to ledger
accounts.

NB: Strictly speaking, the general journals are only used for the above reasons. In some questions,
the use of a general journal is to record double entries of all transations.

At this stage, the entries are yet to be posted. Therefore, to reflect the current financial position of
the company, these entries are posted into three different ledger books. They are:
1. Purchases/creditors ledger
2. Sales/debtors ledger
3. General ledger

NB: The first two ledgers are also known as subsidiary ledgers. They show the amount borrowed or
lend to each individual creditor or debtor so that
1. Helps in referencing
2. Reduce excessive details in the general ledger

Subsidiary ledger is then represented in the general ledger by a summarising acocunt known as a
control account (taught in later lessons).

Details of the flow can be found in Chapter 6 of Accounting: An Asian Edition Pg 228.
Topic 5
Cash Book & Petty Cash Book

Recall in previous topic, 3 major books of prime entry. Cash book functions as one of it. It is also a
ledger for cash and bank accounts. The debit and credit columns for cash book (both cash at bank
and cash at hand) are the ledger accounts itself.

Cash Book records all transactions (receipts and payments) involving cash and cheques. It can either
be a two-column or a three-column format. Syllabus prescribes using the three-column approach. It
includes includes the discounts allowed and discounts received columns.

It is important to differentiate cash discount and trade discount as trade discount is directly
deducted from the list price (as discussed in previous topic). Therefore, they are never part of the
double entry records and will not affect the company’s profit. The nature of a trade discount is one
that encourages bulk buying. On the other hand, cash discount is used to encourage early
repayment.

The Cash and Bank accounts are balanced off at the end of the accounting period (showing the
balance c/d). The discount allowed is summed up and subsequently the amount is debited to
Discount allowed account and credited debtor’s account. This is because it is as if the company is
incurring an expense in order to receive the payment early or on time. Vice versa, the discount
received is sum up and subsequently the amount is credited to Discount received account and
debited Creditor’s account.

Let us now go through one question to understand the whole flow when an account needs to record
several cash transactions.

NB: It is possible to have a credit balance for the Bank column. This is due to overdraft. This makes
it a short-term liability.

NB: Introduce the concept of dishonoured cheques. It can be due to

1. The drawer has insufficient funds.
2. The cheque contains errors. Eg: missing signature or wrong amounts.
3. Post-dated cheque.

To record dishonoured cheque, we debit the debtor account and credit the bank acocunt. A careful
student will realise that we will also need to account the withdrawal of discounts given (if any). In
this case, we will have to debit Debtor account and credit Discount allowed.

Petty Cash Book

A petty cash book is another book of prime entry used specifically to record payment made from the
petty cash fund. They are relatively small amount of cash kept at hand in order to make immediate
payments for small expenses.

How does the petty cash fund work?

It uses an impreset system. The cashier will be given an amount of cash to pay for miscellaneous
expenses. Then, the amount is reimbursed at the end of the period so that the cashier will start the
next period with the same amount of cash on hand.

The reimbursement procedure in the imprest system helps to control the cash outflow and ensures
accountability. Since the amount is little, a junior staff can be in-charge of the petty cash fund.
Cashier can be work on other duties. Lastly, the amount of float can be changed depending on the
operation of the business.

Topic 6
Bank Reconciliation

Previously, we learnt how to record cash transaction in the company’s cashbook. Every month, the
company will receive a bank statement which reflects money deposited and withdrawn by the
business. The accountant would need to reconcil the differences between the Cash Book and Bank
Statement.

How to interprete a Bank Statement?

When the bank credits your account, it means that the transaction will increase your cash balance.
Coversely, if your bank debits your account, your cash decreases. This is because the Bank
Statement is produced from the perspective of the bank, as opposed to the firm.

There are transactions, which are found in the Bank Statement but not in the Cash Book. These are:

Direct Debits (Payments made by the Bank)
Standing Order: Company gave instruction to
its bank to pay to an account at regular
interval.
Bank Charges: Fees directly deducted by the
bank eg: interest charges
Dishonoured Cheque: Cheque not accepted
by the bank due to lack of funds or errors
made on the cheque.
Direct Credit (Receipts made by the bank)
Credit Transfer: Money received by the bank
on behalf of the company eg: rent revenue,
commission received
Interest/ Dividends earned directly and
credited to the bank’s account.

What we should do after identifying all these transactions would be to update our Cash Book.

NB: Go through a short example for updating cash book.

There are also transactions, which are found in the Cash Book but not in the Bank Statement. There
are:

Uncredited Cheques Unpresented Cheques

These are cheques received and debited in
the Cash Book but not credited in the Bank
Statement.
These cheques will be credited in the Bank
Statement when the cheques are deposited
in the bank.
These are cheques paid and credited in the
Cash Book but not debited in the Bank
Statement.
These cheques will be debited in the Bank
Statement when the cheques are presented
to the bank.

These entries would be recorded in a Bank Reconciliation Statement. The formats is as following:

From Bank Statement (ie,credit balance) to Cash Book Balance

Bank Reconciliation Statement as at 31 Dec 20X1
$
Credit Balance as per Bank Statement (NB: XX
No Overdraft)
Add Uncredited Cheques YY
ZZ
Less Unpresented Cheques AA
Cash (Debit) Balance as per Cash Book (NB: BB
This is after updating it) NB: The answer should be equal to the
updated cash book balance.

Sometimes, the company might have an overdraft debit Bank Statement. An overdraft is not to be
mistaken with a bank loan.

Bank Overdraft Bank Loan

The bank allows the business to overdraw This is an outright cash advance given by the
form his account to an agreed amount. bank to the business.
No acocunt is set up. A negative (ie, credit) A loan account is set up.
balance in the bank account will be formed Dr Bank Cr Loan
whenever the company overdraws.
Current Liabilities. Long-term Liability.

In this case, more attention should be given to the format to derive the correct Cash Book balance.
A way to remember it is to do the opposite of a normal balance format.
Bank Reconciliation Statement as at 31 Dec 20X1
$
Debit Balance as per Bank Statement (NB: XX
No Overdraft)
Add Unpresented Cheques YY
ZZ
Less Uncredited Cheques AA
Overdraft (Credit) Balance as per Cash Book BB
(NB: This is after updating it) NB: The answer should be equal to the
updated cash book balance.

Different Opening Balances and Errors

Take a closer look at the opening balances of Cash Book and Bank Statement in the last few
examples. Sometimes, the opening balance of Cash Book and Bank Statement may be different.
When this happens, one needs to identify the deposits or cheques from the Bank Statement (that
were reflected in last month Cash Book but not in the Bank Statement) and simply exclude the item
in Bank Reconciliation.

Erorrs in both Cash Book and Bank Statement can cause the two balances to disagree. If errors occur
in the Cash Book, journal entries will be passed to update the cash book. On the other hand, if it is
the bank’s error, it will be corrected in the bank reconciliation.

Example
Topic 7

At the end of the accounting period, a list of the entire general ledger accounts contained in the
ledger of a business will be produced. The list will contain the namer of the ledger and account and
the value of that nominal ledger account.This value can be either a debit balance value or a credit
balance value.

Why do we need to prepare a trial balance before producing the profit and loss statement and
balance sheet?
A trial balance is to prove that the value of all the debit value balances equals the total of all the
credit value balances. It helps to ensure accuracy of reporting, which is why it is called a trial
balance.

Example:

Tips

If the difference between the debit and credit can be divided by 2, it might be that one account is
placed on the wrong side.

If the difference can be divided by 9, it is likely to be a transposition error. Eg: $490 to 49.

You will face many new terms as you start preparing a trial balance. It is important to understand
the nature of the account (ie, if it is a P&L or a B/S account) and if it is a debit or credit balance.

Return Inwards Goods already sold by the company were

returned to the business by the customers.
Return Outwards Goods purchased from the suppliers and
subsequently return to the suppliers .
Carriage Inwards When the company buys its inventory, it incurs
delivery charges.
Carriage Outwards When the company sells goods to its customer,
it incurs further delivery chargers.
Topic 8

We have gone through the following accounting process so far.

1. Collect and verify source documents
2. Analyse each transaction
3. Journalise each transaction in the books of prime entry
4. Post to the ledgers
5. Prepare a Trial Balance
To complete the accounting cycle, we need to do
6. Closing of accounts
7. Prepare Financial Statements

For this lesson, we will go through the trading account which is used to inform the users about the
gross profit or loss resulting from the trading activities of the business. This is done by matching
sales revenue with COGS in the same accounting period.

We need to know the following formulas to guide in our preparation of account.

 Gross Profit = Net Sales – COGS
A trading business must first purchase goods to sell to its customers. When goods are sold, the
revenue is reported as sales while the cost is recognised, as an expense called COGS. The COGS is
subtracted from sales to arrive at gross profit.
 Net Sales = Sales – Sales Return (AKA Return inwards)
 COGS = COGAFS (Given as Opening Stock + Net Purchases) – Closing Stock
 Net Purchases = Cost of goods purchased + Costs in getting the goods ready for sale (eg:
Carriage inwards, duty, freight charges, packing materials, wages, insurance, etc) –
Purchases Return (AKA Return outwards)

Example (Closing to trading account)

Example (Calculate using the Format of Trading Account)s

Pay special attention to the term closing stock. The closing stock is the value of the inventory that a
business has on hand at the end of a reporting period. There is a variety methods to calculate the
recorded value of closing
1. FIFO
2. LIFO
3. Weighted average method

No matter the method used to calculate the value of closing stock, it needs to be adjusted to reflect
the lower of cost or market value (NRV).

NRV is given as NRV= expected selling price – expected selling expenses.

NRV can be less than the book value of the inventory because the condition of the inventory has
deteriorated, generally due to overstocking or lack of demand.

Example

After arriving at the gross profit, one needs to prepare the profit and loss account. Net profit will be
calculated by matching all revenue against the expenses incurred in the same accounting period.
Net Profit = Gross Profit + Other Revenue – Other Operating Expenses

Example (Closing of accounts to Trading, Profit and Loss Account)

Example (Calculate using the Format of Profit and Loss Account)

With the completion of Profit and Loss account, one has an idea of the increase in owner’s equity.
From this, we can easily work out the Balance Sheet of the company. The Balance Sheet shows the
financial condition of a company at a particular point of time.

Example

The purpose of the Balance Sheet is to inform users of the financial position of the firm. The users
make use of certain formulas to analyse the company.

Working Capital = Current Assets – Current Liabilities

Amount of fund available to the business to meet its daily expenses.

Capital Owned = Assets – Liabilities

Owner’s share of the company’s net assets.

Capital Employed = Capital Owned + Long-term Liabilites

Long term funds used in the operation of the business.

Examples

Transactions occurring after the end of the financial year will alter the financial position of the
company. Therefore, we need to consider the effects of these transactions on the balance sheet.

Example
Topic 9

Business expenditures can either be capital or revenue expenditure. Capital expenditures are
expenditures that produce benefits for the company over multiple time periods. This is normally the
case when a company acquires long-term assets. In contrast, revenue expenditures are
expenditures that produce benefits across one single time period. These are really just items
considered as expenses while preparing the financial statements.

The need to differentiate capital and revenue expenditures stems from the matching principle of
accounting. Recall in the previous less that this principle requires revenue to be recorded in the
same period as the expenses incurred to produce them. This rule thus helps to distinguish capital
expenditure from revenue expenditure by requiring capital expenditure to be expensed over
multiple time periods.

Capital Expenditure Revenue Expenditure

Definition Incurred in the purchase of
assets
Nature Unlikely to incur the same
cost again.
It will be used for more than
1 accounting period to
generate revenue.
Effects on Financial Increases the balance of
Statements assets in the Balance Sheet.
Example Purchase of PPE.
Renovation cost.
Incurred for the daily
operation of the business.
Recurring expenditure
Benefits is limited to this
accounting period.
Increases expenses in Profit
or Loss account.
Purchase of goods,
Depreciation, repairs and
cash discounts.

What will then happen when capital and revenue expenditures are wrongly classified?

If capital expenditure is recorded as revenue expenditure, the profit will be understated while the
fixed assets will be understated. Conversely, if revenue expenditure is recorded as capital
expenditure, the profit will be overstated while the fixed assets will be overstated.

On the other hand, a company can also receive funds either in the form of capital from the owner or
creditors (AKA capital receipts) or by selling its goods and services (AKA Revenue Receipts). The
latter is also what is known as income used in preparing the income statement.

Capital Reciepts Revenue Receipts

Definition Not part of the normal
course of business (ie, usual
transactions)
Effects Incoming cashflow is
recorded as capital or
liabilities.
Example Cash brought in by owners,
funds borrowed from banks.
Receipts related to the normal
course of business.
Incoming cashflow is recorded as
revenue in trading/Profit and Loss
account.
Receipts from Sales of goods or
services/rent/interest/commission.

Example
Topic 10
In earlier lessons, we have learnt the difference between assets and expenses. That is, assets will
provide substantial benefits beyond the end of a financial year. Then how can we match the cost of
the assets to the revenue it generates? Afterall, all assets (except land) have limited useful lives.
They can’t be used forever.
They are subjected to:
1. Wear and tear (the focus of the syllabus)
2. Becoming obsolete (the focus of the syllabus)
3. Expiration (eg: Copyright, patent)
4. Fall in physical reserves (eg: Mining)
Therefore, we need to regularly write them off to reflect the true value of the assets and to match
the revenue they help to generate.

The process of writing-down an asset is known as depreciation. The journal entry for writing down is

Dr Depreciation
Cr Accumulated Depreciation

We start by understanding depreciation. Depreciation can be calculated by either straight-line

method or reducing balance method.

Straight line method is also known as depreciation on cost. Pay special attention to this method as it
is the most popular method used in GCE O level syallbus.

What an accountant does is to estimate the useful life of the asset and assign a scrap value (the
value at the end of the asset, very similar to scrap value of an old car in Singapore) that is likely to
be recoverable at the end of the asset’s useful life. Then, annual depreciation can be calculated by
Depreciation= (Cost – Scrap Value)/ Estimated Useful Life

Example

Another simpler method is to establish an otherwise arbituary depreciation rate (say 20% a year).
Depreciation will then be = depreciation rate X Cost of Assets.

Example

Lastly, in some instances, reducing balance method is used. In that case, the accountant charges
depreciation at a higher rate in earlier years of an assets’ life. The amount of depreciation reduces
as the life of the asset progresses. Why would a company do that? It is a more appropriate method
of depreciating for assets that generate higher economic benefits in the early years. The assets
might face technological obsolescence as the years pass. This is a prime example of the matching
principle. Some assets generate more revenue at the start of the useful life. Therefore, a lot
proportion of cost will be required to be depreciated.

The formula of reducing balance method is given as depreciation = depreciation rate X Net Book
Value of Fixed Assets.

Example
The downside of the reducing balance method is that it reduces profits significantly for the business
during first few years. Assets might also never be fully written off using this method (less of an issue
since eventually it will be too little to be material).

Another principle that helps to govern the method of depreciation (on top of matching principle) is
consistency. Once the business has decided on a particular method in calculating depreciation, the
business cannot change it unless there is sufficient evidence that the new method is more accurate
measurement of the business operation.

NB: Recall in Lesson 1, the reasons for having accounting principles.

Once we understand the debit side of the journal entry, it is not hard to understand the concept of
accumulated depreciation. The debit is to expense off an amount to the Statement of Profit or Loss.
The credit side will be to reduce the value of the asset. Therefore, accumulated depreciation is a
contra-asset account and will not be closed off at the end of the year. The net of original cost of the
asset less its accumulated depreciation will then be shown in the balance sheet.

Example

Unlike inventory, non-current assets are rarely sold off. Instead, they are used to assist the company
in selling its goods or services. Hence, when they are occasionally sold, the journal entries will be
very different from that of sales of inventory.

We will start off with the obvious journal entry. That will be to record the cash inflow and sales.

Dr Cash
Cr Sale of non-current asset

Now that the asset is sold, we shouldn’t have accumulated depreciation or orginal cost of asset.
Hence,

Dr Accumulated Depreciation (recall that AD is

a contra asset)
Cr Sale of non-current asset

Dr Sale of non-current asset

Cr Non-Current Asset

So why do we transfer the net book value to the sale of non-current asset account? When we report
in the financial statements, we need to inform the users what gain/loss have the business made in
selling its non-current asset. Realise that the above two entries will give rise to a debit value
equivalent to the NBV of the asset. This, together with the first entry, will net off to give rise to the
gain/loss of the sales.

The last step will be to transfer the ending balance of the account to profit and loss account at the
end of the year.
Dr Sale of Non-Current Asset
Cr Profit and Loss

NB: this journal entry is only applicable if all the transactions in the year result in a gain.
Example
Topic 11

Recall in Topic 1

Matching
Expenses incurred must be matched against revenue earned in the same period, regardless of when
the transfer of cash takes place. This is what differentiates accrual accounting from cash basis
accounting.
Accrual Cash Basis
Timing of (when) revenue Accounts for revenue only Accounts for revenue when
and expenses are recognised when it is earned and money is received and for
expenses good when they expenses when the money is
are incurred. The revenue is paid out.
recorded even if cash has
not been received (ie, credit
sales) or if expenses have
been incurred but no cash
has been paid (accrued
expenses).

Therefore, we need to do balance day adjustment to add accrued expenses and revenue to the
current accounting year while exclude prepaid expenses and revenue as they are not yet incurred or
realised.

Illustrative

Accrual Expenses are not yet paid but have been incurred in generating revenue for the current
period.

Dr Accrued Rent Expense (Under current

liabilities under Balance Sheet)
Cr Rent Expenses (For calculating profit in the
Statement of Profit and Loss)

Prepaid Expenses are paid in advance when the company have not enjoyed the benefits what they
have paid for.

Dr Prepaid Insurance Expense (Current asset

under B/S since it will generate future
benefits )
Cr Insurance Expense (To reduce the amount of
expense in Profit and Loss)

Accrued Revenue

Revenue earned but have not received the payment for it.

Dr Trade receivables (Current asset under B/S )

Cr Revenue (Revenue is earned since the goods
or services have been delivered in this
accounting period)
Prepaid Revenue

Sometimes, customers choose to pay for the goods before the goods or services have been
delivered. In that case, the business owes the customers the goods or services.

Dr Revenue (To reduce the amount of revenue

in Profit and Loss)
Cr Prepaid Revenue (Current liabilities under
B/S)
Topic 12

Edit Required

What are bad debts?

In previous topics, we have discussed the accounting for transactions for sales of goods or services
on credit. However, what happens if these receivables become uncollectible? While businesses will
try their best to avoid such uncollectible debt, it sometimes happens. When receivables become
confirmed as uncollectible, it becomes known as bad debt. (Can ask students what could give rise to
uncollectible debt as a thinking exercise). Hence, as accountants, it is important to learn how to do
accounting for bad debt. Bad debt expense is recorded in the business’ accounting book only when
there are reasonable evidence or proof that the amount cannot be collected.
Receivables usually become confirmed as uncollectible when:
a) A company goes bankrupt
b) A company closes its business
c) The account is past due, and many attempts have been made to collect the debt but have
been unsuccessful.

What is doubtful debt?

In accordance with generally accepted accounting principles, businesses should be prudent in
reporting their financial position. In the normal course of business, it is given that some of the trade
receivables cannot be collected. Hence, a business should estimate what portion of the receivables
may not be collected and then record these as an operating expense. These potential uncollectible
receivables become known as doubtful debt.
There are two methods of accounting for receivables that appear to be uncollectible. The direct
write-off method involves recognizing the expense only when the accounts are confirmed to be
uncollectible (think back to what gives rise to uncollectible accounts). Another method is the
provision method, which estimates the expense for uncollectible receivables even before the
account is considered to be worthless. We will go on to discuss each of these methods in further
detail.

The direct write-off method

The direct write-off method is the most straightforward method of recording bad debt expense.
Under this method, no provision account needs to be created. When an account is determined to be
uncollectible, we simply write off the bad debt to an expense account in the profit and loss
statement using the following entry
DD/MM Bad Debt Expense $xx
Accounts receivable – John Doe $xx

Situations can also arise where customers can only pay off a portion of their debt, and then the
company will have to write off the balance that the customer is unable to pay. In this case, the entry
should be as follows.
DD/MM Cash $xx
Bad Debt Expense $yy
Accounts receivable – Jane Doe $zz

In the above entries, you can see that the entries will serve to reduce the amount of accounts
receivable outstanding on the balance sheet and charges the bad debt amount to profit and loss.
This also serves to reduce profit for the year.
Later on, circumstances may change, resulting in the customer being able to pay you again. Hence,
when your customer pays you, you may write back that bad debt by way of the following entry.
DD/MM Accounts Receivable $xx
Bad Debt Recovered $xx

Cash $xx
Accounts receivable $xx

The Provision Method

Most businesses use this method to estimate the uncollectible portion of accounts receivable. As
discussed earlier, this method is use when a company does not know exactly which accounts will
become uncollectible, and when they will become uncollectible. If a company is creating a provision
for the first time, it should use the following entry
DD/MM Doubtful Debt Expense $xx
Provision for doubtful debt $xx

As you can see, we do not directly take the amount out of accounts receivable. This is because it is
only an estimate and therefore cannot be credited to specific customer accounts or to the accounts
receivable control account. Instead, the amount should be credited to an account specially created,
provision for doubtful debt. This account is a contra-asset account, which serves to reduce the
amount of assets.
This adjusting entry serves 2 purposes. Firstly, it reduces the value of the receivables to the
expected realizable amount. The provision for doubtful debts is presented in the following manner
in the balance sheet:
Company X
Extract of balance sheet as at 31 December

Current Assets
Accounts receivable $100,000
Less: Provision for Doubtful Debt ($5,000)
$95,000

Secondly, the entry also helps to match the doubtful debt expense to related revenue earned during
the period. This is in line with the matching principle, which requires that all related expenses and
revenues be reported in the same accounting year.
However, if there is an existing provision, it may be that the estimate for the year will be higher or
lower than the existing estimate. In that case, we must make adjustments to the provision for
doubtful debt accounts via the following entries:

DD/MM Provision for Doubtful Debt $xx

Writeback of doubtful debt $xx
OR
DD/MM Doubtful Debt Expense $xx
Provision for doubtful debt $xx

Lastly, we must consider what will happen to the provision when bad debt actually happens, instead
of being an estimate. To create the journal entry for the write off of bad debt when provision has
been set up, we
Dr Bad debt
Cr Debtor
This is exactly the same as the direct write-off method taught earlier on. However, we need to do
one more journal entry to adjust for the provision of bad debt. This is becase provision for doubtful
debts are calculated as a given percentage of net debtors (that is debtors less bad debts).

Example
Topic 13
Correction of Errors

In an earlier topic, we have learnt the role of trial balance in checking the mathematical accuracy of
the debt and credit.

That being said, there are other forms of errors which cannot be found using the trial balance. We
shall examine what are these types of errors are, the effects of the errors and how can we adjust to
reverse the errors.

Ommission can happen when an accountant never record the journal entry at all. This can be
because source documents are lost or due to neglience.

Realise that ommission will have no effect on the trial balance. Therefore, the trial balance will still
balance. The following few mistakes have the same characterteristic. They affect (or not affect) both
debit and debit sides equally such that will never be detected in a trial banace.

Errors can also be made in the original entry. Although the details are provided in the source
documents, the accountant might have keyed in the wrong amount in both debt and credit. An
example of which is when an asset with a cost of $400 is wrongly recorded in the journal entry as
$4000.

Commission relates not to errors made on the figure but rather to the wrong account of the same
nature. For example, instead of debiting debtors-A, the business might have debited debtors-B.

Principle is very similar to commission except that the mistake is made to the wrong account of a
different nature. A prime example will be to debit assets instead of expense. This can be due to a
lack of understanding of the underlying transaction on the accountant’s part.

In the following two errors, the accountant has made two mistakes instead of one.

Compensating happens when two errors of the same amount are made but on the opposite side of
debit and credit offset each other such that they will not be reflected in a trial balance. For instance,
ABC debtor account is debited by 2500 while it was supposed to be 3500, and XYZ debtor account is
debited by 3500 while it was supposed to be 2500. As you can see, the excess debit in XYZ is
compensated in the A=L+OE equation by the short of credit of ABC by 1000.

NB: Test on purchase and sales both overstated by $100.

Lastly, reversal of entry happens when the accountant record the debit as credit and credit as debit.
The business sold $100 worth of goods on credit. The accountant, however, Dr Sales and Cr AR.

Journal Entries to correct the errors.

You can write down the incorrect journal entry, reverse the journal out and then doing the correct
journal entries. After you get used to correcting errors, you can do it in one single journal entry.

Examples testing students the nature of the error and subsequent correction.

Adjusted Trial Balance

Since only a few accounts are affected, we do not need to redo the whole trial balance. Instead, all
we need to do is to adjust the debit and credit amount of the incorrect accounts after doing the
journal entries on correction.

Example of adjusted trial balance.

The effects of an error can extend to both statement of profit and loss and balance sheet. There are
way too many types of errors and therefore do not attempt to memorise the effects of these erorrs.
In fact, it is better to understand the underlying mechanism of how a journal entry affects the
financial position of a business.

Examples of how errors affect the profit, assets, etc

We will focus our attention on an area that is frequently tested. That is on the errors made on
opening stock or closing stock.

In previous lesson we have learnt the formula COGS = COGAFS (Given as Opening Stock + Net
Purchases) – Closing Stock which is used to prepare the Statement of Profit and Loss. Remember
that the closing stock of one year is the opening stock of the next year.

Overvaluation of the closing stock will lead to:

Affected Accounts Financial Year 20x1 Financial Year 20x2

Current Asset Overstated Overstated for opening. No
effect on B/S.
COGS Understated Overstated
Gross and Net Profit Overstated Understated
Owner’s Equity Overstaded Understated

NB: The valuation error mde in 20x1 only affects the opening stock. The closing stock of 20x2 is
accurate.
What you will realise is that profits are recognised prematurely. The timing of recording the profit is
wrong.

Example
Topic 14

Control Account

In topic one, we have learned that individual debtor and creditor accounts are kept separate from
the general ledger. Subsidiary ledgers are required so that it helps in providing details (like source
douments, date of each purchase or sale, the amount for each transaction) and to reduce the
amount of entries in the general ledger (imagine having hundreds of transaction flooding the
general ledger, it will be too difficult to search for an entry or to correct any mistake).

We will need to include a summary of the balances of all debtors and creditors in the general ledger
so that the financial statements can be prepared. In addition, without the control account, the trial
balance will not be balanced.

The trick to do control accounts will be to know which items are included in the control account and
whether the item belongs to a debit or a credit. This is a format I have created. You don’t have to
memorise it but you have to understand why certain accounts are chosen.

For Trade Receivables

Trade Receivables Control Account
Date Items: Debit Credit Balance
$ $ $
Balance b/d
NB: Copy the previous
year closing balance for
Trade Receivables
Sales Revenue (credit
only)
Sales Return (credit only)

Cash Banked in (shown in

cash book or bank
statement) from payment
from trade debtors less
any dishonoured cheque
Discount allowed
Interest charged on trade
receivables (late
payments)
Allowance for impairment
of trade receivables
Trade Payable Control

Example

The trade payable derived from the calculation should equal to the sum of all the ending balances of
the individual trade receivable accounts. Therefore, the purpose of a control accounts is to be an
independent check on the entries made in the individual trade receivable or trade payable accounts.

The format for trade payables will be quite similar.

Date Particulars Debits Credit Balance
$ $ $
Balance b/d
Inventory (Purchases on
credit)
Inventory (Purchases
Returns on credit)
Cash at Bank for the
repayment of purchases on
credit
Discount received for
goods bought on credit
Interest Expense charged
on delayed repayements
Trade Receivables Control

A customer can also be a supplier. For example, Capitaland rents out a space to a construction
company for its office. This makes the construction company its customer. However, the
construction company can also supply Capitaland its services. In this case, Capitaland need not set
up two separate accounts for trade payables or trade receivables. It can offset one balance with the
other.

Dr Trade Payables Control

Cr Trade Receivables Control
Topic 15

Final Accounts with Balance Day Adjustments

Recall that in the first topic, we have learnt the accounting cycle.

When business transactions occur, source documents are produced. These source documents are
used to substantiate a transaction entered in the books of original entry. Books of original entry are
accounting journals on which business transactions are initially recorded. An accountant will record
the journals daily. At the end each financial period, this information is summarised and posted to
the general ledger. The final account balance of the general ledger will be extracted, together with
the account name, at the end of the financial year to be included in the trial balance.

We have posted the journals to general ledger. balance day adjustments are now required to be
performed before the statements of accounts are produced.

Why is there a need for balance day adjustments?

To ensure all income and expenses that relate to the current financial reporting periods are
identified and properly reported in the current period, it is necessary to make certain adjustments in
the accounting records.
NB: Accrual accounting system may result in income or expenses be recognized and paid/received
at different times.

The most common balance day adjustments are:

 Depreciation
 Prepaid expenses and accruals
 Writing off bad debt
 Correction of Error & drawing of goods

NB: Use some timeline to highlight the timing issues of the above adjustments.
Top 16

Partnership

So far, we have assumed that the company is operating as a sole proprietorship. For many SMEs,