SECRET SAUCE (ASLEVEL THEORY NOTES FOR

CLASS OF 2023)

Omair Masood- Cedar College

ACCOUNTING CYCLE
The Accounting Cycle is a series of steps, which are repeated every reporting period. The
process starts with making accounting entries for each transaction and goes through closing the
books. This Involves recording transactions in the daybooks/Journals( books of original entry),
posting them to ledger, extracting a trial balance and finally drawing up financial statements.

Step 1: Recording Transactions in Daybooks ( DAYBOOKS ARE ALSO REFFERED AS

JOURNALS)
Each transaction is recorded first in one of the following daybook ( book of original entry)
according to the nature of the transaction.

1. All goods sold on Credit ( Credit Sales) ….> Sales Daybook

2. All goods purchased on Credit (Credit Purchases) ….> Purchases Daybook
3. All goods sold on credit but now returned by costumers ..> Sales Return (Inwards)
Daybook
4. All goods purchased on credit but now returned to suppliers…> Purchases Return
Daybook

The above four daybooks only record credit transactions related to movement in
inventory. There are no accounts maintained inside the daybooks. It Just contains Date,
Name, Source document number and Amount.

5. All transactions which relate to receipts and payments through cash or cheque ..>
Cashbook

Cash and Bank accounts are made inside the cashbook hence it also serves the purpose of
ledger.

6. All other transactions …..> General Journal

In this we actually write the double entry of only those transactions which cannot be
recorded in the above five daybooks. To name a few transactions
- Non Current Assets Purchased or Sold on Credit
- Writing off Bad debts
- Entries for Provisions of doubtful debts and depreciation
- Adjustments for Prepaid and Owings
- Correction of Errors
What are source documents?

In the accounting industry, source documents include receipts, bills, invoices, statements, checks
– i.e., anything that documents a transaction. Any time a business spends or receives money, a
source document is created. The main ones to remember for exams are as follows

Invoice : A document issued by the seller to the buyer when goods are sold. It is the source
document for the Sales Journal .

Credit Note : A document issued by the seller to the buyer when goods are returned to him .Its a
document to acknowledge the return of goods . It is the source document for the Sales Return
Journal.

Debit Note : A document issued by the buyer to the seller while returning goods ( it is like a
request to issue the credit note). This is not a source document as its only a request to accept the
goods back.

Main thing to remember is summarized in the table below

Action
Issuing an Invoice
Receiving an Invoice
Issuing a Credit Note
Receiving a Credit Note
Issuing a Debit Note
Receiving a Debit Note
Meaning
Goods are sold by us
Goods are purchased by us
Goods are returned to us ( Sales Return)
Goods are returned by us ( Purchase Return)
Goods are returned by us ( Purchase Return)
Goods are returned to us ( Sales Return)

Receipt : A document issued when money( cash or cheque ) is received by us/

Step 2: Posting Transactions In Ledgers

A ledger is a book which contains accounts ( the actual T Accounts guys). There are three types
of Ledgers. In each type we have different type of accounts.

Sales Ledger: This contains accounts of credit costumers ( people to who we sell goods on
credit) – Trader Receivables

At the end of the year all the account balances in the sales ledger are listed in a schedule (list)
which is called list of Trade receivables. This shows the individual account balances( closing)
and also the total debtors which goes into the trail balance.

Purchase Ledger: This contains accounts of credit suppliers ( people from whom we buy
goods on credit) – Trader Payables
At the end of the year all the account balances in the purchase ledger are listed in a schedule
which is called list of Trade Payables. This shows the individual account balances( closing) and
also the total trade payables which goes into the trail balance.

General Ledger: This contains all the other accounts. Like all assets, capital , liabilities
,expenses ,incomes ,provisions (literally all other accounts)
Please remember Sales and Purchases accounts are in the General Ledger cause they are not our
costumers or suppliers

Once all the transactions are posted all the accounts are balanced via inserting a balance C/d in
all accounts.

Step 3: Extracting a Trial Balance

All the closing balances in the General Ledger along with the figure of total trade receivables and
payables are listed in a trail balance. Debit balances and Credit Balances are listed separately
side by side. The Sum of all Debits should be equal to sum of all credit balances. The trail
balances is used to check the completion of the double entry. The trail balance will balance
because
- For each debit entry there is a credit entry ( vice versa)
- The sum of all debit entries is equal to the sum of credit entries
Advantages of trial balance

• It helps in ascertaining arithmetic errors that occur while preparing accounts. Accountants
can make mistakes while recording financial transactions under the double-entry
bookkeeping system. When the debit and credit sides of a Trial Balance do not match, it
means one of two things. One, there was an error in either recording the account balance.
Or two, there is an accounting mistake made while recording the transaction in the
ledgers.
• It helps in preparing the financial statements of a company at the end of a financial year.
The final balance of expenses and revenue accounts is taken from the Trial Balance and
used in the Profit and Loss Account. Similarly, the accounts related to Assets, Liabilities
and Capital gets recorded in the Balance Sheet.
• A Trial Balance helps in summarising the financial transactions done while running a
business. It is a consolidated summary of the financial transactions that have taken place
within a financial year. It can help the management in making business decisions as well.
Limitations of trial balance

• It may hide errors of omission. Some transactions are not journalised at all. Even a
correctly balanced Trial Balance cannot reveal this mistake.
• If a journal entry with an incorrect amount gets recorded in both accounts, the Trial
Balance will not detect that error.
• A journal entry may have the right amount, but the accountant may have entered it under
the wrong accounting heads. The Trial Balance cannot identify such mistakes.
• If a journal entry is missing in the ledger, it will not reflect in the Trial Balance.
Step 4: Closing Entries with Year end Adjustments (Details in following pages)

After making the trail balance we also have to adjust for certain items. Remember only Incomes
and Expenses are taken into account while calculating profit. These accounts are closed by
transferring them to the income statement .This process is called Closing Entries.
Some common adjustments are
- Expenses and Incomes are adjusted for prepaid (advance) and accruals(Owings)
- Non Current Assets are depreciated
- Provision for doubtful debt is adjusted
- Closing inventory is valued by physical stock take and it is adjusted in calculating
cost of goods sold and also for Statement of Financial Position
- Adjustments for goods withdrawn by owner or Inventory Losses

Step 5: Final Accounts ( Financial Statements)

An income statement and Statement of Financial Position ( Balance Sheet) is drawn which ends
the Accounting Cycle. Now by looking at Income Statement owner can check his Profit and by
looking at statement of financial position he can check his worth and his total resources.

WHAT ARE THE BENEFITS OF KEEPING FULL DOUBLE ENTRY RECORDS FOR
THE BUSINESS?

1. Helps in preparation of Trial Balance

2. Helps in preparation of Financial Statements
3. Less Chances of Errors
4. Less Chances of Frauds
5. Improves the Accuracy of Accounting Records

WHAT ARE THE DISADVANTAGES OF KEEPING FULL DOUBLE ENTRY RECORDS

FOR THE BUSINESS?

1. Time consuming
2. Costly
3. Secutiry Risks
ADJUSTMENTS IN DETAIL
BAD DEBTS AND PROVISION (ALLOWANCE)FOR DOUBTFUL(BAD)
DEBTS

What is a bad debt?

When a costumer to whom goods were sold on credit basis, is unable to pay his debt then it
results into an expense for the business. Selling goods on credit basis involves this risk of bad
debt. Any amount of debt which becomes irrecoverable should be written off as bad debt.

Debit: Bad Debts

Credit : Person Who is Bad :>/Trade receivable

What is a Provision for bad debt? ( it is also called allowance for doubtful debts)
A business must consider that some costumers might not pay the amount owed by them; these
debts are considered to be doubtful. Since the business does not know the exact amount of the
doubtful debts( and also which costumer might not pay), an estimate for such amount is kept in a
provision for doubtful debt account ( this account is not an expense account, it’s a reduction in
asset from the statement of financial position). Provision is created to reduce profit now for an
expense which might happen in future. This is done to be pessimistic, in Accounting we call this
being prudent or the Prudence Concept.

A business usually keeps a general provision ( an estimated % of the all debtors), but it is also
possible to make a specific provision against a highly doubtful debt. Specific provision mean the
whole amount due by a particular Trade Recievebale is added to the provision.

For example
Trade Receivables At End= 60000

Case 1: Only General Provision of 5% .. > provision = 5% of 60000 = $3000

Case 2: A specific Provision of $2000 and a general provision of 4% on remaining trade

receivables
Provision = 2000 (Specific) + 4% of 58000 ( general provision on remaining debtors)

How is the amount of provision estimated? ( Factors effecting it)

- Age of Debts ( Since how long they owe us), higher the age more likely bad debts (
so high provision is kept If majority of the debts are owed for long)
- Historical percentage of actual bad debts from previous years
- Reputation of people who us money in the market
- Nature of Business
- Some specific debts may be identified and full amount of them is charged in
provision.
What is the difference between accounting treatment of Provision for doubtful debts and
the actual Bad debts?

The Journal entry for provision:

To create / Increase
Debit : Income Statement
Credit : Provision for doubtful Debts

To Decrease
Debit : Provision for doubtful debts
Credit : Income Statement
The difference in accounting treatment is that the whole of bad debt is treated as an expense but
only the change in provision is treated as either an expense (if increasing) or an income ( if
decreasing). When we write off a bad debt, we remove the person from our books but in case of
a provision we don’t adjust the Trade Receivable account as a separate account is maintained.

What is Bad Debt Recovered?

This is when a debtor whose debt was previously written off , pays us back. This is treated as an
income in the year in which the debt is recovered . The accounting treatment is done in two steps

- Make him or her your debtor (receivable ) as the debt has been written off
previously and the account of that costumer doesn’t exist in our books
Debit : Name of Person(Trade receivable )
Credit: Bad debt recovered account

- Now record the entry to receive the money

Debit: Bank
Credit : Name of person (Trade Receivable )
ACCOUNTING FOR NON CURRENT ASSETS
Whenever we spend money we call it expenditure. The expenditure can be divided in two

Capital Expenditure Revenue Expenditure

Any expenditure incurred on buying
new non-current asset. We take this to
balance Sheet
Usually one off (doesn’t happen on
daily basis)
Includes initial expenses incurred till
we start using the asset e.g. Installation,
delivery charges
Increases the value of earning
capability of the asset e.g. Adding a
Safety device
Any day to day expense to run the
business. We take this to income
statement
Its recurring in nature ( we have to do it
again and again)
Usually occurs after we start using the
asset
Maintains the value or earning
capability of the asset. E.g. Repainting
or Repair

In the same way we can have Capital receipts and Revenue Receipts .

Capital Receipts would include money received from capital transactions e.g. taking a bank loan
, selling a non current asset or additional capital introduced by the owners ( note this money
coming in not earned by the business from profits)
Revenue Receipts are incomes generated from day to day operations of a business ( taken to
income statement) e.g. Sale of goods , Interest received rent received

If these expenditures and receipts are treated in the wrong way then both income statement and
statement of financial position will be wrong.
Depreciation
This is an expense recorded to allocate a non current asset cost over its useful life. Deprecation is
used in accounting to try to match the expense of an asset to the income that the asset helps the
business to earn. For example if a business buys a piece of equipment for $1 million and expects
to use it over a life of 10 years, it will be depreciated over 10 years . Every accounting year, the
company will expense $100000 (assuming straight line , which will be matched with the money
that the equipment helps to make each year. )

Causes of Depreciation

1. Wear and tear

2. Change in technology/Fashion/Taste
3. Passage of time

The Double Entry for Depreciation is :

Debit : Income Statement

Credit : Provision for Depreciation

Methods of Depreciation:

1. Straight Line :
An equal amount of deprecation is charged every year. It is always calculated on cost . In
case of scrap value (residual value) and life given use : Cost –Scrap/Life

2. Reducing Balance Method:

In this deprecation for initial years in always higher then the later years. It is simply a percentage
on net book value (written down value) . Net Book value represents cost minus total deprecation
till date.

3. Revaluation Method:
This is usually used for loose tools ( or any asset which can only be valued collectively) . In
this method at the end of the year the market value is estimated. A numerical example best
explains this
At the start of the year Loose Tools Valued at $5000
During the year Loose Tools purchased = $2000
Loose Tools Sold = $300
At the End Loose tools are worth $4500
Deprecation = 5000 + 2000 – 300- 4500 = 2200
Opening Value+ Purchased –Sold – Closing Value
Which Method is best to use?
It depends on the nature of Non Current Asset
Straight Line method is appropriate for assets like office furniture and fittings (which are used
evenly through out the year useful life, and the efficiency of them doesn’t fall by great amount in
initial years)

Reducing Balance Method is appropriate for assets like machinery or van. Since these assets
are more efficient when new, more depreciation is charged in initial years. As the asset gets old it
looses efficiency and so we charge less deprecation. Another way to look at it is that the
maintenance and repairs of asset will increase in later years so to maintain the overall expense it
makes sense to charge more depreciation in initial years when maintenance is low and then
reduce it as maintenance increases.
How to record disposal of Asset:
Disposal of means getting ride of the fixed asset . it can be sold or may be stolen or just
discarded. Usually there are 4 entries to record sale of asset

1. Remove the Cost of the Asset Sold

Debit : Disposal Credit: Asset

2. Remove the Total Deprecation

Debit : Provision for Depreciation Credit : Disposal

3. Record the Selling Price

Debit: Bank Credit : Disposal

If exchanged then
Debit : Asset Credit Disposal

4. Close the Disposal Account

Close with income statement .

All of this can be done in one single entry without using disposal

For example
Cost of Asset Sold = 50000
Net book Value = 30000
Sold For 28000

Note : total depreciation is 20000 as NBV is 30000

We can do

Bank 28000
Prov for Depn 20000
Income Statement (Loss) 2000
Asset 50000
If sold for $31000 then

Bank 31000
Prov for Depn 20000
Asset 50000
Income Statement( Gain) 1000

Adjusting Entries

To Adjust expenses

Prepaid :
Debit : Prepaid Expense ( its an asset)
Credit : Expense (reduces expense)

Owing/Accrual

Debit : Expense (increases expense)

Credit : Owing Expense ( it is a liability)

To adjust Incomes:

Prepaid:

Debit: Income (as the income reduces because it’s prepaid)

Credit: Prepaid Income (because it’s a current liability)

Owing/Due

Debit: Owing Income (because it’s an asset)

Credit: Income (as the income increases)

To adjust closing inventory

Overstated:
Debit: Trading account (Income Statement)
Credit: Closing Inventory

Understated:
Debit: Closing Inventory
Credit: Trading account (or simply Income Statement)
To adjust Opening Inventory

Overstated:
Debit: Opening Capital
Credit: Trading account (Income Statement)

Understated:
Debit: Trading account (Income Statement)
Credit: Opening Capital

This is because opening inventory has opposite relation with profits. So if understated
profits are overstated and we need to reduce them (debit: Trading account). Also opening
stock of this year was closing stock of last year so we need to amend the opening capital.

Concept of Sale or Return basis:

If we send goods on sale or return basis which means goods can be returned by the customer if
not sold. When goods are send nothing is recorded, just a memorandum is kept. These goods
should not be included in sales and should be included in closing stock (since they belong to us).

If this is recorded as sales and not included in closing Inventory, then we need to:
• Correct sales: Cancel them
Debit: Sales
Credit: Trade Receivable
• Correct Closing Inventory which is understated

Note: We won’t have to correct the Inventory if the goods were included in closing inventory.
BANK RECONCILIATION STATEMENTS
Cashbook is owner’s record (Debit means + balance, Credit means – balance)

Bank statement is bank’s record (Credit means + balance, Debit means – balance)

Some entries which are recorded in the bank statement but not in the cashbook:
For these, we will have to correct the cashbook

1. Credit transfer (Bank Giro): Money deposited by customer directly in the bank
account (We should add it to cashbook balance)
2. Standing order/ Direct Debit: Money paid to supplier directly by the bank.
(We should subtract this from cashbook balance)
3. Bank Charges/ Interest Charged: Money deducted directly by the Bank.
(We should subtract this from cashbook balance)
4. Interest Received/ Dividends Received: Money added to the bank account in form
of interest or dividend (We should ad it to the cashbook balance)
5. Dishonored Cheque: A cheque received from customer but not acknowledged by
the bank (We should subtract this from cashbook balance because we need to
cancel the entry made when the cheque was received).

Some entries which are recorded in the cashbook but not on the bank statement.

For this, we will have to correct the bank statement:

1. Unpresented Cheque: Cheques written by us to a creditor but not yet presented

to the bank for payment, so the bank has not deducted money from our account.
(We should subtract this from bank statement balance)
2. Uncredited Cheque (Lodgments): Cheques received by us but not yet deposited
in the bank, so the bank has not increased the bank balance. (We should add this
to the bank statement balance).
3. Error On the bank statement made by bank
What is the difference between a standing order and direct debit ?
Both are very similar as they are used to make payments directly from our account.
However there are minor differences as illustrated in the table below .

Standing Order Direct Debit

Used for fixed recurring payments ( Like
Rent )
Authority is given to bank to make a
payment on our behalf .
Changes can be made ( like cancellation)
easily by us
Used for Variable bills ( like electricity)
Authority is given to the vendor ( like K-
electric) to deduct money from our bank
account.
For any change in arrangement we have to
notify the vendor

FOR MCQ’s remember

Balance as per Bank statement + Uncredited Cheques – Unpresented Cheques = Balance as per
corrected Cashbook.

If balance as per corrected cashbook is given in the question, simply ignores the entries which
will affect the cashbook balance.

If there is an overdraft (for either cashbook or bank statement), take it as a negative figure in the
equation.
CONTROL ACCOUNTS
What is the difference between Sales Ledger and Salas Ledger Control Account?
Sales ledger is where we make individual accounts of credit customers. It is part of double entry
system and it gives details of amounts owing by each customer. A list of Trade receivables is
extracted from the sales ledger, which gives the figure of Trade receivables for the trial balance.
Sales ledger control account on the other hand is the total receivables account in the general
ledger. It is not part of the double entry system. It I often referred as total receivables account.
All the entries recorded here are totals taken from daybooks e.g. Sales figure is the total of the
sales daybook, discount allowed is total discount allowed from the discount allowed account or
the column in the cashbook.
USES OF CONTROL ACCOUNT
1. Helps to prevent fraud
2. Helps to detect errors
3. Quickly provide figures of total debtors and creditor.
LIMITATIONS OF CONTROL ACCOUNT
1. Cant trace error of omission
2. Cant trace error of original entry
3. Does not give individual amount owed by each costumer
RECONCILIATION OF CONTROL ACOUNT
In these types of questions, two sets of balances of debtors or creditors are known. One is from the control
account and the other is from the sales ledger (or list of debtors).They will also give you several errors
and you will have to reconcile both the balances.
Errors can be classified as:
1. If an error is made in the personal (individual) debtors account, than it will only affect the sales
ledger (list) balances. E.g. Sales made not posted to debtor’s account, this means we should
increase the debtor balances in the ledger.
2. If an error is made in any total figure of the daybook, it will effect only the control account
balance, e.g. Sales daybook undercast, Total sales understated so add it to control account
balance.
3. If an entry is completely omitted from the books, it will affect both the balances. E.g. A sales
invoice completely omitted from the books, add it to both balances.
4. If an entry is originally recorded in the daybook with the wrong amount, it will affect both the
balances, as the total will also be wrong. E.g. A sales invoice of $500 was originally recorded as
$600, this means the total sales are overstated and also the individual account of the customer has
been debited with $600. We should subtract $100 from both.
5. If a balance is omitted from the list of debtors, it will only affect the sales ledger (list) balance. It
cannot affect control account balance.
 ERRORS AND SUSPENSE
Error not affecting the Trial Balance:
1. Error of complete omission: When nothing has been recorded in the books. To correct this,
simply record the transaction.
2. Error of original entry: Where correct double entry is passed but with the wrong amount. To
correct this, adjust for the difference.
3. Error of principal: Where a wrong type of account has been debited or credited instead. For
example, we have debited Rent instead of Motor Van.
4. Error of commission: Where a wrong account but of same type (usually debtors or creditors) has
been debited or credited instead. For example, we have credited Mr. A instead of Mr. B.
5. Error of complete reversal: Where a completely opposite entry is passed with the right amount.
To correct this, pass the correct entry with double amounts.
6. Compensating error: Where one error compensates for other. Like a debit item (say purchase) and
a credit item (say sales) are both undercast with same amounts. (don’t worry about this too much
:P)
All the above errors do not affect the Trial Balance because in all situations the total debits are equal to
total credits.
Errors can be made which can lead to disagreement of the trial balance.
This is when either we have only debited something and forgot to credit (Incomplete double entry) or we
have debited something with a correct amount and credited the other with the wrong amount (Incorrect
double entry). And it can also happen if any daybook is over or under cast. E.g. Sales daybook is
undercast. In these situations Suspense account comes into the picture. Since sales daybook is undercast,
this means only the total sales were wrong (understated), so we need to amend the sales accounts.
Debit: Suspense
Credit: Sales

Also sometimes an error is made in the list of debtors or creditors. Like a debit balance is excluded from
the list of Trade Receivables . This makes the receiveables figure in the trial balance understated.
Logically we should
Debit: Trade Receivables
Credit: Suspense
But guys do you realize that only the list of Trade Receivables is wrong (which is not an account), so we
should
Debit: NO DEBIT ENTRY
Credit: Suspense

What if there is still balance left in the suspense account?

This means all the errors are still not found. If the balance comes on the debit side, then treat it as a
current asset in the balance sheet, if it comes on the credit side then treat it as a current liability.
INCOMPLETE RECORDS:
Remember profit for the year can be calculated using the following formula. If a question says
make an Income Statement, than this doesn’t apply. Only when it says to calculate profit for the
year or make a statement showing profit for the year .

Opening Capital + Additional Capital + Profit for the year – Drawings = Closing Capital

(I really hope you can solve for profit), don’t memorize the formula, it’s the equity section. ☺

For the final account questions (where the income statement and statement of financial postion is
required), always make the following accounts. (By always, I mean always).

1. Sales ledger control account (If business only deals in cash sales, then don’t)
2. Purchase ledger control account
3. Bank account (if it is already given in the question, then it’s okay)
4. Cash account (only make this when the question gives cash balances)

Once you have filled in your accounts, and then move to the Final accounts. Don’t panic if it
doesn’t balance, because marks are for working. Don’t spend your entire lifetime on this
question.

NEVER NEVER NEVER forget depreciation. They will usually give you net book values at
start and end.
Depreciation =

Opening NBV + Purchase of assets – Sale of assets (at NBV) – Closing NBV

Also make expense accounts or adjust for prepaid and owings directly. But show all working.

In Equity by section, you will need opening capital. This will come from Opening Assets –
Opening Liabilities. Don’t forget to include the opening balance of the bank account in your
calculation (like other idiots).
MARGINS AND MARK-UPS
These are tools used to compute the missing figures of sales, figures or stocks. If either of these
percentages is given
MARGINS
Represent Gross Profit as a percentage of selling price.
MARK-UP
Represent Gross profit as a percentage of cost.

Try to use
Sales – Cost = Profit

If Mark up if given Profit is a % of Cost and IF margin is given Profit is a % of Sales

For eg.

Sales = 80000
Cost = ?
Margin = 25%

Sales – Cost = Profit

80000- x = 25 % of 80000

Cost = 60000

But if
Sales = 80000
Cost = ?
Markup =25%

Sales – Cost = Profit

80000- x = 25 % of X
Cost = 64000

Or You can also use unitary method . In margin Sales is always 100 and cost is ( 100 minus
margin)
In markup Cost is always 100 and Sales is ( 100+markup)
PARTNERSHIP ACCOUNTS
A partnership is defined by the Partnership Act 1890 as a relationship, which exists between two
or more persons who carry business with a view of profit.

CHARACTERISTICS OF PARTNERSHIP
• Partners are jointly and severally liable for the debts of the partnership. They have
unlimited liabilities for the debts of the partnership.
• The minimum number of partners is usually two and maximum number is twenty,
with exception of banks, where the maximum number is fixed at ten and some
professional practices where there is no maximum number.
• All partners usually participate in the running of their business.
• There is usually a written partnership agreement.

THE PARTNERSHIP AGREEMENT

The partnership agreement is a written agreement which sets up the terms of the partnership,
especially the financial arrangements between the partners.
The contents of the partnership agreement can vary from one partnership to another. A standard
Partnership Agreement may include the following items:
1. The name of the firm, business type and duration
2. Capital contribution.
3. Profit sharing ratios.
4. Interest on Capital.
5. Partners’ salaries.
6. Drawings.
7. Interest on drawings.
8. Arrangements in case of dissolution, death or retirement of partners.
9. Arrangement for settling disputes.
In absence of a formal agreement between the partners, certain rules laid down by the
Partnership Act 1890 are presumed to apply. These are:
1. Residual profits are shared equally between the partners.
2. There are no partners’ salaries.
3. No interest is charged on drawings made by the partners
4. Partners receive no interest on capital invested in the business.
5. Partners are entitled to interest of 5% per annum on any loans they advance to the
business in excess of their agreed capital.
ADVANTAGES OF PARTNERSHIP OVER SOLE TRADER
1. Additional capital from other partners, and also easier to get loans.
2. Additional expertise.
3. Additional management time.
4. Risk (losses) is shared.
DISADVANTAGES OF PARTNERSHIOP OVER A SOLE
TRADER
1. Profit are shared
2. Possibility of disputes
3. Loss of control

What is a current account?

Majority of partnership keep a fixed capital account, whenever they have fixed capital accounts,
they will have to maintain a current account for each partner. By fixed capital account, we mean
that all the appropriation and drawings will pass through a temporary capital account (current
account), only additional investment by a partner will be recorded in the capital account. This
gives information relating to long term and short term aspects separately. This also helps to
determine the investment made by partner in the business.
Some partnerships also maintain a fluctuating capital account; in this case they will not maintain
a current account. All the transactions will pass through the capital account.

Why do partnerships maintain both capital and current accounts ?

1. To keep capital invested separate from profit and drawings .
2. To simplify calculation of interest on capital , if we don’t have current accounts then
capital will keep on changing throughout the year ( as explained above) and
calculating interst would be complicated .
3. To help avoid the possibility of partners overdrawing . (since his/her profit is kept in
a separate account)

What is total share of profit?

This is different than just the remaining share of profit which we get at the end of appropriation
account. Total share of profit means out of this year’s net profit, how much profit goes to a
particular partner. As we know interest on capital and salary etc are deducted from net profit
only so they also constitute as part of profit. Hence, total share of profit is:

Interest on capital + Salary + Remaining share of Profit – Interest on drawings

LIMITED COMPANIES
Limited companies are business organizations, whose owners’ liabilities are limited to their
capital contributed or guarantees made.

CHARACTERISTICS OF LIMITED COMPANIES

1. Separate legal entity: A company is regarded as a separate person from its owners
and managers. As a result, it can sue or be sued, it can own
property. This concept is often referred to as veil of
incorporation.
2. Limited liability: Shareholders’ liability is limited to what they have paid for
shares.
3. Perpetual succession: Unlike partnership and sole trader, a company does not
cease to exist on the death or retirement of any of the
owners. Owners can buy and sell their shares without
affecting the running of the business.
4. Number of members: There is no limit as to the number of members
5. Capital: Company’s capital is raised through the issuance of shares
6. Profit distribution: Profits are distributed to members through dividends.
7. Retained profits: The retained profits are capitalized are reserves.
8. Legislation: Companies are highly regulated. They are required to
comply with the requirements of Company’s ACT as well
as Financial Reporting Standards.

ADVANTAGES OF OPERATING AS A LIMITED COMPANY:

1. The liability of the shareholders is limited. Therefore, in case of company going
bankrupt, the individual assets of the owners will not be used to meet the company’s
debts. Only shareholders who have only partly paid for their shares can be forced to pay
the balance owing on the shares, but nothing else.
2. There is a formal separation between the ownership and management of the business.
This helps in clearly identifying the responsible persons.
3. Ownership is vastly shared by many people, hence diversifying risk, and funds become
available is substantial amounts.
4. Shares in the business can be transferred relatively easily.

DISADVANTAGES:
1. Formation costs are normally very high.
2. Companies are highly regulated.
3. Running costs are also very high i.e. preparation and submission of annual returns, audit
fees etc.
4. Profit distribution is also subject to some restrictions. Not all surpluses from the business
transactions can be distributed back to the shareholders.
5. Company accounts must be available for inspection to the public.
There are two types of limited companies:
1. Public limited companies:
a- They have the abbreviation Plc of public limited company at the end of their names
b- Their minimum allotted share is required to be £50 000.
c- They can invite the general public to subscribe for their shares
d- Their shares may be traded in the stock exchange i.e. they can be quoted with the
stock exchange.
2. Private limited companies:
a- They have the abbreviation ‘Ltd’ for limited at the end of their names.
b- They are not allowed to invite general public for the subscription of their share
capital.

COMPANY FINANCE
As is a case with sole traders and partnerships, companies also have two main sources of finance,
namely; capital and liabilities. The difference is on naming and classification of these terms.
When the company is formed, it normally issues shares to be subscribed by the potential
members. People who subscribe and buy company’s shares are known as shareholders, and they
become the legal owners of the company depending in the proportion and type of shares they
hold. They receive dividends as return on their invested capital. Dividends are, therefore,
appropriations of the profits.

On the other hand, the company can borrow funds from other people who are not owners. The
main form of company borrowings is by issuing debenture, which is a written acknowledgement
of a loan to a company, given under the company’s seal. The debenture holders are not owners of
the company but they are liabilities. Debenture holders receive a fixed percentage of interest on
the loan amount. Debenture interest is a business expense, which must be paid when is due.
Other forms of borrowings include trade creditors and bank overdrafts.
The difference between shareholders and debenture holders can be analyzed in terms of:
1. Ownership; and
2. Return on investment (Debenture holders will get it even if the company makes losses)
SHARE CAPITAL
Share capital is normally of two types:
1. Ordinary share capital; and ( the real shareholders)
2. Preference share capital ( REMOVED FROM NEW SYLLABUS)

Their difference is summarized in the table below:

Aspect Ordinary shares Preference shares
Voting power Carry a vote Limited or no voting power
Dividends 1. Vary between one year to 1. Fixed percentage of the
another, depending on the nominal value.
profit for the period. 2. Cumulative. If not paid in the
2. Rank after preference year of low or no profits, it is
shareholders. carried forward to the next
3. Not cumulative. years.
3. They may be non-cumulative.
Liquidation Entitled to surplus assets on 1. Priority of payment before
(Company closing liquidation, after all liabilities and ordinary shareholders, but after
down) preference shareholders have all other liabilities.
been paid. Whatever is left, go to 2. Not entitled to surplus assets
Ordinary shareholders. on liquidation.

The distinctions between reserves, provisions and liabilities

The distinctions between reserves, provisions and liabilities are of the utmost importance and
must be learned.

Provisions are:
amounts written off or retained by way of providing for depreciation, renewals or
diminution in the value of assets.
Or, retained by way of providing for nay known liability of which the amount cannot be
determined with substantial accuracy.
Increases and decreases in provisions are debited or credited in the Profit and Loss account and
credited to a Provision account.

Reserves are:
any other amounts set aside out of profits by debiting Profit and Loss Appropriation
account and crediting the relevant provision accounts,
and amounts placed to capital reserve in accordance with the Companies Act such as share
premium, unrealized surpluses on the revaluation of non current assets, and amounts set
aside out of distributable reserves to maintain capital when shares are redeemed.

Liabilities are :amounts owing which can be determined with substantial accuracy.
 Revaluation of Non Current Assets:
Upward Revaluation :
Some assets do appreciate in value, e.g. Land and companies are allowed to revalue them.
The journal entry for revaluation is
Debit: Asset (Cost)
Provision for Depn. (Accumulated Depreciation)
Credit: Revaluation Reserve
For example:
An asset which cost $60 000 and has provision for depreciation of $8 000 is now revalued at $75
000.
In order to handle this, we should just

Debit: Asset 15 000 (Cause it was already at 60 and we want to make it 75)
Provision for Depn. 8 000 (this is always done to cancel the depreciation)
Credit: Revaluation Reserve 23 000

The 23 000 is the difference between the old Net Book Value (60 000 – 8 000) 52 000 and the
new value 75 000.
A relatively simpler case would be where there is no provision for depreciation. Like e.g. Land at
$60 000 is now revalued at $75 000.

Debit: Land 15 000

Credit: Revaluation Reserve 15 000

Downward Revaluation :
Some assets also decrease in value and company’s are supposed to record the loss in value . The
amount of loss can be offset against a previously created revaluation reserve ( if there is enough
balance) other wise it has to be deducted from the income statement or retained earnings
For Example
An Asset with value of $70000 is revalued at $60000. There is a balance of $6000 in the
revaluation reserve .
Journal Entry Will be
Debit : Revaluation Reserve 6000
Debit : Retained Earnings/Income Statement 4000
Credit : Asset 10000
ISSUE OF SHARES
Public Issue: This is normal issue of shares to general public. A company can issue shares to
public to raise more capital , this is done at the market price. Public issues have higher cost of
issue ( this means the company has to incur high expenses when issuing the shares I.e.
advertising and administration ). The main advantage of issuing shares is that no interest has to
be paid on it and the company only have to provide a return when they actually make profits.
Rights Issue : A rights issue represents the offer of shares to the existing shareholders in
proportion to their existing holding at a lower price compared to the market value.
Advantages of Rights Issue over Public issue
• Rights issue are cheaper to administer and less risky way of raising capital
• Shareholders will get some incentive as they will get shares at a lower price.
Disadvantages
• Market price will fall
• The company could have raised more funds through a public issue
Bonus Issue: Is the issue of shares to existing shareholders for free .When the company is short
of cash and can’t give dividends so they give out shares for free to the ordinary shareholders.
Other reasons for bonus issue include.
• To utilize the capital reserves
• To increase confidence in the company’s future prospects as it is normally taken as a
signal of strength by the general public.
Disadvantages of Bonus Issue:
- Company does not receive any cash
- Market price will fall
- Shareholders expecting cash dividends might be disappointed

When doing bonus issue company will always use capital reserves first and then the revenue
reserves i.e. ( keeping in the most flexible form)
We use share premium first but if we don’t have enough balance in both of these reserves then
we will move to
• General Reserve
• Profit and Loss. ( Retained Earnings)
Note: Revaluation Reserve cannot be used for BONUS
ISSUE
DEBENTURES
A debenture is a document containing details of a loan made to a company. The loan may be secured on
the assets of the company, when it is known as a mortgage debenture. If the security for the loan is on
certain specified assets of the company, the debenture is said to be secured by a fixed charge on the
assets. If the assets are not specified, but the security is on the assets as they may exist from time to time,
it is known as a floating charge on the assets. An unsecured debenture is known as a simple or naked
debenture.
Debentures carry the right to a fixed rate of interest which forms part of the subscription of the
debentures.. The interest must be paid whether or not the company makes a profit. This is one of the
distinctions between debentures, and shares on which dividends may only be paid if profits are available.
Debenture interest is debited as an expense in the Profit and Loss account to arrive at the profit before tax.

RESERVES
The net assets of the company are represented with capital and reserves. While capital represents the
claim that owners have because of the number if shares they own, reserves represent the claim that
owners have because of the wealth created by the company over the years but not distributed to them.
There are two main types of reserves:
Revenue Reserve
The reserves which arise from profit (Trading activities of the company) Examples include General
Reserve and Retained Earnings.
Dividends can only be paid to the amount of revenue reserve on the statement of financial position. i.e.
the maximum dividend possible is the sum of both revenue reserves.
Capital Reserve
These are reserves which the company is required to set up by law and cannot be distributed as dividends.
They normally arise out of capital transactions. These include Share Premium and Revaluation Reserve.
Share Premium
Share premium occurs when a company issues shares at a price above its nominal (par) value. This excess
of share price over nominal value is what is known as share premium.
What are the uses of Share Premium?
1. Issue Bonus Shares
2. Write off Formation (Preliminary Expenses)
3. Write off Goodwill.
Revaluation Reserve
When value of Assets go up , companies are allowed to revalue them upwards but gain has to be
recorded in a reserve rather then income statement . This reserve can only be used to devalue the same
asset which was revalued upwards before
Users of Accounting Information
International Accounting Standards
Financial statements are used by a variety of groups for a variety of reasons. The following tableInternational Accounting
identifies the typical Standards
user groups
of financial statements and the reasons for using them
Users
Users of
of financial
financial statements
statements
Financial
Financial statements
statementsare areused
usedby byaavariety
varietyofofgroups
groupsfor
foraavariety
varietyofofreasons.
reasons.TheTheframework
frameworksurrounding
surrounding
IAS
IAS identifies
identifies the
thetypical
typicaluser
usergroups
groupsof
ofaccounting
accountingstatements.
statements.TheThetable
tablebelow
belowidentifies
identifiesthe
theuser
usergroups
groups
(stakeholders) and gives likely reasons for the user groups to refer to financial statements.
(stakeholders) and gives likely reasons for the user groups to refer to financial statements.

Main
Main users
users Reasons
Reasonsfor
foruse
use
to assess efficiency of the stewardship of management
Owners to assess efficiency of the stewardship of management
Owners to assess performance in relation to payment of dividend
to assess performance in relation to payment of dividend
to assess efficiency of their strategies by comparing with
Managers to assess efficiency of their strategies by comparing with
Managers previous years or with similar businesses
previous years or with similar businesses
Investors to assess past performance as a basis for future investment
Investors to assess past performance as a basis for future investment
to assess performance as a basis of future wage and salary
to assess performance as a basis of future wage and salary
negotiations
Employees negotiations
Employees to assess performance as a basis for continuity of
to assess performance as a basis for continuity of
employment and job security
employment and job security
to assess performance in relation to the security of their loan
to assess performance in relation to the security of their loan
to the business
Lenders to the business
Lenders to assess the performance in relation to payment of the
to assess the performance in relation to payment of the
interest (finance cost) on the loan provided
interest (finance cost) on the loan provided
to assess performance in relation to receiving payment of
Suppliers to assess performance in relation to receiving payment of
Suppliers their liability
their liability
to assess performance in relation to the likelihood of
Customers to assessofperformance in relation to the likelihood of
Customers continuity trading
continuity of trading
to assess performance in relation to compliance with
Government to assess performance in relation to compliance
Government regulations and assessment of taxation liabilities with
regulations and assessment of taxation liabilities
Public and environmental bodies to assess performance in relation to ethical trading
Public and environmental bodies to assess performance in relation to ethical trading

Qualitative characteristics
Qualitative characteristics
As shown above, financial statements are prepared for a variety of reasons. The Conceptual Framework for
As shown above, financial statements are prepared for a variety of reasons. The Conceptual Framework for
Financial Reporting developed by the International Accounting Standards Board (IASB) sets out the
Financial Reporting developed by the International Accounting Standards Board (IASB) sets out the
qualitative characteristics of the financial statements that makes them useful to the users:
qualitative characteristics of the financial statements that makes them useful to the users:
Fundamental qualitative characteristics
Fundamental qualitative characteristics
Relevance – the information influences the economic decisions of users.
Relevance – the information influences the economic decisions of users.
Faithful representation – the information must be complete, neutral and free from errors.
Faithful representation – the information must be complete, neutral and free from errors.
Enhancing qualitative characteristics
Enhancing qualitative characteristics
Comparability – the information enables comparisons with similar information about other entities
Comparability
and – the information
with similar information about enables
the samecomparisons withto
entity over time similar information
identify about
and evaluate other entities
trends.
and with similar information about the same entity over time to identify and evaluate trends.
Verifiability – the information is faithfully represented and can be verified, providing assurance to the
Verifiability
user that it is – thecredible
both information
and is faithfully represented and can be verified, providing assurance to the
reliable.
user that it is both credible and reliable.
 RATIOS
PROFITABILITY
1.GROSS PROFIT MARGIN (Gross Profit x 100 )
Net Sales
While the gross profit is a dollar amount, the gross profit margin is expressed as a percentage of
net sales. The Gross Profit Margin illustrates the profit a company makes after paying off its
Cost of Goods sold. The Gross Profit Margin shows how efficient the management is in using its
labour and raw materials in the process of production (In case of a trader, how efficient the
management is in purchasing the good). There are two key ways for you to improve your gross
profit margin. First, you can increase your process. Second, you can decrease the costs of the
goods. Once you calculate the gross profit margin of a firm, compare it with industry standards
or with the ratio of last year. For example, it does not make sense to compare the profit margin of
a software company (typically 90%) with that of an airline company (5%).
Reasons for this ratio to go UP (opposite for down)
1. Increase in selling price per unit
2. Decrease in purchase price per unit due to lower quality of goods or a different supplier.
3. Decrease in purchase price per unit due to bulk (trade) discounts.
4. Extensive advertising raising sales volume (units) along with selling price.
5. Understatement of opening stock.
6. Overstatement of closing stock.
7. Decrease in carriage inwards/Duties (trading expenses)
8. Change in Sales Mix (maybe we are selling some new products which give a higher
margin).

2. PROFIT MARGIN (Profit for the year x 100 )

Net Sales
Profit margin tells you exactly how the management and operations of a business are performing.
Profit Margin compares the profit of a firm with total sales achieved. The main difference
between GP Margin and profit Margin are the overhead expenses (Expenses and loss). In some
businesses Gross Margin is very high but Net Margin is low due to high expenses, e.g. Software
Company will have high Research expenses.
Reasons for this ratio to go UP (opposite for down)
All the reasons for GP margin apply here. Additionally
1. Increase in cash discounts from suppliers
2. A decrease in overhead expenses
3. Increase in other incomes like gain on disposal, Rent Received etc.
3.Return on Capital Employed (ROCE)
This is the key profitability ratio since it calculates return on amount invested in the business. If
this ratio is high, this means more profitability (In exam if ROCE is higher for any firm it is
better than the other firm irrespective of GP and Profit Margin). This return is important as it can
be compared to other businesses and potential investment or even the Interest rate offered by the
bank. If ROCE is lower than the bank interest then the owner should shoot himself. This ratio
can go up if profits increase and capital employed remains the same. Also if Capital employed
decreases, this ratio might go up.

Operating Profit_ x 100

Capital Employed
Net Profit before Interest and Tax

NOTE:
Capital Employed = Non Current Assets + Current Assets – Current
Liabilities

OR
= Total Equity + Non Current Liabilities

LIQUIDITY RATIOS
As we know a firm has to have different liquidity. In other words they have to be able to meet
their day to day payments. It is no good having your money tied up or invested so that you
haven’t enough money to meet your bills! Current assets and liabilities are an important part of
this liquidity and so to measure the firms liquidity situation we can work out a ratio. The current
ratio is worked out by dividing the current assets by the current liabilities.

1.CURRENT RATIO = Current assets _

Current liabilities
The figure should always be above 1 or the form does not have enough assets to meet its
liabilities and is therefore technically insolvent. However, a figure close to 1 would be a little
close for a firm as they would only just be able to meet their liabilities and so a figure of between
1.5 and 2 is generally considered being desirable. A figure of 2 means that they can meet their
liabilities twice over and so is safe for them. If the figure is any bigger than this then the firm
may be tying too much of their money in a form that is not earning them anything. If the current
ratio is bigger than 2 they should therefore perhaps consider investing some for a longer period
to earn them more.
However, the current assets also include the firm’s inventory. If the firm has a high level of inventory, it
may mean one of the two things,
1. Sales are booming and they’re producing a lot to keep up with demand.
2. They can’t sell all they’re producing and it’s piling up in the warehouse!
If the second of these is true then inventory may not be a very useful current asset, and even if
they could sell it isn’t as liquid as cash in the bank, and so a better measure of liquidity is the
ACID TEST (or QUICK) RATIO. This excludes inventory from the current assets, but is
otherwise the same as the current ratio.

2.ACID TEST RATIO =Current assets – Inventory

Current liabilities

Ideally this figure should also be above 1.5 for the firm to be comfortable. That would mean that
they can meet all their liabilities without having to pay any of their stock and still have some
buffer. This would make potential investors feel more comfortable about their liquidity. If the
figure is below 1, they may begin to get worried about their firm’s ability to meet its debts. Any
figure above 2:1 is considered too much liquidity

Note : Working Capital = Current Assets – Current Liabilities

Utilization Ratios/Efficiency Ratios

1.Rate of Inventory Turnover (times)
It shows the number of times, on average, that the business will sell its stock in a given period of
time. It basically gives an indication of how well the stock has been managed. A high ratio is
desirable because the quicker the inventory is turned over, more profit can be generated. A low
ratio indicates that Inventory are kept for a longer period of time (which is not good).

Cost of Goods Sold = ____ Times ( higher the better)

Average Inventory
Note:
Average Inventory = Opening + Closing
2
2.Inventory Days:
This is Rate of Inventory turnover in days. Lower the better.

Average Inventory x 365 = ____ Days ( lower the better)

Cost of Goods Sold

3.Trade Recieveables Days( Collection Period)

Shows how long it takes on average to recover the money from debtors. Lower the better.

Closing Trade Receiveables x 365 = ____ Days (lower the better)

Credit Sales
4.Trade Payables Days: (Payment Period)
Shows how long it takes on average to payback the creditors. Higher the better.

Closing Trade Payables x 365 = ____ Days (higher the better)

Credit Purchases

5..Non Current Asset Utilization (Non Current Asset Turnover)

Shows how much sales are being generated on Non current assets. Higher ratio indicates better
utilization of Non current Assets. As every business would want to achieve more sales on less
Non Current Assets.
Net Sales = ____ Times
Non Current Assets

Advantages of Ratios
1. Shows a trend
2. Helps to compare a single firm over a two years (time – series)
3. Helps to compare to similar firms over a particular year.
4. Helps in making decisions
Disadvantages (Limitations):
1. A ratio on its own is isolated (We need to compare it with some figures)
2. Depends upon the reliability of the information from which ratios are calculated.
3. Different industries will have different ideal ratios.
4. Different companies have different accounting policies. E.g. Method of depreciation
used.
5. Ratios do not take inflation into account.
6. Ratios can over simplify a situation so can be misleading.
7. Outside influences can affect ratios e.g. world economy, trade cycles.
8. After calculating ratios we still have to analyze them in order to derive a conclusion.
How to Comment:
Usually in CIE they assign 2 marks for comment on each ratio. One mark is for indicating if the
ratio is better or worse (not higher or lower). The second mark is to explain the importance or
the reason of the change in ratio. For e.g. If Gross Profit Margin was 40% and now its 50%, you
should say that the Gross profit Margin has improved (rather than increased) and this may be due
to an increase in selling price or a decrease in cost of goods sold (depending upon the question).
Also remember that the liquidity and utilization ratios should be close to industry average. Too
less or too much liquidity is bad!
At the end of your answer, always give a conclusion
• When comparing a single firm over two years then do mention performance of which
year is better. (In terms of profitability and liquidity)
• When comparing two different firms over the same year do mention performance of
which firm is better. (In terms of profitability and liquidity).

If the question says evaluate profitability then use (GP Margin, Profit Margin and ROCE)

If the question says evaluate liquidity, use (Current Ratio and Acid Test)

If the question says efficiency then use ( Inventory Turnover , Non current Turnover

If the question says evaluate the performance it means profitability , liquidity and efficiency

Best way:
2 – Profitability
2 – Liquidity &
2 – Utilization(efficiency)
LOAN VS BANK OVERDRAFT
Whenever a business (company/partnership/sole trader) needs money there are multiple
sources of finance available . Each has its own advantage and disadvantage

1. Long term Loan

Advantage
- Fixed rate of interest
- Helps plan cashflow as have to be repaid later
Disadvantage
- Interest paid for the whole period ( difficult to payback before the set date)
- May need a collateral

2. Bank Overdraft
Advantage
- No interest charged if not used
- Can be repaid easily
Disadvantage
- Higher rate of interest then loan
- Can be called in by the bank at any time
INVENTORY VALUATION ( STOCK)
Remember stock is valued at lower of cost or net realisable value (N.R.V). This is basically the
current market value of the stock after deducting any repair cost. This is application of the
prudence concept.
E.g. If a piece of stock costing $40 is damaged. Now it can be sold for $48 but only if $10 of
repair is undertaken. This means the NRV of stock is 38 (48 – 10). Since NRV (38) is lower than
the cost (40), we should value it as 38. It lets say the NRV was $41, then than the stock would
have been valued at $40.

Assumptions in Stock Valuations

FIFO
Advantages
1. Good representation of sound storekeeping as oldest stock is issued first.
2. Stock is shown close to the current market value (because it is valued at most recent
price)
3. This method is acceptable by accounting regulations
Disadvantages
1. In inflation stock is valued the highest and it overstates profit
2. Since the value of stock issued fluctuates, this will lead to a different cost for an identical
unit.
AVCO
Advantages
1. Since the value of stock issued does not fluctuate, this will lead to a same cost for an
identical unit.
2. This method is acceptable by accounting regulations.
Disadvantages
1. Difficult to calculate.
2. Average price does not represents the true value of stock

NOTE:LAST IN FIRST OUT(LIFO) IS NO LONGER ALLOWED

 ACCOUNTING CONCEPTS
TABLE/SUMMARY/SNAPSHOT OF ACCOUNTING CONCEPTS/CONVENTION

1.Accounting period Also known as Time Period where business operation can be
Concept divided into specific period of time such as month, a quarter
or a year (accounting period)

Final accounts are prepared at the end of the accounting

period, i.e. one year. Internal accounts can be prepared
monthly, quarterly or half yearly.

2.Accrual Concept / Requires all revenues and expenses to be taken into account
Matching for the period in which they are earned and incurred when
determining the profit / (loss) of the business. The net profit /
(loss) is the difference between the revenue EARNED and the
expenses INCURRED and not the difference between the
revenue RECEIVED and expenses PAID.
Major application of this concept is
1. prepayments and accruals
2. Depreciation of Non current Assets
3. Bad debts and Provision for doubtful debts
4. Capitalization of development cost

3.Business Entity Also known as Accounting Entity or Separate Entity

convention which states that the business is an entity or body
separate from its owner. Therefore business records should be
separated and distinct from personal records of business
owner.
Major application of this concept is
1. Capital accounts and Drawings account are kept for
the owner
2. Owners personal transactions are not recorded in
business books
4.Consistency According to this convention, accounting practices should
Concept remain unchanged from one period to another unless there is a
proper need to change them. For example, if depreciation is
charged on non current assets according to a particular
method, it should be done year after year. This is necessary
for purpose of comparison.
But if a wrong policy has been applied in the previous years
like straight line method for Machinery then we can change
the policy to reducing balance method ( the change must be
disclosed in the accounts to the stakeholders)

5.Dual Aspect Double entry system. For every debit, there is a credit entry of
Concept(Duality) an equal amount. All transactions in accounting are recorded
in this form.

6.Going Concern The business will follow accounting concepts and methods on
Concept the assumption that business will continue its operation to the
foreseeable future or for an indefinite period of time. The
major application of this concept is that we record our assets
at cost less estimated deprecation rather then the market
values . Since we know that the market values will keep on
changing and we have to continue our business . BUT if the
business is about to shut down then the Non current assets
must be shown at market values ( disposal values)

Business should report its activities or economic events at

7.Historical Cost their actual costs. For example, Non current assets are
Concept recorded at their cost in account except for land which can be
revalued due to appreciation

The concept of materiality recognises that some types of

8.Materiality Concept expenditure are less important in a business context than
others. So, absolute precision in the recording of these
transactions is not absolutely essential. For example : A
business purchases a ruler. The ruler costs $0.45. It estimated
that the ruler should last for three years. Technically, the ruler
is a non-current asset and should therefore be classified as
capital expenditure. To do this would be rather silly for such a
trivial amount. The $0.45 would be treated as revenue
expenditure and would be debited to either general expenses
or office expenses. This treatment is not going to have a
significant impact on profits or the valuation of net assets on a
statement of financial position – the absolute accuracy of its
treatment is not material.
 Also known as Monetary unit. Transactions related to the
9.Money business, and having money value are recorded in the books
Measurement of accounts. Events or transactions which cannot be expressed
Concept in term of money do not find a place in the books of accounts.
For example motivation / skill / morale of employees cannot
be recorded in accounts. Also the internally generated
goodwill of the business should be written off immediately

Take into account unrealized losses, not unrealized

10.Prudence / profits/gains. Assets should not be over-valued, liabilities
Conservatism under-valued. Provisions are example of prudence or
Concept conservatism concept. Also under this prudence/conservatism
concept, stock/inventory is value at lower of cost or market
value. This concept guides accountants to choose option that
minimize the possibility of overstating an asset or income.
Major Applications include
1. Provision for doubtful debts
2. Provision for depreciation
3. Valuation of inventory
4. Writing off goodwill

11.Substance Over Real substance takes over legal form namely we consider the
Form economic or accounting point of view rather than the legal
point of view in recording transactions. Major application is
when we are leasing the assets we don’t have the legal
ownership but the economic benefits do flow towards the firm
so it is recorded as an asset .

12. Realization The realization Principle is a revenue recognition principle

Concept that states that the income or revenue is recognized only when
earned. The company is reasonably certain that the payment
against the same will be received from the customer. It
generally occurs when the underlying goods are delivered,
risk and rewards are transferred, or income gets due,
irrespective of whether the amount is received or not.
13.Objectivity Concept The objectivity principle in accounting states that financial
statements should be objective, i.e., the accounting
information should be unbiased and free from any external or
internal influence( Based on facts) This helps financial
statements to be trustworthy and useful for evaluation
Computerized Accounting Systems. The business world is becoming
increasingly competitive with each passing year and changing at a pace never before seen.
Businesses today are competing in a global economy and to cope with these pressures managers
need to take full advantageof all aspects of information technology. It has been said that
‘information is one of the most important resources’ that managers have. This information
includes records of the activities of all stakeholders – customers, suppliers and staff – and how
the business deals with them through its activities that involve inventory, payroll, etc. Customers
and suppliers expect a business to be efficient. Managers need to react to stakeholder
requirements quickly and efficiently, so reaction time is of the essence. Information technology
(IT) makes relevant and detailed data available at the click of a mouse.

Nearly all managers of businesses that use a double-entry system of recording financial
transactions will use a computer in some, if not all, parts of their business.

As the use of computers has increased in all kinds and sizes of business, the use of handwritten
entries in the accounting system has steadily decreased; paper documents have given way to
onscreen documents and computer printouts.

The underlying system of accounting remains unaltered but the speed at which information is
processed and made available to users has greatly increased. In any accounting system all
transactions have a ‘knock on effect’; all transactions are interrelated and interdependent and an
efficient computerised accounting system will provide useful feedback to management and staff.

A good IT system of computerised accounting will allow all levels of management to:

● create plans

● put those plans into practice

● control activities

● evaluate outcomes so that adjustments to the business can be made and any errors can be
rectified quickly.

A computerised accounting system provides managers with instant and up-to-date reliable
information in real time that can be used to plan and control the business, allowing prompt
decision making. Information obtained from the computerised accounting system can be used to
help guide and control business policy.

Advantages of introducing a computerised accounting system

● Speed:Data entry into the system can be carried out much more quickly than if done manually.
One entry can be processed into a multitude of different areas. For example one entry can be
made that will simultaneously update a customer’s account, sales account in the general
(nominal) ledger and inventory records.
● Accuracy: Provided that the original entry is correct there are fewer areas where an error can
be made since only one entry is necessary to provide the data that is replicated throughout the
system.

● Automatic document production: Fast and accurate invoices and credit notes are produced
and processed in the appropriate sections of the system.

● Availability of information: Accounting records are automatically updated once information

is keyed in. This information is then readily available to anyone within the organisation who
requires it.

● Taxation returns: Information required by tax authorities is available at the touch of a button.

● Legibility: Data are always legible, whether shown on screen or as a printout. This reduces the
possibility of errors caused by poor handwriting.

● Efficiency: Time saved may mean that staff resources can be put to better use in other areas of
the business.

● Staffmotivation: Since staff require training to acquire the necessary skills to use a
computerised accounting system, their career and promotion prospects are en- hanced, both
within their current role and for future employment. Some staff may benefit from increased
responsibility, job satisfaction and pay.

Disadvantages of introducing a computerised accounting system

● Hardware costs: The initial costs of installing a computerised accounting system can be
expensive. Once the decision has been made to install a system, the hardware will inevitably
need to be updated and replaced on a regular basis, leading to further costs.

● Software costs: Accounting software needs to be kept up to date. Investment in software

therefore requires a long-term financial commitment.

● Staff
training: Staff will need training to use the software and training updates each time the
system is modified.

● Opposition from staff: Some staff may feel demotivated at the prospect of using a
computerised system. Other members of staff may fear that the introduction of a new system will
lead to staff redundancies, which could include them. Changing to a computerised system can
cause disruption in the workplace and changes to existing working practices may make staff feel
uneasy.

● Inputting errors: Staff can become complacent because inputting into the system becomes
more repetitive and therefore they may lose concentration which can lead to input errors.
● Damage to health: There are many cases of reported health hazards to staff working long
hours at a computer terminal. The health issues range from repetitive strain injuries through to
backache and headaches.

● Back-up requirements: All work entered into the computerised accounting system must be
backed up regularly in case there is a failure of the system. Much workhas to be printed out on
paper as a back-up, so hard copies might require further expenditure on secure storage facilities.

● Security breaches: There is always a danger that computer hackers might try to breach the
security of the accounting system while others may try to gain access to hard copy. Some might
argue that a computerised system makes staff fraud simpler to achieve. A computer system that
communicates with outside agencies such as customers, suppliers and government agencies
means there is always the danger of infection from software viruses. Robust anti-virus protection
and firewalls will need to be put in place to protect sensitive and important data.

How to ensure security of data in computerized accounting system?

1. Use of cloud servers

2. Use of Anti -Virus softwares
3. Data Encryption and Passwords
4. No storage of data on personal computers
5. Training of staff related to data security
6. Shredding of data on a Regular Basis
7. Firewalls ( blocking unauthorized access to the network)

Moving from a manual to a computerised system When a computerised accounting

system is first installed great care must be taken to ensure that the transition from manual records
to computer records is smooth and accurate. The opening entries in the computerised system
should be double checked by different members of staff. The check can take the form of, say, a
manually prepared control account which is then compared with a printout; clearly the two
should match. Similarly, a manually prepared trial balance can be compared to a trial balance
extracted from the computer. A system of protective devices (firewalls, virus protection, etc.)
must also be introduced into the system. Each member of staff should have a unique password
allowing access to their area(s) of responsibility within the system. Also its very important to run
both manual and computerized system initially so that an easy transition can be done , Once we
are confident on the new computerized system we can completely discontinue the manual system
.
COST ACCOUNTING
What is Cost Accounting?
Cost accounting is basically the determination of cost whether for a specified thing or activity.
To determine cost, we need to apply accounting and costing principles and techniques. The cost
accounting information is used within the business for planning, controlling and decision
making.
What is a Cost Centre?
Cost centre is the area or a department in a business for which cost are accumulated. There are
two main types of Cost Centres
• Production Cost Centre: Departments which are involved directly in production of a
product. For example, Moulding, Cutting or Assemble Department.
• Service Cost Centre: Departments in which production doesn’t take place but they
provide service to the production departments. For example: store Department or
Maintenance Department.
What is a Cost Unit?
Costs are always related to some object or function or service. For example, the cost of a car, a
haircut, a ton of coal etc. Such units are known as cost units and can be defined as

‘A unit of product or service in relation to which costs are determined’.

Cost unit may be units of production, e.g. kilos of cement, one chair ,one table OR may be units
of service, e.g. consulting hours, Patient nights, Kilowatt hour.

How is cost classified?

There are three possible classifications

• Type 1: Direct and Indirect Cost (classification as per traceability of cost)

Direct cost: This includes all such cost which can easily be traced to the item being
manufactured. E.g. Direct Material, Direct Labour and Direct Expenses (royalties or artwork).
There can also be Direct Selling Cost like Installation or Sales Commission.

Indirect Cost: All the cost which cannot be easily traced to the item is the Indirect Cost. These
are widely known as Overheads. Overheads can be production or non-production (selling and
administration).

• Type 2: Production and Non-Production Cost (classification as per function)

Any cost which is incurred in manufacturing the item is referred as Production Cost. All the
other cost is Non production (Selling ) , Non production ( Administration ) , Non Production (
Financial charges).
 • Type 3: Variable and Fixed Cost ( classification as per behavior of cost)
Variable Cost: Those cost that change in total in direct proportion to changes in level of activity.
An increase/decrease in activity brings proportional increase/decrease in total variable cost. E.g.
Direct Material, Direct Labor. Always remember Variable Cost per Unit will remain constant.

Fixed cost: Those cost that DOES NOT change regardless of changes in activity level. E.g. Rent,
Depreciation etc. Fixed Cost does not change in Total but Fixed Cost per unit will decrease as
more units are produced.

Semi Variable (Mixed) Cost: Include both fixed and variable elements. For example Repairs,
Maintenance and Electricity.

For example the cost of a service: $2 per unit produced up to a maximum of $5 000 per year will
show the following pattern on a graph:
Another example of semi-variable costs in the form of standing charge of $2 500 for
maintenance charges for a specific level plus a charge of $ 5 per unit to a maximum of $10 000
per year, will show the following outline on a graph:

The graphs for the fixed cost per unit and variable cost per unit look exactly opposite to total
fixed costs and total variable costs graphs. Although total fixed costs are constant, the fixed cost
per unit changes with the number of units. The variable cost per unit is constant.
What is the difference between direct cost and variable cost?
The direct cost is directly related to a product and it can be easily traced to the item being
manufactured but it does not include any type of variable overheads. The variable cost includes
all direct cost and variable overheads as well. For e.g. the variable part of the electricity.

What is a Sunk Cost?

This is an expenditure which has already been incurred and it has no importance in future
decision making since the cost has already been spent. For example, a business conducts a
feasibility study of buying a new machine and incurs an expense of $5 000. Now whether the
machine is brought or not, $5,000 has already been spent and cannot be recovered, so we should
not consider them in decision making. This cost is treated as an expense in the profit and loss
account for the year. Other example would be cost incurred on market research before launching
a new product.

What is Stepped Cost?

This is type of cost which is constant till a certain level of Activity (Relevant Range) but it will
increase significantly as the activity level increases. For example Rent is constant till the factory
maximum capacity is reached but then we need another factory to increase production so the rent
will double. If we plot this on a graph it will look like.
 ABSORPTION COSTING

What is Absorption Costing?

It is a costing method in which the overheads (estimated) of a manufacturing business are

charged first to a cost centre (departments) by means of allocation and apportionment and then a
predetermined overhead absorption rate is calculated to charge the amount of overheads onto a
job or a product. The overheads may be absorbed on the basis of activity like direct labor hours,
machine hours or direct labor cost or direct material cost. The basis of absorption depends upon
the intensity of the department. E.g. a machine intensive department would use machine hours.

What is Overhead Absorption rate?

A manufacturer needs to calculate the total cost of the product before he actually produces it.
This is because once the total cost is determined, he or she can set the selling price. Since the
Overhead cost is not easy to trace, a rate is calculated in order to trace the overheads as per the
level of activity. For example, if the overhead Absorption Rate is $3 per direct labor hour and a
particular unit requires 4 hours of labour, the amount of Overheads charged will be $3 x 4 hours
= $12.

Formula for Overhead Absorption Rate (OAR) = Budgeted Overheads _

Budgeted Activity (e.g. Labor hours)

Why do we use Budgeted figures?

As mentioned above, cost has to be determined before the actual production takes place. The
actual overheads and activity is not known at that point. This would make it impossible to quote
the selling price to the customer.

How are Overheads Allocated and Apportioned to the departments?

Firstly all the overheads are split amongst the department by using suitable basis. For some
overheads we don’t need to use basis because they are pre allocated, e.g. indirect materials (they
are usually divided between the departments), and some overheads need to be apportioned using
suitable basis, e.g. rent can be split on basis of floor area. Once all the overheads are shared to
departments (Primary Apportionment), the cost of service departments is re-apportioned
(Secondary Apportionment) to the production department since they provide service to the
production departments.

Some factories do not split the overheads into different departments and just calculate a single
overhead absorption rate for the whole factory. This method is less accurate than the method in
which separate rates are calculated for each department.
What is Over or Under absorption of overheads?

The Overhead Absorption Rate is calculated using budgeted figures but the actual figures of
overheads and activity are always different. This causes a difference between the amount of
overheads absorbed and the actual overheads spend.

Remember Absorbed Overheads mean the amount of overheads we have applied to our cost of
production.

Absorbed Overheads = Budgeted Overheads x Actual Activity

Budgeted Activity

To determine the amount of overhead absorbed and under absorbed always compare the
Absorbed Overheads with Actual Overheads.

Over Absorption occurs when Absorbed Overheads are more that the Actual Overheads (that’s
why its called Over Absorbed, Absorbed is more). This basically means we have over charged
the cost. (Should be treated as a gain in the profit statement because profit is understated).

Under Absorption occurs when Absorbed Overheads are less than the Actual Overheads (that’s
why it’s called Under Absorbed, Absorbed is less). This basically means we have under charged
the cost. (Should be treated as a loss in profit statement because profit is overstated)

What are different types of Overhead Absorption Rates (OAR)

Overhead absorption rate can be calculated on different basis. Remember that best
methods to use are either machine hour or labor hour , depending upon if the department
(or the factory) is machine intensive or labor intensive. But following OAR’S are used by
different businesses.
1. Machine Hours
2. Labor Hours
3. Direct Wages (Direct Labor Cost)
4. Direct Material (Direct Material Cost)
5. Prime Cost
6. Per Unit Rate

Which Rate is Most Appropriate ?

Like I said before time based rates like machine hour and labor hour are the most appropriate
depending on the intensity of the factory. The other rates are useful when
Per Unit Rate : If all products produced are very similar in nature
Direct Labor Cost Rate : If similar products and labor is paid uniformly
Direct Material Cost Rate : Material of uniform value , production time proportional to
material usage ,similar type of equipment used in all products

However the machine hour rate ( if capital intensive ) and labor hour rate ( if labor intensive ) are
used most widely.

What are the problems with using pre-determined ( Budgeted OAR) ?

Use of estimated data can lead to inaccurate costing and results in over or under absorption of
overheads. If the cost absorbed is too low ( under absorbed) this will lead to an understated cost
which will effects profit of the business ( as our selling price based on budgeted cost will be
low). On the other hand if absorbed cost is too high ( over absorbed) this will overstate cost
making the product uncompetitive and will reduce demand.

What is a good format to show the total cost of any order/job/unit/batch?

Direct Material
+ Direct Labor
+ Direct production expense (if any) e.g. royalties or artwork.
= Prime Cost
Add: Factory Overheads
+ Department A
+ Department B
= Cost of Production
Add: Selling and Admin cost (if any)
Installation or Delivery
General Admin Overheads
= Total Cost

Advantages and Limitations of Absorption Costing

Advantages:
- Helps to calculate full cost of a prodcut
- It is accepted by all relevant accounting bodies for financial reporting
purposes.
- Takes into account all production cost so its better for calculating selling price.
- More accurate picture of profits as compared to marginal costing.

Disadvantages:
- Doesn’t help in decision making ( as doesn’t give contribution)
- Difficulty in apportionment of fixed cost ( estimation has to be used)
- Huge variation in output will change the cost significantly .
Marginal Costing
It is a costing technique for decision making, which is based on marginal (variable) cost of a
product. It emphasizes on cost behavior and clearly distinguishes between variable cost and fixed
cost. It is based on the principle that due to change in level of activity only the variable cost
change and the fixed cost remain constant.

What is a marginal cost?

This is all the variable cost to produce and sell a unit. It may be described as the additional cost
to produce and sell each additional unit. This includes Direct Material (DM), Direct Labor (DL),
Direct Expenses, Variable Production Overheads and Variable Admin Overheads and Variable
Selling Overheads. Basically the entire possible variable cost.

What is Contribution?
This is amount left to cover for fixed cost and profit.

Total Contribution = Sales – Variable Cost (Marginal Cost)

Contribution/ unit = Selling Price/ unit – Variable Cost

Or

Contribution/ unit = Total Contribution/ number of units

Note: Sales – Variable Cost = Contribution – Fixed Cost = Profit

So Contribution = Fixed Cost + Profit

As mentioned above the amount for fixed cost and profit.

USES OF MARGINAL COSTING (INCLUDES THE RULES FOR
DECISION MAKING)
Marginal costing is widely used by the managers in making various business decisions. The
concept is that, it is assumed that the fixed cost will not change so all decisions are based
keeping this fact in mind.

• Provides quick calculation of total cost. As the fixed cost remains constant and only the
variable cost changes
Total Cost = (variable cost/ unit x no. of units) + Fixed cost

• Provides quick calculation of profit at different levels

Profit = (Contribution/ unit x no. of units) – Fixed Cost
• Used in break-even analysis (see below)

• Helps in making decision on whether to make a product or buy from outside.

Rule: Only buy from outside if his price is lower than our variable cost to
produce (variable cost to producer does not include variable selling overheads)

• Helps in decision making on acceptance or rejection of special orders under idle capacity.

Rule: Accept all orders under idle capacity as long as it covers the variable cost.
In other words, it gives a positive contribution.

• Helps in making decision on whether to continue or discontinue a product.

Rule: Continue products giving positive contribution unless a replacement
product can generate more positive contribution. Discontinue the product giving
negative contribution. This is because the fixed cost should be ignored as it
doesn’t changes with decision to continue or discontinue. Hence a product which
is making a loss (negative net profit) but is giving a positive contribution should
not be discontinued.

Similarly a product which might give a positive contribution should be added to current
product range.
COMPARISON OF ABSORPTION AND MARGINAL COSTING

ABSORPTION COSTING MARGINAL COSTING

1. It is based on total production cost It is based only on variable cost.
including variable and fixed costs.
2. It divides cost into production and non It divides cost between variable and
production fixed.
3. Stocks include the total production cost Stocks include only the variable
(DM, DL, VPOH and FPOH) production cost (DM, DL and VPOH)
4. It is more suitable for external use as the It is more suitable for internal use as
profit and loss is based on this. decisions are based on this
5. Treats fixed cost as a product cost. Treats Fixed cost as a period cost.
6. Gives Gross Profit Gives Contribution.
7. Required adjustment for Over and Under No adjustment is required as actual fixed
Absorbed. cost is taken.

Breakeven Analysis (CVP ANALYSIS)

Formulas:
Contribution to Sales Ratio = Contribution per unit/ Selling price per unit Or
(csratio) Total Contribution/Total Sales

Breakeven in Units = Fixed Cost / Contribution per unit

Breakeven in value (Sales Revenue) = Breakeven in Units x Selling Price / Unit
or
Fixed Cost/Cs Ratio

Margin of Safety:
This represents the difference between the actual (or budgeted) level of activity and the
breakeven level of activity. For e.g. if a factory produces (or plans or produce) 6 000 units and
the breakeven is at 2 000 units, this means 4 000 units are in margin of safety.
Margin of safety provides an assessment of risk by indicating the extent to which expected
output can fall before a loss is made . It shows the ability to withstand adverse trading
conditions

Margin of Safety in Units: = Sales (Units) – Breakeven Units

Margin of Safety in Value: = Margin of Safety in Units x Selling Price per Unit

Margin of Safety as a % = Margin of Safety units / Sales (Units) x 1 000

Sales for Target Profit = Fixed Cost + Target Profit

C S Ratio
 Assumption Limitations
1. Fixed Cost remains constant. Fixed cost might change at some
level
2. Total cost are divided into variable It is difficult to perfectly do that.
and fixed. Majority of cost are semi-variable.
3. Variable cost per unit remains Economies of scale and bulk
constant and is perfectly discounts will affect this.
proportional
4. Selling Price unit remains constant. Increase in sales volume may
require a price reduction
5. Technology and efficiency remain Changes in them will definitely take
unchanged place.
6. There are no stock levels Every business will have stock
levels

Note: due to the assumptions, the usefulness of breakeven analysis is limited.

Example: Through Diagram

Fixed Cost = $20 000
Variable Cost / Unit = $6
Selling Price / Unit = $10
Units = 10 000 Units

How is break-even found on the graph? ( Drawing a graph is no longer part of syllabus)

Continuing the above example, the following steps are illustrated to draw break-even graph:
Step 1: The horizontal line is knows as X-axis. Draw X-axis for number of units at the
distance of 1 000 each and up to 10 000 units. The vertical line is known as Y-
axis. Draw Y-axis for cost and revenue up to $100 000 at the distance of $10 000
each on the graph paper.
 Where the two axes meet is called the origin and it denotes zero for both axes.

Step 2: Draw fixed cost line parallel tox-axis for $20 000 as follows:
Step 3:Draw total cost line. It will begin from $20 000 on Y-axis. The total costs are equal to
fixed cost plus variable cost that is $20 000 + ($6 x 10 000 = $60 000) = $80 000, as follows:

Step 4:Draw sales revenue line, it will begin from origin. The total sales revenue is $100 000
(i.e. $10 x 10 000)
Step 5: Mark the Break-Even point. The break-even point is the interaction of total sales
line and total cost line, as follows:
What is profit-volume chart? ( Drawing the chart is not in syllabus)
The profit-volume chart is the alternate graphical method used for breakeven analysis. It shows
the relationship between costs and revenues and it basically focuses on profits and losses at
different level of activities. It shows break-even point when the profit and loss line intersects the
sales line. The sales line may be based on sales units or sales revenue. The profit-volume chart is
very useful to show the breakeven point for range of products.
How is profit-volume chart drawn?
The following steps are involved to draw the profit-volume chart:

Step 1: The vertical line is known as Y-axis and has origin at the central point because the
X-axis begins from the central point. Draw Y-axis for profits and losses at the
distance of $10,000 each. All the points above the origin represent amounts of
profit at different level of sale an all the points below origin represent amounts of
loss at different level of sale. The horizontal line is known as X-axis, which may
be used for sale in units or value. Draw X-axis for number of units at the distance
of 1 000 each and up to 10 000 units. The X-axis begins from the center of Y-
axis.
Step 2: Draw the profit and Loss points, as follows:
For example, if the business sells 10 000 units, as budgeted, it is it is expected to earn an amount
of profit of $20 000 I.e. 10 000 x ($10 – $6 = $4) = $40 000 contribution minus fixed cost $20
000 =profit $20 000. If no unit is produced or sold, business will earn no contribution and the
fixed cost will result into a loss of the business.

Step 3:Connect the profit and loss points as drawn in step 2 above. The point at which the profit
and loss line intersects the sale line, it is known as break-even point.
Step 4:The profit-volume chart may be used to find out the amount of profit and loss a different
level of output.
For example, the amount of profit at 8 000 units or loss at 3 000 units can be determined on the
chart as follows:

Note: if there is more than one product then Profit is plotted against Sales.
What is cash break-even?
Cash break-even determines the level of sales at which the business generates enough cash to
meet its operating cash requirements. The cash break-even does not consider the non-cash
expense, like depreciation, which is excluded from total fixed costs.
Example:
The following information is taken from the foregoing example:
Selling Price $10 per unit
Variable costs $6 per unit
Fixed costs $20 000 per annum (including depreciation of $4 000)
Illustration:
Cash Break-even Total fixed costs – Depreciation = $20 000 – $4 000 = 4 000 units
In units = Contribution per Unit $4
To convert in value simply multiply the units with selling price
The principles of just in time (JIT) management of
inventory
What is Just-in-Time (JIT)?

Just-in-time, or JIT, is an inventory management method in which goods are received from suppliers only

as they are needed. The main objective of this method is to reduce inventory holding costs and

increase inventory turnover.

Importance of just-in-time ( Advantages)

Just in time requires carefully planning the entire supply chain and usage of superior software in order to

carry out the entire process till delivery, which increases efficiency and eliminates the scope for error as

each process is monitored. Here are some of the important effects of a just-in-time inventory management

system:

1.Reduces inventory waste :A just-in-time strategy eliminates overproduction, which happens when the

supply of an item in the market exceeds the demand and leads to an accumulation of unsalable

inventories. These unsalable products turn into inventory dead stock, which increases waste and

consumes inventory space. In a just-in-time system you order only what you need, so there’s no risk of

accumulating unusable inventory.

2.Decreases warehouse holding cost:Warehousing is expensive, and excess inventory can double your

holding costs. In a just-in-time system, the warehouse holding costs are kept to a minimum. Because you

order only when your customer places an order, your item is already sold before it reaches you, so there is

no need to store your items for long. Companies that follow the just-in-time inventory model will be able

to reduce the number of items in their warehouses or eliminate warehouses altogether.

Gives the manufacturer more control In a JIT model, the manufacturer has complete control over the

manufacturing process, which works on a demand-pull basis. They can respond to customers’ needs by

quickly increasing the production for an in-demand product and reducing the production for slow-moving

items. This makes the JIT model flexible and able to cater to ever-changing market needs. For example,

Toyota doesn’t purchase raw materials until an order is received. This has allowed the company to keep

minimal inventory, thereby reducing its costs and enabling it to quickly adapt to changes in demand

without having to worry existing inventory.

Smaller investmentsIn a JIT model, only essential stocks are obtained and therefore less working capital

is needed for finance procurement. Therefore, because of the less amount of stock held in the inventory,

the organization’s return on investment would be high. The Just-in-time models uses the “right first time”

concept whose meaning is to carry out the activities right the first time when it’s done, thereby reducing

inspection and rework costs. This requires less amount of investment for the company, less money

reinvested for rectifying errors and more profit generated out of selling an item.
How does just-in-time work?

The above image shows how a just-in-time model works. First, a customer places an order with the

manufacturer. When the manufacturer receives the order, they place an order with their suppliers. The

suppliers receive the order and then supply the manufacturer with the materials needed to meet the

customer’s order. The raw materials are then received by the manufacturer, assembled, and sold to the

customer.
Drawbacks of just-in-time

Even though the just-in-time model saves a lot of costs for businesses that use it, it also has a few

drawbacks:

1. Just-in-time makes it very difficult to rework orders, as the inventory is kept to a bare minimum and

only based on the customers’ original orders.

2. The model is dependent on suppliers’ performance and timeliness, which are hard to ensure.

Additionally, the manufacturer needs to be able to cover any sudden increases in the price of raw

materials, since they cannot wait to order during better pricing.

3. Since the JIT model requires a lot of shipping back and forth between the supplier, manufacturer, and

customer, it can have detrimental effects on the environment due to over consumption of fossil fuels and

packaging.

4. In case of disruptions, a JIT model can have a major impact on the business. Since there is no excess

stock to fall back on, sales may come to a halt.

5. A just-in-time system needs to be carefully tracked and organized, which will be hard if you are doing

it manually. Softwares should be adopted as it makes the whole process more manageable. Even though a

good software help you it can be a bit tricky and/or expensive to adopt a new software system and train

your personnel accordingly to use the same.

IMPORTANT CONCLUSION
Therefore, just in time saves you a lot of costs which would otherwise be tied up as inventory
holding cost. At the same time just in time should be executed carefully so that your business
does not face loss in times of unpredictable events.
 ALL THE SMALL THINGS.
Financial Accounting
- Written down value or net book value means after depreciation.
- Only assets and expenses and drawings have debit balances, all the other things in the
world will have a credit balance.
- Sales invoice would mean good sold on credit.
- If bad debt is inside the trial balance then it means that it has already been subtracted
from the Trade Receivables
- Everything outside the Trial Balance has to come TWICE.
- Provision for depreciation is a Contra Asset Account. It is NOT AN EXPENSE, since its
balance is brought down.
- All the balance c/d go to the Statement of Financial Position.
- All the expenses and incomes are in the Income Statement
- Revenue = Sales.
- If NOTHING is specified about the policy of Depreciation, then you account for it
MONTHLY if dates are available else do it yearly.
- Every Asset has an Opening Debit balance and Closing Credit balance.
- Every Liability has an Opening Credit balance and closing Debit balance.
- The Amount of Loan interest still owing and not paid (which was to be paid this year)
comes in the Current Liabilities.
- Control Account is not part of the double entry. It is THE THIRD ENTRY.
- List price is the price WITHOUT deducting TRADE DISCOUNT.
- Set off always reduces the Control Account!
- Credit Notes received = Purchases Returns
- Credit Notes sent = Sales Returns
- BAD DEBTS recovered comes on the debit side of the Sales Ledger Control Account
(S.L.C.A) and even on the credit side.
- Whenever you receive a cheque from BANK marked ‘REFER TO DRAWER’ then it is
CHEQUE DISHONOURED
- FIX PROFIT: In the Journal, if the account doesn’t go in the balance sheet, then if
something is being CREDITED it will INCREASE N.P, or if it DEBITED, then it will
DECREASE N.P.
- To find the opening balance in the Suspense LEAVE THE FIRST two lines empty.
- The amount of stationery used, goes in the Income statement as an expense.
- Sundry Expense means miscellaneous expenses.
- Whatever goes in the Income statement is REVENUE EXPENDITURE.
- Whatever goes in the BALANCE SHEET is CAPITAL EXPENDITURE.
- CAPITAL EMPLOYED (Sole Trader) = CAPITAL OWNED + LONG-TERM LOAN.
- CAPITAL OWNED (Sole trader) = Assets – Liabilities.
- CAPITAL EMPLOYED (COMPANY) = OSC + RESERVES (share premium, Retain
profits, all reserves) + Long Term Liabilities.
- REFUND FROM Supplier is recorded on the Credit side of the Purchase Ledger Control
Account. And Refund to Costumer on Debit Side of the Sales Ledger Control Account
- In closing Assets, you write the Net Book Value (N.B.V)
- DRAWINGS ARE Neither AN Asset NOR A LIABILITY.
- If they ask you to make a STATEMENT TO find Profit or Loss, then just make that f by
(Opening capital + Profit (x) + Capital Introduced – Drawings = Capital at end)
- If they say make final accounts, then make Income Statement and Statement of financial
position.
- Closing Inventory has a direct relation with profit. If closing inventory is overstated,
profit will be overstated.
- Opening Inventory has an inverse relation with profit. If opening inventory is overstated,
profit will be understated.
- Goods sent on sale or return basis should not be counted as sale unless accepted by the
customer. Infact they should be included in the inventory.
- If no account is wrong, like there is an error in the list of Trade Recieveables then we
only correct it through suspense account (its only one entry, e.g. Debit: Suspense, Credit:
–)
- We only double the amount if it is written on the wrong side of the account.
- If we find purchases/sales through control account we will still have to subtract returns
- Unpresented cheques are payment by us.
- Uncredited cheques are receipts by us (also called LODGMENTS).
- If you can’t find the average inventory, use closing figure instead of instead of average.
- If nothing is specified, we can assume all sales and purchases are on credit basis.
- Provision for bad debt is a separate account. We can notrecord the provision in costumer
account
- net debtors mean after deducting provision.
- We only take the change in provision in the Income statement
- Cashbook is both a daybook and a ledger.
- We only record credit sales and purchases in the Sales and Purchase Daybook, cash and
bank transactions are in the cashbook.
- If a daybook is overcast only that amount will be wrong. E.g. if Sales daybook is
undercast, this means only the Sales account is wrong.
- If profit is given inside the trial balance, the inventory should be closing
inventory(because we don’t need the opening stock).
- Similarly if depreciation for the year is inside the trial balance, the provision for
depreciation would already include this year’s depreciation.
- Gross profit ratio will not change because of sales volume (number of units), but net
profit ratio will increase.
- Net Assets = Assets – Liabilities, but in some cases CIE uses Net Assets as Capital
Employed which is Assets – Current Liabilities.
- Sale or Purchase is recorded when the goods are accepted not when the invoice is sent or
the payment is made.
- If only net book values are available Depreciation for the year = Opening Net Book
Value + Purchase of Asset – Sale of Asset (Nbv) – Closing Net book value.
- In most question they don’t mention depreciation, that doesn’t mean there is no
depreciation, use the above formula to determine. (Don’t forget the depreciation like
idiots).
- Cash banked will come on the debit side of bank and credit side of cash account.
 - Loan is as long term liability unless payable within one year. If nothing is written,
assume long term.
- POOP is for expenses.
- OPPO is for incomes.
- Owing Income is current Asset but Owing expense is current Liability
- Prepaid Income is current Liability but Prepaid expense is current asset
- Opening Prepaid and Closing Owing are always added to the bank value of income or
expense
- Closing Prepaid and Opening Owing are always subtracted from the bank value of
income or expense
- Net realizable value = current selling price – any expenses (repairs)
- We always ignore replacement cost in stock valuation.
- Perpetual methods are those where we make a table.
- Markup is on cost (cost is 100)
- Margin is on sales (Sales is 100)

COST ACCOUNTING
- In case of rising price FIFO will always give higher answer then AVCO
- Cost centre means departments.
- If a business doesn’t split overheads into different departments, they will only have one
Overhead absorption rate for the whole factory (also called blanket OAR).
- Absorption costing means total costing. It is used to calculate total cost.
- We only use OAR to calculate the overheads for a unit/job/order/batch.
- OAR can be calculated on any basis like machine hours, labour hours, unit, labour cost
(direct wages), material cost etc.
- If no basis are given use either labour hours or machine hours depends on what is more
(intensity).
- Absorbed Overheads = OAR x Actual Activity.
- Over absorbed means Absorbed are more than actual overheads
- Under absorbed means Absorbed are less than actual overheads.
- Usually if actual activity is above budget, we will OVER ABSORB
- If actual activity is below budget, we will UNDER ABSORB
- Total cost is cost of Production + the non-production cost.
- Inventorycan only include production cost. In absorption costing, we use total production
cost (DM+DL+VPOH+FPOH) whereas in marginal we use only variable production
cost.(DM+DL+VPOH)
- Marginal costing is about decision making.
- Decisions are based on contribution not profits. It is assumed that fixed cost will still be
incurred.
- (contribution/unit x # of units) – Fixed Cost = Profit.
- Lower breakeven point is better. Higher margin of safety is better.
- Positive contribution product or department should never be closed down.
- Positive contribution product should be accepted under idle capacity.
- When deciding on if we should buy from outside or not, we only consider variable
production cost (ignore Variable Selling cost)
- Only change the fixed cost if the question tells you to.
- Only make Profit Statement on absorption if the question says so. Otherwise always
marginal.
- Profit + Fixed Cost = Total Contribution.
- If firm makes a single product, profit volume chart will be Profit against units.
- If firm makes multiple products, Profit Volume chart will be Profit against Sales Revenue
(Total Sales).
- Direct Labour per hour = Wage rate per hour.
- Normal level of activity is budgeted level of activity. Fixed production Overheads/unit is
calculated using this.
- In calculating contribution per unit we need direct labour per unit.
- MARGINAL COSTING = SALES – VARIABLE COST = CONTRIBUTION – FIXED
COST = NET PROFIT.
- In marginal costing, we always take the total fixed cost. (We never calculate it on per unit
as per normal level of activity).
- ABSORPTION COSTING = SALES – PRODUCTION COST = GROSS PROFIT –
NON PRODUCTION COST = NET PROFIT.
- Under absorbed is added to Cost and Over absorbed is subtracted. We only have to do
this in absorption statement.
- In marginal costing, we always take the total fixed cost. (We never calculate it on per unit
as per normal level of activity).
- If inventory is not there or doesn’t change ( opening inventory units are equal to closing
inventory units )then both marginal and absorption will give same profit
- If inventory level is rising ( closing inventory is more then opening inventory) then
Absorption will give higher profits
- If inventory level is decreasing ( opening inventory is more then closing inventory) then
Marignal will give higher profits
FORMATS
INCOME STATEMENT OF A SOLE TRADER /PARTNERSHIP( TRADING BUSINESS)
$ $
Sales Xxx
(-)Sales Return (xxx)
Net Sales xxx
(-) Cost of Sales
Inventory at start xxx
(+)Purchases xxx
(-)Goods withdrawn (xxx)
(-)Purchase Returns (xxx)
(+)Carriage Inwards xxx
(-)Inventory Loss/Stolen (xxx)
(+)Any other direct purchasing expense xxx
(-)Inventory at End (xxx) (xxx)
Gross Profit xxx
(+)Other Incomes
Discount Received xxx
Decrease In provision for doubtful debts xxx
Bad debts Recovered xxx
Gain on Disposal xxx xxx
(-) Expenses and Losses
Discount Allowed xxx
Rent and Rates xxx
Other Expenses xxx
Bad debts xxx
Creation/Increase In Provision for doubtful debts xxx
Depreciation for the year on non current assets xxx
Loss on disposal xxx
Interest on loan/overdraft xxx (xxx)
Profit for the Year/Loss for the year Xxx/(xxx)

INCOME STATEMENT OF A SOLE TRADER /PARTNERSHIP ( SERVICE BUSINESS)

$ $
Incomes :
Fees Income xxx
Commission Income xxx
Discount Received xxx Xxx
(-)Expenses :
Wages and Salaries xxx
Depreciation for the year of non current assets xxx
Rent and Rates xxx
Bad debts xxx
Discount Allowed xxx
Other Expenses xxx
Interest on loan /Overdraft xxx
Loss on disposal ( show in income if gain) xxx
Provision for doubtful debts ( show in income if decreased) xxx (xxx)
Profit for the Year/Loss for the year xxx/(xxx)
Statement of Financial Position for a Sole trader
COST DEPN NBV
Non Current Assets
Land and Buildings xxx (xxx) xxx
Motor Van xxx (xxx) xxx
Plant and Machinery xxx (xxx) xxx
xxx xxx xxx
Current Assets
Closing Inventory xxx
Trade Recieveables xxx
(-) Provision for doubtful debts (xxx) xxx
Other Receivables xxx
Cash at Bank xxx
Cash in Hand xxx xxx
Total Assets XXX

Capital
Capital at start xxx
(+) Profit for the year xxx
(+) Additional Capital introduced xxx
(-) Drawings (xxx) xxx
Non Current Liabilities
Long term Loan xxx
Current Liabilities
Trade Payables xxx
Other Payables xxx
Bank Overdraft xxx xxx
Total Capital and Liabilities XXX

Note :
1. If Loss for the year then it should be subtracted from capital at start just like profit is being added
2. The order of current assets is super important
3. Other Receivables include prepaid expenses and accrued(owing) incomes
4. Other Payables include accured( owing ) expenses and prepaid incomes.
5. Trade Receivables should be shown after bad debts and provision to be shown separately
Profit and Loss Appropriation Account ( Only in Partnership)

$ $
Profit for the year ( From Income statement) xxx
(+) Interest on drawings
Alex xxx
Barry xxx xxx
(-) Interest on capital
Alex xxx
Barry xxx (xxx)
(-) Salary/Bonuses
Alex (xxx)
Profit to be Shared ( Residual Profit ) xxx
Alex xxx
Barry xxx

Current Accounts of Partners In Columnar Form

Alex Barry Alex Barry
Balance b/d xxx Balance b/d xxx
Interest on drawings xxx xxx Interest on capital xxx xxx
Drawings xxx xxx Salary xxx
Balance c/d xxx Share of profit xxx xxx
Balance c/d Xxx
xxx xxx xxx xxx
Balance b/d Xxx Balance b/d xxx

Note :
1.Balance b/d are starting balances , they can be on either side depending on the situation at start.
2. If there is Loss then Share of loss will come on debit side
3. Balance c/d are closing balances, they can be on either side depending on the situation at end .
4. Debit balance means partner owes the business ( Overdrawing) ( negative balance)
5. Credit balance means business owes the partner ( His money is with the business) positive balance
Statement of Financial Position for a Partnership
COST DEPN NBV
Non Current Assets
Land and Buildings xxx (xxx) xxx
Motor Van xxx (xxx) xxx
Plant and Machinery xxx (xxx) xxx
xxx xxx xxx
Current Assets
Closing Inventory xxx
Trade Recieveables xxx
(-) Provision for doubtful debts (xxx) xxx
Other Receivables xxx
Cash at Bank xxx
Cash in Hand xxx xxx
Total Assets XXX

Capital
Capital of Alex xxx
Capital of Barry xxx
Current Account of Alex (xxx)
Current Account of Barry xxx xxx
Non Current Liabilities
Long term Loan xxx
Current Liabilities
Trade Payables xxx
Other Payables xxx
Bank Overdraft xxx xxx
Total Capital and Liabilities XXX

Note :
1. Current account credit balance is added and debit balance is subtracted
2. No need to show profit/loss or drawings as they are already done in current accounts
3. The order of current assets is super important
4. Other Receivables include prepaid expenses and accrued(owing) incomes
5. Other Payables include accured( owing ) expenses and prepaid incomes.
6. Trade Receivables should be shown after bad debts and provision to be shown separately
 Income Statement of A limited Company
$
Sales /Revenue xxx
Cost of Sales (xxx)
Gross Profit xxx
Other Income xxx
Administrative Expenses (xxx)
Distribution Cost (xxx)
Profit from Operations xxx
Finance charges /Finance Cost (xxx)
Profit For the year xxx
Notes:
1. Only the above items can be shown on the income statement.
2. Administrative includes :Administrative given in trial balance + Discount allowed/Bad debts/Provision
for doubtful debts/Depreciation of Equipment etc.
3. Distribution Cost includes: Distribution given in trial balance + Carriage outwards + any delivery
related expenses ( like depreciation of delivery vehicle )
4. Finance Cost is the Interest expense which includes interest on debentures/Loan or Overdraft.

Statement of Changes in Equity ( Limited Companies Only)

Notes:

Share Revaluation Share General Retained TOTA

Capital Reserve premium Reserve Earnings L
Balance at Start xxx xxx xxx xxx xxx xxx
Profit for the year xxx xxx
Transfer (xxx) xxx -
Bonus Issue xxx (xxx) (xxx) (xxx) -
Issue of share/Rights issue xxx xxx xxx
Gain revaluation xxx Xxx
Loss revaluation (xxx) (xxx) (xxx)
Dividends Paid (xxx) (xxx)
Balance At End xxx xxx xxx xxx xxx xxx
1. For Bonus issue ,first use share premium then general reserve and then retained earnings
2. Loss on revaluation is first deducted from revaluation reserve and then from retained earnings
3. If loss for the year then must be subtracted from retained earnings
4. Ordinary Share Capital or Share Capital is same thing as now we only have one type of shares i.e.
Ordinary Shares
Statement of Financial Position of a Limited Company

$
Non Current Assets xxx
Current Assets
Inventory xxx
Trade and Other Receivables xxx
Cash and Cash Equivalent xxx
xxx
Total Assets XXX

Equity
Share Capital xxx
Share Premium xxx
Revaluation Reserve xxx
General Reserve xxx
Retained Earnings xxx
xxx
Non Current Liabilities
Debentures/Loans xxx
Current Liabilities
Trade and other payables xxx
Cash and Cash Equivalent xxx
xxx
Total Equity and Liabilities XXX

NOTES:
1. All Non current Assets must be shown together as one value
2. Trade and Other Receivables are combined. Also provision for doubtful is not shown but its directly
deducted.
3. Trade and Other Payables are combined
4. All Balance at end from Statement of Changes in Equity Go to the Equity Section .
 Accounts For Non Current Assets

(i) Non Current Asset Cost Account

Balance b/d xxx Disposal xxx

Bank/Cash/Disposal xxx Balance c/d xxx
xxx xxx
Balance b/d xxx

Notes:
Disposal on the debit side only comes when there is a part exchange
Disposal on the credit side is the Original cost of the Asset Sold

(ii) Provision For Depreciation Account

Disposal xxx Balance b/d xxx

Balance c/d xxx Income Statement xxx
xxx xxx
Balance b/d xxx

Note :
Disposal is the total depreciation of the asset sold
Income statement is the total depreciation for that financial year

(iii) Disposal Account

Cost of Non current Asset xxx Provision For Depn xxx

Income statement (gain) xxx Bank/Cash/Trade In xxx
Income statement (Loss) xxx
xxx xxx
Accounts For Incomes and Expenses

EXPENSE ACCOUNT

Prepaid b/d xxx Owing b/d xxx

Bank/Cash xxx Income Statement xxx
Owing c/d xxx Prepaid c/d xxx
xxx xxx
Prepaid b/d xxx Owing b/d xxx

INCOME ACCOUNT

Owing b/d xxx Prepaid b/d xxx

Income Statement xxx Bank/Cash xxx
Prepaid c/d xxx Owing c/d xxx
xxx xxx
Owing b/d xxx Prepaid b/d xxx
Accounts For Bad debt / Provision for Doubtful Debts and Bad Debt
Recovered

BAD DEBT ACCOUNT

Mr. Azam xxx Income Statement xxx
Mr. Gulbahar xxx
Miss Mary xxx
xxx xxx

BAD DEBT RECOVERED ACCOUNT

Income Statement xxx Mr . Johnson xxx
Mr Khalid xxx
xxx xxx

Both the above accounts and closed with income statement there are no
balance b/d or c/d

Provision For Doubtful Debts Account

In case of increase in pr ovision

Balance c/d xxx Balance b/d xxx

Income Statement xxx
xxx xxx
Balance b/d xxx

In case of decrease in provision

Income Statement xxx Balance b/d xxx

Balance c/d xxx
xxx xxx
Balance b/d xxx
CONTROL ACCOUNTS
SALES LEDGER CONTROL ACCOUNT
Balance b/d xxx Balance b/d (min) xxx
Credit Sales xxx Sales Return xxx
Bank (Dishonored ) xxx Bad debts xxx
Interest Charged to Costumers xxx Bank/Cash ( Receipts) xxx
Bank/Cash ( Refund) xxx PLCA ( Setoff) xxx
Bad debt recovered xxx Cash/Bank ( Bad debt Recovered) xxx
Balance c/d (min) xxx Discount Allowed xxx
Balance c/d xxx
XXX XXX
Balance b/d Balance b/d ( min) Xxx
PURCHASE LEDGER CONTROL ACCOUNT
Balance b/d (min) xxx Balance b/d xxx
Purchase Returns xxx Purchases xxx
Bank/Cash ( Payments) xxx Interest Charged by Suppliers xxx
SLCA (Setoff) xxx Bank/Cash ( Refund) xxx
Discount Received xxx Balance c/d (min) xxx
Balance c/d xxx
XXX XXX
Balance b/d ( min) xxx Balance b/d xxx
BANK RECONCILATION

BANK RECONCILATION STATEMENT

$
Balance As per Bank Statement xxx
(+) Uncredited deposits/Cheques/Bank lodgements xxx
(-) Unpresented Cheques xxx
(+)/(-) error on the bank statement ( if any) xxx
Balance As per Updated Cash book xxx

Updated Cashbook
Balance b/d ( if debit) xxx Balance b/d (if overdraft) xxx
Credit Transfer/Bank Giro Standing Order
Interest Received Direct Debit
Interest Charged
Bank Charges
Dishonoured cheque
Balance c/d ( if Overdraft) xxx Balance c/d ( if debit) xxx
xxx xxx
Balance b/d ( if debit) xxx Balance b/d( if overdraft) xxx
LEDGER ACCOUNTS OF COMPANIES (EQUITY
ITEMS)

Share Capital ( Ordinary Share Capital)

Balance b/d xxx
Bank ( In case of issue/rights issue) xxx
Share Premium ( In case of bonus issue) xxx
Balance c/d xxx Retained Earnings( In case of bonus xxx
issue)
xxx xxx
Balance b/d xxx

Share Premium
Share Capital ( In case of bonus xxx Balance b/d xxx
issue)
Balance c/d xxx Bank (In case of issue/rights issue) xxx
xxx xxx
Balance b/d xxx

Retained Earnings
Share Capital ( In case of bonus xxx Balance b/d xxx
issue)
Transfer to General Reserve xxx Profit for the year xxx
Dividends Paid xxx
xxx xxx
Balance b/d xxx

General Reserve
Balance b/d xxx
Balance c/d xxx Retained Earnings xxx
xxx xxx
Balance b/d xxx
COSTING PROFIT STATEMENTS
ABSORPTION
$ $
Sales xxx
Cost of Production
Inventory at start xxx
Direct Material xxx
Direct Labour xxx
Variable Production Overheads xxx
Fixed Production Overheads xxx
Inventory at End (xxx)
(+) Underabsorbed (-) Overabsorbed xxx(xxx) (xxx)
Gross Profit xxx
Non Production Cost
Variable Selling overheads xxx
Fixed Admin and Selling Overheads xxx (xxx)
Profit for the year xxx

MARGINAL
$ $
Sales xxx
Variable Cost
Inventory at start xxx
Direct Material xxx
Direct Labour xxx
Variable Production Overheads xxx
Variable Selling Overheads xxx
Inventory at End (xxx) (xxx)
Contribution xxx
Fixed Cost
Fixed production overheads xxx
Fixed Admin and Selling Overheads xxx (xxx)
Profit for the year xxx
Notes
-Inventory is valued at DM+DL+VPOH+FPOH(per unit) in Absorption
-Inventory is valued at DM+DL+VPOH in Marginal
-Make 4 columns instead of 2 if data is for 2 years.
Reconciliation Statement for two profits

$
Profit As per Absorption Costing xxx
(+) difference in opening inventory xxx
(-) difference in closing inventory (xxx)
Profit As per Marginal Costing xxx

Note: ( Important )
1. Can also be made in reverse , starting from marginal profit.
2. If inventory is not there or doesn’t change ( opening inventory units are equal to closing
inventory units )then both marginal and absorption will give same profit
3. If inventory level is rising ( closing inventory is more then opening inventory) then Absorption
will give higher profits
4. If inventory level is decreasing ( opening inventory is more then closing inventory) then
Marginal will give higher profits
 INVENTORY VALUATION ( FIFO AND AVCO)
Example :
Opening Inventory :100 units @$20 each
Purchased : 200 units @ $30 each
Sold : 160 units ( selling price doesn’t matter)
Closing Inventory = 140 units ( 100+200-160)

FIFO (PERPETUAL)

Purchases Sales Balance

Date Qty Rate Value Qty Rate Value Qty Rate Value
1st March 100 20 2000
2nd March 200 30 6000 100 20 2000
200 30 6000
8000
5th March 100 20 2000
60 30 1800 140 30 4200

AVCO(PERPETUAL)

Purchases Sales Balance

Date Qty Rate Value Qty Rate Value Qty Rate Value
1st March 100 20 2000
2nd March 200 30 6000 200 30 6000
300 26.67 8000
5th March 160 26.67 4267 140 26.67 3733
EXAM TIPS
PAPER 1
You have 60 minutes of 30 mcqs. 2 minutes for each.

First only attempt those questions which you are 100% sure of and skip others.

Read the MCQ carefully, because CIE likes to play around.

Now spend time on these questions.

If you are stuck try to eliminate the most obvious wrong answer.

5-6 questions are theoretical, at least read them thrice.

Sometimes it’s best to use the answer to check if it’s wrong or right.

If you see something in the answer choice which you haven’t heard of (that can never be the
answer).

Please don’t leave it blank. Take an educated guess. There is no negative marking.

PAPER 2
You have 105 minutes for 90 marks.

Always attempt the question which you know the best out of 4 first. This will give you
confidence and save time. You will end up spending time and getting it wrong if you do the
toughest one first.
Don’t panic, usually in every paper one question is tricky. Do it at last.

You won’t get any award if you balance the statement of financial position. If it is off by a large
amount, that doesn’t mean everything is wrong, might be a single big figure which you have
missed. DON’T WASTE YOUR TIME.
Remember you don’t have to get 90 on 90. Go for the maximum
HOPE THIS HELPS ☺