Slide f3 1 Student

• The purpose of financial reporting
Chapter 1 • Types of business entity

• Users
Introduction to • Governance
accounting • The main financial statements

Syllabus learning outcomes 1
• Define financial reporting and understand the nature, principles
and scope of financial reporting.
• Identify and define the different business entities of: sole trader,
partnership and limited liability company and recognise the
legal differences between them.
• Identify the advantages and disadvantages of operating as each
of the three types of business entity.
• Identify the users of financial statements and state and
differentiate between their information needs.
• Explain what is meant by governance specifically in the context of the preparation of
financial statements.
• Describe the duties and responsibilities of directors and other parties covering the
preparation of financial statements.
• Understand and identify the purpose of each of the main
• Define and identify assets, liabilities, equity, revenue and
expenses.
Overview
Statement of financial
Statement of profit or loss
position
Users of financial
Financial statements
information
Governance Introduction
to accounting
Types of business
entities
Limited liability
Sole trader Partnership
company
The purpose of financial reporting 1
• Financial reporting is a way of recording, analysing and summarising financial data.
• Financial data is the name given to the actual transactions carried out by a business eg
sales of goods.
The purpose of financial reporting 2
• Financial data is recorded in the books of prime entry.
• Transactions are analysed in the books of prime entry and the totals are posted to the
ledger accounts.
• The transactions are summarised in the financial statements.
Types of business entity 1
What is a business?
• A business of whatever size or nature exists to make a profit.
• Profit occurs when income exceeds expenses.
Types of business entity 2
Types of business entity
• Sole traders – refers to ownership, sole traders can have employees
• Partnerships – two or more people working together to earn profits
• Limited liability company – owners have liability limited to the amount they pay for
their shares
• A limited liability company has a separate legal identity from its owners
Users
Users of accounts
• Managers of the company
• Shareholders of the company
• Trade contacts
• Providers of finance to the company
• Taxation authorities
• Employees of the company
• Financial analysts and advisors
• Government and their agencies
• The public
Discussion question
Required
What information would these users of financial information be interested in?
(a) Investors
(b) Employees
(c) Lenders
(d) Suppliers
(e) Customers
(f) Governments and their agencies
(g) Public
Governance
Directors
• Main aim – to create wealth for shareholders.
• Have a duty of care to show reasonable competence; may have to indemnify the
company against loss caused by their negligence.
• Are in a fiduciary position in relation to the company which means that they must act
honestly in what they consider to be the best interests of the company and in good
faith.
• Are responsible for the preparation of the financial statements of the company.
The main financial statements 1
• The statement of financial position is a list of all the assets owned and all the
liabilities owed by a business at a particular date.
• An asset is a resource controlled by an entity as a result of past events and from
which future economic benefits are expected to flow to the entity.
• A liability is a present obligation of the entity arising from past events, the settlement
of which is expected to result in an outflow from the entity of resources embodying
economic benefits.
• Equity is the residual interest in the assets of the entity after deducting all its
liabilities.
• A statement of profit or loss is a record of income generated and expenditure
incurred over a given period.
• Income is increases in economic benefits during the accounting period in the form of
inflows or enhancements of assets or decreases of liabilities that result in increases in
equity, other than those relating to contributions from equity participants.
• Expenses are decreases in economic benefits during the accounting period in the
form of outflows or depletions of assets or incurrences of liabilities that result in
decreases in equity, other than those relating to distributions to equity participants.
Chapter Summary 1
1 Accounting
 Accounting is a way of recording, analysing and summarising a business‘s transactions.
Chapter Summary 2
2 Accounting records
 All businesses must keep sufficient accounting records in order to be able to produce
accurate information about the entity's activities.
Chapter Summary 3
3 The concept of business entity
 The business entity concept states that a business is a separate entity from its owners.
Chapter Summary 4
4 Types of business entities
 There are three main types of businesses. For sole traders and partnerships the
owners have unlimited liability and bear all the risks and reap all the rewards of being
in business. For a limited liability company the shareholders' liability is limited to the
extent of their investment.
Chapter Summary 5
5 Users of financial information
 Financial statements are used by a wide variety of users, each with different
information needs. Satisfying the investors' needs will mean that the majority of other
users' needs are also met.
Chapter Summary 6
6 Governance
 Corporate governance is the process by which businesses are directed and controlled
by those responsible for running the business.
Chapter Summary 7
7 Proforma financial statements
Companies must follow a prescribed format when producing their financial statements,
there is however no set format for a sole trader's statement of profit or loss and
statement of financial position.
• The regulatory system
Chapter 2
• IASB
The regulatory
framework
• Understand the role of the regulatory system including the roles
of the:
— International Financial Reporting Standards Foundation
(IFRSF)
— International Accounting Standards Board (IASB)
— International Financial Reporting Standards Advisory
Council (IFRSAC)
— International Financial Reporting Standards
Interpretations Committee (IFRSIC)
• Understand the role of International Financial Reporting
Standards (IFRS)
Overview
Regulatory
framework
IFRSF
IFRS AC IASB IFRS IC
Issue IFRS
The regulatory system 1
• Financial statements are produced by an entity's managers in order to show its owners
how the entity has performed over a period of time.
• Company financial statements particularly need to show a true and fair view.
• This means a system of regulation is necessary to ensure that financial statements are
produced to a high standard and are comparable across different companies.
Influences upon financial accounting
• National law – form and content of accounts may be regulated by national legislation.
'Fair presentation'.
• Accounting standards – IASB produces standards.
• Accounting concepts and individual judgement can lead to subjectivity; accounting
standards developed to address subjectivity.
Influences upon financial accounting (cont'd)
• GAAP – Generally Accepted Accounting Principles – drawn from: local company law,
accounting standards, statutory requirements in other countries and stock exchanges
• Other international issues
IASB 1
• The IASB develops International Financial Reporting Standards (IFRSs).
• The parent entity of the IASB is the IFRS Foundation.
IASB 2
• The main objectives of the IFRS Foundation are to:
— Develop a single set of high quality, understandable,
enforceable and globally accepted IFRSs through
standard-setting body IASB
— Promote use and rigorous application of these
standards
— Take account of the needs of emerging economies and
SMEs
— Bring about convergence of national accounting
standards and IFRSs to high quality solutions
IASB 3
Monitoring board
IFRS Foundation
IFRS Advisory
IASB
Council
Appoints
IFRS Interpretations
Reports to Committee (IFRIC)
Advises
Lecture example 1
Which body oversees the work of the International Accounting Standards Board?
A The IFRSIC
B The IFRSF
C The IASB
D The IFRSAC
Lecture example 2
Which of the following bodies is involved is trying to achieve convergence of global
accounting standards?
A The IASB
B The IFRSIC
C The IFRSF
D The IFRSAC
Lecture example 3
International Financial Reporting Standards are prepared by:
A The IFRS Foundation
B The IASB
C The IAASB
D The accounting bodies of each country
Lecture example 4
Which of the following best describes the role of the International Financial Reporting
Standards Interpretations Committee?
A Issues International Financial Reporting Standards
B Provides advice on the development of standards
C Interprets International Financial Reporting Standards
D Investigates listed companies to ensure they comply with
International Financial Reporting Standards
Chapter summary 1
1 Regulatory system
 Financial statements are relied on by many different user groups to make economic
decisions. A system of regulation is therefore necessary to ensure that the information
produced is of a high standard.
The IFRSF appoints members to the IASB, IFRSIC and IFRSAC.
 The IASB issues International Financial Reporting Standards.
 The IFRSIC issues guidance on how to apply accounting standards.
 The IFRSAC advises the IASB on its agenda.
Chapter summary 2
2 The role of international financial reporting standards
 International financial reporting standards give guidance as to how transactions should
be recorded in the accounts.
Chapter 3 • The IASB's Conceptual Framework
• Qualitative characteristics of financial
information
The qualitative
characteristics of
financial information
Syllabus learning outcomes
• Define, understand and apply accounting concepts and
qualitative characteristics.
• Understand the balance between qualitative characteristics.
Overview
The qualitative characteristics of
financial information
The objective of
Underlying assumption
financial statements
IASB Conceptual Framework
Qualitative characteristics Elements of financial

of financial information statements
The IASB's Conceptual Framework 1
Underlying assumption
Going concern
• The financial statements are normally prepared on the assumption that an entity is a
going concern and will continue in operation for the foreseeable future.
Not an underlying assumption but accounts should be prepared on an accruals basis:
Accruals basis
•The effects of transactions and other events are recognised when they occur (and not as
cash or its equivalent is received or paid) and they are recorded in the accounting records
and reported in the financial statements of the periods to which they relate.
Qualitative characteristics
Two fundamental qualitative characteristics:
• Relevance
• Faithful representation
Relevance
—Information is relevant when it influences decisions of users, affected by nature and
materiality
—Materiality: information is material if its omission or misstatement could influence
the economic decisions of users taken on the basis of the financial statements
Faithful representation
—Financial information must faithfully represent the underlying economic
phenomena
—Complete, neutral, free from error
Enhancing characteristics
•Comparability
•Verifiability
•Timeliness
•Understandability
Comparability
—Users must be able to compare financial statements through time and with other
entities
—Disclose accounting policies
—Disclose corresponding information for comparative periods
Verifiability
—Information that can be independently verified
Timeliness
— Information is available in time to be capable of
influencing decisions
Understandability
— Users must be able to understand financial statements
— Users assumed to have some economic, business and
accounting knowledge
— Complex matters should not be left out if relevant
Other concepts
Business entity concept

• In accounting, the business is treated as separate to its owners. Not the same as
limited liability!
Fair presentation
• Financial statements are required to present fairly in all material respects the financial
results and position of the business.
• Compliance with IFRSs will achieve this.
Consistency
• Presentation and classification of items should remain consistent from one period to
the next.
Chapter summary 1
1 The IASB's Conceptual Framework
 Financial statements should present fairly the activities of an entity for a particular
period.
 The IASB's Conceptual Framework provides a set of principles on which financial
accounting is based.
 The objective of financial statements is to provide information on an entity's financial
position, financial performance and financial adaptability. The accruals basis requires
that transactions are recognised when they occur rather than when any cash is
received or paid.
Chapter summary 2
 The going concern basis assumes that the entity will continue in operation for the
foreseeable future.
 In order for the information in the financial statements to be useful it should possess
the fundamental characteristics of relevance and faithful representation and the
enhancing characteristics of comparability, verifiability, timeliness and
understandability.
Chapter 4 • Statement of financial position
• Statement of profit or loss
Sources, records • The role of source documents
and books of • Sales and purchase day books
• Cash books
prime entry • Controlling petty cash – the
imprest system
• Identify and explain the function of the main data sources in an
accounting system and how the accounting system provides
useful information.
• Outline the contents and purpose of different types of business
documentation such as an invoice.
• Identify the main types of business transactions, for example,
sales, purchases, payments and receipts.
• Identify the main types of ledger accounts and books of prime entry, and understand
their nature and function.
• Understand and record sales and purchase returns.
• Understand the need for a record of petty cash transactions and security over the
petty cash system.
NB: The following slides introduce the accounting terms Statement of financial position
and Statement of profit or loss. These will be explained fully as we progress through
the later chapters.
Overview
position
Sources, records and

books of prime entry
Books of prime entry Memorandum ledgers
Sales day Purchase day Petty cash

Cash book Journal book
book book book
Lecture example 1
Required
List out everything you own and owe.
Statement of financial position
For a business, this list is formalised as a statement of financial position and shows the
entity's assets and liabilities.
— Asset: is a resource controlled by the entity as a result of past events and from which
future economic benefits are expected to flow to the entity.
— Liability: is a present obligation of the entity arising from past events, the settlement
of which is expected to result in an outflow of economic benefits.
Key features 1
— Always headed 'as at', for the date of the statement of

financial position.
— Non-current assets – assets held and used in the
business over the long-term (ie more than one year).
— Current assets – not non-current assets! Conventionally listed in increasing order of
liquidity (ie closeness of assets to cash).
Key features 2
— Capital: what the business owes the proprietor/owner. In

this case the sole trader owns all of the business, ie its
total net worth.
— Don't include a caption (item heading) if there isn't a value
for it.
The statement of financial position is a snapshot of the business at one point in time.
Statement of profit or loss 1
A statement of profit or loss for a sole trader will have the following key features:
— Headed up with the period for which the income and expenses are being included.
— The top part is the trading account which records sales, less cost of sales, to arrive at
the gross profit.
— Expenses (rent, electricity, wages and salaries etc) are deducted from the gross profit
to arrive at the profit for the year.
— Do not include nil value captions.
Profit is the excess of total income over total expenditure. If expenditure exceeds
income, the business has made a loss.
The statement of profit or loss is a summary of the business's performance over a

period of time.
The role of source documents 1
Types of source documents
• Quotation
• Sales order
• Purchase order
• Invoice
• Credit note
• Debit note
• Goods received note
Books of prime entry
• The source documents are recorded in books of prime entry.
The main books of prime entry
• Sales day book
• Purchase day book
• Sales returns day book
• Purchase returns day book
• Journal
• Cash book
• Petty cash book
Sales and purchase day books 1
Sales day book
• The sales day book is used to keep a list of all invoices sent out to credit customers
each day.
Sales day book

The sales day book is used to keep a list of all invoices sent out to
credit customers each day. Here is an example.
SALES DAY BOOK
Date Invoice number Customer Rec'bles ledger ref. Total invoiced
$
3.3.X9 207 ABC & Co SL 12 4,000
208 XYZ Co SL 59 1,200
5,200
Sales and purchase day books 2
Purchase day book
• This is used to keep a record of invoices which a business receives for credit purchases.
Purchases day book

This is used to keep a record of invoices which a business receives
for credit purchases. Here is an example.
PURCHASES DAY BOOK
Date Supplier Payables ledger ref. Total invoiced
$
3.4.X9 RST Co PL31 215
10.4.X9 JMU Inc PL19 1,804
15.4.X.9 DDT & Co PL24 758
2,777
Cash books 1
Cash book
• Cash receipts and payments are recorded in the cash book.
Cash receipts are recorded as follows, with the total column analysed
into its component parts.
CASH RECEIPTS
Date Narrative Total Discounts Rec'bles ledger Cash Sundry
allowed sales
$ $ $ $ $
3.3.X9 Cash sale 150 150
ABC & Co 1,000 50 1,000
(discount taken)
1,150 50 1,000 150 –
• Cash payments are recorded in a similar way.

Cash books 2
Petty cash book
• Petty cash payments and receipts are recorded in a petty cash book.
Most businesses keep a small amount of cash on the premises for

small payments, eg stamps, coffee.
PETTY CASH BOOK
RECEIPTS PAYMENTS
Date Narrative Total Date Narrative Total Stationery Coffee etc
$ $ $ $ $ $
3.3.X9 Bank 50 3.3.X9 Paper 10 10
Coffee 5 5
50 15 10 5
Cash books 3
Petty cash imprest system
• Under the 'imprest system':
Cash still held in petty cash X
Plus voucher payments X
Must equal the agreed sum or float X
• Reimbursement is made equal to the voucher payments to bring the float back up to
the imprest amount.
Controlling petty cash – the imprest system
An imprest system acts as an accounting control by having a set amount of petty cash.
— Pre-set limit, say $50

— Voucher filled in when money is taken out to pay
expenses
— At any time, vouchers + cash = pre-set limit
— At the end of the week/month, the petty cash book is filled
in from the vouchers
— The amount needed to bring the balance back up to the
pre-set limit = money spent
Chapter summary 1
1 Statement of financial position
 The statement of financial position shows the assets and liabilities of a business at a
particular point in time.
Chapter summary 2
2 The statement of profit or loss
 The statement of profit or loss shows its performance over a period.
Chapter summary 3
3 The relationship between the statements of financial position and profit or loss
 The statement of profit or loss largely explains the movement between the business'
assets and liabilities at the beginning of the year and at the end of the year.
Chapter summary 4
4 From business transactions to financial statements
 A business will enter many transactions during the year. All of these need to be
recorded and summarised to produce the entity's financial statements.
Chapter summary 5
5 Books of prime entry
 The business' transactions must first be categorised into the books of prime entry.
The cash book records money paid in to and out of the bank account; the sales day
book records credit sales; the purchase day book records credit purchases; the petty
cash book records transactions made in petty cash and the journal book is used to
correct errors and make other adjustments such as accruals and prepayments. The
totals on these books are then summarised in the nominal ledger.
• The nominal ledger
Chapter 5 • The accounting equation
• Double entry bookkeeping
Ledger accounts • The journal
and double entry • Day book analysis
• The receivables and payables
ledgers
• Understand and apply the concept of double entry accounting,
the duality concept and the accounting equation.
• Identify the main types of ledger account and illustrate how to
balance and close a ledger account.
• Understand and illustrate the uses of journals and the posting of
journal entries into ledger accounts.
• Identify correct journals from given narrative.
• Record credit sale; credit purchase and cash transactions in
ledger accounts and day books.
• Understand and record sales and purchase returns.
Overview
Ledger accounts
and double entry
Ledger accounts Double entry
Balancing off Debit Credit

The nominal ledger 1
Ledger accounting and double entry
• Method used to summarise transactions in the books of prime entry
• A ledger account or 'T' account looks like this:
NAME OF ACCOUNT
$ $
DEBIT SIDE CREDIT SIDE
The nominal ledger
• Is an accounting record which summarises the financial affairs of a business
Accounts within the nominal ledger include the following.
• Plant and machinery (non-current asset)
• Inventories (current asset)
• Sales (income)
• Rent (expense)
• Total payables (current liability)
The accounting equation 1
The accounting equation
• CAPITAL + LIABILITIES = ASSETS
Capital
• Investment of funds with the intention of earning a return
Drawings
• Amounts withdrawn from the business by the owner
The accounting equation 2
The accounting equation is based on the principle that an entity is separate from the
owner, ie the business entity concept.
Double entry bookkeeping 1
Basic principles
• Double entry bookkeeping is based on the same idea as the accounting equation.
• Every accounting transaction has two equal but opposite effects.
• Equality of assets and liabilities is preserved.
• In a system of double entry bookkeeping every accounting event must be entered in
ledger accounts both as a debit and as an equal but opposite credit.
A debit entry will:
• Increase an expense
• Increase an asset
• Decrease a liability
A credit entry will:
• Decrease an asset
• Increase a liability
• Increase income
Double entry bookkeeping
• The rules of double entry bookkeeping are best learnt by considering the cash book.
• A credit entry indicates a payment made by the business; the matching debit entry is
then made in an account denoting an expense paid, an asset purchased or a liability
settled.
• A debit entry in the cash book indicates cash received by the business; the matching
credit entry is then made in an account denoting revenue received, a liability created
or an asset realised.
Lecture example 1
Required
What is the double entry for each of the following?
Explain each entry in terms of the general rules above.
(a)Sales for cash
(b) Sales on credit
(c)Purchase for cash
(d) Purchase on credit
(e)Pay electricity bill
(f) Receive cash from a credit customer
(g)Pay cash to a credit supplier
(h) Borrow money from the bank
Answer to lecture example 1
Transaction Debit Credit
d
Answer to lecture example 1 (cont'd)
Transaction Debit Credit
h
Lecture example 2
Douglas
• Douglas had the following transactions during January:
(1) Introduced $5,000 cash as capital
(2) Purchased goods on credit from Richard, worth $2,000
(3) Paid rent for one month, $500
(4) Paid electricity for one month, $200
(5) Purchased car for cash, $1,000
(6) Sold half of the goods on credit to Tish for $1,750
(7) Drew $300 for his own expenses
(8) Sold goods for cash, $2,100
Lecture example 2 (cont'd)
Required
Post transactions (1) to (8) to the relevant ledger accounts.
Lecture example 3
The following information has been posted to the cash account below.
Required
Balance off the cash account to determine the amount of cash held at the end of
January.
The journal
The journal
• Book of prime entry
• Keeps a record of unusual movements between accounts
• Format of journal entries is as follows:
Date Debit Credit
$ $
DEBIT A/c to be debited X
CREDIT A/c to be credited X
Narrative to explain transaction
Day book analysis 1
Day book analysis
• Entries in the day books are totalled and analysed before posting to the nominal
ledger.
• Note that day books are often analysed as in the following extract (date, customer
name and reference not shown).
Total invoiced Calculator sales Book sales
$ $ $
340 160 180
120 70 50
600 350 250
Total 1060 580 480
Day book analysis 2
• To identify sales by product, total sales would be entered ('posted') as follows.
$ $
DEBIT Receivables a/c 1,060
CREDIT Sales: Calculators 580
Sales: Books 480
• Other books of prime entry are analysed in a similar way.

The receivables and payables ledgers 1
Trade account receivable
• A customer who buys goods without paying for them straight away (an asset).
• Also known as a debtor.
Trade account payable

• A person to whom a business owes money (a liability).
• Also known as a creditor.
Receivables and payables ledgers
• To keep track of individual customer and supplier balances it is common to maintain
subsidiary ledgers called the receivables ledger and the payables ledger. Each account
in these ledgers represents the balance owed by or to an individual customer or
supplier.
• These receivables and payables ledgers are usually kept purely for reference and are
therefore known as memorandum records. They do not form part of the double entry
system.
• However, some computerised accounting packages treat the
receivables and payables ledgers as part of the double entry
system, in which case separate control accounts are not kept.
Entries to the receivables ledger are made as follows:
• When making an entry in the sales day book, an entry is then
made on the debit side of the customer's account in the
receivables ledger.
• When cash is received and an entry made in the cash book, an
entry is also made on the credit side of the customer's account in
the receivables ledger.
• The payables ledger operates in much the same way.
Flow of information
Assorted transactions
Categorised in books of
prime entry
TOTALS
double entry
Posted to nominal ledger
FINANCIAL STATEMENTS
Chapter summary 1
1 Introduction
 In chapter 4 the totals on the books of prime entry were summarised in the nominal
ledger. These amounts are posted to the nominal ledger using double entry.
 The principles of double entry work on the basis that for each debit entry there must
be a credit entry. This is also known as the dual effect.
Chapter summary 2
2 Ledger accounts
 A debit entry increases assets, expenses and drawings and a credit entry increases
liabilities, income and capital – this can be remembered as DEAD CLIC.
Chapter summary 3
3 Flow of information
 A business' transactions are categorised in the books of prime entry and the totals are
then posted to the nominal ledger. A trial balance (Chapter 6) can then be extracted
from the balances on the nominal ledger accounts and the statement of financial
position and statement of profit or loss produced.
Chapter summary 4
4 Balancing off the ledger accounts
 At the end of each period the nominal ledger accounts (T accounts) are 'balanced
off' to determine the closing balance on each account.
Chapter summary 5
5 Memorandum ledgers
 There are two memorandum ledgers: the receivables ledger
and the payables ledger. The receivables ledger shows how
much the business is owed by each individual customer at a
point in time and the payables ledger shows how much it owes
to each individual supplier at any point in time.
• The trial balance
Chapter 6 • Statement of profit or loss
• Statement of financial position
From trial balance to • Preparing financial statements
financial statements
• Identify the purpose of a trial balance
• Extract ledger balances into a trial balance
• Prepare extracts of an opening trial balance
• Identify and understand the limitations of a trial balance
Overview
Trial balance
From trial balance

to financial statements
position
Accounting equation
The trial balance 1
Balancing ledger accounts
• At the end of an accounting period a balance is struck on each ledger account.
• Total all debits and credits
• Debits exceed credits = debit balance
• Credits exceed debits = credit balance
The trial balance 2
• An example of balancing a ledger account is shown below
The trial balance 3
Trial balance
• The balances are then collected in a trial balance. If the double entry is correct, total
debits = total credits.
• An example of a trial balance, incorporating the above receivables balance, is shown
on the next slide.
The trial balance 4
Lecture example 1
• Douglas
Cash
$ $
Capital 5,000 Rent 500
Sales 2,100 Electricity 200
Car 1,000
Drawings 300
Capital
$ $
Cash 5,000
Trade payables
$ $
Purchases 2,000
Purchases
$ $
Trade payables 2,000
Rent
$ $
Cash 500
Electricity
$ $
Cash 200
Car
$ $
Cash 1,000
Drawings
$ $
Cash 300
Trade receivables
$ $
Sales 1,750
Sales
$ $
Trade receivables 1,750
Cash 2,100
Required
Balance off the ledger accounts for Douglas
Cash
$ $
Capital
$ $
Trade payables
$ $
Purchases
$ $
Rent
$ $
Electricity
$ $
Car
$ $
Drawings
$ $
Trade receivables
$ $
Sales
$ $
Lecture example 2
Douglas
• Refer to Lecture example 1 where the ledger accounts were balanced off.
• Using the ledger accounts for Douglas, prepare the trial balance as at the end of
January.
Trial Balance
Debit Credit
Cash $ $
Capital 5,100
Trade payables 5,000
Purchases 2,000
Rent 2,000
Electricity 500
Car 200
Drawings 1,000
Trade receivables 300
Sales 1,750
3,850
10,850 10,850
• First open up a ledger account for the statement of profit or loss. Continuing our
example for ABC Traders this ledger account is shown below, together with the rent
account to illustrate how balances are transferred to it at the end of the year.
ABC TRADERS
STATEMENT OF PROFIT OR LOSS
FOR THE YEAR ENDED 30 JUNE 20X7
$ $
Sales 35,000
Cost of sales (here = purchases) 13,000
Gross profit 22,000
Expenses
Rent 4,000
Sundry expenses 3,500
Loan interest 1,000
8,500
Net profit 13,500
Statement of profit or loss 3 –
Transferring
Rent
$ $
Cash 4,000 Bal c/d 4,000
Bal b/d 4,000 SPL 4,000
SPL

Rent 4,000
NB: The remaining profit or loss account balances are also then
transferred to the statement of profit or loss account as illustrated
above.
Lecture example 3
• Douglas
Refer to Lecture example 2.
Required
Prepare a statement of profit or loss in ledger account form.
Purchases
$ $
Rent
$ $
Electricity
$ $
Sales
$ $
$ $
Purchases Sales
Gross profit c/d
Rent Gross profit b/d

Electricity
Net profit c/d
Net profit b/d

Statement of financial position 1
Statement of financial position
• The statement of financial position is prepared by following these steps.
• Balance off the accounts relating to assets and liabilities.
• Transfer the balances (per ABC Traders) on the drawings account and the statement of
profit or loss ($13,500) to the capital account as follows:
DRAWINGS
$ $
Cash 5,000 Capital 5,000
STATEMENT OF PROFIT OR LOSS

$ $
Purchases 13,000 Sales 35,000
Rent 4,000
Sundry expenses 3,500
Loan interest 1,000
Capital a/c 13,500
35,000 35,000
CAPITAL
$ $
Drawings 5,000 Capital 10,000
Balance c/d 18,500 SPL 13,500
23,500 23,500
• This gives us the statement of financial position as follows:
Lecture example 4
• Douglas
Refer to Lecture example 2 and Lecture example 3.
Required
Draw up a statement of profit or loss for the period and a statement of financial
position at the end of January.
DOUGLAS
STATEMENT OF PROFIT OR LOSS FOR THE MONTH OF
JANUARY
$ $
Sales
Less cost of sales:
Purchases
Gross profit
Less expenses:
Rent
Electricity
Net profit
DOUGLAS
STATEMENT OF FINANCIAL POSITION AS AT 31 JANUARY
$ $
NON-CURRENT ASSET
Motor Vehicle
CURRENT ASSETS
Trade receivables
Cash
Lecture example 5
• Douglas
Required
Transfer the profit and drawings to the capital account.
Drawings
$ $
$ $
Purchases Sales
Gross profit c/d
Rent Gross profit b/d

Electricity
Net profit c/d
Capital Net profit b/d

Capital
$ $
Lecture example 6
• Douglas
Required
Prepare the accounting equation for Douglas.
Assets = capital + (profit – drawings) + payables
Preparing financial statements
Accounting process overview
Receipt/
Invoice Payment Invoice
Receivables Sales day Purchase Payables

Cash book
ledger book day book ledger
Dr Cr
Dr Dr
General
ledger
Cr Cr
Preliminary trial balance

Journal
Dr
eg closing
inventory Cr
Clear income and expenditure
balances to SPL
Clear profit and drawings

balances to capital account
Prepare statement of financial position

Chapter summary 1
1 Introduction
 Once a business‘s transactions have been categorised in the books of prime entry and
summarised in the nominal ledger accounts the next step is to extract a trial balance.
Chapter summary 2
2 The trial balance
 The trial balance consists of a list of the balances brought down on each ledger
account.
Chapter summary 3
3 The statement of profit or loss
 The balances on all of the income and expenditure ledger accounts are transferred to
the statement of profit or loss.
 As we will see later the statement of profit or loss will be affected by certain
adjustments that will affect profit (such as closing inventory).
Chapter summary 4
4 The statement of financial position
 The statement of financial position lists out the balances on all of the asset and liability
ledger accounts.
Chapter summary 5
5 The accounting equation
 The accounting equation expresses the statement of financial position as an equation:
 Assets = capital + profit – drawings + payables
• Nature and collection of
Chapter 7 sales tax
• Accounting for sales tax
Sales tax
• Understand the general principles of the operation of a sales tax.
• Calculate sales tax on transactions and record the consequent accounting entries.
Overview
Output tax Input tax
Accounting treatment
Sales tax
Irrecoverable sales tax Discounts

Nature and collection of sales tax 1
Sales tax
• Is an indirect tax levied on the sale of goods and services
• Administered by tax authorities
• Can have a number of rates, eg standard rate, reduced rate
Output sales tax
• Sales tax charged by the business on goods/services
Input sales tax

• Sales tax on purchases made by the business
Output tax greater than input?
• Pay difference to tax authorities
Input tax greater than output?

• Refund due to business
Accounting for sales tax 1
Credit sales
• Include sales tax in sales day book; analyse it separately
• Include gross receipts from receivables in cash book; no need to show sales tax
separately
• Exclude sales tax element from statement of profit or loss
• Credit sales tax control account with output sales tax element of sales invoices
Credit purchases
• Include sales tax in purchases day book; analyse it separately
• Include gross payments in cash book; no need to show sales tax separately
• Exclude recoverable sales tax from statement of profit or loss
• Include irrecoverable sales tax in statement of profit or loss
• Debit sales tax control account with recoverable input sales tax element of credit
purchases
Cash sales
• Include gross receipts in cash book; show sales tax separately
• Exclude sales tax element from statement of profit or loss
• Credit sales tax control account with output sales tax element of cash sales
Cash purchases
• Include gross payments in cash book: show sales tax separately
• Exclude recoverable sales tax from statement of profit or loss
• Include irrecoverable sales tax in statement of profit or loss
• Debit sales tax control account with recoverable input sales tax element of cash
purchases
Lecture example 1
A business buys goods for $1,000 plus 15% sales tax. They then sell those goods for $1,500 + 15% sales tax.
The purchases will cost ($1,000 × 1.15) = $1,150

The sales will raise ($1,500 × 1.15) = $1,725
The sales tax payable to tax authorities will be:
Payable on outputs (sales) (15% × $1,500) 225.00

Reclaimable on inputs (purchases) (15% × $1,000) (150.00)
Net sales tax to tax authorities 75.00
As the business is purely collecting the sales tax for the tax authorities, and is able to set off its sales tax
suffered it does not include sales tax as either an expense or income in the statement of profit or loss.
The sales tax is accounted for when the transaction occurs.
Required
(a) Post the double entry to the ledger account below.
$ $
Dr Purchases 1,000
Dr Sales tax control account 150
Cr Trade payables 1,150
(b) Post the double entry to the ledger account below.
$ $
Dr Trade receivables 1,725
Cr Sales 1,500
Cr Sales tax control account 225
Purchases
$
Trade payables
Trade receivables
$
Sales tax control a/c
$ $
Sales
$ $
Chapter summary 1
1 Introduction
 A business acts as a collecting agent for the tax authorities and
charges sales tax (output tax) on its sales and reclaims sales
tax (input tax) on its purchases.
Chapter summary 2
2 Accounting treatment
 Sales and purchases are recorded at the net amount.
 Sales tax may be charged at various rates, however the rate
of sales tax will always be provided in an exam question.
Chapter summary 3
3 Irrecoverable sales tax
 Sales tax may not be recoverable on certain purchases. Where
this is the case the question will state that the sales tax is not
recoverable and the cost recorded will be the gross amount.
Chapter summary 4
4 Sales tax and discounts
 The effect of discounts on sales tax is covered in Chapter 14.
Chapter summary 5
5 Rates of sales tax
 Zero rated supplies have sales tax charged on them at 0%
whereas exempt supplies are not subject to sales tax.
• Cost of goods sold
Chapter 8 • Accounting for opening and
closing inventories
• Counting inventories
Inventory • Valuing inventories
• IAS 2 Inventories
• Recognise the need for adjustments for inventory in preparing financial statements.
• Record opening and closing inventory.
• Identify the alternative methods of valuing inventory.
• Understand and apply the IASB requirements for valuing inventories.
• Recognise which costs should be included in valuing inventories.
• Calculate the value of closing inventory using 'first in, first out' and 'average cost' (both
periodic weighted average and continuous weighted average).
• Understand the use of continuous and period end inventory records.
• Understand the impact of accounting concepts on the valuation of inventory.
• Identify the impact of inventory valuation methods on profit and on assets.
Overview
Accounting adjustments
Inventory
Valuation Effects on profit
Cost Net realisable value
Methods of estimating cost
FIFO AVCO
Cost of goods sold 1
• Formula for the cost of goods sold
$
Opening inventory value X
Add: purchases (or production costs) X
X
Less: closing inventory value (X)
Cost of goods sold X
Carriage inwards
• Cost paid by purchaser of having goods transported to his business
• Added to cost of purchases
Carriage outwards
• Cost to the seller, paid by the seller, of having goods transported to customer
• Is a selling and distribution expense
Accounting for opening and closing inventories 1
Entries during the year

• During the year, purchases are recorded by the following entry.
DEBIT Purchases $ amount bought

CREDIT Cash or payables $ amount bought
• The inventory account is not touched at all.

Entries at year-end
• The first thing to do is to transfer the purchases account balance to the statement of
profit or loss:
DEBIT Statement of profit or loss $ total purchases

CREDIT Purchases $ total purchases
• The balance on the inventory account is still the opening inventory balance. This must
also be transferred to the statement of profit or loss:
DEBIT Statement of profit or loss $ opening inventory

CREDIT Inventory $ opening inventory
• The exact reverse entry is made for the closing inventory (which will be next year's
opening inventory):
DEBIT Inventory $ closing inventory

CREDIT Statement of profit or loss $ closing inventory
Counting inventories 1
Counting inventories
• In order to make the entry for the closing inventory, we need to know what is held at
the year-end. We find this out not from the accounting records, but by going into the
warehouse and actually counting the boxes on the shelves.
Counting inventories 2
• Some businesses keep detailed records of inventory coming in and going out, so as not
to have to count everything on the last day of the year. These records are not part of
the double entry system.
Valuing inventories 1
Valuation
Inventories must be valued at the lower of:
• Cost
• Net realisable value (NRV)
Cost
Can use per IAS 2:
• FIFO (First In Last Out)
• Average cost (both periodic weighted average and continuous weighted average)
• LIFO (Last In First Out) is not permitted
NRV
Expected selling price X
Less: costs to get items ready for sale (X)
selling costs (X)
X
• Inventory forms a major part of the assets of some companies.
• So the value placed on the inventory can make a big difference to the profit or loss
reported.
IAS 2 Inventories
IAS 2
• Inventories should be measured at the lower of cost and
net realisable value – the comparison between the two should ideally be made
separately for each item.
• Cost is the cost incurred in the normal course of business in bringing the product to its
present location and condition, including production overheads and costs of
conversion.
IAS 2 Inventories 2
IAS 2
• Inventory can include raw materials, work in progress, finished goods, goods
purchased for resale
• FIFO and average cost (both periodic weighted average and continuous weighted
average) are allowed
• LIFO is not allowed
IAS 2 Inventories 3
Inventories are assets:
• Held for sale in the ordinary course of business
• In the process of production for such sale; or
• In the form of materials or supplies to be consumed in the production process or in the
rendering of services
IAS 2 Inventories 4
Net realisable value is the estimated selling price:
• In the ordinary course of business less the estimated costs of completion and the
estimated costs necessary to make the sale
Lecture example 1
According to IAS 2: Inventories, which of the following should not be included in
determining the cost of the inventories of an entity?
(1) Labour costs
(2) Transport costs to deliver goods to customers
(3) Administrative overheads
(4) Depreciation on factory machine
A All four items
B 1 only
C 2 and 3 only
D 2, 3, and 4 only
Lecture example 2
Jessie is trying to value her inventory. She has the following information available:
$
Selling price 35
Costs incurred to date 20
Cost of work to complete item 12
Selling costs per item 1
Required
What is the net realisable value of Jessie's inventory?
Net realisable value is:

$
Estimated selling price
Less: costs of completion
Less: selling costs
Lecture example 3
On 1 January 20X7 a company held 200 units of finished goods valued at $10 each.
During January the following transactions took place:
Date Units purchased Cost per unit

10 January 300 $10.85
20 January 350 $11.50
25 January 250 $13.00
Sales during January were as follows:
Date Units sold Cost per unit

14 January 280 $18.00
21 January 400 $18.00
28 January 80 $18.00
Required
Determine the valuation of closing inventories and cost of sales using:
(a) FIFO
(b) Weighted average cost (continuous)
(c) Weighted average cost (periodic)
(a) Closing inventories (FIFO)
Purchases
Opening 10 Jan 20 Jan 25 Jan
inventories
200 300 350 250
Sales
14 Jan (200) (80)
21 Jan (220) (180)
26 Jan (80)
Nil Nil 90 250
@ $11.50 @ $13.00
= $1,035 = $3,250
$4,285
Cost of sales (FIFO)

$
Opening inventories (200 × $10) 2,000
Purchases 10,530
12,530
Less: closing inventories (4,285)
8,245
(b) Closing inventories and cost of sales (AVCO – continuous)
Average Total Cost of
Units Cost Unit Cost Cost Sales
$ $ $ $
1.1.X2 b/f 200 10.00 2,000
10.1.X2 Purchase 300 10.85 3,255
500 (W1) 10.51 5,255
14.1.X2 Sales (280) 10.51 (2,943) 2,943
220 2,312
20.1.X2 Purchase 350 11.50 4,025
570 (W2) 11.12 6,337
21.1.X2 Sales (400) 11.12 (4,448) 4,448
170 1,889
25.1.X2 Purchase 250 13.00 3,250
420 (W3) 12.24 5,139
28.1.X2 Sale (80) 12.24 (979) 979
340 4,160 8,370
(W1) $5,255/500 = $10.51
(W2) $6,337/570 = $11.12
(W3) $5,139/420 = $12.24
(c) Closing inventories and cost of sales (AVCO – periodic)
Total
Units Units Cost Value
$ (opening +
purchases
)
$
1.1.X2 b/f 200 10.00 2,000
10.1.X2 Purchases 300 10.85 3,255
14.1.X2 Sales (280)
20.1.X2 Purchases 350 11.50 4,025
21.1.X2 Sales (400)

25.1.X2 Purchases 250 13.00 3,250
28.1.X2 Sales (80)

1,100 (760)
(c) Closing inventories and cost of sales (AVCO - periodic)
$
Opening inventories ($200 × $10) 2,000
Purchases (3,255 + 4,025 + 3,250) 10,530
12,530
Average cost for the period = $12,530 ÷ 1,100 = $11.39
Closing inventory value = (1,100 – 760) × $11.39 = $3,873
Cost of sales $
Opening inventories 2,000
Purchases 10,530
12,530
Less closing inventories (3,873)
8,657
Chapter summary 1
1 Introduction
 Inventories can be a significant figure in an entity's accounts
and will impact both the profit figure and the net asset
position. It is important therefore that it is recorded correctly.
Chapter summary 2
2 Accounting adjustment
 As seen in chapter 6 the statement of profit or loss matches
the sales revenue earned in a period with the cost of sales
incurred to generate that revenue. There are therefore two
inventory adjustments: the opening inventory adjustment
and the closing inventory adjustment.
Chapter summary 3
3 Valuation
 Inventories should be valued at the lower of cost and net
realisable value.
Chapter summary 4
4 Cost
 The cost of inventory includes the cost of purchase, costs of
conversion and any other costs necessary to bring the
inventory to its present location and condition.
Chapter summary 5
5 Net realisable value (NRV)
 Net realisable value is the estimated selling price less the
costs to completion and any selling and distribution costs.
Chapter summary 6
6 Theoretical methods of estimating cost
 Methods available to estimate the cost of inventories are first
in, first out (FIFO) and average cost. Under FIFO the
inventories held at the year end are the most recent
purchases but under average cost the cost of all inventories
purchased is weighted to produce an average figure.
Chapter summary 7
7 Valuation effects on profit
 In times of rising prices, using FIFO will mean the financial
statements show higher inventory values and higher profits.
• Capital and revenue expenditure
Chapter 9 • IAS 16 Property, plant and
equipment
• Depreciation
Tangible non current • Non-current asset disposals
assets • Revaluations
• Disclosure
• Define non-current assets and recognise the difference between current and non-
current assets.
• Explain the difference between capital and revenue items and classify expenditure
accordingly.
• Prepare ledger entries to record the acquisition, disposal, depreciation and
accumulated depreciation of noncurrent assets.
• Calculate and record profits or losses on disposal of non-current assets in the
statement of profit or loss.
• Record the revaluation of a non-current asset and calculate its subsequent
depreciation and profit or loss on disposal.
• Illustrate how non-current asset balances and movements are disclosed in company
• Explain the purpose and function of an asset register.
• Understand and explain the purpose of depreciation.
• Calculate the charge for depreciation using the straight line and reducing methods,
identifying when each is appropriate.
• Calculate the adjustments to depreciation necessary if changes are made in the
estimated useful life and/or residual value of a non-current asset.
• Record depreciation in the statement of profit or loss and statement of financial
position.
Overview
Capital versus revenue
Cost
expenditure
Tangible non-current
assets
Revaluations Depreciation Disposals
Straight line Reducing balance

method method
Capital and revenue expenditure 1
What is capital expenditure?
• Capital expenditure results in the acquisition of non-current assets, or an increase in
their earning capacity.
Capital and revenue expenditure 2
What is revenue expenditure?
• Revenue expenditure is incurred for the purpose of trade or to maintain the existing
earning capacity of the non-current assets.
IAS 16 Property, plant and equipment 1
IAS 16
• Initial measurement – at cost
• Components of cost
— Purchase price (including import duties, excl trade discount, recoverable sales tax)
— Initial estimate of dismantling and restoration costs
— Directly attributable costs, eg site preparation, delivery and handling costs installation,
assembly costs, testing and professional fees
IAS 16 Property, plant and equipment 2
• Subsequent expenditure
— added to carrying amount if improves condition beyond previous performance
• Repairs and maintenance costs are expensed

Depreciation 1
Depreciation – accruals concept
• Is a process of spreading the original cost of a non-current asset over the accounting
periods in which its benefit will be felt
Depreciation 2
Two methods
• Straight line
dep'n = cost – RV
useful life
• Reducing balance
dep'n = cost × RB%
Depreciation 3
• The double entry for depreciation is as follows:
DEBIT Depreciation expense (SPL)

CREDIT Accumulated depreciation (SOFP)
Depreciation 4
Change in expected life
• If after a period of an asset's life it is realised that the original useful life has been
changed, then the depreciation charge needs to be adjusted.
• The revised charge from that date becomes:
CV at revised date
Remaining useful life
Non-current asset disposals 1
Disposal
• On disposal of an asset a profit or loss will arise depending on whether disposal
proceeds are greater or less than the carrying value of the asset.
• If proceeds > CV = profit
• If proceeds < CV = loss
Double entry for a disposal
• Eliminate cost
DEBIT Disposals
CREDIT Non-current assets
• Eliminate accumulated depreciation

DEBIT Provision for depreciation
CREDIT Disposals
• Account for sales proceeds
DEBIT Cash
CREDIT Disposals
or if part exchange deal
DEBIT Non-current assets
CREDIT Disposals
with part exchange value
• Transfer balance on disposals account to the statement of profit or loss

Revaluations 1
IAS 16 allows a choice between
• Keeping asset at cost
• Revaluing to fair value
Fair value may give fairer view on business.
Revaluations 2
Accounting for a revaluation
A revaluation is recorded as follows:
DEBIT Non-current asset

(revalued amount less original cost)
DEBIT Accumulated depreciation
(total depreciation to date)
CREDIT Revaluation surplus
(revalued amount less carrying value)
Disclosure
Disclosure
With regard to disclosure, a proforma non-current asset note is shown here.
Total Land and Plan and
buildings equipment
$ 000 $ 000 $ 000
Cost or valuation
At January 20X7 160 100 60
Revaluation surplus 20 20 –
Additions in year 50 30 20
Disposals in year (45) (15) (30)
At 31 December 20X7 185 135 50
Depreciation
At 1 January 20X7 30 20 10
Charge for year 7 5 2
Eliminated on disposals (3) – (3)
At 31 December 20X7 34 25 9
Carrying value
At 31 December 20X7 151 110 41
At 1 January 20X7 130 80 50
Lecture example 1
Required
What examples of tangible non-current assets can you identify?
Lecture example 2
On 10 December 20X7 an entity bought a machine.
The breakdown on the invoice showed:
$
Cost of machine 20,000
Delivery costs 200
One-year maintenance contract 900
21,100
Further installation costs of $500 were also incurred.
Required
At what amount should the machine be capitalised in the entity's records?
A $20,000
B $20,700
C $20,200
D $21,600
Lecture example 3
A business buys a machine for $2,500. It is expected to have a useful life of three years
after which time it will have a scrap value of $250.
Required
(a) Calculate the annual depreciation charge.
(b) Calculate the cost, accumulated depreciation and net book value (NBV)
for each year of the asset's life. Note: NBV = cost – accumulated depreciation to
date.
Lecture example 4
A business buys a machine costing $6,000. The depreciation rate is 40% on a reducing
balance basis.
Required
Calculate depreciation expense, accumulated depreciation and net book value of the
asset for the first three years.
Lecture example 5
Required
Using the information in Lecture example 3, show:
(a) The journal entry which would have been written at the end of the first
year.
(b) The treatment of depreciation for all years in the relevant ledger accounts.
(c) The relevant statement of profit or loss and statement of financial position
extracts for each year.
Lecture example 6
The machine costing $6,000 in Lecture example 4 is sold in year 3 for $3,000. No
depreciation is charged in the year of disposal.
Required
(a) Calculate the profit or loss on disposal of the machine.
(b) Complete the ledger accounts to show how the disposal would be
accounted for.
Lecture example 7
Assume in Lecture example 6 that instead of cash proceeds of $3,000, there is a part
exchange allowance of $3,000 on a replacement machine costing $10,000.
Required
(a) Calculate the profit or loss on disposal of the machine.
(b) Calculate the amount of cash paid for the new machine.
(c) Complete the ledger accounts to show both the disposal and the
acquisition.
Lecture example 8
A building costing $100,000 on which depreciation of $20,000 has been charged is to
be revalued to $150,000.
Required
(a) Show the double entry to record the revaluation and make the postings
to the ledger accounts.
(b) What would be the depreciation charge for the year if the building has a
remaining useful life of 40 years?
Lecture example 9
1.1.X1 Asset cost $40,000
Estimated useful life five years
No residual value
1.1.X3 Total useful life revised to four years.
Required
Calculate the depreciation charge, accumulated depreciation and NBV for each year of
the asset's life (year end 31 December).
Lecture example 10
1.1.X1 Asset cost $40,000
Residual value $1,500
Useful life five years
Depreciation: 25% reducing balance
1.1.X3 Change depreciation method to straight line
Required
Calculate the depreciation charge, accumulated depreciation and NBV for each year of
the asset's life (year ended 31 December).
Chapter summary 1
1 Introduction
 Expenditure on non-current assets is often significant and it is
important therefore that it is accounted for appropriately.
Chapter summary 2
2 Non-current assets
 Capital expenditure results in a non-current asset being
shown on the statement of financial position. Revenue
expenditure, such as repairs and maintenance, is shown as an
expense in the statement of profit or loss.
 Tangible non-current assets should initially be recorded at
cost. This includes the purchase price of the item plus any
directly attributable costs to bring the item to its intended
location and ready to use.
Chapter summary 3
3 Depreciation
 Depreciation is an expense charged in relation to the asset
each year to reflect the using up of the asset. Land usually has
an unlimited useful life and so is not depreciated.
Chapter summary 4
4 Methods of depreciation
 Depreciation is usually calculated on a straight line or
reducing balance basis.
Chapter summary 5
5 Straight line method
 This method is suitable for assets which are used up evenly
during their life time. The depreciation expense is the same
each year.
Chapter summary 6
6 Reducing balance method
 This method is suitable for assets which generate more
revenue in the earlier years of their life. The depreciation
expense is higher in the initial years.
Chapter summary 7
7 Accounting for depreciation
 Depreciation is recorded by way of a journal entry. The
expense is recorded as a debit entry and reduces profit. The
credit is made to the accumulated depreciation account and
reduces the carrying value of the asset in the statement of
financial position.
Chapter summary 8
8 Disposal of non-current assets
 On disposal of a non-current asset the sales proceeds are
compared to the net book value of the asset in order to
calculate the profit or loss on disposal. Where an asset is
given in part exchange for another asset, the part exchange
allowance takes the place of the sales proceeds.
Chapter summary 9
9 Revaluations
 An entity may choose to revalue its assets rather than hold
them at cost – this is a choice of accounting policy. Where an
entity revalues, it must revalue all assets in the same class
and the depreciation charge is based on the revalued
amount.
Chapter summary 10
10 Depreciation revisited
 If an entity changes the method of depreciation used from
straight line to reducing balance (or vice versa) or revises the
useful life of an asset it should write off the asset's net book
value using the revised method or useful life.
• Intangible non-current assets
Chapter 10 • Research and development costs
Intangible non current

assets
• Recognise the difference between tangible and intangible non-current assets.
• Identify types of intangible assets.
• Identify the definition and treatment of research and development costs in accordance
with IFRS.
• Calculate amounts to be capitalised as development expenditure or to be expensed
from given information.
• Calculate and account for the charge for amortisation and explain its purpose.
Overview
Intangible non-current
assets
Research Development expenditure
Amortisation
Intangible non-current assets 1
Intangible non-current assets
• Non-current assets which have a value to the entity but no physical substance.
Examples
• Goodwill (see Chapter 24)
• Leases
• Patents and trade names
• Deferred development costs
Amortisation
• Intangible assets must be amortised systematically over their useful life. An intangible
asset with an indefinite useful life is not amortised but should be reviewed each year
for impairment.
Disclosure
• Method of amortisation used
• Useful life of the assets or amortisation rate used
• Gross carrying value, accumulated amortisation and accumulated impairment losses at
beginning and end of period
• Movements during the period
• Carrying amount of internally-generated intangible assets
Research and development costs 1
IAS 38 Intangible assets
• Pure or basic research
• Applied research
• All costs written off as incurred
• Development expenditure must be capitalised if all criteria stated under IAS 38 can be
demonstrated.
Research and development costs 2
IAS 38 criteria:
•P – Probable future economic benefits
•I – Intention to complete the intangible asset and use or sell it
•R – the availability of Resources to complete the development and use or sell
•A – Ability to use or sell
•T – Technical feasibility of completing the asset
•E – reliable measurement of Expenditure
Lecture example 1
Z Co incurred the following costs during the year ended 31 August 20X8:
(1) $20,000 on salaries for market research staff sent out to canvass drivers'
opinions on a potential new car.
(2) $100,000 to purchase a machine to manufacture components for the new car.
It has an estimated useful life of ten years.
(3) $25,000 on materials to manufacture a prototype and $50,000 on salaries
relating to its design and manufacture. The new car is expected to go on sale in
20X9.
Required
How should each of the above items be shown in the financial statements for the year
ended 31 August 20X8?
Lecture example 2
Development Co incurs the following expenditure in years 20X1–20X5.
Research Development
$ $
20X1 35,000 55,000
20X2 – 65,000
20X3 – –
20X4 – –
20X5 38,000 –
The development expenditure meets the IAS 38 criteria that require capitalisation
('PIRATE'). The item developed in 20X1 and 20X2 goes on sale on 1.1.X3 and it will be
three years from then until any competitor is expected to have a similar product on the
market.
Required
Show statement of profit or loss and statement of financial position extracts for the years
20X1–20X5 inclusive.
Chapter summary 1
1 Definition
 An intangible non-current asset is an identifiable non-
monetary asset without physical substance.
Chapter summary 2
2 Research and development expenditure
 Some entities spend significant sums of money on research
and development it is therefore essential that these
transactions are accounted for appropriately.
Chapter summary 3
3 Intangible assets (IAS 38)
 IAS 38 defines research and development. Research
expenditure is incurred where the entity is acquiring new
scientific or technical knowledge. Development expenditure
relates to the application of research findings.
Chapter summary 4
 Research relates to costs incurred to obtain knowledge or
understanding. There is no certainty of future profit from this
expenditure and so it should be shown as an expense in the
 Development expenditure MUST be capitalised as an
intangible non-current asset provided all of the PIRATE
criteria are met. This asset will then be amortised over the
period during which it is expected to generate income.
Chapter summary 5
5 Amortisation of capitalised development expenditure
 Amortisation is essentially the same as depreciation but
relates to intangibles. Where an entity has capitalised
development expenditure it should amortise the intangible
once the asset is ready for use.
• Accruals and prepayments
Chapter 11
Accruals and
prepayments
• Understand how the matching concept applies to accruals and prepayments.
• Identify and calculate the adjustments needed for accruals and prepayments in
preparing financial statements.
• Prepare the journal entries and ledger entries for the creation of an accrual or
prepayment.
• Illustrate the process of adjusting for accruals and prepayments in preparing financial
statements.
• Understand and identify the impact on profit and net assets of accruals and
prepayments.
Overview
Accruals and
prepayments
Accounting
treatment
Reversing out Presentation in

Year end
accruals and the statement
adjustments
prepayments of financial position
Accrued income Accounting

and deferred income treatment
Accruals and prepayments 1
Accrual
• Expenses charged against the profits of a period even though they have not yet been
paid for
Prepayment
• Payments made in one period but charged to the later period to which they relate
Prepayment
Accruals
Expense incurred – no invoice yet
Part relating to current accounting period is an accrual

Debit SPL
Credit SOFP payables (liability)
• Remember that the financial statements are prepared on an accruals basis.

Lecture example 1
• Fiona set up a business on 1 January 20X7. Her cash payments for the year to 31
December 20X7 included:
Date paid Amount Period
$
Electricity
10.3.X7 96 2 months to 28 February 20X7
12.6.X7 120 quarter to 31 May 20X7
14.9.X7 104 quarter to 31 August 20X7
10.12.X7 145 quarter to 30 November 20X7
Rent
1.2.X7 375 3 months to 31 March 20X7
6.4.X7 1,584 12 months to 31 March 20X8
Note: On 6 March 20X8 Fiona received an electricity bill for $168 for
the quarter to 28 February 20X8.
Required
(a) Calculate the expense incurred by Fiona for electricity and rent for the
year ended 31 December 20X7.
(b) Calculate the amount of any accruals/prepayments at the end of the year.
(c) State the journal entry required for the year-end adjustments.
Lecture example 2
Required
Using the figures from Lecture example 1:
Complete the necessary entries in Fiona's ledger accounts
as at 31 December 20X7, then balance off the accounts.
Lecture example 3
In 20X8 Fiona paid the following electricity bills:
Date paid Amount Period

$
12.3.X8 168 quarter to 28 February 20X8
9.6.X8 134 quarter to 31 May 20X8
12.9.X8 118 quarter to 31 August 20X8
12.12.X8 158 quarter to 30 November 20X8
During March 20X9 Fiona received an electricity bill for $189 for the quarter to 28
February 20X9.
Required
Calculate the electricity expense and accrual for the year ended 31 December 20X8 and
complete the ledger accounts.
Lecture example 4
Jimmy Co prepares its financial statements for the year to 30 June each year. The
company pays for its insurance quarterly in advance on 1 March, 1 June, 1 September
and 1 December each year. The annual insurance premium was $24,000 until 31 August
20X6, after that date it increased to $30,000 per year.
Required
What insurance expense and end of year prepayment should be included in the
financial statements for the year ended 30 June 20X7?
Expense Prepayment
A $29,000 $2,500
B $29,000 $5,000
C $28,500 $2,500
D $28,500 $5,000
Chapter summary 1
1 Introduction
 An entity should produce its financial statements using the
accruals basis. This is an implied assumption in the IASB
Conceptual Framework.
 Accruals are made when expenses are paid in arrears,
whereas prepayments arise when expenses are paid for in
advance.
Chapter summary 2
 Accruals increase expenses and are shown as a liability on the
statement of financial position at the year end.
 Prepayments reduce expenses and are an asset on the
Chapter summary 3
3 Reversing out accruals and prepayments
 Accruals and prepayments from the previous year are
reversed at the beginning of the next accounting period so
that the current year expense is correct.
Chapter summary 4
4 Accrued income and deferred income
 These follow a similar theory to accruals and prepayments but
relate to income.
 An entity will accrue income where it has earned the income
during the period but not yet invoiced for it. This will increase
income and be shown as a receivable at the year end.
 Where an entity has received income in advance of it being
earned it should be deferred to the following period. This will
reduce income and be shown as a payable at the year end.
• Irrecoverable debts and
Chapter 12 receivables allowances
• Accounting for irrecoverable
debts and receivables allowances
Irrecoverable debts and
allowances
• Explain and identify examples of receivables and payables.
• Identify the benefits and costs of offering credit facilities to customers.
• Understand the purpose of credit limits and an aged receivables analysis.
• Prepare the bookkeeping entries to write off an irrecoverable debt, record an
irrecoverable debt recovered and create and adjust an allowance for receivables.
• Identify the impact of irrecoverable debts on the statement of profit or loss and on the
• Illustrate how to include movements in the allowance for receivables in the statement
of profit or loss and how the closing balance of the allowance should appear in the
• Account for contras between trade receivables and payables.
• Prepare, reconcile and understand the purpose of supplier statements.
• Classify items as current or non-current liabilities in the statement of financial position.
Overview
Amounts recovered
Irrecoverable debts
Irrecoverable debts
and allowances
Allowance for receivables
Allowances
Specific General
Irrecoverable debts and receivables allowances 1
Irrecoverable debts and receivables allowances

• A receivable should only be classed as an asset if it is recoverable.
Irrecoverable debts
• If definitely irrecoverable, it should be written off to the statement of profit or loss as
an irrecoverable debt.
DEBIT Irrecoverable debt expense (SPL)

CREDIT Trade receivables (SOFP)
Receivables allowances
• If uncertainty exists as to the recoverability of the debt, an allowance should be set up.
This is offset against the receivables balance on the statement of financial position.
DEBIT Irrecoverable debt expense (SPL)

CREDIT Allowance for receivables (SOFP)
Receivables allowances (cont'd)

• Allowances can either be specific, against a particular receivable, or general, against a
proportion of all receivables not specifically allowed for.
Accounting for irrecoverable debts and receivables allowances 1
General allowances
• When calculating the general allowance to be made, the following order applies.
$
Receivables balance per receivables control account X
Less: irrecoverable debts written off (X)
amounts specifically allowed (X)
Balance on which general allowance is calculated X
• Note. Only the movement in the general allowance needs to be charged or credited to
the SPL.
$
Allowance required X
Existing allowance (X)
Increase/(decrease) required X/(X)
• If a reduction in the receivables allowance is required, then:
DEBIT Allowance for receivables (SOFP)

CREDIT Irrecoverable debts expense (SPL)
• If a increase in the receivables allowance is required, then:
DEBIT Irrecoverable debt (SPL)

CREDIT Allowance for receivables (SOFP)
Subsequent recovery of debts

• If an irrecoverable debt is recovered, having previously been written off, then:
DEBIT Cash (SOFP)

CREDITIrrecoverable debts expense (SPL)
Lecture example 1
Fight & Co has trade receivables at 31 December 20X7 of $65,000. A review of customer
files indicates that two customers, Ali and Tyson, which owe $7,000 and $8,000
respectively, have gone bankrupt and their debts are considered irrecoverable.
Required
(a) Calculate the balance c/d on the trade receivables
account at the end of the year.
(b) Calculate the irrecoverable debt expense shown in the
Lecture example 2
A further review of Fight & Co's customer files indicates there is some uncertainty as to
whether a debt of $3,500 owed by Bugner is recoverable.
(a) Calculate the allowance for receivables shown on the statement of financial
position.
(b) Calculate the allowance for receivables expense shown in the statement of profit
or loss.
(c) Show how the information from Lecture examples 1 and 2 would be shown in
extracts from the statement of profit or loss and statement of financial position.
Lecture example 3
A business's trade receivables account showed a year end balance of $47,440. It was decided that amounts
totaling $340 should be written off as irrecoverable, a specific allowance was to be made against an
amount of $400 due from Dodgy Co, a customer, and a general allowance of 2% was to be made against
remaining debts.
Required
(a) Calculate the allowance for receivables shown in the
(b) Calculate the total receivables expense shown in the
Lecture example 4
Fight & Co (see Lecture example 1) subsequently receive a cheque of $7,000 from Ali.
Required
Show the treatment of this recovery in the relevant 'T' accounts.
Lecture example 5
Required
Show the accounting treatment for Fight & Co if, having made a specific allowance (see
Lecture example 2), during the next year Bugner repays his debt of $3,500 to Fight &
Co in cash?
Lecture example 6
Required
Following on from the information used in Lecture example 2, suppose that in the next
accounting period, the debt from Bugner is considered to be irrecoverable.
What double entry would be required to record this?

Lecture example 7
The following information is available for A Co:
Year ended 31 December 20X7: Trade receivables $20,000

Year ended 31 December 20X8: Trade receivables $30,000
A Co requires a general allowance of 5% of trade receivables in each year.
Required
Show the required adjustment to the allowance for receivables account in the year
ended 31 December 20X8.
Lecture example 8
At 30 September 20X7 G Co had an allowance for receivables of $24,000.
During the year ended 30 September 20X8 G Co recovered $2,000 from a customer
whose balance was written off in 20X7 and wrote off further debts totaling $18,000. The
closing allowance for receivables is required to be $21,000. No adjustments have been
made for this information.
Required
What amount should appear in the statement of profit or loss for the year ended 30
September 20X8 for the above items?
A $13,000
B $15,000
C $17,000
D $23,000
Chapter summary 1
1 Introduction
 A trade receivable is an asset of the business which should
only be shown in the financial statements if it is believed to be
recoverable.
Chapter summary 2
2 Irrecoverable debts
 Bad or irrecoverable debts must therefore be written off as
an expense in the statement of profit or loss.
Chapter summary 3
3 Allowance for receivables
 An allowance should be made against trade receivables
where there is concern as to whether or not a balance will be
recoverable. There are two types of allowance: specific and
general.
 Specific allowances relate to particular customer balances
whereas a general allowance is usually a percentage of
remaining debts.
Chapter summary 4
4 Effect in subsequent periods
 The key to being able to account for the effect in subsequent
periods is to know what accounting entries have previously
been made and then make any relevant adjustments.
 For example, if cash is received from a receivable that was
previously written off then the receivable has already been
removed from the accounts.
 Consequently the only adjustments needed are to record the
cash received and remove the irrecoverable debt expense
recorded last year which has proved to be unnecessary.
• IAS 37 Provisions, contingent
Chapter 13 liabilities and contingent assets
Provisions and
contingencies
• Understand the definition of 'provision', 'contingent liability' and 'contingent asset',
distinguish between them and classify items accordingly.
• Identify and illustrate the different methods of accounting for provisions, contingent
liabilities and contingent assets.
• Calculate provisions and changes in provisions and account for the movement in
provisions.
• Report provisions in the final accounts.
Overview
Accounting treatment Recognition criteria
Provisions
Provisions and
contingencies
Contingent liabilities Contingent assets

IAS 37 Provisions, contingent liabilities and contingent assets
Provision
• A liability of uncertain timing or amount
• The amount recognised as a provision should be the best estimate of the expenditure
required to settle that present obligation.
IAS 37 (cont'd)
Contingent liability
• A possible obligation that arises from past events, whose existence will be confirmed
by the occurrence or non-occurrence of future events not wholly in the entity's
control.
• A present obligation not recognised because:
— It is not probable that settlement of the obligation will be required.
— The amount cannot be measured.
IAS 37 (cont'd)
Contingent asset
• A possible asset that arises from past events and whose existence will be confirmed by
the occurrence of one or more uncertain future events not wholly within the entity's
control.
IAS 37 (cont'd)
Lecture example 1
Grass Co is reviewing its warranty obligations. Based on sales during 20X7 it
has established that if all lawnmowers sold required minor repairs this would
cost $1m whereas if major repairs were required this would cost $6m.
Grass Co expects that 75% of lawnmowers will have no faults, 20% will need
minor repairs and 5% major repairs.
Required
(a) What provision should be made in 20X7 and what accounting entry is
needed to record it?
(b) What entry should be made in 20X8 assuming the provision required then
is $0.75m?
(c) What entry should be made in 20X9 assuming the provision required then
is $0.3m?
Chapter summary 1
1 Introduction
 IAS 37 provides guidance on when a provision must and must
not be made.
Chapter summary 2
2 Provisions
 A provision should only be made in the financial statements
when an entity has a present obligation to incur expenditure.
It must also be more likely than not that the expenditure will
be incurred and a reliable estimate of the amount is known.
Chapter summary 3
3 Contingent liabilities
 A contingent liability should be disclosed where the criteria
for making a provision are not met, but where there is either
a possible obligation or a present obligation but it is only
possible that the expenditure will be incurred.
Chapter summary 4
4 Contingent assets
 Contingent assets should only be included in the financial
statements if it is certain to be received and should be
disclosed if probable.
• What are control accounts?
Chapter 14 • Discounts
• The operation of control
accounts
• The purpose of control accounts
Control accounts
• Understand the purpose of control accounts for accounts receivable and accounts
payable.
• Understand how control accounts relate to the double entry system.
• Prepare ledger control accounts from given information.
• Perform control account reconciliations for accounts receivable and accounts payable
and identify errors which would be highlighted by performing them.
• Identify and correct errors in control accounts and ledger accounts.
• Account for discounts allowed and discounts received.
• Account for contras between trade receivables and trade payables.
Overview
Reconciliations
Receivables ledger control account Receivables ledger

Payables ledger control account Payables ledger
Control accounts
Discounts Returns, credit notes,

Contra entries
allowed and received Refunds and over payments
Trade discounts Settlement discounts
Sales tax considerations

What are control accounts? 1
What are control accounts?
A control account is a total account.
• Its balance represents an asset or a liability which is the grand total of many individual
assets or liabilities.
• These individual assets/liabilities must be separately detailed in subsidiary accounting
records, but their total is conveniently available in the control account ready for
immediate use.
Most businesses operate control accounts for trade receivables and payables, but such
accounts may be useful in other areas too, eg sales tax, payroll taxes.
With regard to the double entry relating to receivables and payables, note the
following:
— The accounts of individuals are maintained for memorandum purposes only.
— Entering a sales invoice, say, in the account of an individual receivable is not part of
the double entry process.
Discounts 1
Two types of discount
• Trade discount – reduction in cost of goods eg regular customers, bulk discounts
Accounting treatment for trade discounts

• Discount received: deduct from purchases
• Discount allowed: deduct from sales
Discounts 2
• Cash/settlement discount – reduction in amount payable, eg for cash or prompt
payment
Accounting treatment for cash/settlement discount

• Received: include as other income
• Allowed: include as expenses
The operation of control accounts 1
The invoices in the sales day book are totalled periodically and the total amount is posted
as follows:
DEBIT Receivables control account

CREDIT Sales account
Similarly, the total of cash receipts from receivables is posted from the cash book to
the credit side of the receivables control account.
DEBIT Cash account

CREDIT Receivables control account
In the same way, the payables control account is credited with the total purchase
invoices logged in the purchase day book and debited with the total of cash payments to
suppliers.
DEBIT Purchases account

CREDIT Payables control account
DEBIT Payables control account

CREDIT Cash account
The purpose of control accounts 1
Reasons for maintaining control accounts
• Check on the accuracy of the personal accounts in the receivables ledger.
• The control accounts provide a convenient total which can be used immediately in
extracting a trial balance or preparing accounts.
• A reconciliation between the control account total and the receivables ledger will help
to detect errors, thus providing an important control.
• Proforma of receivables control account
• Proforma of payables control account
Reconciling control a/cs with memorandum ledgers
• Step 1 – correct the total of the balances from the memorandum ledger
• Step 2 – correct the control a/c balance
• Step 3 – the balances should now agree
NB: The corrected control a/c balance appears in the final accounts.
Possible reasons for credit balances on receivables ledger accounts, or for debit balances
on payables ledger accounts
• Overpayment of amount owed
• Return of goods
• Payment in advance
• Posting errors
Lecture example 1
A Co has the following information:
•10 January 20X6
•Sells $150 of goods to customer A
•Sells $200 of goods to customer B
•15 January 20X6
•A Co purchases $100 of goods from supplier Y
•A Co purchases $1,300 of goods from supplier Z
•21 January 20X6
•A Co receives full payment from customer B and this money is used to pay supplier Y.
Required
(1) Record the above transactions in the books of prime entry and the
memorandum ledgers.
(2) Post the totals from the BOPE to the nominal ledger.
(3) Balance off nominal ledger accounts.
(4) Reconcile the memorandum ledgers to the control accounts.
Lecture example 2
(a) On 1 January 20X7 a business made a sale on credit for $12,000. A trade discount of
$2,000 was available with a further 10% settlement discount if payment were made
within ten days.
Required
Record the initial sale.
(b) On 4.1.X7, the customer pays for the goods taking advantage of the settlement
discount. The discount will be 10% of sales value.
Required
Record the full settlement of the amount owed.
Required
(c) What would your answer be to part (b) if the settlement
discount were not taken?
Lecture example 3
Ryan Co purchases goods worth $5,000 from Austin Co. Ryan Co will receive a 5% settlement discount if
the goods are paid for within seven days. Ryan Co has every intention of taking advantage of the
settlement discount.
Required
In the books of Ryan:
(a) Show the initial recording of the purchase.
(b) Record the payment for the goods assuming Ryan
pays within seven days.
(c) Record the payment for the goods if payment is made
after seven days.
Lecture example 4
Brick buys goods with a list price of $50,000 from Cement. Brick receives a trade discount of 12% from
Cement and a further discount of 4% if payment is made within ten days. Sales tax is at 15%.
Required
What amount should Brick show in Cement's payables ledger to record this purchase?
A $48,576
B $50,336
C $50,600
D $57,500
NB: VAT is calculated after ALL discounts.

Lecture example 5
(a) Required
Post the following transactions to and balance off the receivables ledger control account.
(1) Opening balance $614,000
(2) Credit sales made during the month $302,600
(3) Receipts from customers $311,000
(4) Irrecoverable debts were written off $32,000
(5) Discounts allowed for prompt payment $3,400
(6) Contras against amounts due to suppliers in payables
ledger $8,650
(b) The receivables ledger list of balances totals to $563,900.
You have found the following errors:
(i) The total of the sales day book was undercast by $3,600.
(ii) A credit balance of $450 was included in the list of
balances as a debit.
(iii) A customer balance of $2,150 was left out when the
receivables ledger list of balances was totaled.
Required
Reconcile the receivables ledger control account to the receivables ledger list
of balances.
Chapter summary 1
1 Recap
 The balance of the receivables ledger control account and the
payables ledger control account in the nominal ledger show
the total owed by all credit customers and due to all credit
suppliers.
 The purpose of the memorandum ledgers is to show the
balance on each individual customer or supplier account.
Chapter summary 2
2 The flow of information
 Given that the nominal ledger and the memorandum ledgers
are updated from the same source documentation, at any
point in time the balance on the control accounts should
equal the total of all the balances in the memorandum
ledgers.
 Where the two balances are not the same an error must have
arisen and a reconciliation should be performed to identify
the errors (Section 5).
Chapter summary 3
3 Other entries
 If an entity has a customer is also a supplier the two parties
may choose to settle their accounts by making a contra entry.
The contra is always for the lower of the two balances.
 If a customer returns goods having paid for them or overpays
for goods then the entity will owe money back to that
customer and the customer will have a credit balance on their
account.
 If a customer is late in settling their account the entity may
decide to charge them interest on the overdue account. This
will increase the balance owed.
Chapter summary 4
4 Discounts
 Sometimes a business may offer discounts to attract custom.
There are two types of discounts: trade discounts and
settlement discounts.
 Sales and purchases are recorded after trade discounts but
before settlement discounts.
 Sales tax is calculated on the amount after all discounts,
regardless of whether the discount is taken or not.
Chapter summary 5
5 Control account reconciliations
 As illustrated in the chapter if the balance on the control
account does not agree to the total of all the balances on the
memorandum ledger then an error must have occurred and a
reconciliation will need to be carried out to identify the
differences.
• Bank statement and cash book
Chapter 15 • Bank reconciliation
Bank reconciliations
• Understand the purpose of bank reconciliations.
• Identify the main reasons for differences between the cash book and the bank
statement.
• Correct cash book errors and/or omissions.
• Prepare bank reconciliation statements and identify the bank balance to be reported in
the final accounts.
• Derive bank statement and cash book balances from given information.
Overview
Bank reconciliations
Cash book balance Bank statement balance
Differences
Timing differences Errors by the business Errors by the bank

Bank statement and cash book 1
Bank reconciliation
• A comparison of a bank statement with the cash book.
• The bank reconciliation is an important financial control.
• The bank reconciliation will invariably show a difference.
Bank statement and cash book 2
Differences on bank reconciliation
• Errors: more likely in the cash book
• Omissions: items on the bank statement not in the cash book (eg bank charges)
• Timing differences: eg cheques issued and entered in the cash book but not yet
presented at the bank
Bank reconciliation 1
Performing a bank reconciliation
Step1: Correct the cash book
CASH ACCOUNT
Balance b/f X Dishonoured cheque X
Undercast error Bank charges X
in balance b/f X Standing orders X
Direct debits X
_ Balance c/f X
X X
Corrected balance b/f X
• The corrected cash book balance is the cash balance that is shown in the SOFP.
Bank reconciliation 2
Step 2: Reconcile to the bank statement
Proforma bank reconciliation
$
Balance per bank statement X
Less: outstanding cheques (X)
Plus: outstanding lodgements X
Plus/less: bank errors X/(X)
Balance per corrected cash book X
Tackling the exam
Exam focus point:
•In the exam, you may be given a list of adjustments and asked to
select which ones will be adjusted in the cash book and/or the
bank reconciliation.
•Alternatively you may be asked to calculate the bank balance to
be reported in the SOFP (the adjusted cash book figure).
Lecture example 1
The cash account of Graham showed a debit balance of $204 on 31 March 20X8. A
comparison with the bank statements revealed the following:
$
(1) Cheques drawn but not presented 3,168
(2) Amounts paid into the bank but not credited 723
(3) Entries in the bank statements not recorded
in the cash account
(i) Standing order payments 35
(ii) Interest on bank deposit account 18
(iii) Bank charges 14
(4) Balance on the bank statement at 31 March 20X8 was $2,618
Required
Make any necessary adjustments to the cash book balance and complete the
bank reconciliation statement as at 31 March 20X8.
Lecture example 2
Whilst preparing a bank reconciliation statement at 31 December. The following items
caused a difference between the bank statement balance and the cash book balance.
(1) Bank interest charged to the account in error
(2) Direct debit for $500 for insurance
(3) Bank charges of $70
(4) Cheque paid to a supplier on 29 December
(5) Receipt from a trade receivable by electronic transfer
Required
Which of these items will result in an adjustment to the balance per the bank
statement?
A 2, 3, and 5
B 1 and 4
C 1, 4, and 5
D 1, 3 and 5
Chapter summary 1
1 Introduction
 A business maintains a cash book to tell it how much cash it
has at a particular point in time. It should reconcile this
balance to the bank statement in order to ensure the cash
book information is accurate.
Chapter summary 2
2 Bank statement and cash book
 Differences between the cash book balance and the bank
statement balance will arise for three reasons: timing
differences, errors by the business and errors by the bank.
Chapter summary 3
3 Preparing a bank reconciliation
 The bank reconciliation is produced by checking all of the
items on the bank statement to the cash book to ensure that
they have all been recorded.
 Any items not in the cash book will then need to be recorded
and the cash book updated.
 The balance per the bank statement must then be adjusted
for any timing differences (unrecorded lodgements and
outstanding cheques) or errors by the bank.
• Types of error in accounting
Chapter 16 • The correction of errors
Correction of errors
• Identify the types of error which may occur in bookkeeping systems.
• Identify errors which would be highlighted by the extraction of a trial balance.
• Prepare journal entries to correct errors.
• Calculate and understand the impact of errors on the statement of profit or loss,
statement of profit or loss and other comprehensive income and statement of financial
position.
• Understand the purpose of a suspense account.
• Identify errors leading to the creation of a suspense account.
• Record entries in a suspense account and make journal entries to clear it.
Overview
Types of error
Suspense account Adjustments to profit

Types of error in accounting 1
The main types of error are as follows
• Errors of transposition, eg writing $381 as $318 (the difference is divisible by 9)
• Errors of omission, eg receive supplier's invoice for $500 and do not record it in the
books at all
Types of error in accounting 2
The main types of error are as follows
• Errors of principle, eg treating capital expenditure as revenue expenditure
• Errors of commission, eg putting telephone expenses in the electricity expense
account
• Compensating errors, eg both sales day book and purchases day book coincidentally
undercast by $500
The correction of errors 1
• Errors can be corrected using the journal, but only those errors which required both a
debit and an (equal) credit adjustment.
• Example
Accountant omits to record invoice from supplier for $2,000. This would be corrected
by the following journal entry.
DEBIT Purchases $2,000

CREDITPayables $2,000
A transaction previously omitted.
• Another example
Accountant posts car insurance of $800 to motor vehicles account. Correct as follows.
DEBIT Motor expenses $800

CREDIT Motor vehicles $800
Correction of error of principle.
A suspense account is a temporary account that is used in the following
circumstances.
• The bookkeeper knows in which account to make the debit entry for a transaction but
does not know where to make the corresponding credit entry (or vice versa).
— The credit is temporarily posted to the suspense account until the correct credit
entry is known.
Suspense account (cont'd)
• A difference occurs in the trial balance caused by the incomplete recording of the
double entry in respect of one or more transactions.
— The difference is recorded in the suspense account and included in the trial balance,
so restoring equality.
Any balance on a suspense account must be eliminated. It is never included in the final
accounts.
Lecture example 1
Dan, the bookkeeper of Tiffany's, has made his usual mess of things and produced the
following attempt at a trial balance for the year ended 30 April 20X7.
$ $
Property, plant and equipment
At cost 60,000
Provision for depreciation 31,000
Capital at 1 May 20X6 53,000
Profit for the year 12,300
Inventory, at cost 14,000
Receivables ledger control account 9,600
Payables ledger control account 6,500
Balance at bank 1,640
85,240 102,800
As chief accountant you discover the following:
(1) A rent payment of $350 in March 20X7 had been debited
in the receivables ledger control account.
(2) Discounts allowed of $500 during the year ended 30 April
20X7 had not been recorded in the books.
(3) No entry had been made for the refund of $2,620 made
by cheque to V Woolf in March 20X7, in respect of
defective goods returned to Tiffany. V Woolf, who had
already paid for the goods, returned them on 28 February
20X7.
(4) The total column of the cash receipts book had been overcast by $1,900 in March
20X7.
(5) The purchase of stationery for $1,460 cash in June 20X6
has not been posted to the appropriate expense account.
(6) Capital of $35,000 was recorded incorrectly as $53,000.
Required
Prepare
(a) Journal entries to correct the above errors
(b) A suspense account showing how it is cleared
Lecture example 2
Required
Prepare a statement of adjustments to profit for Lecture example 1.
Lecture example 3
Z Co's statement of profit or loss showed a profit of $112,400 for the year ended 30
September 20X7. The following errors were later discovered:
(1) Sales returns of $2,700 had been recorded as a new sale.
(2) A machine which had been held for two years and had originally cost $15,000
was depreciated this year using a 331/3% reducing balance basis. Z Co's policy is to
depreciate machines over four years.
Required
What would be the net profit after adjusting for these errors?
A $103,250
B $105,750
C $105,950
D $108,450
Chapter summary 1
1 Introduction
 If the trial balance doesn't balance an error has been made
and must be corrected.
Chapter summary 2
2 Types of error
 There are four types of errors: errors of omission,
commission, principle and compensating errors which will still
allow the trial balance to balance.
 If an error is made however where debits ≠ credits then the
trial balance will not balance.
Chapter summary 3
3 Suspense accounts
 Where the trial balance does not balance a suspense account
will be inserted and the errors, once identified, will be
corrected via a journal entry.
 A suspense account should never appear in the final financial
statements.
Chapter summary 4
4 Adjustments to profit
 Where the process of correcting errors requires changes to
income and expense accounts the business' profit will be
affected. In this case a statement of adjustments to profit can
be prepared to determine the revised profit figure.

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• The purpose of financial reporting

Chapter 1 • Types of business entity

accounting • The main financial statements

IFRS AC IASB IFRS IC

IASB Conceptual Framework

Qualitative characteristics Elements of financial

Business entity concept

Sources, records and

Books of prime entry Memorandum ledgers

Sales day Purchase day Petty cash

— Always headed 'as at', for the date of the statement of

— Capital: what the business owes the proprietor/owner. In

The statement of profit or loss is a summary of the business's performance over a

Sales day book

Purchases day book

• Cash payments are recorded in a similar way.

Most businesses keep a small amount of cash on the premises for

— Pre-set limit, say $50

Ledger accounts Double entry

Balancing off Debit Credit

Transaction Debit Credit

Transaction Debit Credit

• Other books of prime entry are analysed in a similar way.

Trade account payable

Posted to nominal ledger

From trial balance

Capital 5,000 Rent 500

Sales 2,100 Electricity 200

Rent Gross profit b/d

Net profit b/d

STATEMENT OF PROFIT OR LOSS

Rent Gross profit b/d

Capital Net profit b/d

Receivables Sales day Purchase Payables

Preliminary trial balance

Clear profit and drawings

Prepare statement of financial position

Irrecoverable sales tax Discounts

Input sales tax

Input tax greater than output?

The purchases will cost ($1,000 × 1.15) = $1,150

The sales tax payable to tax authorities will be:

Payable on outputs (sales) (15% × $1,500) 225.00

Valuation Effects on profit

Cost Net realisable value

Methods of estimating cost

Entries during the year

DEBIT Purchases $ amount bought

• The inventory account is not touched at all.

DEBIT Statement of profit or loss $ total purchases

DEBIT Statement of profit or loss $ opening inventory

DEBIT Inventory $ closing inventory

Net realisable value is:

Date Units purchased Cost per unit

Date Units sold Cost per unit

Cost of sales (FIFO)

21.1.X2 Sales (400)

28.1.X2 Sales (80)

Average cost for the period = $12,530 ÷ 1,100 = $11.39

Closing inventory value = (1,100 – 760) × $11.39 = $3,873

Revaluations Depreciation Disposals

Straight line Reducing balance